Accounting for goodwill

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Goodwill

Goodwill = Selling price as a going concern –

Fair value of separate net assets

Goodwill = Selling price – (Assets – Liabilities)

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FEATURES OF GOODWILL
 It is an intangible asset.
 It may be purchased or inherent in the business.
 It is capable of transfer from one person to
another.
 Value of goodwill generally fluctuates from time
to time.
 It can be sold only with entire business and not
separately

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Reason for payment of goodwill

 In buying the an existing business which has been

established for some time,
 there may be quite a few possible advantages.

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Goodwill
 Buyer may be willing to pay more for a business as a going
concern because of:
- Good location
- Good customer relations
- Good reputation
- Well-known products
- Experienced and efficient employees and management team
- Good relation with suppliers

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Types of Goodwill
 Inherent Goodwill
 Purchased Goodwill

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Inherent Goodwill
• Goodwill generated internally because of the above
advantages
• Inherent goodwill is only an estimation. Therefore, it should
not be brought into the books, and no accounting entry is
required

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Purchased Goodwill
•It is the goodwill generated during the acquisition of a
business
•It is the difference between the selling price of a business as
a going concern and the total value of its separable net assets
•It can be treated as an intangible fixed asset.
•Some companies may write it off immediately against
reserves, or amortized through the profit and loss account
over its useful economic life

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 METHOD OF VALUING
GOODWILL
 Capitalization Method
 Purchase of Past Average Profit

 Super profit-

(i)Purchase of Super Profit

(ii)Annuity Method
(iii)Capitalisation of Super Profit
Method
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CAPITALISATION METHOD

Following are the main steps to be taken in computing by this

method –
a. ascertain the average net profit which it is expected will be
earned in future.
b. capitalize this net profit at the rate which is considered a
suitable return on capital invested in a business of the type
under consideration
c. find the value of the net tangible assets used in the business
(assets less outside liabilities)
d. deduct the net tangible assets from the capitalized profit
obtained and the difference is goodwill
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Purchase of Past Average Profit
It is calculated on the following basis:
1.profit for an agreed number of year preceding valuation are averaged so
as to arrive at the average annual profit earned during that period
(average may be simple or weighted).
2. The goodwill is then estimated to be worth so many year purchase of
such average profit .The number of year selected is presumed to bear
relation to the number of years benefit to be derived from past
association.
The value of goodwill is calculated by multiplying the adjusted annual
purchase profit by the number of year of purchase.
Goodwill = Average profits x Number of years purchase

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WEIGHTED AVERAGE PROFITS
METHOD
Goodwill = Weighted Average Profits x
Number of Years Of Purchase

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SUPER PROFIT
It is the excess of the average profit over the normal profit based on normal
rate of return for representative firm in the industry for computation
of super profit , the following three factor are required:
Normal rate of return-This is the rate of profit or return which an
investor expects on his investment.
Capital employed –it may be calculated on the basis
of assets side items or liabilities side items.
capital employed=fixed assets +trade investment + current assets –
debenture – current liabilities
Normal profit – it is calculated by multiplying the
normal rate of return with capital employed as the
case may be.
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 PURCHASE OF SUPER PROFIT
 Super Profit = Average Profit - Normal Profit

 Normal profits=Capital Employed-Normal rate

of return/100

Goodwill = Super profit x No. of Years

Of Purchase

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 Super profits=Average Profits –Normal
Profits.

 Normal profits=Capital Employed-Normal

rate of return/100

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CAPITALISATION OF SUPER
PROFIT METHOD
Under this method, the value of goodwill is
calculated by capitalizing the super profit at a
normal rate of return. This method attempts to
determine the amount of capital needed for
earning super profit.
Goodwill= Average Super Profit x 100
Normal Rate of Return

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 ANNUITY METHOD
 Under this method, the value of goodwill is
calculated by finding the present worth of an
annuity paying the super profit (per year) over
the estimated period discounted at the
appropriate rate of interest. The annuity method
of calculation of goodwill is based on the present
worth of an annuity of Re 1 for n years at r
percent.

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 GOODWILL =
SUPER Profit X ANNUITY VALUE

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