TS Grewal Solution Class 12 Chapter 3 Goodwill Nature and Valuation

 

Question 1. Define Goodwill.

Answer  1:  

Goodwill is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation and connections of a business. It is the attractive force which brings in customers. It is one thing which distinguishes an old established business from a new business at its first start.

 

Question 2. State any three circumstances other than (i) admission of a new partner, (ii) retirement of a partner and (iii) death of a partner, when need for valuation of goodwill of a firm may arise.

Answer  2:

The need for valuation of goodwill arises in the following circumstances:

1.)   When there is a change in the profit sharing ratio.

2.)   When partnership firm is sold as a going concern.

3.)   When two or more firms amalgamate.

 

Question 3. Give any two features of Goodwill.

Answer  3:   

Below are the features of Goodwill:-

1.)   It is an intangible asset i.e. an asset which cannot be seen and touched.

2.)   It does not have an existence separate from that of an enterprise. Thus, it has realisable value when business is sold.

 

Question 4. What is meant by Purchased Goodwill?

Answer  4:   

Purchased Goodwill is that goodwill which is acquired by a firm for a consideration, whether paid in cash of kind. For example, when a business is purchased and purchase consideration is more than value of net assets (i.e. Assets – Liabilities), the difference amount is the value of purchased goodwill.

 

Question 5. What is meant by Self-generated Goodwill?

Answer  5:

Self-generated goodwill is that goodwill which is not purchased for a consideration but is earned by the efforts of the management (or partners). It is an internally generated goodwill which arises from a number of factors (such as favourable location, efficient management, good quality of products, etc.) that a running business possess due to which it is able to earn higher profit.

 

Question 6. What is meant by Average Profit?

Answer  6:

Goodwill under Average Profit Method can be calculated either by:

(i)   Simple Average Profit Method: Under Simple Average Profit Method, normal business profits earned by the business for the specified number of years are considered. Profits earned are totalled and average is determined. Average profit as calculated is multiplied by a number of year’s purchase to determine the value of goodwill. In the form of formula, value of Goodwill = Average Profit ᵡ Number of year’s Purchase. 

(ii) Weighted Average Profit Method: It is a method whereby weight is assigned to each year and thereafter, normal business profit of each year is multiplied by the assigned weight to determine the value. Recent year’s profit being more relevant in determining value of Goodwill is assigned higher weight.

Weighted Average Profit Method is considered better as compared to Simple Average Profit Method as it gives more weightage to the profit of recent year. This method is particularly effective when profit show rising or falling trends.

 

Question 7. What are 'Super Profits?

Answer  7:

Capital employed in a business yields profit. Some of the enterprises earn more profit, while other earn less profit or incur loss on the same amount of capital employed. When a similar type of business earns profit at a certain percentage of the capital employed it called normal return. But a buyer’s advantage lies in the excess of the normal return on capital employed. It is only such enterprises which enjoy goodwill. The excess of actual profit over the normal profit is known as super profit. 

 

Question 8. What is meant by Capitalisation of Average Profit?

Answer  8:

In this method goodwill is calculated by deducting capital employed (i.e., Net Assets as on the date of valuation) in the business from the capitalised value of average profit on the basis of Normal Rate of Return.

 

Question 9. What is meant by Capitalisation of Super Profit?

Answer  9:   

In this method, goodwill is calculated by capitalising super profit at the normal rate of return. Thus, as a first step Super Profit is determined on the same basis as is determined under Super Profit Method, which is capitalised at the Normal Rate of Return to determine the value of goodwill.

 

Question 10. Why is Goodwill considered as an intangible asset but not a fictitious asset?

Answer  10:

Goodwill is a valuable intangible asset like patents, trademarks, copyrights, etc. It is not depreciated like tangible assets but is amortised over its useful life. Intangible Assets prescribes that goodwill should not be recorded in the books of account unless consideration is paid for it.

Fictitious assets are the expenses of a firm such as expenditure on formation of business, debit balance of profit and loss account, deferred revenue expenditure, etc., which are still to be charged against the profits. They all have a debit balance and cannot be considered as assets of the firm.

 

Question 11. State any two factors affecting the value of Goodwill of a firm.

Answer  11:

Goodwill of a firm is affected by all the factors which increase the earning capacity of the firm. These factors are:

(i)   Efficient Management:- If the management is experienced capable and competent, the firm will earn higher profit as compared to other firms. It will, thus, increase the value of goodwill. 

(ii) Favourable Location:- If the business is located at a favourable place, resulting in increased customer walk-in and, therefore, sale, the value of goodwill will be higher.

 

Question 12. How does the factor 'efficiency of management' affect the Goodwill of a firm?

