In accounting,Goodwill is an intangible asset that a company can have beyond its assets, by way of a good reputation and a solid customer base.Goodwill can arise when one company purchases another for a premium value.
Now let"s see some main terms to know for calculation of goodwill.
Investment
Non Trade Investment Trade Investment
The Main motive is to earn The main motive is to
Business Benefit earn financial Interest
ROCE
Return on Capital Employed(ROCE)
(Owner’s + Loaner’s) funds
Net Profit before Interest
(Owner’s + Loaner’s) funds
ROI
Return on Investment(ROI)
Owner’s Fund
Net Profit before Interest
Loaner’s Fund
For healthy Business ROI should be Greater then ROCE
Note: Own goodwill is never shown in balance sheet. If it is shown then it may be purchase under AS-14(Accounting for Amalgamation) or under AS-26 (Accounting for intangible Assets). Following are the differences between AS-14 and AS-26:
AS-14
- Accounted under Amalgamation
- Resulting due to Negotiation
- Write off within 5 years
AS-26
- Accounted under Intangible Assets
- Desperately calculated
- Write off within 10 years
Assumption
- While calculating goodwill always assume liquidation.
- Follow assets approach method. It means sale all assets and settles all Liabilities.
- Ignore proposed Dividend if given and reverse it back to that account from it is created.ü Ignore non-trade investments only take trade investments.
- While calculating goodwill if numbers of year is not mention then assume that the goodwill is purchase for 3 year
Methods to calculate Goodwill
Capitalization Method Super Profit Method
Market Capitalization Value Future Maintainable Profit
Less: Closing Capital Employed Less: Normal Profit Returns
Working Notes:
Market Capitalization Value :
Average Capital Employed * 100
Normal Rate of Return
Normal Profit Returns :
Average Capital Employed or closing capital Employed * Normal Rate of Return
Closing capital Employed :
All Assets – All Liabilities
Future Maintainable Profit :
1.Profit given in Balance sheet is profit after Tax, so convert that profit into PBT.
2.After converting, adjust all abnormal items and also deducted interest income from non-trade Investments.
3.After adjusting all abnormal items, give weights and calculate Future Maintainable Profits.