CHAPTER 01

INTRODUCTION
 CHAPTER 1
INTRODUCTION
1. MEANING OF VALUATION
Valuation is the process of estimating what something is worth. Valuation can be used as a very
effective business tool by management for better decision making throughout the life of the
enterprise. Valuations are needed for many reasons such as investment analysis, capital budgeting,
merger and acquisition transactions, financial reporting, determination of tax liability. Companies
are governed and valuations are influenced by the market supply &demand life cycles along with
product and technology supply-demand lifecycles. Correspondingly, the value of an enterprise over
the course of its lie peaks with the market and product technology factors. Both financial investors
such as venture capitalists and entrepreneurs involved in a venture would ideally like to exit the
venture in some form near the peak to maximize their return on investment. Thus, valuation helps
determine the exit value of an enterprise at that peak. This exit value typically includes the tangible
and intangible value of the company’s assets. Tangible value would typically include balance sheet
items recorded as the book value of the enterprise. Intangibles would typically include intellectual
property, human capital, brand and customers, and others. In more traditional companies
considering the private equity markets, the value of intangibles is much higher than the value of the
tangible assets. Therefore, an effective enterprise valuation methodology needs to be developed.
One can also define valuation as Measurement of value in monetary terms. Measurement of income
and valuation of wealth are two interdependent core aspects of financial accounting and reporting.
Wealth comprises of assets and liabilities. Valuation of assets and liabilities are made to portray the
wealth position of a firm through a balance sheet and to supply logistics to the measure of the
periodical income of the firm through a profit and loss account. Again valuation of business and
valuation of share are made through financial statement analysis for management appraisal and
investment decisions. Valuation is pivotal in strategic, long term or short term decision making
process in cases like reorganization of company, merger and acquisition, extension or
diversification, or for launching new schemes or projects. As the application area of valuation
moves from financial accounting to financial management, the role of accountant also undergoes a
transition. That order of transition in the concept and use of valuation process is followed in the
subsequent units of this chapter.
2. GOODWILL
2.1) MEANING OF GOODWILL
Goodwill is said to be that element arising from reputation, connection or other advantages
possessed by a business which enables it to earn greater profits than the return normally to be
expected on the capital represented by net tangible assets employed in the business. In considering
the return normally to be expected, regard must be had to the nature of the business, the risk
involved, fair management remuneration and other relevant circumstances. Goodwill of a business
may arise in two ways. It may be inherent to the business that is generated internally or it may be
acquired while purchasing any concern. Purchased goodwill can be defined as being the excess of
fair value of the purchase consideration over the fair value of the separable net assets acquired. The
value of purchased goodwill is not necessarily equal to the inherent goodwill of the business
acquired as the purchase price may reflect the future prospects of the entity as a whole. Goodwill in
financial statements arises when a company is purchased for more than the fair value of the
identifiable net assets of the company. The difference between the purchase price and the sum of
the fair value of the net assets is by definition the value of the "goodwill" of the purchased
company. The acquiring company must recognize goodwill as an asset in its financial statements
and present it as a separate line item on the balance sheet, according to the current purchase
accounting method. In this sense, goodwill serves as the balancing sum that allows one firm to
provide accounting information regarding its purchase of another firm for a price substantially
different from its book value. Goodwill can be negative, arising where the net assets at the date of
acquisition, fairly valued, exceed the cost of acquisition. Negative goodwill is recognized as a gain
to the extent that it exceeds allocations to certain assets. Under current accounting standards, it is no
longer recognized as an extraordinary item. For example, a software company may have net assets
(consisting primarily of miscellaneous equipment, and assuming no debt) valued at ` 1 million, but
the company's overall value (including brand, customers, intellectual capital) is valued at ` 10
million. Anybody buying that company would book ` 10 million in total assets acquired, comprising
` 1 million physical assets, and ` 9 million in goodwill.

2.2) Modern Meaning

Goodwill is a special type of intangible asset that represents that portion of the entire business value
that cannot be attributed to other income producing business assets, tangible or intangible.
For example, a privately held software company may have net assets (consisting primarily of
miscellaneous equipment and/or property, and assuming no debt) valued at $1 million, but the
company's overall value (including customers and intellectual capital) is valued at $10 million.
Anybody buying that company would book $10 million in total assets acquired, comprising $1
million physical assets and $9 million in other intangible assets. And any consideration paid in
excess of $10 million shall be considered as goodwill. In a private company, goodwill has no
predetermined value prior to the acquisition; its magnitude depends on the two other variables by
definition. A publicly traded company, by contrast, is subject to a constant process of market
valuation, so goodwill will always be apparent. While a business can invest to increase its
reputation, by advertising or assuring that its products are of high quality, such expenses cannot be
capitalized and added to goodwill, which is technically an intangible asset. Goodwill and intangible
assets are usually listed as separate items on a company's balance sheet.

AIMS AND OBJECTIVES

This project aims to study the method of goodwill accounting treatment in case of admission,
retirement, or death of a partner.
There are many objectives for this project. Major few objectives are given below.
Objectives:
• To understand what is goodwill accounting
. To know the purpose behind goodwill accounting
• To understand the various methods of goodwill accounting
• To know the importance of goodwill accounting
To ascertain any doubts regarding the various methods of valuation of goodwill
• To understand the need for goodwill accounting
3) Research Methodology
The required data is collected only from secondary sources.
Secondary Sources :
Secondary data is a data which is collected and complied for different purpose, which is used in
research for the study. The secondary data includes material collected from internet, newspaper,
books and magazines.
 CHAPTER 02

THEROTICAL BACKGROUND
 CHAPTER 3
THEROTICAL BACKGROUND

1. VALUATION OF GOODWILL
1.1) Concept of valuation
 Valuation means measurement of an item in monetary term. The subjects of valuation are varied
as stated below:
 Valuation of Tangible Fixed Assets
 Valuation of Intangibles including brand valuation and valuation of goodwill
 Valuation of Shares
 Valuation of Business
 The objectives of valuation are again different in different areas of application in financial
accounting and in financial management.

