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CHAPTER 3

GOODWILL METHODS OF VALUATION OF GOODWILL

SIMPLE AVERAGE PROFIT METHOD Under this method, the goodwill is

valued at the agreed numbers of years
of purchase of the average profits of the
past years.

STEPS OF CALCULATE GOODWILL

1. Calculate Adjusted Profits/Normal

Business Profit:

Profit or Loss of the past year

ADD : Abnormal losses

Loss on Sale of Fixed Assets

Overvaluation of opening stock

Undervaluation of closing stock

Non-recurring Expenses

Capital Expenditure charged as

Revenue Expenditure

LESS : Abnormal gains

Profit on sale of Fixed Assets

Overvaluation of closing stock

Undervaluation of opening stock

Non-recurring incomes

Partner's remuneration, if it is not de-

ducted

Income from Non-trade Investments

Any future Expense

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ADJUSTED/FUTURE MAINTAINABLE PROFIT

TOTAL OF ADJUSTED PROFIT

2. AVERAGE PROFIT =
No. of YEARS
3. GOODWILL = AVERAGE PROFIT X NO. OF YEAR'S
OF
   PURCHASE
SUPER PROF- Under this method, the goodwill is valued at the agreed
IT METHOD number of year's of purchase of the super profits of the
firm

STEPS TO CALCULATE GOODWILL

Opening capital employed + clo sin g

capital employed
1) Average Capital =
2
2) Calculate average maintainable profit (as above)

3) Normal of profit = Average Capital Employed

Normal rate of return

×
100
4) Super Profit = Average maintainable profits - Normal
Profits

5) GOODWILL = SUPER PROFIT × NO. OF YEAR'S OF

    PURCHASE

Calculation of capital employed

• Assets side Approach

• Capital Employed = All Assets (except goodwill,

non-trade investments and ficitious assets) - Outside
liabilities

• Liabilities side Approach

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Capital Employed = Capital + Reserves - Goodwill (if ex-

ists in books)-

Ficitious Asset - Non- trade investments

CAPITALI- Under this method, the value of goodwill is calculated

SATION OF by deducting the actual capital employed from the
AVERAGE capitalization value of the average profits on the basis of
PROFITS the normal rate of return

STEPS TO CALCULATE GOODWILL

1. Calculate Average Normal Profit

Average profit ×100

2. Capitalised value of the Business =
Normal rate of return
3. Capital Emloyed = All Assets (except goodwill, non-trade
investment and ficitious assets) - Outside liabilities

4. GOODWILL = Capitalised value of the Business - Net

Assets

Under this method, Goodwill is calculated by capitalizing

the super profits

CAPITALISA- STEPS TO CALCULATE GOODWILL

TION OF SU-
PER PROFITS 1. Capital Employed = All Assets (except goodwill, non-trade
   investments and ficitious assets) - Outside Liabilities

Normal rate of return

2. Normal Profit = Capital Employed ×
100
3. Сapital average maintainable profit (as above)

4. Super Profit = Average maintainable profits - Normal

Profits

Super Profit
5. GOODWILL = × 100
Normal rate of return

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Simple Average Profit Method

Illustration 1.

Shweta purchased a business on 1st April 2019. It was agreed to value

goodwill at three years purchase of average normal profits of last 4 years.
The Profits are as follows.

Year Ended Profit ( `)

31st March 2016 (`) 90,000

31st March 2017 (`)1,60,000

31st March 2018 (`)1,80,000

31st March 20169 (`)2 20,000

Following facts are noticed–

1. During the year. ended 31/march/2016, an asset was sold at a profit of

` 10,000

2. During the year ended 31/March/2017, firm had incurred a abnormal loss
of ` 20,000

3. Repairs to car amounting to ` 50,000 was wrongly debited to vehicles on

1st May 2017. Depreciation charged on vehicles @ 10 % on straight line
Method

4. Firm had abnormal gain of ` 10,000 during the year. ended 31 March
2019

5. During the year ended 31 March 2019, a machine got destroyed in

accident & ` 30,000 was written off as loss in Profit & Loss Account.

Calculate the value of goodwill

Solution

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CALCULATION OF NORMAL PROFIT

Yr Ended PROFIT ADJUSTMENT (`) NORMAL PROFIT

(`)

31/Mar/2016 90,000 (10000) Profit on 80,000

sale of Asset

31/Mar/2017 1,60,000 (20,000) Abnormal 1, 80,000

loss

31/Mar/2018 1,80,000 (45,000) In note (i) 1, 35,000

& (ii)

31/Mar/2019 2,20,000 (5000) Deprecia- 245,000

tion

(10,000) Abnormal
loss
30,000 Loss on
`
sale of asset
6, 40,000

Total Normal Profit 640 000

Average Profit = =` = ` 1,60,000
No. of years 4
Goodwill = Average Profit x No. of years Purchase

