Page 60 - DEBKVOL-1

3.2 Double Entry Book Keeping—CBSE XII

CHAPTER SUMMARY

• Goodwill: Goodwill is the benefit and advantage of the good name, reputation and connection of a
business. It is the attractive force which brings in customers. It is one factor which distinguishes an old
established business from a new business at its first start.
• Nature and Characteristics of Goodwill
(i) It is an intangible asset and not a fictitious asset.
(ii) It helps to earn more than normal profit.
(iii) It is an attractive force which brings in customers to the old place of business.
(iv) It is composed of a variety of elements.
(v) It is difficult to ascertain the exact value of goodwill.

• Factors Affecting the Value of Goodwill: Value of goodwill depends upon the capacity of a business to
earn profit in excess of normal profits. Therefore, all such factors which help to increase the profits of a
business will also affect the value of goodwill. These factors are: 1. Efficiency of Management, 2. Quality of
products, 3. Favourable location, 4. Contracts, 5. Control over raw materials, and 6. Other factors like after
sale service, good customer relations, etc.
• Classification of Goodwill: Goodwill can be classified into two groups:
1. Purchased Goodwill: Purchased goodwill means goodwill acquired by paying money or money’s worth.
It may be purchased as an intangible asset but generally it arises when a business is purchased and
purchase consideration is more than the value of net assets (i.e., Assets – Liabilities) acquired. The
difference amount is the value of purchased goodwill. It is recorded in the books of account.
2. Self-generated Goodwill or Non-purchased Goodwill: It is an internally generated goodwill which arises
from a number of attributes that a running business possessed. It is not recorded in the books.
• Need for Valuation of Goodwill for Partnership Firms
For partnership firms the need for valuation of goodwill arises in the following circumstances:
(i) When there is a change in the profit-sharing ratio of existing partners.
(ii) When a new partner is admitted.
(iii) When a partner retires or dies.
(iv) When the firm is sold as a going concern.
(v) When two or more firms are amalgamated.
(vi) When a partnership firm is converted into a company.
• Methods of Valuation of Goodwill:
1. Average Profit Method: Goodwill = Average Profit × No. of Years’ Purchase.
2. Super Profit Method: Goodwill = Super Profit × No. of Years’ Purchase.
3. Capitalisation of Super Profit: Goodwill = Super Profit × 100/Normal Rate of Return.
4. Capitalisation of Average Profit: Goodwill = Capitalised Value of the Business – Net Assets.
• Capital Employed: Capital employed means capital invested in the firm to carry on business.
(i) Liabilities Side Approach:
Capital Employed = Capital + Reserves – Goodwill, if any, existing in the books – Fictitious Assets
– Non-trade Investments.
(ii) Assets Side Approach:
Capital Employed = All Assets (except goodwill, non-trade investments and fictitious assets)
– Outside Liabilities.