Goodwill is the value of a firm's reputation — its ability to earn profits above the normal rate. It is an intangible asset that cannot be seen but can be bought and sold.
Factors that affect goodwill
- Nature of business and its location
- Efficiency of management and quality of products
- Market situation and competition
- Special advantages: licences, patents, favourable contracts
- Period over which the business has earned above-normal profits
Methods of valuation
| Method | Formula |
|---|---|
| Average profit | Average profit × Number of years' purchase |
| Weighted average profit | Weighted average profit × Number of years' purchase |
| Super profit | (Average profit − Normal profit) × Number of years' purchase |
| Capitalisation of average profit | (Average profit × 100 ÷ Normal rate of return) − Capital employed |
| Capitalisation of super profit | Super profit × 100 ÷ Normal rate of return |
Normal profit = Capital employed × Normal rate of return ÷ 100. Capital employed = Total assets (excluding goodwill and fictitious assets) − Outside liabilities.
Adjustments before averaging
- Add back abnormal losses; deduct abnormal gains and non-recurring income.
- Deduct a partner's remuneration if it is to be charged in future.
- Adjust for undervalued or overvalued assets and for expenses that should have been capitalised.
A worked example using one set of figures for every method is in our article on valuation of goodwill.
Recorded lectures for this chapter
5 lectures (1 h 34 min) by Ronak Dugar in Class 12 Accountancy Book 1: Accounting for Partnership Firms. Enrolled students watch them in the student portal.
- Class 1 - Meaning, Types, Factors affecting, Average Profit Method, Weighted Average Profit Method18 min
- Class 2 - Super Profit Method, Capitalization Method19 min
- Class 3 - Adjustments in Valuation of Goodwill28 min
- Class 4 - Practice Questions with Adjustments14 min
- Class 5 - Additional Questions13 min
Learn this chapter with Ronak Sir
Classroom batches in Sector 9, Faridabad and recorded lectures online. Book a free demo class or call +91 83685 45620.