Answer  12:

If the management is experienced capable and competent, the firm will earn higher profit as compared to other firms. It will, thus, increase the value of goodwill.

 

Question 13. How does the factor 'quality of product' affect the Goodwill of a firm?

Answer  13: 

If a firm enjoys good reputation for the quality of its products, there will be a ready sale and the value of its goodwill, therefore, will be high.

 

Question 14. How does location affect the Goodwill of a business?

Answer  14:

If the business is located at a favourable place, resulting in increased customer walk-in and, therefore, sale, the value of goodwill will be higher.

 

Question 15. How does the market situation affect the value of Goodwill of a firm?

Answer  15:

If a firm is in a business wherein demand for the products dealt in is higher than the supply, it will lead to lower capital requirement and higher profit. It will, thus, increase the value of its goodwill.

 

Question 16. How does the nature of business affect the value of Goodwill of a firm?

Answer  16:

It the business of a firm is of the nature where the products dealt in are in high demand although not short in supply, the profit will be higher. It will, thus, increase the value of its goodwill.

 

Question 17. Name any four factors which affect the Goodwill of a partnership firm.

Answer  17:

Below are the factors affecting the goodwill of a partnership firm:-

1.)   Efficient Management

2.)   Access to Supplies

3.)   Market Situation

4.)   Risk Associated with Business

 

Question 18. Give the formula for calculation of Goodwill by Capitalisation of Average Profit.

Answer  18:

 

 

Question 19. Give the formula for calculation of Goodwill by 'Capitalisation of Super Profit Method'.

Answer 19:

 

Question 20. Enumerate two main steps involved in valuing Goodwill according to Super Profit Method.

Answer  20:

 

Question 21. Suraj and Dilip are partners in a firm dealing in stationery items. The firm is well managed and advantage of being cost effective. It buys stationery items at reasonable cost from Dilip's relative manufacturer of stationery items. The firm's sale outlet is situated near a school. As a result, the firm h demand of stationery items and is earning good profits. The firm is donating 10% of its profits to the school for the education of the students of below poverty line. State any two factors affecting the goodwill of the firm. Also, identify any two values which the firm is trying to propagate.

Answer  21:

Two factors affecting the value of goodwill of the firm:

(a)   Efficiency of management

(b)   Favourable location

Two Values:

(a)   Sensitivity towards promotion of education among the student of below poverty line.

(b)   Promoting healthy trade practices in the society.

 

 

Answer 5:

Option 1:-

Goodwill under Average Profit method = Average profit per year × Years Purchase

= Rs. 14,100 × 4

= Rs. 56,400

Option 2:-

Goodwill under Average Profit method = Average profit per year × Years Purchase

= Rs. 14,125 × 4

= Rs. 56,500

Goodwill of the firm will be the higher value of the above two options i.e, 56,400 or 56,500. So the goodwill of the firm will be 56,500.

 

Working Note:-

1.     Calculation of Average profit for Five Years:-

2.     Calculation of Average profit for Four Years:- 

Question 6:   Annu, Baby and Chetan are partners in a firm sharing profit and losses equally. They decide to take Deep into partnership from 1^st April, 2019 for 1/5^th share in the future profit. For this purpose, goodwill is to be valued at 100% of the average annual profit of the previous three or four years, whichever is higher.

The annual profit for the purpose of goodwill for the past four years was:

Books of Account revealed that:

(i)            Abnormal loss of Rs. 20,000 was debited to Profit and Loss Account for the year ended 31st March, 2015.

(ii)           A fixed asset was sold in the year ended 31st March, 2016 and gain (profit) of Rs. 25,000 was credited to Profit and Loss Account.

(iii)          In the year ended 31st March, 2017 assets of the firm were not insured due to oversight. Insurance premium not paid was Rs. 15,000. Calculate the value of goodwill.

Answer 11:

Goodwill under Average Profit Method = Average Normal Profit per year × Years Purchase

 

 

Question 12:  Geet and Meet are partners in a firm. They admit Jeet into partnership for equal share. It was agreed that goodwill will be valued at three years' purchase of average profit of last five years. Profits for the last five years were:

 

Books of Account of the firm revealed that:
(i) The firm had gain (profit) of Rs. 50,000 from sale of machinery sold in the year ended 31st March, 2016. The gain (profit) was credited in Profit and Loss Account.
(ii) There was an abnormal loss of Rs. 20,000 incurred in the year ended 31st March, 2017 because of a machine becoming obsolete in accident.
(iii) Overhauling cost of second hand machinery purchased on 1st July, 2017 amounting to Rs. 1,00,000 was debited to Repairs Account. Depreciation is charged @ 20% p.a. on Written Down Value Method.
Calculate the value of goodwill.

