The valuation of goodwill depends upon assumptions made by the valuer.

Methods to be adopted
in valuation of goodwill would depend on circumstances of each case and is often based on the
customs of the trade.
The various methods that can be adopted for valuation of goodwill are follows:
1. Average Profit Method
2. Super Profit Method
3. Capitalization Method
4. Annuity Method.
1. Average Profit Method:
Under this method the value of Goodwill is calculated by multiplying the Average Future profit
by a certain number of years purchase.
Goodwill = Future maintainable profit after tax x No. of years purchase
The first step under this method is the calculation of average profit based on past few years
profit. Past profit are adjusted in respect of any abnormal items of profit or loss which may affect
future profit. Average profit may be based on simple average or weighted average.
If profits are constant, equal weight-age may be given in calculating the average profits i.e.,
simple average may be calculated. However, if the trend shows increasing or decreasing profit, it
is necessary to give more weight-age to the profits of recent years.
Number of years purchase:

After calculating future maintainable average profits, the next step is to determine the number of
years purchase. The number of years of purchase is determined with reference to the probability
of new business to catch up with an existing business. It will differ from industry to industry and
from firm to firm. Normally the number of years ranges between 3 to 5.
Steps Involved under Average Profits Method:
(i) Calculate past profits before tax.
(ii) Calculate future-maintainable profit before tax after making past adjustments.
(iii) Calculate Average Past adjusted Profits (taking simple average or weighted average as
applicable).
(iv) Multiply Future Maintainable Profits by number of years purchase.
Value of Goodwill = Future Maintainable Profits x No. of years purchase.
Illustration 1:
X Ltd. agreed to purchase business of a sole trader. For that purpose, goodwill is to be valued at
3 years purchase of average profits of last 5 years.

Illustration 2:
Y Ltd. proposed to purchase business carried on by Mr. A. Goodwill for this purpose is agreed to
be valued at 3 years purchase of the weighted average profits of the past four years.
The profit for these years and respective weights to be assigned are as follows:

On a scrutiny of the accounts, the following matters are revealed:

(a) On 1st September, 2012 a major repair was made in respect of plant incurring Rs. 6,000
which was charged to revenue, the said sum is agreed to be capitalized for goodwill calculation
subject to adjustment of depreciation of 10% p.a. on reducing balance method.
(b) The closing stock for the year 2011 was over valued by Rs. 2,400; and
(c) To cover management cost an annual charge of Rs. 4,000 should be made for the purpose of
goodwill valuation.

Required:
Compute the value of goodwill of the firm.
Solution:
Before calculating goodwill, it is necessary to compute adjusted profit on the basis of
information given.

2. Super Profit Method:

Super profit is the excess of estimated future maintainable profits over normal profits. An
enterprise may possess some advantages which enable it to earn extra profits over and above the
normal profit that would be earned if the capital of the business was invested in some other
business with similar risks. The goodwill under this method is ascertained by multiplying the
super profits by certain number of years purchase.
Steps Involved in Calculating Goodwill under Super Profit Method:
Step 1: Calculate capital employed (it is the aggregate of Shareholders equity and long term debt
or fixed assets and net current assets).
Step 2: Calculate Normal Profits by multiplying capital employed with normal rate of return.
Step 3: Calculate average maintainable profit.
Step 4: Calculate Super Profit as follows:
Super Profit = Average maintainable profits Normal Profits.
Step 5: Calculate goodwill by multiplying super profit by number of years purchase.
Illustration 3:
From the following information calculate the value of goodwill on the basis of 3 years
purchase of super profits of the business calculated on the average profit of the last four
years (simple average and weighted average):
(i) Capital employed Rs. 50,000
(ii) Trading profit (after tax):

2010 Rs. 12,200;

2011 Rs. 15,000;
2012 Rs. 2,000 (loss); and
2013 Rs. 21,000
(iii) Rate of interest expected from capital having regard to the risk involved is 10%.
(iv) Remuneration from alternative employment of the proprietor (if not engaged in business) Rs.
3,600 p.a.
Goodwill: Definition and Valuation of Goodwill!
Definition:
A business builds up some reputation after it has continued for some time. If the reputation is
good, the firm will come to acquire a fixed clientele in the sense that a number of customers will
automatically make their purchases from the firm. This is a very valuable asset even if one
cannot touch or see it. The asset is intangible but not fictitious. This asset is known as goodwill
and may be defined as the value of the reputation of a firm. Its tangible effect is extra profit
which firms not possessing equal reputation do not earn.
This reputation will depend on:
(a) The personal reputation of the owners and/or management;
(b) The reputation of the goods dealt in or the quality of the service rendered;

