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Goodwill - Nature and Valuation

Define Goodwill. [2006]
Answer:
Goodwill is the excess amount paid for purchasing a running business as a
whole, over the book values or over the computed value of all tangible assets
purchased from that business. Normally, goodwill thus acquired is only of one type
( i.e. purchased), appearing in books of account and in financial statements.
How does the market situation affect the value of goodwill of a firm? [2011]
Answer:
The monopoly condition or limited competition enables the concern to earn high
profits which leads to higher value of goodwill because demand for the products
dealt in is higher than the supply resulting in lower capital requirement and higher
profits.
How does the nature of business affect the value of goodwill of a firm?[2019,2011]
Answer:
The firm that produces high value products and has stabilized demand, will be able
to earn more profit and more goodwill because of repeated sales and sound
customer base.
How does the factor ‘quality of product' affect the goodwill of a firm? [2010]
Answer:
If the firm enjoys good reputation for its product quality, there will be higher sales
and the value of its goodwill will increase because this will not only retain existing
customers but also bring new customers too thereby increasing sales as well as
customer base.
How does the factor ‘efficiency of management’ affect the goodwill of a firm?
[2010]
Answer:
When the management of a firm is capable and competent, the firm will earn
higher profits, therefore, the 'efficiency of management' surely will affect or
increase the goodwill. Efficiency of management results in cost savings as well as
in time saving resulting in increase in sales as well as profits.
How does the factor location affect the goodwill of a firm? [2010, 2009]
Answer:

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The value of the business will be more if it is located in a convenient or prominent

locality. A location is said to be favourable when customers can easily approach
the business.
On 1st April, 2014 a firm had assets of Rs 1,00,000 excluding stock of Rs 20,000.
Partners’ capital accounts showed a balance of Rs 60,000. The current liabilities
were Rs 10,000 and the balance constituted the reserve. If the normal rate of return
is 8% the ‘Goodwill’ of the firm is valued at Rs 60,000 at four years’ purchase of
super profit, find the average profit of the firm. [2015]
Answer:
Goodwill = Super Profit ×× Number of Years' Purchase
60,000 = Super profit ×× 4
Super profit = 60,000460,0004 = 15,000
Capital Employed
⇒⇒ Total Assets - Current Liabilities
⇒⇒ (1,00,000 + 20 ,000) - 10,000
⇒⇒ Rs 1,10,000
Normal Profit = Capital Employed ×× Normal Rate of Return
= 1,10,000×8100×8100 = Rs 8,800
Super Profit = Average Profit - Normal Profit
15,000 = Average profit - 8,800
Average profit = 15,000 + 8,800 = Rs 23,800
The average profit earned by a firm is Rs 75,000 which includes undervaluation of
stock of Rs 5,000 on an average basis. The capital invested in the business is Rs
7,00,000 and the normal rate of return is 7%. Calculate goodwill of the firm on the
basis of 5 times the super profit. [2015]
Answer:
Average profit =75,000+ 5,000 = Rs 80,000
Normal Profit = Capital Employed ×× Normal Rate of Return
= 7,00,000 ×7100×7100= Rs 49,000
Super Profit = Average Profit - Normal Profit
= 80,000 - 49,000 = Rs 31,000
Goodwill = Super Profit ×× Number of Years' Purchase
= 31,000××5 = Rs 1,55,000
State any three circumstances other than (i) death of a partner (ii) admission of a
partner and (iii) retirement of a partner when need for valuation of goodwill of a
firm may arise. [2016]
Answer:
The need for valuation of goodwill may arise:-

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1. When there is a Change in Profit Sharing Ratio: In case the existing

partners in the firm decide to mutually change the profit sharing ratio
between them, there is a need to value the goodwill.
2. When the Partnership Firm is Sold as Going Concern: The need for
valuation of goodwill arises, in case the partnership firm is sold to some
other concern on going basis.
3. When Two Firms Amalgamate: The need for valuing also arises in case of
amalgamation of two firms that is merger or acquisition of two business.

Main need for valuing goodwill arises whenever there is a change in profit sharing
ratio among partners due to any reason e.g. change in ratio between existing
partners, Due to Admission of a new partner, Due to Retirement / Death, Sale /
Amalgamation of firm etc. The objective being to compensate the sacrificing
partners by the gaining partners.
Why ‘Goodwill’ considered an ‘Intangible Asset’ but not a ‘Fictitious Asset’?
[2009]
Answer:
Goodwill is considered as an 'intangible asset' because it cannot be seen or touched
but it helps the business to earn more profits like other assets of the business. It is
shown in the balance sheet of the firm under the head of 'fixed assets'. Goodwill is
not a 'fictitious asset' because it can be purchased or sold like other fixed assets of
the business.
A business has earned average profits of Rs 1,00,000 during the last few years and
the normal rate of return in a similar business is 10%. Find out the value of
goodwill by

1. Capitalisation of super profit method.

2. Super profit method, if the goodwill is valued at 3 years’ purchase of super
profit.

The assets of the business were Rs 10,00,000 and its external liabilities Rs
1,80,000.
[2011]
Answer:

1. As per Capitalisation of Super Profit Method

Goodwill = Super Profit×100 Normal Rate of Return ×100 Normal Rate of
Return = 18,000×10010×10010= Rs 1,80,000

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2. As per Super Profit Method

Goodwill = Super Profit ××Number of Years' Purchase
= 18,000 ××3 = Rs 54,000

Working Notes:

• Capital Employed = Total Assets - External Liabilities

= 10,00,000 - 1,80,000 = Rs 8,20,000

• Normal Profit = Capital Employed× Normal Rate of Return 100× Normal

Rate of Return 100

= 8,20,000 ×10100×10100= Rs 82,000

• Super Profit = Average Profit - Normal Profit

= 1,00,000 - 82,000 = Rs 18,000

A partnership firm earned net profits during the last 3 years as follows
Year Net Profit
2007-2008 1,90,000
2008-2009 2,20,000
2010-2011 2,50,000
The capital employed in the firm throughout the above mentioned period has been
Rs 4,00,000. Having regard to the risk involved, 15% is considered to be a fair
return on the capital. The remuneration of all the partners during this period is
estimated to be Rs 1,00,000 per annum. Calculate the value of goodwill on the
basis of

1. 2 years’ purchase of super profits earned on average basis during the above
mentioned 3 years and
2. By capitalisation method.

[2011]
Answer:

1. Goodwill = Super Profit ×× Number of Years' Purchase

= 60,000 ×× 2 = Rs 1,20,000

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2. Capitalised Value of Goodwill = Super Profit ×100 Normal Rate of

Return ×100 Normal Rate of Return
= 60,000×10015×10015 = Rs 4,00,000

working Notes:
3 years' total profit = 1,90,000 + 2,20,000 + 2,30,000= Rs 6,60,000
Average profit = 6,60,00036,60,0003= Rs 2,20,000
(-) Remuneration to partners = Rs 1,00,000
Actual average profit = Rs 1,20,000
Capital employed = Rs 4,00,000
Normal rate of return =15%
Normal profit = 4,00,000×15100×15100 = Rs 60,000
Super Profit = Actual Average Profit - Normal Profit
= 1,20,000 - 60,000 = Rs 60,000
Give two main steps involved in valuing the Goodwill by according to Super Profit
Method.
[2012]
Answer:
The steps involved in calculating the Goodwill by Super Profit method are as
follows:
Step 1. Calculation of Super Profit i.e. Average Profits - Normal Profits
Step 2. Calculation of Goodwill i.e. Super Profit ×× No. of years purchase
Neeraj and Dheeraj are carrying on a business of repairing electronic items. There
are no other technicians for repairing electronic items in the locality. As the
electric supply has a lot of fluctuations the equipments get damaged. Therefore,
both the partners themselves do the repairing work to the satisfaction of the
customers. The firm donates 10% of its profits to a Charitable Hospital of the
locality for the medical treatment of persons below poverty line. State the two
factors affecting the goodwill of the firm discussed in the above para. Also identify
any two values which the firm is trying to propagate.
[2016]
Answer:
The factors affecting the goodwill of the firm are:
1. Locational Factor:
If the firm is centrally located or located in a very prominent place, it can attract,
more customers resulting in an increase in turnover. Therefore, locational factor
should always be considered while ascertaining the value of goodwill.
2. Nature of Business:

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This is another factor which also influences the value of goodwill which
includes:
(i) The nature of goods;
(ii) Risk involved;
(iii) Monopolistic nature of business;
(iv) Benefits of patents and Trademarks; and
(v) Easy access of raw materials, etc.
The values which the firm is trying to propogate are:

1. Sensitivity towards people belonging to lower income group.

2. Working towards customer satisfaction.

What do you understand by Super Profits?

[2011]
Answer:
The term 'super profit' is described as excess profit of a business made over normal
profit. Normal profit means return on capital at the normal rate of return prevailing
in the industry.In simple words, it is the difference between Average Annual
Earning (actual) of the business and the expected or normal return on capital
invested in the business.
Under this method, goodwill is calculated on the basis of super profits. Normal rate
of return on the capital employed is compared with the actual average profits to
find out the super profits.
Super Profit = Average Profits – Normal Profits
Give the formula of goodwill by Capitalisation of Average Profits?
[2012]
Answer:
Goodwill = Capitalised Value of Average Profits - Net Assets
Capitalised Value = Average future Maintainable Profits Normal Rate of
Return ×100 Average future Maintainable Profits Normal Rate of Return ×100
When a similar type of business earns profit at a certain percentage of the capital
employed, it is called normal rate of return.
Give the formula of calculation of goodwill by Capitalisation of super profits
method.
[2012]
Answer:
Goodwill = Super Profit ×100 Normal rate of Return ×100 Normal rate of Return

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When a similar type of business earns profit at a certain percentage of the capital
employed, it is called normal rate of return.
J and K are partners in a firm. Their capitals are : J : Rs 3,00,000 and K :
Rs 2,00,000. During the year ended 31st March, 2010 the firm earned a profit of
Rs 1,50,000. Assuming that the normal rate of return is 20%, calculate the value of
goodwill of the firm :

1. By Capitalisation Method; and

2. By Super Profit Method if the goodwill is valued at 2 years’ purchase of
super profit.

[2011]
Answer:
Goodwill expresses the prudent value that a company can have beyond its assets,
by way of a good reputation and a solid customer base, for
example. Goodwill shows the value of a firm in terms of reputation thus calculated
as follows:-

1. Capitalisation Method :
Total Capitalised Value of the Firm
= Average Profit ×100 Normal Rate of Return = Average
Profit ×100 Normal Rate of Return
=31,50,000×10020=31,50,000×10020
= Rs 7,50,000
Goodwill = Total Capitalised Value of Business - Capital Employed
= Rs 7,50,000 - Rs 5,00,000 [i.e., Rs 3,00,000 (J) + Rs 2,00,000 (K)]
Goodwill = Rs 2,50,000
2. Super Profit Method :
Normal Profit = Capital Employed x Normal Rate of Return
= Rs 5,00,000 ×× 20/100 = Rs 1,00,000
Average Profit = Rs 1,50,000
Super Profit = Average Profit - Normal Profit
= 1,50,000 - Rs 1,00,000 = Rs 50,000
Goodwill = Super Profit x Number of Years’ Purchase
Goodwill = Rs 50,000 ×× 2 = Rs 1,00,000

A firm earned average profit of Rs.3,00,000 during the last few years. The normal
rate of return of the industry is 15%. The assets of the business were Rs.17,00,000
and its liabilities were Rs.2,00,000. Calculate the goodwill of the firm by
capitalisation of average profits.
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[2019]
Answer:
Actual profits = Rs.3,00,000
Capitalised value of the firm = (Average Profits x 100)/ Normal rate of return
= Rs. 3,00,000×100153,00,000×10015 = Rs. 5,00,000
Capital Employeed = Assets – Liabilities
= Rs.17,00,000 – Rs.2,00,000
= Rs.15,00,000
Goodwill = Capitalised value of the firm – Capital Employeed = Rs.20,00,000 -
Rs.15,00,000 = Rs.5,00,000
Average profits of a firm during the last few years are Rs.80,000 and the normal
rate of return in a similar business is 10%. If the goodwill of the firm is
Rs.1,00,000 at 4 years purchase of super profit, find the capital employed by the
firm.
[2019]
Answer:
Goodwill = Super Profits x 4
Rs. 1,00,000 = Super Profits x 4
Super Profits = Rs. 1,00,00041,00,0004 = Rs. 25,000
Super Profits = Average Profits - Normal Profits
Rs. 25,000 = Rs. 80,000 - Normal Profits
Normal Profits = Rs. 80,000 - Rs. 25,000 = Rs. 55,000
Capital Employed = 100NRR×100NRR× Normal Profits
Rs. 55,000 ×10010×10010 = Rs. 5,50,000
Name any two factors affecting goodwill of a partnership firm.
[2008]
Answer:

1. Favourable Location of the Business.

2. Efficiency of Management.

Yash and Karan were partners in an interior designer firm. Their fixed capitals
were ₹6,00,000 and ₹4,00,000 respectively. Their current account balances are
₹4,00,000 and ₹5,00,000 respectively. The firm had a balance of ₹1,00,000 in the
General Reserve. The firm did not have any liability. They admitted Radhika into a
partnership for 1/4th share in the profits of the firm. The average profits of the firm
for the last five years were ₹5,00,000. Calculate the value of goodwill of the firm
by the capitalization of the average profits method. The normal rate of return of the
business is 10%.

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[2020]
Answer:
Goodwill = Capitalised value of average profit - Capital employed
The capitalised value of average profit =Average Profits×100Normal rate of
return=Average Profits×100Normal rate of return
=₹5,00,000×10010=₹5,00,000×10010
= ₹50,00,000
Capital employed = Yash’s Capital + Karan’s capital + Yash’s Current Account +
Karan’s
Current Account + General reserve
= ₹6,00,000 + ₹4,00,000 + ₹4,00,000 + ₹5,00,000 + ₹1,00,000
= ₹20,00,000
Goodwill = ₹50,00,000 - ₹20,00,000
= ₹30,00,000
Kabir and Farid are partners in a firm sharing profits in the ratio of 3:1 on 1-4-2019
they admitted Manik into a partnership for 1414th share in the profits of the firm.
Manik brought his share of goodwill premium in cash. Goodwill of the firm was
valued on the basis of 2 years purchase of the last three years average profits. The
profits for the last three years were:
2016-17 ₹ 90,000
2017-18 ₹ 1,30,000
2018-19 ₹ 86,000
Profit of 2018-19 is calculated after deducting the loss of ₹ 30,000 due to fire.
Calculate the value of goodwill and pass the necessary journal entries for the
treatment of goodwill.
[2020]
Answer:
In the books of Kabir and Farid
Journal
Date Particulars L.F. Dr. (₹)
2019 Apr.01 Premium for Goodwill A/c Dr. 56,000
To Kabir’s Capital A/c
To Farid’s Capital A/c
(Being share of goodwill credited to the existing partners in 3:1)
Working Notes:
Average Profit for the =90,000+1,30,000+(86,000+30,000)3=90,000+1,30,000+(86,000+30,00
last three years 1,12,000
Goodwill of the firm = Average Profits of the last three years ×× Number of Years’ Purchase
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(1,12,000 ×× 2) = ₹ 2,24,000
Manik’s share of
= ₹ (2,24,000 ×× ¼) = ₹ 56,000
goodwill
Sacrificing Ratio
among the partners will
=3:1
be the same as the old
ratio
Note: Loss due to fire has not been accounted for thus; the profits for the year
2018-19 is taken before deducting loss by fire.
Excess value of net assets over purchase consideration at the time of purchase of
business is:
[2020]

a. Credited to the General Reserve Account

b. Credited to the Capital Reserve

Correct Answer

Excess of Net Assets over purchase consideration Credited to the Capital

Reserve.

c. Credited to the Vendor's Account

d. Debited to the Goodwill Account

The total capital of the firm of Sakshi, Mehak and Megha is ₹ 1,00,000 and the
market rate of interest is 15%. The net profits for the last 3 years were ₹ 30,000; ₹
36,000 and ₹ 42,000. Goodwill is to be valued at 3 years' purchase of the last 3
years' super-profits. Calculate the goodwill of the firm. [2017]
Answer:
Goodwill = Super Profit ×× Number of Years' Purchase
Super Profits = Average Profit - Normal Profit
Average Profits = Total Profits Number of Years= Total Profits Number of
Years =30,000+36,000+42,0003=30,000+36,000+42,0003 = ₹ 36,000
Normal Profits = Capital Employed ×× Normal Rate of Return
=1,00,000×15100=1,00,000×15100 =Rs. 15,000
Super Profits = 36,000 - 15,000 =Rs. 21,000
Goodwill of firm = 21,000 ×× 3 = ₹ 63,000
A business earned an average profit of ₹ 8,00,000 during the last few years. The
normal rate of profit in a similar type of business is 10%. The total value of assets

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and liabilities of the business were ₹ 22,00,000 and ₹ 5,60,000 respectively.