Answer 12:

Goodwill under Average Profit Method = Average Normal Profit per year × Years Purchase

 

Point of Knowledge:-

 

Weighted Average Profit Method

 

Question 13:  Profits of a firm for the year ended 31st March for the last five years were:

Goodwill under weighted Average Profit Method

= Weighted Average profit per year × Years Purchase

 

Question 15:  Raman and Daman are partners sharing profits in the ratio of 60:40 and for the last four years they have been getting annual salaries of Rs. 50,000 and Rs. 40,000 respectively. The annual accounts have shown the following net profit before charging partners' salaries:

Year ended 31st March, 2017 – Rs. 1,40,000; 2018 – Rs. 1,01,000 and 2019 – Rs. 1,30,000.

On 1st April, 2019, Zeenu is admitted to the partnership for 1/4th share in profit (without any salary). Goodwill is to be valued at four years' purchase of weighted average profit of last three years (after partners′ salaries); Profits to be weighted as 1:2:3, the greatest weight being given to the last year. Calculate the value of Goodwill.

Answer 15:

 

Weighted Average Profit Method when Past Adjustment are Made

 

Question 16:  Calculate goodwill of a firm on the basis of three years' purchase of the Weighted Average Profit of the last four years. The profits of the last four financial years ended 31st March, were: 2016 – Rs. 25,000; 2017 – Rs. 27,000; 2018 – Rs. 46,900 and 2019 – Rs. 53,810. The weights assigned to each year are: 2016 − 1; 2017 − 2; 2018 − 3; 2019 − 4. You are supplied the following information:

(i)            On 1st April, 2016, a major plant repair was undertaken for Rs. 10,000 which was charged to revenue. The said sum is to be capitalised for goodwill calculation subject to adjustment of depreciation of 10% on Reducing Balance Method.

(ii)           The Closing Stock for the years ended 31st March, 2017 and 2018 were overvalued by Rs.  1,000 and Rs. 2,000 respectively.

(iii)          To cover management cost an annual charge of Rs. 5,000 should be made for the purpose of goodwill valuation.

Answer 16:

 

Question 17:  Dinesh and Mahesh are partners sharing profits and losses in the ratio of 3:2. They admit Ramesh into partnership for 1/4th share in profits. Ramesh brings in his share of goodwill in cash. Goodwill for this purpose shall be calculated at two years' purchase of the weighted average normal profit of past three years. Weights being assigned to each year 2017−1; 2018−2 and 2019−3. Profits of the last three years were:

2017 − Profit Rs. 50,000 (including profits on sale of assets Rs. 5, 000.)

2018 − Loss Rs.  20,000 (including loss by fire Rs. 35, 000.)

2019 − Profit Rs.  70,000 (including insurance claim received 18,000 and interest on investments and dividend received Rs. 8, 000.)

Calculate the value of goodwill. Also, calculate the goodwill brought in by Ramesh.

Answer 17:

 

 Scrutiny of books of account revealed the following: 

(i)      A second-hand machine was purchased for Rs. 5,00,000 on 1st July, 2017 and Rs.  1,00,000 were spent to make it operational. Rs. 1,00,000 were wrongly debited to Repairs Account. Machinery is depreciated @ 20% p.a. on Written Down Value Method. 

(ii)    Closing Stock as on 31st March, 2018 was undervalued by Rs. 50,000. 

(iii)   Remuneration to partners was to be considered as charge against profit and remuneration of Rs.20,000 p.a. for each partner was considered appropriate. 

Calculate the value of goodwill.  

Answer 19:

Point of Knowledge:- 

(a)   Liabilities Side Approach: 

Capital Employed = Capital + Reserve – Fictitious Assets – Non-trade Investments  

(b)   Assets Side Approach: 

Capital Employed = All Assets (except goodwill, fictitious assets and non-trade investments) – Outside Liabilities. 

 

Question 29:  Varuna and Karuna are partners for equal shares. They admit Lata into partnership for 1/4th share. It was agreed to value goodwill of the firm at 4 years' purchase of super profit. Normal rate of return is 15% of the capital employed. Average profit of the firm is Rs. 4,00,000. Balance Sheet of the firm as at 31st March, 2019 was as follows:

Average Profit = 4,00,000 (Given)

Question 36:  Ayub and Amit are partners in a firm and they admit Jaspal into partnership w. e. f. 1st April, 2018. They agreed to value goodwill at 3 years' purchase of Super Profit Method for which they decided to average profit of last 5 years. The profit for the last 5 years were:

 

Points of Knowledge: