Page 250 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Unit 11: Valuation of Goodwill

calculation of capital employed notes

`
Paid up share capital XXXX

Add: Credit Balance of P&L Account XXXX
Reserves XXXX
Profit on Revaluation of Fixed Assets XXXX
XXXX
Less: Debit Balance of P & L A/c XXXX
Loss on Revaluation of Assets XXXX
Fictitious Assets XXXX
Non-Trading Assets XXXX XXXX
Capital Employed XXXX
According to the views of some accountants, for the purpose of valuation of goodwill, the amount
of debentures or loans should also be subtracted from the total assets of the business, because
profits are considered after interest on debentures or loans. In order to make the agreement
between capital employed and profits, debentures and loans should be excluded.
Some accountants express the view that average capital employed should be used in the place of
capital employed for the purpose of valuation of goodwill. If there are given the balance sheets
of the previous years, on the basis of these balance sheets, capital employed will be calculated for
every year and then average capital employed will be calculated. If the previous years’ balance
sheets are not available, average capital employed can be calculated by adding the capital in the
beginning and capital at the end divided by 2. In another method, if half of the current year’s after
tax are subtracted from the capital at the end, or by adding the half of the current year’s profit
after tax to the capital in the beginning, average capital employed can be found.

Notes If the current year’s profits are not clearly mentioned in the liability side of the
balance sheet, in examination problems, students should presume capital employed as
average capital employed and a note should be given that question is solved through
capital employed.

Normal Profits: With the help of Normal Rate of Return and Average Capital employed, the
normal profit can be ascertained formula:
Normal Profits = Average Capital Employed × Normal Rate of Return
100

Valuation of Goodwill Based on Super Profit

There are two methods to calculate the value of goodwill based on super profit. These methods
are as below:

(i) Purchase of super profit method: Under this method goodwill of a business will be:
Goodwill = Super Profit x No. of years’ Purchase.
(ii) Valuation of goodwill according to the sliding-scale of super profit: Sliding-scale of super
profit method was advocated by A.E. Cutforth and it is based upon the theory that the
greater the amount of super profit, the more difficult it is to maintain its uniformity over

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