TREATMENT OF GOODWILL IN PARTNERSHIP FIRM
ADVANCED ACCOUNTING
Dr. KAVITHAMANI R
Assistant Professor
PG and Research Department of International Business
Sri Ramakrishna College of Arts & Science
Coimbatore - 641 006
Tamil Nadu, India
1
Goodwill
A well-established firm earns a good name in the market, builds trust with
the customers and also has more business connections as compared to a newly set
up business. Thus, the monetary value of this advantage that a buyer is ready to pay
is termed as Goodwill. The buyer who pays for Goodwill expects that he will be
able to earn super profits as compared to the profits earned by the other firms. Thus,
goodwill exists only in the case of firms making super profits and not in the case of
firms earning normal profits for losses.
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Valuation of Goodwill
Goodwill is recorded in the books only when some
consideration in money or money’s worth is paid for it. Thus, in
the context of a Partnership firm, the need for valuation of
goodwill arises at the time of:
Change in the profit sharing ratio amongst the existing partners
Admission of a new partner
The retirement of a partner
Death of a partner
Dissolution of a firm where business is sold as going concern.
Amalgamation of partnership firms
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Methods of Valuation of Goodwill
• The choice of the method of goodwill valuation depends
entirely on the partners or the partnership deed when they
have made it.
1. Average Profits Method
Simple Average
Weighted Average
2. Super Profits Method
3. Capitalization Method
Capitalization of Average Profits
Capitalization of Super Profits
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1. Average Profits Method
i] Simple Average: Under this method, the goodwill is valued
at the agreed number of years’ of purchase of the average
profits of the past years.
Goodwill = Average Profit x No. of years’ of purchase
ii] Weighted Average: Under this method, the goodwill is
valued at an agreed number of years’ of purchase of the
weighted average profits of the past years. We use the
weighted average when there exists an increasing or decreasing
trend in the profits giving the highest weight to the current
year’s profit.
• Goodwill = Weighted Average Profit x No. of years’ of
purchase
• Weighted Average Profit = Sum of Profits multiplied by
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2. Super Profits Method
Under this method, the goodwill is valued at the
agreed number of years’ of purchase of the super
profits of the firm.
Super profit means the profit earned by a firm over and
above the normal profit earned by the other firms in
same business.
Average profit is compared with the normal yield.
Excess of average profit over normal profit is known
as Super profit.
Super Profit = Actual or Average profit – Normal Profit
Normal Profit = Capital Employed x (Normal Rate of
Return/100)
Goodwill = Super Profit x No. of years’ of purchase
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3. Capitalization Method
(i) Capitalization of Average Profits: Under this method, the
value of goodwill is calculated by deducting the actual capital
employed from the capitalized value of the average profits on the
basis of a normal rate of return.
• Goodwill = Capitalized Average profits – Actual Capital
Employed
• Capitalized Average profits = Average Profits × 100/Normal
Rate of Return
• Actual Capital Employed = Total Assets (excluding goodwill) –
Outside Liabilities
(ii). Capitalization of Super Profits: Under this method, it is
calculated by capitalizing the super profits directly.
• Goodwill = Super Profits × 100/ Normal Rate of Return
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