= 1,60,000 × 3 = ` 4,80,000

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W. NO
i). Repaie Exp. tha should have been debited to P & L A/c as expense but
accounted as capital expenditure ` ( 50,000 )
Hence, Loss rises by ` 50,000
(ii) Depreciation wrongly debited to P & L A/c for the year ended 31/Mar/2018
` ( 5,000 )
Adjustment for year ended 31/march/2018 ` (45,000 )
(iii) Adjutstment of depreciation for year ended 31/March/2019 (10 %
50,000) = ` (5,000 )
Weightened Averarge Profit Mehtod
Illustration 2. Sunil & Anil are partners sharing profit in the ratio 3:2. They
admit Deepak into partnership. It was agreed to value goodwill at three
years purchase on the basis of average profit of the past five years.
The Profits for these 5 years were-
Year Ended Profit (`)
31st March 2015 1,80,000
31st March 2016 1,60,000
31st March 2017 2, 50,000
31st March 2018 3,00,000
31st March 2019 3,50,000
Following additional Information is given
(i) An abnormal gain of ` 20,000 was earned in the year eded 31st March
2016
(ii) Expenses of ` 50,000 incurred to overhaul a machine on 1st, April
2017 was debited to P&L A/ instead of being debited to Machinery Account.
Depreciation is charged on machinery @ 20 % on written Down value
Method.
(iii) The closing stock for the year ended 31st March, 2018 was under valued
by ` 20,000
(iv) To Cover management cost an annual charge of ` 9600 should be made
for the purpose of goodwill valuation.

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Calculate the value of goodwill

Solution

CALCULATION OF ADJUSTED PROFIT

Particulars 31st March 31st March 31st March 31st March 31st March
2015 ( ` ) 2016 (( ` ) 2017 ( `) 2018 ( ` ) 2019 ( ` )

Given
Profits Less 1,80,000 1,60,000 2,50,000 3,00,000 3,50,000
Abnormal
Gain (20,000)

1,40,000

Add Capital ----------- ----------- ----------- 50,000 3,50,000

Expenditure
on Machin-
ery

Less Depre- ----------- ----------- ----------- (10,000) (8,000)

ciation on
Machinery
@ 20 %
W.D.V

1,80,000 1,40,000 2,50,000 3,40,000 3,42,000

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Particulars 31 March 31 March 31 March 31 March 31 March

2015 (`) 2016 (`) 2017 (`) 2018 (`) 2019 (`)

Add Underavalu- 1,80,000 1,40,000 2,50,000 3,40,000 3.42,000

ation of closing
stock - - - 20, 000 -

Less undervalu- 1,80,000 1,40,000 2,50,000 3,60,000 3.42,000

ation of opening
stock (20,000)
1,80,000 1,40,000 2,50,000 3, 60,000
3.22,000

Calculation of Goodwill
Average Profit = Total Normal Profit
No. of years

= 180, 000 + 1,40000 + 250,000 + 3,60,000+ 3,22,000

5
= 12, 52,000 `. 2,50, 400/-
5
Value of Goodwill = Average
Profit x No. of years Purchase
= ` 250.400 X 3

= ` 7,51,200

Super Profit Method

Illustration (3) The average net profits expected of a firm is future are ` 68000 per
years and capital invested in the business by the firm is ` 3,50,000. The rate of interest
expected from capital invested in this class of business is 12%. The renumeration of
the partners is estimated to be ` 8000 for the year. Calculate the value of goodwill on
the basis of two years purchase of super profits.

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Solution

Average Profit Partner's Remuneration

= Average net -
Profit
(Adjusted)

` 68000 - ` 8000

= ` 60,000
Normal Profit Normal Rate of Return
= Capital Em- x
ployed
100
` 3,50,000 * ` 12
100
= ` 42,000

Super Profit = Average Profit - Normal Profit

` 60,000- ` 42000 = 18000

Goodwill = Super Profit x No. of years purchase

= ` 18000 X 2 = ` 36,000

Illustration 4. Average profit earned by a firm is ` 75,000 which includes undervaluation

of stock of ` 5000 on average basis. The capital invested in the business is ` 8,00,000
& the normal rate of return is 8 %. Calculate goodwill of the firm on the basis of 5 times
the Super Profit.

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Solution

Adj. Average Profit

= Average Profit + Undervaluation of stock

` 75000 + ` 5000

= ` 80,000
Normal Profit
= Capital Em- x Normal Rate of Return
ployed
100

` 800,000 × 8
100

= 64,000

Super Profit = Adjusted Average Profit - Normal Profit

= ` 80,000 × 2 = ` 80,000 – ` 64,000

= ` 16000

Goodwill = ` 16000 × 5 = ` 80,000

Capitalisation of Average Profit Method

Illustration 5.

