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Chapter 2 Goodwill: Nature and Valuation

Meaning of Goodwill: It is the value of good name or reputation enjoyed by a firm that enables it to earn
profit over and above the normal profits.
Features of Goodwill:
1. It is an intangible asset (cannot be seen or touched).
2. It cannot have existence separate from that of an enterprise.
3. Its value depends on the subjective judgment of the valuer.
4. Its helps to earn higher profits.
5. It is an attractive force which brings in customers to old place of business.
6. It comes into existence due to various factors such as locational advantages, favourable contracts,
location and market reputation.
Nature of Goodwill: It is an intangible asset. Intangible asset means an asset not having physical existence.
But it is not fictitious asset. It can be sold, though a sale will be possible only along with the sale of the business
itself sometimes, goodwill has more value than the tangible asset.
Need for valuing Goodwill:
1. When there is a change in the profit sharing ratio.
2. When a new partner is admitted.
3. When a partner retires or dies.
4. When partnership firm is sold as a going concern.
5. When two firms amalgamate.
Factors affecting the value of Goodwill:
1. Efficient Management
2. Location of a business
3. Favourable Contracts
4. Advantages of Patents
5. Access to supplies
6. quality
7. Market Situation
8. Nature of business
9. Other factors like after sale service, past performance of the firm, Good customer relations and Good
labour relations, etc.
Classification of Goodwill: Goodwill can be classified into two categories:
1. Purchased Goodwill
2. Self-generated Goodwill
Purchased Goodwill: It is the Goodwill that is acquired by making a payment. For example, when a
business is purchased, the excess of purchase consideration of its Net Assets (Assets- Liabilities) is the
Purchased Goodwill.
Features of Purchased Goodwill:
1. It arises on the Purchase of a business or purchase of a brand, etc.
2. It is recorded in the books of accounts.
3. It is shown in the Balance Sheet as an Asset.
4. Value of Goodwill is a subjective judgement but is is ascertained when both purchaser and seller agree
to its valuation.
Self generated Goodwill: It is an internally generated goodwill which arises from a number of factors(such
as location, management, good quality of products, etc.) that a running business possesses due to which it is
able to earn higher profit.
Features of Self generated Goodwill:
1. It is generated internally, generally over the years.
2. As per AS-26, internally generated goodwill is not to be recognised as an asset(Not to be recorded in the
books of accounts)
3. Valuation depends on the subjective judgement of the valuer.
Methods of Valuation of Goodwill:
1. Average Profit Method(Simple Average Profit and Weighted Average Profit)
2. Super Profit Method
3. Capitalisation Method(Capitalisation of Average Profit and Capitalisation of Super Profit)