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Types of Valuing Goodwill: (A) Simple Profit Method

Steps to calculate goodwill under various methods Dr. C Nagadeepa Kristu Jayanti College Bangalore

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3K views3 pages

Types of Valuing Goodwill: (A) Simple Profit Method

Steps to calculate goodwill under various methods Dr. C Nagadeepa Kristu Jayanti College Bangalore

Uploaded by

cnagadeepa
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Types of Valuing Goodwill

There are basically two types of valuing goodwill: (a) Simple profit method and (b) Super profit
method.
(a) Simple Profit Method:
Goodwill is generally valued on the basis of a certain number of years’ purchase of the average
business profits of the past few years. While calculating average profits for the purposes of
valuation of goodwill, certain adjustments are made. Some of the adjustments are as follows:

Trading Profit/Business Profit/Recurring Profit/Normal Profit (of Past Year)


Particulars 1st Year 2nd Year 3rd Year
Net Profit before Adjustment and Tax
Less: Non Occurring/recurring Income in future
Less: Recurring expenses in future

Add: Recurring income in future


Add: Non-recurring expenses/losses in future
Trading Profit after Adjustment

Example:

Profit before adjustment ***


Add: Capital expenditure charged to revenue ***
Add: Overvaluation of opening stock ***
Add: Undervaluation of closing stock ***
Add: Unrecorded income ***
Add: Abnormal loss due to fire or ***
***
Less: Undervaluation of opening stock ***
Less: Overvaluation of closing stock ***
Less: Abnormal or non-recurring income ***
Profit on sale of assets
Less: Profit on sale of Fixed Asset ***
Less: Revenue expenses recorded as capital expenditure
Major expenses on plant charged as revenue expenses
Less: Non trading income (interest, dividend, rent) *** ***
Adjusted profit ***
Methods of valuation of goodwill
• Average Profits Method
• Capitalization Method
• Super Profits Method
• Annuity Method

(I) Goodwill by purchase of average profit method:


Steps:
(a) Calculate Adjusted profit

(b) Calculate adjusted average profit.


• Add profit of all the years / no of years.
(c) Calculate the number of year purchase (it will always be given in problem).
Goodwill: Number of year purchase × adjusted Average profit.

(II)Goodwill by capitalisation method:

Steps:
(a) Calculate Adjusted average profit.
(b) Calculate the value of the business
= Adjusted Average profit x Normal Rate of return
(c) Calculate capital employed.
(d) Goodwill = Total Value of business – Capital Employed

Capital employed

Marketable asses (other than goodwill and fictitious assets) at market value xxx
Less: Liability (third party liability other than capital and reserves and surplus) xxx

Capital employed

Less ½ of current year adjusted profit xxx

Average capital employed


(I) Goodwill by purchase of super profit method: Steps:

(a) Calculate Adjusted average profit.


(b) Calculate average capital employed.
(c) Calculate normal profit
a. Average capital employed x normal rate of return
(d) Calculate super profit
a. Super profit = Adjusted average profit – normal profit
(e) Goodwill = super profit x no of years of purchase
profit or return which an investor expects on his investment in a

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