Question

Under the capitalization method the formula for calculating the goodwill is

Answer 1

Goodwill under this method can be calculated by capitalizing average normal profit or capitalizing super profits.

(i) Capitalisation of Average Profit Method:

Under this method goodwill is ascertained by deducting Actual Capital Employed (i.e., Net Assets as on the valuation date) from the capitalised value of the average profits on the basis of normal rate of Return (also known as value of the firm or capitalised value of business)

Goodwill = Capitalised Value – Net Assets of Business

Steps involved in calculating goodwill as per capitalisation of Average Profits Method:

Step 1: Calculate Average future maintainable profits

Step 2: Calculate Capitalised value of business on the basis of Average Profits


Step 3: Calculate the value of Net Assets on the valuation date

Net Assets = All Assets (other than goodwill, fictitious assets and non-trade investments) at their current values – Outsider’s Liabilities

Step 4: Calculate Goodwill

Goodwill = Capitalised Value – Net assets of business.

(ii) Capitalisation of Super Profit Method:

The goodwill under this method is ascertained by capitalizing the super profits on the basis of normal rate of return. This method assesses the capital needed for earning the super profit.

Answer 2

Super profits divided by the rate of return