1.2) NEED FOR VALUATION

Financial statements must give a “true and fair view” of the state of affairs of a company as per
provisions of the Companies Act. Proper valuation of all assets and liabilities is required to ensure
true and fair financial position of the business entity. In other words, all matters which affect the
financial position of the business have to be disclosed. Under or overvaluation of assets may not
only affect the operating results and financial position of the current period but will also affect these
for the next accounting period. The present unit deals with different principles involved in the
valuation of different types of assets. Assets can be classified as (i) Non- current assets and (ii)
Current assets.
Non-current assets have been further sub-classified into (a) fixed assets i.e. tangible assets,
intangible assets, capital W.I.P. and intangible assets under development (b) noncurrent investments
(c) deferred tax assets (Net) (d) long term loans and advances and (e) other non-current assets.
Current assets have been further sub-classified into (a) Current Investments (b) Inventories (c)
Trade Receivables (d) Cash and Cash Equivalents (e) Short Term Loans and Advances and (f)
Other Current Assets.
The students are expected to learn the essence and modalities of valuation, a core function in
financial accounting. Valuation is done sometimes by the
Values / Engineers in cases where technical in puts and knowledge is required to arrive at the Fair
value and accepted by various Government and Statutory Authorities. Students should be familiar
with these valuation Reports and their basis of valuation.
Different approaches to valuation of different kinds of assets and liabilities in different perspectives
have pushed the role of accountant to a complex position. This chapter is aimed to differentiate the
objectives, approaches and methods of valuation in order to integrate them in a comprehensive
logical frame.
1.3) BASES OF VALUATION
A number of different measurement bases are employed to different degrees and in varying
combinations in valuation of different assets in different areas of application. They include the
following: (a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or
the fair value of the other consideration given to acquire them at the time of their acquisition. (b)
Current cost. Assets are carried at the amount of cash or cash equivalents that would have to be paid
if the same or an equivalent asset were acquired currently. (c) Realizable (settlement) value. Assets
are carried at the amount of cash or cash equivalents that could currently be obtained by selling the
asset in an orderly disposal.
(d) Present value. Assets are carried at the present value of the future net cash inflows that the item
is expected to generate in the normal course of business. Other generally used valuation bases are as
follows: Net Realizable Value (NRV): This is same as the Realizable (settlement) value. This is the
value (net of expenses) that can be realized by disposing off the assets in an orderly manner. Net
selling price or exit values also convey the same meaning. Economic value: This is same as the
present value. The other name of it is value to business Replacement (cost) value: This is also same
as the current cost.
Recoverable (amount) value: This is the higher of the net selling price and value in use. Deprival
value: This is the lower of the replacement value and recoverable (amount) value. Liquidation
value: This is the value (net of expenses), that a business can expect to realize by disposing of the
assets in the event of liquidation. Such a value is usually lower than the NRV or exit value. This is
also called break-up value. Fair value: This is not based on a particular method of valuation. It is the
acceptable value based on appropriate method of valuation in context of the situation of valuation.
Thus fair value may represent current cost, NRV or present value as the case may be. In financial
accounting ‘An asset is recognized in the balance sheet when it is probable that the future economic
benefits associated with it will flow to the enterprise and the asset has a cost or value that can be
measured reliably.’ ‘The measurement basis most commonly adopted by enterprises in preparing
their financial statements is historical cost. This is usually combined with other
Measurement bases. The requirements of regulations and accounting standards as to recognition of
assets, reliability of measurement and disclosure in financial reports have set certain limitations to
the freedom of valuation so far as financial accounting is concerned.
1.4) TYPES OF VALUE
The following are six types of value:
Going-concern value is the value of a firm as an operating business.
Liquidation value is the projected price that a firm would receive by selling its assets if it were
going out of business
 Book value is the value of an asset as carried on a balance sheet. In other words, it means (i) the
cost of an asset minus accumulated depreciation (ii)the net asset value of a company, calculated
by total assets minus intangible assets (patents, goodwill) and liabilities (iii) the initial outlay for
an investment. This number may be net or gross of expenses such as trading costs, sales taxes,
service charges and so on. It is the total value of the company’s assets that shareholders would
theoretically receive if a company were liquidated. By being compared to the company’s market
value, the book value can indicate whether a Inventory is under or overpriced. In personal
finance, the book value of an investment is the price paid for a security or debt investment.
When an inventory is sold, the selling price less the book value is the capital gain (or loss) from
the investment.
 Market value is the price at which buyers and sellers trade similar items in an open market
place. It is the current quoted price at which investors buy or sell a share of common Inventory
or a bond at a given time. The market capitalization plus the market value of debt, sometimes
referred to as “total market value”. In the context of securities, market value is often different
from book value because the market takes into account future growth potential.
 Fair market value is the price that a given property or asset would fetch in the market place,
subject to the following conditions: (i) Prospective buyers and sellers are reasonably
knowledgeable about the asset; they are behaving in their own best interests and are free of
undue pressure to trade. (ii) A reasonable time period is given for the transaction to be
completed. Given these conditions, an asset’s fair market value should represent an accurate
valuation or assessment of its worth. Fair market values are widely used across many areas of
commerce. For example, municipal property taxes are often assessed based on the fair market
value of the owner’s property. Depending upon how many years the owner has owned the
home, the difference between the purchase price and the residence’s fair market value can be
substantial. Fair market values are often used in the insurance industry as well. For example,
when an insurance claim is made as a result of a car accident, the insurance company covering
the damage to the owner’s vehicle will usually cover damages up to the fair market value of the
automobile.
 Intrinsic value is the value at which an asset should sell based on applying data inputs to a
valuation theory or model. The actual value of a company or an asset based on an underlying
perception of its true value including all aspects of the business, in terms of both tangible and
intangible factors. This value may or may not be the same as the current market value. Value
investors use a variety of analytical techniques in order to estimate the intrinsic value of
securities in hopes of finding investments where the true value of the investment exceeds its
current market value. For call options, this is the difference between the underlying Inventory’s
price and the strike price. For put options, it is the difference between the strike price and the
underlying Inventory’s price. In the cases, if the respective difference value is negative, the
intrinsic value is given as zero. For example, value investors that follow fundamental analysis
look at both qualitative (business model, governance, target market factors etc.) and quantitative
(ratios, financial statement analysis, etc.) aspects of a business to see if the business is currently
out of favour with the market or is really worth much more than its current valuation.
 Extrinsic value is another variety. It is the difference between an option’s price and the intrinsic
value. For example, an option that has a premium price of 10 and an intrinsic value of ` 5 would
have an extrinsic value of ` 5. Denoting the amount that the option’s price is greater than the
intrinsic value, the extrinsic or time value of the option declines as the expiration date of an
option draws closer. These types of values can differ from one another. For example, a firm’s
going concern value is likely to be higher than its liquidation value. The excess of going
concern value over liquidation value represents the value of the operating firm as distinct from
the value of its assets. Book value can differ substantially from market value. For example, a
piece of equipment appears on a firm’s books at cost when purchased but decreases each year
due to depreciation charges. The price that someone is willing to pay for the asset in the market
 may have little relationship with its book value. Market value reflects what someone is willing
to pay for an asset whereas intrinsic value shows what the person should be willing to pay for
the same asset
1.5) APPROACHES OF VALUATION
Three generally accepted approaches to valuation are as follows:
(1) Cost Approach: e.g. Adjusted Book Value
(2) Market Approach: e.g. Comparables
(3) Income Approach: e.g. Discounted Cash Flow
Each approach has advantages and disadvantages. Generally there is no “right” answer to a
valuation problem. Valuation is very much an art as much as a science! These approaches can be
briefly discussed as:
1.6) Cost Approach
This technique involves restating the value of individual assets to reflect their fair market values. It
is useful for valuing holding companies where assets are easy to value (for example, securities) and
less useful for valuing operating businesses. The value of an operating company is generally greater
than that of its assets. The difference between that value of the expected cash flows and that of its
assets is called the “going concern value”. It is a useful approach when the purpose of the valuation
is that the business will be liquidated and Trade payables must be satisfied. The financial adviser
estimates the amount of current cost required to recreate the goodwill component elements. The
cost approach typically involves a component restoration method. The first procedure in the
component restoration method is to list all of the individual components of the entity’s goodwill.
The second procedure is to estimate the amount of current cost required to replace each goodwill
component. This procedure is based on the concept of goodwill as represented by the intangible
value of all entity assets in place and ready to use. One procedure in the restoration method is the
analysis of forgone income (considered an opportunity cost in the cost approach) during the time
period required to assemble all of the entity’s tangible assets and identifiable intangible assets.
While doing this valuation following adjustments to book value can be made:
 Bad debt reserves
 Market value of plant and equipment
 Patents and franchises
 Investments in affiliates
 Tax-loss carried forward
 Inventory undervaluation

1.5) Market Approach:

The market approach, as the name implies, relies on signs from the real market place to determine
what a business is worth. It is to be understood that business does not operate in vacuum. If what
one does is really great, then chances of others doing the same or similar things are more. If one is
looking to buy a business, one decides what type of business he is interested in and then looks
around to see what the "going rate" is for businesses of this type. If one is planning to sell business,
he will check the market to see what similar businesses sell for. So the market approach to valuing a
business is a great way to determine its fair market value - a monetary value likely to be exchanged
in an arms-length transaction, when the buyer and seller act in their best interest. There are two
common market approach methods related to goodwill. The first method estimates the value of
goodwill as the residual from an actual business acquisition price. This method is called the residual
from purchase price method. The second method estimates the value of goodwill based on an
analysis of guideline sale transactions. This method is called the sales comparison method.
Goodwill is rarely sold separately from any other assets (either tangible assets or intangible assets)
of a going-concern business

1.6) Income approach.

The income approach considers the core reason for running a business ie. making money. Here the
so-called economic principle of expectation applies. Since the business value must be established in
the present, the expected income and risk must be translated to today. The income approach
generally uses two ways to do this translation: (i) Capitalization and (ii) Discounting.
The Income Approach With regard to goodwill, the income approach methods include the residual
from business value method, the capitalized excess earnings method, and the present value of future
income method. Each of these valuation methods is based on the concept of goodwill as the present
value of future income not associated with the entity’s tangible assets or identifiable intangible
assets.
 2.GOODWILL
2.1) WHAT IS GOODWILL ACCOUNTING
Goodwill is that the price of the name of a firm designed over time with relevance to the expected
future profits over and on top of the traditional profits. A well-established firm earns a decent name
within the market, builds trust with the purchasers, and conjointly has additional business
connections as compared to a recently came upon business. Thus, the price of this advantage that a
client is prepared to pay is termed as Goodwill. The buyer who pays expects that he is going to be
ready to earn super profits as compared to the profits attained by the opposite companies. Thus, it
will be aforesaid that goodwill exists solely just in case} of companies creating super profits and not
in case of companies earning traditional profits or losses. It an intangible real plus that can't be seen
or felt however exists essentially and might be bought and sold. Goodwill is excess of purchase
price over share of Net Assets (Fair Value) Goodwill is Intangible Asset Goodwill is Reputation ,
higher earning of income , etc Goodwill = Purchase price – FV of Net Assets acquired as on date of
purchase
2.2) DEFINITION OF GOODWILL
An intangible asset that arises as a result of the acquisition of one company by another for a
premium value. The value of a company’s brand name, solid customer base, good customer
relations, good employee relations and any patents or proprietary technology represent goodwill.
Goodwill is considered an intangible asset because it is not a physical asset like buildings or
equipment. The goodwill account can be found in the assets portion of a company's balance sheet.
2.3) EXPLANATION OF GOODWILL
The value of goodwill typically arises in an acquisition when one company is purchased by another
company. The amount the acquiring company pays for the target company over the target’s book
value usually accounts for the value of the target’s goodwill. If the acquiring company pays less
than the target’s book value, it gains “negative goodwill,” meaning that it purchased the company at
a bargain in a distress sale.
Goodwill is difficult to price, but it does make a company more valuable. For example, a company
like Coca-Cola (who has been around for decades, makes a wildly popular product based on a secret
formula and is generally positively perceived by the public), would have a lot of goodwill. A
competitor (a small, regional soda company that has only been in business for five years, has a
small customer base, specializes in unusual soda flavors and recently faced a scandal over a
contaminated batch of soda), would have far less goodwill, or even negative goodwill. Because the
components that make up goodwill have subjective values, there is a substantial risk that a company
could overvalue goodwill in an acquisition. This overvaluation would be bad news for shareholders
of the acquiring company, since they would likely see their share values drop when the company
later has to write down goodwill.
2.4) CHARACTERISTIC OF GOODWILL
 It belongs to the category of intangible assets.
 It is a valuable asset.
 It contributes to the earning of excess profits.
 Its value is liable to constant fluctuations.
 Its value is only realised when a business is sold or transferred.
 It is difficult to place an exact value on goodwill and it will always involve expert judgement.
 There can be effect of personal ability for valuation of goodwill.

2.5) WHEN GOODWILL IS VALUED

 When the business is sold as a going concern.
 When the business is amalgamated with another firm.
 When business is converted into private or public company.
 When there is a change in the profit-sharing ratio amongst the existing partners.
 When a new partner is admitted.When a partner retires or dies or reconstruction.

NEED FOR VALUATION OF GOODWILL;

Generally goodwill may be valued at the time of disposal of business of the firm. But in many cases
the goodwill may be valued to find out value of the firm. In case of proprietorship business it will
be valued at the time of disposal of business, in case of firm it may be calculated at the time of
addition, resignation and disposal of firm. Now in case of companies the need for valuation of
goodwill arises in the following circumstances;
1. In case of Amalgamation of company;
2. In case of takeover of one company by another or sold of business of one company;
3. In case of a company wants to write off or reduce debit balance in its profit and loss
account;
4. In case of a company wants to exercise controlling interest in other company;
5. In case of valuation of shares of an Unlisted Company;
6. In case of conversion of shares from one class to another class;
7. In case of company’s management has been taken over by Government and some other
events in which valuation of Goodwill held.
 l
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 (a) In 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.
 (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.


