Accounting for Partnership : Basic Concepts Important Questions for CBSE Class 12 Accountancy valuation and Treatment of Goodwill
1. Meaning of Goodwill Goodwill means the good name or reputation of a business earned by a businessman through his hard work and honesty. This helps the business to earn more profit.
2. Methods of Valuation of Goodwill
(i) Average profit method
Under this method, goodwill is valued on the basis of simple average or weighted average of profits of the firm multiplied by the number of years’ of purchase.
Value of Goodwill = Average Profit x Number of Years’ Purchase
NOTE
Any abnormal gain or abnormal loss should not be taken into consideration while calculating the average profit.
(ii)
Super profit method
In any business a certain amount or percentage of profits is normally expected. But in practice, we may earn more than normal profit or we may earn less than that normal profit. Excess of actual profits over the normal profit is called super profit.
Super Profit = Average Profit – Normal Profit
Value of Goodwill = Super Profit x Number of Years Purchase
(iii)
Capitalisation of average profit
In this method, goodwill of the firm is calculated by deducting actual capital employed from the capitalised value of average (actual) profits on the basis of normal rate of return.
Capitalised Value of Average Profit = Average Profit / Normal Rate of Return x 100
(iv)
Capitalisation of super profit method
In this method, goodwill is calculated by the capitalisation of super profit on the basis of normal rate of return.
Value of Goodwill = Super profit / Normal Rate of Return x 100
Previous Years Examination Questions
1 Marks Questions
1. How does the nature of business affect the value of goodwill of a firm? (All India 2011)
Ans.
The firm that produces high value products and has stabilised demand, will be able to earn more profit and more goodwill.
2. What are super profits? (Delhi 2011c)
Ans.
Super profit is the excess of actual average profit over the normal profit.
i.e. Super Profit = Actual Profit – Normal Profit
3. How does the factor ‘quality of product’ affect the goodwill of a firm? (Delhi 2010)
Ans.
If the firm enjoys good reputation for its product quality, there will be higher sales and the value of its goodwill will increase.
4. How does the factor ‘efficiency of management’ affect the goodwill of a firm?
(All India 2010)
Ans.
When the management of a firm is capable and competent, the firm will earn higher profits therefore the ‘efficiency of management’ surely will affect or increase the goodwill.
5. How does the factor location affect the goodwill of a firm? (Delhi 2010)
Ans.
The value of business will be more, if it is located in a convenient or prominent locality.
6. Define goodwill? (All India 2008)
Ans.
Goodwill means the good name or reputation earned by a businessman through his hard work and honesty. This helps the business to earn more profit.
2 Marks Question
7. Explain any two methods for valuation of goodwill. (Delhi 2008C)
Ans.
The two methods for valuation of goodwill are as follows
(i) Average Profit Method of Valuation of Goodwill
Under average profit method, goodwill is valued on the basis of simple average or weighted average profits of the firm, multiplied by the number of years’ of purchase.
Average Profit =Total Profit (after adjustments) / Number of Years
Goodwill = Average Profit x Number of Years’ of Purchase.
(ii)
Valuation of Goodwill by Capitalisation of Super Profit Method
Under this method, goodwill is the capitalised value of super profits. For calculating goodwill, the following steps are followed
(a) Ascertain the average profits based on the past few years’ performance.
(b) Calculate normal profit on capital employed by applying normal rate of return.
(c) Calculate super profits by deducting normal profit from average profits.
Goodwill = Super Profit x 100 / Normal Rate of Return
3/4 Marks Questions
8. A business earned average profits of Rs. 1,00,000 during the last few years. The normal rate of return in similar type of business is 10%. The assets of the business were Rs. 10,00,000 and external liabilities was Rs. 1,80,000. Calculate the value of goodwill of the firm by super profit method, if the goodwill is valued at 2. 1/2 years’ purchase of super profits.
9. A business has earned average profits of Rs. 1,00,000 during the last few years and the normal rate of return in similar business is 10%. Find out the value of goodwill by
(i) Capitalisation of super profit method.
(ii) Super profit method, if the goodwill is valued at 3 years’ purchase of super profit. The assets of the business were Rs. 10,00,000 and its external liabilities Rs. 1,80,000.
(Delhi 2011)
10. A partnership firm earned net profits during the last 3 years as follows
The capital employed in the firm throughout the above mentioned period has been Rs. 4,00,000. Having regard to the risk involved, 15% is considered to be a fair return on the capital. The remuneration of all the partners during this period is estimated to be Rs. 1,00,000 per annum.
Calculate the value of goodwill on the basis of
(i) 2 years’ purchase of super profits earned on average basis during the above mentioned 3 years and
(ii) By capitalisation method.
Important Questions for Class 12 Accountancy
Class 12 Accountancy
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