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Valuation of Goodwill In accountancy
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Valuation of Goodwill In accountancy

Valuation of Goodwill In accountancy

In accounting Goodwill is intangible assets .It is found the Assets side of balance sheet .The value of a company’s brand name, solid customer base, good customer relations, good employee relations and any patents or proprietary technology represent goodwill.it is not a physical asset like buildings or equipment.

Valuation of Goodwill In accountancy

There are three method of valuation of goodwill

  • Average profit method
  • Super profit method
  • Capitalisation Method

 

Average profit method

Under average profit method the goodwill is calculated according to average of agreed number of past years profit.This is very simple and one of the most used method of calculating goodwill.

Goodwill =Average Profit X numbers of past year profit.

But before calculating average profit of goodwill following adjustment are made :

  • Abnormal profit should be deducted from the net profit of that year.
  • Abnormal loss should be added back to the net profit of that year.
  • Non operating income should be deducted

Example :

Ram agreed to buy the business of Rahim .Therefore goodwill is to be valued of three year purchase of average of average of profit of last five year.

Years     Profit

2009     100000

2010    200000

2011    300000

2012    10000 loss

2013    300000

In the year 2013 company suffer a loss due to fire 20000

In the Year 2010 investment was made 50000

Total profit 900000- 10000 + 20000 -50000

=860000 / 5= 172000

so goodwill is 172000 X  3= 516,000

Super Profit method

It is the profit earned above the normal profit.under this method goodwill is calculated on the basis of super profit ie the excess of actual profit over the average profit.

Step for calculating goodwill ;

1)Normal Profit = Capital invested X normal Rate of return

2) Super Profit = Actual profit – Normal Profit

3) Goodwill = Super profit X number of purchse.

Example :

Capital Employed by Ram is 20,00000 and the normal rate of return is 10% .Goodwill is to be calculated on the basis of 3 year.

 

Year           Profit

2012      200000

2013      300000

2014     400000

Total of last 3 years = 900000

Average profit =900000/3 =300000

Normal profit = 20,00000 X 10% = 200000

Super profit = average – normal

300000-200000

=100000

100000X3=300000

Capitalization Method : there are two of calculating goodwill under this method

  • Capitalization of average profit method
  • Capitalization of super profit method

 

Capitalization of average profit method

under this method following formula is applicable :

Capitalization of average profit method = Average Profit X 100/normal rate of return.

Capital employed = Assets – Liabilites

Goodwill = Capitalization of average profit – Capital employed.

Capitalization of super profit method ;

Goodwill = normal profit X 100/ Normal rate of return

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