(c) The peculiar advantage of the site of the business;

(d) The peculiar advantage available to it as regards sales or supplies of materials; and
(e) The patents, copyrights or trademarks owned by the firm, (but often a separate value is put on
these).
Those who purchase goodwill will acquire the name of the firm and also the site, the patents and
trademarks, etc., and existing contracts. All the factors named above result in extra profits and
hence goodwill will arise only when the business is profitable.
A business running into losses will have, generally, no goodwill. What has to be particularly
remembered is that it is the expectation of profits in future that makes goodwill a valuable asset.
A firm which has made good profits by virtue of an exceptionally favourable contract, that is not
to be renewed, cannot expect to get much for its goodwill.
Valuation of Goodwill:
Three methods are in use:
(a) Average Profits Basis:

In this method, the profits of the past few years are averaged and adjusted for any change that is
expected to occur in the near future. The adjusted average is multiplied by a certain number (say,
2 or 3 or 5) as agreed. It is expressed, for example, as 3 years purchase of five years average
profits. If, for example, the profits for the last five years have been Rs 80,000, Rs 90,000, Rs
70,000 Rs 85,000 and Rs 1, 00,000; the average yearly profit comes to

If, goodwill is to be valued at 3 years purchase of average profits for. 5 years, goodwill will be
Rs 85,000 x 3 = Rs 2, 55,000.
(b) Super Profits Basis:

In every industry, there is a rate which is considered to be the normal rate at which profits are
expected to the earned on capital employed. If a firm is able to earn more than the normal
expected profit, the excess is called super profits which can be attributed to the special
advantages of firm.
Suppose, the capital of the firm is Rs 4, 00,000 and that 15% is reasonable return in the industry.
The reasonable or normal profits are Rs 60,000. If the average profits are Rs 85,000, the super
profits in this case come to Rs 25,000. Super Profits multiplied by the number of years purchase
agreed upon gives goodwill. In the example given above, if goodwill is to be calculated at 3
years purchase, the goodwill is Rs 75,000 i.e. Rs 25,000 x 3.
(c) Capitalisation Method:

In this method, the value of the whole business is found out by the formula,

Then, from this figure, the net assets (excluding goodwill) of the firm are deducted and the
remainder is goodwill. In the example given above, the value of the whole business is

or 15, 66,667. Net assets (excluding goodwill) or capital is Rs 4, 00,000. Hence, the goodwill is
Rs 1, 66,667 i.e. Rs 5,66,667Rs 4,00,000.
The necessity for the valuation of goodwill in a firm arises in the following cases:
(a) When the profit-sharing ratio amongst the partners is changed;
(b) When a new partner is admitted;
(c) When a partner retires or dies; and
(d) When the business is sold;
In the last case, obviously, the value of goodwill will be a matter for negotiation between the
firm and the intending purchaser.
Accounting Treatment of Goodwill:
Because of the provisions of the Accounting Standard 10 on Accounting for Fixed Assets,
accounting treatment of goodwill has undergone a fundamental change.
Consider extract of the Accounting Standard which runs as follows:
Goodwill should be recorded in the books only when some consideration in money or moneys
worth has been paid for it. Whenever a business is acquired for a price (payable in cash or in
shares or otherwise) which is in excess of the value of net assets of the business taken over, the
excess should be termed as goodwill.

