(For Classroom Circulation only)

FACULTY OF COMMERCE, THE M. S. UNIVERSITY OF BARODA

S.Y.B.Com(Hon) Semester IV (CBCS) CORPORATE ACCOUNTING (2020-21)
Unit III Chapter-I: Valuation of Goodwill
Note - This study material is not exhaustive. The examples are issued / given to save time in
dictation. Students are requested to refer reference books.
Meaning of Goodwill:
Goodwill may be defined as the value of the reputation of a business house in respect of
profits expected in future over and above the normal level of profits earned by an
Undertaking belonging to the same class of business.
Definition of Goodwill:
(A) Kohler in his Dictionary for Accountants defines Goodwill as “the current value of
expected future income in excess of normal rate of return on the investments in net
tangible assets.” In other words”, Goodwill is the present value of firms anticipated super
normal profits.” The term super normal earnings mean the excess of earnings attributable
to operating tangible and intangible assets (other than goodwill) over and above the
normal rate of return earned by attaching to a prosperous business because of factors that
other firms do not possess to the same degree.
(B) According to Wilson, “Goodwill has been very ably divided into three types – cat,
dog and rat- in view of peculiar habits of these three animals. The cat tends to stick the
abode, cat goodwill is therefore that which will adhere to the business which is being
transferred and is the most valuable. The dog follows his master, dog goodwill is difficult
to transfer and correspondingly less valuable. The rat is migrant, rat goodwill is
practically valueless, as it represents those customers who have no specialties either to the
business or its properties and who may be here today and gone tomorrow. Summed up cat
goodwill is adherent, dog personal and rat fugitive. Adhering goodwill is only valuable as
attaching to the business; personal goodwill is unsaleable, fugitive goodwill is only
valuable in that as one fugitive goes another may arrive.”
Following are other definitions:
“Goodwill is nothing more than the probability that the old customers will resort to the
old place”. (lord eldon)
“The value of business connections, the value of probability that present customers will
continue to buy in spite of the allurements of competing dealers” (Hatfield)
“The elements of established business which makes the business as a going concern
worth more than its book value, that is, its net worth as shown by the books” (Walton).
“It is the influence that the proprietor or his organization has upon the purchasing public
through which he is enabled to attract and retain patronage”. (Wildman)
According to chartered Accounts of India,
“Goodwill is an intangible asset arising from business connections or trade name or
reputation of a business.”
Need of Valuation of Goodwill:
In case of Joint Stock Company, the need for evaluating goodwill may arise in the
following cases:
1. When the business of the company is sold to another company or when the company is to
be amalgamated with another company
2. When, stock exchange quotations not being available, share have to be valued for taxation
purposes.
3. When a large block of shares, such as to enable the holder to exercise control over the
company concerned, has to be bought or sold.

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4. When company has previously written off goodwill and wants to write it back
5. When the company is being taken over by the Government
6. When one class of shares is to be converted into another.

Factors affecting the valuation of Goodwill:

The main factors affecting the value of goodwill are as follows:
1. Nature of industry, its history and the risk to which it is subject
2. Prospects of the industry in future
3. The company’s history its past performance and its record of past profits and dividend
4. The basis of valuation of assets of the company and their value
5. The ratio of Liability to Capital
6. The nature of management and the change for its continuation
7. Size, location and reputation of the company’s products
8. The major fair valuation of goodwill is the profits of the company. One who pays for
goodwill looks to the future profits. The profits that are expected to be earned in future
are extremely important for valuation of goodwill. The most important factors that have a
bearing on future profits are Personal skill in management, nature of business, Favorable
location, Access of supplies, Patents & trademarks protection, Exceptionally favorable
contracts and capital requirements and arrangements of capital.
9. Market reputation, which the company and its management enjoy.
10. Returns expected by investors into the industry to which the firm or company belongs.

