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Define goodwill and explain various methods of its valuation with suitable examples.

Meaning and definitions of reputation

(Meaning and Definition of Goodwill) In simple words, by reputation we mean the value of ‘famous’ of the business. Reputation is as easy to describe as it is more difficult to define it. From the business point of view, goodwill can be considered as an element due to which or by which the capital invested in the business is affected.

More profit than usual can be made.

(1) According to Dixie, “A person pays an amount to goodwill so that by doing so he may obtain such an income as he could not have without it.”
(2) According to Story, “Reputation is the profit earned by a business entity in excess of the capital employed.”
(3) According to Lord McNaughton, “Reputation is the power of attraction which attracts the customers.”

nature of reputation (Nature of Goodwill)

Goodwill is neither a real asset nor an artificial asset, but reputation is an intangible asset which can be experienced in business but cannot be seen in tangible form, because it is an invisible asset. It is not recognized separately like other fixed assets. Other assets are bought and sold separately whereas goodwill is not sold separately. It is bought or sold along with other assets, so goodwill is not a fictitious asset. The reputation arises due to the personal qualities of the trader and the reasons like monopoly etc. and enables the business to earn profit. In fact, fame is an intangible and invisible asset, because it has neither a physical form nor can it be touched.

type of reputation

(1) The reputation of a cat’s nature is derived from the local quality of its business. If the business is situated at such a place that the profit earning capacity will be reduced if its location is changed. It will be called fame rising from the place. A special quality of this type of fame is that whoever the owner may be, Arjuna does not lack in power to gain it. This is the reason why it is called a cat’s nature, because the nature of a cat is that it stays in its own place no matter where its owner goes.

(2) Reputation of dog’s nature – Sometimes profit in business does not depend on the place of the person depends on. The profit earning power in a business remains so long as there is a particular The person lives and the super profit earning power is destroyed as soon as that person is separated from the business. Kuro it Can be said to have a reputation of nature, because a dog leaves his master’s place after leaving his place goes with the owner.

(3) Reputation of the nature of rat – Sometimes the profit earning power does not depend on the particular person or place, but also depends on other reasons, such as the good relationship between the employee and the owner, the lack of the commodity in the market. If there is even a slight change in these reasons, the super profit earning power ends, that is, it is today and may not be there tomorrow. The nature of the rat is fickle and it never stays in one place.

Needs or Conditions of Valuation of Goodwill

Appraisal of goodwill is needed because of the following reasons

(1) In case of sole trade (1) When the business is being sold.

(ii) When a new partner is joining the business. (iii) When the business is being amalgamated with any other business.

(2) In the case of a partner—(i) when the profit-profit ratio of the partners

(ii) When a new partner is taking admission. (iii) When a partner is retiring has changed.

(3) In the case of a company (1) when the shares are being valued. (ii) when the whole or any part of the business of the company is being sold.

(iii) when the company is being amalgamated or reconstituted.

(iv) When the goodwill after writing off is again being shown in the books of account at fair value.

Factors Affecting the Value of Goodwill

The list of factors, factors or elements affecting the value of goodwill is very long. For the purpose of making the study easier, these factors can be clarified as follows: (1) Location of the building of business – If the building of business is at the right place and for business If the environment is favorable, the value of reputation will be high. would be less in adverse conditions.

(2) Duration of business- If the business is old, then its reputation will be high.

(3) Quality of the manufactured product If the product is of good nature and quality, then it is of repute Price will be higher.

(4) Good Patents and Trade Marks – If the business has long duration and good reputation If there are patents and trade marks, the value of goodwill will be higher.

(5) Profitability – If the profit making potential of the business is high, then the value of its goodwill is also will be more.

(6) Good relations with customers The reputation of an organization having good relations with customers is high.

(7) Proper arrangement of sales and distribution – Institutions with proper arrangement of sales and distribution have more reputation.

(8) Personal image of the managers – If the owner or partner or directors of the organization If personal fame, credibility and image are good, then the value of the reputation of such institutions is also high.

(9) Attitude of financial institutions – If the financial institutions have a favorable attitude towards the institution, then goodwill value will be higher.

(10) Policy of the government- The value of goodwill is high when the import-export policy of the government is favorable to the business. Similarly, if the tax policy of the government is easy and liberal, the value of goodwill will be high. Those industries which are protected by the government, the value of their reputation is high. Also, the value of reputation is higher when there is political stability.

Methods of Valuation of Goodwill

Following are the main methods of valuation of goodwill

(1) Average Profit Method

According to this method, average is found by adding some previous profits and this average is equal to the purchase of some years i.e. multiplied by two or three years to find the value of goodwill which has the following formula

Goodwill = Average Profit x No. of Purchasing years

(2) bonus method

According to this method, if the profit of the firm is more (whose goodwill is being calculated) than the rate at which the other firm is earning profit on the same capital as has been invested in the firm, then this additional profit It is called and it is due to the characteristic of the firm itself. Often the accountants calculate it with the average profit rate of interest. The excess of average profit over interest is called super profit. This bonus is multiplied by a number specified in the partnership deed. In this way, goodwill can be evaluated whose formula is as follows-

Goodwill S. P. xn.

S.P=A.A.P.- N.P.

N.P. = Average Capital Employed x Normal Rate of Return/100

Calculation of Average Capital Employed Total Real Assets

Less: External liabilities

Net Assets

Less: Pref. Share Capital Capital Employed

Less: Half of the Current year Profit Average Capital Employed

The Actual Average Profit will be known as follows: (1) Depreciation of the increased value of the assets shall be deducted.

(2) Income of non-business investments shall not be included.

(3) Interest on loans or debentures, if not deducted from profit, shall be deducted.

(4) If the remuneration of the owner of the business has not been reduced, it shall be reduced.

(5) The amount of income tax should be deducted from the profit.

(6) Contingent profits which tend not to happen frequently, should be reduced.

(3) Capitalization of Profit Method

There are two methods of extracting goodwill by capitalization- (1) They should be capitalized by taking out the profit, thus the amount coming on capitalization is. Capitalization can be done at the rate of simple interest. Goodwill =

Bonus x 100
simple rate of interest

(ii) Goodwill can also be worked out by capitalizing the simple average profit. According to this method, after capitalizing the simple average profit, the amount left after deducting the net capital of the company from the capital is the same amount.

Fame =100 x average profit normal interest rate – Net assets

(4) Annuity method (Annuity Method)

In this method the conversion value of the amount of the dividend at a fixed rate for a reasonable period is arrived at. This value can be found from the annuity table or from the formula. This is the value of reputation. If average simple profit is taken as annuity instead of super profit, then this average

The present value of ordinary profit is worked out by the annuity table or formula. After deducting the value of net assets or capital employed from this value, the amount of goodwill is determined as follows:

(i) If the value of the annuity is less than Rs. Goodwill = Super profit x Value of annuity

(ii) if the value of the annuity exceeds Rs.1

Goodwill = Super profit X Value of annuity

 

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