It means that goodwill can appear in the books only when it has been paid for. When a business
is acquired and the consideration paid for it exceeds the fair amount paid for net assets other than
goodwill, such excess can be recorded as goodwill.
Suppose, P and Q are equal partners in a firm. They take over the business of XY (Pvt.) Ltd. for
Rs 20, 00,000 payable in cash.
On the date of the takeover, the abridged balance sheet of the private company is as
follows:

The firm takes over all the assets and liabilities at book values except that machinery is valued
by an expert at Rs 8, 94,000 and a provision for bad debts @2% is created against debtors.
The journal entries in the books of the partnership firm will be as follows:

A firm cannot raise a goodwill account for internally generated goodwill although it may be sure
that if it sells its business, it will be able to get a certain sum of money for its goodwill. In this
connection, paragraphs 35, 36 and 37 of Accounting Standard 26 on Intangible Assets (issued in
2002) are noteworthy.
These paragraphs run as follows:
35. Internally generated goodwill should not be recognized as an asset:
36. In some cases, expenditure is incurred to generate future economic benefits, but it does not
result in the creation of an intangible asset that meets the recognition criteria in this statement.
Such expenditure is often described as contributing to internally generated goodwill. Internally

generated goodwill is not recognized as asset because it is not an identifiable resource controlled
by the enterprise that can be measured reliably at cost.
37. Difference between the market value of an enterprise and the carrying amount of its
identifiable net assets at any point of time may be due to a range of factors that affect the value
of the enterprise. However, such differences cannot be considered to represent the cost of
intangible assets controlled by the enterprise.
The effect of the abovementioned provisions is that the question of raising goodwill account on a
change in profit sharing ratio among partners, admission of a new partner or retirement of a
partner or death of a partner does not arise any longer. However, in any one of the
abovementioned cases, the partners may agree upon a value of internally generated goodwill and
an appropriate adjustment entry involving the capital accounts of the concerned partners may be
passed.
Change in the Profit-sharing Ratio:
If partners decide to share profits in future in a ratio different from the one hitherto, the gaining
partner must compensate the losing partner unless otherwise agreed upon. The compensation is
the value of goodwill represented by the gain because the change in profit-sharing ratio means
that one partner is purchasing from another partner a share of the profits previously belonging to
the latter. Suppose, A and B, are partners sharing profits in the ratio of 3: 1 respectively. It is
decided that in future both will be equal partners; it means that A is selling to B 1/4th share of
profits.

Therefore, B will pay to A an amount equal to one-fourth of the total value of goodwill. In
concrete terms, suppose, the profit is Rs 60,000, previously A would get Rs 45,000 and B would
get Rs 15,000. After the change in the profit-sharing ratio, each would get Rs 30,000 A,
therefore, loses annually Rs 15,000 and B gains Rs 15,000. If the goodwill is valued at Rs 1,
50,000, B must pay A one-fourth of Rs 1, 50,000 viz., Rs 37,500.
Illustration 1:
A, B and C are partners who were sharing profits in the ratio of 6:5:2 respectively. On 1st April,
2010, they, agree to become equal partners. The value of firms goodwill is agreed upon to be Rs
78,000. Pass the necessary adjustment entry.

Illustration 2:
A and B are partners sharing profits as to A 3/4 and B 1/4. The capitals are A Rs 90,000 and B Rs
30,000. It is decided that with effect from 1st April, 2010 the profit-sharing ratio will be: A 5/8
and B 3/8. The partnership deed states that goodwill is to be valued at 2 years purchase of three
years profits and those capitals of the two partners should be proportionate to the profit-sharing
ratio. The profits for the years ended 31st March, 2008, 31st March, 2009 and 31st March, 2010
were Rs 42,000, Rs 39,000 and Rs 45,000 respectively. Make necessary journal entries.

A further problem to be tackled after the profit-sharing ratio has been changed is regarding bad
debts written off but subsequently received. It requires a treatment depending upon the intention
of the partners.
(a) If the debts were considered really bad and written off, the partners must have been debited in
the old ratio (through the Profit and Loss Account). On receipt of amounts due from such

debtors, the partners would be credited in the new ratio, again through the Profit and Loss
Account, this account being credited when the amount is received.
(b) If the debts were written off only as a precautionary measure, the amount received (or for that
matter any appreciation in the value of assets) would be credited to the old partners in the old
ratio.
(c) Sometimes, on a true valuation of the asset or debts, the values of such assets and debts are
not changed but the amount of appreciation or loss is put in a Memorandum Revaluation
Account, the corresponding debit or credit being to the partners capital accounts in the old ratio
to be immediately written back, or written off in the new ratio. Thus, suppose, bad debts occur in
a firm to the extent of Rs 3,000. A and B, the two partners, share equally but now decide to share
in the ratio of 3: 2 in future. The accounts of the debtors are not to be changed.
Then, the entries will be:

If debts prove to be good and cash is received, the amount will be credited to the customers
accounts (it should be remembered that the debtors accounts were not written off). If the debts
prove to be finally bad, the loss should be written off to partners capital accounts in the new
ratio.

