CA NITIN GOEL TREATMENT OF GOODWILL
Unit 2: TREATMENT OF GOODWILL
Whenever you get pains in your life, just think about the full form of pains.
Positive attitude in negative situation.? Follow it, life will change.”
1. Goodwill is the value of reputation of a Firm in respect of profits expected in future over
and above the normal rate of profits earned by similar Firms in the same locality.
2. Goodwill is the benefits & advantages of good name, reputation & connections of a business
firm. It is that attractive force which brings in customers & enhances the revenues of firm.
3. Extra amount over and above the saleable values of the identifiable assets that could be
fetches by selling an existing firm as a going concern.
TYPES OF GOODWILL
A. Purchased Goodwill B. Self-Generated Goodwill
1. Purchased Goodwill arises when a 1. It refers to internally generated goodwill,
business is purchased, & the consideration that arises to the special advantages
paid therefore is more than the value of possessed by the Firm.
assets taken over. 2. Internally Generated Goodwill is not
2. Purchased Goodwill= Purchase recorded in the books of account, since
Consideration Less Net Assets taken over Accounting Standard 26 issued by ICAI
3. Purchased Goodwill is recorded in books specifically provides so.
of accounts & is shown in balance sheet.
4. The firm may write off purchased Goodwill
over a period of time.
Situations which may involve valuation of Goodwill in case of Firms:
Following are the situations warranting Valuation of Goodwill in case of Partnership Firms-
Change in Profit Sharing Ratio amongst the Partners,
Admission of a new Partner,
Retirement or Death of a Partner
METHODS OF VALUATION OF GOODWILL
METHOD 1: AVERAGE PROFITS METHOD
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CA NITIN GOEL TREATMENT OF GOODWILL
METHOD 2: SUPER PROFITS METHOD
Example:
A firm earned Net Profits during the last three years as follows-
Year I II III
Profit ₹ 24,000 ₹ 20,000 ₹ 22,000
The capital investment of the Firm is ₹ 60,000. A fair return on the capital having regard to
the risk involved is 10%. Compute the value of Goodwill based on three years purchase of the
Super Profits for the last three years.
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METHOD 3: ANNUITY METHOD
Example:
Super Profits = 16,000
What will be the value of Goodwill if future cash flow of next 3 years are discounted at 8%
rate?
METHOD 4: CAPITALISATION METHOD
Sometimes Question specifies to apply Average Capital Employed
Average Capital Employed = Opening Capital Employed + Closing Capital Employed
2
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CA NITIN GOEL TREATMENT OF GOODWILL
TREATMENT OF GOODWILL IN CASE OF CHANGE IN PSR
Accounting Issue involved Journal Entry
1. Writing off Goodwill All Partner’s Capital A/c (individually) Dr. (in old ratio)
existing in books To Goodwill A/c
2. Adjusting Goodwill on Gaining Partner’s Capital A/c Dr. ( in Gain ratio)
change in PSR To Sacrificing Partners’ Capital A/c (in Sacrifice Ratio)
Sacrifice Gain
Partners whose shares in Profit have Partners whose shares in profits have
deceased as a result of change in PSR, are increased as a result of change in PSR, are
known as Sacrificing Partners. known as Gaining Partners
The ratio in which Partners have agreed to The ratio in which Partners have agreed to
reduce their profits in favour of the other gain their profits from the other Partner (s)
Partner(s) is called Sacrifice Ratio or is called Gain Ratio or Gaining Ratio
Sacrificing Ratio.
Sacrifice Ratio = Old Ratio less New Ratio Gain Ratio = New Ratio less Old Ratio
Example:
P, Q and R are partners sharing profits and losses in the ratio of 3:2:1. The goodwill of the
firm is valued at ₹ 12,000. They have decided to change the profit-sharing ratio to 2:2:1.
Pass Journal Entry for goodwill adjustment.
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CA NITIN GOEL TREATMENT OF GOODWILL
ASSIGNMENT QUESTIONS
Question 1 Pg no._____
The past profits of five years of a partnership firm are: ₹ 50,000; ₹ 40,000; ₹ 52,000; ₹ 48,000
and ₹ 56,000 respectively. Calculate the value of goodwill on the basis of 4 years’ purchase
of the average profits of the last five years.
Question 2 Pg no._____
A firm of A, B and C has a total capital investment of ₹ 4,50,000. The firm earned net profits
during the last four years as: I-₹ 70,000; II-₹ 80,000; III-₹ 1,20,000 and IV- ₹ 1,00,000. The
reasonable expected return is 15 per cent having regard to the risk involved. Calculate the
value of goodwill based on 3 years’ purchase of average super profits of the past four years.
Question 3 Pg no._____
Calculate the goodwill by annuity method of super profit from the following facts:
(a) Annual maintainable profit after tax is ₹ 65,000.
