266 . [CH.6] PARTNERSHIP ACCOUNT (I) PROFIT DISTRIBUT^
METHODS OF VALUATION OF GOODWILL
No accurate formula can be laid down for the measurement of the value of goodwill. The value! goodwill depends upon the nature of a particular business and die circumstances connected with it.
Various methods are advocated for the valuation of goodwill. In many cases the method adoptedpurely arbitrary one and is often .governed by the custom of the particular trade in which the businealengaged. The more usual bases of valuation are as follows: . ]
1. Average profits method I
The average profits of given number of a past years multiplied by an agreed number is consideredbe the value of goodwill. Thus 'three years' purchase of average profits of the last five years is commaspoken of as the basis upon which goodwill is to be valued. The average profits of a given number of years is multiplied by an agreed number of years to arrive at the value of goodwill. This method is palarbitrary and will frequently produce a figure for goodwill out of all proportions to its true value.Suppose the goodwill is to be valued on 3 years purchase of the average profits of the last five years.
The profits earned during the last five years are Rs. 13,000, Rs. 10,000, Rs. 12,000, Rs. 15,000 and!
20,000. The goodwill be valued as follows: 1
Year Profit(Rs.) I
Istyear 13,000 1
2nd year 10,000 J
3rdyear 12,000 1
4th year 15,000 1
5th year . 20,000 1
Total profits 70,000 fl
. • • ' . - •
Average profits: 70,000-5-5 = Rs. 14,000 •
Value of goodwill (being three years purchase of the average net profits for five jdl= 14,000x3 = 42,000. «
2. Superprofits method • . •
Super profits of a business are the profits which can be expected in the future over and above tflnecessary to pay a fair return upon the capital invested in the business, having regard to the risk invohpflthat particular business and a fair remuneration for the services of the partners who work therein. SMprofits is the excess of actual profits over normal profits. The normal profits are calculated by mnllijilJthe average capital employed with the rate of general expectation. The super profits iBnis calculatedmultiplied by an agreed figure to find out the value of goodwill. •
Suppose a firm earned net profits during the last five years as follows: •
Istyear • 2nd year 3rd year 4th year ,5th year __
Rs. 7,000 Rs, 6,500 Rs. 8,000 ^Rs. 7,500,- Rs. 6,000 1