11.06.2012

Goodwill

A brief note on  Goodwill for general understand and to help understand term Goodwill used in Accounting Standards. Goodwill in general, it means reputation of Business.
In accounting,Goodwill is an intangible asset that a company can have beyond its assets, by way of a good reputation and a solid customer base.Goodwill can arise when one company purchases another for a premium value. 

Now let"s see some main terms to know for calculation of goodwill.

         Investment     
Non Trade Investment    Trade Investment
The Main motive is to earn The main motive is to
Business Benefit      earn financial Interest


ROCE 
Return on Capital Employed(ROCE)       
(Owner’s + Loaner’s) funds            

Net Profit before Interest
(Owner’s + Loaner’s) funds     


ROI 
Return on Investment(ROI)   
Owner’s Fund

Net Profit before Interest
Loaner’s Fund

For healthy Business ROI should be Greater then ROCE

Note: Own goodwill is never shown in balance sheet. If it is shown then it may be purchase under AS-14(Accounting for Amalgamation) or under AS-26 (Accounting for intangible Assets). Following are the differences between AS-14 and AS-26:

AS-14              

  • Accounted under Amalgamation      
  •  Resulting due to Negotiation        
  • Write off within 5 years         


AS-26

  • Accounted under Intangible Assets
  • Desperately calculated
  • Write off within 10 years

Assumption
  •  While calculating goodwill always assume liquidation.
  • Follow assets approach method. It means sale all assets and settles all Liabilities.
  • Ignore proposed Dividend if given and reverse it back to that account from it is created.ΓΌ  Ignore non-trade investments only take trade investments.
  • While calculating goodwill  if numbers of year is not mention then assume that the goodwill is purchase for 3 year

Methods to calculate Goodwill

Capitalization Method          Super Profit Method
Market Capitalization Value        Future Maintainable Profit
Less: Closing Capital Employed       Less: Normal Profit Returns


Working Notes:

Market Capitalization Value :

        Average Capital Employed * 100
         Normal Rate of Return

Normal Profit Returns :

       Average Capital Employed or closing capital Employed * Normal Rate of Return

Closing capital Employed :

        All Assets – All Liabilities

Future Maintainable Profit :

1.Profit given in Balance sheet is profit after Tax, so convert that profit into PBT.
2.After converting, adjust all abnormal items and also deducted interest income from non-trade Investments.
3.After adjusting all abnormal items, give weights and calculate Future Maintainable Profits.