Valuation of Goodwill

Valuation of Goodwill

Factors affecting the Value of Goodwill

1.      Future Profits expected to be earned by the concern.
2.      Capital Requirements.
3.      Possibility of transfer of Goodwill.

Methods of valuing Goodwill

1.      Average Profits Methods

2.      Super Profit Method

3.      Capitalization Method

4.      Annuity Method

Let us discuss each method detail –

1.      Average Profit Method:

Goodwill under this method is calculated based on the Average Profits of Past few years. The Average Profit is multiplied by the No. of Years for which such profit is expected to be earned.

Goodwill = Average Profit X No. of Years Purchase

Average Profit =           Total Profit

                                    No. of Years

There is an extension of this method wherein the profits of each year are given weights and based on this the weighted profits are calculated.

Goodwill = Weighted Average Profit X No. of Years Purchase

Weighted Average Profit =     Total Weighted Profits

                                                      Total Weights

Note: While allotting weights we need to remember that the highest weight is to be given to the most recent year, i.e. lowest weight (1) is to be given to the oldest year.

 

2.      Super Profit Method:

Under this method FMP (Future Maintainable Profits) of the firm are compared with the Normal Profits. The amount of FMP more then the Normal Profits is known as “Super Profit”

Goodwill = Super Profit X No. of Years Purchase

Super Profit = FMP – Normal Profit

FMP = Average Profit +/- Adjustments related to future profit

Calaulation of Future Maintainable Profits
	Past Average Profits	XXX
Add:	Expenses not likely to inccur in future	XXX
	Expected New Incomes in future	XXX	XXX
Less:	New Expenses expected to be	XXX
	inccured in future	XXX
	Incomes not likely to inccur in future	XXX	XXX
	Future Maintainable Profits		XXX

 

Normal Profit = Average Capital Employed X NRR/100

NRR means Normal Rate of Return

 

Capital Employed can be calculate using either the Asset Side Approach or the

Liability Side Approach.

 

Asset Side Approach
Total Assets	XXX
(Except Goodwill &
fictitious Assets)
(-) Outside Liabilities	XXX
Capital Employed	XXX

 

Liability Side Approach
	Share Capital	XXX
	Reserve Fund	XXX
	P & L A/c	XXX
	Apprn in value of assets
	due to Revaluation	XXX	XXX
Less:	Goodwill	XXX
	Fictitious Assets	XXX
	Fall in value of assets
	due to Revaluation	XXX	XXX
	Capital Employed		XXX

 

3.      Capitalization Method:

Under this method the value of Goodwill is calculated by Capitalizing the Super Profits of the Business.

Goodwill = Super Profit X 100/NRR