Valuation of Goodwill
Valuation of Goodwill depends upon reputation of a business organization. Goodwill of a business may be
termed as the credibility of the business in the market earned over a period of time. Goodwill is qualitative in
nature. It is the reputation of the business which increases with the passage of time. It is included under the head
of Intangible Assets. Good will depends upon many factors such as:

Location of business

Nature of products and their reputation

Personal reputation of partners

After sale service and sale promotion including advertisement

Maintaining the quality of products

Possession of efficient employees

Order in hands etc.
The necessity of calculating valuation of goodwill arises when the:
a) Profit sharing ratio is being changed
b) A new partners is being introduced
c)
A partner retires or dies
Methods of Valuation of Goodwill
Various methods of valuation of goodwill are used to calculate the goodwill of a firm at a particular date. Some
of the commonly used methods are explained below:
1. Average Profit Method
Under average profit method profit of some years, say 5 years, are averaged out and adjusted for any change that
is expected to incur in near future. The average profit is then multiplied by an assumed purchase period to
calculate the goodwill.
Exercise # 1: If profits of a firm for past 4 years are Rs. 9,000, Rs. 10,000, Rs. 12,000 and Rs. 15,000 and the
good will is to be calculated at 2 years purchase, the valuation of goodwill may be calculated under average
profit basis as:
= 9,000 + 10,000 + 12,000 + 15,000 / 4
11,500
= 11,500 X 2 years of purchase
= Rs. 23,000
In above method of valuation of goodwill suggested that Rs. 23,000 is goodwill of business.
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2. Super Profit Method
Super profit method is one step ahead of the average profits method. In this method the normal profits for the
year under consideration are taken after deduction of interest on capital and salary of partners. The net profits so
derived are then compared with average profit and the excess of normal profit are the super profit. The super
profits are multiplied by number of year’s purchase to calculate the goodwill.
Exercise # 2: If profits of a firm for past 4 years are Rs. 9,000, Rs. 10,000, Rs. 12,000 and Rs. 15,000, interest
on capital is Rs. 2,000 and the goodwill is to be calculated at 2 years purchase, the valuation of goodwill may be
calculated under super profit basis as:
Normal profit
15,000
Less interest on capital
(2,000)
13,000
Average profit
(11,500)
Super Profit
1,500
Valuation of goodwill = 1,500 X 2 years of purchase
= Rs. 3,000
3. Capitalization Method
Under capitalization method, goodwill of the firm may be calculated by comparing the net assets and value of
whole business. The value of business is calculated by dividing normal profits by reasonable or return (i.e. profit
to capital employed ratio). The bet assets or the capital employed is then deducted from value of business to
determine the goodwill. Under capitalization method, valuation of goodwill may be calculated as:
Step 1: profit /reasonable rate of return X 100 = Value of whole business
Step 2: value of whole business less net assets appearing in the financial statement is the amount of goodwill
of the company.
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