GOODWILL

Chapter 2 -Accounting for Partnership Firms : Goodwill

IMPORTANT POINTS

There are three methods of valuation of goodwill of the firm;

1.                 Average Profits Method

2.                 Super Profits Method

3.                 Capitalisation Method

Ø   Average Profits Method:

Goodwill = Average Profits X Number of years of Purchase

Before calculating the average profits the following adjustments should be made in the profits of the firm:

a.                 Any abnormal profits should be deducted from the net profits of that year.

b.               Any abnormal loss should be added back to the net profits of that year.

c.                 Non operating incomes eg. income from investments etc should be deducted from the net profits of that year.

Ø   Super profits method:

Steps for calculating Goodwill under this method are given below:

i)           Normal Profits = Capital Employed X Normal rate of return/100

ii)         Super Profits = Actual Profits – Normal Profits

Goodwill = Super Profits x No. of years purchased

Capitalisation Method:

There are two ways of calculating Goodwill under this method:

(i)         Capitalisation of Average Profits Method

(ii)       Capitalisation of Super Profits Method

(i) Capitalisation of Average Profits Method:

Capitalised Value of Average Profits = Average Profits X (100 / Normal Rate of Return)

Capital Employed = Assets – Liabilities

Goodwill = Capitalised Value of Average Profits – Capital

Capitalisation of Super Profits:

Under this method first of all we calculate the Super Profits and then calculate the capital needed for earning such super profits on the basis of normal rate of return. This Capital is the value of our Goodwill . The formula is:-

                    Goodwill= Super profit x 100/normal rate of return

IMPORTANT QUESTION -PDF