Valuation of goodwill

different methods of valuation of Goodwill

1. VALUATION OF
GOODWILL
PRESENTED BY--
DR. JYOTIKHARE
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
•Underthismethod,averageprofitofthelastfewyearsismultipliedbyoneormore
numberofyearsinordertoascertainthevalueofgoodwillofthefirm.Howmany
years’profitshouldbetakenforcalculatingaverageandthesaidaverageshouldbe
multipliedbyhowmanynumberofyears—bothdependontheopinionsofthe
partiesconcerned.
•Theaverageprofitwhichismultipliedbythenumberofyearsforascertainingthe
valueofgoodwillisknownasYears’Purchase.ItisalsocalledPurchaseofPastProfit
MethodorAverageProfitBasisMethod.
•ProfitBasisMethod:
•AverageProfit=TotalProfitsforalltheyears/Numberofyears
•Value of Goodwill = Average Profit ×Years’ Purchase.

8. Illustrations Related To Valuing Goodwill Under
Average Profit Method
•Illustration 1:
Sumana, Suparnaand 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. ThismethodisthemodifiedversionofYears’PurchaseofAverage
ProfitMethod.Underthismethod,eachandeveryyear’sprofit
shouldbemultipliedbytherespectivenumberofweights,e.g.1,2,3
etc.,inordertofindoutthevalueofproductwhichisagaintobe
dividedbythetotalnumberofweightsforascertainingtheweighted
averageprofit.Therefore,theweightedaverageprofitismultiplied
bytheyears’purchaseinordertoascertainthevalueofgoodwill.
Thismethodisparticularlyapplicablewherethetrendofprofitis
rising.
WeightedAverageProfit=TotalProfitsforalltheyears/Numberof
years
ValueofGoodwill=WeightedAverageProfitxYears’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-profitrepresentsthedifferencebetweenthe
averageprofitearnedbythebusinessandthenormal
profit(onthisbasisofnormalrateofreturnfor
representativefirmsintheindustry)i.e.,thefirm’s
anticipatedexcessearnings.Assuch,ifthereisno
anticipatedexcessearningovernormalearnings,there
willbenogoodwill.
Super-profit Method

15. Step1:Calculatecapitalemployed(itistheaggregateofShareholders’
equityandlongtermdebtorfixedassetsandnetcurrentassets).
Step2:CalculateNormalProfitsbymultiplyingcapitalemployedwith
normalrateofreturn.
Step3:Calculateaveragemaintainableprofit.
Steps4:calculatesupernormalprofit:-
SuperProfit=averageprofit(adjusted)-normalprofit
ValueofGoodwill=SuperProfitXYears’Purchase
Super-profit Method

16. Problem –Related To Super-profit Method
Illustration5:
Statewithreasonswhetherthefollowingstatementiscorrectornot:XandY’sfinancialpositionisas
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. Underthismethod,thevalueoftheentirebusinessisdeterminedonthebasisofnormalprofit.
GoodwillistakenasthedifferencebetweentheValuesoftheBusinessminusNetTangibleAssets.
Underthismethod,thefollowingstepsshouldbetakenintoconsiderationforascertainingthe
amountofgoodwill:
(i)ExpectedAverageNetProfitshouldbeascertained;
(ii)Capitalisedvalueofprofitistobecalculatedonthebasisofnormalrateofreturn;
(iii)NetTangibleAssets(i.e.TotalTangibleAssets–CurrentLiabilities)shouldalsobecalculated;
(iv)Tobededucted(iii)from(ii)inordertoascertainthevalueofGoodwill.
CapitalisedValue of Profit = Profit (Adjusted)/Normal Rate of Return ×100
Value of Goodwill = CapitalisedValue 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. Underthismethod,Super-profit(excessofactualprofitovernormal
profit)isbeingconsideredasthevalueofannuityoveracertain
numberofyearsandforthispurpose,compoundinterestis
calculatedatacertainrespectivepercentage.Thepresentvalueof
thesaidannuitywillbethevalueofgoodwill.
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. Thenetprofitsofacompany,afterprovidingfortaxationforthepast
fiveyears,are:
Rs.20,000;Rs.25,000;Rs.15,000;Rs.35,000;andRs.40,000.The
NetTangibleAssetsinthebusinessisRs.2,00,000onwhichthe
normalrateofreturnisexpectedtobe10%.Itisalsoexpectedthat
thecompanywillbeabletomaintainitssuper-profitsforthenext
tenyears.
CalculatethevalueofGoodwillofthebusinessonthebasisofan
annuityofsuper-profits,takingthePresentValueofanannuityof
onerupeeforfiveyearsat10%interestasRs.3.78.
PROBLEM

29. Solution

30. Thank you