DEFINITION

Goodwill is a long-term (or non-current) asset categorized as an

intangible asset. Goodwill arises when a company acquires another
entire business. The amount of goodwill is the cost to purchase the
business minus the fair market value of the tangible assets, the
intangible assets that can be identified, and the liabilities obtained in
the purchase.
Outside of accounting, goodwill might be referring to some value that
has been built up within a company as a result of delivering amazing
customer service, unique management, teamwork, etc. However, this
goodwill is unrelated to a business combination and cannot be
recorded or reported on the company's balance sheet.
The amount in the Goodwill account will be adjusted to a smaller
amount if there is impairment in the value of the acquired company
as of a balance sheet date.
Goodwill is reported on the balance sheet as a long-term or non-
current asset.
METHODS OF VALUATION OF GOODWILL

 Average maintainable profits method

 Super profit method

 Capitalisation method

 Annuity method

 Hidden method
Average Maintainable Profit Method
Under this method, average profit means average profits of actual
profits of past three to five years depending upon the nature of
business. The average of actual profits must be adjusted in the light of
future events that may affect the future profits so this method is also
known as” future maintainable profits”. Under this method, we can
calculate the value of goodwill by multiplying the average future
maintainable profits by a certain number of years. The following
formula used for calculating the value of goodwill:
Step 1:- Calculate average maintainable profits of past few years as
follow-
Average maintainable profits = Total adjusted profits / No. of years
Step 2 :- Calculate the Value of goodwill by using the following
formula-
Goodwill = Average maintainable profits x Number of years
purchased.
To calculate the total adjusted profits, the following adjustments
should be made in the profits.
 Any abnormal losses such as strikes, floods, and accidents etc.
should be added back to the past profits.
 Any abnormal profits should be deducted from the past profits.
 Interest, remuneration, commission etc. should be adjusted.
 The past average profits should be calculated after deducting
tax at current rates.
Super profits method
Under this method, the value of goodwill is calculated on the basis of
super profits. Super profits are the profits that are earned above the
normal profits i.e. In excess of the actual profits over the normal profits.
For calculating the value of goodwill, following formula should be
followed:-
Super Profits = Actual Profits – Normal Profits
Normal Profits = Capital Invested x Normal rate of return/100
Goodwill = Super Profits x No. of years purchased

Capitalisation Method
Under this method, the value of goodwill is calculated by two ways :
a) Capitalisation of average profits method
b) Capitalisation of super profits method
Capitalisation of average profit method
The formula for calculating the value of goodwill under capitalization
of average profits method is as follows-
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

Capitalisation of Super Profits

For calculating the value of goodwill under this method, the formula
is as follow-
Goodwill = Super Profits x (100/ Normal Rate of Return)
Problem :
The net profits of a Company, after providing for taxation, for the past
five years are Rs. 42,000; Rs. 47,000; Rs. 45,000; Rs. 39,000 and Rs.
47,000. The capital employed in the business is Rs. 4,00,000 on which a
reasonable rate of return of 10% is expected.
Calculate the goodwill under:
(a) Capitalisation of Average Profit Method and
(b) Capitalisation of Super Profit Method.
Annuity method
Under this method, the time value of money is taken into
consideration . Annuity method is a variation of a number of years
purchased method. Under this method, to calculate the value of
goodwill of the firm the following formula is used:
Goodwill = Super profits per annum x Relevant annuity value
Hidden Goodwill
Under hidden goodwill method, the value of goodwill is calculated on
the basis of capital contributed by the partners and their respective
share in the firm.
Hidden goodwill method is used in such case when no particular
method of valuation of goodwill or information is provided in the
question. The steps to compute the value of hidden goodwill are:-
Total capital = New partner capital x Reverse of new partner’s share
Now, from the total capital, the combined capital of the all the
partners are to be deducted.
Balance is the value of goodwill
Problem:
From the following information find out Goodwill (a) as per annuity
method, (b) as per 4 years’ purchase of super profit, and (c) as per
capitalisation of super profit method.
Net profits for four years:
I year Rs. 30,000; II year Rs. 40,000 III year Rs. 50,000; IV year Rs. 60,000.
The profit includes non-recurring profits on an average basis of Rs.
3,000.
Rs.
Average capital employed 3,00,000
Normal rate of profit 10 %
Present value of annuity of Re.1 for 4 years at 10% is 2.5.
Problem 3 (Capitalisation Method):
Balance Sheet of Mr. X as on 31st Dec. 2004 was as under:

Find out Goodwill by Capitalisation Method.

Solution:
Problem (Capitalisation of weighted average profit):
P. Ltd. proposed to purchase the business carried on by Mr. A. Goodwill
this purpose is agreed to be valued at three years purchase of the weighte
average profits of the past four years.
The appropriate weights to be used are:

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

(a) On 1st September 2003, a major repair was made in respect of the
plant incurring Rs. 30,000 which amount was charged to revenue. The
said sum is agreed to be capitalised for goodwill calculation subject to
adjustment of depreciation of 10% p.a. on reducing balance method.
(b) The closing stock for the year 2002 was overvalued by Rs. 12,000.
(c) To cover management cost of annual charge of Rs. 24,000 should be
made for the purpose of goodwill valuation.
Compute the value of goodwill of the firm.
Solution: