Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.

Theory Handouts on
PART A: ACCOUNTING FOR PARTNERSHIP FIRMS AND
COMPANIES
UNIT – 1: ACCOUNTING FOR PARTNERSHIP FIRMS
CHAPTER - 2.
GOODWILL: NATURE AND VALUATION

SCAN ME TO DIRECTLY SCAN ME TO GET THE

CALL TO EXPERT PDF OF THIS HANDOUT

CBSE EXPECTED WEIGHTAGE = 03 MARKS

PRACTICAL or THEORY = 1 QUESTION OF 3 MARKS EACH = 03 MARKS

S.No. TOPICS PAGE NO.

1. Definition and Meaning of Goodwill G2
2. Characteristics Or Features of Goodwill G2
3. Tangible & Intangible Assets G2
4. Nature of Goodwill G3
5. Need for Valuing the Goodwill G3
6. Factors Affecting the Value of Goodwill Or Origin of Goodwill G3
7. Kinds Or Types of Goodwill G4
8. Classification of Goodwill G5
9. Method of Valuation of Goodwill G5

Note: This handout contains 14 pages.

G1
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

Presented By – AMIR
Mob.+918287656283
[Assistant Professor, BYJU’S Subject Expert, B.Com. (H),
M. Com., 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]
: support@amircommerceclasses.com : www.amircommerceclasses.com

1. Definition and Meaning 1. Define Goodwill. (CBSE AI 2008)

of Goodwill 2. Why is Goodwill considered as an intangible asset but
not a fictitious asset? (CBSE D, AI, F 2009)

 Definition of Goodwill: According to Lord Eldon, Goodwill

is the probability that the old customer will resort to the
old place.
 Meaning of Goodwill: Goodwill is an intangible asset that
places a firm in an advantageous position due to which the
firm is able to earn higher profits without putting extra
effort.
 Goodwill is not a fictitious asset: Goodwill is considered
an intangible asset of the firm. It does not have any
physical existence. It just has the capability to help the
business in earning more and more profits. On the other
hand, fictitious assets are neither tangible nor intangible
assets. They are the expenses or losses which are still to
be charged (debited) from the profit in the Profit and Loss
A/c.
 For example: If a firm/company is also providing after-
sales service besides selling its products, this will satisfy
the customer and will bring them back to the
firm/company. This will help them in achieving higher sales
and hence, higher profits.
2. Characteristics Or  It is an intangible asset. Hence, it cannot be seen or
Features of Goodwill touched.
 It does not have an existence separate from that of an
enterprise. Thus, it has realizable value when the business
is sold.
 It helps in earning higher profits.
 It is an attractive force that brings in customers regularly
to the place of business.
3. Tangible & Intangible  Tangible Assets– These are the assets that have a
Assets physical existence, i.e., they can be seen and touched.

G2
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

Examples are land, building, plant and machinery, etc.

 Intangible Assets– These are the assets that do not have
a physical existence, i.e., they cannot be seen and touched.
Goodwill, patents and trademarks are examples of
intangible assets.
4. Nature of Goodwill  According to the Accounting Standard – 26 (AS – 26),
intangible assets prescribe that goodwill should not be
accounted for in the books of account unless consideration
is paid for it.
 Therefore, self-generated goodwill is not accounted for
in the books of account whereas purchased goodwill is
accounted.
5. Need for Valuing the 1. State any three circumstances other than (i)
Goodwill admission of a new partner, (ii) retirement of a
partner, and (iii) death of a partner, when need for
valuation of goodwill of a affirm may arise. (CBSE D,
AI 2016)
2. On what occasions does the need of valuation of
goodwill arise? (CBSE 1994, 1996)

The need for valuing the goodwill in case of partnership form

arises in the following circumstances:
 When the profit sharing ratio is changed,
 When a new partner is admitted,
 When a partner retires or dies,
 When two firms are amalgamated,
 When a firm’s business is dissolved,
 When a firm is sold as a going concern, and
 When a partnership firm is converted into a company.
6. Factors Affecting the 1. How does 'Nature of Business' affect the value of
Value of Goodwill Or goodwill of a firm? (CBSE F, AI 2011, D 2019)
Origin of Goodwill 2. How does the factor 'efficiency of management'
affect the Goodwill of a firm? (CBSE D, AI 2010)
3. How does the factor 'quality of product' affect the
Goodwill of a firm? (CBSE D, AI 2010)
4. How does location affect the Goodwill of a business?
(CBSE AI 2010, F 2009)
5. How does the market situation affect the value of
Goodwill of a firm? (CBSE D 2011)
6. Suraj and Dilip are partners in a firm dealing in
stationery items. The firm is well managed and enjoys
the advantage of being cost-effective. It buys

G3
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

stationery items at a reasonable cost from Dilip's

relative who is a manufacturer of stationery items.
The firm sales’ outlet is situated near a school. As a
result, the firm has a steady demand for stationery
items and is earning good profits. The firm is
donating 10% of its profits to the nearby school for
the education of the students of below poverty line.
State any two factors affecting the value of goodwill
of the firm. (CBSE D 2016 C, Modified)

The following are the main factors that affect the value of
goodwill:
 Favourable location or site- If the business is located in a
good locality, its value will be more as compared to a
locality that is not so popular.
 Time factors- Time also increases the value of goodwill. A
business that is running for a long on profit will have more
value than a business that has been established only a few
years back.
 Favorable contracts- Sometimes a form has long term
contracts for the sale and purchase of goods at favorable
prices. This will also affect profits and hence, the goodwill
of the firm.
 Quality- If a firm enjoys a good reputation for the quality
of its products, there will be a ready sale and hence, the
value of its goodwill will be high.
 Efficiency of the management- If the management of a
business concern is more efficient and reputed, naturally
the value of goodwill in such business will be more as
compared to the value where the management is not
efficient.
 Trend of profits- In the case of a continuous increase in
profits, the value of goodwill increases.
 Other factors- (a) Good business relations, (b) Favorable
Government attitude, (c) Effective advertisement system,
(d) Popularity of the product of the business, etc.
7. Kinds Or Types of Goodwill is expressed in terms of characteristics of different
Goodwill animals as under:
 Cat Goodwill- Cats have more attachment to the house
than to the persons who live in that house and it does not
leave their place even if all the persons leave that house.
Similarly, all customers will go to the old places even if the
proprietorship changes. In case the business has more such

G4
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]
8. Classification of Goodwill
9. Method of Valuation of
Goodwill
customers, the value of the goodwill will be high.
 Dog Goodwill- Dogs are most loyal and faithful towards
their master. So, a dog follows its master whenever he
goes. The customers of this nature will go to the old
proprietor. This is especially so, in the case of professional
services like those of doctors, chartered accountants and
lawyers, etc. Hence, if a business has more such customers
the value of goodwill will not be much.
 Rat Goodwill- Rat has no attachment either with the house
or with the master of the house. The behaviour of the rat
is quite uncertain. Similarly, these types of customers are
of uncertain nature and can go anywhere. The goodwill of
such business houses will be very little.
Goodwill can be classified into two categories:
 Purchase Goodwill- It is the goodwill that is acquired by
making a payment. It arises when a business is purchased.
If the purchase consideration is more than its net assets,
the difference between the two is called purchase goodwill.
 Features of Purchased Goodwill
a) It rises on the purchase of a business.
b) It is recorded in the books of account.
c) It is shown as an asset on the Balance Sheet.
d) It is written off over its useful economic life.
 Self-Generated Goodwill or Inherent Goodwill- It is
internally generated goodwill that arises due to a number
of attributes that an ongoing firm possesses.
 Feature of Self-Generated Goodwill
a) It is internally generated over a long period of time.
b) Its valuation depends on the subjective judgment of
the valuer. So, its true cost cannot be fixed.
c) As per Accounting Standard - 26 (Intangible Asset)
as it is not recorded in the books of accounts
because no consideration in money or money’s worth
is paid for it.
1. Give the formula for calculation of Goodwill by
'Capitalisation of Average Profit'. (CBSE D, Al 2012
C)
2. Give the formula for calculation of Goodwill by
'Capitalisation of Super Profit Method’. (CBSE D
2012 C)
3. Enumerate two main steps involved in valuing Goodwill
according to Super Profit Method. (CBSE Al 2012 C)
G5
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

4. What is super profit method of calculating goodwill?

(P.B. 2002, 2004, 2012, 2013 C)
5. What is average profit method of calculating goodwill?
(P.B. 2002, 2012, 2014)
6. Give three methods of valuation of goodwill. (P.B.
2001, 2004C, 2012C)

Goodwill is valued as per the method stated in the partnership

deed or as per the method of valuation agreed by the
partners. However, the following three methods are valued
for valuing goodwill.
 Average Profit Method- Goodwill under the average profit
method can be calculated either by the Simple Average
Profit Method, or Weighted Average Profit Method.
 Simple Average Profit Method- Under this method,
past profits for a number of years are taken into
consideration. The average of these profits is
calculated. The average profit is multiplied by a given
number of years to arrive at the value of goodwill.
Thus, the formula is:
𝐓𝐨𝐭𝐚𝐥 𝐀𝐝𝐣𝐮𝐬𝐭𝐞𝐝 𝐏𝐫𝐨𝐟𝐢𝐭𝐬
Average Profit = .
𝐍𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐲𝐞𝐚𝐫𝐬
Goodwill = Average Profit X Number of years’
purchase.

Reasons or Justification for Using Average Profit

and Number of Years’ Purchase- The buyer of the
business would like to estimate future profits for which
profits are averaged. Buyers would also like to earn
that profit because of the efforts put in the past.

Question: What is the number of years’ purchase?

Answer: Number of years’ purchase means the number
of years for which the firm is likely to earn the same
amount of profit after a change in the ownership
because of the efforts put in the past.

Valuation of Goodwill
Step 1: Calculate Normal Business Profit (Future
Maintainable Profit)
Particulars Rs.
Profit (Loss) of Past Year XXX
(Before Adjustment)

G6
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

Add: XXX
a) Abnormal Losses (loss by
fire, loss by theft)
b) Loss on sale of fixed
assets
c) Overvaluation of opening
stock or Undervaluation
of closing stock
d) Non-recurring expenses
(Such expenses are not
expected in the future)
e) Capital Expenditure
charged as Revenue
Expenditure (e.g.,
Purchase of Machinery
wrongly debited to
Purchases A/c)

Less: XXX
a) Abnormal Gains
b) Overvaluation of Closing
Stock or undervaluation
of opening stock
c) Non-recurring incomes
(such incomes are not
expected in the future)
d) Income from Non-trade
Investments
e) Partner’s Remuneration, if
it is not deducted
f) Any future expenses (like
insurance premium)
Normal Business Profit XXX
(Future Maintainable Profit)

Step 2: Find Average Profit

Average Profit = Total of Profits/Number of Years

Step 3: Determine the Number of Years’ Purchase

It is given in the question. It is estimated for the
valuation of goodwill.

Step 4: Find Value of Goodwill

G7
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

Goodwill = Average Profit X Number of Years’

Purchase

Drawback of Simple Average Profit Method

Drawback of the above method for the valuation of
goodwill is that:
a) Trend of profitability is not considered since each
year's profits are given equal weightage,
b) A distinction is not made between a business that
has rising profits and one that has falling profits.
 Weighted Average Profit Method- It is a method
under which weight is assigned to each year. Normal
business profit for each year is multiplied by the
assigned weight to determine the value, i.e., Weighted
Profit. Weighted Profit, as well as the weights, are
totaled. Total of Weighted Profit is divided by the
total of weights to determine the Weighted Average
Profit.
Note: More Weightage is assigned to the profit of
recent year as it indicates the most likely profits in
future.

Valuation of Goodwill
Step 1: Calculate Normal Business Profit
Normal Business Profit is calculated as follows:
1. Take profit for each year.
2. Deduct abnormal gain (profit), if any, credited to
Profit and Loss Account. Such as gain (profit) on the
sale of fixed assets.
3. Deduct recurring expenses not incurred during the
year, if any.
4. Add abnormal loss, if any, incurred during the year
and debited to Profit and Loss Account.
At this stage, the normal profit for each year will be
determined.
Step 2: Select the Weight to be Assigned (given) to
each year's profit
Step 3: Calculate Weighted Average Normal Profit
1. Profit for each year (determined as per Step 1) is
multiplied by the weight assigned for that year and
find the product (Weighted Profit).
2. Total the Weighted Profit (Product) and also the