(b) Capital employed is ₹ 4,00,000.
(c) Normal rate of return is expected at 12% p.a.
(d) Present value of an annuity of ₹ 1 for five years @ 12% interest is 3.604776.
Question 4 Pg no._____
The net tangible assets of a firm are worth ₹ 4,10,000 and the average profit of last four years
amounts to ₹ 60,000. Find out the value of goodwill under capitalization method if the
reasonable return on capital invested is 12%.
Question 5 (ICAI Study Material) Pg no._____
th
Lee and Lawson are in equal partnership. They agreed to take Hicks as 1/4 partner. For this
it was decided to find out the value of goodwill. M/s Lee & Lawson earned profits during 2020-
2023 as follows:
Year Profit Year Profit
2020 1,20,000 2022 1,30,000
2021 1,25,000 2023 1,50,000
On 31.12.2023 capital employed by M/s Lee and Lawson was ₹ 5,00,000. Rate of normal profit
is 20%. Find out the value of goodwill following various methods. (Consider 3 years purchase)
Question 6 (RTP Nov 2018) / (Nov 2019) / (Nov 2021) / (Nov 2023) (Similar) Pg no._____
Vasudevan, Sunderarajan and Agrawal are in partnership sharing profit and losses at the
ratio of 2:5:3. The Balance Sheet of the partnership as on 31.12.2021 was as follows:
Balance Sheet of M/s Vasudevan, Sunderarajan & Agrawal
Liabilities ₹ Assets ₹
Capital A/cs Sundry fixed assets 5,00,000
Vasudevan 85,000 Stock 1,00,000
Sunderarajan 3,15,000 Debtors 50,000
Agrawal 2,25,000 Bank 5,000
Sundry Creditors 30,000
6,55,000 6,55,000
The partnership earned profit ₹ 2,00,000 in 2021 & the partners withdrew ₹ 1,50,000 during
the year. Normal rate of return 30%. Find out the value of goodwill on the basis of 5 years'
purchase of super profit. Calculate super profit using average capital employed
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Question 7 (ICAI Study Material) Pg no._____
The following particulars are available in respect of the business carried on by Rathore
1. Capital Invested 1,50,000
2. Trading Results: 2020 Profit 40,000
2021 Profit 36,000
2022 Loss 6,000
2023 Profit 50,000
3. Market Rate of interest on investment 10%
4. Rate of risk return on capital invested in business 2%
5. Remuneration from alternative employment of the ₹ 6,000 per annum
proprietor (if not engaged in business).
You are required to compute the value of goodwill on the basis of 5 years’ purchase of super
profit of the business calculated on the average profits of the last four years.
Question 8 (ICAI Study Material) Pg no._____
A, B and C are in partnership sharing profits and losses in the ratio of 4:3:3. They decided to
change the profit sharing ratio to 7:7:6. Goodwill of the firm is valued at ₹ 20,000. Calculate
the sacrifice/gain by the partners and make the necessary journal entry.
Question 9 (ICAI Study Material) Pg no._____
A, B, C and D are in partnership sharing profits and losses equally. They mutually agreed to
change the profit sharing ratio to 3:3:2:2. Goodwill of the firm is valued at ₹ 20,000. Pass
necessary journal entry.
Question 10 (ICAI Study Material) Pg no._____
Wise, Clever and Dull were trading in partnership sharing profits and losses 4:3:3
respectively. The accounts of the firm are made up to 31st December every year.
The partnership provided, inter alia, that:
On the death of a partner the goodwill was to be valued at three years' purchase of average
profits of the three years upto the date of the death after deducting interest @ 8 per cent on
capital employed and a fair remuneration of each partner. The profits are assumed to be
earned evenly throughout the year.
On 30th June, 2023, Wise died and it was agreed on his death to adjust goodwill in the capital
accounts without showing any amount of goodwill in the Balance Sheet. It was agreed for the
purpose of valuation of goodwill that the fair remuneration for work done by each partner
would be ₹ 15,000 per annum and that the capital employed would be ₹ 1,56,000. Clever and
Dull were to continue the partnership, sharing profits and losses equally after the death of
Wise.
The following were the amounts of profits of earlier years before charging interest on capital
employed.
Year Profit
2020 67,200
2021 75,600
2022 72,000
2023 62,400
Compute the value of goodwill and show the adjustment thereof in the books of the firm.
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CA NITIN GOEL TREATMENT OF GOODWILL
PRACTICE QUESTIONS
MULTIPLE CHOICE QUESTIONS
1) Goodwill brought in by incoming partner in cash for joining in a partnership firm is taken
away by the old partners in their………ratio.
(a) Capital.
(b) New Profit Sharing.
