- Goodwill is the value of reputation of a firm in respect of profits expected in future over and above the normal rate of profits.
- Necessity for valuation of goodwill in a firm arises in the following cases:
1.When the profit sharing ratio amongst the partners is changed;
2.When a new partner is admitted;
3.When a partner retires or dies, and
4.When the business is dissolved or sold.
- Methods for valuation of goodwill:-
(1) Average profit basis : Average Profit = Total profit/Number of years
Goodwill = Average Profit x No. of Years’ purchased
The profits taken into consideration are adjusted with abnormal losses, abnormal gains, return on non-trade investments and errors.
(2) Super profit basis :
Calculate Capital Employed
Less: Liability …….
Capital Employed ……..
- Find the normal Rate of Return (NRR)
- Find Normal Profit=Capital Employed X Normal rate of Return
- Find Average Actual Profit
- Find Super Profit=Average Actual Profit-Normal Profit
- Find Goodwill=Super Profit X Number of Years Purchased
(3) Annuity basis :
Goodwill=Super Profit x Annuity Number
(4) Capitalization basis:
Goodwill = Super Profit / Normal Rate of Return