Match the following in regard to method of calculation of goodwill:

1) d 2) c 3) a 4) b

* Average profit- Under average method, the goodwill is valued at agreed number of ‘years’ purchase of the average profits of the past few years. It is based on the assumption that a new business will not be able to earn any profits during the first few years of its operations. Hence, the person who purchases a running business must pay in the form of goodwill a sum which is equal to the profits he is likely to receive for the first few years. The goodwill, therefore, should be calculated by multiplying the past average profits by the number of years during which the anticipated profits are expected to accrue. So, average profit is calculated from the actual profit earned by the firm in last years.

* Super profit- The excess of actual profits over the normal profits is termed as super profits where Normal Profit = Firm’s Capital × Normal Rate of Return/100.

* Weighted average profit- If there exists an increasing or decreasing trend, it is considered to be better to give a higher weightage to the profits to the recent years than those of the earlier years. Hence, it is a advisable to work out weighted average based on specified weights like 1, 2, 3, 4 for respective year’s profit.

* Capitalisation of average profit- Under this method, the value of goodwill is ascertained by deducting the actual firm’s capital in the business from the capitalized value of the average profits on the basis of normal rate of return. This involves the following steps: (i) Ascertain the average profits based on the past few years’ performance. (ii) Capitalize the average profits on the basis of the normal rate of return to ascertain the capitalised value of average profits as follows: Average Profits × 100/Normal Rate of Return (iii) Ascertain the actual firm’s capital (net assets) by deducting outside liabilities from the total assets (excluding goodwill and fictitious assets). Firms’ Capital = Total Assets (excluding goodwill) – Outside Liabilities Where Outside Liabilities include both long term and short-term Liabilities. (iv) Compute the value of goodwill by deducting net assets from the capitalised value of average profits, i.e. (ii) – (iii)