MEANING

&
VALUATION OF
GOODWILL
 Meaning of Goodwill

Goodwill is the value of the

reputation of a firm which
enables it to earn higher profits
in comparison to the normal
profits earn by other firms in
the same trade.
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Rs. 5 Lakhs extra is for what reasons?

BRAND NAME
+
CUSTOMER SIZE
+
SUPPLIERS
+
ITS WORK FORCE
_______________
GOODWILL
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 Characteristics of
Goodwill
• It is an intangible asset
• It is a valuable asset
• It is helpful in earning excess
profits.
It is valuable only when entire
business is sold.
• It is difficult to place an exact value
on goodwill 16/05/2023 6
 Nature of Goodwill

Goodwill is an intangible and in

visible asset of the business.
It has no physical existence.
It can not be seen or touched.
It is not a fictitious asset.
Where as goodwill has a value in
case of profit making concerns.
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 Factor of Existence of Goodwill
 1 Good public relation
 2 Regular consumer
 3 Quality maintenance
 4 Management skills
 5 Location
 6 Good relation with supplier
 7 Employees
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 Nature of
Business

Special adv.
Licensee,
Personal
popularity etc. Location
Factors
affecting
Goodwill

Efficiency
Market
Of
Situation
Management
NEED FOR THE VALUATION OF
GOODWILL
When there is a change in the profit
sharing ratio among the existing
partners.
When a new partner is admitted.
When a partner retires or dies.
When a firm is sold and
When a firm is amalgamated with
other firm. 16/05/2023 11
 Methods for valuation
of Goodwill
There are three methods for
valuation of goodwill :

1) Average profit method

2) Super profit method
3) Capitalisation method

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 AVERAGE PROFIT METHOD

WEIGHTED
SIMPLE AVERAGE AVERAGE PROFIT
PROFIT METHOD METHOD

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 NOTE

Before calculating the average profits the following

adjustments should be made in the profits of the
firm.

 Any abnormal profit should be deducted from the

net profit of that year.
Any abnormal loss should be added back to the
net profits of that year .
Non operating income e.g. income from
investments etc should be deducted from the net
profit of that year.
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 SIMPLE AVERAGE PROFIT
METHOD

Average Profit = Total profit

Number of Years

Goodwill = Average Profits X Number of years purchase

SIMPLE AVERAGE PROFIT METHOD
Under average profit method ,goodwill Is
calculated on the basis of the number of past years
profits . Average of such profits is multiplied by the
agreed number of years to find out the value of
goodwill . Thus ……….

Average profit =
(Sum of profits of given years – loss if any)
No. of years
Goodwill = Average profit * (No. of years of
purchase.)
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 Illustration 1.
Calculate the value of goodwill of Raman
Bros. at three years purchase of average
profits of the last five years . The profits are as
under :-
Years Profits (Rs.)
2012 60,000
2013 10,000(loss)
2014 65,000
2015 5,000(loss)
2016 30,000
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 Solution :
Total profits of last five years :
(60,000-10,000+65,000-5,000+30,000)

=Rs.1,40,000
Average profit
=Rs.1,40,000/5
=Rs.28,000

Goodwill =Average profit *No of Years

purchase 16/05/2023 18
Illustration 2:
Sonam purchased Nidhika’s business from 1st
January 2016.The profits disclosed by Nidhika’s
business for the last 4 years were as follows :

2012 – Rs.55,000(including insurance claim

Rs.5,000)
2013 – Rs.45,000(after charging abnormal loss
of Rs.10,000 )
2014 – Rs. 55,000
2015 – Rs. 60,000
Calculate the value of firms goodwill on the basis of
3 years Purchase of the average profits for the last
four years. 16/05/2023 19
Solution :
Valuation of goodwill : Rs. Rs.
Profit for 2012 55,000
Less : Insurance claim ( 5,000) 50,000
Profit for 2013 45,000
Add : Abnormal loss 10,000 55,000
Profit for 2014 55,000

Profit for 2015 60,000

Total Profit 2,20,000
Average Profit = Rs.2,20,000/4 = Rs. 55,000
Goodwill =Average profit * No of years purchase
= 55,000 * 3
= Rs.1,65,000 16/05/2023 20
 WEIGHTED AVERAGE PROFIT
METHOD
WT AVG PROFIT = TOTAL OF PRODUCTS
TOTAL OF WEIGHTS

GOODWILL = WEIGHTED AVERAGE

PROFIT * NO.OF YEARS PURCHASE
ILLUSTRATION 3:
The profits of a firm for the last five years were as follows :
 Years 31 March profits(Rs)
 2011 43,000
 2012 50,000
 2013 52,000
 2014 65,000
 2015 85,000
You are required to calculate the value of goodwill on the
basis of two years purchase of weighted average profits.
The weights to be used are
2011-1; 2012-2; 2013-3; 2014-4; 2015-5 .

