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How to use Capitalized method to determine the value of Goodwill?

 

Valuation of Goodwill by Capitalization method:

Capitalization by average profit:

Goodwill = Capitalized average profit method- capital employed

Capitalized average profit method = Average profit*100/normal rate of return

Average profit = total profit /number of years

Capital employed = Total assets (excluding goodwill) – Outside liabilities

Or

Capital employed = Capital +Reserves and Surplus

Capitalization by super profit method:

Goodwill = Super profit * 100/normal rate of return

Super profit = Average profit – normal profit

Normal profit = Capital employed *normal rate/100

Example: Find out the value of goodwill with the help of given information using capitalization average profit method:

·         Total assets = Rs. 56,000

·         Average profit = Rs. 12,000

·         Normal rate of return = 6% per annum

·         Outside liabilities = Rs.20,000

Solution: Capital employed = 56,000- 20,000

= Rs. 36,000

Capitalization of average profit method = 12,000*(100/6)

= 2, 00,000

Goodwill = 2, 00,000 – 56,000

= Rs. 1, 44,000

Example:  Company XYZ 5 years of profit and loss are as follows: Rs. 5000, Rs.6000, Rs. (3000), Rs.10, 000 and Rs.4, 000. The capital employed in a company is Rs. 85,000. The normal rate is 6%. Company LMN has capital employed double than XYZ Company. The average profit of LMN Company is 2/3 of XYZ Company. The market rate is 5%. Find out whose goodwill value is more than other.

Solution: Average profit = (5000+6000+(4000)+10000+7000)/5 =Rs. 24,000

Capitalization of average profit method = 24000*100/6= Rs. 4, 00,000

Goodwill = Rs. 4, 00,000 – 85,000 = Rs. 3, 95,000

Company LMN:

Average profit = 2/3 *24000 = Rs. 16000

Capitalized average profit = 16000*100/5 = 3, 20,000

Capital employed = 85,000 *2 = 1, 70,000

Goodwill =Rs. 3, 20,000 - 1, 70,000 = Rs. 1, 50,000

Company XYZ has high goodwill in comparison to Company LMN.

Example: The capital invested in ABC Company is Rs. 75,000.And the 4 years profit is given below: 1-Rs.4,000, 2- Rs.1 6,000, 3- Rs. 10,000, 4-Rs. (2,000).The normal rate of return is 8%. Find out the goodwill value with the help of capitalized super profit.

Solution: Normal profit = 75,000*8/100 = Rs. 6,000

Average profit = 14000+26000+10000+12000/4 = 15,500

Super profit =Rs. (15,500 – 6,000) = Rs. 9,500

Goodwill = 9,500*100/8 = Rs. 1, 15,750

Example: There are two companies whose data are given below. Find out the goodwill value with the help of capitalized super profit method.

Company LMN:

·         Fixed assets =Rs. 4,50,000; Current assets = Rs. 1,70,000; current liabilities = Rs. 50,000

·         Total profit for 4 years is Rs. 2,40,000

·         Normal rate of return is 6%

Company PQR:

·         Fixed assets =Rs. 3,80,000; Current assets = Rs. 80,000; current liabilities = Rs. 20,000

·         Total profit for 4 years is Rs. 1,60,000

·         Normal rate of return is 6%

Solution:

Particulars

Company LMN:

Company PQR:

Fixed assets

4,50,000

3,80,000

Current assets

1,70,000

80,000

Total assets

6,20,000

4,60,000

Less: current liabilities

50,000

20,000

Capital employed

5,70,000

4,40,000

 

LMN Company:

Average profit = 240,000/4 = Rs. 60,000

Normal profit = 5,70,000*6/100 = Rs. 34,200

Super profit = 60,000 – 34,200 = Rs. 25,800

Goodwill = 25,800*100/6 = 4,30,000

PQR Company:

Average profit = 1, 60,000/4 = Rs. 40,000

Normal profit = 4, 40,000*6/100 = Rs. 26,400

Super profit = 40,000 – 26,400 = Rs. 13,600

Goodwill = 13,600*100/6 = Rs. 2, 26,667

 

 

 

 

 

 

 

 

 

 

 

 

 

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