[CHAPTER 3]

VALUATION OF GOODWILL
1. INTRODUCTION :
When we want to purchase any good we insist on purchasing branded goods e.g. If one want to purchase a refrigerator he can choose among various refrigerator launched by reputed companies like LG, Godrej, Samsung, etc. Why does one go in for branded goods ? Because those assure quality value for money & also for after sell service & about all the reputation created by the companies in the market. This reputation created is known as goodwill.

2. MEANING OF GOODWILL :
1. The Monetary value of the reputation of the business is known as Goodwill. It is the value attached to the profit earning capacity of a business arising out of the wide publicity & reputation. 2. Goodwill & profit go hand in hand for every were know & settled business has its goodwill. This goodwill cant be seen(but that is inexistence). Therefore, Goodwill is known as intangible asset. Goodwill has a realizable value.

2.1.

Definitions of Goodwill : Following are the some basic definitions of goodwill :

Goodwill is nothing more than the probability that they own the customers, will resort to old place Lord Ebdon

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Goodwill can also been self generated by a business over a period of time establishing its reputation which gives & ability to earn excess profit as compare to a new business. From the above defination we may conclude that goodwill is the value that business gets over & above its net assets.

3. CHARACTERISTICS OF GOODWILL :

Characteristics of Goodwill
No Depreciation Can be Realised

Not a Fictious Asset

Attached to Business

4. FACTORS AFFECTING VALUE OF GOODWILL :

Factors Affecing Value of a Goodwill

Capital requirement Measure of Business Location of Business Possession of Business Reputation of Businessman Risk in Business

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5. METHODS OF VALUATION OF GOODWILL :

Methods of Valuation of Goodwill

Average Profit Method

Super Profit Method

5.1.

AVERAGE PROFIT METHOD : Under this method the profit of the past few years are avearaged & adjusted for any

aspect expected change in future.The average profit so calculated is then multiplied by certain no. of years. If the losses of the business are more than the profit then there is no goodwill. Goodwill is the money value of the business reputation earning in the course of regular business. Goodwill is an INTANGLIBLE assets. The formula is as Follows :
TOTAL PROFIT - LOSSES(IF ANY) No. of Years

AVERAGE PROFIT =

5.1.1. Drawbacks of Average Profit Method : 1. It does not take into account the capital employed in the business. 2. Consider Past Profits only. 3. Not a Scientific Method.

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5.2.

SUPER PROFIT METHOD : Goodwill under this method is arrived as under : Step 1 : Average Capital Employed. Step 2 : Average Profit. Step 3 : Normal Profit = Capital Employed X Normal Rate of Return(NRR). Step 4 : Super Profit = Average Profit Normal Profit. Step 5 : Goodwill = Super Profit X Average Purchase.

6. PROBLEMS :
AVERAGE PROFIT
Q.1. Mona, Reena and Sona were carrying on the business in partnership for last 5 years.

Goodwill of the firm is to be valued at 3 years purchase on Average profit of last 5 years. Profits for the last five years are given below : Profit - Rs. 16,000 Profit - Rs. 15,000 Loss - Rs. 8,000 Profit - Rs. 7,000 Profit - Rs. 10,000 You are asked to calculate the amount of goodwill of the firm.

Q.2. A & B are partners sharing profits and losses equally. For the purpose of admitting a new partner it was decided to value goodwill, on 2 years purchase of last 4 years average profits. Year Profit 2000-01 1,44,000 2001-02 1,20,000 2002-03 80,000 2003-04 1,30,000 Calculate value of goodwill. It is noticed that in 2000-01 depreciation on fixed asset Rs.20,000 was remained to be charged.

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Q.3. Priti and Pritam are partners sharing profits and losses in the ratio of 3:2. They admit Prasad for 1/6 share. For the purpose of admission of Prasad, goodwill of the firm should be valued on the basis of 3 years purchase of last 5 years average profit. The profits were: Year 1990-91 1991-92 1992-93 1993-94 1994-95 Calculate goodwill. Profit Rs. 60,000 62,500 45,000 ( Loss ) 42,500 80,000

Q.4. Mahipati and Ganapati are partners sharing profits and losses in the ratio of 4:3. They admitted in partnership Shripati for 1/8th share. For the purpose of admission of Shripati, goodwill of the firm should be valued on the basis of 2 years purchase of the last 5 years average profit. Year 1991 1992 1993 1994 1995 Profit (Rs.) 75,000 1,00,000 1,25,000 85,000 1,15,000

Calculate the goodwill of the firm.

Q.5. A,B & C were partners in a firm sharing equally. C decided to retire from the firm from 1-4-2005. According to Partnership deed, when any partner retires or dies, goodwill is to be valued at 3 years purchase of last four years average profits. Profits for the last four years before charging depreciation on plant & machinery Rs. 10,000 p.a. were as under : Year 2004-05 2003-04 2002-03 2001-02 Profit (Rs.) 50,000 46,000 44,000 40,000

Calculate the value of goodwill.

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SUPER PROFIT
Q.6. The capital of a partnership firm is Rs. 4,00,000 and the profits for the last 4 years are Rs.32,500, Rs. 35,000, Rs. 36,000 and Rs. 39,000. The reasonable return on the capital employed is 12%. Calculate the value of Goodwill under Super Profit Method.

Q.7. M/s.Tirupati Traders capital employed is Rs. 1,00,000. The normal rate of return in similar type of business is 10%. The last three years profits of M/s. Tirupati Traders are Rs. 20,000; Rs. 18,000 and Rs. 22,000 respectively. The Goodwill of the firm is to be valued at two years purchase of Super Profit.

Q.8. A company has earned an average profit in the past Rs. 30,000 p.a. and this average profit will continue in future except the following :
(i) Directors Fees Rs. 2,000 charged against profit will not be required to be paid

henceforth. (ii) Rent Rs. 4,000 p.a. paid previously would not be required to be paid, as the building is purchased for Rs. 1,00,000. The capital employed, excluding the building purchased this year, was Rs. 2,65,000. It was considered that return on capital invested, for the type of business was 8%. Calculate value of Goodwill at three years purchase of Super Profits.

Q.9. The present average net profit of the Praful, Shobha partnership firm before deducting partners remuneration is Rs. 27,000 p.a. The capital employed in the business by the partners Praful Rs. 1,00,000; Shobha Rs. 50,000. The profit expected from the total capital invested is 10% p.a. The total remuneration of the partners is estimated to be Rs. 6,000 p.a. Find out the value of goodwill on the basis of 2 years purchases of super profits.

Q.10. The capital of a partnership firm is Rs. 5,00,000 and the profit for the last four years are Rs. 65,000; Rs. 70,000; Rs. 72,000 and Rs. 73,000. The reasonable return on the capital employed is 12%. Calculate the value of Goodwill at : (a) 2 years purchase of average profits of last 4 years. (b) 3 years purchase of super profit.
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PROBLEMS FOR PRACTICE

Q.1. Following were net profits of the firm for the year ending 31-03-2002, 31-03-2003 & 31-03-2004, Rs. 30,000; Rs. 50,000 and Rs. 52,000 after setting aside Rs. 3,000 p.a. for Reserve Fund. You are required to calculate value of goodwill at 3 years purchase of average net profits of the last 2 years.

Q.2. A partnership firm desirous of selling its business to a another firm has earned average profit Rs. 1,50,000 p.a. It is expected that this profit will be earned in future except that. (a) Salary of a secretary Rs. 10,000 paid annually is not required to be paid in future. (b) Rent Rs. 20,000 p.a. paid each year is no longer to be paid. Calculate the value of goodwill at 3 years purchase of average net profit.

Q.3. Average profit of a partnership firm for the last 5 years is Rs. 40,000. Calculate the value of goodwill at 3 years purchase of average net profits of last five years.

Q.4. For the purpose of valuation of goodwill it was agreed to consider net profits of the last 4 years and goodwill is to be valued at one years purchase of average net profits of last 4 years. The profits were : 1 = Rs. 80,000 2 = Rs. 90,000 3 = Rs. 1,05,000 4 = Rs. 1,10,000 Calculate the value of goodwill.

Q.5. Find out value of goodwill from the following : Net Profits for last 5 years : Rs. 30,000; Rs. 36,000; Rs. 24,000; Loss Rs. 4,000; Profit Rs. 14,000. (a) Goodwill to be valued at 3 years purchase of average net profit. (b) Goodwill to be valued at 3 years purchase of super profits, presuming average capital employed Rs. 1,00,000 and the normal rate of earning is expected at 10%.

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Q.6. Calculate the value of goodwill at 3 years purchase of : (i) Average profit (ii) Super profit Profit for the last four years: 1. Profit Rs. 40,000 2. Loss Rs. 2,000 3. Profit Rs. 50,000 4. Profit Rs. 60,000 Capital employed Rs. 2,00,000. 8% return is expected on average capital.

Q.7. M, R & S are carrying on the business in partnership. Goodwill to be valued at 3 years purchase of average profits of last 5 years, which are Rs. 16,000; Rs. 15,000; Loss Rs. 8,000; Loss Rs. 5,000; Profit Rs. 12,000 and Profit Rs. 10,000. Calculate the value of goodwill.

Q.8. Find the value of goodwill at 3 years purchase of: (i) Average profit (ii) Super profit Profit for the last four years were: 1. Profit Rs. 40,000 2. Loss Rs. 2,000 3. Profit Rs. 50,000 4. Profit Rs. 60,000 Capital employed Rs. 2,00,000. Normal profit expected on average capital employed 8%.

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Q.9. The Balance Sheet of Patel & Co. discloses the following position on 31.03.2005

Liabilities Capital General Reserve 5% Bank Loan Trade Creditors

Rs. 5,00,000 2,50,000 5,00,000 4,50,000

Assets Land & Building Plant & Machinery Stock Debtors Cash at Bank

Rs. 3,00,000 5,00,000 5,00,000 3,00,000 1,00,000

17,00,000

17,00,000

Calculate the value of goodwill of the business, considering the following information : (a) Present Market Value of Plant & Machinery is Rs. 8,00,000. Profits for the last 3 years were : Rs. 1,01,000; Rs. 1,50,000 and Rs. 1,72,000. (b) The reasonable return on capital employed 8%. (c) Goodwill is to be valued at 3 years purchase of Super Profits.

Q.10. The average profits of a business for the last 3 years amounted to Rs. 2,20,000 but on adjustment of certain items the same were Rs. 2,30,000. 7 1/2% represented a fair commercial return on average capital employed. The book value of capital employed worked out to be Rs. 13,45,000 but upon a proper revaluation of certain assets capital employed was Rs. 11,50,000. Find out value of goodwill at 5 years purchase of super profits.

Q.11. Calculate the value of goodwill according to super profit method. (a) Capital employed Rs. 1,20,000. (b) Normal Rate of Return 15%. (c) Average profit for last four years Rs. 30,000. (d) Goodwill to be valued at 2 years purchase of Super Profits.

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Q.12. Following is the Balance Sheet of A & B as on on 31.03.2004 Liabilities Capital: A B Reserve Fund Profit & Loss A/c ( for current year ) Creditors Rs. 90,000 70,000 44,000 26,000 38,000 2,68,000 2,68,000 Assets Fixed Assets Current Assets Investments Rs. 91,000 1,47,000 30,000

The profits for 2002-03 & 2003-04 were Rs. 15,000 & 25,000. You are required to ascertain the value of goodwill at two years purchase of super profits on the basis of 3 years average profits. The normal rate of return on the average capital employed is 10%.

Q.13. Calculate value of goodwill at 1 years purchase of super profits. (a) Average profits for last four years is Rs. 50,000 before charging depreciation Rs. 5,000 p.a. (b) Capital employed is Rs. 1,00,000. (c) Normal rate of return 12%.

Q.14. Calculate value of goodwill at 3 years purchase of super profits. (a) (b) (c) (d) Capital employed Rs. 3,56,000. Normal profit expected ( after tax ) 12%. Actual profit earned Rs. 1,10,000. Income-tax to be provided at 50% of profit.

Q.15. Following were net profits after transferring Rs. 1,000 to Reserve Fund 2000-01 Rs. 14,000; 2001-02 Rs. 24,000 and 2002-03 Rs. 25,000. Capital employed is Rs. 1,30,000. The normal profit expected 12% Calculate value of goodwill at 2 years purchase of super profits.
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7. OBJECTIVES : ANSWER IN ONE SENTENCE [Q.1 (A) 5 Questions, Carries 5 Marks]

1. 2. 3. 4. 5. 6. 7. What is Goodwill ? What are the method of valuation of goodwill ? What is Total Profit ? What is an Average Profit ? What do you mean by Capital Employed ? What is Normal Rate of return (NRR) ? What do you mean by Super Profit ?

Answers :
1. Goodwill is the monetary value of the reputation of a firm as measured in term of its expected future profits. 2. The two methods of valuation of goodwill are : A. The Average Profit and B. The Super Profit Method. 3. Total amount of profit earned by the business concern over a certain number of years is called total profit. 4. Amount of profit earned by the business concern per year is called an average profit. 5. Amount of capital used by the business concern to run and manage its business activities is called Capital Employed. 6. Normal Rate of Return(NRR) is the return or profit normally expected on the capital employed by considering the returns actually earned by the other firms in the same industry. 7. Super profit is the profit earned over and above the normal return on the capital employed by the business firm.

WRITING A WORD/TERM/PHRASE [Q.1 (B) 5 Questions, Carries 5 Marks]

1. Money value of the reputation of the business. OR An intangible asset which has realizable value.

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2. 3. 4. 5. 6. 7. 8. 9.

Amount of capital used by the business concern to run its business activity. Total amount of profit earned by the business concern over certain number of the years. Amount of profit earned by the business concern per year. Rate of profit estimated or expected on capital employed. Reasonable profit earned by the business concern to survive in the industry after meeting all its expenses. Profit earned by the firm over and above its normal profit. Excess of average profit over a normal profit. Intangible Asset measurable in terms of money.

Answer : 1. Goodwill 2. Capital Employed 3. Total Profit 4. Average Profit 5. Normal Rate of Return 6. Normal Profit 7. Super Profit 8. Super Profit 9. Goodwill

MATCH THE PAIRS [Q.1 (C) 5 Questions, Carries 5 Marks]

GROUP A 1. 2. 3. 4. 5. Capital Employed Normal Profit Goodwill Super Profit Average Profit Method a. b. c. d. e. f. g.

GROUP B Tangible Assets Outside Liabilities Tangible Assets New Ratio Old Ratio Reasonable Profit of entrepreneur Intangible Asset Valuation of goodwill Average Profit Normal Profit

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Answers :
1. 2. 3. 4. Capital Employed Normal Profit Goodwill Super Profit Tangible Assets Outside Liabilities Reasonable Profit of entrepreneur Intangible Asset Average Profit Normal Profit Valuation of goodwill

5. Average Profit Method

MULTIPLE CHOICE [Q.1 (D) 5 Questions, Carries 5 Marks]

1. . . . . . . . . means the value of the reputation of the business concern which is expressed in terms of money. (a) Patent (b) Goodwill (c) Trade Mark (d) Copyright Goodwill is . . . . . . . asset (a) A Tangible (b) A Fictitious

2.

(c) An Intangible

(d) A Current

3.

Average Profit = . . . . . . . . . . . No. of Years (a) Total Loss (b) Total Net Worth (c) Total Assets (d) Total Profit . . . . . . . rate of return usually expected on the capital employed. (a) Average (b) Super (c) Annual (d) Normal Super Profit = Average Profit less . . . . . . . (a) Net divisible Profit (b) Normal Profit (c) Net Profit (d) Total Profit Profit over and above the normal profit is called . . . . . . . . (a) Super Profit (b) Average Profit (c) Gross Profit (d) Net Profit Normal Profit = . . . . . . . * Normal Rate of Return (a) Total Assets (b) Total Liabilities (c) Total Profit (d) Capital Employed

4.

5.

6.

7.

Answers :
1. Goodwill means the value of the reputation of the business concern which is expressed in terms of money. Goodwill is An Intangible asset.

2.

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3.

Average Profit = Total Assets No. of Years Normal rate of return usually expected on the capital employed. Super Profit = Average Profit less Normal Profit. Profit over and above the normal profit is called Super Profit. Normal Profit = Capital Employed * Normal Rate of Return

4. 5. 6. 7.

TRUE OR FALSE, WITH REASONS [Q.1 (E) 2 Statements, Carries 5 Marks]

1. 2. 3. 4. 5. Goodwill is a tangible asset of the business. Goodwill is Fictitious Asset. Goodwill has Monetary Value. Super Profit = Normal Profit Average Profit. While calculating the average profit, the losses are ignored.

Answers : 1. False Reasons : 1. Goodwill is the monetary value of reputation of the business organization as measured in terms
of its expected future profit. 2. Goodwill is an intangible asset because its existence cannot be verified by our sense.

2. False Reasons : 1. Goodwill is an intangible asset. Losses or expenses incurred in huge an=mount not yet written
off are termed as factious asset. 2. Since goodwill contributes extra profit over and above its normal profit, it is considered as real asset and not factious asset.

3. True Reasons : 1. Goodwill is nothing but a monetary value of reputation earned by the business over number of
years. 2. Goodwill is always valued in terms of money by taking into consideration, the different factor such as earning capacity, age of the business, etc. Thus, goodwill has monetary value.

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4. False Reasons : 1. Super profit is nothing but the excess of average profit over the normal profit.
2. Therefore, it is necessary to deduct the amount of normal profit from the amount of Average Profit to calculate the amount of Super Profit. Hence, the formula is Super Profit = Average Profit - Normal Profit

5. False Reasons : 1. Total amount of profit earned by the business organization over a certain number of years is
called total profit. 2. Since losses are termed as negative profits, such losses are required to be adjusted with the profits earned in the other years while finding out the total profit of the given number of years.

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