Valuation of Goodwill

TOPIC GOODWILL VALUATION SUBMITTED BY: BHUMIKA PATIL

ROLL NO. 47 CLASS: M.Com (Accountancy) SEMESTER II SUBMITTED TO: UNIVERSITY OF MUMBAI PROJECT GUIDE: Prof: MR DEEPAK DAVE

PRAHLADRAI DALMIA LIONS COLLEGE OF COMMERCE & ECONOMICS S.V. Road, Malad (W), Mumbai- 400 064 YEAR: 2016 -17

DECLARATION

I Ms. BHUMIKA PATIL Dalmia Lions

Roll No. 47 of Prahladrai

College of Commerce and Economics,

Malad (W) of M.Com – ACCOUNTANCY (Semester II) has completed project on “GOODWILL VALUATION” in the academic year 2016-17. This information submitted is true and original to the best of my knowledge.

Date: of student

Signature

PRAHLADRAI DALMIA LIONS COLLEGE OF COMMERCE & ECONOMICS S.V. Road, Malad (W), Mumbai- 400 064 CERTIFICATE I MR. DEEPAK DAVE hereby certify that Ms. BHUMIKA PATIL

. A student of Prahladrai Dalmia

Lions College of M.Com ACCOUNTANCY (Semester II) Roll no.47 has completed Project on “GOODWILL VALUATION” in the Academic Year 2016-17. This information submitted is true and Original to the best of my Knowledge.

External Examiner: Principal Date: Project Co-ordinator: College Seal Date:

ACKNOWLEDGEMENT I would like to thank the University of Mumbai and my college for giving me this opportunity for taking such a challenging project, which has enhanced

my

knowledge

about

“GOODWILL

VALUATION” I express my sincere gratitude to the principal, course coOrdinator , Guide Prof.DEEPAK DAVE and our librarian and other teachers for their constant support and helping for completing the project. I am also grateful to my friends for giving support in my project. Lastly, I would like to thank each and every person who helped me in completing the project especially my parents. “NO ENDEAVOUR ACHIEVES SUCCESS WITHOUT THE ADVICE & COOPERATION OF OTHER”

EXECUTIVE SUMMARY The valuation of goodwill assumed even greater importance with the advent of the corporate intangible fixed assets regime from 1 April 2002, which in many cases enables a newly incorporated business to claim a tax deduction on the amortisation of goodwill. In most valuation analyses, goodwill includes concepts from both the residual and the income definitions. Financial advisers sometimes identify and value goodwill collectively as the total intangible value of a business entity. In this regard, goodwill may be valued using an aggregate residual analysis. In such an analysis, the goodwill can be either a residual from a total business acquisition price or a business value. In this analysis, the total goodwill value is measured as the unidentified residual amount after the values of the identified tangible assets are subtracted from the total business value. Financial advisers often measure goodwill as a discrete (or separate) intangible asset. Using this definition, goodwill is measured as the remaining unidentified intangible value of the entity after subtracting the values of all tangible assets and all identifiable intangible assets. Accordingly, this discrete goodwill may be quantified using either a residual analysis or an income analysis. Goodwill in accounting is an intangible asset that arises when a buyer acquires an existing business. Goodwill represents assets that are not separately identifiable. Goodwill does not include identifiable assets that are capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability regardless of whether the entity intends to do so. Goodwill also does not include contractual or other legal rights regardless of whether those are transferable or separable from the entity or other rights and obligations. Examples of identifiable assets that are not goodwill include a company’s brand name, customer relationships, artistic intangible assets, and any patents or proprietary technology. The goodwill amounts to the excess of the "purchase consideration" (the money paid to purchase the asset or business) over the total value of the assets and liabilities. It is classified as an intangible asset on the balance sheet, since it can neither be seen nor touched. however, may elect to amortize

goodwill over a period of ten years or less under an accounting alternative from the Private Company Council of the FASB.

INDEX

SR.NO

TOPIC NAME

PAGE NO.

