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168 views34 pagesGoodwill Valuation - 1
Uploaded by
Kunvar MattewalCopyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF or read online on Scribd
/ 34
oa SHAPTER =
Valuation Of Goodwill
nd honesty: This helps the business to earn more
jon ofafrm in respect of Profits expected in future “profit. Thus, goodwill is the value of the
fin the same business,
4
pefnitions of Goodwill
ill is a commercial word and iti
‘he term goodwil ¢ and it is very easy to descri ;
per sme definitions given by learned persons are at follows. nn VOT Sic to define,
1) according to Lord Eldon, “Goodwill is nothing more than the fa
f will resort to the old place.” Probability that the old customers
iq) According to Lord Lindley, “The term goodwill is generally used to denote benefit arising from
connections and reputation. ”
(8) In technical language, it may be defined as the present value of the firm’s anticipated excess
earnings.
‘us, it can be said that goodwill is the extra earning capacity of a business. Its value increases or
dareases according to profit earning capacity of the business. Ifthe profit increases the value of goodwill
teases and if the profit decreases, the value of goodwill decreases. In case of increasing losses the value
‘goodwill will be zero. However, value of goodwill can never be a negative figure.
aracteristics of Goodwill
Geodvill has some special features which distinguish it from others assets such as building
"winery, furniture, ete. Thus, on the basis of above definitions, the following particular features of
xd emerge: a
UY itis an intangible assets: As goodwill does not suffer wear and tear so no depreciation
Provided on it, as is the case on other fixed assets. |
‘ i i yer profit (i.e.
‘ore than normal profits) but decreases in value with the ae
, 'Sliable to constant fluctuation whereas goodwill does on in ad separately but goodwill
'tis valuable only when entire business is sold: All oa Sa with the entire business except in
mot be sold separately. In other words, goodwill can be /
ie of admission and retirement of a partners. aiye may fluctuate from tine to time
's difficult to ascertain the exact value of soodw oodwill an not be ascertained easily.
Ne to different reasons, therefore, exact value oF 8
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Corpor
ep,
yy
62
ill: The valuation of good,
ies ion of goodwill: 7 BOOdwill
be no subjective valuation * erer so its valuation wil difer ron sg
ne
of
subjective (persona Seon of its valuation.
in differer P
srother valuer in sevonpurchased: Purchase gOOdMT ares hoy
(6) Goodwill may be paras business concern andthe Purchase price jin <™
concern is purchaset i quired (ie., assets — liabilities, whereas non-purchaseg cdi
value of the 4 ventes its own goodwill over 2 period of time due to various fact
fesuable leston, efficient management, good quality of products, favour Customer, wh
* at
etc, Thus, purchased goodwill will be shown in books of accounts. i
ae
(5) There can
Nature of Goodwill |
Like buildings, machinery and furniture, etc. goodwill is also an asset, but the a Point oF itera
that building etc. can be seen and touched, while goodwill cannot be seen and touched but it can, fe,
invisible, hence, it is treated as an intangible asset. All assets can be separately sold but goody canny
separately sold. Thatis why goodwill has no separate existence while other assets do have. Hence x 14,
fictitious asset ast can be purchased or sold with any other asset. Thus, goodwill isan intangible ase
sometimes it is more valuable even to tangible assets but usually it is not shown in the balance sia
the concern unless cash or any ther assets have been paid for it It is subject to fluctuation andi
affected by excess business profits.
Factors Affecting the Value of Goodwill
Ithas already been said that goodwill ofa business is represented by its capacity to earn excesspoi,
Thus, all reasons which help in earning profits are known as factors affecting the value of goodwill. Thee
are as follows:
(1) Nature of business: A business which produces best quality of products or having 2 ssbe
demand is able to earn more profits. Therefore, such firm has enjoys good reputation.
(2) Favourable Location of business: If the business is centrally located or is at a convenient
Prominent place having heavy customer traffic, results in higher sales. Thus, it increases is
goodwill.
(3) Monopoly: The monopoly conditions or limited competition enables the concern to eam i
Profits which leads to higher value of goodwill.
(4) Efficiency of Management: A well managed concern usually enjoys the advantage of he
pducty and cost efficiency. This leads to higher profits and so the value of goodwill wil
5) 5 ives: i woe
(5) Special incentives: The business which enjoys special advantages like import licences, o" we
at assured supply of electricity, long term contracts for supply of materials, well ko"
collaborators, ae
rs, patents, trade marks, etc, enjoy higher value of goodwill.
Scanned with CamScanner vationor Good
63
tion, the better the relatioy
In addition, ns between employ
in country, favor ; yer and employee favourable govt. policy,
austria peace in cou Re urable trend of financial institution and inne fe ble tation of
fpptal market and political peace in country, the y ‘ors, favourable situation o!
alue of goodwill will be more.
classification or Types of Goodwill
‘Goodwill may be classified as follows:
(1) Purchased Goodwill
(2) Non-Purchased Goodwill or Self (or internall
(1) Purchased goodwill: It arises when one b
concern and the purchase price is in exc
assets-liabilities). Thus, goodwill is acquired
(a) Arises on purchase of business,
(b) Both buyer and seller agreed to value
(c) Shown on asset side of balance sheet.
(2) Non-purchased goodwill: It arises when business cr
due to various factors such as favourable locati
products, favourable customers relations,
goodwill. Features of this goodwill are:
(a) Generated internally over period of time.
(b) Subjectivity in its valuation.
(c) Not shown in the balance sheet.
Accounting Standard 10 recognises only the purchased goodwill because some price has been paid
forit. As such, purchased goodwill can be shown in the balance sheet whereas non-purchased goodwill is
not shown in the balance sheet.
'y) Generated Goodwill
usiness concern is purchased by another business
85 of the value of the net assets acquired (ie.,
by making payment. Features of this goodwill are:
goodwill despite subjectivity in its valuation.
‘eates its own goodwill over a period of time
ion, efficient management, good quality of
etc. This is also known as self (or internally) generated
Need for Valuing Goodwill
The need for valuation of goodwill depends on the form of business organisation. In case of sole
trader or partnership or company, there are circumstances when goodwill has to be valued. Therefore, a
question may arise as to the necessity of valuation of goodwill:
(1) In case of sole trader, the necessity arises in connection with the following:
(i) When the business is to be sold,
(ii) When some one is to be admitted as a partner,
(ili) When the business is converted into private or a public company.
(2) In case of partnership, the necessity arises in connection with the following:
(i) When a new partner is admitted, :
(ii) When a partner retires or dies and there is reorganisation,
(iii). When there is change in the present sharing ratio among the partners.
(iv) When the two partnership firms are amalgamated,
(v) When the partnership firm is sold oe v's tortaay
(vi hip firm is converte fp ‘
(3) Ineneat fae ae ‘ompany, the necessity arises n connection with the following:
(i) When one company takes over another,
(ii), When two or more companies amalgam:
(ii) When valuation of share is made,
iv) When government takes over the business.
ate,
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64
Basis of Valuation of Goodwill
business sea
ee eee pas for goodt depends upon the performance in the ft
the future al
future, But the estimate for
" Past, Th
king one year's profit as ba,
jing goodwill. Instead tal ear
base for valuing g00 erage profit is taken as bag,
ad on Sl a ear snd find out average profit. The avera6 a
take profit so m:
goodwill
only when he is likely 0 Bet advantgp,
Methods of Valuing Goodwill
.d exactly due to intangible asset, but its value can be estimateg They
will. ll methods are depended upon profits becayye
ty of the business. Following are the methods of yj."