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A IMPORTANCE OF GOODWILL

A). Goodwill is for Business what Reputation is for a Person

You can say that goodwill is an emotion that exists within us and when you create an emotional
bond with the people, you deal with; you are rewarded with opportunity, business networks,
endorsements and trust. Here is a list of points to support the importance of business goodwill.
 Building goodwill with customers. Goodwill is important to increase your customer base but
also retain your old clients. This happens through word-of-mouth publicity and
recommendations. Many customers return to you if you’ve provided them good customer
service and have established a good relationship with them.
Investors are attracted to businesses that have goodwill. The goodwill of your firm is equivalent
to solid cash. It will help you obtain loans from banks with ease knowing that you are a valued
customer.
New avenues open up; opportunities are created through business networks if you have
longstanding business goodwill.
When you want to sell your business at any point in time, your reputation and the goodwill of
your business will attract many potential buyers. You will be able to sell your business for a
good amount.

How to Build Business Goodwill

Goodwill is something that cannot be bought but has to be earned; there is no way to earn it
overnight. It will take considerable time and effort to develop goodwill in for a business. We have
listed some factors that aids in developing goodwill in business.
 Maintain the quality of your products or services  – Remember that the first impression is
the best impression. If your business provides quality products/services right from the
beginning, you are taking the steps towards developing goodwill.
  Rapport building and integrity  – People will find dealing with your business easier when
you take pleasure in servicing them and when you provide business integrity.
 Brand commitment -Your business should be one step ahead of your competitors. A
business under the limelight for the right reasons will attract goodwill for itself.
 Service satisfaction – A customer is likely to return to you and also recommend your
services/products if he is happy with his experience.
 Community service not only helps in developing business good will but also leads to
small business longevity - As your business grows, you should focus on investing in
community goodwill. Some suggestions could be, making a small donation to community
functions or by giving a helping hand to those start-ups of a different industry that are
struggling. You can also promote amateur artisans and musicians by holding exhibitions or
concerts for them. Local residents would be willing to buy tickets that are fairly priced. You
should include other small businesses to help with local events.  It will pay-off with long-
term sales growth and business referrals.
Goodwill is all about the nature of the business and the integrity and ethics with which you conduct
your business. The understanding between your customers and you, your employees and you also
contribute to the business goodwill. Consider goodwill as an honour that is impossible to imitate.

A) The Importance of Creating Goodwill with Customers

Creating goodwill among people is important in almost every area of your life. Spreading goodwill
makes people feel good about you, and it encourages them to spread goodwill to others. In business,
creating goodwill can help you to build relationships that ensure the long-term success of your
business.
You can create goodwill in a number of ways, from creating customer appreciation programs to
going the extra mile when you are providing a service. In return, your business will reap a number
of benefits. Here are just a few ways that creating goodwill with customers can help your business.
1) Encourages Brand Loyalty:- When you feel good about a company, you want to do
business with them again and again. Creating goodwill with customers encourages brand
loyalty by making them feel good about doing business with you. Not only does it
encourage customers to contact your company the next time they need a product or service
that you offer, but it also encourages them to recommend your company to their family and
friends, helping you to expand your customer base.
 2) Encourages Forgiveness:- Think about how you feel when your neighbour brings you a big
tin of cookies at Christmas time. You are probably less likely to be upset when that same
neighbor parks in front of your yard or doesn’t bring in their newspaper, letting a pile form
in the driveway. The same concept applies to your business. When you create goodwill with
your customers by going the extra mile, by exceeding their expectations, or by showing
them personal attention they are more likely to overlook your mistakes when you make
them.
3) Sets You Apart from the Competition:- When customers are having a hard time choosing
between companies who have similar products and price points, the goodwill you create can
help set you apart from your competition and push them in your favour. Maybe you went the
extra mile by tracking down obscure information to answer a question.

4) Improves the Value of Your Business:- Investors understand the importance of goodwill
and what it builds with customers. If your company has a positive reputation as a result of
the goodwill it has built, it will increase its value. This will help you to attract more
investors or secure credit more easily if you are looking to expand your operations, and it
will help you to command more in a sale if you choose to sell your business. Building
goodwill builds value.

FACTORS AFFECTING THE VALUE OF GOODWILL :

1. The profitability of company is past and expected profit in future will affects value of Goodwill;
2. Capital Employed to earn profit;
3. The yield from business as expected by the investors;
4. The longevity of existence of business concern;
5. Market share of products of entity;
6. Quality of services rendered;
7. The edge of concern over its competitions in the market;
8. Relationship between management and staffs;
9. Location of business enterprise;
10. Brand position and efforts taken to establish brand of the concern;
11. Technical innovation, modern technology, patents, etc,;
12. Tax Planning;
13. Relationship with Government, Local Bodies;
14. There are some other factors affecting the value of Goodwill.
15. Nature of business: A firm that deals with smart quality merchandise or has stable demand for
its product is in a position to earn additional profits and so has additional worth.
16.Location of business: A business that is found within the main market or at an area wherever
there's additional client traffic tends to earn an additional profit and additionally additional
goodwill.
17. Owner's reputation: an owner, who incorporates a smart personal name within the market, is
honest and trustworthy, attracts additional customers to the business, and makes additional profits
and additionally goodwill.
18. Efficient management: a corporation with economic management has high productivity and
value potency. This offers it multiplied profits and, additionally, high goodwill.
19. Market situation: The organization having a monopoly right or condition within the market or
having restricted competition, permits it to earn a high profit that successively ends up in the higher
worth of goodwill.
20. Special blessings: A firm that has special Advantages like import licenses, patents, trademarks,
copyrights, assured an offer of electricity at low rates, subsidies for being placed in an exceedingly
special economic zona (SEZs), etc. possess a better worth of goodwill.
ACCOUNTING FOR GOODWILL
The various ways in which goodwill can be accounted for are as follows:
(a) Carry it as an asset and write it off over a period of years through the profit and loss account.
(b) Write it off against profits or accumulated reserves immediately.
(c) Retain it as an asset with no write-off unless a permanent diminution in value becomes evident.
(d) Show it as a deduction from shareholders funds which may be authorized carried forward
indefinitely.
In this connection, it is important to state that goodwill should be recognized and recorded in
business only when some consideration in money or money’s worth has been paid for it.

