Goodwill ~ Super profit Method

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 Super profit methods

 

Under these methods, super profit is the base for calculation of the value of goodwill. Super profit is the excess of average profit over the normal profit of a business.

Super profit = Average profit – Normal profit

 

Average profit is calculated by dividing the total of adjusted actual profits of certain number of years by the total number of such years. Normal profit is the profit earned by the similar business firms under normal conditions.

 

Normal profit = Capital employed × Normal rate of return Capital employed = Fixed assets + Current assets – Current liabilities

 

Normal rate of return = It is the rate at which profit is earned by similar business entities in the industry under normal circumstances

 

(a) Purchase of super profit method

Under this method, goodwill is calculated by multiplying the super profit by a certain number of years of purchase.

Goodwill = Super profit × Number of years of purchase

 

(b) Annuity method

Under this method, value of goodwill is calculated by multiplying the super profit with the present value of annuity.

Goodwill = Super profit × Present value annuity factor

Present value annuity factor is the present value of annuity of rupee one at a given time. It can be found out from annuity table or by using formula.

Annuity refers to series of uniform cash flows at regular intervals. The table value gives the present value of annuity of rupee one received at the end of every year for a specified number of years.

The following formula is used to compute annuity factor:

(c)  Capitalisation of super profit method

Under this method, value of goodwill is calculated by capitalising the super profit at normal rate of return, that is, goodwill is the capitalised value of super profit.

 

Goodwill =                Super profit           ´100

                                     Normal rate of return


Click here for Video Notes https://www.youtube.com/watch?v=SeDAQJq9_pw



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