Types of Goodwill:
Goodwill is generally of two types:
(a) Purchased goodwill (or Acquired goodwill); and
(b) Non-Purchased (or Inherent goodwill or Raised or Self-Generated goodwill).
(а) Purchased Goodwill:
Purchased goodwill arises when one business buys another and the purchase consideration
paid is more than the value of the net tangible assets received. It is the accepted practice to
recognise only the purchased goodwill in the accounting system.
Following are the important features of purchased goodwill:
1. It arises on an acquisition.
2. It is demonstrated by a purchase transaction.
3. Price paid for goodwill depends upon the purchaser’s expectation of future profits.
4. It is recognised in financial statements.
For example: P Limited acquired the following assets and liabilities of S Limited:
Particulars Book Value Fair Value
Building 4,00,000 8,10,000
Furniture 1,20,000 1,00,000
Machinery 2,90,000 2,15,000
Debtors 70,000 65,000
Creditors 1,00,000 1,00,000
10% Loan 2,00,000 2,20,000
The net assets taken over by P Limited can be calculated as:
Net Assets=Fair value of assets taken over – Fair value of liabilities taken over
= (8,10,000+1,00,000+2,15,000+65,000) - (1,00,000+2,20,000)
= (11,90,000) – (3,20,000) = Rs. 8,70,000

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 If the amount of purchase consideration is Rs. 8,70,000, there is no Goodwill. But if pur-
chase consideration is Rs. 9,20,000, then the excess of purchase consideration over Net As-
sets taken over shall be regarded as Goodwill.
So, Goodwill =Purchased Consideration – Net Assets taken over
= Rs. 9,20,000-Rs. 8,70,000 = RS. 50,000
(b) Non-Purchased Goodwill/Inherent Goodwill/Internally Generated Goodwill:
Non-Purchased or Inherent goodwill is referred to as internally generated goodwill and it
arises when a business may over the years generate its own goodwill.
The enterprise while doing business slowly develops the goodwill. Goodwill generated in the
process of doing business called internally generated goodwill. This type of goodwill may be
generated because of number of factors like good business practice, good and trained
employees, advertisement, continuous training to employees, etc. Certainly, to generate the
goodwill internally involves cost, but can this cost of generating the goodwill be measured
reliably? Certainly ‘NOT’. As the cost cannot be measured reliably, the self-generated
goodwill is not recognized in books/financial statements.
Following are the features of Non-Purchased goodwill:
1. It is internally generated.
2. A cost cannot be placed on these types of goodwill.
3. Valuation depends on subjective judgment of the valuer.
4. It is not demonstrated by a purchase consideration.
5. It is never recognised in financial statements.
Goodwill can be positive and can be negative also.

Zoological Classification of Goodwill:

The following are the Four types of Goodwill under zoological classification:
(I) Cat Goodwill: The basic tendency of animal ‘Cat’ is to give more importance to the
place. It always remains attached more with the place or home rather than on the persons
living therein. It means the Cat Goodwill represents that the customer is more loyal with
the shop or locality or place. He will not follow the outgoing owner rather he will
continue with the old shop, although owner has been changed.
(II) Dog Goodwill: The ‘Dog’ is a faithful animal who always follows its master. This
goodwill is attached to the owner of the business. In case of professionals like doctors,
accountants, lawyers etc. this type of goodwill prevails.
(III) Rat Goodwill: The animal ‘Rat’ is supposed to be neither attached with person nor with
the place. This type of goodwill is purely casual and is difficult to be estimated.
(IV) Rabbit Goodwill: Rabbits remain to confine to a patch and do not like to venture far
away. Similarly, the rabbit consumers will only pick a product if it is available in their
acceptable radius. For example, no one likes to go through extra efforts to buy fruits,
vegetables and groceries. A consumer would like to go no farther than the nearest
departmental store to make the purchase.

Goodwill and Accounting Standards:

1. Accounting Standard 10 (Property, Plant & Equipment)
Goodwill should be recorded in the books only when some consideration in money or
money’s worth has been paid for it. Whenever a business is acquired for a price (payable
in cash or in shares or otherwise) which is in excess of the value of the net assets of the
business taken over, the excess should be termed as ‘Goodwill’.
2. Accounting Standard 14 (Accounting for Amalgamation) (Paras 19 and 20)
(a) (Para 19): Goodwill arising on amalgamation represents a payment made in anticipation
of future income and it is appropriate to treat it as an asset to be amortised to income on a

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 systematic basis over its useful life. Due to the nature of goodwill, it is frequently difficult
to estimate its useful life with reasonable certainty. Such estimation is, therefore, made on
a prudent basis. Accordingly, it is considered appropriate to amortise goodwill over a
period not exceeding five years unless a somewhat longer period can be justified.
(b) (Para 20): Factors which may be considered in estimating the useful life of goodwill
arising on amalgamation include: (a) the foreseeable life of the business or industry; (b)
the effects of product obsolescence, changes in demand and other economic factors; (c)
the service life expectancies of key individuals or groups of employees; (d) expected ac-
tions by competitors or potential competitors; and (e) legal, regulatory or contractual pro-
visions affecting the useful life.
3. Accounting Standard 21 (Consolidated Financial Statements) :
In preparing consolidated financial statements, any excess of the cost to the parent of its
investment in a subsidiary over the parent’s portion of equity of the subsidiary, at the date
on which investment in the subsidiary is made, should be described as goodwill to be
recognised as an asset in the consolidated financial statements.
4. Accounting Standard 26 (Intangible Assets)
(a) (Para 48): Internally generated goodwill should not be recognised as an asset.
(b) (Para 49) : In some cases, expenditure is incurred to generate future economic benefits,
but it does not result in the creation of an intangible asset that meets the recognition cri-
teria in this Standard. Such expenditure is often described as contributing to internally
generated goodwill. Internally generated goodwill is not recognised as an asset because it
is not an identifiable resource (i.e. it is not separable nor does it arise from contractual or
other legal rights) controlled by the entity that can be measured reliably at cost.
Methods for Goodwill Valuation:
Simple Profit method: Under this method goodwill is valued as follows
Goodwill = Average Future maintainable profit (AFMP) X No. of years of purchase
Capitalization of Profit method: under this method the total value of the business is found
out by capitalizing the average future maintainable profits on the basis of normal rate of
return. The value of goodwill is the difference between the value of business so found out and
the actual capital employed in the business. The formula to find out the value of business is as
follows:
Value of business = Average Future maintainable Profits / Normal rate of return X 100
Value of goodwill = value of business - Actual capital employed.
Super Profit Method: Under this method goodwill is based on the average annual super
profits earned by the business. The term super profit means the profits (i.e. Average Future
maintainable profits) over and above the normal profits. The goodwill shall be calculated as
follows:
Goodwill = Average annual super profits X No. of years of purchase
Capitalization of Super profits: Under this method the amount of super profits is
capitalized at the normal rate of return. The value of goodwill is ascertained as follows:
Goodwill = Average annual super profit /Normal rate of return X 100
Annuity method: It is refinement of super profit method. This method is based on the logic
that the buyer should pay now for goodwill only the present value of super profits calculated
at a proper rate of interest. It means that the values of super profit should be discounted using
appropriate discount factor. Thus, here goodwill will be the discounted value of the total
amount calculated as per purchase of super profits method. The formula to calculate goodwill
will be as follows:
Goodwill = Average Annual Super profit X Annuity Factor

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 Determination of Future Maintainable Profits:
The future profits, likely to be earned are relevant for valuing goodwill. The estimate of
future profits is made on the basis of past profits. While estimating the future maintainable
profits the following points should be considered:
1. Profits for the past four or five normal years should be averaged since the average is more
reliable than a single year profit. The objective should be to consider only the normal
profits, which the business is expected to earn in the normal conditions. Thus any
abnormal gain or loss has to be excluded. The nonrecurring items such as loss of
exceptional nature through strikes, fires, floods and theft etc. profit or loss of any isolated
transaction not being part of the business of the company, lump sum compensation or
retiring allowances, damages and costs in legal actions, abnormal repair charges in a
particular year etc. should be eliminated
2. All usual working expenses including interest to debenture holders and depreciation of
the assets of the company should be provided for. If the fixed assets have to be revalued,
depreciation should be based on the values arrived at as a result of the revaluation.
3. The income derived from non-trading assets should be excluded. Only operating profits
are to be considered.
4. Any capital profit or loss or receipt or expenses included in the profit & loss a/c should
also be excluded.
5. All necessary provisions for liabilities such as taxation or otherwise should be made. But
transfer to reserve, dividend equalization fund, or sinking fund for redemption of
liabilities should not be taken note of, as such transfers merely transfer profits from one
account to another and the availability of profits is not affected.
Note:
1. If the profits over the past four or five years shows distinct falling or rising trend, the simple
average fails to consider a significant factor namely trends in earnings. In such cases, a
weighted average, giving more weight to the recent years than to the past is appropriate. In
other words weighted average profits should be calculated for the purpose of valuation of
goodwill.
2. Results of development that have taken root, but are likely to bear fruit in future should be
estimated and the past profits should be adjusted for this factor in order to arrive at the future
maintainable profits.
Normal Rate of Return:
Normal rate of return is the rate of return that the investors in general expect on their
investments in a particular industry. This rate differs from industry. The normal rate of return
comprises of these components.
1. Return at zero Risk level: this refers to return from a safe investment.
2. Additional Return for Business risk: the term business risk refers to the variability in
operating profits due to change in sales. In case the nature of business of firm is such that
it has more than the normal or average risk, the investor will expect a higher rate of
return.
3. Additional Return for Financial Risk: the term financial risk refers to the risk on
account of pattern of capital structure. In general, it may be said that a firm having higher
debt content in its capital structure is more risky as compared to a firm, which has
comparatively low debt content.
The normal rate of return in case of limited company can also be estimated on the basis of the
dividend paid by the company, the normal rate of dividend expected and the market price of
the shares of the company. The formula is
Normal Rate of Return = Dividends paid (in Rs.)/Market price of share X 100

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 Capital Employed:
The goodwill of a business depends on the amount of capital employed also. The term capital
employed for the valuation of goodwill should be calculated from the point of view of
shareholder. Capital employed may be expressed as the total of Share Capital and Reserves
less the amount of Non-Trading assets. It can also be ascertained by adding up the value of
Trading assets and deducting all External liabilities. This means that the amount of
debentures or loans should also be excluded from capital employed. Of course, any profit or
loss on revaluation of Trading assets should be taken in to account.

While valuing goodwill it is desirable to use average capital employed in place of “capital
employed” because the capital employed must be such as may fairly represent the capital
investment throughout the years. Average capital employed is the average of capital
employed at the beginning and that employed at the end of the year. If the capital employed
in the beginning of the year is not given, average capital employed can be ascertained by
deducting half the profits of the year from the capital employed at the end of the year. The
assumption is the profits have been used in business and that the profits have not yet been
distributed.

