Goodwill : Nature and Valuation
Meaning of Goodwill:
Goodwill places the organization at a good position due to which the organization
is ableto earn higher profits without any extra efforts. Goodwill cannot be seen
but felt.Therefore goodwill is called an Intangible asset.
Factors affecting the value of Goodwill :
1. Efficient management
2. Quality of products
3. Location of business
4. Availability of raw material
5. Favorable contracts
Need for valuing goodwill : Whenever the mutual rights of the partners
changes thenparty which makes a sacrifice must be compensated. This basis of
compensation is goodwill so we need to calculate goodwill.
Mutual rights change under following circumstances
1) When profit sharing ratio changes
2) On admission of a partner
3) On Retirement or death of a partner
4) When amalganation of two firms taken place.
5) When partnership firm is sold.
Methods of valuation of goodwill :
1. Average profit method
2. Super profit method
3. Capitalization method
Average Profit Method
The profit earned by a Firm during previous accounting periods on an average
basis is called average profit. Goodwill is calculated on the basis of average
profit due to futureexpectations of earning capacity of the firm.
Illustration 1. (Average Profit Method)
Akanksha,Chetna and Dipanshu are partners in a firm sharing profits and
losses in the ratio of 3:2:1. They decide to take Jatin into partnership from
January 1,2012 for 1/5 share in the future profits. For this purpose , goodwill is
to be valued at 2 times the average annual profits of the previous four years.
The average profits for the past fouryears were:
Meaning of Goodwill:
Goodwill places the organization at a good position due to which the organization
is ableto earn higher profits without any extra efforts. Goodwill cannot be seen
but felt.Therefore goodwill is called an Intangible asset.
Factors affecting the value of Goodwill :
1. Efficient management
2. Quality of products
3. Location of business
4. Availability of raw material
5. Favorable contracts
Need for valuing goodwill : Whenever the mutual rights of the partners
changes thenparty which makes a sacrifice must be compensated. This basis of
compensation is goodwill so we need to calculate goodwill.
Mutual rights change under following circumstances
1) When profit sharing ratio changes
2) On admission of a partner
3) On Retirement or death of a partner
4) When amalganation of two firms taken place.
5) When partnership firm is sold.
Methods of valuation of goodwill :
1. Average profit method
2. Super profit method
3. Capitalization method
Average Profit Method
The profit earned by a Firm during previous accounting periods on an average
basis is called average profit. Goodwill is calculated on the basis of average
profit due to futureexpectations of earning capacity of the firm.
Illustration 1. (Average Profit Method)
Akanksha,Chetna and Dipanshu are partners in a firm sharing profits and
losses in the ratio of 3:2:1. They decide to take Jatin into partnership from
January 1,2012 for 1/5 share in the future profits. For this purpose , goodwill is
to be valued at 2 times the average annual profits of the previous four years.
The average profits for the past fouryears were:
