Goodwill- Concept and Mode of Valuation

  • Goodwill is benefit and advantage of good name, reputation and connections of a business.
  • Features of goodwill are: it is an intangible fixed asset, has no existence separate from that of business, helps to earn higher profits, etc.
  • Factors affecting goodwill are nature of business,favourable location, efficiency of management, market situation, etc.
  • There is a need for valuation of goodwill at the time of change in profit-sharing ratio, at the time of admission of partner, at the time of retirement of partner, at the time of death of partner, at the time of sale of firm as a going concern and at the time of amalgamation of firm.
  • There is also need to value goodwill for a sole trader and for a company. Goodwill purchased is Difference between the value paid for a business and its net assets.
  • Self-generated goodwill arises when a business has been providing better services to its customers for several years.
  • The three method of calculating goodwill are Average Profit Method, Super profit method and Capitalisation method (Capitalisation method can be used with average profit and super profit.).
  • Average Profit Method is based on the assumption that a new business will not be able to earn profits during the first few years of its operations.
  • In Super profit method, goodwill is calculated on the basis of the excess profits and not the actual profits.
  • In the capitalisation method goodwill is calculated on the basis of the capitalised value of the profits of the firm on the basis of normal rate of return.

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  • Q1

    What is Super Profit?

    Marks:1
    Answer:

    Excess of actual average profit over normal profit of the firm is known as super profit.

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  • Q2

    Explain Normal Profit.

    Marks:1
    Answer:

    It is that profit which should be generated by a similar business in similar kind of business activities during the normal course of business.

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  • Q3

    Explain Capitalisation Method of goodwill.

    Marks:1
    Answer:

    This is a method of calculating the amount of goodwill on the basis of capitalisation of the profits (actual average profit or super profit) of the firm.

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  • Q4

    What is Abnormal Loss?

    Marks:1
    Answer:

    A loss generated due to those activities which are not in the normal course of business is known as abnormal loss.

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  • Q5

    What is Goodwill?

    Marks:1
    Answer:

    Goodwill is an intangible asset of the firm that arises due to satisfactions of the customers & reputation.

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