EXAMPLES
1. Classify the following into appropriate type of Goodwill:
(a) The excess of amount paid over the value of Net Assets taken over.
(b) When customer goes to the same shop irrespective of change in ownership of that shop.
(c) Goodwill due to Brand Loyalty.
(d) When the Goodwill is attached to the person rather than place.
(e) When Goodwill is not dependent upon person or place and is very casual.
(f) Goodwill arising in the course of amalgamation in the nature of purchase.
(g) When the Goodwill is attached to the place rather than the person.
2. The Financial Position of ABC Mfg. Co. Ltd. discloses the following as on 31/3/2020.
Liabilities Rs. Assets Rs.
90,000 Equity Shares of Rs. 10 each fully paid 9,00,000 Goodwill at cost 90,000
Capital Reserve 30,000 Land 5,25,000
Profit & Loss 2,28,000 Plant & Machinery 2,70,000
(W.D.V)
Provision for Taxation 1,65,000 Stock at cost 3,45,000
Sundry Creditors 2,13,000 Book Debts 2,85,000
Cash at Bank 21,000
15,36,000 15,36,000
Additional Information:
(i) Current year’s adjusted PAT is 1,65,000. (ii) Opening balance of capital employed is
Rs.9,00,000. Compute Average Capital Employed under various methods.
3. Beta ltd. proposed to purchase the business carried on by Deepak Ltd. Goodwill for this
purpose is agreed to be valued at 3 years purchase of the weighted average profits of the
past four years. The profits for the years and appropriate weights to be used are as follows:
Year Weights Profits (Rs.)
2016-17 1 3,75,000
2017-18 2 5,70,000
2018-19 3 7,95,000
2019-20 4 10,20,000
Beta Ltd closed books of accounts every year on 31 st March. The following were
found during the scrutiny of accounts.
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 1. On 1.4.2019 a part of machinery having book value of Rs.75,000 was sold for
Rs.75,000 but the proceeds were wrongly credited to sales account. Depreciation
has been charged on machinery at 18.10% p.a. under Reducing Balance Method.
2. The closing stock on 31.3.2019 was overvalued by Rs. 45,000.
3. Each year’s profit includes on average Rs.30,000 as income from non-trade
investments.
4. Profits for the year 2016-17 includes capital profit amounting to Rs. 45,000.
Find out the value of Goodwill
4. The following information of Krishna Enterprise Limited is made available to you:
Year 2016-17 2017-18 2018-19 2019-20
Profit Before Tax (Rs.) 1,50,000 2,00,000 3,00,000 4,00,000
Weight 1 2 3 4
Tax (Assume) 30.9% 30.9% 25.75% 26%
st
1. The closing capital employed as on 31 March 2020 is Rs. 13,50,000.
2. The Normal rate of Return is 12% and the Present Value of Annuity of 1 rupee for 4
years at 12% rate of interest is 3.037.
3. Stock was undervalued by Rs. 10,000 in 2016-17 and overvalued by Rs. 30,000 in
2017 - 18.
4. Non-Recurring Income on an average basis is Rs. 4,500. An annual charge of Rs.
5,000 should be made to cover managerial costs for the purpose of valuation of
goodwill.
5. On 1st December, 2017, a major repair was made in respect of plant for Rs.15,000
which was charged to Profit & Loss A/c. The said sum is to be capitalized and
depreciated @ 18.10% on WDV basis for the purpose of goodwill valuation.
6. The capital employed may be taken as on 31.3.2020.
You are required to calculate goodwill (i) Simple profit method at 4 years purchase
of weighted average profit of last 4 years (ii) At 4 years purchase of super profit (iii)
As per capitalization of super profit and (iv) As per Annuity Method.
5. Net Profit After Tax of Sun ltd. for the past years were Rs. 60,000, Rs. 63,750, Rs.69,000,
Rs.78,000 and Rs.88,500. The average trading capital employed in the business in Rs.
6,50,000. The market rate of interest on investment in 8% whereas the rate of risk returns
on capital employed in business in 2%.
Calculate Goodwill on the basis of:
1. Five years purchase of Super profit and 2. Capitalisation on Super Profits
Use Weighted Average Method applying weights of 1 to 5 respectively for calculating
Weighted Average Profit.
6. Following is the Financial Position of a Galaxy ltd., as on 31st March, 2020.
Liabilities Amt Assets Amt (Rs.)
(Rs.)
3250 Equity Shares of Rs.100 each 3,25,000 Goodwill 25,000
750 6% Pref.nce shares of Rs.100 75,000 Freehold property 1,87,500
each
Profit & Loss 2,25,000 Plant & Machinery 1,75,000
(less depreciation)
5% Debentures 1,50,000 Stock 1,85,000
Sundry creditors 1,19,625 Debtors (net) 1,99,625
Bank 1,22,500
Total 8,94,625 Total 8,94,625
Profit after tax for the three years 2017-18, 2018-19, 2019-20 were Rs.1,43,000 Rs.2,22,502
and Rs. 1,65,840 respectively.