1.

INTRODUCTION

7-12

2.

FEATURES OF GOODWILL

13

3.

TYPES OF GOODWILL

14

4.

FACTORS AFFECTING GOODWILL

15

5.

IMPORTANCE OF GOODWILL VALUATION

16

6.

METHODS OF VALUATION GOODWILL

7.

CONCLUSION

34

8.

BIBILIOGRAPHY

35

INTRODUCTION  Value and valuation

17-33

“VALUE” is the worth of all the rights and benefits arising from ownership”. Common terms for the value of an asset or liability are market value, fair value, and intrinsic value. The meanings of these terms differ. For instance, when an analyst believes a stock's intrinsic value is greater (less) than its market price, an analyst makes a "buy" ("sell") recommendation. Moreover, an asset's intrinsic value may be subject to personal opinion and vary among analysts. The International “VALUATION” Standards include definitions for common bases of value and generally accepted practice procedures for valuing assets of all types. In finance, valuation is the process of estimating what something is worth.[1] Items that are usually valued are a financial asset orliability. Valuations can be done on assets (for example, investments in marketable securities such as stocks, options, businessenterprises, or intangible assets such as patents and trademarks) or on liabilities (e.g., bonds issued by a company). Valuations are needed for many reasons such as investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability, and in litigation..

 What is Valuation? Knowing what an asset is worth and what determines that value is a pre-requisite for intelligent decision making -- in choosing investments for a portfolio, in deciding on the appropriate price to pay or receive in a takeover and in making investment, financing and dividend choices when running a business. The premise of valuation is that we can make reasonable estimates of value for most assets, and that the same fundamental principles determine the values of all types of assets, real as well as financial. Some assets are easier to value than others, the details of valuation vary from asset to asset, and the uncertainty associated with value estimates is different for different assets, but the core principles remain the same. This introduction lays out some general insights about the valuation process and outlines the role that valuation plays in portfolio management, acquisition analysis and in corporate finance. It also examines the three basic approaches that can be used to value an asset.

 Goodwill –

“GOODWILL” used to describe the ‘GOOD’ name or ‘REPUTATION’ on earned by a firm as it trades. Goodwill is a long-term asset categorized as an intangible asset. Goodwill arises when a company acquires another entire business. The amount of goodwill is the cost to purchase the business minus the fair market value of the tangible assets, the intangible assets that can be identified, and the liabilities obtained in the purchase. The amount in the Goodwill account will be adjusted to a smaller amount if there is an impairment in the value of the acquired company as of a balance sheet date. An intangible asset which provides a competitive advantage, such as a strong brand, reputation, or high employee morale. In an acquisition, goodwill appears on the balance sheet of the acquirer in the amount by which the purchase price exceeds the net tangible assets of the acquired company.

 Definition: Goodwill is the excess of the purchase price paid for an acquired entity and the amount of the price not assigned to acquired assets and liabilities. It arises when an acquirer pays a high price to acquire another business. This asset only arises from an acquisition; it cannot be generated internally. Goodwill is an intangible asset, and so is listed within the long-term assets section of the acquirer's balance sheet. Negative goodwill arises when an acquirer pays less for an acquiree than the fair value of its assets and liabilities. This situation usually only arises as part of a distressed sale of a business. The value of goodwill is highly subjective, especially since it does not independently generate cash flows. Consequently, the accounting standards require that an acquirer regularly test its goodwill asset for impairment, and to write down the asset if impairment can be proven.

 Some definitions of goodwill are:

1. According to SSAP-22, UK Accounting Standard on Accounting for Goodwill, “Goodwill is the difference between the value of a business as a whole and the aggregate of the fair values of its separable net assets.” 2. If time value of money is taken into account, goodwill may be defined as the present value of the firm’s anticipated excess earnings. 3. “Goodwill is nothing more than the profitability that the old customers will resort to the old place.” —Lord Eldon 4. According to Lord Macraughton “Goodwill is a thing very easy to describe, very difficult to define. It is the benefit and advantage of good name, reputation and connection of a business. It is the attractive force which brings in customers. It is one thing which distinguishes an old established business from a new business at its start.”