3. Capitalization Method:
Goodwill under this method can be calculated by capitalizing average normal profit or
capitalizing super profits.
(i) Capitalisation of Average Profit Method:

Under this method goodwill is ascertained by deducting Actual Capital Employed (i.e., Net
Assets as on the valuation date) from the capitalised value of the average profits on the basis of
normal rate of Return (also known as value of the firm or capitalised value of business)
Goodwill = Capitalised Value Net Assets of Business
Steps involved in calculating goodwill as per capitalisation of Average Profits Method:
Step 1: Calculate Average future maintainable profits
Step 2: Calculate Capitalised value of business on the basis of Average Profits

Step 3: Calculate the value of Net Assets on the valuation date

Net Assets = All Assets (other than goodwill, fictitious assets and non-trade investments) at their
current values Outsiders Liabilities
Step 4: Calculate Goodwill
Goodwill = Capitalised Value Net assets of business.
Illustration 5:
From the following calculate the value of goodwill according to capitalisation of Average
Profits Method:

(ii) Capitalisation of Super Profit Method:

The goodwill under this method is ascertained by capitalizing the super profits on the basis of
normal rate of return. This method assesses the capital needed for earning the super profit.
The value of goodwill is computed as follows:

Illustration 6:
Balance Sheet of X Ltd. on 31st March, 2013 was as under:

4. Annuity Method:
Under this method, goodwill is calculated by taking average super profit as the value of an
annuity over a certain number of years. The present value of this annuity is computed by
discounting at the given rate of interest (normal rate of return). This discounted present value of
the annuity is the value of goodwill. The value of annuity for Rupee 1 can be known by reference
to the annuity tables.
If the value of annuity is not given, it can be calculated with the help of following formula:

Illustration 7:
The net profit of a company after providing for taxation for the past five years is:

The net tangible assets in the business are Rs. 4, 00,000 on which the normal rate of return is
expected to be 10%. It is also expected that the company will be able to maintain its super profits
for next five years. Calculate the value of goodwill of the business on the basis of an annuity of
super profits, taking present value of an annuity of Rs. 1 for five years at 10% interest is Rs.
3.78.

The 4 important methods adopted for valuing goodwill are:

1.

by an arbitrary assessment.

2.

by a capitalization of expected net profits or earnings (or

Capitalization Method).

3.

by a certain number of years purchase of past average

profits or earnings.

4.

by super profits or earnings.

1.

Purchase of Super Profit

2.

Annuity Method

3.

Capitalization of super Profit Method.

Each of these methods will be discussed now.
(1) Arbitrary Assessment
The valuation of goodwill is arrived at by making a valuation
by one of the parties, i.e. vendor or purchaser to which the
other agrees. The parties may together estimate the value to
be placed on the goodwill or an independent party may be
called in to give his opinion as to the value, it being left to the
parties to decide whether they will accept or reject such
valuation. This method can be used only when information
relating to earning capacity is available. If this information is
not available because of non-availability of the profit
immediately prior to sale or if the profits are abnormal or
unreliable then such profits cannot be used as a guide to
future profits. Similarly information relating to earning
capacity may not be available if the business being acquired
may be converted into one of a different nature from that
existing prior to date of purchase such as where a retail shop
dealing in garments is purchased with a view to converting it

to a pharmacy. Consideration should also be given to the

question of trading advantages (e.g., quotas) made available
to the purchaser by a vendor and licenses to import goods up
to authorized values. There are really no guides obtainable
from the accounting data as to the valuation of such benefits
passed on to the purchaser and their worth remains a matter
of assessment to be agreed upon by the parties.
(2) Capitalization of Expected Future Net Profits (or
Capitalization Method)
The following are the main steps to be taken in computing
good will by this method:
a) Ascertain the average net profit which it is expected will
be earned in future.
b) Capitalize this net profit at the rate which is considered a
suitable return on capital invested in a business of the type
under consideration.
c) Find the value of the net tangible assets used in the
business, i.e., assets less outside liabilities : (here outside
liabilities will also include preference capital) and
d) deduct the net tangible assets as per (a) from the
capitalized profit obtained in (b) and the difference is
goodwill.
Past adjusted profits generally provide the basis for
ascertaining the average .net profit which it is expected will be

