The following are the common methods used for valuing good will
1. Average profit method/simple average profit method.
2. Super profit method
3. capitalisation method.
1. Average Profit method: Under this method, the goodwill is valued at agreed number of years purchase of the average profits of the past few years. Goodwill = Average profits × No. of years purchased.
Average profit = \( \frac{\text { Total profits }} {\text { No. of years }}\)
Weighted Average Profit method: Goodwill = weighted Average Profit × No. of years purchase. Weighted average is based on specified weights like 1, 2, 3, 4 for respective year’s profit.
2. Super profit Method: Under this method, goodwill is calculated by multiplying the super profit with the agreed number of years.
Goodwill = Super Profit × No. of years purchase Super Profit = Actual or
Average Profit – Normal Profit Normal profit = Capital employed × Normal Rate of Return
Capital employed = Total Assets – Total Liabilities or outside liabilities
Average profit = \(\frac{\text { Total profits }} {\text { No. of years }}\)
3. Capitalisation Method: Under this method, the goodwill can be calculated in two ways
- by capitalising the average profits.
- by capitalising the super profits.
(i) Capitalisation of average profits
Under this method, the value of goodwill is calculated by deducting the capital employed (net assets) in the business from the capitalized value of average profits on the basis of normal rate of return.
Good will = capitalised value – capital employed (net asset) Capitalised value of average profit Average Profit × \(\frac{100}{\text { Normal Rate of Return }}\)
(ii) Capitalisation of Super Profits
Under this method the goodwill can be ascer tained by capitalising the super profit directly. Goodwill = Super Profits x \(\frac{100}{\text { Normal Rate of Return }}\)
