Methods for Evaluating Goodwill

Presented by: Rajkaran Chhina

Goodwill
An intangible asset which provides a competitive
advantage, such as a strong brand, reputation, or
high employee morale. In a acquisition, goodwill
appears on the balance sheet of the acquirer in
the amount by which the purchase price exceeds
the net tangible assets of the acquired company.
 Goodwill
Click icon to add
picture Accounting for goodwill does spark some
controversy in the accounting field.  Because it is
an intangible asset, goodwill is very hard to
value, identify, and measure. 
 Methods of Valuation of Goodwill
Click icon to add
picture 1. Average Profit Method

2. Weighted Average Profit Method

3. Super Profit Method

4. Capitalization of Average Profit Method

5. Capitalization of Super Profit Method

Average Profit Method
Under this method goodwill is calculated on the basis of
the average profit of previous years. The average profit
is multiplied by the number of year's purchase.

Formula

Goodwill = Average Profit x Number of Years Purchase

Example
 Calculate goodwill at twice the average profits of last four years' profits. The
profits of the last four years were:

1. Rs. 27,000

2. Rs. 39,000

3. Rs. 16,000 (Loss)

4. Rs. 40,000
 Solution: Total Profit for last four years = Rs. 27,000+ Rs. 39,000-Rs.
16,000+Rs. 40,000 = Rs. 80,000
 Average Profit = Rs. 80,000/4 = Rs. 20,000.

 Goodwill = Rs. 20,000 x 2 = Rs. 40,000.

Weighted Average Profit Method
This method is a modified version of the average profit
method. Under this method the respective number of
weights i.e. 1,2,3,4 multiplies profit of every year, in
order to find out value product and the total of products is
then divided by the total of weights in order to ascertain
the weighted average profits.

Formula
Goodwill = Weighted Average Profits x No. of years
Purchase
Weighted Average Profit = Total of Products of Profits/
Total of Weights
Example
 Calculate goodwill at twice the weighted average profits of last four
years' profits. The profits of the last four years were:

 2001. Rs. 37,000

 2002. Rs. 29,000

 2003. Rs. 26,000

 2004. Rs. 40,000

Solution
year Profit Rs. weight Product Rs.
2001 37,000 1 37,000
2002 29,000 2 58,000
2003 26,000 3 78,000
2004 40,000 4 1,60,000
total 10 3,33,000

 Weighted Average Profit = Rs. 3,33,000/10 = Rs. 33,300

 Goodwill = Rs. 33,300 x 2 = Rs. 66,600

Super Profit Method
When the actual profit is more than the expected profit
or normal profit of a firm, it is called 'Super Profit.'
Under this method goodwill is to be calculate of on the
following manner:

Formula

Goodwill = Super Profit x Number of Years Purchase

Example
 The books of a business showed that the capital employed on January 1,
2001 was Rs. 4,50,000 and the profits for the last five years were as follows:

 2001-Rs. 40,000

 2002 -Rs. 50,000

 2003 - Rs. 60,000

 2004 -Rs. 70,000

 2005 -Rs. 80,000

 You are required to find out the value of goodwill, based on three years'
purchase of the super profit of the business given that the normal rate of
return is 10%.
Solution
 Total Profit of last five years = Rs. 40,000 + Rs. 50,000 + Rs. 60,000 + Rs.
70,000 + Rs. 80,000 = Rs. 3,00,000

 Average Profit = Rs. 3,00,000/5 =Rs. 60,000

 Normal Profit = Rs. 4,50,000 x 10/100 = Rs. 45,000

 Super Profit = Actual/Average Profit - Normal Profit

 Super Profit = Rs. 60,000 - Rs. 45,000 = Rs. 15,000

 Goodwill = Rs. 15,000 x 3 = Rs. 45,000.

Capitalization of Average Profit
Method
Under this method goodwill is difference between the
total Capitalized value of the firm and the net assets of
the firm.
 Formula

Goodwill = Capitalized Value the firm - Net Assets

 Capitalized Value of the firm = Average Profit x 100/ Normal Rate of Return

 Net Assets = Total Assets - External Liabilities

Example
A firm earns Rs. 65,000 as its average profits. The usual
rate of earning is 10%. The total assets of the firm
amounted to Rs. 6,80,000 and liabilities are Rs.
1,80,000. Calculate the value of goodwill.

 Solution : Total Capitalized value of the firm = Rs. 65,000 x 100/10 = Rs.
6,50,000

 Net Assets = Rs. 6,80,000 - Rs. 1,80,000 = Rs. 5,00,000

 Goodwill = Total Capitalized value of the firm - Net Assets

 Goodwill = Rs. 6,50,000 - Rs. 5,00,000 = Rs. 1,50,000.

Capitalization of Super Profit
Method
 Calculate Capitalized value of the firm

 Calculate required profit on capital employed by using the

following formula:
 Normal Profit = Capital Employed x Required Rate of
Return/100
 Calculate normal profit

 Calculate super profit

 Goodwill = Super Profit x 100/Normal Rate of Return

Example
 Verma Brothers earn a profit of Rs. 90,000 with a capital of Rs.
4,00,000. The normal rate of return in the business is 15%. Use
Capitalization of super profit method to value the goodwill.

 Solution

 Normal Profit = Rs. 4,00,000 x 15/100 = Rs. 60,000

 Super Profit = Rs. 90,000 - Rs. 60,000 = Rs. 30,000

 Goodwill = Super Profit x 100/Normal Rate of Return

 = Rs. 30,000 x 100/15 = Rs. 2,00,000

Click icon to add picture

Thank You.