Valuation of

goodwill
Index
Goodwill: nature, factors affecting and methods of
valuation - average profit, super profit, and
capitalization
 Valuation Of Goodwill
Goodwil
l
Value of the reputation of a firm in respect of the
profits expected in future over and above the
normal profits.
Factor affecting goodwill

Location

Nature of Business

Efficiency of Management

Market situation:

Special Advantages
 Need for valuation for
goodwill

When profit On admission of

sharing ratio a partner
changes

On Retirement or Amalgamation
death of a of firms.
partner
 Methods of
valuation

Average
Super profit Capitalizatio
profit
method n method
method

Capitalizatio Capitalizatio
n of average n of super
profits profit
Average Profits Method

The profit earned by a Firm during previous accounting

periods on an average basis is called average profit.

Goodwill is calculated on the basis of average profit due

to future expectations of earning capacity of the firm.

Total profits
Average profits =
No of years

Goodwill = Average profits x No Of Years

Purchased

Note:-
ADD:- Abnormal Losses ( in any )
Example:- loss by fire, loss by theft

Less:- Abnormal Profits/Gains ( in any )

Example:- gains on sale of assets
Calculate
The profit for the last five years of a firm were as follows
– year 2002 Rs. 4,00,000; year 2003 Rs. 3,98,000; year
2004 Rs. 4,50,000; year 2005 Rs. 4,45,000 and year
2006 Rs. 5,00,000. Calculate goodwill of the firm on the
basis of 3 years purchase of 5 years average profits

Total profit = 4,00,000 +3,98,000+ 450000 + 445000 + 500000

= 21,93,000

Total profits
Average profits=
No of years

2193000
Average profits= = 4,38,600
5

Goodwill = Average profits x No Of Years

Purchased
Goodwill = 438600 x 3 = 1315800
Calculate
Goodwill of the firm is valued at three years purchased of the
average profit of the last five years. The profits are under
1997 Rs 50,000 (Profit)
1998 Rs 20,000 (Loss)
1999 Rs 10,000 (Profit)
2000 Rs 60,000 (Profit)
2001 Rs 80,000 (Profit)
Calculate the value of goodwill

Total profit = 50,000- 20,000 + 10,000 + 60,000 + 80,000

= 1,80,000

Total profits
Average profits =
No of years

= 1,80,000
Average profits = 36,000
5

Goodwill = Average profits x No Of Years

Purchased
Goodwill = 36,000 x 3 = 1,08,000
Calculate
Menu purchased Simmi’s business from 1st January 1998. The
profits disclosed by Simmi’s business for the last three year
were as follows
1985 Rs 40,000 (including an abnormal gain of Rs 5,000)
1986 Rs 50,000 (after charging abnormal loss of Rs 10,000)
1987 Rs 45,000 (excluding Rs 5000 an annual insurance
premium of firm’s property now insured)
Calculate the value of the firm’s goodwill on the basis of 2
years purchase of the average profits for the last three years.

Particulars Amount

Profit for the year 1985 40,000

Less:- Abnormal Gain -5,000 35,000

Profit for the year 1986 50,000

Add- Abnormal Gain 10,000 60,000

45,000
Profit for the year 1987

Total profit of the firm 1,40,000

Calculate
Menu purchased Simmi’s business from 1st January 1998. The
profits disclosed by Simmi’s business for the last three year
were as follows
1985 Rs 40,000 (including an abnormal gain of Rs 5,000)
1986 Rs 50,000 (after charging abnormal loss of Rs 10,000)
1987 Rs 45,000 (excluding Rs 5000 an annual insurance
premium of firm’s property now insured)
Calculate the value of the firm’s goodwill on the basis of 2
years purchase of the average profits for the last three years.

1,40,000 46,667
Average profits = =
3
-5,000
Less:- Annual Premium
41667

Goodwill = Average profits x No of years

Purchased
Goodwill = 41667 x 2 = 83,334
Calculate
Calculate goodwill of a firm on the basis of three year’ purchase of the
weighted
average profits of the last four years. The profit of the last four years
were: 2012
Rs. 20,200; 2013 Rs. 24,800; 2014 Rs. 20,000 and 2015 Rs. 30,000. The
weights
assigned to each year are : 2012 – 1; 2013 – 2; 2014 – 3 and 2015 – 4.
You are supplied the following information:
1. On September 1, 2014 a major plant repair was undertaken for Rs.
6,000,
which was charged to revenue. The said sum is to be capitalized for
goodwill calculation subject to adjustment of depreciation of 10% p.a.on
reducing balance method.
2. The Closing Stock for the year 2013 was overvalued by Rs. 2,400.
3. To cover management cost an annual charge of Rs. 4,800 should be
made for purpose of goodwill
 Calculation of 2012 2013 2014 2015
Adjusted Profit
Given Profits 20,200 24,800 20,000 30,000
Less: Management (4,800) (4,800) (4,800) (4,800)
Cost
Add: Capital 15,400 20,000 15,200 25,200
Expenditure 6,000
Charged to Revenue
Less: Unproductive 15,400 20,000 21,200 25,200
Depreciation (200 ) (580)

Less: over valuation of 15,400 20,000 21,200 24,620

Closing Stock 2400

Add: over value of 15,400 20,000 21,200 24,620

opening stock 2400

Adjusted Profits 15,400 17,600 21,000 24,620

Adjusted Profits 15,400 17,600 21,000 24,620

Year Profit Weight Product

2012 15400 1 15400
2013 17600 2 35200
2014 23400 3 70200
2015 24620 4 98480
10 219280
Super Profits Method
•If a firm earns higher profit in comparison to normal profit
(generally earned by other firms of same industry) then the
difference is called Super Profit.

