Valuation of Goodwill

VALUATION OF GOODWILL

Average Profit Method Step 1 – Find the adjusted profit or loss for each year in the following manner: Adjusted Profit = NP during the year + Untreated Income + Abnormal loss or expense – Untreated Expense – Abnormal gain or income Step 2 – Find total profit of all the given years Step 3 – Find average profit as below: Average Profit =

𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡𝑠 𝑁𝑜. 𝑜𝑓 𝑌𝑒𝑎𝑟𝑠

Step 4 – Find Goodwill using the formula given below – Goodwill = Average Profit x No. of purchase years

Questions 1. Goodwill is to be valued at three years' purchase of four years' average profit.

Profits for last four years ending on 31st March of the firm were: 2008 – Rs.21,000; 2009 − Rs.28,000; 2010 − Rs.26,000; 2011− Rs.24,000.

Calculate amount of Goodwill.

Sol. Total Profit = 99000 Average Profit = 99000/4 = 24,750 Goodwill = 24750 x 3 = Rs.74,250 2. Goodwill of the firm was to be valued on the basis of three years' purchase of last five years' average profit. Profits for the last five years ended 31st March, were: Year 2007 2008 2009 2010 2011 Profit (Rs) 25,000 10,000 87,500 (2,500) 25,000 In the year 2007, there was a loss due to fire of Rs.22,000 In the year 2010, the interest received of Rs.6000 was not included.

In the year 2008, an insurance premium of Rs.3000 was not accounted for.

In the year 2011, there was an abnormal profit of Rs.8000.

Calculate Goodwill.

Sol. Calculation of Adjusted Profit Year 2007 2008 2009 2010 2011

Net Profit 25000 10000 87500 (2500) 25000

Adjusted Profit 25000 + 22000 = 47,000 10000 – 3000 = 7,000 87,500 -2500 + 6000 = 4,500 25,000 – 8000 = 17,000

Total Profit = 1,63,000 Average Profit = 32,600 Goodwill = 32,600 x 3 = 97,800 3. Goodwill of the firm will be valued at two years' purchase of three years' normal average profit of the firm. Profits of the previous three years ended 31st March, were 2011 - Profit Rs.20,000 (after debiting loss of stock by fire Rs.30,000).

2010 - Loss Rs.70,000 (includes voluntary retirement compensation paid Rs.1,00,000).

2009 - Profit Rs.1,00,000 (including a gain of 30,000 on the sale of fixed assets).

Calculate the value of goodwill.

Sol. Calculation of Adjusted Profit Year 2009 2010 2011

Net Profit 1,00,000 (70000) 20,000

Adjusted Profit 1,00,000 – 30,000 = 70,000 -70,000 + 1,00,000 = 30,000 20,000 + 30,000 = 50,000

Total Profit = 1,50,000 Average Profit = 50,000 Goodwill = 50,000 x 2 = 1,00,000

4. Profits shown by the business for the last three financial years were: 2009 : Rs.1,00,000 (after charging an abnormal loss of Rs.12,500).

2010 : Rs.1,25,000 (including an abnormal gain of Rs.25,000).

2011 : Rs.1,12,500 (excluding Rs.12,500 as insurance premium.)

Calculate the value of firm's goodwill on the basis of two year's purchase of the average profit of the last three years.

Sol. Calculation of Adjusted Profit Year 2009 2010 2011

Net Profit 1,00,000 1,25,000 1,12,500

Adjusted Profit 1,00,000 + 12,500 = 1,12,500 1,25,000 – 25,000 = 1,00,000 1,12,500 – 12,500 = 1,00,000

Total Profit = 3,12,500 Average Profit = 1,04,167 Goodwill = 1,04,167 x 2 = 2,08,334

Weighted Average Profit Method Step 1 – Find the adjusted profit or loss for each year in the following manner: Adjusted Profit = NP during the year + Untreated Income + Abnormal loss or expense – Untreated Expense – Abnormal gain or income Step 2 – Make table as below – Year

Profit

Weight

Product

Step 3 – Find weighted average profit as below – Weighted Average Profit =

𝑇𝑜𝑡𝑎𝑙 𝑜𝑓 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝑇𝑜𝑡𝑎𝑙 𝑊𝑒𝑖𝑔ℎ𝑡

Step 4 – Find Goodwill using the formula given below – Goodwill = Weighted Average Profit x No. of purchase years

Questions 1. Goodwill is to be valued at three years' purchase of four years' weighted average profit. Profits for last four years ending on 31st March of the firm were: 2008 – Rs.11,000; 2009 − Rs.18,000; 2010 − Rs.16,000; 2011− Rs.14,000.

Calculate amount of Goodwill.