G8
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

weights.
3. Divide the Total of Weighted Profit (Product) by the
total of weights.
𝐓𝐨𝐭𝐚𝐥 𝐨𝐟 𝐖𝐞𝐢𝐠𝐡𝐭𝐞𝐝 𝐏𝐫𝐨𝐟𝐢𝐭
Weighted Average Profit =
𝐓𝐨𝐭𝐚𝐥 𝐨𝐟 𝐖𝐞𝐢𝐠𝐡𝐭𝐬

Step 4: Find the Value of Goodwill

Multiply Weighted Average Profit (as determined in
Step 3) by the 'Number of Years' Purchase’. It is the
value of goodwill. Expressed as a formula, it is

Goodwill = Weighted Average Profit X Number

of Years' Purchase.

Reason or Justification for using Weighted Average

Profit
a) Past profits show the trend of financial performance
which is the trend of profits.
b) Profits earned by an enterprise in recent years is
more relevant as compared to earlier years.
Therefore, more weightage should be given to recent
profits which is followed under the method.
c) Weighted Average Profit Method is considered
better as compared to Simple Average Profit
Method as it gives more weightage to the profits of
recent years. This method is particularly effective
when profits show rising (upward) or falling
(downward) trends.
 Super Profit Method- The excess of actual/average
profit over normal profit is known as super profit.

Super Profit = Average Profit – Normal Profit

Valuation of Goodwill
Step 1: Calculate Average Capital Employed

𝐎𝐩𝐞𝐧𝐢𝐧𝐠 𝐂𝐚𝐩𝐢𝐭𝐚𝐥 𝐄𝐦𝐩𝐥𝐨𝐲𝐞𝐝 + 𝐂𝐥𝐨𝐬𝐢𝐧𝐠 𝐂𝐚𝐩𝐢𝐭𝐚𝐥 𝐄𝐦𝐩𝐥𝐨𝐲𝐞𝐝

𝟐
a. Liabilities Side Approach:
Capital Employed = Capital + Reserves - Goodwill, if
any existing in the books - Fictitious Assets – Non
trade Investments.

b. Assets Side Approach:

G9
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

Capital Employed = All Assets (except Goodwill,

Non-trade Investments and Fictitious Assets) -
Outside Liabilities.

Goodwill = Super Profit x Number of Years'

Purchase

Note: Unless investments are specified to be trade

investments, they are taken as Non-trade Investments.
Capital employed means capital invested in the firm to carry
on business. It is calculated to determine the value of
goodwill.

Basis Trade Investments Non-Trade Investments

Meaning Trade investments Non-trade investments
are those are those investments
investments that are that are made to earn
made in another revenue by investing
enterprise for the surplus funds and not for
furtherance of own the purpose of
business. furtherance of own
business.

Step 2: Calculate Adjusted Average Profit

Already calculated in Average Profit Method.

Step 3: Calculate Normal Profit

Normal Profit =
𝐍𝐨𝐫𝐦𝐚𝐥 𝐑𝐚𝐭𝐞 𝐨𝐟 𝐑𝐞𝐭𝐮𝐫𝐧
Average Capital Employed X .
𝟏𝟎𝟎
Note: Normal Rate of Return means the return normally
earned by other firms in a similar industry.
Step 4: Calculate Super Profit

Super Profit = Adjusted Average Profit - Normal Profit

Step 5: Calculate Value of the Goodwill

Goodwill = Super Profit X Number of Years’ Purchase

For example, a firm has a capital employed of Rs.10,00,000
and average profit is Rs.1,50,000. Normal return on capital
employed in similar business is 10%, i.e., Rs.1,00,000
(Rs.10,00,000 X 10%). The firm has super profit of
Rs.50,000 (i.e., Rs.1,50,000 – Rs.1,00,000).

