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Q.1. What is
Goodwill? When Valuation of Goodwill is necessary?
Ans. Goodwill is the value of the reputation of a firm in respect of
profits expected in future over and above the normal profits.
In
the words of Eric L. Kohler "Goodwill is the present value of expected future
income in excess of a normal return on the investment in tangible assets.”
Reasons
for Valuation of Goodwill: In case of a partnership firm, the need for
valuation of goodwill may arise under the following circumstances:
(i) When
a new partner is admitted,
(ii) When
a partner retires or dies,
(iii) When
the firm is sold as a going concern,
(iv) When
there is a change in profit sharing ratio among partners,
(v) When
partnership firm is sold to a company.
Ans. Nature and Characteristics of Goodwill are:
(i) It
is an intangible and not a fictitious asset.
(ii) It
helps in earning more than normal profit.
(iii) It
is an attractive force which brings in customers to old place of business.
(iv) It
is composed of variety of elements.
(v) It
is difficult to ascertain the exact value of goodwill.
Ans. Factors affecting the value of Goodwill are:
(i) Skill
in Management: If the management is capable, the firm will earn good profits
and that will raise the value of goodwill.
(ii) Location
Factor: If the business is located at a favourable place, resulting in good
sale or in economics, the value of goodwill will be correspondingly higher.
(iii) Favourable
Contracts: Sometimes, a firm enters into long term contracts for sale and
purchase of goods at favourable prices. This will also affect profits and
goodwill of the firm.
(iv) Risk
Involved: When the risk is less in the business it creates more goodwill but if
the risk is more, it creates less goodwill.
Ans. Goodwill is an intangible asset and not a fictitious asset.
Ans Super Profits means profits earned in excess of the normal Profit,
i.e., Actual Profit –Normal Profit.
Ans. Normal Profits means the profits earned by other firms in similar
industry.
Ans. Capitalisation of Profit means multiplying the profit by the number
of years purchase. It is a method of determining value of goodwill.
Ans. Goodwill is mainly of two types:
(i) Purchased
Goodwill
(ii) Non-Purchased
Goodwill
Purchased
Goodwill: When one business is taken over by another business, the excess of
purchase consideration over its net value (assets-liabilities) is termed to as
purchased Goodwill.
Non
Purchased Goodwill: Non Purchased Goodwill is an internally generated goodwill
which arises because of favourable factors that a business possesses (e.g.,
favourable location, time factor and efficiency of management).
Q.9. What are Various methods of Valuation of Goodwill? Explain some of them.
Ans. Methods of Valuation of Goodwill:
(i)
Average profits method
(ii)
Weighted average profits method
(iii)
Super profit method
(iv) Capitalisation
method
(v)
Annuity method.
(i) Average Profits Method:
In this method, normal past business profits of a number of years are taken
into account. Such profits are totaled up and their average is arrived at. The
average profits are multiplied by the number year’s purchases to arrive at the
value of goodwill.
(ii) Super Profit Method: Super
Profits means profits earned in excess of the normal Profit, i.e., Actual
Profit –Normal. Normal profits mean the profit which the firms could normally
earns in a particular business.
Under
this method, the normal profit is compared with the actual profits. The excess,
if any, of actual profit over normal profit is called super profit. After this,
the super profit is multiplied by the number of year’s purchase, to find out
the amount of goodwill.
(iii)
Capitalisation Method: Under this
method, the value of goodwill is obtained by capitalizing the super profit of
the basis of normal rate.
Goodwill
= Super Profit X 100
Normal Rate
Q.10. Distinguish between Average Profits and Super
Profits.
Ans.
|
Basis |
Average Profits |
Super Profits |
|
1. Meaning |
It is the average of the
profits of the past few years. |
It is the excess of
average profits over normal profits. |
|
2. Normal Profit |
It need not to be
calculated. |
It is always required. |
|
3. Normal rate of Profit |
No function of normal
rate. |
Without it super profit
cannot be calculated. |
|
4. Relevance of Valuing
Goodwill |
It is relevant for
average profits method, super profits method and capitalisation methods of
valuation of goodwill |
Super profit is relevant
for super profit method and capitalization of super profit method of
valuation of goodwill. |