Sol Year 2008 2009 2010 2011

Profit 11000 18000 16000 14000

Weighted Average Profit =

Weight 1 2 3 4 10 1,51,000 10

Goodwill = 15100 x 3 = 45,300

= 15,100

Product 11000 36000 48000 56000 1,51,000

2. Goodwill of the firm was to be valued on the basis of three years' purchase of last five years' weighted average profit. Profits for the last five years ended 31st March, were: Year 2007 2008 2009 2010 2011 Profit (Rs) 1,25,000 1,10,000 1,87,500 (22,500) 1,25,000 In the year 2007, there was a loss due to fire of Rs.22,000 In the year 2010, the interest received of Rs.60000 was not included.

In the year 2008, an insurance premium of Rs.30000 was not accounted for.

In the year 2011, there was an abnormal profit of Rs.80000.

Calculate Goodwill.

3. Goodwill of the firm will be valued at two years' purchase of three years' weighted average profit of the firm. Profits of the previous three years ended 31st March, were 2011 - Profit Rs.1,20,000 (after debiting loss of stock by fire Rs.30,000).

2010 - Loss Rs.50,000 (includes voluntary retirement compensation paid Rs.1,10,000).

2009 - Profit Rs.80,000 (including a gain of 30,000 on the sale of fixed assets).

Calculate the value of goodwill.

4. Profits shown by the business for the last three financial years were: 2009 : Rs.10,000 (after charging an abnormal loss of Rs.2,500).

2010 : Rs.15,000 (including an abnormal gain of Rs.5,000).

2011 : Rs.12,500 (excluding Rs.2,500 as insurance premium.)

Calculate the value of firm's goodwill on the basis of two year's purchase of the weighted average profit of the last three years.

Super Profit Method Step 1 – Find the adjusted profit or loss for each year in the following manner: Adjusted Profit = NP during the year + Untreated Income + Abnormal loss or expense – Untreated Expense – Abnormal gain or income Step 2 – Find average profit as below – Average Profit =

𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡 𝑁𝑜.𝑜𝑓 𝑌𝑒𝑎𝑟𝑠

Step 3 – Find normal profit as below – Normal Profit = Capital Employed x Normal Rate of Return Step 4 – Find Super Profit using the formula given below – Super Profit = Average Profit – Normal Profit Step 5 – Find Goodwill using the formula given below – Goodwill = Super Profit x No. of purchase years Questions 1. Goodwill is to be valued at two years' purchase of super profit. Profits for last four years ending on 31st March of the firm were: 2008 – Rs.12,000; 2009 − Rs.18,000; 2010 − Rs.16,000; 2011− Rs.14,000. The capital employed of the firm is Rs. 85,000 and the normal rate of return is 10%.

Calculate amount of Goodwill.

Sol: Average Profit = 60,000/4 = 15,000 Normal Profit = 85000 x 10% = 8500 Super Profit = 15000 – 8500 = 6500 Goodwill = 6500 x 2 = Rs.13,000

2. Goodwill of the firm was to be valued on the basis of four years' purchase of super profit. Profits for the last five years ended 31st March, were: Year 2007 2008 2009 2010 2011 Profit (Rs) (1,25,000) 1,10,000 1,87,500 1,22,000 1,75,000 In the year 2007, there was a loss due to fire of Rs.25,000 In the year 2010, the interest paid of Rs.60000 was not recorded.

In the year 2008, an insurance claim of Rs.30000 was received and was included in the profit.

In the year 2009, there was an abnormal profit of Rs.22,500.

In the year 2011, there was an abnormal loss of Rs.25,000.

The capital employed of the firm is Rs.3,00,000 and the normal rate of return is 12%. Calculate Goodwill.

Sol Year 2007 2008 2009 2010 2011

Profit -1,25,000 1,10,000 1,87,500 1,22,000 1,75,000

Average Profit = 81,400 Normal Profit = 3,00,000 x 12% = 36,000 Super profit = 45,400 Goodwill = 45,400 x 4 = 1,81,600

Adjusted Profit - 1,00,000 80,000 1,65,000 62,000 2,00,000 4,07,000

Capitalisation Method A. Capitalisation of Super Profit Method Step 1 – Find the adjusted profit or loss for each year in the following manner: Adjusted Profit = NP during the year + Untreated Income + Abnormal loss or expense – Untreated Expense – Abnormal gain or income Step 2 – Find average profit as below – Average Profit =

𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡 𝑁𝑜.𝑜𝑓 𝑌𝑒𝑎𝑟𝑠

Step 3 – Find normal profit as below – Normal Profit = Capital Employed x Normal Rate of Return Step 4 – Find Super Profit using the formula given below – Super Profit = Average Profit – Normal Profit Step 5 – Find Goodwill using the formula given below – Goodwill = Super Profit / Normal Rate of Return

Example Super Profit = 5000 Normal Rate of Return = 10% 𝐺𝑜𝑜𝑑𝑤𝑖𝑙𝑙 =

5000 10%

=

5000 10

× 100 = 50,000

Questions 1. Goodwill of the firm will be valued at three years' purchase of the capitalized average profit of four years. Profits of the previous four years ended 31st March, were 2011 - Profit Rs.1,20,000 (after abnormal gain of Rs.30,000).

