Goodwill
Good will definition: An account that can be found in the assets portion of a company's balance sheet. Goodwill can often arise when one company is purchased by another company. In an acquisition, the amount paid for the company over book value usually accounts for the target firm's intangible assets.
Goodwill is seen as an intangible asset on the balance sheet because it is not a physical asset like buildings or equipment. Goodwill typically reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations and any patents or proprietary technology.
Method:
There are three methods of valuation of goodwill of the firm;
1. Average Profits Method
2. Super Profits Method
3. Capitalisation Method
1. Average Profits Method:
This method of goodwill valuation takes the average profit of previous years as its basis. This average profit is multiplied by the number of purchases made in that year.
Goodwill = Average Profit x Number of Purchases in the year
Before calculating the average profits the following adjustments should be made in the profits of the firm:
a. Any abnormal profits should be deducted from the net profits of that year.
b. Any abnormal loss should be added back to the net profits of that year.
c. Non-operating incomes eg. Income from investments etc should be deducted from the net profits of that year. Example:
An Ltd agreed to buy the business of B Ltd. For that purpose Goodwill is to be valued at three years purchase of Average Profits of last five years. The profits of B Ltd. for the last five years are: Year | Profit/Loss ($) | 2005 | 10,000,000 | 2006 | 12,250,000 | 2007 | 7,450,000 | 2008 | 2,450,000 (Loss) | 2009 | 12,400,000 |
Following additional information is available:
1. In the year 2008 the company suffered a loss of $1,000,500 due to fire in the factory.
2. In the year 2009 the company earned an income from investments outside the business $
Goodwill is seen as an intangible asset on the balance sheet because it is not a physical asset like buildings or equipment. Goodwill typically reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations and any patents or proprietary technology.
Method:
There are three methods of valuation of goodwill of the firm;
1. Average Profits Method
2. Super Profits Method
3. Capitalisation Method
1. Average Profits Method:
This method of goodwill valuation takes the average profit of previous years as its basis. This average profit is multiplied by the number of purchases made in that year.
Goodwill = Average Profit x Number of Purchases in the year
Before calculating the average profits the following adjustments should be made in the profits of the firm:
a. Any abnormal profits should be deducted from the net profits of that year.
b. Any abnormal loss should be added back to the net profits of that year.
c. Non-operating incomes eg. Income from investments etc should be deducted from the net profits of that year. Example:
An Ltd agreed to buy the business of B Ltd. For that purpose Goodwill is to be valued at three years purchase of Average Profits of last five years. The profits of B Ltd. for the last five years are: Year | Profit/Loss ($) | 2005 | 10,000,000 | 2006 | 12,250,000 | 2007 | 7,450,000 | 2008 | 2,450,000 (Loss) | 2009 | 12,400,000 |
Following additional information is available:
1. In the year 2008 the company suffered a loss of $1,000,500 due to fire in the factory.
2. In the year 2009 the company earned an income from investments outside the business $