Goodwill can not be value
so many popular methods for valuing g00'
goodwill is based on profit earning capaci
goodwill:
|. Average Profit Method:
(1) Simple Average Profit Method
(2) Weighted Average Profit Method
UL Super Profit Method
Ml, Capitalisation Method:
(1) Capitalisation of Super Profit Method
(2) Capitalisation of Average Profit Method
IV. Annuity Method
V. Purchase Consideration Method
Average Profit Method
1. Simple Average Profit Method
Meaning: Under this method, past profits of as number of years are taken into consideration s
profits are totalled up and divided by number of year to find out simple average profit. This simple 322%
profit is multiplied by an agreed number of years purchase (such as 1, 2, 3) to arrive at the valut
goodwill.
Formula:
Total Profits
No. of Years
{i) Calculation of Simple Average Profit
because he cannot forsee the future. But
other things remains the same, can alway
upon the performance in the past. Ther
Gepends upon its average performance it
together and averaged provides a more
circumstances and therefore, may not b
otic behind number of year’s pur
e reliable.
ns?
that the seller of the business ‘chase: Logic behind the 5 4g purchase se
Macatee weiness has to hand over to th number of year's PUTCN iy bu
€ from th the buyer the profits of the business ™! yal
’ business
profit entirely due to s Peete to sell
Customers. As such, thy
Bets because of seller’
1's effort. For some year’s to come the buSiNeSS Wa
the Purchaser's efforts begin to get due recoe ten
ller for the few years profits which
's efforts,
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yo “ 8s
’
of Actual Average Profits
ti” ofaveraging past profits is to project the future earnings i
Open Thus, before calculating the average profit, the pro
,, what profits are likely to be
é s earned in the past m
f tations. So, the followi Paseeouenee!
peel fre oee following adjustments should be taken into account to
e profit:
i ast averas -
Hate Toss Abnormal oss of 2 ear Such as loss from ire or theft, ee, should be added back
Ooo he profit of that Year in order to arrive at the normal profits of that year.
‘0 i
in: Abnormal gain of a year such as income fro i
veal Gain: Al 1m speculation or lottery or sale of
w aor, shoud be deducted from out of profit of that year, .
Frome fom investment: INCOME from investments should be deducted out of the profits of that
| Br egr because this income is nor related to the main activities of business. In other words, this
vere is received outside the business.
| 4 Non-Operating Income: Non-operating income is that income which is not related to activities of
votrexs such as receipt of rent from property. It should be deducted from out of profit of that
at.
| Ther above adjustments, the average profits is calculated and out of which the following
Musiments related to future should be made to arrive at actual average profit or future
maintainable profit:
{) Expenses that will not incur in future: If some past expenses will not be incurred in future,
they are added in the average profit.
(i) Expenses that will occur in future: If some new expenses are likely to be incurred in future
they are deducted from average profit.
(i) Income that will arise in future: If some new incomes are to be earned in future. They
should be added in average profit.
{W) Income that will not arise in future: If some items of income are not to be continued in
future, they should be deducted from the average profit.
| (| Remuneration to the proprietors of the business: If in future years the remuneration to the
proprietors are likely to be paid, it should be deducted out of average profit.
lv) Income Tax: After making the above adjustments, the balance left as average profit will be
tared as per income tax rate, This income tax should be deducted from such balance left
he above all adjustments, average profits which can be expected to be maintained in future
ation These are termed as actual average profit or future maintainable profits.
Mera pu (Simple Average profit method) ; ee
aa hee chased Simmi’s business on Ast April, 2017. The profits disclosed by Simmi’s busine
eas eae were as follows:
Bsa6_g apse (including an abnormal gain of ¥ 50,000) :
tea asian (after charging an abnormal loss of & 1,00,000) vepertynowto be nsured)
Ast 000 (excluding € 50,000 as insurance premium of firm’s prop sto
if for a domestic purpose and debite
go 18 oe
int Ari
Meg beige @ Motorbike % 60,000 was purchase
Glue nes account,
Naas itet fit of the last
ry *Vélue of frm’s goodwill on the basis of 2 years’ Purchase ofthe eka al
A
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fter adjustments;
saa lation of Actual Total Profits of last three years after adjustments;
(i) Calculation
z
4,00,0000 t
Profits for 2014-15 50,000)
Less: Abnormal Gain z 35tp,
5,00,000
Profits for 2015-16 1.00.00
Add: Abnormal Loss Ee $0,
3,90,000
Profits for 2016-17 ; pape
Add: Travelling Expenses wrongly debited sae
Less: Insurance premium (50,009) ty,
Actual Total Profits Bay
Actual Total profits _ % 1350000
i ae it= oe =%4
(i) Calculation of Simple Average Profit NaroIvears : 50,000
Ui) Calculation of Value of Goodwill = Simple Average profit x No. of years' purchase
= %450,000 x 2 = % 9,00,000,
Note: Cost of motorbike was wrongly debited to travelling expenses instead of drawings account
rectification the profit of 2016-17 will be increased by 60,000.
ILLUSTRATION 2, (simple Average profit method)
The Profits and Loss Account of Mr. Y
2014-15 Profits% 40,000; 2015-16 Profits—Z 56,000 and 2016-17 Profits— 60,000.
mY. Calculate the amount of goodwill after taking into consideration
following factors:
(2) Profits of 2015-16 included a speculative Profit of & 5,000,
(2) Profit of 2016-17 was reduced by & 4,000 due toan
(3) The properties were not insured and it wae thought py
Premium was estimated % 500
extra-ordinary loss on account (a
Tudent to insure the business in futue.
; per annum.
(4) Pantha ie of eee business, was mployed with Krishna Limited and waseettine® 2"
. He intent is
per month * toreplace the manager of the business wha at present is getting?
‘The goodwill is to be valued at 2 year’ °
SOLUTION. Year's purchase of the simple average profits of past three
(1) Calculation of Actual Average Profit: fi
Profits for 2014-15 : “I “
Profits for 2015-16 eo
Less: Non-recurring profit (abnormal profit) .
Profits for 2016-17 en yy
Add: Extra-ordi foo
ordinary (abnormal loss) 400 get
if
Total profits a |
|
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coool
67
fits =Total profit
imple Average profits =Total profits No. of years = (2)
srrppxpenses to be paid in future: Years =% 165,000 +3 Sp
Insurance premium
salary to proprietor (% 2,000 x 12) (500)
(24,000), _ (24,500)
add: xpenses not to be paid in future: 30,500
salary of manager (& 1,200 x 12)
simple Actual average profits (Future maintainable profits) ears
«collation of Value of Goodwil
Goodwill = Simple actual average profit x No. of
. of years hi
=% 44,900 x 2 = % 89,800, Lilia
weighted Average Profit Method
searing: This method is a modified version of the simple average profit method. Under this method
apasroft is multiplied by the respective number of weights, 12,3, 4 etc. n order to find out
ih productand after thatthe total of productsis divided by the total of weights in order to ascertain
vonaehted average profit. Therefore, the weighted average profit s multiplied by the agreed number of
‘espurchase (such 1, 2, 3,...) to find out the value of goodwill.
formula
Total of Products of Profits
Total of Weights
{i) Calculation of Value of Goodwill = Weighted Average Profits x No. of years’ purchase
(i) Calculation of Weighted Average Profits
Weights: Methods of assigning weights are as follows:
() In case there is a sufficient and continuous rise in profits, it will be better to give more
importance to the profits of the latest year because iti ltely to be maintained in the future by
the firm.
