SUMMARY OF VALUATION OF GOODWILL :

Methods of Valuing Goodwill:

Average Profits Method, Super Profits Method, Capitalisation Method & Annuity Method.

1. Average Profits Method:
(i) Ascerain Profits of Normal year of the Business Return which shall be adjusted for

(a) Non recurring items eg: Profit on sale of Asset

(b) Non Operating items eg: Income from Investments

(c) Changes in Business Condition eg: Change in Tax rates.

(ii) Computation of Average Profits

Note: Simple Average = For Fluctuating Profits

Weighted Average = For Increasing / Decreasing Profits in a trend.

(iii) Goodwill is Computed as the no. of years purchase of average profits.
Note: No. of years purchase represents the multiplication factor.

2. Super Profits Method:

Step 1 : Ascertain Normal Rate of Return (NRR) for the Industry in which the Company whose Goodwill being valued.

Step 2 : Compute actual profits – operating profits made by the Company.

Step 3 : Compute actual capital employed – Either Terminal Capital employed or Average Capital employed = Opening Capital Employed + Closing Capital 2 (or) = Closing Capital employed – 1/2 the year profit.

(or) = Opening Capital employed + 1/2 the year profit. Capital employed is calculated under two approaches as
follows:

(a) Shareholders Approach :
Capital employed = Share capital + Reserves & Surplus – Miscellaneous Expenditure

(b) Longterm funds Approach

Capital employed = Shareholder funds + Longterm borrowings.

The Capital employed ascertained as above is referred as Liabilities side approach and is to be adjusted for the changes in values of OperatingAssets and after excluding non operating Assets.Capital employed can alternatively be calculated under the Assets side Approach as follows:

(a) Value of operating Assets to Business.
(b) Less Outside Liabilities
(c) Capital Employed = (a) – (b)

Step 4 : Compute Normal Profit ie., excess of actual profits (2) over normal profit (4)

Step 5 : Compute super profit ie., excess of actual profits (2) over normal profit (4)

Step 6 : Goodwill = No. of Years purchase x Super Profits 3. Capitalisation Method

Steps 1,2 and 3 same as in Super profit method.

Step 4 : Compute Normal Capital employed.

Normal Capital employed = Actual Profit x 100

Normal rate of Return

Step 5 : Goodwill = Excess of Normal Capital employed over Actual Capital Employed.

4. Annuity Method Goodwill under this method calculated by multiplying the Annuity Factor with the Average Profit or Super Profit.