Calculate the value of goodwill of the firm by super profit method if it is valued at
2½ years' purchase of super-profits.
[2014]
Answer:
Average Profit = ₹ 8,00,000
Normal Profit = Capital Employed × Normal Rate 100× Normal Rate 100
= 16,40,000 ×10100×10100 = ₹ 1,64,000
Capital Employed = Total Assets - Outside Liabilities
= 22,00,000 - 5,60,000
= ₹ 16,40,000
Super Profit = Average Profit - Normal Profit
= 8,00,000 - 1,64,000
= ₹ 6,36,000
Goodwill = Super Profit ×× No. of Years' Purchase
= 6,36,000 ×× 2.5
= ₹ 15,90,000
If normal rate of return of business is not given then NRR of similar business can
be taken.
Capital of the firm of Sharma and Verma is ₹ 2,00,000 and the market rate of
interest is 15%. Annual salary to partners is ₹ 12,000 each. The profits for the last
three years were ₹ 60,000; ₹ 72,000 and ₹ 84,000. Goodwill is to be valued at 2
years' purchase of last 3 years' average super profit. Calculate goodwill of the firm.
[2013]
Answer:
Goodwill = Super Profit ×× Number of Year's Purchase
Normal Profit = Capital Investment × Normal Rate of Return 100× Normal Rate of
Return 100
=2,00,000×15100=2,00,000×15100 = ₹ 30,000
Profit before Partner’s Partner’s Actual Profit after
Year – =
Salary Salary Salary
1 60,000 – 24,000 = 36,000
2 72,000 – 24,000 = 48,000
3 84,000 – 24,000 = 60,000
Average Actual Profit after Salary to
Partner's =36,000+48,000+60,0003=1,44,0003=36,000+48,000+60,0003=1,44,000
3 = 48,000
Super Profit = Average Actual Profit after Salaries - Normal Profits
= 48,000 - 30,000
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= 18,000
Number of Year's Purchase : 2
∴∴ Goodwill = 18,000 ×× 2 = ₹ 36,000
Salary of one partner is given.Both partner's salary = 12,000 ×× 2 = Rs.24,000
Average profit earned by a firm is ₹ 1,00,000 which includes undervaluation of
stock of ₹ 40,000 on an average basis. The capital invested in the business is ₹
6,30,000 and the normal rate of return is 5%. Calculate goodwill of the firm on the
basis of 5 times the super profit.
[2015]
Answer:
Average normal profit = (Average Profit + Undervaluation of stock on average
basis*)
= ₹ (1,00,000 + 40,000) = ₹ 1,40,000
Capital Employed in the business = ₹ 6,30,000
Normal Profits = (Capital Employed × Normal Rate of Return 100× Normal Rate
of Return 100) = ₹ 6,30,000 ×5100×5100 = ₹ 31,500
Super Profits = Average Normal Profits - Normal Profits = ₹ (1,40,000 - 31,500) =
₹ 1,08,500
Goodwill = Super Profits ×× No. of years of purchase = ₹ (1,08,500 ×× 5) = ₹
5,42,500
A business has earned average profit of ₹ 4,00,000 during the last few years and
the normal rate of return in a similar business is 10%. Find value of goodwill by:

1. Capitalisation of Super Profit Method, and

2. Super Profit Method if the goodwill is valued at 3 years' purchase of super
profits.

Assets of the business were ₹ 40,00,000 and its external liabilities ₹ 7,20,000.
[2013]
Answer:
Goodwill by Capitalisation of Super profit
Goodwill = Super Profits ×100 Normal Rate of Return ×100 Normal Rate of
Return
Capital Employed = Assets - External Liabilities
= 40,00,000 - 7,20,000
= ₹ 32,80,000
Normal Profit = Capital Employed × Normal Rate of Return 100× Normal Rate of
Return 100
= 32,80,000 ×10100×10100 = ₹ 3,28,000

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Super Profit = Actual Profit - Normal Profit

= 4,00,000 - 3,28,000
= ₹ 72,000
Goodwill = 72,000 ×10010×10010 = ₹ 7,20,000

1. Super Profit Method if the goodwill is valued at 3 years’ purchase of super

profits
Goodwill = Super Profits ×× Number of Years of Purchase
= 72,000 ×× 3 = ₹ 2,16,000
Therefore, Goodwill is valued at ₹ 2,16,000

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