CAPITAL EMPLOYED :
The goodwill of a business depends on the amount of capital employed also. The term ‘capital employed’ for the valuation of goodwill should be calculated from the point of view of shareholders. Capital employed may be expressed as the aggregate of share capital and reserves less the amount of non-trading assets and fictitious assets. It can also be ascertained by adding up the present value of trading assets and deducting all liabilities. For this purpose, the amount of debentures or loans should also be excluded from capital employed. Of course any profit or loss on revaluation of assets should be taken into account.
It is considered desirable to use average capital employed in place of ‘capital employed’ because the capital employed must be such as may fairly represent the capital investment throughout the year. Average capital employed is the average of capital employed at the beginning and that employed at the end of the year. But if the current year’s profit is not disturbed during the year itself the average capital employed is to be ascertained by deducting half the profit from capital employed at the end. This is appropriate for goodwill to be ascertained by reference to current year’s profit and current year’s capital employed.
llustration :
EXE LIMITED
Balance Sheet as at 31st March, 2014
| Liabilities | Rs. | Assets | Rs. |
| 11% Preference Share | Fixed Assets: | ||
| Capital | 5,00,000 | Cost | 50,00,000 |
| Less : Depreciation | 30,00,000 | Equity Share Capital | 20,00,000 |
| Reserves and Surplus | 25,00,000 | Capital Work in-Progress | 40,00,000 |
| 10% Loans | 27,00,000 | 6% Government Securities | 5,00,000 |
| Current Liabilities | Current Assets | 25,00,000 | |
| and Provisions | 15,00,000 | Underwriting Commission | 2,00,000 |
| 92,00,000 | 92,00,000 |
The company earned a profit of ` 9,00,000 after tax @ 50% in 2000-01. The capital work in progress represents additional plant equal to half the capacity of the present plant; it will be immediately operational, there being no difficulty in sales. With effect from 1st April, 2001, two additional part-time directors are being appointed at ` 75,000 p.a. Ascertain the future maintainable profit and the capital employed, assuming the present replacement cost of fixed assets is ` 1,00,00,000 and the annual rate of depreciation is 10% on original cost.
Solution:
| Future Maintainable Profit: | Rs | |
| After-tax profit at present | 9,00,000 | |
| Add: Tax | 9,00,000 | |
| Depreciation – 10% of ` 50,00,000 | 5,00,000 | |
| Present profit before depreciation and tax | 23,00,000 | |
| Less: Interest of Investments (non-trading income) | 30,000 | |
| 22,70,000 | ||
| Add: Increase in profit since sales will increase by 50% | 11,35,000 | |
| 34,05,000 | ||
| Less: Depreciation @ 10% on ` 1,00,00,000 | 10,00,000 | |
| on `40,00,000 | 4,00,000 | |
| 14,00,000 | ||
| Additional Remuneration | 1,50,000 | 15,50,000 |
| Less: Tax @ 50% | 9,27,500 | |
| Future Maintainable Profit | 9,27,500 | |
| Capital Employed: | ||
| Fixed Assets – Present Replacement Cost | 1,00,00,000 | |
| Depreciation (adjusted) | 60,00,000 | |
| 40,00,000 | ||
| Additions to Plant | 40,00,000 | |
| 80,00,000 | ||
| Current Assets | 25,00,000 | |
| 1,05,00,000 | ||
| 10% Loans | 27,00,000 | |
| Current Liabilities and Provisions 15,00,000 | 42,00,000 | |
| Capital Employed | 63,00,000 | |
| Alternatively: | ||
| Preference Share Capital | 5,00,000 | |
| Equity Share Capital | 20,00,000 | |
| Reserves and Surplus – At present | 25,00,000 | |
| Profit on Revaluation | 20,00,000 | 45,00,000 |
| Less: Non-trading assets, Investments | 5,00,000 | |
| Underwriting Commission | 2,00,000 | 7,00,000 |
| Capital Employed | 63,00,000 | |