Q.1. What do you mean by Goodwill? What are the different methods
of calculating goodwill? Discuss every method with suitable examples.
(CBSE 1982,85,87,88,89,98; All India 1986,1990)
Answer: Goodwill is a thing which is not so easy to describe
but in general words goodname, reputation and wide business connection
which helps the business to earn more profits than the profit could
be earned by a newly started business. The monetary value of the
advantage of earning more profits is known as goodwill. Goodwill
is an attractive force, which brings in customers to old place of
business. Goodwill is an intangible but valuable asset. In a profitable
concern it is not a fictitious asset.
Prof. Dicksee has defined goodwill as " When
a man pays for goodwill, he pays for something which places him
in the position of being able to earn more than he would be able
to do by his own unaided efforts."
According to J. O. Magee " The capacity of a business
to earn profits in future is basically what is meant by the term
goodwill."
According to Lord Lindley " The term goodwill is generally
used to denote benefit arising from connections and reputation."
Lord Eldon has defined goodwill as " Goodwill
is nothing more than the probability, that the old customers will
resort to the old place."
In the words of Lord Macnaghten, " Goodwill is
a thing very easy to describe, very difficult to define. It is the
benefit and advantage of the good name, reputation and connections
of a business. It is the attractive force, which brings in customers.
It is one thing which distinguishes an old established business
from a new business at its first start."
In the words of Dr. Canning, "Goodwill is the present
value of a firm’s anticipated excess earnings."
Methods of Valuation of Goodwill
The following are the methods of valuation of goodwill of a firm:

 Average Profit Method
 Weighted Average Profit Method
 Super Profit Method
 Capitalization of Average Profit Method
 Capitalization of Super Profit Method
 Present Value of Super Profits Method
1. Average Profit Method: Under this method goodwill is
calculated on the basis of the average profit of previous years.
The average profit is multiplied by the number of year’s purchase.
Goodwill = Average Profit x Number of Years Purchase
Example: Calculate goodwill at twice the average
profits of last four years’ profits. The profits of the last four
years were:
 Rs. 27,000
 Rs. 39,000
 Rs. 16,000 (Loss)
 Rs. 40,000
Solution: Total Profit for last four years = Rs. 27,000+
Rs. 39,000Rs. 16,000+Rs. 40,000 = Rs. 80,000
Average Profit = Rs. 80,000/4 = Rs. 20,000.
Goodwill = Rs. 20,000 x 2 = Rs. 40,000.
2. Weighted Average Profit Method: This method is a modified
version of the average profit method. Under this method the respective
number of weights i.e. 1,2,3,4 multiplies profit of every year,
in order to find out value product and the total of products is
then divided by the total of weights in order to ascertain the weighted
average profits.
Goodwill = Weighted Average Profits x No. of years Purchase
Weighted Average Profit = Total of Products of Profits/ Total
of Weights
Example: Calculate goodwill at twice the weighted
average profits of last four years’ profits. The profits of the
last four years were:
2001. Rs. 37,000
2002. Rs. 29,000
2003. Rs. 26,000
2004. Rs. 40,000
Solution:
Years

Profits
Rs.

Weight

Product
Rs.

2001

37,000

1

37,000

2002

29,000

2

58,000

2003

26,000

3

78,000

2004

40,000

4

1,60,000

Total


10

3,33,000

Weighted Average Profit = Rs. 3,33,000/10 = Rs. 33,300
Goodwill = Rs. 33,300 x 2 = Rs. 66,600