 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.

 Calculating goodwill

:

In order to calculate goodwill, the fair market value of identifiable assets and liabilities of the company acquired is deducted from the purchase price. For instance, if company A acquired 100% of company B, but paid more than the net market value of company B, a goodwill occurs. In order to calculate goodwill, it is necessary to have a list of all of company B's assets and liabilities at fair market value. Fair market value Accounts Receivable $10 Inventory

$5

Accounts payable Total Net assets

$6 = $10 + $5 - $6

= $9 In order to acquire company B, company A paid $20. Hence, goodwill would be $11 ($20 - $9). The journal entry in the books of company A to record the acquisition of company B would be: DR Goodwill

$11

DR Accounts Receivable $10 DR Inventory

$5

CR Accounts Payable CR Cash

$6

$20

A business builds up some reputation after it has continued for some time. If the reputation is good, the firm will come to acquire a fixed clientele in the sense that a number of customers will automatically make their purchases from the firm. This is a very valuable asset even if one cannot touch or see it. The asset is intangible but not fictitious. This asset is known as goodwill and may be defined as the value of the reputation of a firm. Its tangible effect is extra profit which firms not possessing equal reputation do not earn.

 This reputation will depend on: (a) The personal reputation of the owners and/or management; (b) The reputation of the goods dealt in or the quality of the service rendered; (c) The peculiar advantage of the site of the business; (d) The peculiar advantage available to it as regards sales or supplies of materials; and (e) The patents, copyrights or trademarks owned by the firm, (but often a separate value is put on these). Those who purchase goodwill will acquire the name of the firm and also the site, the patents and trademarks, etc., and existing contracts. All the factors named above result in extra profits and hence goodwill will arise only when the business is profitable. A business running into losses will have, generally, no goodwill. What has to be particularly remembered is that it is the expectation of profits in future that makes goodwill a valuable asset. A firm which has made good profits by virtue of an exceptionally favourable contract, that is not to be renewed, cannot expect to get much for its goodwill.

 Need of valuation of goodwill : 

When the business is so;d 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.

 Key factor affecting goodwill: 

The nature of the business. The goodwill relating to a service based business is likely to be different than that of a manufacturing business.



Favorable location. If a business is situated in a good location it will generally have a positive effect on the value of goodwill.



Longetive of the business. If a business has been trading for a long period it may have had more time to develop a good solid reputation, and more goodwill.



Possession of licenses or technical know. How.



After sales services and general customer care.



Business risk involved.

 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.

Features of Goodwill The following are the features of goodwill: 1. Goodwill is an intangible asset. It is non-visible but it is not a fictitious asset. 2. It cannot be separated from the business and therefore cannot be sold like other identifiable and separable assets, without disposing off the business as a whole. 3. The value of goodwill has no relation to the amount invested or cost incurred in order to build it. 4. Valuation of goodwill is subjective and is highly dependent on the judgment of the valuer. 5. Goodwill is subject to fluctuations. The value of goodwill may fluctuate widely according to internal and external factors of business. Here are some of the features of goodwill – 1. It is an intangible asset implying that it is one cannot be seen or touched like land or building but it has certain value attached to it. 2. The value of goodwill is highly dependent on the person who is valuing the goodwill, in other words it is subjective in nature. Also it is difficult to assign a particular value to goodwill because it keeps on fluctuating on the basis of company’s performance. 3. It is dependent on various factors like location of the company, relationship with the suppliers, long term contracts of the company with customers etc…. Goodwill is considered to be primary reason for many mergers and acquisitions because goodwill brings customers to the acquiring company almost without any effort, though acquiring company has to pay price for goodwill.

Types of Goodwill Goodwill is generally of two types: (a) Purchased goodwill; and (b) Non-Purchased or Inherent goodwill.