Bharat and Bhusan are partners in a retail business. Balances in Capital & Current
Accounts as on 31st March 2019 were

Capital Account Current Account

Bharat ` 400 000 ` 1000 000

Bhusan ` 480 000 ` 20, 000 (Dr)

The firm earned an average profit of ` 97000. If the normal rate of return is 8%, find
the value of goodwill

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Solution

Capital Employed ` 400,000 + ` 4,80, 000 + ` 10,00,00 - `

= 20,000

= ` 9,60,000

Capitalised
= Average Profit × 100
value of the
Normal Rate of Return
Business

` 97,000 × 100 = ` 12, 12, 500

8

Goodwill = ` 12, 12, 500 - ` 960000

` 2, 52, 500

Capitalisation of Super Profit Method

Illustration 6. Average Profit of the firm is ` 1, 50, 000. Total tangible assets in the
firm are ` 12,00,000 & outside liabilities are ` 7,00,000. In the same type of business,
the normal rate of return is 20 %. Calculate the value of goodwill of the firm by
Capitalisation of Super Profit method if the goodwill is valued at 2 years. Purchase of
Super Profit.
Solution

Normal Profit = Capita; Employed × Normal Rate of Return

100

= ` 5,00,000 × 20
100
= ` 1,00,000
Capital Employed = Total tangible Assets - Outside liabilities

= ` 12, 00, 000 - ` 7,00,000

= ` 5,00,000

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Average Profit = ` 1, 50,000 (given)

Super Profit = Average Profit - Normal Profit

= = ` 1, 50, 000 - ` 1,00, 000

= = ` 50,000

Super Profit    Super Profit

=          × 100
Normal rate of return

= = ` 50, 000 x 100

20

= = ` 2, 50, 000

Practice Exercise

Ques.1. On Ist April 2018, a firm had assets of ` 3,00,000 including Cash of
` 5,000. The Partner's Capital A/c showed a balance of ` 2, 00, 000 & the Reserve
Constituted the rest. If the normal rate of return of is 10 % & the goodwill of the firm
is valued at ` 200,000 at four years purchase of Super Profit. Find the average Profit
of the firm.

[Hint:- Average Profit = Super Profit + Normal Profit]

Ques.2. Balance Sheet of M/s Laxmi Stores as at 31/3/2019 was as

follows.

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Liabilities ` Assets `
Capital A/cs Land & Building 400,000

A 1,50,000 Computers 70,000

B 1,50,000 Furniture 30,000

C 1,50,000 4,50,000 Investments 1,00,000

Reseves 2,50,000 Stock 2,00,000

Sundry Debitors 1,50,000

Sundry Creditors 3,00,000 Bill Receivable 50,000

Outstanding Ex- 10,000 Cash in Hand 50,000

penses
90,000 Advertisement 50,000
bank Overdraft Suspense
11,00,000 11,00,000

Average Profit was ` 125000. Calculate goodwill at 3 year's puchase of Super Profit
given NRR = 15 % if ---

(a) Investment is treated as Trade Investment

(b) Investment is taken as Non- Trade Investment

[Hint;- Non Trade Investment are deducted to calculate Capital Employed]

Ques.3. Calculate value of goodwill of the firm -

(a) At 3 years purchase of Average Profit

(b) At 3 year's purchase of Super Profit

(c) On the basis of Capitalisation of Super Profit

(d) On the basis of Capitalisation of Average Profit

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Following Information is given -

(i) Average capital Employed is ` 6,00,000

(ii) Net Profit/(Loss) of the firm for the last 3 years ender are

31st March 2019

` 2,00,000
31st March 2018
` 1, 80, 000
31st March 2017
` 1,60,000

iii) Normal Rate of return in similar business is 10 %

(iv) Remuneration of ` 1,00,000 to partners is to be taken as charge against profit

(v) Assets of the firm (excluding goodwill) fictitious assets and Non-trade investments)
is ` 7,00,000 whereas Partner's Capital is ` 6,00,000 & outside liabilities ` 1,00,000.

Ques.4. The Capital Employed in a firm is ` 10,00,000 & the market rate of
interest is 15 %. Annual Salary of the partners is ` 80,000. the profit of the last 3 years
were ` 3,00,000. ` 4,00,000 & ` 5,00,000 respectively. Calculate value of goodwill
on the basis of 2 years purchase of average super profit of last 3 years.

Ques.5. Average profit earned be a firm is ` 2,50,00 which includes overvalu-

ation of stock of ` 10,000 on an average basis. Capital invested in the business is `
14,00,000 & the normal rate of return is 15 %. Calculate goodwill of the firm on the
basis of 4 times the Super Profit.

Ques.6. On April 1, 2018, a firm has assets of ` 1,00,000 excluding stock of

` 20,000 . The current liabilities were ` 10,000 and the balance constituted partner's
capital Accounts. If the normal rate of return is 8 %, the Goodwill of the firm is valued
at ` 60.000 at four years purchase of super profit, find the actual profits of the firm.

Sol. Total Assets = ` 1,20,000

Capital Employed = Total Assets - Current Liabilities

= 1, 20,000- 10,000

= ` 1,10,000

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Normal Profits = 8 % of 1, 10,000

= ` 8.800

Goodwill = Super Profits X No. of Years Purchase

Super Profits = Actual Average Profits - Normal Profits

Given Goodwill = ` 60, 000

60,000 = 4 (Average Actual Profits - Normal Profits)

15000 = Average Actual Profits - 8,000

Average Actual Profits = 15, 000 + 8,800 = ` 23, 800

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Source: EDUDEL