Normal rate of return

, x = ` , , . . Capitalisation method Under this method, goodwill is the excess of capitalised value of average profit of the business over the actual capital employed in the business. Goodwill = Total capitalised value of the business – Actual capital employed The total capitalised value of the business is calculated by capitalising the average profits on the basis of the normal rate of return.

Average profit Capitalised value of the business = x Normal rate of return Actual capital employed = Fixed assets (excluding goodwill) + Current assets – Current liabilities Illustration From the following information, find out the value of goodwill by capitalisation method: (a) Average profit = ` , (b) Normal rate of return = % (c) Capital employed = ` , , Average profit Total capitalised value of the business = x Normal rate of return , x = ` , , Goodwill = Total capitalised value of the business – Capital employed = , , – , , = ` , , Goodwill based on capitalisation of average profit method and capitalisation of super profit method will give the same amount of goodwill. Points to remember Goodwill is the good name or reputation of the business which brings benefit to the business. It is an intangible fixed asset. Following are the circumstances that require valuation of goodwill of partnership firms in order to protect the rights of the partners: When the profit sharing ratio is changed, when a new partner is admitted into a firm, when an existing partner retires from the firm or when a partner dies and when a partnership firm is dissolved Goodwill may be classified into acquired goodwill and self-generated goodwill.

Following are the methods generally followed to value goodwill: Average profits methods, super profit methods and capitalisation method Self-examination questions I Multiple choice questions Choose the correct answer . Which of the following statements is true? (a) Goodwill is an intangible asset (b) Goodwill is a current asset (c) Goodwill is a fictitious asset (d) Goodwill cannot be acquired . Super profit is the difference between (a) Capital employed and average profit (b) Assets and liabilities (c) Average profit and normal profit (d) Current year’s profit and average profit .

The average rate of return of similar concerns is considered as (a) Average profit (b) Normal rate of return (c) Expected rate of return (d) None of these . Which of the following is true? (a) Super profit = Total profit / number of years (b) Super profit = Weighted profit / number of years (c) Super profit = Average profit – Normal profit (d) Super profit = Average profit × Years of purchase . Identify the incorrect pair (a) Goodwill under Average profit method - Average profit × Number of years of purchase (b) Goodwill under Super profit method - Super profit × Number of years of purchase (c) Goodwill under Annuity method - Average profit × Present value annuity factor (d) Goodwill under Weighted average - Weighted average profit × Number of years of profit method purchase .

When the average profit is ` , and the normal profit is ` , , super profit is (a) ` , (b) ` , (c) ` , (d) ` , . Book profit of is ` , ; non-recurring income included in the profit is ` , and abnormal loss charged in the year was ` , , then the adjusted profit is (a) ` , (b) ` , (c) ` , (d) ` , . The total capitalised value of a business is ` , , ; assets are ` , , and liabilities are ` , . The value of goodwill as per the capitalisation method will be (a) ` , (b) ` , (c) ` , , (d) ` , Answers (a) (c) (b) (c) (c) (c) (a) (d) II Very short answer questions .

What is goodwill? . What is acquired goodwill? .

What is super profit? What is normal rate of return? State any two circumstances under which goodwill of a partnership firm is valued. III Short answer questions .

State any six factors determining goodwill. . How is goodwill calculated under the super profits method? .

How is the value of goodwill calculated under the capitalisation method? . Compute average profit from the following information. : ` , ; : ` , ; : ` ,