Valuation of Goodwill Dr. Kawale Pushpalata G. Assistant Professor Department of Commerce Rajarshi Shahu Mahavidyalaya (Autonomous), Latur. Prepared by: Dr. Kawale Pushpalata

Prepared by: Dr. Kawale Pushpalata Meaning of Goodwill It is a good name or reputation earned by a firm. It is an intangible asset. It is the value of business over and above the value of its assets. It is the difference between the purchase price and the value of net assets. It has a positive impact on the future turnover and profits of the business. Prepared by: Dr. Kawale Pushpalata

Factors Affecting Valuation of Goodwill 1. Good Public Relation 2. Regular Customers 3. Quality Product in Reasonable Price 4. Management Skills 5. Location of Business 6. Good Relation with Suppliers 7. Employees Prepared by: Dr. Kawale Pushpalata

Methods of Valuation of Goodwill 1. Simple Average Profit Method 2. Super Profit Method 3. Weighted Average Method 4. Capitalization Method a. Capitalization of Average Profit Method b. Capitalization of Super Profit Method Prepared by: Dr. Kawale Pushpalata

1. Simple Average Profit Method Goodwill = Average Profit * Number of year of purchase Average Profit = Total Profit / Number of Years Number of years of purchase means the number of year for which the firms is likely to earn the same amount of profit. Prepared by: Dr. Kawale Pushpalata

Prepared by: Dr. Kawale Pushpalata Things to consider before calculating the average profits :- 1. Any abnormal profit should be deducted from the net profits of that year. 2. Any abnormal loss should be added back to the net profits of that year. 3. Non-operating incomes e.g. income from investments should be deducted from the net profits of that year. Prepared by: Dr. Kawale Pushpalata

Prepared by: Dr. Kawale Pushpalata Illustration No. 1 Following details are available about Alpha ltd. Profits 2010 ₹ 100000, 2011- ₹ 125000, 2012- ₹ 140000 2. Profits of 2010 have been reduced by ₹ 15000 because goods were destroyed by fire. 3. Non-recurring income of ₹ 10000 is included in the profit of 2011. 4. Profits of 2012 include ₹ 10000 income from investment. Calculate goodwill on the basis of four years’ purchase of the average profit of last three years. Prepared by: Dr. Kawale Pushpalata

Prepared by: Dr. Kawale Pushpalata Solution :- 1. Profit of 2010 ₹ 100000 add ₹ 15000 = ₹ 115000 2. Profit of 2011 ₹ 125000 less ₹ 10000 = ₹ 115000 3. Profit of 2012 ₹ 140000 less ₹ 10000 = ₹ 130000 Average Profit/ Future Maintainable Profit = Total Profit / No. of Years Purchase = 360000 / 3 = 120000 Goodwill = Future Maintainable Profit * No. of years purchase = 120000 * 3 = 40000 Prepared by: Dr. Kawale Pushpalata

Prepared by: Dr. Kawale Pushpalata 2. Super Profits Method Goodwill is calculated on the basis of Super Profit i.e. the excess of actual profits over the average profits. Formula:- Goodwill = Super Profit * No. of years purchase 2. Super Profit = Average Profits - Normal Profits 3. Normal Profits = Capital Employed * Normal Rate of Return / 100 Prepared by: Dr. Kawale Pushpalata

Prepared by: Dr. Kawale Pushpalata Illustration No. 2 Average Profit is ₹. 60000, Capital employed is ₹ 500000, NRR is 10%. Calculate goodwill on the basis of four year’s purchase of the super profit of last four years. Solution: Normal Profit = Capital employed * NRR = 500000 * 10% = 50000 Super Profit = Average Profit – Normal Profit = 60000 - 50000 = 10000 Goodwill = Super Profit * No. of years purchase = 10000 * 4 = 40000 Prepared by: Dr. Kawale Pushpalata

3. Weighted Average Profit method This method is the modified version of the simple average profit method. In this method, each year’s adjusted profits are multiplied with the respective number of weights in order to calculate the total product. The total of products is then divided by the total of weights to calculate the weighted average profits. Thereafter, the weighted average profits are multiplied by the number of years of purchase. Formula : Weighted Average Profits = Total Products o Profits / Total of Weights Goodwill = Weighted Average Profits * No. of years of purchase Prepared by: Dr. Kawale Pushpalata

4. Capitalization of Profit Method Capitalization of Average Profit Method = Average Profit / NRR * 100 b. Capitalization of Super Profit Method = Super Profit / NRR * 100 Prepared by: Dr. Kawale Pushpalata

Prepared by: Dr. Kawale Pushpalata Thank You Prepared by: Dr. Kawale Pushpalata