earned in .the future. A reduction is, made for remuneration

of proprietors (if that has not-already. been done) and in the
case of a limited company, income tax payable on such profit.
If, of course, it is known that certain expenses will not recur or
that other or increased expenses are likely to be incurred, then
due allowance should be made for these. The main difficulty
in valuing goodwill by this method is arriving at what return
on capital is deemed appropriate to the particular business
concerned. Normal return on capital invested in a business
depends on the pure interest (i.e., the return which can be
expected without incurring any risk, as, return on buying
government securities), the business risk (i.e. a margin, to
cover the ordinary risks attendant in business) and the
financial risk.
The future maintainable profit needs elaboration. While
making an estimate of future maintainable profit on the basis
of past profits, the following points arc to be taken into
consideration :

All unusual working expenses should be excluded.

Interest on debentures and depreciation on all fixed assets
should be excluded. If fixed assets are revalued for goodwill
purpose, depreciation should be based on the revalued figures
of fixed assets.

Non-trading assets such as non-trading investments

should be excluded from the capital employed and income

derived from such assets should also be excluded from profit.

All necessary provisions for liabilities such as provision

for taxation should be made. But appropriations of profits
such as amount transferred to general reserves, sinking fund
for redemption of a liability and dividend equalization reserve
should not be taken note of as such transfers merely transfer
profit from one account to another account and the
availability of maintainable profit is not affected.

Preference dividend should be deducted.

While calculating average profits, profits for the past four

or five years during which conditions have remained normal

should be considered.

Effects of developments which have already taken place

but whose results are likely to come in the future should also
be considered.

If the profits of the past four or five years have been

increasing or decreasing in a significant manner, it will be
better to give more importance to the profits of the last year
and least importance to the profits of the first year. This is
because conditions of the last year are likely to have more
effect on future maintainable profits. This can be taken care of
by taking weighted average profit by assigning weights as
1,2,3,4 and 5 to the profits of 1st year, 2nd year, 3rd year, 4th year

and 5th year respectively. This practice is not to be followed if

there is consistent decline of profits. In that case, profits for
the future should be lower than the profits for the latest year.
(3) Purchase of fast Average Profits :
This method of valuing goodwill is commonly met with in
practice and probably is the one most generally understood. It
is calculated on the following basis:

The profit (gross or net) for an agreed number of years

preceding valuation are averaged so as to arrive at the average
annual profit earned .during that period. Avenge used may be

simple or weighted.

The goodwill is then estimated to be worth so many

years purchase of such average profit. The number of years
selected is presumed to bear relation to the number of years
benefit to be derived from past association.
This method is generally adopted when a partner dies or
retires and a clause to this effect is frequently found in
partnership agreements.
The number of years over which the profits are averaged and
the number of years purchase applied, may considerably vary
in practice but generally fall between one and five years. This
method suffers from two defects, i.e., the uncertainty as to me
number of years purchase of profits and no account is taken

of the capital to be employed in the business. The profit which

should be taken for the purpose is normal.
This method is adopted for valuing the goodwill of the
professional persons or firms such as Chartered or Cost
Accountants, Doctors, Advocates, etc. It ignores the amount of
capital employed for earning the profit.
(4) Super Profits :
It is the excess of the average profits over the normal profits
based on normal rate of return for representative firm in
industry. For computation of super profit, the following three
factors are required :
(i) Normal rate of return. This is the rate of profit or return
which an investor expects on his investment in a particular
type of industry. It may be aggregate of pure rate of return
(i.e., return on risk free securities) and risk rate of return.
(ii) Capital employed. It may be calculated on the basis of
assets side items or liabilities side items.
Proceeding from assets side capital employed = Fixed Assets
+ Trade Investments + Current Assets Debentures
Current Liabilities.
Proceeding from liabilities side :
Capital employed = paid up equity and preference share
capital + Accumulated balance on capital reserves, general
reserves and credit balance in profit and loss account
Revaluation profits (or loss) Fictitious assets Nontrading assets.

A refinement in the figure of capital employed can be

average capital employed. Average capital employed can be
calculated as follows :
Average Capital Employed
= (Capital employed at the beginning + Capital employed
at the end of the year) or Average Capital Employed
= Capital employed at the end of the year of current
years profit after tax.
= Capital employed at the beginning of the year + of
current years profit after tax
(iii) Normal Profit. It is calculated by multiplying the
normal rate of return with capital employed or average
capital employed as the case may be.
Super Profit method has three variations i.e.
(a) Purchase of Super Profit.
(b) Annuity Method.
(c) Capitalization of Super Profit.
(a) Purchase of Super Profits
In this method of valuing goodwill, attention is focused upon
super profits which are those profits remaining after
deducting from the estimated annual future profit:
(a) reasonable remuneration of proprietors and
management, and
(b) an amount considered to be a reasonable return on the
amount of capital invested in the tangible assets.

While averaging the past profits it is desirable to cover a span

of years, in such a way as to include all possible seasonal
changes and fluctuations. Allowance should be made for
expenses charged against past profits which arc not likely to
recur and also for expenses which are likely to recur in the
future. The next step is to reduce this by amount which is
considered to be reasonable in respect of the services of the
proprietors. This reduction would only be made where there
had been no such charge for management against the average
profit selected. The matter of taxation may also require to be
considered from the purchasers point of view.
There must also be deducted an amount which is calculated to
be a reasonable return on the capital invested in tangible
assets. The reasonable return differs from business to
business.
This percentage is then applied to the capital invested and the
resulting figure deducted from the already reduced average
profit, the final result giving the average annual super profit.
On this basis the goodwill is to be calculated, say five years
purchase of super profits, then it will be arrived at by
multiplying the average annual super profits referred to above
by five. If the super profits are large, a large number of years
purchase is allowed for calculating the value of goodwill. In
case of professional people, goodwill is usually valued on the

basis of one years purchase of gross fees earned because in

case of a profession personal skill of the professional will play
a very important role in earning the income.
There are three methods of valuation of goodwill of the firm;
1. Average Profits Method
2. Super Profits Method
3. Capitalisation Method

1. Average Profits Method:

Under this metod goodwill is calculated on the basis of the average of some agreed
number of past years. The average is then multiplied by the agreed number of years.
This is the simplest and the most commonly used method of the valuation of goodwill.
Goodwill = Average Profits X Number of years of Puchase
Before calculating the average profits the following adjustments should be made in the
profits of the firm:
a. Any abnormal profits shoulld be deducted from the net profits of that year.
b. Any abnormal loss should be added back to the nat profits of that year.
c. Non operating incomes eg. income from investments etc should be deducted from the
net profits of that year.
Now we will explain this method with the help of a simple example.

A Ltd agreed to buy the business of B Ltd. For that purpose Goodwill is to be valued at
three years purchase of Average Profits of last five years. The profits of B Ltd. for the last
five years are:
Year

Profit/Loss ($)

2005

10,000,000

2006

12,250,000

2007

7,450,000

2008

2,450,000 (Loss)

2009

12,400,000

Following additional information is available:

1. In the year 2008 the company suffered a loss of $1,000,500 due to fire in the factory.
2. In the year 2009 the company earned an income from investments outside the
business $ 4,500,250.
Solution:
Total profits earned in the past five years= 10,000,000 + 12,250,000 + 7,450,000
2,450,000 + 12,400,000 = $ 39,650,000
Total Profits after adjustments = $ 39,650,000 + $ 1,000,500 $ 4,500,250=$
36,150,250
Average Profits= $ 36,150,2505=$ 7,230,050

Goodwill = $ 7,230,0503=$ 21,690,150

Thus A Ltd would pay $21,690,150 as the price of Goodwill earned by B Ltd.

