CBSE Class 12 Accountancy Goodwill Nature And Valuation Worksheet

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Goodwill: Meaning, Nature... Short & Easy Notes for Board Exam
 
Question 1. What is goodwill? What are its characteristics?
=> Goodwill is good name of reputation of the business. It either than the normal profit.
Following are its characteristics;
(i) It is mirror of the business.
(ii) It is an intangible assets.
(iii) It can be bought and sold.
(iv) it cannot be remain same throughout the year.
(v) It is connected with the business.
 
Question 2. Write the factors affecting the value of goodwill.
=> The factors, which are responsible for change the value of goodwill, are as below;
(i) favourable location help to attract the customers.
(ii) Monopolistic nature of the business, increase the value of goodwill.
(iii) Required amount of capital.
(iv) Trade cycle.
(v) Condition of money market.
(vi) Good industrial relation.
(vii) Research and development work.
(viii) Production of good quality product.
 
Question 3. For what purpose goodwill to be calculated.
=> Following are the some reasons due to which goodwill to be calculated;
(i) when there is change in profit sharing ratio of the partners.
(ii) when you partner admitted.
(iii) when any partner retire from the firm.
(iv) when any partner dies.
(v) when two or more firms are amalgamated.
(vi) when the firm is sold.
(vii) when a firm is convert into a company.
 
Question 4. write the method of valuation of goodwill.
=> There are three method of valuation of goodwill;
(i) Average profit method;
(a) Simple average profit method = Under this method, following steps are to be taken to calculate the amount of goodwill.
Step 1: Calculate the total profit.
Step 2: Calculate average profit. Average profit = Total profit / Number of year
Step 3: Calculate goodwill.
Goodwill = Average profit*Number of year purchase
 
(b) weightage average profit method = Under this method, following steps are to be taken to calculate the amount of goodwill.
Step 1: Profit multiply by their weight.
Step 2: Add all the product.
Step 3: Add all the weight.
Step 4: Compute weightage average profit.
weightage average profit = Sum of product/Sum of weight.
Step 5: Calculate goodwill.
Goodwill = weightage average profit*No of year purchase.
 
(ii) Super profit method;
Step 1: Find-out average profit.
Average profit = Total profit/No of year.
Step 2: Find-out average profit.
Normal profit = Capital employed*Normal rate of return/100.
(Capital employed = Total assets - Total liabilities
or, capital employed = capital+reserve+profit-fictitious assets)
Step 3: Calculate super profit.
Super profit = Average profit-normal profit.
Step 4: Calculate goodwill.
Goodwill = super profit*No of year purchase.
 
(iii) Capitalization method;
(a) Capitalization of average profit method;
Goodwill = Capitalized value - capital employed.
(Capitalized value = Average profit*100/normal rate of return.)
(b) Capitalization of super profit method;
Goodwill = super profit*100/normal rate of return.
 
POINTS;
i. Goodwill is an intangible assets.
ii. As per Accounting Standard 26, only purchased Goodwill will be recorded in the book of accounts.
iii. Goodwill helps in earning higher profit.

 

GOODWILL: NATURE AND VALUATION..................

Question 1. Define Goodwill.

Question 2. List the characteristics of goodwill.

Question 3. Explain the nature of goodwill.

Question 4. Under what circumstances has the goodwill to be valued?

Question 5. List the factors affecting the value of goodwill.

Question 6. What do you understand by purchased goodwill and self generated goodwill?

Question 7. What are the different methods of valuation of goodwill?

Question 8. What is meant by” number of years purchase”?

Question 9. What is meant by :-

(i) Super profit

(ii) Capital employed

(iii) capitalized value of business

(iv) capitalized value of Super profits

Question 10. Distinguish between average profits and super profits.

