Page 241 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Accounting for Companies – II

notes self assessment

State whether the following statements are true or false:
7. Goodwill is not an intangible asset.

8. If there are expected future profits less than normal profits, there will be negative
goodwill.
9. Excess of average profits over the normal profit is called super profit.

10. Goodwill calculated according to the purchase of super profit method will be more than
the goodwill calculated as per annuity method.
11. For ascertaining the value of goodwill, past profits will not need have to be adjusted
keeping in mind the future possibilities.
12. Normal rate of return is that which is decided according to the risk free-rate of interest
in government securities and the business and financial risks associated with the
investment.

11.4 factors affecting goodwill

Capacity to earn more profit over normal profits in future is the main factor in determining
the value of goodwill of a business. But there are some other factors which affect the value of
goodwill. Some important factors are given below:
1. Use of Capital: The amount of capital used in the business will affect the value of its
goodwill. If there are two business units which are earning the same profits but their
capital employed are different, that business unit will enjoy more goodwill which utilises
the lesser amount of capital.
2. Skill in Management: In some business or professions, the personal skill of the owner in
the management plays an important role e.g., success of the firm of a chartered accountant
depends upon the personal skill and ability of its owner. In these cases, goodwill of the firm
will not be higher. If the success of the business depends upon the skill of the employees
and its officials, there will be more value of goodwill.
3. Use of Patents and Trade Marks: If a firm possesses valuable patents and trademarks and
has reputation due to these it will enjoy a valuable goodwill. Here, the period for which
patents and trademarks will be used in future must be considered at the time of valuation
of goodwill. The longer the future period for the use of patents or trademark, the more will
be the value of goodwill.
4. Favourable Location or Site of the Business: A favourable location or site of a business is
sometime more important than all other factors put together. If the business is established
in the main market a of city, the site of the business will play an important role in assessing
the value of goodwill. Favourable site may be with respect of availability of raw materials
or of selling or of both, enabling the business to enjoy substantial economies through saving
in freight or through facility in sale.
5. Risk Involved in Business: If there is greater risk in a business, the amount of goodwill will
be less than those businesses in which risks is less.
6. Nature of Business: The nature of business involves the following:
(a) Nature of Goods in Business: Profit of a business depends upon the nature of goods. If
a business deals in the domestic articles of daily use, profit of such business will be
near about constant due to constant demand of the articles of daily use. The more
constant the profits, the more is the goodwill and vice versa.

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