Page 257 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Accounting for Companies – II

notes form of super profit. But super profits are made in future and he pays for goodwill immediately
upon purchase of business.

Example: The super profits of a business are ` 50,000 and the number of years of purchase
is decided at 3. Then, value of goodwill will be ` 1,50,000 as per super profit method. This value
will be paid by the purchaser to the vendor immediately at the time of purchase of business and
this amount will be reimbursed fully by the business to him in the form of super profit in the
coming three year (or ` 50,000 per annum). But in this case he is not being fully reimbursed,
because he paid ` 1,50,00 immediately on the purchase of business and he is receiving ` 50,000
annually (in instalments). Thus, the purchaser is suffering a loss of interest on ` 1,50,000.
Therefore, the amount of goodwill should be equal to the present value of future returns. For this
purpose the super profits are discounted at the normal rate to return. This procedure is called the
annuity method of super profit. The present value of ` 1 paid annually can be determined with
the help of Annuity Table or a formula.

Notes Here, it should be noted that super profits of the business are not multiplied
by the number of years’ purchase. But it is multiplied by the present value of ` 1 paid
annually at the normal rate of return to calculate the value of the goodwill.

Goodwill = Super Profit × Reference to Annuity Table
Generally, in examination problems, the present value is given to calculate the value of goodwill
if, not given, can be calculated with the help of following formula:

 r  n  1 − 1 
 1 +   ( + i ) n 
1
= −A 1  100   − or 
r  i 
100    
where A = present value of ` 1 paid annually

i or r = value of interest in per cent.
n = number of years.
To ascertain the value of goodwill, under this method, the present value of Re 1 paid annually
can be multiplied by the super profit or average profit. If average profit is multiplied by present
value of Re. 1 paid annually, product will be the present value of the business. And to calculate
the value of goodwill, capital employed is subtracted from this product.

!
Caution In case of annuity method, if present value of ` 1 paid annually is multiplied by the
average profit then the product will be considered as the present value of the business.
Illustration 8 (Annuity Method of Super Profit)
From the following particulars, calculate the value of goodwill of XYZ as per annuity method:
(i) Net Profit: 2009 ` 1,05,000, 2010 ` 97,000 & 2011 ` 1,08,000.

(ii) The average capital employed in the business is ` 5,00,000.
(iii) Return expected from invested capital having regard to risk involved is 10%.
(iv) An amount of ` 900 is included in the profits of 2010, which has been recovered from a
debtor whose account had been written as bad several years before.

252 lovely professional university