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2
Goodwill is good name or the reputation of the business, which is earned by
a firm through the hardwork and honesty of its owners. If a firm renders good
service to the customers, the customers who feel satisfied will come again
and again and the firm will be able to earn more profits in future.

Thus, goodwill is the value of the reputation of a firm which enables it to earn
higher profits in comparison to the normal profits earned by other firms in the
same trade.

It is concluded that,Goodwill is the value of the reputation of a firm built

over time with respect to the expected future profits over and above the
normal profits. Goodwill is an intangible real asset which cannot be seen or
felt but exists in reality and can be bought and sold.

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The goodwill possessed by a firm may be due, to the following:
1. The location of the business premises, the nature of the firm’s products
or the reputation of its service.
2. The possession of favourable contracts, complete or partial monopoly,
etc.
3. The personal reputation of the promoters.
4. The possession of efficient and contented employees.
5. The possession of trade marks, patents or a well-known business
name.
6. The continuance of advertising campaigns.
7. The maintenance of the quality of the firm’s product and development
of the business with changing conditions

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The need for evaluating goodwill may arise in the following cases:

1. When the business or when the company is to be sold to another

company or when the company is to be amalgamated with another
company;

2. When, stock exchange quotations not being available, shares have to

be valued for taxation purposes, gift tax, etc.;

3. When a large block of shares, so as to enable the holder to exercise

control over the company concerned, has to be bought or sold; and

5
When one company buys another company, the purchasing company
may pay more for the acquired company than the fair market value of its
net identifiable assets .
The amount by which the purchase price exceeds the fair value of the
net identifiable assets is recorded as an asset of the acquiring company.

Although sometimes reported on the balance sheet with a descriptive

title such as “excess of acquisition cost over net assets acquired”, the
amount is customarily called goodwill.

Goodwill arises only part of a purchase transaction.

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EXAMPLE:
Company X acquired all the assets of company Y, for` 15 lakh cash.
Company Y has cash - 50,000 ;accounts receivable value of - 60,000,
and other identifiable assets that are estimated to have a current market
value of - 11lakhs.

Particulars Amount
Total purchase price 15,00,000
Less: Cash acquired 50,000
Accounts receivable 60,000
Other identifiable assets 11,00,000
TOTAL (12,10,000)

GOODWILL 2,90,000
This extra amount of RS. 2,90,000 paid over and above, Net worth `
12,10,000 is goodwill. 7
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Steps, Method and Formula for Calculation of Goodwill:
1) Goodwill by purchase of future maintainable profit method: In
valuation of G/W, the first step is to find out the amount of the expected future
income.The purchaser is interested in finding out how much the past profits will
continue to be earned in future. This is called the amount of Future Maintainable
Profits. Though it is difficult to calculate precise amT., however future profits can
be estimated to a certain extent on the basis of profits earned in the past few
years.

Steps:
(a) Goodwill: No of years purchase × Future maintainable profit.

(b) Number of year purchase (given in problem).

(c) Find out future maintainable profit.

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FUTURE MAINTAINABLE PROFITS: 1) ON THE BASIS of
AVERAGE ADJUSTED PROFIT 2) NOS.OF YEARS OF
PURCHASES

PARTICULARS YEAR 1 YEAR 2 YEAR 3

A) PAST PROFITS (given in question)
B) add: abnormal expenses ( not payable in future)
C) less: abnormal income ( not receivable in future)
D)ADJUSTED PROFITS
E) AVERAGE ADJUSTED PROFITS (TOTAL ADJT. PROFITS
/YEARS)
F) add: income receivable in future
G) less: expenses payable in future
H) less: non trading income
I) TRADING PROFIT (NPBT)
j) less: INCOME TAX
k) future maintainable profits

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Goodwill by capitalisation method:

Steps:
(a) Goodwill = Capitalised Value of F.M.P. – Capital Employed

(b) Capitalisation Value of Future Maintainable Profit = F.M.P × 100

N.R.R
(c) Find out future maintainable profit

(d) Calculate capital employed.

Capital employed = Assets (excl.G/W) - external liab.

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Goodwill by super profit method:

Steps:
a)GOODWILL= Super Profit * Nos.Years’ of Purchases(given in quen)

b) Super Profit = Future Maintainable Profit- Normal Profit

c) Future Maintainable Profit= average trading Profit(refer table given in

FMP)

d) Normal Profit = Capital employed * N .R.R (given in quen.)

100
e) Capital Employed = Assets (excl.G/W)-External Liabilities
12
Q.2)

13
14
Q.1)

15
16
Q.3)

17
Q.4)

18
Q.6)

19
20
Q.6)

21
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Factors Influencing Valuation
The valuation of shares of a company is based, inter alia, on the following factors:
1. Current stock market price of the shares.
2. Profits earned and dividend paid over the years:
3. Availability of reserves and future prospects of the company.
4. Realisable value of the net assets of the company.
5. Current and deferred liabilities for the company.
6. Age and status of plant and machinery of the company.
7. Net worth of the company.
8. Record of efficiency, integrity and honesty of Board of Directors and other managerial
personnel
of the company.
9. Quality of top and middle management of the company and their professional
competence.
10. Record of performance of the company in financial terms.
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1) Intrinsic Value Method:
This method is also called as Assets Backing Method, Real Value
Method, Balance Sheet Method or Break-up Value Method. Under this method,
the net assets of the company including goodwill and non-trading assets are
divided by the number of shares issued to arrive at the value of each share.
This method is used for valuation of 1) Equity shares 2) Non-participating
preference shares & 3) Participating preference shares.

If the market value of the assets is available, the same is to be considered and in
the absence of such information, the book values of the assets shall be taken as
the market value. While arriving at the net assets, the fictitious assets such as
preliminary expenses, the debit balance in the Profit and Loss A/c should not be
considered. The liabilities payable to the third parties and to the preference
shareholders is to be deducted from the total asset to arrive at the net assets.
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STEP 1) INTRINSIC VALUE OF SHARES= FUNDS AVAILABLE FOR EQUITY
SHAREHOLDERS/ TOTAL NOS. OF EQUITY SHARES

STEP 2) FUNDS AVAILABLE FOR EQUITY SHAREHOLDERS

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2) YIELD METHOD:
The valuation of shares under the Yield Method may be done under two categories:
a) “ Expected Dividend Basis” b) “ Expected Earning Basis.

Equity Shares may be purchased in a small lot for earning dividends. Such small lots
of equity shares are valued on the basis of the expected dividend.

Value of shares = Expected Rate of Dividend × Paid-up Value of Shares

Normal Rate Of Return

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On the other hand , equity shares purchased in large number, the purchaser is more
concerned about total earning capacity of the company (capital employed) rather than
Dividend paid.in such case, equity shares are valued on the basis of the expected
earnings of the company.

The value of the share under this method is calculated by the formula:

Value of shares = Return of Capital Employed × Paid-up Value of Shares

Normal Rate of Return

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3) Fair Value of a Share: Technically this is not method. It is the compromise formula
which arbitrarily fixes the value of shares as the Average of earlier two methods.
The fair value of a share is the average of the value obtained by the net asset method
and the
yield method.

Fair Value = Intrinsic Value Method + Yield Value Method

2

31
Q.1)

32
Q.2)

33
Q.3)

34
Q.4)

35
Q.5)

ADDITIONAL PLANT IS PURCHASED ON 1/4/12.

36
37
Q.6)

38
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