Question 11. Give the formula for calculating goodwill in each of the following methods:-

(i) Average profit method

(ii) super profit method

(iii) capitalization method

Question 12. Calculate the value of goodwill as on 1st Jan 2007 on the basis of three years’ purchases of average profits of the last five years profits. The p + L for the years were

2001 – 30000 (profit)

2002 – 40000 (loss) 

2003 – 92000 (profit)

2004 – 55000 (profit)

2005 – 70000 (profit)

2006 – 90000(profit)

During 2002 profit on sale of fixed asset amounted to Rs 2000, during 2004 amounted to Rs 5000, and in 2006 loss on sale of fixed asset amounted to Rs 5000. [Ans 1, 59,000]

Question 13. The profits of a firm for the last three years were:-

2001 – 5, 00,000 (including an abnormal gain of Rs 1, 50,000)

2002 – 4, 00,000 (after charging an abnormal loss of Rs 2, 00,000)

2003 – 6, 00,000 (excluding Rs 2, 00,000 payable on the insurance of P + m)

Calculate the value of firms’ goodwill on the bases of four years’ purchases of the average profits of the last three years. [Ans 18, 00,000]

Question 14. On 1st April 2001 an existing firm had assets of Rs 75000 including cash of Rs 5000. The creditors amounted to Rs 5000 on that date. The firm had reserve fund of Rs 10,000 while partner’s capital accounts  showed a balance of Rs 60,000. If the normal rte of return is 20% and the goodwill of the firm is valued at Rs 24,000 at four years’ purchase of super profits, find the average profits per year.[Ans super profit – 6000, av. profit – 20000]

Question 15. Is goodwill an intangible asset or a fictitious asset? Explain.

Question 16. Is goodwill an intangible asset or a fictitious asset? Explain.
 

Q.1. Goodwill is which type of asset?
(a) Fictitious asset
(b) Current asset
(c) Fixed Intangible asset
(d) Wasting asset
Answer : C

Q.2. Which one is method of valuation for goodwill?
(a) Average Profit Method
(b) Super Profit Method
(c) Capitalisation of Profits Method
(d) All of the above
Answer : D

Q.3. A business has earned average profits of ₹1,00,000 during the last few years and the normal rate of return in similar business is 10%. What will be the value of goodwill by Super Profit method if the goodwill is valued at 3 yrs’ purchase of super profits. The assets of the business were ₹10,00,000 and its external liabilities were ₹1,80,000
(a) ₹ 50,000
(b) ₹ 60,000
(c) ₹ 54,000
(d) ₹ 58,000
Answer : C

Q.4. The average profits of a firm are ₹2,00,000. The total tangible assets in the firm are ₹14,00,000 and outside liabilities are ₹4,00,000. In the same type of business, the normal rate of return is 10% of the capital employed. Calculate value of goodwill by Capitalisation of Super Profits method:
(a) ₹15,00,000
(b) ₹5,00,000
(c) ₹ 7,00,000
(d) ₹10,00,000
Answer : D

Q.5. Which goodwill is generated in a business internally?
(a) Purchased Goodwill
(b) Hidden Goodwill
(c) Self generated Goodwill
(d) None of the above
Answer : C

Goodwill is good name or the reputaion of the business, which is earned by a firm through the hardwork and honesty of its owners. If a firm renders good service to the customers, the customers who feel satisfied will come again and again and the firm will be able to earn more profits in future.

Thus, goodwill is the value of the reputaion of a firm which enables it to earn higher profits in comparison to the normal profits earned by other firms in the same trade.
 
Features of Goodwill
1. It is an intangible asset : Goodwill cannot be seen or touched, it does not have any physical existence, thus it belongs to the category of intangible assets such as patents, trade marks, copy rights, etc.
2. It is a valuable asset
3. It is helpful in earning excess profits.
4. Its value is liable to constant fluctuations : While goodwill does not depreciate, its value is liable to constant fluctuation, its vlaue is liable to constant fluctuations.It is always present as a silent asset in a business where there are super profits (i.e.more than the normal) but declines in value with the decline in earnings.
5. It is valuable only when entire business is sold : Goodwill cannot be sold in part. It can be sold with the entire business only. The only exception is at the time of admission or retirement of the partner.
6. It is difficult to place an exact value on goodwill : This is beecause its value may fluctuate from time to time due to changing circumsatnces which are internat and external to business.
 
