different methods of valuation of Goodwill

1. VALUATION OF
GOODWILL
PRESENTED BY--
DR. JYOTI KHARE
GOVT. P. G. COLLEGE
MALDEVTA, RAIPUR
DEHRADUN

2. NEED OF VALUATION OF
GOODWILL
➢In the Case of a Partnership Firm
➢In the Case of a Company:
➢In the Case of a Sole-Proprietorship Firm:

3. NEED OF VALUATION OF GOODWILL
Valuation of goodwill may be made due to any one of the following reasons:
• (a) In the Case of a Sole-Proprietorship Firm:
• (i) If the firm is sold to another person;
• (ii) If it takes any person as a partner and
• (iii) If it is converted into a company.
• (b) In the Case of a Partnership Firm:
• (i) If any new partner is taken;
• (ii) If any old partner retires from the firm;
• (iii) If there is any change in profit-sharing ratio among the partners;
• (iv) If any partner dies;
• (v) If different partnership firms are amalgamated;
• (vi) If any firm is sold and
• (vii) If any firm is converted into a company.

4. CONTINUE …………………
• (c) In the Case of a Company:
• (i) If the goodwill has already been written-off in the past but value of the same is to be
recorded further in the books of accounts.
• (ii) If an existing company is being taken with or amalgamated with another existing
company;
• (iii) If the Stock Exchange Quotation of the value of shares of the company is not available in
order to compute gift tax, wealth tax etc.; and
• (iv) If the shares are valued on the basis of intrinsic values, market value or fair value
methods.

5. METHODS OF VALUING GOODWILL
• 1. Years’ Purchase of Average Profit Method:
•2. Years’ Purchase of Weighted Average Method
•3. Capitalization Method
•4. Annuity Method
•5. Super-Profit Method

6. SOME ADJUSTMENT WITH PROFIT
At the time of calculating average profit, some adjustment is to be done:
(-)speculative / extra ordinary profit
(-)Future losses
(-)income from investment
(-)overvaluation of stock
(-)manager’s remuneration
(+) speculative / extra ordinary loss
(+) Future income
(+) under valuation of stock
Note: These items are (deducted/added) adjusted with respective years (if mention), then calculate average profit.

7. (1) YEARS’ PURCHASE OF AVERAGE PROFIT METHOD
• Under this method, average profit of the last few years is multiplied by one or more
number of years in order to ascertain the value of goodwill of the firm. How many
years’ profit should be taken for calculating average and the said average should be
multiplied by how many number of years — both depend on the opinions of the
parties concerned.
• The average profit which is multiplied by the number of years for ascertaining the
value of goodwill is known as Years’ Purchase. It is also called Purchase of Past Profit
Method or Average Profit Basis Method.
• Profit Basis Method:
• Average Profit = Total Profits for all the years/Number of years
• Value of Goodwill = Average Profit × Years’ Purchase.

8. Illustrations Related To Valuing Goodwill Under
Average Profit Method
• Illustration 1:
Sumana, Suparna and Aparna are partners in a firm. They share profits and losses in the ratio
of 3: 2: 1. The partnership deed provides that, on the retirement of a partner, Goodwill shall be
calculated on the basis of 5 years’ purchase of the average net profits of the preceding 8
years. Aparna retires from the business on 31.12.1993.
The net profits for the last 8 years are as follows:
1996 Rs. 6,000; 1997 Rs. 12,000; 1998 Rs. 20,000; 1999 Rs. 16,000; 2000 Rs. 25,000; 2001
Rs. 30,000; 2002 Rs. 36,000; 2003 Rs. 31,000.
Compute the Goodwill of the firm which is payable to Aparna.

9. SOLUTION :-
• Average profit of 8 years:
6,000+ 12,000+. 20,000+ 16,000+ 25,000+ 30,000+36,000+ 31,000/ 8
=22000
Total value of Goodwill= average profit x year’s purchased
= 22,000 x 5
= Rs. 1,10,000
the Goodwill of the firm which is payable to Aparna= 110000x 1/6
= Rs. 18333.