G 10
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

Basis Average Profit Super Profit

1. Meaning It is the average of It is the excess of
the normal profits of average profit over
past agreed years. normal profit.
2. Normal Normal rate of Normal rate of return
Rate of return is not relevant is considered while
Return
in the calculation of calculating the super
average profit. profit.
3. Average Average capital Average capital
Capital employed is not employed is taken into
Employed
considered while account while
calculating average calculating the super
profit. profit.
4. Relevance Average profit is Super profit is
of Valuing relevant for the relevant for Super
Goodwill
Average Profit Profit Method and
Method, Super Profit Capitalisation of Super
Method. and Profit Method of
Capitalisation Method valuation of goodwill.
of valuation of
goodwill.

 Capitalization Method- Under this, goodwill can be valued

using two methods:
1. Capitalization of Average Profit Method, and
2. Capitalization of Super Profit Method.
1. Capitalization of Average Profit Method
For calculating goodwill under this method, the steps are as
follows:
Step 1: Calculate average normal profit earned.
As calculated in super profit method above.

Step 2: Calculate capitalised value of the firm

By using the formula given below:

Capitalised Value of the Business =

𝟏𝟎𝟎
Average Profit x .
𝐍𝐨𝐫𝐦𝐚𝐥 𝐑𝐚𝐭𝐞 𝐨𝐟 𝐑𝐞𝐭𝐮𝐫𝐧

For example, if a firm earns a profit of Rs.60,000 annually

and firms normally earn 10%, the total capitalised value of
the firm will be Rs.6,00,000 (i.e., Rs.60,000 x 100/10).
Step 3: Determine the value of Net Assets, on the date

G 11
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

of valuation of goodwill.

Net Assets = All Assets (other than goodwill, non-

trade investments and fictitious assets) at their
current values minus outside liabilities.
OR
Net Assets = Capital + Reserves - Goodwill, if any
existing in the books - Fictitious Assets – Non trade
Investments.

Step 4: Determine the value of Goodwill

Goodwill = Capitalised Value of the Business (as per

Step 2) — Net Assets (as per Step 3).

2. Capitalization of Super Profit Method

Under this method, goodwill is calculated by capitalising
super profit at the normal rate of return. For calculating
the goodwill under this method, the steps are:
Step 1: Calculate Capital Employed (i.e., Net Assets as
on the date of valuation) of the firm:

Net Assets = All Assets (except goodwill, non-trade

investments and fictitious assets) — Outside
Liabilities.
OR
Net Assets = Capital + Reserves - Goodwill, if any
existing in the books - Fictitious Assets – Non trade
Investments.

Step 2: Calculate Normal Profit on Capital Employed

By using the following formula:

Normal Profit =
𝐍𝐨𝐫𝐦𝐚𝐥 𝐑𝐚𝐭𝐞 𝐨𝐟 𝐑𝐞𝐭𝐮𝐫𝐧
Capital Employed x .
𝟏𝟎𝟎

Step 3: Calculate Average Profit of past years

As we did in Average Profit Method.
Step 4: Calculate Super Profit
By using the following formula:

Super Profit = Average Profit – Normal Profit

Step 5: Calculate Goodwill of the firm

By using the following formula:

G 12
Presented By – AMIR, Mob.+918287656283, [Assistant Professor, BYJUS Subject Expert, 3 Times UGC-NET Qualified, Pursuing C.A. and C.S.]

𝟏𝟎𝟎
Goodwill = Super Profit x .
𝐍𝐨𝐫𝐦𝐚𝐥 𝐑𝐚𝐭𝐞 𝐨𝐟 𝐑𝐞𝐭𝐮𝐫𝐧

For example, Average Profit = Rs.50,000 and the Normal

Profit = Rs.40,000, then Super Profit = Rs.10,000 (i.e.,
Rs.50,000 – Rs.40,000). Normal rate return of return =
10%. Thus, the value of goodwill = Rs.1,00,000 (i.e.,
Rs.12,000 X 100/10).

HAPPY READING

Are You SCARED of ACCOUNTANCY,

ECONOMICS & MATHEMATICS ?
YOUR SEARCH ENDS HERE
90* % ’’ Marks
To Get ‘‘More Than

Contact : AMIR
Mob. No. - +918287656283

“More Than 15 Years ” Teaching Experience

[Assistant Professor, BYJU’S Subject Expert, B.Com. (H), M.Com., 3
Times UGC-NET Qualified, Pursuing C.A. and C.S.]
Google me on : www.amircommerceclasses.com
* Conditions Apply

G 13