goodwill: Nature and Valuation LEARNING OBJECTIVES mestudy of this Chapter would enable students to understand: Meaning of Goodwill Characteristics or Features and Nature of Goodwill Need for Valuing Goodwill Factors Affecting the Value of Goodwill n of Goodwill Methods of Valuation of Goody {@) Average Profit Method —Simple Average Profit Method Weighted Average Capitalisat —Capitalisation of —Capitalisation o Gi Difference between yhich the excess of normal aid for a business of all tangible net Dicksee will m at element ai ther advantages d by a business which enables it to earn greater the returns normally to be expected on capital represented by the net tangible assets employed —Spicer and Pegler CHARACTERISTICS OR FEATURES OF GOODWILL The characteristics or features of goodwill are: 1. Itis an intangible asset, ic., it does not have physical existence, and has a value, a fictitious asset. 2. It does not have an existence separate from that of an enterprise. Thus, Tealisable value when business or a part of business is sold ie,, it is not normally it hasSE XI! 3.2 Double Entry Book Keeping — CBSE pov’ % 006 fe fit frequently to the place ¢ ra 3. It helps in earning stomers more freq Of busin, Lo te @ ect eieeactive§ ‘ a as locational advantages fovea ext “eye ‘ ; rt nav! k the val ads f profi of ¢ : c val - Act —— ASSETS 6 TANGIBLE AND INTANGIBLE ASS ts they canbe seen cig al A Fangibe arses oe the ove 7, Qu ste lon tug plot ond machine not have physical existence, ie, they copa) el Intangible Assets: ke ; f ible assets. fata endl touched Goode potent, b i Accountants of India has dened ina . Mi AS-26, Intangible Assets ‘sued by the Laiset x foe ue sical substance, held for use in the pro onder cet on ier ® 9. Ri 0. Ni Degree pee odwill is 1 i, for ; x ce 2.0 peek eae tee ke Good LP 2. Wh . \ , 2s When a partner re LP 4. When partnership firm is sold a nce « 5. When two or more firms amalgamate ce 6 When a partnership firm is converted into a company ar u Methods ar ty Clea cc : 2 are t Goodwill is affected by the factors which inc ase the earning capacity of the firm. These pe q 1. Efficient Management: {f the management is experienced, capable and comP@! the firm will eam higher profits as compared to other firms, all 2. Favourable Location: Ifthe business is located at a favourable place, resulting in in ‘ customer walk-in and, therefore, increased sale and increased profit.‘ ‘ioe 00 Biot March, 2008 tat March, 2019 194 March, 2020 31st March, 2021 ist March, 2022 Total Normal Profit Total Normal Profit _ %2,35,000 Average Profit =~ mber of Years 5 rofit « Number of Years’ Purchase = 47,000 Goodwill = Average Pi = © 47,000 « 4 = 1,88,000. Note: Colevtation of Adjusted Loss for the year ended 31st March, 2022: z Loss for the year ended 31st March, 2022 1,20,000 Less: Cost of Cycles wrongly debited to Profit and Loss A/c 20,000 ‘Add. Depreciation @ 25% pra. on & 20,000 (cycles) Lows for the year Miustration 7 (Average Profit Method when Adjustments are Made). Luy and Kush are partners sharing profits equally. They admit Shubh into partnership for ‘equal share. Goodwill was agreed to be valued at two years’ purchase of average profit oflat four years, Profits for the last four years were: Year Ended Normal Profit/(Loss) (@) 31st March, 2019 70,000; 34st March, 2020 100,000; 3st March, 2021 55,000 (Loss); st March, 2022 144,000. ‘The books of account of the firm revealed as follows: 1, Firm had abnormal gain of % 10,000 durin, 2, Firm incurred abnormal loss of 7 20,000 di 4, Repairs to car of % 50,000 was wron it y/ gly debited to Ve hich Depreciation was charged on vehicles w 12% P.a.on Behe ie Meee oa Calculate the value of Goodwill Dee Solution: ig the year ended 31st March, 2019, CALCULATION OF NORMAL PROFIT uring the year ended 31st March, 2020. ao co! at ii It de an Ay likrep Calculate Super Profit, ie, step : Goodwill = Super Profit x - = 10 ep Normal Rateoffemmm ite of, WG a For example, where average profit is % 60,000 and the an valde 12.000, € 60.000 C480), Nant ed Renee wail be €1.20,000 (e, €12.000 » Wyo, oe Note: Unless investments are specified to by Investments. They are, therefore, deduct Mustration 20. Average profit of the firm is = 1,50,000, Ti il outside liabilities are % 4,00,000. In the ance of fe if by a of the capital employed. ene te ia Calculate value e Trade Investments, t1 4 they ace eto calculate capa emg mee 0 be of goodwill by Capitalisation of Super Profit Method. Sq Solution: Capital Employed = Total Tangible Assets — Outside Liabilities Voy 2 14,00,000 — & 400,000 = & 10,00,000 Normal Profit = Capital Employed x Normal Rate of Return/100 = % 10,00,000 x a = 1,00,000 a Super Profit = Average Profit — Normal Profit 1,50,000 — % 1,00,000 = % 50,000 Si x a eee ate ns Profit a Es 80,000%100 Te apnth Illustration 21. Normal Rate of Return 10 (08 A business has earned average profit of ® 1,00,000 during the last few years and the normal ‘ait rate of return in similar business is 10%, Find out the value of Goodwill by: (i) Capitalisation of Super Profit Method; and (ii) Super Profit Method if the goodwill is valued at 3 years’ purchase of super profit. gt _48Sets of the business were € 10,00,000 and its external liabilities € 1,80,000. (Dethi 2012) "Solution: vot ()_ As per Capitalisation of Super Profit Method: 3 | Super Profit 100 ___18,000100_ Goodwill = Xicrmal Rate of Retum 10 (i) As per Super Profit Method: meh = Super Profit « Number of Years’ Purchase Capital Employed = Assets ~ External Liabilities _ : 10,00,000 - &1,80,000 = a tate ¢Ilustration 22. sa From the following information, calculate vé ne (i) At three years’ purchase of Average Profit: Gi) Atthree years’ purchase of Super Profit, ii) On the basis of Capitalisation of Super Pro a (iv) On the basis of Capitalisation of Average Profit. Information: (a) Average Capital Employed — % 10,00,000. (b) Net Profit/Loss of the firm for the past years: 202 (Profit); 2022—% 2,70,000 (Profit). (©) Normal Rate of Return on capital is 11%. (a) Remuneration to each partner for his service to be % 2,500 per month. (e) Assets feeding goodwill) —% 11,00,000; Liabilities — 1,00,000 Solution: (@) Calculation of Goodwill at three years’ purchase of Average Profit: % 1,60,000+% 1,40,000+% 2,70,000 _ %5,70,000 RES 3 Average Normal Profit = = 1,90,000 - Remuneration of Partners = %1,90,000 - (% 2,500 x 2 x 12) = % 1,90,000 — 60,000 = & 1,30,000 Goodwill = Average Normal Profit x No. of Years’ Purchase = %1,30,000 x 3 = % 3,90,000. (ii) Calculation of Goodwill at three years’ purchase of Super Profit Normal Profit = Capital Employed x Normal Rate of Return/100 = % 10,00,000 x 11/100 = 1,10,000 Super Profit = Average Profit — Normal Profit =% 1,30,000 - 1,10,000 = & 20,000 Goodwill = Super Profit x No. of Years’ Purchase = 20,000 x 3 =% 60,000, i) Calculation of Goodtvil! under Capitalisation of Super Profit « of goodwill of M/s Sharma & Gunga, 10% 1,60,000 (Profit); 2021 1 treated as a charge on prof. Average Profit = =71,90000 Goodwill = Super Profit x —"100__ Normal Rate of Return = % 20,000 x 100/11 = 1,81,818.18 or Z 1,81,818. (iv) Calculation of Goodvwill under Capitalisation of Average Profit: Goodwill = Total Capitalised Value of Business ~ Net Assets ° Total Capitalised Value of the Firm ~ A¥€t@ge Normal Profit 100 Normal Rate of Return _ %1,30,000x100 ya are S ALL, 818.18Chapter 3 - Goodwat Neaeeeet cee ‘wil: Nature and Valuation 3.23 5 (exe! | Spor o ae goodwill) ~ Outside L ; nh 00,000 = & 10,0¢ Goodwill = &11,81,818 -& 10,00,000-¢ perry abilities 181,818, can QR Code for Additional Illustrations Multiple Choice Questions (MCQs) selectthe correct alternative: 4, Which of the following statement is Correct? f@) Goodwill isa fictitious asset (b) Goodwill is a current asset. Reena tng asset (4) Goodwillis an intangible asset. 2, Excess amount that.a firm gets over and above the market value of assets atthe time of sale ofits business is (a) Profit. (b) Super Profit. (0 Reserve. (6). Goodwill 43, Theterm Number of Years’ Purchase’ means {@) The number of years during which the purchaser of Goodwill expects that the profit due to goodwill are likely to aise in future. (b) Number of years in which goodwill is purchased {@ Number of years for which goodwill purchased will not help the firm in earning similar profits (@) None of the above. 4 Capitalemployed by a partnership firm is €5,00,000. Its average profits € 60,000. The normal rte of return 1 type of business is 10%. The amount of super profit is issi (@) %50,000. (b) € 10,000. (¢ 76,000. (d) %56,000. ‘ends to value its Goodwill. Average profit for the past 5 years is 5, Raj & Associates is a partnership firm. It int hase of average profit, value of Goodwill of the firm 150,000, and Goodwill is being valued at 3 years’ purcl will be (@) %4,50,000. (© %3,00,000. §. Following were the profits of a firm for the last 3 years: (b) &1,50,000. (a) €6,00,000. ieee Profit @ SEZ) in {including abnormal gain of € 90,000) 2020-21 [240,000 (after charging abnormal loss of 1,20,000) B0zi22 [73:60,000 (excluding & 1,20,000 payable on the insurance ‘of machinery) the average profit for the last 3 years will be (b) €10,80,000. (@) None of these. Goodwill ofthe firm on the basis of 4 years’ purchase ofSTIONS: QUESTIONS WITH MISSING VALUES