(c) Sacrificing.
2) A & B are partners sharing profits and losses in the ratio 5:3. On admission, C brings
₹70,000 cash and ₹48,000 against goodwill. New profit sharing ratio between A, B and C
are 7:5:4. Find the sacrificing ratio of A:B.
(a) 3:1.
(b) 4:7.
(c) 5:4.
3) Following are the factors affecting goodwill except:
(a) Nature of business.
(b) Efficiency of management.
(c) Location of the customers.
4) Weighted average method of calculating goodwill should be followed when:
(a) Profits has increasing trend.
(b) Profits has decreasing trend.
(c) Either ‘a’ or ‘b’.
5) In the absence of any provision in the partnership agreement, profits and losses are shared
(a) In the ratio of capitals.
(b) Equally.
(c) In the ratio of loans given by them to the partnership firm
6) The profits and losses for the last 4 years are 2018-19 Losses ₹ 10,000; 2019-20 Losses ₹
2,500; 2020-21 Profits ₹ 98,000 & 2021-22 Profits ₹ 76,000. The average capital employed
in the business is ₹ 2,00,000. The rate of interest expected from capital invested is 12%. The
remuneration of partners is estimated to be ₹ 1,000 per month not charged in the above
losses/ profits. Calculate the value of goodwill on the basis of two years purchase of super
profits based on the average of four years.
(a) ₹ 9,000.
(b) ₹ 8,750.
(c) ₹ 8,250.
7) A, B and C are partners sharing profits and losses in the ratio 3:2:1. They decide to change
their profit sharing ratio to 2:2:1. To give effect to this new profit sharing ratio they decide
to value the goodwill at ₹ 30,000. Pass the necessary journal entry if Goodwill not
appearing in the old balance sheet and should not appear in the new balance sheet.
(a) B’s Capital Account Dr. ₹ 2,000
C’s Capital Account Dr. ₹ 1,000
To A’s Capital Account ₹ 3,000
(b) Goodwill Account Dr. ₹ 30,000
To A’s Capital Account ₹ 15,000
To B’s Capital Account ₹ 10,000
To C’s Capital Account ₹ 5,000
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CA NITIN GOEL TREATMENT OF GOODWILL
(c) A’s Capital Account Dr. ₹ 12,000
B’s Capital Account Dr. ₹ 12,000
C’s Capital Account Dr. ₹ 6,000
To Goodwill Account ₹ 30,000
8) Firm has earned exceptionally high profits from a contract which will not be renewed. In
such a case the profit from this contract will not be included in ………
(a) Profit sharing of the partners.
(b) Calculation of the goodwill.
(c) Both.
ANSWERS MCQs
1 (c) 2 (a) 3 (c) 4 (c) 5 (b) 6 (b) 7 (a) 8 (b)
TRUE / FALSE
State with reasons, whether the following statements are true or false:
1) Goodwill is intangible asset therefore it cannot be valued.
2) Goodwill is valued whenever there is change in profit sharing ratio among the partners.
3) Goodwill is the value of reputation of a firm in respect of profits expected in future over
and above the normal rate of profits
4) At the time of admission or retirement of a partner, goodwill can be raised in the books
of accounts and shown as an asset.
5) Only simple average method can be used for valuation of goodwill.
6) Super profit means excess of actual average profit over normal profit.
7) Normal profit means profit earned by similar companies in the same industry.
8) Normal profit depends upon Normal Rate of Return and past profits.
9) At the time of admission/retirement of a partner, since goodwill cannot be raised in the
books of accounts is recorded through capital accounts of the partners.
10) At the time of admission of a partner, goodwill brought in by the new partner is shared
equally by old partners.
Solution
1) False: Even though Goodwill is intangible asset it can be valued in terms of money.
2) True: Goodwill has to be valued every time whenever there is a reconstitution.
3) True: Goodwill is the brand image the firm has in the market due to which it enjoys an
advantageous position over the other players in the market.
4) False: At the time of admission or retirement of a partner, goodwill should not be raised
in the books of account of partnership firm because no consideration in money or money
worth has been paid for it.
5) False: Weighted average profit method, capitalisation method, super profits methods also
can be used for valuation of Goodwill.
6) True: Super profit means excess profit that can be earned by the firm over and above the
normal profit usually earned by similar firms under similar circumstances.
7) True: The rate of return is considered as an average for the industry, which is applied to
the capital employed in the concerned firm.
8) False: Normal profit depends upon Normal rate of return only and not on past profits.
9) True: Generally, the goodwill at the time of admission is adjusted through the capital
accounts and not shown in the books of the firm.