10. This method is the modified version of Years’ Purchase of Average
Profit Method. Under this method, each and every year’s profit
should be multiplied by the respective number of weights, e.g. 1, 2, 3
etc., in order to find out the value of product which is again to be
divided by the total number of weights for ascertaining the weighted
average profit. Therefore, the weighted average profit is multiplied
by the years’ purchase in order to ascertain the value of goodwill.
This method is particularly applicable where the trend of profit is
rising.
Weighted Average Profit = Total Profits for all the years/Number of
years
Value of Goodwill = Weighted Average Profit x Years’ Purchase.
(2)Years’ Purchase of Weighted Average Method:

11. 4800
Problem

13. Continue……….
source: http://www.yourarticlelibrary.com/accounting/goodwill/accounting-procedure-for-
valuation-of-goodwill-4-methods/57243

14. Super-profit represents the difference between the
average profit earned by the business and the normal
profit (on this basis of normal rate of return for
representative firms in the industry) i.e., the firm’s
anticipated excess earnings. As such, if there is no
anticipated excess earning over normal earnings, there
will be no goodwill.
Super-profit Method

15. Step 1: Calculate capital employed (it is the aggregate of Shareholders’
equity and long term debt or fixed assets and net current assets).
Step 2: Calculate Normal Profits by multiplying capital employed with
normal rate of return.
Step 3: Calculate average maintainable profit.
Steps 4: calculate super normal profit:-
Super Profit= average profit(adjusted)- normal profit
Value of Goodwill = Super Profit X Years’ Purchase
Super-profit Method

16. Problem – Related To Super-profit Method
Illustration 5:
State with reasons whether the following statement is correct or not: X and Y’s financial position is as
under:
(i) Capital employed – Rs. 50,000
(ii) Trading profit (after tax):
2010 Rs. 12,200;
2011 Rs. 15,000;
2012 Rs. 2,000 (loss); and
2013 Rs. 21,000
(iii) Rate of interest expected from capital having regard to the risk involved is 10%.
(iv) Remuneration from alternative employment of the proprietor (if not engaged in business) Rs.
3,600 p.a.

17. • Average profit=11550
• Average adjusted profit=
(AP-Remuneration)
=11550-3600
=7950/-
SP= AAP-NP
• NP= Capital employed
x rate of return/100

18. PROBLEM: 2

19. Solution

20. Under this method, the value of the entire business is determined on the basis of normal profit.
Goodwill is taken as the difference between the Values of the Business minus Net Tangible Assets.
Under this method, the following steps should be taken into consideration for ascertaining the
amount of goodwill:
(i) Expected Average Net Profit should be ascertained;
(ii) Capitalised value of profit is to be calculated on the basis of normal rate of return;
(iii) Net Tangible Assets (i.e. Total Tangible Assets – Current Liabilities) should also be calculated;
(iv) To be deducted (iii) from (ii) in order to ascertain the value of Goodwill.
Capitalised Value of Profit = Profit (Adjusted)/Normal Rate of Return × 100
Value of Goodwill = Capitalised Value of Profit – Net Tangible Assets.
CAPITALISATION METHOD

21. TYPES OF CALCULATION OF GOODWILL IN
CAPITALIZATION METHOD
•According to capitalization of average profit
•According to capitalization of super profit

22. Problem : 1

23. Solution
Capitalized value of profit=
AAP x 100/Normal Rate of
Return
Value of Goodwill=
Capitalized value of profit -
Net Tangible asset
Net tangible asset(C. Emp.)=
Total tangible asset- current
liabilities
Capital employed=
share capital+ reserve &
surplus +long term debts- misc.
to the extent of written off

24. Problem :2

25. Solution

26. Continue solution……

27. Under this method, Super-profit (excess of actual profit over normal
profit) is being considered as the value of annuity over a certain
number of years and for this purpose, compound interest is
calculated at a certain respective percentage. The present value of
the said annuity will be the value of goodwill.
ANNUITY METHOD
When A.V. is more than Rs. 1
Goodwill = SP x Present value of
Re.1/1
When A.V. is less than Rs. 1
Goodwill =
SP/ Present value of Re.1

28. The net profits of a company, after providing for taxation for the past
five years, are:
Rs. 20,000; Rs. 25,000; Rs. 15,000; Rs. 35,000; and Rs. 40,000. The
Net Tangible Assets in the business is Rs. 2,00,000 on which the
normal rate of return is expected to be 10%. It is also expected that
the company will be able to maintain its super-profits for the next
ten years.
Calculate the value of Goodwill of the business on the basis of an
annuity of super-profits, taking the Present Value of an annuity of
one rupee for five years at 10% interest as Rs. 3.78.
PROBLEM

29. Solution

30. Thank you