2010 - Loss Rs.50,000 (includes loss due to fire Rs.60,000).

2009 - Profit Rs.80,000 (including a loss of 30,000 on the sale of fixed assets).

2008 – Profit Rs.90,000 (including abnormal loss of Rs.20,000) The capital employed is Rs.6,80,000 and the normal rate of return is 10%.

Calculate the value of goodwill.

Sol Year 2008 2009 2010 2011

Profit 90,000 80,000 -50,000 1,20,000

Adjusted Profit 1,10,000 1,10,000 10,000 90,000 3,20,000

Average Profit = 80,000 Normal Profit = 6,80,000 x 10% = 68,000 Super profit = 12,000 Goodwill = 12,000/10% = Rs.1,20,000

2. Profits shown by the business for the last three financial years were: 2009 2010 2011 2012

: : : :

Rs.10,000 (after charging an abnormal loss of Rs.2,500).

Rs.15,000 (including an abnormal gain of Rs.5,000).

Rs.12,500 (excluding Rs.2,500 as insurance premium.)

Rs. 10,000 (including abnormal gain of Rs.6500)

Calculate the value of firm's goodwill on the basis of the capitalised average profit of the last four years, when the normal rate of return is 15% and the capital employed is Rs.25,000.

Sol Year 2009 2010 2011 2012

Profit 10,000 15,000 12,500 10,000

Average Profit = 9,000 Normal Profit = 25,000 x 15% = 3,750 Super profit = 5,250 Goodwill = 5250/15% = 35,000

Adjusted Profit 12,500 10,000 10,000 3,500 36,000

B. Capitalisation of Average Profit Method Step 1 – Find the adjusted profit or loss for each year in the following manner: Adjusted Profit = NP during the year + Untreated Income + Abnormal loss or expense – Untreated Expense – Abnormal gain or income Step 2 – Find average profit as below – Average Profit =

𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡 𝑁𝑜.𝑜𝑓 𝑌𝑒𝑎𝑟𝑠

Step 3 – Find the capitalised profit as below – Capitalised Profit =

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑟𝑜𝑓𝑖𝑡 𝑁𝑜𝑟𝑚𝑎𝑙 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛

Step 4 – Find Goodwill using the formula given below – Goodwill = Capitalised Profit – Capital Employed

1. Goodwill of the firm was to be valued on the basis of four years' purchase of super profit. Profits for the last five years ended 31st March, were: Year 2007 2008 2009 2010 2011 Profit (Rs) (1,25,000) 1,10,000 1,87,500 1,22,000 1,75,000 In the year 2007, there was a loss due to fire of Rs.25,000 In the year 2010, the interest paid of Rs.60000 was not recorded.

In the year 2008, an insurance claim of Rs.30000 was received and was included in the profit.

In the year 2009, there was an abnormal profit of Rs.22,500.

In the year 2011, there was an abnormal loss of Rs.25,000.

The capital employed of the firm is Rs.3,00,000 and the normal rate of return is 12%. Calculate Goodwill.

Sol Year 2007 2008 2009 2010 2011

Profit -1,25,000 1,10,000 1,87,500 1,22,000 1,75,000

Adjusted Profit - 1,00,000 80,000 1,65,000 62,000 2,00,000 4,07,000

Average Profit = 81,400 Capitalised Profit = 81400/12% = 6,78,333 Goodwill = 6,78,333 – 3,00,000 = 3,78,333

2. Profits shown by the business for the last three financial years were: 2009 2010 2011 2012

: : : :

Rs.10,000 (after charging an abnormal loss of Rs.2,500).

Rs.15,000 (including an abnormal gain of Rs.5,000).

Rs.12,500 (excluding Rs.2,500 as insurance premium.)

Rs. 10,000 (including abnormal gain of Rs.6500)

Calculate the value of firm's goodwill on the basis of two year's purchase of the capitalised average profit of the last three years, when the normal rate of return is 15% and the capital employed is Rs.25,000.

Sol Year 2009 2010 2011 2012

Profit 10,000 15,000 12,500 10,000

Average Profit = 9,000 Capitalised Profit = 9000/15% = 60,000 Goodwill = 60,000 – 25,000 = 35,000

Adjusted Profit 12,500 10,000 10,000 3,500 36,000