(а) 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.

Factors Affecting Goodwill The important factors that give rise to goodwill are as follows 1. Outstanding quality of products/services. 2. Locational factors— If a business is located at a favourable place; it enhances the value of goodwill. 3. The period for which the business has been in business. 4. Special advantages— A company that enjoys special advantages such as favourable contracts, assured supply of raw material at low rates, possession of trademarks, patents, copyrights, technical knowhow and research and development, well known collaborators etc. contribute to higher value of goodwill. 5. Nature of Business— A business having stable continuous demand for its products such as consumer goods is able to earn more profits and hence has more goodwill. If the business is risky, profits will be uncertain. The monopoly condition or limited competition enables the enterprise to earn higher profits which leads to higher value of goodwill. 6. Good relations with customers, suppliers, labour and government. 7. Efficiency of Management— A firm having efficient management enjoys advantages of high productivity and cost of efficiency. This leads to higher profits which in turn increases the value of goodwill. 8. Capital Required— If two businesses have same rate of profit, the business which requires lesser amount of capital tends to enjoy more goodwill. 7. Patent Right— A firm having patent right for production of goods can earn more goodwill than others. 8. Other Factors— Besides the factors mentioned above, money market condition, peace in the country, government's policy, tendency of profit etc. also affects the valuation of goodwill.

Importance of goodwill Just as a good reputation is vital for the social standing of a person, goodwill is vital to the long-term success of any business. Some of the ways in which business goodwill affects a business are mentioned below.



Goodwill in a business increases the number of return customers and recommendations based on their pleasant experiences.



A well-established business goodwill increases the chances of loan sanctions from a bank and the interest of potential investors.



It strengthens the business networks, opens new avenues and creates opportunities for expansion in business.



In case of a blunder or mistake, people are more forgiving to a business based on the goodwill it garners, much like the mistakes of an individual with a 'good name' will be given the benefit of doubt.



In any business, goodwill provides ammunition against resistance and sabotage.



The equity value and the accounting value of a business are greatly affected by the goodwill of that business.



As mentioned in the beginning of this article, goodwill is one of the major intangible assets of any business. Greater the goodwill of a business, greater the value of its intangible assets and thus, greater the acquisition price in a takeover.

Methods of Valuing Goodwill (7 Methods) The valuation of goodwill depends upon assumptions made by the valuer. Methods to be adopted in valuation of goodwill would depend on circumstances of each case and is often based on the customs of the trade. The various methods that can be adopted for valuation of goodwill are follows:  YEARS’ PURCHASE OF AVERAGE PROFIT METHOD  SIMPLE AVERAGE TRADING PROFIT METHOD  YEARS’ PURCHASE OF WEIGHTED AVERAGE METHOD  CAPITALISATION METHOD  ANNUITY METHOD  SUPER – PROFIT METHOD  CAPITALISATION OF SUPER – PROFIT METHOD  SLIDING SCALE VALUATION METHOD

1. Years’ Purchase of Average Profit Method: Under this method, average profit of the last few years is multiplied by one or more number of years in order to ascertain the value of goodwill of the firm. How many years’ profit should be taken for calculating average and the said average should be multiplied by how many number of years — both depend on the opinions of the parties concerned. The average profit which is multiplied by the number of years for ascertaining the value of goodwill is known as Years Purchase. It is also called Purchase of Past Profit Method or Average Profit Basis Method. Profit Basis Method:

Value of Goodwill = Average Profit x Years’ Purchase

 Illustration 1: Majumdar & Co. decides to purchase the business of Banerjee & Co. on 31.12.2003. Profits of Banerjee & Co. for the last 6 years were: 1998 Rs. 10,000; 1999 Rs. 8,000; 2000 Rs. 12,000; 2001 Rs. 16,000, 2002 Rs. 25,000 and 2003 Rs. 31,000. The following additional information about Banerjee & Co. were also supplied: (a) A casual income of Rs. 3,000 was included in the profit of 2000 which can never be expected in future. (b) Profit of 2001 was reduced by Rs. 1,000 as a result of an extraordinary loss by fire. (c) After acquisition of the business, Majumdar & Co. has to pay insurance premium amounting to Rs. 1,000 which was not paid by Banerjee & Co. (d) S. Majumdar, the proprietor of Majumdar & Co., was employed in a firm at a monthly salary of Rs. 1,000 p.m. The business of Banerjee & Co. was managed by a salaried manager who was paid a monthly salary of Rs. 4,000. Now, Mr. Majumdar decides to manage the firm after replacing the manager. Compute the value of Goodwill on the basis of 3 years’ purchase of the average profit for the last 4 years.

2.Simple Average Trading Profit Method: Under this method the value of Goodwill is calculated by multiplying the Average Future profit by a certain number of year’s purchase. Goodwill = Future maintainable profit after tax x No. of years purchase The first step under this method is the calculation of average profit based on past few years’ profit. Past profit are adjusted in respect of any abnormal items of profit or loss which may affect future profit. Average profit may be based on simple average or weighted average. If profits are constant, equal weight-age may be given in calculating the average profits i.e., simple average may be calculated. However, if the trend shows increasing or decreasing profit, it is necessary to give more weight-age to the profits of recent years. Number of year’s purchase: After calculating future maintainable average profits, the next step is to determine the number of years’ purchase. The number of years of purchase is determined with reference to the probability of new business to catch up with an existing business. It will differ from industry to industry and from firm to firm. Normally the number of years ranges between 3 to 5.

Steps Involved under Average Profits Method: (i) Calculate past profits before tax. (ii) Calculate future-maintainable profit before tax after making past adjustments. (iii) Calculate Average Past adjusted Profits (taking simple average or weighted average as applicable). (iv) Multiply Future Maintainable Profits by number of years’ purchase. Value of Goodwill = Future Maintainable Profits x No. of years’ purchase.

 Illustration 1: X Ltd. agreed to purchase business of a sole trader. For that purpose, goodwill is to be valued at 3 years’ purchase of average profits of last 5 years.

 Illustration 2: Y Ltd. proposed to purchase business carried on by Mr. A. Goodwill for this purpose is agreed to be valued at 3 year’s purchase of the weighted average profits of the past four years. The profit for these years and respective weights to be assigned are as follows:

On a scrutiny of the accounts, the following matters are revealed: (a) On 1st September, 2012 a major repair was made in respect of plant incurring Rs. 6,000 which was charged to revenue, the said sum is agreed to be capitalized for goodwill calculation subject to adjustment of depreciation of 10% p.a. on reducing balance method. (b) The closing stock for the year 2011 was over valued by Rs. 2,400; and (c) To cover management cost an annual charge of Rs. 4,000 should be made for the purpose of goodwill valuation. Required: Compute the value of goodwill of the firm. Solution: Before calculating goodwill, it is necessary to compute adjusted profit on the basis of information given.

3. Years’ Purchase of Weighted Average Method: This method is the modified version of Years’ Purchase of Average Profit Method. Under this method, each and every year’s profit should be multiplied by the respective number of weights, e.g. 1, 2, 3 etc., in order to find out the value of product which is again to be divided by the total number of weights for ascertaining the weighted average profit. Therefore, the weighted average profit is multiplied by the years’ purchase in order to ascertain the value of goodwill. This method is particularly applicable where the trend of profit is rising.

Value of Goodwill = Weighted Average Profit x Years Purchase

 Illustration 1:

XYZ Co. Ltd. intends to purchase the business of ABC Co. Ltd. Goodwill for this purpose is agreed to be valued at 3 years’ purchase of the weighted average profits of the past four years. The appropriate weights to be used: 1998 — 1; 1999 — 2; 2000 — 3; 2001-4. The profits for these years were:

The following information were available: (a) On 1.9.1999 a major repair was made in respect of a Plant at a cost of Rs. 8,000 and this was charged to revenue. The said sum is agreed to be capitalized for Goodwill calculation subject to adjustment of depreciation of 10% p.a. on Diminishing Balance Method. (b) The Closing Stock for the year 2000 was overvalued by Rs. 3,000. (c) To cover the Management cost an annual charge of Rs. 10,000 should be made for the purpose of Goodwill valuation. You are asked to compute the value of Goodwill of the company.