10) False: Goodwill brought in by new partner is shared by old partners in sacrificing ratio
and not equally
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CA NITIN GOEL TREATMENT OF GOODWILL
HOMEWORK
11) QUESTIONS
Question 1 Pg no._____
Shiv and Mohan are partners in a firm sharing profits and losses equally. On 31st March, 2023,
the balances of their capital accounts were ₹ 3,00,000 and ₹ 2,00,000 respectively. The
average profits of the firm are ₹ 1,36,000 and the rate of normal profit is 20%. On 1st April,
2023 they agreed to admit Hari as a partner for one fourth share. Hari will bring ₹ 1,00,000 as
capital. Compute value of the goodwill of firm on admission of Hari, if it is to be calculated on
the basis of:
a) 5 years purchase of super profit b) Capitalization method
c) 3 years purchase of average profit.
Question 2 (RTP Nov 2019)/(May 2020)/(Nov 2020)/(May 2022)/(Nov 2022)/(Sep 2024) Pg no._____
A and B are partners in a firm. Their capital are A ₹ 6,00,000 and B ₹ 4,00,000. During the year
ended 31st March, 2024 the firm earned a profit of ₹ 3,00,000. Assuming that the normal rate
of return is 20%, calculate the value of goodwill of the firm:
(i) By Capitalization Method; and
(ii) By Super Profit Method if the goodwill is valued at 2 years’ purchase of Super Profit.
Question 3 (RTP May 2023) / (RTP May 2021)/ (RTP May 2019) (Similar) Pg no._____
The profits and losses for the previous years are: 2019 Profit ₹ 15,000, 2020 Loss ₹ 25,500,
2021 Profit ₹ 75,000, 2022 Profit ₹ 1,12,500. The average Capital employed in the business is ₹
3,00,000. The rate of interest expected from capital invested is 10%. The remuneration from
alternative employment of the proprietor is ₹ 9,000 p.a. Calculate the value of goodwill on the
basis of 3 years’ purchases of Super Profits based on the average of 4 years.
Question 4 (ICAI Study Material) Pg no._____
A, B & C are equal partners. They wanted to change the profit sharing ratio into 4:3:2. Make
the necessary journal entries. Goodwill of the firm is valued at ₹ 90,000.
Question 5 (ICAI Study Material) Pg no._____
Antoo, Bantoo and Chintoo were in partnership sharing profits and losses 3:4:3 respectively.
The accounts of the firm are made up to 31st March every year. The partnership provided,
interalia, that: On the retirement of a partner the goodwill was to be valued at three years’
purchase of average profits of the past four years up to the date of the retirement after
deducting interest @12%p.a. on capital employed and remuneration of ₹ 2,000 p.m.to each
partner. On 1st April 2023, Antoo retired and it was agreed on his retirement to adjust goodwill
in the capital accounts without showing any amount of goodwill in the Balance Sheet. It was
agreed that the capital employed would be ₹6,50,000. Bantoo and Chintoo were to continue
the partnership, sharing profits and losses equally after the retirement of Antoo.
The following were the amounts of profits of earlier years before charging salary to partners
and interest on capital employed.
Year Profit
2019-20 2,60,000
2020-21 2,75,000
2021-22 2,65,000
2022-23 2,80,000
You are required to compute the value of goodwill & show the adjustment there of in the books
of firm.
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Question 6 (CA Foundation June 2022) (5 Marks) Pg no._____
Mr. X gives the following particulars in respect of business carried on by him:
Particulars Amount (₹)
Capital Invested in business 9,00,000
Market rate of interest on investment 8%
Rate of risk return on capital invested in business 3%
Remuneration per annum from alternative employment of proprietor 36,000
if he was not engaged in business
The business earned profits of ₹ 2,40,000, ₹ 2,16,000 and ₹ 3,00,000 in the years 2018, 2019
and 2021 respectively but made a loss of ₹ 36,000 in the year 2020.
Compute the value of Goodwill on the basis of 6 years' purchase of super profits of the
business, calculated on the basis of average profit of last four years.
Question 7 (CA Foundation Dec 2022) (5 Marks) Pg no._____
R and S are partners in a firm with a capital of 14,00,000 and 12,00,000 respectively. During
the year ended on 31st March, 2022 firm earned a profit of ₹ 6,50,000. Assuming that the
normal rate of return is 20%. Calculate the amount of Goodwill of the firm by using
a. Capitalization method
b. Super Profit method, if the goodwill is valued at 6 years purchase of super profits.
Question 8 (RTP Jan 2025) Pg no._____
The following information given below:
(i) Total Assets ₹10,00,000
(ii) External Liabilities ₹1,80,000
(iii) Normal Rate of Return 10%
(iv) Average Net Profit of last five years ₹1,00,000
You are required to calculate goodwill by applying:
(i) Capitalization Method and
(ii) 3 year’s purchase of super profits.
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