(i) Incase there is sufficient and continuous decline of profits instead of assigning the weights, the
profs for the future year should be estimated on the basis of the trend. These will be lower than
ra at ne ast Year 2013-14-2, 2014-15-3 and so
snag astuation more weight is given to recent years like roieas-47 Bate emer
eth average profit method of valuation of goodwill is better than he inet ern
‘lim, Cause it gives more weightage to latest profit which is likely to be maintal
ny gle The profits ofthe firm for the year ended 31st March for the last five years were as follows:
7,500; 2014-8 20,000; 2015-¥ 24,000; 2016-X 25,000; 2017-% 30,000. sage prota
late the value of goodwill on the basis of three years! purchase of weighted averse’
12, h t
Seige” 4 and 5 respectively assigned to the profits.
eae
cult;
lation of Weighted Average Profits: . roche
ight
Yearended Profits weig wo
i z 1 17351
aa March, 2013 17,500 2 40,000
‘arch, 2014 20,000
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8 3
. 24,000 Ff *
%
gust March, 2025 sete 5 lag
3ist March, ae 30, 15 ea
3ist March, 201 Ny
0 SQ
Total of products 2 BREE = 25,300 oS
1
jghted average Prof “Toral of weights ,
weighted average Profit x No. of Years! purchase
£95300 X 3=€ 75,900
Wei
(i Calculation of Value of Goodwill =
profit method)
hase the busines:
ars purchase o!
s carried on by Ashok Bros. Gooduil fy,
this
ILLUSTRATION 3. (Weighted average
f the weighted average profits ofthe pan
Prem Limited proposed to Pure
purpose is agreed to be valued at ie ca
its for these years ar :
ania Jo14-15-X 1,24,000; 2015-16-% 1,00,000; co 1,50,000,
‘on 2 Scrutiny of the accounts, the following matters are revealed:
(i) The closing stock for the year 2014-15 was over-valued by € 12,000.
(ii) On Ast December 2015, a major repair was made in respect of the plant incurring & 30,000 whi,
“amount was charged to revenue, The said sum is agreed to be capitalised for goodwill calculi,
subject to adjustment of depreciation of 10% p.a. on reducing balance method.
(ii) To cover management cost an annual charge of % 24,000 should be made for the purpose ¢f
goodwill valuation.
Compute the value of goodwill of the firm.
SOLUTION.
(i) Calculation of Actual Weighted Average Profits:
Particulars
Profits Weights
Profits for 2013-14 z (®) (2)
1,01,000 1
Profits for 2014-15
Less: Over-valuation of closir 2 1,24,000)
Profs for 2015-16 Sag stock 12,000] 1,12,000] 2
‘Add: Over-valuation of openit a 1,00,000 :
pening stock? ea
‘Add: Capitalised value of repairs? 22,000
30,000)
Less: Depreciatior 00]
Profs or 201617" © 19% 98 30,000 for & months? 12,000)
Less: Depreciation (-) 1,000] 1,41,000] 3
© 10% on 28,000 830,000 - 24 son) _ 0,000
, {-)2,900} 1,47,100|__4
Weigh
'ehted average profit = Total_of Products 21336400
sem
to
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scoodvil
wn
fa) Incase 2013-14 being first year will be assigned 69
zi 6-17 years will be assign, . led a we
ye 201 igned a weight of 93, yc of one than 2016-15, 2015-16 ana
19) Asa result of over valuation of closing tek of mone nets
stands over valued Because the closing st 2014-15 the openi
stock of 2015-16. As such the over Mines ng stock of 2017-18 also
n
014.
Cee ot S28 automatically becomes the opening
2014- the profit of 2015-16, The exe must Ua¥e increased the profit of
(a) The amount of repair on machinery being te same has now been adjusted
its and depreciation wil ;
profit a ill decrease the profits as this
Perot. Thus, the same has now been adjustea is has not been deducted because of
at
fed as capital expenditure will increase the
for 2015-16 and
and 2016-17.
pontges of Average Profit Method
and easy calculation: This method is si
1) simple and is method is simple from the poi
Fs : a value
_Q) Knowledge of earning power: As goodwill is valued on the basis of average profits of a
| fortis easy to have knowledge of profit earning capacity of business i aaantl
pisadvantages of Average Profit Method
a No use of capital employed: This method is not complete as without capit:
cannot be valued accurately. ut capital employed, goodwill
2) Unscientific: In this method, number of years are determined on the basis of estimate, so this
method is not a scientific method.
Il, Super Profit Method
Meaning: The term super profit means the profit over and above the normal or average profit earned
asia firms. In other words, if actual profits ofa firm are more than the normal profits, the difference
sloown as super profit. Such super profit is multiplied by the agreed number of years purchased (such 1,
23}to find out the value of goodwill.
Formula: The following steps are involved for calcul
(i) Actual average profit = Total profits/No. of years
lating goodwill by Super Profit Method :
| ae
| (i Normal profit = Capital employed x Normal rate of return/100
(ii) Super profit = Actual Average profit - Normal profit
(il Value of goodwill = Super profit x No. of years’ purchase
Note (2) Actual average profit is calculated in the same mannht as diced erin —
(2) Capital Employed/Net Assets = Total Assets (excluding Goo wi) een
__ Bample: The average profits expected of 2 firm in ik are 73,009 r,t tof
Samal profit of & 5,000 and capital invested in ea ye remuneration ‘of the partners is
Ring Cted from capital invested in this class of Busines 12 Tee ont
tobe %8,000 re required to fin
's ,000 for the year. Youal
ashase of Super Profits
0) ioe, 2 8,000 (Remuneration) = % 60,000
A ,
fi)
‘abnormal Profit)
Normal rate of return / 100
42,000
Normal pro
tual average profit = < 73,000 -© 5,000 (/
Normal profit Capital employed
%3,50,000 X 12/100 =
‘Actual average profit
60,000 ~ £42,000 = x18)
fit
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Corporate
6.10
ill of a firm of An,
method) value of goodwil and an
ILLUSTRATION 4. Se Lae below, calculate the a 7"
ym the informati jehted):
super prof method (simple ante usiness € 18,00,000- ae
e 22,800,
(a) Average capital emp! co firm for the past three ¥ md Ta
(b) Net trading profits o
%3,37,500.
(c) Rate of interest expected from
(d)_ Fair remuneration to each partn
Loss Account so far. (Garhwal poo pie
{e) No. of years purchase = 1.5 years. 7
apital having regard to the risk involved is 12%,
tr for ther service % 18,000 per annum, not charged to p,,
SOLUTION.
fa) Simple Average Method: 7
‘ (i) Calculation of Actual Average Profit:
Total profits of past 3 years =€ 322,800 + € 2,72,100 +X 3,37,500 = & 9,32,400
Average profit = Total profits + No. of years =% 932,400 + 3 3089
Less: Remuneration of partners i.e., future expenses (% 18,000 x 2) (a
Actual average profit
Calculation of Super Profit:
Actual average profit
Less: Normal profit on capital employed, i.e., 12% on % 18,00,000
Super profit
(iil) Calcualtion of Value of Goodwill:
Goodwill = Super profitx No. of years’ purchase
= %58,800 x 1.5 =% 88,200,
(b) Weighted Average Method:
(i) Calculation of Actual Weighted Average Profit:
Year
ae x Weights = pot
is 3,22,800 ‘: aust
2nd 272,100, 7 sam
a 3,37,500 sf
37, 1028
Weighted average profit =Total of p — =F
re Femuneration of partners (g 10008) total of weights= €18,79,500 +6 ss
_, Actual weighted average 000 x a
(li) Calculation of Super ms Ties ye
Actual Wegithed Average pron, #
Less: Normal prof 2° Profit 2
i ‘
Super profit" ©@Pital employ 236
(ti) Cacualtion of
Val
Goodwill Ue Of Goodwill;
Yed (12% on g 4
18,00,000) se
UPEr rofit x ty
0. of years!
S250 x15. ae Purchase
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yn 644
on 5 (002° profit method)
v 4 company is to be absorbed by the Delta Co
A ree years’
Ft ene net profits being averaged over five years, Years’ purchase of the average annual
res of the Gamma Company for the last five
z pis tallows: 2012-13-X 50,000; 2013-14
i14 75,000- ,
she rectors of Gamma Serre (3 in number) will be appointed to the Board of Delta Company on
sion anditis considered that their services have been (and will be in the future) worth & 5,000 each
Hamm, There has Never been made any charge against the profits of Gamma Company for such
a ahe average capital invested in net tangible assets over the period is € 1,80,000 and it is
jeed tat the normal return to be expected from the particular type of business carried on by
wena company is 20%, Calculate the goodwill of Gama Company.
squTION.
(i) Calculation of Actual Average Profit:
| Total profit for past S year (850,000 + 265,000 + 245,000 + %55,000 + €75,000
years (before chargin,
ig income tax @ 25% on
z 65,000; 2014-15-% 45,000; 2015-16-% 55,000 and
‘Average profits = Total profits + No. of Years =%2,90,000+ 5 58,000
less: Directors’ fees, ie., expenses that will occur in future (3x 5,000p.a.) ___(25,000)
Profit before tax 43,000
Less: Income tax (25% on ® 43,000)
| Actual average profit
{i) Calculation of Super profit:
Actual average profit 32,250
Less: Normal profit on capital employed /e., 10% on & 1,80,000 28,00)
Super profits
(ii) Calculation of Goodwill:
Goodwill = Super profits x No. of years’s purchase
= % 14,250 x 3 = & 42,750
Smputation of Capital Employed in the Business
Malence sheet is given in the question, the capital ‘employedis
pa tt of capital employed is one of the most important featu
e related to the capital employed. For calculating Capita
; be adopted:
| I Tangible Fixed Assets: These assets should
| {ake (or market value) is not mentioned in the qu
| ‘own in the balance sheet. ares
tangible assetar These assets except goodwill ncude patent, trade marks,
to be calculated as per balance sheet.
res in valuation of goodwill, since the
| Employed, the following procedure
nt value (or market value). If current
mat curre
be taker T should be taken at book value as
jestion, I
\eSe asset. lisati Jue. 7
i) 'S are taken at realisation Va! be included.
Goo Id not be it
) can wil: Goodwill shown in the balance sheet shoul meyers willbe taken after adjustment of
fae Assets: These should be taken at net value & 9
() sion for bad debts etc.
ori tment: It should be excluded becot
Not invested in the business.
has been invested outside the business
se this amount
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ras discount on issue of debentures, y,
ould be ignored because actually tj yt"™,
‘es which is to be deducted out of profits in future, "®hey
He assets as explained above, the liabilities or yey,
res, ereditors ills payable, bank overdraft, pry i
cl
assets: unamortized expenses 51
jous
4 ment expenses €|
commission, advertise’
worth but a combination of 105s
utside Liabilities: Out of the to
io Sarie are to be deducted e.g., debentu
income tax, etc.
Thus, total of outside liabi
In brief:
(6)
sesshould deducted from total of 2ssets for finding out copay,
t
Value t
if any, otherwise at Book -
Feed Assets at (Market value). aN srket value), f any, otherwise at Book Value
Current Assets at Current value (or Mar}
otal Assets excluding Goodwill Fictitious Assets and Investment SS
ese: All Outside Liabilities, Le., Non-Current Liabilities + Current Liabilities ria
Net Capital Employed =
Calculation of Average Capital Employed
The concept of average capital employed has gained significance because the capital employed my
be such as may fairly represent the capital employed throughout the year. Average capital employe,
calculated as follows:
Capital employed in the beginning + Capital employed at t
‘Average Capital Employed = apt employed inthe beginning + Cophet employed ttheent
If the capital employed in the beginning of the year is not given in the question, average capi
‘employed can be ascertained by deducting half the profits of the year from the capital employed atthe
end of the year:
‘Average Capital Employed = Capital at the end— 1/2 of Current Year's Profits
1/2 of the profits are deducted on the assumption that profits have been earned evenly throughat
the year. The logic behind it can be explained by taking an example. Let capital in the beginning te
%1,00,000 and let there be a profit of @ 12,000 during the year so that capital at the end is ¥1,12,000 F
this case average capital employed is (8 1,00,000 + ¥ 1,12,000) + 2 = € 1,06,000. If opening capitlis
given in the question, the same result can be obtained by deducting half of the profits from the ct?
employed at the end. Thus, average capital employed is € 1,12,000 — 1/2 of % 12,000 = @ 1,06,000.
‘Average capital employed is ascertained and used on the k ; ing they
“ logic that the profits earned during
are re-employed into the business and thus more and more capital was used to earn the profits of eat?
subsequent month o the above said case, the capital employed in the beginning of the Ye"
00,000 and due to profits it increased by € 1,000 per month on an average basis so that it Came |
1,12,000 at the end of the year. As such, i ie
Beers a6 050 an ane Yat As such the average capital employed throughout the yet ™#
7 forvaling good come accountants use the concept of net capital employed whereas te
it fairy represents the capital een The use of average capital employed is more logis! Oe
ppt 6. (Super profit method — calculatio; a
rom the following Particulars, you are required pie eae i
a to calculate goodwill by 3 years’ purchase of SUPE
1. EQUITY AND LIABILITIES
1. Shareholders’ Funds:
Preference Share Capit
fe pital i
Equity Share Capital i
2,50"
Scanned with camSeannér ' il
ot goo" 6.13
a
eserve .
oo ‘compensation Fund 65,000
werent Liabilities: 25,000)
om bites: 75,000)
| ge payables
Total
[Man current Assets
tand and Buildings 80,000
Less: Depreciation '15,000)| 65,000
Plant . 1,00,000
Less: Depreciation '20,000)| 80,000)
Goodwill 25,000
Investment in Government Securities 80,000
Investment for Plant Replacement 30,000
2, current Assets:
Other Current Assets 3,20,000
Total 00,000)
‘sume 10% normal rate of return on ‘average capital employed’. Current year’s profit excluding
iterest on investment and before payment of tax amounted to ¥ 1,00,000. Assume taxation at 50%.
SUTION.
Step 1. Calculation of Actual Average Profit: z
Average profit 1,00,000
Less: Income-tax (50% on % 1,00,000) 50,000)
Actual average profit or Current Year’s Profit —50,000-
Step 2. Calculation of Average Capital Employed:
Assets at Market Value, if any otherwise at book value
land and Buildings $5.00
Plant ee
Investment for plant replacement 3 Bree
Other 495,000.
Current Assets 4,95,000
Less: Outside Liabilities: 5, aa
10% Debentures "
10) (1,60,000)
in Trade Payables ae 3,35,000
let Capital employed 25, 00)
Less: Half of the current year’s profit e., 1/2 of € 50,000 3:10.00"
Average capital employed
(i ¢, u
aeulation of Super Profit: 50,000
tual Average profit 31,000)
Less: Normal profit (i.e.,10% on % 3,10,000) 19,000.
(iy: CuPer Profit
ulation of Goodwill:
=% 57,000.
Pdwill = Super profit No. of years’ purchase =® 19,000 * aa
Scanned with CamScanner Corporate, Acco
6.14 thy
ment securities is taken as a non-business investment, Thy.
pital employed.
Fund is not a li
(a) Investment in govern it shoug
not be included in ca
(2) Workmen’ Compensation
ee , half of current year’s profits afte
(3) For calculating aerge capital employe , "et
investment and tax to be B |
ILLUSTRATION 7. (Super profit method - calculation of capital employed)
The extracts balance sheet of X Limited as at 31st March, 2015 is as follows):
: ability fore, it should di
ility, therefore, it should not be dog,
Ucted fron
Particulars
1. EQUITY AND LIABILITIES
1, Shareholders’ Funds:
{856 5,000 Preference Shares of € 10 each
10,000 Equity Shares of ¥ 10 each
Reserves and Surplus
2, Non-Current Liabilities
8% Debentures
3, Current Liabilities:
Trade Payables
Provision for Taxation
I, ASSETS
1. Non-Current Assets:
(a) Fixed Assets:
{i) Tangible Assets
(i) Intangible Assets (Goodwill)
(b) Non-Current investment (5% Government Loan)
2. Current Assets
3. Current/Non-Current Assets
Discount on Issue of Debentures
The current year’s profit of the company (after deducting interest on debentures and taxes) §
731,000 The market value of the machinery included in fixed assets is € 5,000 more. Expected rate of
return is 10% on closing capital employed. Rate of tax may be assumed 50%.
Evaluate the goodwill of the company at 5 times of the super profits.
SOLUTION,
Step 1. Calculation of Actual Average Profit: ‘
Current year’s (after deducting interest on debentures and taxes) al
cit ncome-tax (833,000 x50 /50) Sa
sett year’s ae before tax and interest on investment _ poo)
: Income from investment being non- it i ,
ott bee eing non-business income, i.e. 5% on & 20,000 6, a
« Co Income-tax (50% on & 61,000) es
Step 2, eae Eats Profit after tax =
. lation of i it
ern Mae or Closing Capital Employed:
alue, if any, otherwise at Book Value: z
Fixed assets RS 000
1,80,
Scanned with CamScanner 4 ‘goodwill
ao
‘add: Increase in the value of machinery
Current Assets
6.15
5,000 1,85,000
00,000
tess: Outside Liabilities: 2,85,000
8% Debentures .
Trade Payables peaay
Pas ;
Provision for Taxation sco ene
Net Capital employed
2,00,000
4, Calculation of Super Profit: z
* profit before Tax (say Actual average profit)
Less: Normal profit (10% on ¥ 2,00,000) ae
super Profit 20.000)
gap. Calculation of Goodwil
. ()
sae (side the business,
Goodwill = Super profit x No. of years purchas
% 10500 x 5 =% 52,500
Investment in 5% Govt. Loan will not be included in assets because this amount is invested
(2) Since rate of returns is given on closing capital employed in the question, hence there is no
need to calculate average capital employed.
ustRaTION 8. (Super profit method ~ Calculation of capital employed)
from the following extracts of balance sheet of Martin Limited as at 31st March, 2015 find out the
se of goodwill according to super profit method, assuming three years’ purchase:
[ Particulars z
tuty and Liabilities
1 Shareholders’ Funds:
| Preference Share capital 1,00,000)
Eqity Share capital) 40,000
12,000
General Reserve
Profit and Loss Balance:
Balance on 01-04-14
Profit for the year 2014-15
2 Curent Liabilities:
| pa Peales “F000
a ‘ons for Doubtful Debts Total 32,01
: percent Assets:
fuite 00
Lee Current investment 41,30,000
coe “am
at! Receivables ss
~“'shand Bank Balance
20,000
2,120,000] 2,30,000
|_55.000)
Total|" _5,32,000)
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Ain
6.16 %
‘The following information is supplied to you :
(a) Present value of building is % 2,00,000
| rate of return is 10% | |
fa mr for the past three years have shown an increase of € 40,000 annually
fc) Pr
(d) Non-Current Investment consists of 1,500, 5% gold bonds of € 100 each
{e) Assume taxation at the rate of 60%. (Gorakhpuy es
SOLUTION.
Step 1. Calculation of Actual Profits: ?
Profit for 2014-15 200m
Profit for 2013-14 (2,10,000 - 40,000) rho
Profit for 2012-13 (1,70,000 - 40,000) aime
Since there is sufficient and continuous rise in profits, it will be appropriate to calulte
weighted average.
Step 2. Calculation of Actual weighted Average Pr
Year Profits Income from investment” Adjusted Products
®) profit
z
yo12-13 130,000 (-)7,500 222,500 1 12800
2013-14 1,70,000 (-)7,500 1,62,500 2 3.25000
2014-15 —_2,10,000 (-)7,500 202,500 3 _ 6.07500,
Total & wee
z
Weighted Average profit = € 10,55,000 + 6 aaa
Less: Income-tax (60% on @ 1,75,833) 058i
Actual weighted Average Profit Be
Step 3. Calculation of Average Capital Employed:
Assets at market value, if any, otherwise at book value: ‘
Buildings 2aose
Furniture CA
Inventories 2
Trade Receivables less provision ie. & 5 oo
ie, & 50,000 ~& 2, ’
Cash and Bank balance on se
523,000
Less: Outside liabi les i.e. Tr se
rad ee
Net Capital employed arabes “ae
Less: 172 of current year’
; Year's profit after tax 1, 5
nee Average capital employed 2 of & 81,000
Iculation of ‘Super Profit:
ae Weighted aver
ss: Normal Profit or it
sacted balance sheet of H.S. Ltd as on 31st March, 2017 was as follows: ;
tars.
May
oi Uabitities 5,00,000
hare Capi
& re Cay - 2,00,000
(heal Naser! 50,000 shares of € 10 each See
80,000)
de Payables) Totall ~8,80,000
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I Assets
Plant
Investments
Inventory
Trade Receivables
Bank balance
Prepaid expenses
Share Issue Expenses
Tata Ltd, Intends to purchase the business and the assets are revalued as follows
Plant 3,00,000, Inventory & 2,40,000, and prepaid expenses € nil. 5% provision for doubtful det,
deemed necessary. The profits for the past four years were: 2013-14 — % 60,000, 2014-15 -% 80,009, 201545
= 1,18,000 and 2016-17 & 1,00,000. These profits include income from invetments % 4,000 each yea,
‘Ascertain the value of goodwill according to capitalisation method if the normal rate of returnis 1gy
SOLUTION.
Step 1. Calculation of Actual Average Profits:
Year Profits Adjustment Profits
(income from after
investment) adjustmen
ts
z z z
2013-14 60,000 (-)4,000 56,000
2014-15 80,000 (-)4,000 76,000
2015-16 41,18,000 (14,000 1.14000
2016-17 1,00,000 (-) 4,000 + 6,000 90,000 |
Total Profits ~3,36,00_ |
z
Average profit = Total profits + No.of years =& 3,36,000-+ 4 84,000 |
Less: Future adjustments tb
Actual average profit so
Step 2. Calculation of Average Capital Employed:
t
Plant 3,00,000
Inventory 2,40,000
Trade Recein i, Hei:
a ae ‘.e,%1,20,000-% 6,000 (provision for doubtful debts) a |
a
Less: Outside liabilities:
Loan <
,000)
Trade Payables te oa (2,80000)
573000
Less: Half of current year's 45000)
year’s profit, i.e, (ase
Average Capital Employed eet ee
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; re 6.23
lation of Capitalised Value of Actual it
i es een Average Proift:
“Normal rate of return ~ Atul average profit
209 = 84,000
14 ut z 6,00,000
calculation of Value of Goodwill: .
Capitalised value of actual average profit
Less: Average capital employed eS
odwill :
Value of Goi a
ye} meme from vestrment is deducted from average profits since the income is received from
(2) %6,000 i.e., 5% provision for doubtful debts on & 1,20,000 is an adjustment entry. Thus, on
one hand it should be deducted out of current year’s profit and on another hand, it should
be deducted from debtors. "
{3) Investments are not included in assets for the purpose of calculating capital employed since
the amount is invested outside business,
(4) If nothing is mentioned about taxation in the question, there is no need to provide for it.
(5) 1/2 of the current year’s profit after interest on investment and tax is deducted in order to
ascertain the amount of average capital employed.
WSTRATION 13. (Capitalisation of profit method)
Khas invested a sum of % 3,00,000 in his own business which is a very profitable one. The annual
polttearned from his business is ¥ 60,000 which includes as sum of % 10,000 received as compensation
‘raquistion of apart of his business premises.
‘The money could have been invested in deposits for a period of S years and over at 10% interest and
‘ehimself could earn & 7,200 per annum in alternative employment.
(Considering 2% as fair compensation for the risk involved in the business, calculate the value of the
Saiuil of his business on capitalisation of super-profits at the normal rate of return
(K.U, 2014, MDU. 2016)
Sumon,
Sep. Calculation of Actual Average Profit: z
Less: Compensation for premises (not being business income) “Hat
Annual profit being average profit ee
Less: Remuneration of proprietor Mr. X eae
| Mina Actual average profit or Future maintainable profit =s2.000
f ciklation of Super Profit: ee
“tual average profit
% 3,00,000 (36,000)
Less: Normal profit on capital employed Le. 12% (10% + 24) on rT
Super profit
G Fi
ee ve station o Value of Goodwilt = 100 xz 6,800 = 756,667.
lve of Goodwill = 100 super profit =
Normal rate of return
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Rg,
Method
the amount paid for goodwil
method is that n dil as
f prof ew years. But no attention has been paid to the Sig,
ae ere isa loss of interest on this amount. If amount tha
een generated interest on this investeg By
dill is paid today but this amount, purchaser yg
first year, another & 10,000 in the second year ang an, a
the amount of interest over % 30,000. tn relation to th _
is,
, one of interest can be ci ,
a ich above mentioned loss of i n be compen
annuity method is the scie
i is known as
sa peis caleutated with the help of anny tables and i now 3 od
Such 2 eter te following formulae can be used for caeulting value of ood by annuity meta
iy ie veesent value of annuity is given in the question the following formula can be veg,
(a) Hf the present Yer goodwl by annuity MetPOd: or profit
(a) troresent value of annuity is more than € 3, then multip
Woe of Goodwill = Super Profit x Present value of annulty
ty is less than € 1, then divided super profit
(2) if the present value of annuity | an, ther
Value of Goodwill = + value of Annuity
ot given in the question, first the following formula is appli
(b) if present value of annuity is m t
vrtculating annuity. After that, calculate the value of goodwill by annulty method.:
v, Annuity
behind supe
fits during th
il in present, th
ning: The object
d from pro
for goodwil
invested elsew!
Mea
will be recovere!
onthe amount paid
odwill had been i ;
which heis not receiving now. pone ets
ithe shape of super profits as < 10.0 i
10,000 in the third year Purchaser will lose
puri
[isa
100.
a
100
\ormal rate of return, n = number of years
where, r
ILLUSTRATION 14. (Annuity method)
Average capital employed of Sushil Limited is € 6,00,000. Its profits for the first four years respectively
are: & 65,000, Z 70,000, % 75,000 and X 80,000. It is expected that the company would maintain its super
ue of annuity of & 1 at 5% for four years is 0-282012. Reasonable
profits in coming four years. Present va
income is 11% per annum. Calculate value of goodwill by annuity method. (Avadh 2010)
SOLUTION.
Step 1. Calculation of Actual Average Profit:
2,90,000
Total Profits of 4 years = % 65,000 + % 70,000 + & 75,000 + % 80,000
Average Profit =Total Profits « No. of Years = ™2,90,000 +4
Less: Adjustments
Actual Average Profits
Step 2. Calculation of Super Profit:
Actual Average Profit 72,500
Less: Normal Profit on Capital i y 8
ee pital Employed, i.e,, 11% on & 6,00,000 "50
Step 3. Calculation of Value of Goodwill: Se
As it 5
Present value of annuity is less than & 1. So, divided super profit
Value of Goodwill =_SuperProfit_ ___ 6500 _ x raq4g66 or € 23047
Present value of annuity 0.282012
Scanned with CamScanner sono cool
jon 6.25
on 15. (Annuity method)
ft of a company during the last four
2 P he capital employed is 2,00,000 a years were @ 16,000, & 28,000, € 20,000 and ¢ 32,000
ae ae annuity method srau nd return in similar business is 10% on capital employed.
goodw ning the rate of interest to be 5% p.a. for 4 years after
RA
a: pe any table which sas under:
Years 3% 4% 5
1%
3 0.353530 0.360349 0.367209
: 0.269027 0.275490 0.282012
0.213355 0.224627 0.230975,
ION.
step 1. Calculation of Actual Average Profit:
Total profit of 4 years (& 16,000+€ 28,000 + & 20,000+ & 32,000) = 96,000
Average profit = Total profits + No.of years =% 96,000« 4 eo
Less: Future adjustments on
Actual average profit
Step 2. Calculation of Super Profit:
Actual average profit 24,000
Less: Normal profit on capital employed, i.e., 10% on ® 2,00,000
Super profit
Step 3. Calculation of Value Goodwill:
{As present value of annuity is less than € 1 so, divided super profit
Super Profit
resent value of Annuity
= 14,183.79 or 7 14,184
value of Goodwill =
% 4,000
0.282012
ISTRATION 16, (Annuity method)
From the following information, compute the value of goodwill:
(1) Average capital employed %3,00,000.