Goodwill is divided into two categories.
 
I. Purchased Goodwill: Purchased goodwill means goodwill for which a consideration has been paid e.g. when business is purchased the excess of purchase consideration of its net assets i.e. (Assets – Liabilities) is the Purchased Goodwill. It is separately recorded in the books because as it is purchased by paying in form of cash or kind.
 
Characteristics
(i) It arises on purchase of a business or brand.
(ii) Consideration is paid for it so it is recorded in books.
(iii) Shown in balance sheet as on asset.
(iv) It is amortised (depreciated).
(v) Value is a subjective judgment & ascertained by agreement of seller & purchaser. It is approximate value and cannot be sold separately in the market or in parts.
 
II. Self-generated Goodwill also called as inherent goodwill. It is an internally generated goodwill which arises from a number of factors that a running business possesses due to which it is able to earn more profits in the future.
 
Features
(i) It is generated internally over the years.
(ii) A true cost cannot be placed on this type of goodwill.
(iii) Value depends on subjective judgment of the value.
(iv) As per Accounting Standard 26( Intangible Asset), it is not recorded in the books of accounts because consideration in money or money's worth has not be paid for it.
 
Factors Affecting the Value of Goodwill
1. Efficient management : If the business is run by experienced and efficient management, its profits will go on increasing, which results in increase in the value of goodwill. 
2. Quality of products : If the firm is suppyong good quality of products, then the customer will come again and again for the same and thus will create the goodwill and brand name for the same.
3. Location of business : If the business is located at a convenient or prominent place, it will atract more customers and therefore will have more goodwill.
4. The Longevity of the business : An older business is better known to its customers, therefore it is likely to have more goodwill. When a business enterprise has built up good repuation over a period of time, the number of customers will be more in comparison to the customers of new entrants. Number of customers is an indicator of profit earning capacity of a business.
5. Monopolistic and other Rights : If a buiness enjoys monopoly market, it will have assured profits. Similarly, if it holds some special rights such as patents, trade marks, copyrights or concessions, etc, it will have more goodwill.
6. Other factors:
(i) Good industrial relations.
(ii) Favourable Government regulations
(iii) Stable political conditions
(iv) Research and development efforts
(v) Effective advertising to establish brand popularity
(vi) Popularity of product in terms of quality.
 
Need for Valuing Goodwill: Whenever the mutual rights of the partners changes the party 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 amalgamation of two firms taken place
5. when partnership firm is sold.
 
Method of valuation of goodwill :
It is very difficult to assess the value of goodwill, as it is an intangible asset. In case of sale of a business, its value depends on the mutual agreement between the seller and the purchaser of the business. Usually, there are three methods of valuing goodwill:
1. average profit method
2. Super profit method
3. Capitalization method
 
Average Profit Method
This is a very simple and widely followed method of valuation of goodwill. In this method, goodwill is calculated on the basis of the number of past years years. Average of such profits is multiplied by the agreed number of years (such as two or three) to find out the value of goodwill.
Formula for calculation of goodwill
Goodwill = Average Profits Number of years of purchase
Number of years of purchase means for how many years the firm will earn the same amount of profits in future.
Average Profits = Total Profits/Number of years
A buyer always wants to estimate the future profits of a business. Future profits depend upon the average performance of the business in the past. Past profits indicate as to what profitsare likely to accrue in the future. Therefore the past profits are averaged. But before calculating the average profits, the profits earned in the past must be adjusted in the light of future expectations and the following factors should be taken into account while calculating the average profits:
(i) Abnormal income of a year should be deducted out of the net profit of that year. 
(ii) Abnormal loss of a year should be added back to the net profit of that year.
(iii) Income from investments should be deducted out of the net profits of that year, because this income is received from outside the business.
 
