GOODWILL AND VALUATION OF

GOODWILL
1. GOODWILL
Goodwill is an intangible asset that arises as a result of the acquisition of
one company by another for a premium value.
The value of a companys brand name, solid customer base, good customer
relations, good employee relations and any patents or proprietary
technology represent goodwill.
Goodwill is considered an intangible asset because it is not a physical
asset like buildings or equipment.
The goodwill account can be found in the assets portion of a
company's balance sheet.

2. METHODS OF VALUATION OF GOODWILL

There are three methods of valuation of goodwill of the firm:
Average Profits Method
Super Profits Method
Capitalisation Method

2(a). Average Profits Method:

Under this method 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 * No. of years of Purchase

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 (Rs)

2001

20,000

2002

22,000

2003

24,000

2004

(26,000)

2005

40,000

Following additional information is available:

1. In the year 2008 the company suffered a loss of Rs 10,000 due to fire in
the factory.
2. In the year 2009 the company earned an income from investments outside
the business Rs 50,000.

Solution:
Total profits earned in the past five years

Total profits
Total profits
Loss due to fire
Income Earned from outside business
Total profits after adjustments

20,000
22,000
24,000
(26,000)
40,000
80,000
80,000
(10,000)
50,000
1,20,000

Average Profits = 1,20,000 5 = Rs. 24,000

Goodwill = Average Profits * No. of years of Purchase

Goodwill = 24,000 * 3 = Rs. 72,000

Thus A Ltd would pay Rs. 72,000 as the price of Goodwill

earned by B Ltd.

2(b). Super Profits Method:

3

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 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 * Normal rate of return / 100
ii) Super Profits = Actual Profits Normal Profits
iii) Goodwill = Super Profits * No. of years purchased
Example: The capital employed as shown by the books of ABC Ltd is Rs.
50,000 and the normal rate of return is 10 %. Goodwill is to be
calculated on the basis of 3 years purchase of super profits of the last
four years. Profits for the last four years are as follows .
Year

Profit/Loss (Rs)

2001

10,000

2002

20,000

2003

30,000

2004

40,000

Total profits earned in the past five years

Total profits

10,000
20,000
30,000
40,000
100,000

Average Profits = Total Profit / No. Of Years

= 100,000 / 4
= Rs. 25,000
Normal Profits = Capital Employed * Normal Rate of Return
= 50,000 * 10 / 100
= Rs. 5,000
Super Profits

= Average Profits Normal Profits

= 25,000 5,000
= Rs. 20,000

Goodwill

= Super profits * No. of years Purchase

= 20,000 * 3
= Rs. 60,000