(2) Normal rate of profit 10%.
(2) Profits for 2013-14 40,000, for 2014-15 %41
60,000.
(0) Profits for the first two years include a non-recurring income of €5,000 and the profit for 2016-17
has been arrived at after deducting an abnormal loss of 76,000. : ‘
(5) Goodwill is to be calculated on the basis of annuity of 4 years purchase of super profits.
18,000, for 2015-16 €31,000 and for 2016-17 *
i The present value of the annuity of & 1 for 4 years at 10% Is & 3.17.
ION,
a z z
Step 1. calculation of Actual Average Profit: 40,000
Profit for 2013-14 (5,000) 35,000
Less: Non-recurring income ‘48,000
Profit for 2014-15 (5,000) 43,000
31,000
Less: Non-recurring income
Profit for 2015-16
Scanned with CamScanner OPO ate
6.26 0,
60,000
profit for 2016-47, ‘s per
‘dd: Abnormal lo: %
Total profits aie
fits +No. of years = %1,75,000+ 4 ‘
average profit = Total profits .
‘Less: Future adjustments as
‘Actual average profit =a
Step 2. Calculation of Super Prof
‘Actual average profit : - ont ~
Less: Normal profit on average capital employed .e., 10% on & 3,00,000 a
= hy
Super profit will
. Calculation of Value of Goodwill ;
aad As present value of annuity is more than % 1, so multiplied super profit
Value of Goodwill = Super Profit x Present Value of Annuity
= 13,750 x % 3.17 =% 43,587.50
ILLUSTRATION 17. (Annuity method) .
The following particulars are available in respect of Ashish Ltd.:
(a) Profit for past three years % 50,000, & 60,000 and % 55,000 respectively.
{b) Normal rate of profit 10%.
(c) Average capital employed % 3,00,000.
(d) The profit included non-recurring prot
deemed that even non-recurring profit
% 1,000 p.a.
(e) Present value of an annuity of one rupee for 5 years at 10% =% 3-78.
Compute goodwill from the following methods:
(i) as per five year’s purchases of super profit.
(ii) as per capitalisation of super profit.
fits on an average basis of © 4,000 out of which it was
shad a recurring tendency of appearing the rateof
(ii) as per annuity method. (Kanpur 2009; Meerut, Avadh 201)
SOLUTION.
Step 1. Calculation of Actual Average Profit: z
Total Profits of 3 years = € 50,000 + % 60,000 + € 55,000 = 16508
Average Profit = Total Profits + No. of Years = % 1,65,000+3 = “sa
Less: Abnormal Profit 4,000 1,000) 7 30a)
Actual Average Profit . au
Step 2. Calculation of Super Profit: Fry
Actual Average Profit sao
Less: Norm: i
a al Profit on Capital Employed (10% on & 3,00,000) ea
Step 3. Calculation of Value of Goodwill:
i 5
(i) As per 5 years’ purchases of Super Profit:
Value of Ge il
}oodwill = Super Profit x No. of Years’ Purchase
=%22,000x5=% 1,10,000
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wn 6.27
fay As per Capitalisation of Super Profit
value of Goodwill = Super Profit x ___ 100.
Normal Rate of Profit
of Profi
=% 22,000 x 100 ror
10 7 * 220,000
(ii) As per Annuity Method:
Value of Goodwill = Super Profit x Present Value of An
. i
=% 22,000 x% 3.78 = % 83,160 ny
anion 18. (Different methods of valuation of goodwill)
f a firm were & 1,00,000 out of whi
tre net assets of 00, which % 10,000 were in the fi
ities purchased at par. The expected future profits of the firm are & 15, pcb cates ine val of
el according to the following methods: ee atealae ane Maine @
* a) Three years’ purchase of average profits;
jp fve years’ purchase of super profits;
(a capitalisation @ 10% of average profit;
(d|coitalisation @ 10% of super profits; and
[e)on the basis of annuity of super profits, present value of annuity of € 1 at 10% is € 3.791.
{QUTION.
Step 1. Calculation of Actual Average Profit:
z
Expected profit 15,000
Less: Interest on Govt. Securities ( 10,000 x 8/100 x 1) (800)
Actual average profit 14.200,
Step 2. Calculation of Capital Employed: z
Net Assets 1,00,000
Less: 8% Govt. Securities (Investment) —{10,000)
Capital employed 20.000.
Step 3. Calculation of Super Profit: a aa
Actual Average profit b
Less: Normal profit (€ 90,000 x 10%) (2,000),
Super profit ek
Step 4, Calculation of Value of Goodwill: ee
(a) 3 years purchase of average profit: € 14,200 x ea 26
(b) 5 years purchase of super profit: % 5,200 x5 = % 25,
00
“ = 10
(©) Capitalisation @ 10% of super profits: € 5,200 x= % 52,001
(4) Capitalisation @ 10% of average Profits: 4,
a) 41,42,000
Capitalised average profits = €14,200 x =
(90,000)
Less: Actual capital employed 52,000.
Value of Goodwill = % 19,713.20 or € 19,713.
(©) Annuity of super profits based on 3.791: € 5,200 x 3.791 = 19)
ind Super Profit
Difference Between Normal Profit 2
‘Super Profit
cess of average profit over}
able The eee called SuPer pret
m
profits earned
course of business.
Scanned with CamScanner 2
Cor
6.28 "Pore
yed is considered for| Average Profit. j
profit. calculating super prog Msi
‘Super profit = Prof a
Average Profit ‘
10
2. | Consideration of capital] Capital employ
~ | employed calculating n
Formula Normal Profit =
se Normal Rate
of Return
Capital Employed x — 100
is required for Super| Super profit is requir
if capitalisation of] method, capitalisate © Spy
# valuation off method and annoit°! Sipe
valuation of goodwill” Pet
Normay Pro
Normal Profit
Profit method an
super profit method o!
| goodwill.
VI. Purchase Consideration Method
ice received for the sale of business is known as ‘purchase consideration’, the
business (i.e., Assets — Outside liabilities) is req.
Preens
4, | Requirement
Meaning: Pr
purchase consideration over the net assets of the
as the value of goodwill.
Formula: Value of goodwill can be calculated with the help of formula given below:
Purchase Consideration
Less: Capital Employed
Value of Goodwill
Example: A Ltd took over assets of€3,50,000 and liabilities of & 30,000 from B Ltd. for the puns
consideration of € 5,20,000. Calculate the value of goodwill.
