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VALUATION OF GOODWILL

Gayatri D.
25 May 0 0

 This is one of the important chapter in graduation level as well as in professional exams.

The brief notes on methods and calculation of Goodwill in easy steps is presented below:

Methods of Valuation of Goodwill

  1. Average Profits Method
  2. Super Profits Method
  3. Annuity Method
  4. Capitalisation Method
    1. By Average Profits Method
    2. By Super Profits Method

 

 Let us discuss each method in detail.

  1. AVERAGE PROFITS METHOD

STEPS for calculation

  1. Adjusted average annual profits (See note 1)
  2. Number of years of purchase (given in question)
  3. Value of Goodwill= Adjusted average annual profits multiplied by number of years of purchase

Note :

  • If number of years of purchase for valuation of goodwill not given in question, then the number of years for which data of profit or loss are given should be taken.

 

  1. Calculation of Adjusted average annual profits:

 

      Steps for calculating it are as follows:

  • Calculation of Adjusted profits OR Adjusted Future profits OR Future Maintainable Profits

 

Particulars

Rs.

Profits   (given in Question)

---

Add: All expenses and losses not likely to occur or incur in future (e.g. extraordinary salary of a person, loss from fire or theft, abnormal losses, capital expenses etc.)

---

Add: All profits likely to come in the future

(e.g. profit due to new line of business)

---

Less: All expenses and losses likely to occur in future (e.g. salaries on new appointments etc.)

---

Less: Profits not likely to occur

---

ADJUSTED PROFIT /FUTURE PROFIT

---

  •  Calculation of Adjusted average profits

There are 2 methods:

Simple average method

(If in the question there is fluctuation in the profits for given periods with no specific trend then use this method). The formula is

 Total adjusted profits of all the given years divided by number of years

 

Weighted average method

(Increasing or Decreasing trend in the profits for periods given in the question then use this method). The format for calculating it is as follows

 

Profits

weights

Product

(profits for all years

(greater weightage for recent years and less weightage for earlier or past years)

(profits multiplied by weights)

  

  1. SUPER PROFITS METHOD

STEPS for calcuation

  1. Adjusted average annual profits (See Note below)
  2. Average Capital Employed (See Note below)
  3. Normal Rate of Return (given in question)
  4. Normal Profits = Average Capital Employed multiplied by Normal Rate of Return
  5. Super Profits = Adjusted average annual profits less Normal Profits
  6. Value of Goodwill = Super Profits multiplied by number of years of purchase

Note

  • Calculation of Adjusted average annual profits (as discussed earlier)
  • Calculation of Average Capital Employed

            There are two ways to ascertain Average Capital Employed.Asset Based Approach

Particulars

rupees

Assets (other than non-trading assets , intangible assets and fictitious assets) at market value

---

Less: Liabilities to outsiders at revised values

---

CAPITAL EMPLOYEDAT THE END OF THE YEAR

---

Less: Half of the profit earned during the year

---

AVERAGE CAPITAL EMPLOYED FOR THE YEAR

---

 

 

 Liabilities Based Approach

Particulars

rupees

rupees

Equity Share Capital

 

---

Preference Share Capital

 

---

Reserves and Surplus

 

---

Profit on Revaluation of Assets and Liabilities

 

---

 

 

---

Less: Goodwill at book value

---

 

Accumulated Losses and expenses not yet written off

---

 

Loss on Revaluation

---

---

CAPITAL EMPLOYEDAT THE END OF THE YEAR

 

---

Less: Half of the profit earned during the year

 

---

AVERAGE CAPITAL EMPLOYED FOR THE YEAR

 

---

 

 

 

  1. ANNUITY METHOD 

STEPS for calculation

  1. Super Profits (Refer Super Profits method )
  2. Annuity Value (given in question)
  3. Value of Goodwill = Super profits multiplied by Annuity Value

 

  1. CAPITALISATION METHOD

By Average Profits Method

STEPS for calculation

  1. Adjusted average annual profits (See Note below)
  2. Normal Rate of Return (given in question)
  3. Total Value of Business = (Adjusted average annual profits divided by Normal Rate of Return) multiplied by 100
  4. Value of Goodwill = Total Value of Business Less Capital Employed

 Note: Capital Employed = Assets minus Liabilities

 

By Super Profits Method

 STEPS for calculation

  1. Super Profits (Refer Super Profits method )
  2. Normal Rate of Return (given in question)
  3. Value of Goodwill = (Super Profits divided by NRR) multipled by 100

 

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