Goodwill means the reputation earned by the business over the period through right pricing, quality of products,

customer handling and management efficiency.

Goodwill places the firm in better position to earn higher profits in comparison to normal profits earned by its competitors.

Goodwill is an intangible asset since it does not have physical existence and thus, cannot be seen or touched.

Purchased goodwill is excess of purchase consideration over its net assets. It is recognised
as Intangible Asset in Balance sheet in accordance with Accounting Standard 26, Intangible Assets.
Self-generated goodwill is an internally generated goodwill and is not recognised in
the books of accounts since consideration is not paid and received by independent persons at arms length.
Need for valuation of Goodwill arises:
1. On change in profit sharing ratio among the existing partners.
2. On admission of a new partner or retirement/death of a partner.
3. On amalgamation with another firm.
4. On dissolution of a firm.

Methods of Valuation of Goodwill

Average Profit Method Super Profit Method Capitalisation Method

Simple Average Weighted Capitalisation of Capitalisation of

Method Average Method Average Profit Super Profit
Method Method

Simple Average Weighted Average

Profit × No. of Profit × No. of Super Profit × Capitalised Value Super Profit
Years’ Purchase Years’ Purchase No. of Years’ of Business – Net ×
Purchase Assets 100/NRR

(i) Simple Average Profit Method

Goodwill = Average Adjusted Profit × Number of Years’ Purchase
(ii) Weighted Average Profit Method
Goodwill = Weighted Average Profit* × Number of Years’ Purchase
*Sum of Weighted Profits/Sum of Weights
Super profit is the profit earned by the business that is in excess of the normal profits.
Goodwill is determined by multiplying super profits by the numbers of years’ purchase.
Goodwill = Super profit × No. of years’ purchase
Super Profit = Actual Average Profit – Normal Profit
Normal Profit = Capital Employed × Normal Rate of Return/100
Capital employed can be calculated from two approaches:
1
(a)
Capital Employed = All assets (except Goodwill, Non-trade Investments and Fictitious Assets) – Outside
Liabilities (Both Long-term and Short-term Liabilities)
(b)
Capital Employed = Capital + Reserves – Goodwill – Fictitious Assets – Non-trade Investments
Unless Investments are specified to be trade investments, they are taken as Non-trade Investments.
Under the method, goodwill can be calculated by two Methods:
Under this method, first average profit is calculated, and the average profit
is multiplied by 100 and divided by normal rate of return to arrive at capitalised value of business.
Capitalised Value of Business = Average Profit × 100/Normal Rate of Return
Then, Net Assets as on the date of valuation of goodwill are determined.
Net Assets = All assets (except Goodwill, Non-trade Investments and Fictitious Assets) – Outside Liabilities
Value of Goodwill = Capitalised Value of Business – Net Assets
Under this method goodwill is calculated by capitalising super profit at the
normal rate of return.
Goodwill = Super Profit × 100/Normal Rate of Return
Super Profit = Actual Average Profit – Normal Profit