2. Super profits method:

Super Profits are the profits earned above the normal profits. Under this method
Goodwill is calculated on the basis of Super Profits i.e. the excess of actual profits over
the average profits. For examplle if the normal rate of return in a particular type of
business is 20% and your investment in the business is $1,000,000 then your normal
profits should be $ 200,000. But if you earned a net profit of $ 230,000 then this excess
of profits earned over the normal profits i.e. $ 230,000 $ 200,000= Rs.30,000 are
your super profits. For calculating Goodwill, Super Profits are multiplied by the agreed
number of years of purchase.
Steps for calculating Goodwill under this method are given below:
i) Normal Profits = Capital Invested X Normal rate of return/100
ii) Super Profits = Actual Profits Normal Profits
iii) Goodwill = Super Profits x No. of years purchased
For example, the capital employed as shown by the books of ABC Ltd is $ 50,000,000.
And the normal rate of return is 10 %. Goodwill is to be calculated on the basis of 3 years
puchase of super profits of the last four years. Profits for the last four years are:
Year

Profit/Loss ($)

2005

10,000,000

2006

12,250,000

2007

7,450,000

2008

5,400,000

Total profits for the last four years = 10,000,000 + 12,250,000 + 7,450,000 +
5,400,000 = $35,100,000
Average Profits = 35,100,000 / 4 = $ 8,775,000
Normal Profits = 50,000,000 X 10/100 = $ 5,000,000
Super Profits = Average/ Actual Profits Normal Profits = 8,775,000 5,000,000 = $
3,775,000
Goodwill = 3,775,000 3 = $ 11,325,000

3. Capitalisation Method:
There are two ways of calculating Goodwill under this method:
(i) Capitalisation of Average Profits Method
(ii) Capitalisation of Super Profits Method
(i) Capitalisation of Average Profits Method:
Under this method we calculate the average profits and then assess the capital needed
for earning such average profits on the basis of normal rate of return. Such capital is
called capitalised value of average profits. The formula is:Capitalised Value of Average Profits = Average Profits X (100 / Normal Rate of Return)
Capital Employed = Assets Liabilities
Goodwill = Capitalised Value of Average Profits Capital Employed

For example a firm earns $40,000 as its average profits. The normal rate of rteturn is
10%. Total assets of the firm are $1,000,000 and its total external liabilities are $
500,000. To calculate the amount of goodwill:
Total capitalized value of the firm = 40,000 100/10 = 400,000
Capital Employed = 1,000,000 500,000 = 500,000
Goodwill = 500,000 400,000 = 100,000

(ii)Capitalisation of Super Profits:

Under this method first of all we calculate the Super Profits and then calculate the
capital needed for earning such super profits on the basis of normal rate of return. This
Capital is the value of our Goodwill . The formula is:Goddwill = Super Profits X (100/ Normal Rate of Return)
For example ABC Ltd earns a profit of $ 50,000 by employing a capital of $ 200,000,
The normal rate of return of a firm is 20%. To calculate Goodwill:
Normal Profits = 200,000 20/100 =$ 40,000
Super profits = 50,000 40,000 = $10,000
Goodwill = 10,000 100 / 20 = $50,000

Concept Of Goodwill
The name and fame of an organization can be termed as goodwill. Goodwill is the
benefit and merit of good name and reputation. Goodwill refers to a measure of the
capacity of a business to earn excess profit. Therefore, goodwill can be defined as
an intangible asset of the business.
Thus, goodwill may also be defined as "value of the reputation of business". It is a
valuable asset if the concern is profitable. It is useless if the concern is a loosing
concern. Goodwill can be described as the extra sale able value attached to a
prosperous business beyond the intrinsic value of net assets. Thus the existence of
goodwill can be felt through extra earning power. Because of such a nature, it seems

like a real assets. But since it is invisible such as patents, trademark, copyrights etc.
goodwill is termed as intangible assets.
Need For Valuation Of Goodwill
The need for valuation of goodwill arises in various circumstances. Some of the
circumstances are as follow:
1. In the case of sole trading concern, goodwill is valued at the time of selling of
business, to take any person as a partner, to convert sole trading concern into a
company.
2. In the case of partnership, when there is an admission, retirement and death of
partner, amalgamation, conversion into a company and change in profit sharing
ratio.
3. In the case of company, goodwill is valued at the time of amalgamation of two or
more companies, absorption of company, reconstruction and holding company. The
valuation of goodwill also becomes necessary, if the shares have to be valued on
the basis of intrinsic value, market value or fair value and if the stock exchange
quotation of the value of shares of a company is not available.
4. For taxation purpose such as wealth tax also, the valuation of goodwill is
necessary