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Additional information:
1. The market rate of interest on investment is 8% whereas the rate of risk returns on capital
employed in business is 2%.
2. The value of Freehold property is to be ascertained on the basis of 8% Return. The current
rental value is Rs.25, 200.
3. Rate of Tax applicable 2017-18: 30.9%, 2018-19: 25.75 % and 2019-20:26%.
4. 10% of the profits for 2018-19 referred to above arose from a transaction of a non-
recurring nature.
5. A provision of Rs.7,875 on sundry debtors was made in 2018-19 which is no longer
required.
6. A claim of Rs.4,125 against the company is to be provided and adjusted against profit for
the year 2019-20.
7. Calculate goodwill:
i. As per Super Profit method at 3 times the adjusted average super profit of the three
years referred to above.
ii. As per annuity method. (present value of Annuity of Re/ 1 for three years at 10% p.a. is
2.487)
Ascertain the value of the Goodwill of the company. The capital employed for the
purpose of valuation of goodwill may be taken as on 31st March 2020.
7. Manshi Ltd. is desirous of purchasing the business of Devi Ltd. On 31.3.2020 the
financial position is as follows:
Liabilities Amt (Rs.) Assets Amt(Rs.)
Equity share Capital (Rs.10 each) 5,00,000 Goodwill 20,000
General Reserve 1,70,000 Land 3,50,000
Secured loan (secured against land) 2,00,000 Plant & Machinery 2,00,000
Short term loan 1,00,000 Furniture 50,000
Creditors 50,000 Stock 1,50,000
Debtors 1,25,000
Bills receivables 75,000
Cash at Bank 50,000
Total 10,20,000 Total 10,20,000
The profits of the company before managerial remuneration (Rs.20,000 p.a .) and taxation
are as Follows:
2015-16 Rs 1,80,000
2016-17 Rs 1,90,000
2017-18 Rs 2,60,000 (including speculative profit of Rs. 40,000)
2018-19 Rs 2,50,000 (including Rs. 10,000 profit on sale of fixed assets)
2019-20 Rs 2,80,000
Additional information:
1. A casual income of Rs.3,000 was included in the profit of 2015-16, which can never
be expected in future.
2. Profit of 2019-20 was reduced by Rs.1,000 as result of an extraordinary loss by fire.
3. After the acquisition of the business Manshi Ltd has to pay insurance premium
amounting to Rs.1,200 p.a. which was not paid by the transferor company.
4. The company falls in tax bracket of 26%.
The companies engaged in similar business normally earn 15% p.a. Calculate the
value of Goodwill on the basis of 4 years purchase of Super profit (the capital
employed may be taken as on 31.3.2020 for the purpose of valuation of Goodwill.)

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8. Following is the Financial Position of X Ltd as on 31st March 2020.
Liabilities Amount Rs Assets Amount Rs
Equity Shares of Rs 10 each 18,00,000 Goodwill 45,000
5,000 8% Preference Shares 5,00,000 Land 2,50,000
of Rs 100 each
Capital Reserve 4,50,000 Building 2,00,000
General Reserve 1,00,000 Plant and Machinery 10,50,000
6% Secured Debentures 4,00,000 Investment in 5% 2,00,000
Government Security
(Nominal value
Rs1,50,000)
Trade Creditors 4,45,000 Stock 10,00,000
Debtors 5,00,000
Cash and Bank 4,50,000
Total 36,95,000 Total 36,95,000
The profits of the company before considering Managerial cost of Rs 20,000 p.a.
(expected to be incurred in future)
2015-16 Rs 3,00,000 (included Rs 30,000 Non-Recurring Income)
2016-17 Rs 3,50,000 (loss Rs 50,000 on sale of Machinery)
2017-18 Rs 4,00,000 (Speculative profit Rs 50,000)
2018-19 Rs 5,00,000
2019-20 Rs 6,00,000
Additional Information:
1. Closing stock for 2015-16 was undervalued by Rs 30,000 and opening stock for
the year 18-19 was undervalued by Rs 40,000.
2. On 1.10.18 a major repair of Rs 50,000 was made in respect of Plant which was
charged to Profit and Loss A/c. The said sum is to be capitalized and depreciated
@ 18.10 % on WDV basis for the purpose of goodwill valuation.
3. Land was revalued at Rs 4,50,000.
4. 30% of the amount invested in Building is treated as non-trading assets on which
rent of Rs 20,000 is realised annually.
5. Normal Rate of Return on closing trading capital employed as on 31st March 2020
for valuation of goodwill is 10%.
6. Present value of annuity of one rupee for 5 years at 10% is 3.78.
7. Ignore Taxation.
Your are required to calculate the value of goodwill;
1. As per Five years purchase of simple profit,
2. As per five years purchase of super profit,
3. As per capitalization of super profit and
4. As per Annuity Method.