GOODWILL - Complete Guide
Treatment & Calculation Methods
WBCHSE Class 12 Accountancy - Partnership
1. Types of Goodwill
What is Goodwill?
Goodwill is an intangible asset that represents the value of a firm's reputation, customer relationships, brand name, and other factors that contribute to earning capacity beyond normal returns.
Types of Goodwill:
1.1 Purchased Goodwill (Recorded in Books)
- Definition: Goodwill acquired by purchasing another business
- Treatment: Shown as an asset in Balance Sheet
- Example: Firm A buys Firm B for ₹5,00,000 when net assets are ₹4,00,000. Goodwill = ₹1,00,000
1.2 Self-Generated Goodwill (Not Recorded)
- Definition: Goodwill developed internally through business operations
- Treatment: NOT shown in books (as per accounting standards)
- Example: A firm builds reputation over 20 years - not recorded until there's a change in partnership
Nature of Goodwill in Partnership:
| Situation | Treatment | Reason |
|---|---|---|
| Admission of Partner | New partner brings premium | Compensates old partners for share in goodwill |
| Retirement of Partner | Continuing partners pay | Compensates retiring partner for goodwill share |
| Death of Partner | Continuing partners pay | Compensates deceased partner's estate |
2. Methods of Calculating Goodwill
Method 1: Average Profit Method
Goodwill = Average Profit × Number of Years' Purchase
Average Profit = Total Profits / Number of Years
Example:
Profits for last 3 years: ₹50,000, ₹60,000, ₹70,000
Goodwill at 2 years' purchase
Solution:
Average Profit = (₹50,000 + ₹60,000 + ₹70,000) / 3 = ₹60,000
Goodwill = ₹60,000 × 2 = ₹1,20,000
Method 2: Super Profit Method
Super Profit = Actual Average Profit - Normal Profit
Normal Profit = Capital Employed × Normal Rate of Return / 100
Goodwill = Super Profit × Number of Years' Purchase
Example:
Average Profit: ₹80,000; Capital Employed: ₹4,00,000; Normal Rate: 15%
Solution:
Normal Profit = ₹4,00,000 × 15% = ₹60,000
Super Profit = ₹80,000 - ₹60,000 = ₹20,000
Goodwill = ₹20,000 × 3 = ₹60,000 (at 3 years' purchase)
Method 3: Capitalization Method
(a) Capitalization of Average Profit:
Total Firm Value = (Average Profit × 100) / Normal Rate
Goodwill = Total Firm Value - Net Assets
(b) Capitalization of Super Profit:
Goodwill = (Super Profit × 100) / Normal Rate
Example:
Average Profit: ₹90,000; Net Assets: ₹5,00,000; Normal Rate: 18%
Solution (Method a):
Total Value = (₹90,000 × 100) / 18 = ₹5,00,000
Goodwill = ₹5,00,000 - ₹5,00,000 = ₹0
5. Years' Purchase Method (6 Problems)
Concept of Years' Purchase
Years' Purchase Method: Goodwill is calculated by multiplying average or super profit by a certain number of years.
Goodwill = Average/Super Profit × Number of Years
Problem 5.1 (Easy) - Simple Years' Purchase
Question: A firm's profits for last 3 years were ₹60,000, ₹75,000, ₹90,000. Calculate goodwill at 2 years' purchase of average profits.
Solution:
Average Profit = (₹60,000 + ₹75,000 + ₹90,000) / 3 = ₹75,000
Goodwill = ₹75,000 × 2 = ₹1,50,000