Weighted Average Profit Method: This method is a modified version of average profit method.In this Method each year’s profit is assigned a weight. The highest weight is attached to profit of most recent year.
Eg: 2011-1, 2012-2, 2013-3, 2014-4.
Each year profits are multiplied by assigned weights. Products are added & divided by total number of weights. Weighted average is multiplied by agreed Number of years of Purchase.
Weighted Average Profit: = Total product of profits / Total of Weights
Goodwill = Weighted Average Profit x No. of years of purchase.
Weighted average profit method is considered better than the simple average profit method because it assigns more weightage to the profits of the latest year which is more likely to be earned in future. This method is preferred when profits over the past years have been continously rising or falling.
 
Super profit Method : In this method goodwill is calculated on the basis of surplus (excess) profits earned by a firm in comparison to average profits earned by other firms. If a business has no anticipated excess earnings, it will have no goodwill. Super Profit are the excess of actual profit over normal profits. Where Normal profits are profits earned by similar business.
If a firm earns higher profit in comparison to normal profit (generally earned by other firms of same industry) then the difference is called Super Profit. Goodwill is calculated on the basis of Super profit due to future expectations of earning capacity of the firm.
Goodwill is calculated by the formula
Goodwill = Super Profit Number of years of purchase
Super Profit = Average profit - Normal profits

 Acco2

Capital Employed = Capital + Free Reserves – fictitious Assets (if any), or
All Assets – (Goodwill, fictitious assets and non-trade Investment) – Outsider’s Liabilities
Capitalised Method Under this method, goodwill can be calculated in two ways:
 
(A) Capitalisation of Average Profit Method: Under this method first of all we calculate the average profits and then we assess the capital needed for eanring such average profits on the basis of normal rate of return. Such capital is also called capitalised value of average profits. It is calculated as under.

 Acco3

Goodwill is calculated by deducting the actual capital employed in business from the capitalised value of average profits.There will be no goodwill if the actual capital employed in the business exceeds or equals the capitalised value of the average profits.
Net Assets or Capital employed = Total assets – Outside liabilities
Goodwill = Capitalized value of average profits – Capital Employed
 
(B) Capitalisation of Super Profit Method: Underthis method first of all we calculate the super profits and then we assess the capital needed for earning such super profits on the basis of normal rate of return. Such capital is actually the amount of goodwill. Super profits are calculated in the same manner as calculated in super profits method.
Goodwill of the firm = Super Profits * 100 / Normal rate of return. 
 
 

Question : 1. A business has earned average profit of Rs. 4,00,000 during the last few years and the normal rate of return in similar business is 10%. Find out the value of goodwill by
(i) Capitalisation of Super Profit
(ii) Super profit method if the goodwill is valued at 3years’ purchase of super profits.
The assets of the business were Rs. 40,00,000 and its external liabilities Rs. 7,20,000.
(Ans. 2,16,000)

Question : 2. Capital of the firm Sharma and Verma is Rs. 4,00,000 and the market rate of interest is 15%. Annual salary to partners is Rs. 2,400 each. The profit for the last three years were Rs. 1,20,000, Rs. 1,44,000 and Rs. 1,68,000. Goodwill is tovalued at 2 years’ purchase of last 3 years average super profit. Calculate the Goowill of the firm. (Hint Rs. 72,000)

Question : 3. On Ist Jan 2014 an existing firm has Asset of Rs. 1,50,000 including cash of Rs. 10,000. Its creditors amounted to Rs. 10,000 on that date. The firm had a Reserve of Rs. 20,000 while Partner’s Capital Accounts showed a balance of Rs. 1,20,000. If Normal Rate of Return is 20% and goodwill of the firm is valued at Rs. 4,8000 at four years’ purchase of super profit, find the average profit per year of the existing firm.
(Ans Average profit – Rs. 40,000)

Question : 4. Calculate value of goodwill on the basis of three year purchase of average profit of the preceding five years which were as follows:
Years ended                    31.3.2014                    4,00,000
Years ended                    31.3.2013                    7,50,000
Years ended                    31.3.2012                    9,00,000
Years ended                    31.3.2011                    2,00,000 (loss)
Years ended                    31.3.2010                    6,50,000
Hint: (Goodwill = 1,5,00,000) 

1. A business has earned average profits of 100000 during the last few years and the normal rate of return in similar business is 10%. Find out the value of goodwill by:
(i) Capitalization of super profit method and
(ii) Super profit method if the goodwill is valued at 3 years purchase of super profit. The assets of the business were 10,00,000 and its external liabilities 1,80,000.