ADJUSTMENT FOR GOODWILL

The concept of goodwill can be understood on the basis of its operational significance. Goodwill is
what goodwill does. It brings in more customers to a firm, without much persuasion.
Goodwill arises mainly on account of:
(1) Good reputation of the owners,
(2) Established popularity of products,
(3) Effectiveness of Advertising,
(4) Favourable Locality,
(5) Monopoly and
(6) Non-availability of similar products etc.
In case a firm is not going and is not successful, there will be no value attached to goodwill; if any
value appears, then it will be not only intangible but also fictitious. Goodwill arises only if a firm
earns extra profits, which is called super profits.
There are two points:
(1) When one buys a business, he will be able to get profits in future only and is not concerned with
the past profits at all.
(2) Goodwill is paid for the ability to earn super profits and not for ordinary profits. Goodwill is the
value of reputation of a firm in respect of profits expected in future over and above the normal
profits.
Indications for the Existence of Goodwill:
There are a number of contributing factors responsible for the existence of goodwill.
The following are some of the deciding factors in favour of the existence of goodwill:
1. In a manufacturing firm, the quality, standardization, and price of a product etc. are important
factors.
2. In a distribution firm, the terms and conditions of the credit facility etc. are important.
3. In bank services, the safety of money deposited, liberal policy of lending, prompt services etc.
are indicators of goodwill.
4. In hotels, the taste and quality of the food, cleanliness and courteous service etc. are indicators of
goodwill.
5. In a firm of Doctors, the diagnostic ability, surgical dexterity is evidence for goodwill.
6. In a firm of Chartered Accountants, the sharp insight is an indication of goodwill.
7. In a provision store, the courtesy shown to the customers, supply of good quality items at
reasonable price etc. are the proof of existence of goodwill.
Because of all these special attractions, a firm may attract many customers, in turn more sales, in
turn more profits; in turn establish the existence of goodwill. The goodwill is a silent super-
salesman and an attractive force by which customers become invitees without persuasion.
ACCOUNTING TREATMENT OF GOODWILL
A) In case of admission of a new partner.
B) In case of a death or retirement of a partner.
C) In case of Reconstitution of Partnership.

(A).IN CASE OF ADMISSION OF A NEW PARTNER

When a new partner enters in partnership firm, the old partner sacrifices his share for him , so it is
the duty of new partner to give goodwill in cash or in any other way to old partner . There are
following method with this new partner give his share of goodwill to old partners .

1st method
Private distribution of goodwill

Under this method , new partner gives his share of goodwill to old partners personally .So there is
no need to record it to the books of firm . No journal entry will pass .

2nd method
Goodwill is given in cash form by new partner

Under this method , old partner bring his share of goodwill in cash form in the firm and it is taken
by old partner in their sacrifice ratio . For this following journal entry pass in the books of firm (1)
Cash / Bank Account (Dr) ................xxxx
To Goodwill / Premium Account .............xxxx

(2) Goodwill account (Dr.).................. xxxx ( share of new partner’s goodwill )

To old partner’s capital account ..............xxxx ( divide in sacrifice ratio )
3rd method
when new partner bring goodwill in cash in business and taken by old partner and then
withdraw by old partner

Above two entries will pass as same as in second method but third new entry will pass

Old partner’s capital account (Dr.)................ xxxx

To cash / bank account ...........................xxxx
4th method

When new partner do not bring goodwill in cash form

If new partner do not bring goodwill in cash in firm , then following entry will pass for the
adjustment of goodwill .

New partner’s capital account (Dr.).......... xxxx (share of goodwill )

To old partner’s capital account .......xxxx (division in sacrifice ratio)

5th method

If partial in cash form of goodwill

Part of cash goodwill

(1)Cash account(Dr.).............. xxxxxx
To goodwill / premium account .............xxxx

(2) Goodwill account (cash goodwill)(Dr.).......... xxxx

New partner account ( not in cash goodwill)(Dr.)......... xxxx
To old partner capital account in sacrifice ratio ........xxxxxxx

6th method 

If goodwill already exits in balance sheet of old partner , then it must be transfer to old
partner’s capital account in old ratio .
Other method is same above from 1 to 5 method .

Entry passed for transferring of old goodwill

Old partner’s capital account (Dr.) ..............xxxxxxx

To goodwill ...................xxxxxxx
7th method

If new partner brings other asset as goodwill of his share of goodwill .

Then following entry will pass
1. Asset account (Dr) ....................................xxxxxx
To goodwill account.............................. xxxxxxxx
2. Goodwill account (Dr.)............................... xxxxxxxxx
To old partner’s capital account in sacrifice ratio ........xxxxxxxxxx

(B) IN CASE OF DEATH OR RETIREMENT OF A PARTNER

The valuation of goodwill has been discussed in admission of a partner. The same process should be
followed here too. But during the time of retirement, the retiring partner has the right to get his
share of goodwill of the firm. Therefore, to give effect to the same, the following adjustment must
be carried out.

A. Goodwill already appears in the books

i. If old value of goodwill is equal to new valuation of goodwill:
- Adjustment entry is not needed

ii. If the existing value of goodwill is less than the new valuation:
Goodwill A/C.........Dr.(excess value)
To all partners' capital A/C
Note: The excess amount of goodwill is transferred to remaining and outgoing partners according to
old profit sharing ratio.

iii. If the existing value of goodwill is greater than new valuation:

All partners' capital A/C..........Dr.(less value)
To Goodwill A/C

B. Goodwill not already appeared in the book

i. Goodwill raised at its full value:

Goodwill A/C.............Dr.
 To All partners' capital A/C

ii. Goodwill raised at its full value and written off immediately:
Goodwill A/C ...........Dr.
To all partners' capital A/C (old profit sharing ratio)

iii. Goodwill raised at only retired partner's capital account and immediately written off:
Goodwill A/C............Dr.
To retired partner's capital A\C

(C) IN CASE OF RECONSITITUION OF PARTNERSHIP

1. Accounting Treatments required at the time when Existing Profit Sharing Ratios changes.
Following Accounting Treatments are required at the time of changing in Existing Profit Sharing
Ratios :
(i)    Accounting Treatment for Goodwill (In Sacrificing and Gaining Ratio).
(ii)    Accounting Treatment for Revaluation of Assets and Liabilities ( In Old Profit Sharing
Ratio)
(iii)   Accounting Treatment for Distribution of Undistributed Profits-Losses and Reserves 
        (In Old Profit Sharing Ratio)
(iv)   Accounting Treatment for Adjustment of Capital ( If Capital is changed)

2. Accounting Treatments are required at the time of Admission of a New Partner

Following Accounting Treatments are required at the time of Admission of a New
Partner/Partners :
(i)     Accounting Treatment for Goodwill (In Sacrificing Ratio).
(ii)    Accounting Treatment for Revaluation of Assets and Liabilities ( In Old Profit Sharing
Ratio)
(iii)   Accounting Treatment for Distribution of Undistributed Profits-Losses and Reserves 
        (In Old Profit Sharing Ratio)
(iv)   Accounting Treatment for Adjustment of Capital ( If Capital is changed)

3.Accounting Treatments are required at the time of Retirement/Death of a Partner

Following Accounting Treatments are required at the time of Retirement/Death of a Partner :

A) Calculation of Amount Due :

First of all Amount Due will be calculated with the help of the following points to be paid to the
Retiring partner or the legal heir/heirs of the deceased partner.
(i)     Accounting Treatment for Goodwill (In Sacrificing Ratio and Gaining Ratio).
(ii)    Accounting Treatment for Revaluation of Assets and Liabilities ( In Old Profit Sharing Ratio)
(iii)   Accounting Treatment for Distribution of Undistributed Profits-Losses and Reserves 
        (In Old Profit Sharing Ratio)
(iv)   Accounting Treatment for Life Insurance Policies (If taken)
(v)    Other Accounting Treatments :
        a)    Interest on Capital
        b)    Interest on Drawings
        c)    Share in Profits (for the current accounting period, if retirement/death happens mid term)
        d)    Any Remuneration or Commission Amount.