4. Capitalisation Method: Under this method, the value of the entire business is determined on the basis of normal profit. Goodwill is taken as the difference between the Value of the Business minus Net Tangible Assets. Under this method, the following steps should be taken into consideration for ascertaining the amount of goodwill: (i) Expected Average Net Profit should be ascertained; (ii) Capitalised value of profit is to be calculated on the basis of normal rate of return; (iii) Net Tangible Assets (i.e. Total Tangible Assets – Current Liabilities) should also be calculated; (iv) To deduct (iii) from (ii) in order to ascertain the value of Goodwill. Capitalised Value of Profit = Profit (Adjusted)/Normal Rate of Return x 100

Value of Goodwill = Capitalised Value of Profit – Net Tangible Assets

 Illustration 1: The following is the Balance Sheet of P. Ltd. as at 31.12.2009:

The profits of the past four years (before providing for taxation) were: 2006 — Rs. 20,000; 2007 — Rs. 30,000; 2008 — Rs. 36,000 and 2009 — Rs. 40,000. Compute the value of Goodwill of the company assuming that the normal rate of return for this type of company is 10%. Income Tax is payable @ 50% on the above profits.

 Illustration 2: From the following Balance Sheet and other necessary information of P. Ltd. for the year ended 31.12.2001, compute the value of Goodwill by the application of Capitalisation Method:

The company commenced operation in 1997 with a paid-up capital of Rs. 2, 00,000. Profits earned before providing for taxation have been: 1997 — Rs. 90,000; 1998 — Rs. 95,000; 1999 — Rs. 1, 05,000; 2000 — Rs. 80,000; 2001 — Rs. 1, 10,000. Assume that Income-Tax @ 50% has been payable on these profits. Dividends have been distributed from the profits of the first three years @ 10% and for those of the next two years @ 15% on the Paid-up Capital.

5. Annuity Method: Under this method, Super-profit (excess of actual profit over normal profit) is being considered as the value of annuity over a certain number of years and, for this purpose,

compound interest is calculated at a certain respective percentage. The present value of the said annuity will be the value of goodwill. Value of Goodwill, V=

Where, V = Present value of Annuity a = Annual Super Profit n = Number of Years I = Rate of Interest

 Illustration 1: From the following particulars, compute the value of goodwill under Annuity Method: Super-Profit Rs. 10,000 Number of years over which Super-Profit is to be paid 5 Rate Per cent p.a. 5% Computation of Goodwill:

6. Super-Profit Method: Super-profit represents the difference between the average profit earned by the business and the normal profit (on the basis of normal rate of return for representative firms in the industry) i.e., the firm’s anticipated excess earnings. As such, if there is no anticipated excess earning over normal earnings, there will be no goodwill.

This method for calculating goodwill depends on: (i) Normal rate of return of the representative firms; (ii) Value of capital employed/Average capital employed; and (iii) Estimated future profit, i.e. the average profit of the last few years. Super-Profit = Average Profit (Adjusted) – Normal Profit Value of Goodwill = Super-Profit x Years’ Purchase The students should remember that the number of years’ purchase of goodwill differs from firm to firm and industry to industry. One or two years’ purchase should be taken into consideration if the retiring partner of a business was the main source of success. It should also be remembered that three to five years’ purchase is usually taken. Of course, a large number of years’ purchase may be considered if the super-profit itself is found to be large. If there is a declining trend in super-profit, one or two years’ purchase may be considered. The following steps should carefully be followed for calculating the value of Goodwill under Super- Profit Method: (a) Ascertain the amount of Capital Employed/Average Capital Employed; (b) Ascertain the amount of Normal Profit (i.e. Percentage of Normal Rate of Return on Capital/Average Capital Employed); (c) Ascertain the Actual Maintainable Profit; (d) Ascertain the difference between Actual Maintainable Profit minus Normal Profit. If Actual Maintainable Profit is more than the Normal Profit, the excess is called SuperProfit and, in the opposite case, this is no Super-Profit; (e) Value of Goodwill = Super-Profit x Year’s Purchase.