2. A partnership firm earned net profits during the last three years as follows:
2007-2008 - 190000
2008-2009 - 220000
2009-2010 - 250000
The capital employed in the firm throughout the above mentioned period has been 4,00,000. Having regard to the risk involved, 15% is considered to be a fair return on the capital. The remuneration of all the partners during this period is estimated to be1,00,000 p.a. Calculate the value of goodwill on the basis of (i) two years’ purchases of super profits earned on average basis during the above mentioned three years (ii) by capitalization method.

3. What are the factors affecting goodwill?

4. Explain the various methods of valuing goodwill.

5. The profits for the last five years of a business are 4,000, 6,000, 8,000, 12,000 and 15000. Goodwill is 3 years purchase of the last five years average profits. Calculate goodwill based on average profit method.

6. The profits for the last five years of a business are 2010- 4,000, 2011- 6,000, 2012-8,000, 2013 - 12,000 and 2014 - 15000. Goodwill is 3 years purchase of the last five years average profits. Calculate goodwill based on 3 years purchase of weighted average profits after assigning weights 1,2,3,4 and 5respectively to the profits for 2010, 2011, 2012,2013 and 2014.

7. Calculate the value of goodwill as on 1.1.2007 on the basis of 3 years purchases of the Average profits of the last 5 years profits. The profits and losses for the years were- 2001- 30,000; 2002- 40,000 (loss); 2003- 92,000; 2004- 55000; 2005- 70000; 2006- 90000. Profit on sale of a fixed asset during 2002 amounted to 2,000, during 2004 amounted to 5000. Loss on sale of a fixed asset during 2006 amounted to 5,000.

8. Calculate the value of goodwill as on 1.1.2007 on the basis of 3 years purchases of the Average profits of the last 5 years profits. The profits and losses for the years were- 2001- 30,000; 2002- 40,000 (loss); 2003- 92,000; 2004- 55000; 2005- 70000; 2006- 90000

9. Calculate goodwill of a firm on the basis of three year’ purchase of the weighted average profits of the last four years. The profit of the last four years was: 2011 20,200; 2012 . 24,800; 2013 20,000 and 2014 30,000. The weights assigned to each year are: 2011 – 1; 2012 – 2; 2013 – 3 and 2014 – 4.
You are supplied the following information:
1. On September 1, 2013 a major plant repair was undertaken for 6,000,which was charged to revenue. The said sum is to be capitalized for goodwill calculation subject to adjustment of depreciation of 10% p.a. on reducing balance method.
2. The Closing Stock for the year 2012 was overvalued by 2,400.
3. To cover management cost an annual charge of 4,800 should be made for purpose of goodwill valuation.

10. A firm earned profits of 80,000, 1,00,000, 1,20,000 and 1,80,000 during 2010-11, 2011-12, 2012-13 and 2013-14 respectively. The firm has capital investment of 5,00,000. A fair rate of return on investment is 15% p.a. Calculate goodwill of the firm based on three years’ purchase of average super profits of last four years.

11. From the figures given below, calculate goodwill according to the capitalization of Average Profit Method. Actual Average Profit 72000, Normal Profit @10%, Assets 970000 Liabilities 400000.

12. The average net profits Y Ltd. expected in the future are 54000 per year. The average capital employed in the business is 200000. The rate of interest expected from capital invested in this class of business is 10%. The remuneration of the partners is estimated to be 10000 per annum. Find out the value of goodwill on the basis of three years purchase of super profits.

13. A firm earns 16200 as its annual profits, the rate of normal profit being 10%. The assets of the firm amounted to 150000. The value of goodwill is 45000. Find the value of outsider’s liabilities.

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