(B) Payment of Amount Due :

After calculation of Amount Due, next step will be "the payment of the Amount Due". Payment can
be made by any of the following three methods :
(i)       Lump-Sum Payment
(ii)      In Instalments
(iii)     By giving Annuity
So we are to take care of the above mentioned Accounting Treatments in the various cases of
Reconstitution of Partnership Firm.

3.Accounting Treatments are required at the time of

Retirement/Death of a Partner
Following Accounting Treatments are required at the time of Retirement/Death of
a Partner :

(A)   Calculation of Amount Due :

First of all Amount Due will be calculated with the help of the following points to be
paid to the Retiring partner or the legal heir/heirs of the deceased partner.

(i)     Accounting Treatment for Goodwill (In Sacrificing Ratio and Gaining Ratio).
(ii)    Accounting Treatment for Revaluation of Assets and Liabilities ( In Old Profit
Sharing Ratio)
(iii)   Accounting Treatment for Distribution of Undistributed Profits-Losses and
Reserves 
        (In Old Profit Sharing Ratio)
(iv)   Accounting Treatment for Life Insurance Policies (If taken)
(v)    Other Accounting Treatments :
        a)    Interest on Capital
        b)    Interest on Drawings
        c)    Share in Profits (for the current accounting period, if retirement/death
happens in mid term)
        d)    Any Remuneration or Commission Amount

(B)    Payment of Amount Due :

After calculation of Amount Due, next step will be "the payment of the Amount
Due". Payment can be made by any of the following three methods :
(i)       Lump-Sum Payment
(ii)      In Instalments
(iii)     By giving Annuity
So we are to take care of the above mentioned Accounting Treatments in the various
cases of Reconstitution of Partnership Firm.
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(a) Purchased Goodwill:-

Purchased goodwill arises when a business concern is purchased and the purchase consideration

paid exceeds the fair value of the separable net assets acquired. The purchased goodwill is shown

on the assets side of the Balance sheet. Para 36 of AS-10 ‘Accounting for fixed assets’ states that

only purchased goodwill should be recognized in the books of accounts.

(b) Non-Purchased Goodwill/Inherent Goodwill:-

Inherent goodwill is the value of business in excess of the fair value of its separable net assets. It is

referred to as internally generated goodwill and it arises over a period of time due to good

reputation of a business. The value of goodwill may be positive or negative. Positive goodwill

arises when the value of business as a whole is more than the fair value of its net assets. It is

negative when the value of the business is less than the value of its net assets.
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1.Arbitrary Valuation:-
METHODS OF GOODWILL

These methods have been explained as follows:-

value of goodwill, in this case is fixed by mutual agreement between the parties. In
some cases, the value may be fixed by an independent person known as Arbitrator.
This method can be used only where earning capacity of the firm is exactly known.

2.Average Profits :-

Under this method goodwill is calculated on the basis of the average of some agreed
number of past years. The average is then multiplied by the agreed number of years.
This is the simplest and the most commonly used method of the valuation of
goodwill.

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 e.g. income from investments etc should be deducted from
the net profits of that year.
3. Super profits method:-
Super Profits are the profits earned above the normal profits. Under this method Goodwill is
calculated on the basis of Super Profits i.e. the excess of actual profits over the average profits.

For example if the normal rate of return in a particular type of business is 20% and your investment
in the business is $1,000,000 then your normal profits should be $ 200,000. But if you earned a net
profit of $ 230,000 then this excess of profits earned over the normal profits i.e. $ 230,000 – $
200,000= Rs.30,000 are your super profits. For calculating Goodwill, Super Profits are multiplied
by the agreed number of years of purchase.

Steps for calculating Goodwill under this method are given below:

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

ii) Super Profits = Actual Profits – Normal Profits

iii) Goodwill = Super Profits x No. of years purchased

Excess of future maintainable profit over normally expected profit is called super profit. Under this
method goodwill is taken as the aggregate super profit of the future years for which such super
profit is expected to be maintained. Factors considered in this method are:
(i) Future maintainable profit;
(ii) Actual capital employed;
(iii) Normal rate of return;
(iv) Period for which super profit is projected.
Super profit = Future maintainable profit minus (Actual Capital employed × Normal rate of return)
Goodwill = Super profit × No. of years for which Super Profit can be maintained.

Super Profits are the profits earned above the no rmal profits. Under this method Goodwill is
calculated on the basis of Super Profits i.e. the excess of actual profits over the average profits.
For example if the normal rate of return in a particular type of business is 20% and your investment
in the business is $1,000,000 then your normal profits should be $ 200,000. But if you earned a net
profit of $ 230,000 then this excess of profits earned over the normal profits i.e. $ 230,000 – $
200,000= Rs.30,000 are your super profits. For calculating Goodwill, Super Profits are multiplied
by the agreed number of years of purchase.
Steps for calculating Goodwill under this method are given below:
i) Normal Profits = Capital Invested X Normal rate of return/100
ii) Super Profits = Actual Profits – Normal Profits
iii) Goodwill = Super Profits x No. of years purchased
4.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:
Under this method we calculate the average profits and then assess the capital needed for earning
such average profits on the basis of normal rate of return. Such capital is called capitalised value of
average profits. The formula is:-
Capitalised Value of Average Profits = Average Profits X (100 / Normal Rate of Return)
Capital Employed = Assets – Liabilities
Goodwill = Capitalised Value of Average Profits – Capital Employed

(ii)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 Profits X (100/ Normal Rate of Return)

1. Annuity Method:- Under this method, goodwill is calculated by finding the present worth of
annual super profits to be earned over an estimated period by discounting at a given rate of
interest. The present value factor of annuity for the given number of years and interest rate can
be obtained by making a reference to annuity table. Under this method, value of goodwill is
calculated by using the following formula:
Goodwill =super profits x Annuity factor

2. Hidden Goodwill:-  When the value of goodwill is not given in the question, it has to be
calculated on the basis of total capital/net worth of the firm and profit sharing ratio. Illustration
8. X and Y are partners with capitals of ₹ 10,000 each. They admit Z as a partner for 1/4th share
in the profits of the firm.
COMPONENTS OF GOODWILL

