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C H A P T E R

Goodwill: Concept and

Mode of Valuation

MEANING OF KEY TERMS USED IN THE CHAPTER

1. Goodwill
Goodwill is the value of benefit or advantage that a business has because of the factors that help
in increasing its profitability. It may be because of its location, favourable contracts, access to
supplies and customer loyalty, etc.
Goodwill is an intangible asset.
2. Purchased Goodwill
Purchased Goodwill means the goodwill for which a consideration has been paid.
3. Self-generated Goodwill
Self-generated Goodwill is the goodwill that has been generated by the business because of which
it is able to earn higher profit.
4. Methods of Valuation of Goodwill
(i) Simple Average Profit Method
It is calculated by taking the average profit for a specified number of years and multiplying it with
the number of years of purchase.
Goodwill = Average Profit × No. of Years’ Purchase
(ii) Weighted Average Profit Method
It is calculated by multiplying the profit for each year with the weight assigned to it. The amounts so
arrived at are totalled and divided by the total of weights. The weighted average profit is multiplied
by the number of years of purchase.
Goodwill = Weighted Average Profit × No. of Years’ Purchase
(iii) Super Profit Method
Super profit is the profit earned by the business that is in excess of the normal profit. Goodwill is
determined by multiplying the super profit by the number of years’ purchase.
Goodwill = Super Profit × No. of Years’ Purchase
Capitalisation Method
(iv) Capitalisation of Average Profit
Under the Capitalisation Method, the capitalised value of the business is determined by capitalising
the average profit by the normal rate of return. Out of the value so determined, value of net assets
is deducted to determine the value of goodwill.
Goodwill = Capitalised Value of Business – Net Assets of Business.
(v) Capitalisation of Super Profit
Under this method, super profit is capitalised at the normal rate of return.
100
Goodwill = Super Profit × ◊
Normal Rate of Return