0This is one of the introductory chapters at the graduation level as well as in professional exams.
The brief notes on methods and calculation of goodwill in easy steps are presented below:
Methods of Valuation of Goodwill
- Average Profits Method
- Super Profits Method
- Annuity Method
- Capitalisation Method
- By Average Profits Method
- By Super Profits Method
Let us discuss each method in detail.
- AVERAGE PROFITS METHOD
STEPS for calculation
- Adjusted average annual profits (See note 1)
- Number of years of purchase (given in question)
- Value of Goodwill= Adjusted average annual profits multiplied by the number of years of purchase
Note :
- If several years of purchase for goodwill valuation are not given in the question, then the number of years for which data of profit or loss are provided should be taken.
Calculation of Adjusted average annual profits:
Steps for calculating it are as follows:
- Calculation of Adjusted profits OR Adjusted Future profits OR Future Maintainable Profits
| Particulars | Rs. |
| Profits (given in Question) | --- |
| Add: All expenses and losses not likely to occur or incur in future (e.g. extraordinary salary of a person, loss from fire or theft, abnormal losses, capital expenses etc.) | --- |
| Add: All profits likely to come in the future (e.g. profit due to new line of business) | --- |
| Less: All expenses and losses likely to occur in future (e.g. salaries on new appointments etc.) | --- |
| Less: Profits not likely to occur | --- |
| ADJUSTED PROFIT /FUTURE PROFIT | --- |
- Calculation of Adjusted average profits
There are two methods:
Simple average method
(If there is fluctuation in the profits for given periods with no specific trend, then use this method). The formula is
Total adjusted profits of all the given years divided by the number of years.
Weighted average method
(An increasing or decreasing trend in the profits for periods given in the question then use this method). The format for calculating it is as follows.
| Profits | weights | Product |
| (profits for all years | (greater weightage for recent years and less weightage for earlier or past years) | (profits multiplied by weights) |
SUPER PROFITS METHOD
STEPS for calculation
- Adjusted average annual profits (See Note below)
- Average Capital Employed (See Note below)
- Expected Rate of Return (given in question)
- Regular Profits = Average Capital Employed multiplied by Normal Rate of Return
- Super Profits = Adjusted average annual profits less Normal Profits
- Value of Goodwill = Super Profits multiplied by the number of years of purchase
Note
- Calculation of Adjusted average annual profits (as discussed earlier)
- Calculation of Average Capital Employed
There are two ways to ascertain Average Capital Employed.
| Particulars | rupees |
| Assets (other than non-trading assets , intangible assets and fictitious assets) at market value | --- |
| Less: Liabilities to outsiders at revised values | --- |
| CAPITAL EMPLOYEDAT THE END OF THE YEAR | --- |
| Less: Half of the profit earned during the year | --- |
| AVERAGE CAPITAL EMPLOYED FOR THE YEAR | --- |
Liabilities Based Approach
| Particulars | rupees | rupees |
| Equity Share Capital |
| --- |
| Preference Share Capital |
| --- |
| Reserves and Surplus |
| --- |
| Profit on Revaluation of Assets and Liabilities |
| --- |
|
|
| --- |
| Less: Goodwill at book value | --- |
|
| Accumulated Losses and expenses not yet written off | --- |
|
| Loss on Revaluation | --- | --- |
| CAPITAL EMPLOYEDAT THE END OF THE YEAR |
| --- |
| Less: Half of the profit earned during the year |
| --- |
| AVERAGE CAPITAL EMPLOYED FOR THE YEAR |
| --- |
ANNUITY METHOD
STEPS for calculation
- Super Profits (Refer Super Profits method )
- Annuity Value (given in question)
- Value of Goodwill = Super profits multiplied by Annuity Value
- CAPITALISATION METHOD
By Average Profits Method
STEPS for calculation
- Adjusted average annual profits (See Note below)
- Expected Rate of Return (given in question)
- Total Value of Business = (Adjusted average annual profits divided by Normal Rate of Return) multiplied by 100
- Value of Goodwill = Total Value of Business Less Capital Employed
Note: Capital Employed = Assets minus Liabilities
By Super Profits Method
STEPS for calculation
- Super Profits (Refer Super Profits method )
- Average Rate of Return (given in question)
- Value of goodwill = (Super Profits divided by NRR) multiplied by 100