• Goodwill is calculated on the basis of Super profit due to

future expectations of learning capacity of the firm.

Normal rate of return

Normal = Capital employed x
profits 100

Super profit = Actual/average profits Normal

profits

= Super Profit x No of years

Goodwill
purchased
Calculate
The books of a business showed that the capital
employed on December 31, 2006, Rs. 5,00,000 and the
profits for the last five years were: 1997– Rs. 40,000:
1998-Rs. 50,000; 1999-Rs. 55,000; 2000-Rs.70,000 and
2001-Rs. 85,000. find out the value of goodwill based on
3 years purchase of the super profits of the business,
given that the normal rate of return is 10%.
Normal rate of return
Normal = Capital employed x
profits 100

= 5,00,00 x 10
= 50,000
0 100

Total profit = 4,00,000+ 50,000 + 55,000 + 70,000 + 85,000

= 2,90,000

Average profits = Total profits

No of years

Average profits = 3,00,000 = 60,000

5
Calculate
The books of a business showed that the capital
employed on December 31, 2006, Rs. 5,00,000 and the
profits for the last five years were: 1997– Rs. 40,000:
1998-Rs. 50,000; 1999-Rs. 55,000; 2000-Rs.70,000 and
2001-Rs. 85,000. find out the value of goodwill based on
3 years purchase of the super profits of the business,
given that the normal rate of return is 10%.

Super profit = Actual/average profits Normal

profits

= 60,000 50,000 = 10,000

Goodwill = Super Profit x No of years

purchased

= 10,000 x 3

= 30,000
Calculate
On April 1st 1998 an existing firm had assets of Rs 75,000
including cash of Rs 5,000. The partner’s capital accounts
showed a balance of Rs 60,000 and reserve constituted the rest.
If the normal rate of return is 10% and the goodwill of the firm is
valued at Rs 24,000 at 4 years purchased of super profits. Find
the average profits of the firm.

Normal rate of return

Normal = Capital employed x
profits 100

= x 10
= 50,000
100
 Capitalization Method

Capitalization Of Average Capitalization Of Super

Profits Profit
Capitalization of average profits
In this method capitalized value of the firm is calculated on the
basis of normal rate of return.

Difference between the capitalized value and actual capital

employed is called goodwill.

Capitalized = 100
Average profit x
value of the Rate of normal
firm profit

Capital = Total Assets - Liabilities

employed

Goodwill = Capitalized Value - Capital Employed

Calculate
From the figures given below calculate the goodwill of the basis
of average profits method
Actual average profits = Rs 72,000
Normal rate of return = 10%
Assets = 9, 70,000
Liabilities = Rs 4, 00,000
100
Capitalized = Average profit x
value of Rate of normal
average profit
profits of firm 100
= 72,000 x = 7,20,000
10

Actual Capital = Total Assets - Liabilities

employed
= 9,70,000 – 4,00,000 = 5,70,000

Goodwill = Capitalized Value - Capital Employed

= 7,20,000 – 5,70,000 = 1,50,000

Capitalization
Method
In this method goodwill is valued on the basis of capital
required for earning super profits on the basis of normal rate
of returns

Capital = Total Assets - Liabilities

employed

Super profits = Actual average profits – normal

profits

Goodwill = 100
Super profits x
Rate of normal
profit
Calculate
The following information relates to the partnership firm
Profits for the last years
1996 80,000
1997 1,00,000
1998 2,00,000
1999 1,50,000
2000 2,70,000

Average capital employed is Rs 5, 00,000.Rate of normal profits

20%

Find the value of goodwill on the basis of Capitalization of super

profits
Total profit = 80,000 + 1,00,000 +2,00,000 + 1,50,000+ 2,70,000

= 8,00,000

Total profits
Actual/Average =
profits No of years

Actual/Average = 8,00,000
= 1,60,000
profits 5
Calculate
The following information relates to the partnership firm
Profits for the last years
1996 80,000
1997 1,00,000
1998 2,00,000
1999 1,50,000
2000 2,70,000

Average capital employed is Rs 5, 00,000.Rate of normal profits

20%

Find the value of goodwill on the basis of Capitalization of super

profits

Super profits = 1,60,000 – 1,00,000 = 60,000

Goodwill = 100
Super profits x
Rate of normal
profit

Goodwill = 100
60,000 x = 3,00,000
20