For the valuation of goodwill by super profit method, capital employed by business, expected rate of return, expected profit, average profit etc. are used.
Excess of average profit over the expected profit is called ‘Super Profit’ means when a business earns excess profit over average profit then the amount of excess profit is called super profit.
While calculating goodwill on the basis of super profit method, following points should be kept in mind.
– Capital Employed = Total Assets – Total External Liabilities.
– Generally expected rate of raturn is given.
– Expected profit = Capital Employed × Expected rate of return /100
– Average profit is considered after adjustment.
– Super profit = Average profit – Expected profit
– Goodwill = Super profit × No. of years of purchase
Illustration : On the basis of the following information of a firm, determine the valuation of goodwill on the basis of three years purchase of super profit.
Total Assets ₹ 1,40,000; Total Liabilities ₹ 5,00,000; Expected rate of return 10%.