SOLUTION. (i) Caculation of Capital Employed:
Capital Employed = Assets ~ Outside Liabilities
=%3,50,000 — % 30,000 = & 3,20,000
Calculation of value of Goodwill x
Purchase Cosideration s,zn000
Less: Capital Employed 20,000)
Value of Goodwill 2,p0p0
Which Method of goodwill is the Best a
The super profit method is an ideal method because of the following reasons:
(4) In super profit method due consideration is gi 4
‘ is give i i ness whieh
ol absolutely ignored in average profit method, “P/! employed in the business
2) Capitalisation methods shows mavi ;
ae ‘S maximum amount of goodwill so as not to leave any scope tot
(3) Annuity method tries to become to exact in uncertain situation:
s.
Higher Order Thinking Skills Illustrations
ILLUSTRATION 19, (Hots)
The following information is given:
a Average capital employed ® 1,00,000,
i >yed 1,00,000,
® Pier Nalue of annuity of 8 1 for 5 years t 10:
al rate of profit j fone as
(4) Profits for 5 re ‘.
years are: Ist year % 1!
are ota: 000; nd year 16,000; rd year’ 17,000; veh Year® “
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v7 s years purchase of super profit
(As annuity method.
{iS per capitalisation of profit method,
‘3 A for 2 years purchase of average profit,
,gumion.
1, caeuation of Actual Average Profit:
, z
otal Profits of 5 years (® 15,000 + 16,000 + % 17 000 + &
jverage Profit = Total Profits + No. of Years = 8 86,000 : 8,000 + & 20,000) 86,000
tess: Abnormal Profit (€1,500-% 300) eo) 17,200
Remuneration to Propreitor to be paid
Actual Average Profit (800)
2, Calculation of Super Profit:
Actual Average Profit
Less: Normal Profit (i.e., 10% on & 1,00,000)
super Profit
2p 3. Calculation of Value of Goodwill:
(i) As per Super Profit Method:
Value of Goodwill = Super Profit x No. of Years’ Purchase
= 5,200 x 5 = 26,000
(i) As per Annuity Method:
Value of Goodwill = Super Profit x Present value of Annuity
= € 5,200 x 3.78 =F 19,656
(il) As per Capitalisation of Profit Method:
sep
15,200
(10,000)
100
‘Normal Rate of Profit
=%5,200 x 02 =z 52,000
10
Value of Goodwill = Super Profit x
(iv) As per Average Profit method:
Value of Goodwill = Actual Average Profit x No. of Years’ Purchase
Ny = & 15,200 x 2 = & 30,400.
STRATION 20, (Miscellaneous)
From the following information, calculate the value of good
(a) At3 years purchase of average profits,
(0) 3 years purchase of super profits,
(¢)On the basis of capitalisation of super profits,
) he the bass of capitalisation of average profits»
ty ne® pital employed inthe business Is €7,00,000.
ois aang results of the firm for the past three ¥
li) Rate rl 1,48,100; Profit 2016-17—% 4,48,700.
em mest expected from capital having reat
iy ion to each partner for his service
* (excluding goodwill & 7,54,762 and Liabilities © 34,329.
{will of a firm of chander and Gupta:
profit 2014-15—% 1,47,600; Loss
ed to the risk involved 18%
per month.
Scanned with CamScanner 6.30
and Super Profit:
00 + 4,48,700
+3
@ °500 p.m. for 12 months
SOLUTION:
(i) Calculation
Total Profits ie., 1,47,601
Average Profit ie.,% 4,48,200
Less: Remuneration of 2 partners
‘Actual Average Profit
Less: Normal Profit | © 7,00,000 x 5
of Actual Average Profits
0 — % 1,48,1
Super Profit
(ii) Calculation of Value of Goodwill:
{a) At 3 years purchase of average profits:
‘Actual Average profits x No. of years’ purchase
2 1,37,400 x3 = % 4,12,200
{b) At 3 years purchase of super profits:
Super profit x No. of years’ purchase
% 11,400 x 3 = % 34,200
(c)_ On the basis of capitalisation of super profit:
100
= Super Profit x —————____
Normal rate of return
= 211,400 x 22 - z 63,333
18
(d) On the basis of capitalisation of average profits:
Capitalised Value of Average Profit =
100
Actual Average Profit x — ——— z
Normal rate of return
=e 1374002" 7,63,333
Less: Net Capital employed on the date of
valuating goodwill (® 7,54,762 -% 31,329):
Value of Goodwill 29k er
39,900
Note: When both average capital employed and net caj
question,
capital employed. Sony escalated on the basis of average capital employed, not on net
is used for calculating good Pitalisation of average profit method, net capital employed
ILLUSTRATION 21. (Hots) wil not average capital employed.
From the following informa
ition ascertai th i
(i) Awroeeaptl employee nae value Boodwil ofa company a per annuity meta
(ii) Normal Rate Of profit 10% a
(iii) Profit for 2014.
MH “15 ~% 62,000:
(iv) Prof fog aa 1000; 2015-16 -& 59,000
Sa 2000 ,000 and 2016-17-¥ 66,000
2016-17 includ fee ated at after writing off abmowan te prof
(vy) Goodwill is to by ecurring income of % 3. 000, tsetse arte :
@ calculated on the ban
basis of annuity of 3 years purchase of super profits
pital employed or net assets are given in the
Scanned with CamScanner good
C
ain of Average Profit and Super Prof
as for 20S
for 2015-16
mal loss
Kono"
profit of 2036-17
re Non-ecurting income
sot Pits for 3 Years
Teenage Profits = € 186,000 3
tos Normal Profit (20% of € 4,00,000)
super Profit
Calculation of Present value of annuity
to annuity table is not i ,
ce reference et
ity is 28 FOllOW: question,
protts
softs
si
annuit
si
11331
10 1000
331, 10 3310 _z 2.48685
qast 1 1381
93, aleuation of Goodwill:
Goodwill = Super Profit x Present Value of Annuity
= 22,000 x 248685 = € 54,710.70 or 54711.
NUSTRATION 22. (Hots)
Thefollowing particulars are extracted from Notes to Account
"March 31, 2012):
6.31
z
62,000
59,000
2,000 61,000
66,000
3,000) __63,000
186,000
62,000
(40,000)
22,000
hence the formula for calculating
's to Balance Sheet of Meera Limited as
t ey ‘and Liabilities :
mi Funds ‘os
Se copa zn
otal Reserve i.
*roft and Loss Balance
Current Liabilities
"ade Payables se
1a Creditors :
"Term Provision 3
3,000
“sion for Taxation
“sion for Doubtful Debts
Total
Scanned with CamScanner 6.32
z
IL Assets
Ar
Non-Current Assets
, Land and Building 1
Plant and Machinery =
Goodwill at cost
2. Current Assets a
Inventories at cost i
Trade Receivables =
Cash at Bank va ae
40
You are asked to value the goodwill of the company for which purpose of the following information;
u
vested in the class of business done by company is 125,
supplied:
a n capital in :
tax and depreciation.
(a) The reasonable return of ‘ $ 7
{b) Adequate provision has been made in accounts for incom
50%
(c) The rate of tax may be taken at .
(d) The average rate of dividend declared by the company for the past five years was 15%.
(KU. 2011, 12)
SOLUTION.
Step 1. Calcualtion of Current Year’s Profit before Tax:
Suppose current year’s profit is 100 and provision of taxation on it is % 50.
If provision for taxation is ¥ 50, current year’s profit is 100
If provision for taxation is € 55,000, current year’s profit before Tax is
