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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.

Q.2.  Explain the nature of goodwill.

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.

Q.3.  State the factors which influence the valuation of Goodwill of a partnership firm.

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.

Q.4.  Do you think that Goodwill is a fictitious asset?

Ans. Goodwill is an intangible asset and not a fictitious asset.

Q.5.  What do you understand by ‘Super Profits?

Ans  Super Profits means profits earned in excess of the normal Profit, i.e., Actual Profit –Normal Profit.

Q.6.  What do you understand by ‘Normal Profits’?

Ans. Normal Profits means the profits earned by other firms in similar industry.

Q.7.  What do you understand by Capitalisation of Profit?

Ans. Capitalisation of Profit means multiplying the profit by the number of years purchase. It is a method of determining value of goodwill.

Q.8.  What are various types 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.

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