1. Excess of the fair values over the book values of the acquirer’s recognized
assets.
In a business acquisition, as assets acquired are measured at fair value, these excesses should
not exist. Subsequent to the acquisition, the acquirer’s goodwill could include such excesses
where assets are measured at cost.
3. Fair values of other net assets not recognized by the acquire
The assets of concern here are those tangible assets which are incapable of reliable measurement
by the acquire, and nonphysical assets that do not meet the identifiability criteria for intangible
assets.
4. Fair value of the ‘going concern’ element of the acquirer’s existing business.
This represents the ability of the acquire to earn a higher return on an assembled collection of
net assets than would be expected from those net assets operating separately. This reflects
synergies of the assets, as well as factors relating to market imperfections such as an entity’s
ability to earn a monopoly profit, or where there are barriers to competitors entering a particular
market.
5. Fair value from combining the acquirer’s and acquirer’s businesses and net assets.
This stems from the synergies that result from the combination, the value of which is unique to
each combination.
6. Overvaluation of the consideration paid by the acquirer.
This relates to errors in valuing the consideration paid by the acquirer, and may arise
particularly where shares are issued as consideration with differences in prices for small parcels
of shares as opposed to controlling parcels of shares. There could also be overvaluation of the
fair values of the assets acquired. This component could then relate to all errors in measuring
the fair values in the business combination.
7. Overpayment or underpayment by the acquirer.
This may occur if the price is driven up in the course of bidding; conversely, goodwill could be
understated if the acquirer’s net assets were obtained through a distress or fire sale.
GOODWILL DATA SOURCE
Goodwill data sources can be either internal or external to the entity. Internal data sources typically
relate to documentation regarding the entity’s historical or prospective results of operations.
External data sources typically relate to empirical pricing data with regard to the goodwill of
guideline business or professional practice sale transactions
Internal Data Sources :-
1. The existence of identified tangible assets and intangible assets, including a detailed listing of
working capital accounts, real estate, tangible personal property, and identifiable intangible assets
(including intellectual property)
2. The valuation of tangible assets and identifiable intangible assets, including recent appraisals of
any asset category
3. The historical results of business operations, including historical income statement extern
balance sheets, cash flow statements, and capital statements
4. The prospective results of business operations, including current budgets, plans, forecasts, and
projections prepared for any purpose Information from these internal data sources can be used in the
goodwill valuation.
External Data Source :-
For certain industries (principally professional practices), there are publications, periodicals, and
online data sources that report on the goodwill components of actual business sale transactions.
Some of these data sources are listed in the next section
 Bank M&A Weekly (Charlottesville, VA: SNL Financial, weekly). Bank M&A Weekly is
the only source dedicated to comprehensive coverage of bank and thrift industry
consolidation, including branch deals and other asset transactions. Delivered via e-mail
every week, each issue includes key deal ratios, buyer and target financials, industry trends,
and feature stories
 The Lawyer’s Competitive Edge: The Journal of Law Office Economics and Management
(Eagan, MN: West, monthly). Practical management information to minimize falling profits,
client loss, and employee dissatisfaction.
 Merger & Acquisition Survey of Architecture, Engineering, Planning & Environmental
Consulting Firms (Natick, MA: Zweig White & Associates, annual).

REASONS TO VALUE GOODWILL

1.Economic damage analyses:

When a business has suffered a breach of contract or a tort (such as an infringement, breach of a
fiduciary duty, or interference with business opportunity), one measure of the damages suffered is
the reduction in the value of the entity’s goodwill due to the wrongful action.
2.Business or professional practice merger:
When two businesses merge, the equity of the merged entity typically is to be allocated to the
merger partners. One common way to allocate equity in the merged entity is in proportion to the
relative value of the assets contributed, including the contributed goodwill
 .
3.Business or professional practice separation:
When a business separates, the assets of the consolidated business typically have to be allocated to
the individual business owners. One common way to allocate the assets to the separating business
partners is in proportion to the relative value of the assets controlled by or developed by each
partner, including the goodwill of each business partner.
4.Solvency test:
The solvency of a business entity is an issue with regard to lender’s fraudulent conveyance concerns
during a financing transaction or a financial restructuring. One of the individual tests to determine if
a business entity is solvent is: Does the fair value of the entity’s assets exceed the value of the
entity’s liabilities (after consideration of the financing transaction).
5.Insolvency test.
The degree of insolvency of a business entity may have federal income tax consequences if debt is
forgiven (in whole or in part) during a refinancing transaction or financial restructuring. One of the
specific tests to determine if a business entity is insolvent for federal income tax purposes is: Is the
fair market value of the entity’s assets less than the value of the entity’s liabilities.
6.Business enterprise valuation.
The identification and quantification of goodwill is one procedure of the asset-based approach to
business valuation. An asset-based approach is often used in the valuation of an industrial or
commercial company or professional service business.
7.Deprivation analysis.
The goodwill valuation may be one component in the damages analysis associated with a business
that is subject to a condemnation, expropriation, or eminent domain action. Financial advisers
sometimes only consider the value of the entity’s real estate and tangible personal property subject
to the condemnation or other “taking.”
8.Intercompany transfer price.
When intangible assets are transferred between related entities (for example, between a parent
corporation and a less than wholly owned subsidiary), an arm’s-length price should be estimated for
the intercompany transfer of the assets.
9.Ownership allocation litigation.
Several forms of litigation involve the allocation of direct or indirect ownership interests in a
business entity.
10.Intercompany transfer price.
When intangible assets are transferred between related entities (for example, between a parent
corporation and a less than wholly owned subsidiary), an arm’s-length price should be estimated for
the intercompany transfer of the assets. Such an intercompany transfer may affect the profitability
and return on investment of, say, two subsidiaries—one that is wholly owned and one that has a 10
percent minority interest owner.

2.8) LET US CONSIDER MAIN COMPONENTS OF GOODWILL:

1. PROFITABILITY :
The profitability is the most important factor in valuation of Goodwill. The main emphasis is on
future profits of the concern. Whether concern will able to increase in its profit in future. Since the
profit earned in past provides a base for the concern’s future profit. The process of assessment,
whether a concern will maintain its profits in the future is otherwise called “Future Maintenance
Profit”.
Following factors are to be considered, while estimating the “Future Maintenance Profit”;
(i) All normal working expenses should be included;
(ii) Any appreciation in the fixed assets should be excluded;
(iii)Any appreciation in the value of Current Assets should be included;
(iv) Provision for taxes should be included;
(v) Income from non trading assets should not be taken into account;
(vi) Transfer to General Reserve should be excluded;
(vii) Dividend to Preference Shareholders should be excluded;
(viii) Non –recurring expenses should be included;
(ix) Average profits of past years should be considered
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2. NORMAL RATE OF RETURN;
Every person investing his/her/its funds in companies needs a fair return; this is referred as “Rate of
Earnings”. The rate return is depend on the nature of industry and other factors such as bank rate,
risk, type of management, etc., it consists of following elements;
(i) Return at Zero Risk Level; in this case the risk to the investor is nil or zero, the concern in
which it has invested , do not has any risk in its activities. But at the same time the return will be
lower than expected. Such as investment in Government securities, Bonds, NSCs etc.
(ii) Premium for business risk; it refers to risky investment. If a concern faces more risk in its
business transactions, then the rate of return or earning will be high. The profit will vary in
proportion to risk covered in the industry. The more is risk, higher is the Premium.
(iii) Premium for financial risk; it refers to risk connected with the Capital Structure. A concern
having higher debt/equity ratio is considered more risky. There are other factors that affects the
Rate of Returns are;
(a) The bank rate;
(b) Period of investment;
(c) Risk ( due to nature of business or capital structure);
(d) Economic and Political Scenario, etc
3. CAPITAL EMPLOYED;
The quantum of profits earned with respect to the capital used is an important basis for valuation of
goodwill. The Capital Employed represents Fixed Assets + Net Working Capital. This represents
Equity Holders fund plus long terms borrowings. Following items to be included in determining
Capital Employed;
(i) All Fixed Assets Less Depreciation written off;
(ii) Trade Investments;
(iii) All Current Assets
Following items should be excluded;
(i) Long term liabilities;
(ii) All Current Liabilities;
(iii) Intangible Assets including Goodwill;
(iv) Non Trading Assets;
(v) Fictitious Assets
Generally “Average Capital Employed” is used instead of “Capital Employed. Since profit earning
is a continuous process during the year.
2.6) VALUATION OF GOODWILL
There are basically two accounting methods for goodwill valuation. These are:
(i) Capitalisation Method and (ii) Super Profit Method. A third method called annuity method is a
refinement of the super profit method of goodwill valuation.
(i) Capitalisation method:
Under this method future maintainable profit is capitalised applying normal rate of return to arrive
at the normal capital employed. Goodwill is taken as the excess of normal capital employed over
the actual capital employed. Normal Capital employed = Future maintainable profit ÷ Normal rate
of return.
Goodwill = Normal Capital Employed – Actual Closing Capital Employed
Factors considered in this method are:
(i) Future maintainable profit;
(ii) Actual capital employed in the business enterprise for which goodwill is to be computed;
(iii) Normal rate of return in the industry to which the business enterprise belongs
2.9) METHODS OF VALUATION OF GOODWILL;
Following are the methods;
1. Average Profits Method;
2. Super Profits Method;
3. Capitalization Method;
4. Annuity Method

1) Average Profits Method:

Under this methodology, the worth of Goodwill is calculated by multiplying the typical Future
profit by an exact range of year's purchase.
Goodwill = Future reparable profit when tax x No. of years purchase
The first step below this methodology is that the calculation of average profit supported the past few
years' profits. Past profit is adjusted in respect of any abnormal things of profit or loss, which can
affect future profit. Average profit could also be supported easy average or weighted average. If
profits are constant, equal weight-age could also be given in hard the typical profits, i.e., the easy
average could also be calculated. However, if the trend shows increasing or decreasing profit, it's
necessary to administer a lot of weight-age to the profits of recent years.
i] Simple Average: Under this method, the goodwill is valued at the agreed number of years’ of
purchase of the average profits of the past years. Goodwill = Average Profit x No. of years’ of
purchase
ii] Weighted Average: Under this method, the goodwill is valued at an agreed number of years’ of
purchase of the weighted average profits of the past years. We use the weighted average when there
exists an increasing or decreasing trend in the profits giving the highest weight to the current year’s
profit.
 Goodwill = Weighted Average Profit x No. of years’ of purchase
 Weighted Average Profit = Sum of Profits multiplied by weights/ Sum of weights
Explore more about Treatment of Goodwill
Treatment of goodwill
Accounting treatment of goodwill- death /retirement of partner-
 Accounting treatment of goodwill- change in PSR.
 Accounting treatment of goodwill in case of admission of partner
 Concept of Goodwill
Steps concerned below Average Profits Method:
1. Calculation of past profits before tax.
2. Calculate future-maintainable profit before tax when creating past changes.
3. Calculate Average Past adjusted Profits (taking the easy average or weighted average as
applicable).
4. Multiple Future reparable Profits by a range of years' purchase.
Value of Goodwill = Future reparable Profits x No. of years' purchase.
2) Super profit method

3. Capitalization Method
 goodwill below this technique is observed by capitalizing the super profits on the premise of the
traditional rate of come back. This technique assesses the capital required for earning the super
profit.

i) Capitalization of average Profits:

Under this method, the value of goodwill is calculated by deducting the actual capital employed
from the capitalized value of the average profits on the basis of the normal rate of return.
 Goodwill = Normal Capital The – Actual Capital Employed
 # Normal Capital or Capitalized Average profits = Average Profits x (100/Normal Rate of
Return)
 # Actual Capital Employed = Total Assets (excluding goodwill) – Outside Liabilities
(ii) Capitalization of Super Profits: Under this method, Goodwill is calculated by
capitalizing the super profits directly.
Steps in calculating goodwill by capitalisation of average profit method
 Step 1: Calculate average estimated profits
 Step 2: Calculate the capitalised average profits
 Step 3: Calculate the value of Actual capital employed or net assets of the business
 Step 4: Calculate goodwill by subtracting the actual capital employed from the capitalised
average profit

4.ANNUITY METHOD
It is a refinement of the super profit method. Since super profit is expected to arise at different
future time periods, it is not logical to simply multiply super
 profit into number of years for which that super profit is expected to be maintained. Further future
values of super profits should be discounted using appropriate discount factor. The annuity method
got the nomenclature because of suitability to use annuity table in the discounting process of the
uniform super profit. In other words, when uniform annual super profit is expected, annuity factor
can be used for discounting the future values for converting into the present value. Here in addition
to the factors considered in super profit method, appropriate discount rate is to be chosen for
discounting the cash flows.
This method considers the time value of money. Here, we consider the discounted value of the super
profit.
 Super profit is that the more than predictable future rectifiable profits over traditional profits. An
enterprise might possess some benefits that change it to earn additional profits over and on top of
the conventional profit that may be attained if the capital of the business was endowed in another
business with similar risks. The goodwill below this methodology is observed by multiplying the
super profits by a bound range of year's purchase.
 Steps concerned in calculative Goodwill below Super Profit Method:
 Step 1: Calculate capital used (it is that the combination of Shareholders' equity and future debt or
fastened assets and current internet assets).
 Step 2: Calculate traditional Profits by multiplying capital used with a traditional rate of come back.
 Step 3: Calculate average rectifiable profit.
 Step 4: Calculate the Super Profit as follows:
 Super Profit = Average rectifiable profits - traditional Profits.
 Step 5: Calculate goodwill by multiplying super profit
 Goodwill = Capitalized worth - net assets of the business.
If the value of annuity is not given, it can be calculated with the help of following formula :