3. Super Profit Method: When the actual profit is more than
the expected profit or normal profit of a firm, it is called ‘Super
Profit.’ Under this method goodwill is to be calculate of on the
following manner:
Goodwill = Super Profit x Number of Years Purchase
Example: The books of a business showed that the capital
employed on January 1, 2001 was Rs. 4,50,000 and the profits for
the last five years were as follows: 2001Rs. 40,000; 2002 Rs.
50,000; 2003  Rs. 60,000; 2004 Rs. 70,000 and 2005 Rs. 80,000.
You are required to find out the value of goodwill, based on three
years’ purchase of the super profit of the business given that the
normal rate of return is 10%.
Solution: Total Profit of last five years = Rs. 40,000 +
Rs. 50,000 + Rs. 60,000 + Rs. 70,000 + Rs. 80,000 = Rs. 3,00,000
Average Profit = Rs. 3,00,000/5 =Rs. 60,000
Normal Profit = Rs. 4,50,000 x 10/100 = Rs. 45,000
Super Profit = Actual/Average Profit – Normal Profit
Super Profit = Rs. 60,000 – Rs. 45,000 = Rs. 15,000
Goodwill = Rs. 15,000 x 3 = Rs. 45,000.
4. Capitalization of Average Profit Method: Under this method
goodwill is difference between the total Capitalized value of the
firm and the net assets of the firm.
Goodwill = Capitalized Value the firm – Net Assets
Capitalized Value of the firm = Average Profit x 100/ Normal
Rate of Return
Net Assets = Total Assets – External Liabilities
Example: A firm earns Rs. 65,000 as its average profits.
The usual rate of earning is 10%. The total assets of the firm amounted
to Rs. 6,80,000 and liabilities are Rs. 1,80,000. Calculate the
value of goodwill.
Solution : Total Capitalized value of the firm = Rs.
65,000 x 100/10 = Rs. 6,50,000
Net Assets = Rs. 6,80,000 – Rs. 1,80,000 = Rs. 5,00,000
Goodwill = Total Capitalized value of the firm – Net Assets
Goodwill = Rs. 6,50,000 – Rs. 5,00,000 = Rs. 1,50,000.
5. Capitalization of Super Profit Method:
 Calculate Capitalized value of the firm
 Calculate required profit on capital employed by using the following
formula:
Normal Profit = Capital Employed x Required Rate of Return/100
 Calculate average profit
 Calculate super profit
Goodwill = Super Profit x 100/Normal Rate of Return
Example: Verma Brothers earn a profit of Rs. 90,000 with
a capital of Rs. 4,00,000. The normal rate of return in the business
is 15%. Use Capitalization of super profit method to value the goodwill.
Solution:
Normal Profit = Rs. 4,00,000 x 15/100 = Rs. 60,000
Super Profit = Rs. 90,000 – Rs. 60,000 = Rs. 30,000
Goodwill = Super Profit x 100/Normal Rate of Return
= Rs. 30,000 x 100/15 = Rs. 2,00,000
6. Present Value of Super Profit: Under this method, goodwill
is estimated as the present value of the future super profits. The
following steps are taken:
 Calculate the future super profits for next years
 Choose the required rate of return
 Calculate present value factors
 Multiply present value factors with future super profits
 The sum of product of present value factors and super profits
is the value of goodwill.
Example: A firm has the forecasted profits for the coming
4 years as follows:
Years

Profits
Rs.

1

80,000

2

1,00,000

3

90,000

4

1,20,000

The total assets of the firm are Rs. 9,00,000 and outside liabilities
are Rs. 3,00,000. The present value factors at 10% are as follows:
Years

Present Value Factor

1

.9279

2

.8029

3

.7056

4

.6978

Calculate the Value of goodwill.
Solution:
Net Assets = Total Assets – Liabilities
= Rs. 9,00,000 – Rs. 3,00,000
= Rs. 6,00,000
Normal Profit = 10/100 x Rs. 6,00,000 = Rs. 60,000
Years

1

2

3

4

Profits (Rs.)

80,000

1,00,000

90,000

1,20,000

Normal Profit

60,000

60,000

60,000

60,000

Super Profit

20,000

40,000

30,000

60,000

Present Value Factor

.9279

.8029

.7056

.6978

Present Value of Super Profit

18,558

32,116

21,168

41,868

Goodwill = Rs. 18,558 + Rs. 32,116 + Rs. 21,168 + Rs. 41,868
= Rs. 1,13,710.