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 SOLUTION :
YEAR PROFITS WEIGHT PRODUCTS
31 March (Rs) (Rs)
• 2011 43,000 1 43,000
• 2012 50,000 2 1,00,000
• 2013 52,000 3 1,56,000
• 2014 65,000 4 2,60,000
• 2015 85,000 5 4,25,000
_____ ________
15 9,84,000
Weighted average profit = 9,84,000/15 = Rs 65,600
Goodwill = Rs 65,600 * 2 = Rs 1,31,200

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Super profit method :
In this method goodwill is calculated on the basis of
surplus profit earned by a firm in comparison to
average profits earned by other firms. If a firm has no
excess profits , it will have no goodwill. Thus……………

(1) Normal Profit = Capital invested * N.R.R.

100
(2) Super Profit = Average profit – Normal Profit

(3) Goodwill = Super Profit * Years of Purchase

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Illustration 4:
A firm earned net profits during the last five years as
I Yr Rs.55,000;
II yr Rs.78,000;
III Yr Rs.82,000;
IV Yr Rs.5,000(loss); and
V Yr Rs.90,000
respectively.
The capital invested in the firm by the X and Y is
Rs.3,00,000 . Normal rate of return in the similar type of
business is 12%.
Calculate the value of goodwill on the basis of 3 years’
purchase of super profit earned during the above mentioned
period.
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Solution :
Average profit
=Rs.(55,000+78,000+82,000-5,000+90,000) /5
=Rs.60,000
Normal Profit =Capital Invested *N.R.R.
100
=Rs.3,00,000*12 /100
=Rs.36,000
Super Profit = Avg. Profit - Normal Profit
=Rs.60,000-Rs.36,000=Rs.24,000
Goodwill =Super Profit*Years of Purchase
=Rs.24,000* 3
=Rs.72,000
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Calculation of Goodwill by
Capitalization Method

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1. By capitalising the average profits :

Under this method first of all we calculate the capitalised

value of business as under :

Capitalised value = Average profits * 100

Normal rate of return

Goodwill (GW) = Capitalised value – Net assets

Net assets/ capital employed = Total Assets – External

liabilities
Or
GW = Capitalized Value – Actual Capital employed

.
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2- By capitalising the super profits :
Under this method first of all we calculate super
profits then we use the following formula for finding
out the value of goodwill ….

Goodwill = Super Profit (SP) *100

Normal Rate of Return (NRR)

Super Profit = Actual Profit/Average Profit (AP)–

Normal Profit

Normal Profit (NP) = Capital Employed x NRR

100
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Illustration 5
From the figures given below , calculate
goodwill using capitalisation of average profits
method :
Rs.
1- Profit for the year 2015 1,20,000
2 –Normal rate of return 12%
3 –Assets 13,65,000
4 –External Liabilities 79,0000

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Solution :
Capitalised value of Average Profits =
Average Profits * 100
N.R.R.
1,20,000*100/12 =Rs.10,00,000

Net Assets = Assets – External liabilities

= Rs.13,65,000-Rs.7,90,000
= Rs. 5,75,000

Goodwill = capitalised value of A .p.- Net Assets

Goodwill = Rs.10,00,000 - Rs.5,75,000

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Illustration 6

From the figures given in

illustration 5 , calculate
goodwill according to the
Capitalisation of Super Profit
Method.

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 Solution :
Capital Invested = Assets – Liabilities
=Rs.13,65,000 - Rs.7,90,000
=Rs. 5,75,000
NORMAL PROFIT = 5,75,000 *12/100
=Rs.69,000
Super Profit = Average profit- Normal profit
=Rs.1,20,000 - Rs.69,000
=Rs.51,000
Goodwill = Super Profit *100 /N.R.R.
= Rs.51,000*100 /12
= Rs.4,25,000
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 CONCLUSION

“ Just as cement binds together the

bricks and other building materials
into walls, similarly goodwill binds
together or unites the other assets
and aspects of the business into
cohesive whole .”

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THANK YOU !!

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