 Illustration 1: The following particulars are available in respect of the business carried on by Mr. R. N. Mitra:

Compute the value of Goodwill of the business on the basis of 3 years’ purchase of super-profit taking average of last four years.

 Illustration 2: The following is the Balance Sheet of Mithu Ltd. as on 31.12.2009:

The Assets were revalued as: Plant and Machinery Rs. 50,000; Land and Building Rs. 40,000; Investments Rs. 25,000; Profit includes Rs. 1,000 income from Investment. Calculate the value of Goodwill on the basis of 3 years’ purchase of Super-profit. Normal rate of return in this type of business is 12%.

 Illustration 3: From the following information, compute the Goodwill of the firm XYZ Co. Ltd. on the basis of four years’ purchase of the average Super-Profit on a 10% yield basis:

As per the Articles of Association of this private company, its Directors have declared and paid dividends to its members in the month of December each year out of the profit of the related year. The cost of the Goodwill to the company was Rs. 5, 00,000. Capital employed at the beginning of the year 2006 was Rs. 19, 30,000 including the cost of Goodwill and balance in Profit and Loss Account at the same time was Rs. 60,000.

Value of Goodwill will be four years’ purchase of Average Super-Profit, i.e. Rs. 4,75,833 x 4 = Rs. 19,03,332, or, say, Rs. 19,00,000.

7. Capitalisation of Super-Profit Method: Under the method, we are to consider super-profit in place of ordinary profit against the normal rate of return. The same is calculated as: Value of Goodwill = Super-Profit/Normal Rates of Returns x 100

 Illustration 1: X Ltd. Presented the following information: Normal Rate of Return @ 10% Capital Employed Rs. 3,00,000 Profit for last 5 years are Rs. 20,000; Rs. 25,000; Rs. 45,000; Rs. 30,000 and Rs. 50,000 Compute the value of goodwill.

8. Sliding Scale Valuation Method: Under this method, the distribution of profit which is related to super-profit may vary from year to year. In other words, in order to find out the value of goodwill, sliding scale valuation may be considered relating to super-pr8fits of an enterprise. Illustration 1: Compute the value of Goodwill on the basis of Sliding Scale Method. Amount of Super-Profit estimated at Rs. 12,000. Sliding Scale: First Rs, 6,000 for 3 years’ purchase Next Rs. 4,000 for 2 years’ purchase Balance Rs. 2,000 for 1 year’s purchase

Conclusion When turning to the two research questions, it can be concluded that as a result of new accounting regulation, goodwill has become a more concise term. Further, it is shown that goodwill contains elements of value creation: characteristics of value-creating acquisitions have a positive effect on purchased goodwill. This conclusion holds after controlling for characteristics of empire-building and bargaining. It can be concluded that results indicate that characteristics from the empire-building theory and from bargaining do also influence goodwill. Turning to the central question, it can be concluded that new regulation did indeed bring the accounting concept of goodwill closer to the economic approach to goodwill, in which goodwill is regarded as the present value of the expected additional profits from the acquisition. Results show that goodwill under the new regime might be a measure of value creation, although other characteristics also determine the amount of purchased goodwill. “Just as cement binds together the bricks and other building material into walls, similarly goodwill binds together or unites the other assets and aspects of the business into cohesive whole.”

BIBILIOGRAPHY https://en.wikipedia.org/wiki/Goodwill_(accounting) valuation_goodwill.html Bussiness wikepedia.com