1 2 VALUATION OF GOODWILL LEARNING OBJECTIVES After studying this chapter, you should be able to understand: ‘0 Meaning of Goodwill o Nature of Goodwill o Characteristics of Goodwill o Types of Goodwill 9 Factors Affecting Goodwill © Methods of Valuation of Goodwill © How to calculate Goodwill under Average Profits Method How to calculate Goodwill under Super Profits Method © How to calculate Goodwill under Annuity Method How to calculate Goodwill under Capitalisation of Super Profits Method How to calculate Goodwill under Capitalisation of Average Profits Method 4.0. WHAT IS THE MEANING OF GOODWILL? Goodwill is the value of reputation of a firm in respect of the profits expected in future over and above the normal profits eamed by other similar firms belonging to the same industry. Such excess of future profits over the normal profits is known as super profits. Thus, goodwill exists only when the firm earns super profits. Any firm that earns only normal profits oF is ineurrng losses has no goodwill. I time value of money is considered, goodwill can be defined as the present value of anticipated super profits. OTHER DEFINITIONS 1. “Goodwill is the difference between the value of a business as a whole and the aggregate of the fair values of its separable Net Assets”. Separable Net Assets are those assets which can be identified and sold (or discharged) separately without necessarily disposing ott-the business as a whole. This includes the identifiable intangibles. Fair value is the amount for which an asset (or liability) could be exchanged in an arm's length transaction. 2 “Goodwill is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation and connection of a business. It is the attractive force which brings in customers. It is one thing which distinguishes an old established business from a new business at its first start. Goodwill is composed of a variety of elements. It ditfers in its composition indifferent trades and in diferent businesses in the same trade. One element may preponderate here and another there.” —Lord Macnaughton In IRC Vs. Muller (1901), } | |12,2 _Tulsian’s Corporate Accounting i ment arisi 3. From the accountant's point of view, goodwill is ea ojpentsth jelemant arising om repulation, connection or olher advantages possessed by a businass Wit ropreataal earn greater profits than the return normally tobe expected on | rommally bese net assets employed in the business. In considering the return normally to Pe expect regard must be had to the nature of the business, the risk , demon, remuneration and other relevant circumstances. 2.0 WHAT IS THE NATURE OF GOODWILL? Goodwill is regarded as an intangible asset and not a fictitious esrel oa] eter arity assets it contributes to the profit earning capacity of the business. a ples Set the firm is earning profits and is a valueless asset if the firm is incurring : However, in the periods of temporary recession, the goodwill of the firm which is incurring tea losses as compared to other similar firms, may be a valuable asset. 3.0 WHAT ARE THE CHARACTERISTICS OF GOODWILL? 1. Goodwill is an unidentifiable intangible asset. 2.. Goodwill can not be sold like other identifiable and separable assets, without disposing of the business as a whole. Individual intangible factors which may contribute to goodwill cannot be valued, 4. The value of goodwill may fluctuate widely according to internal and external factors over relatively short periods of time. 5. Subjectivity is involved in the assessment of the value of goodwill. 8. The value of goodwill has no reliable or predictable relationship to any costs which may have been incurred. 2 4.0 WHAT ARE THE TYPES OF GOODWILL? 1. Purchased Goodwill Purchased goodwill is the goodwill acquired while Purchasing any business. Purchased Goodwill can be defined as being the excess of fair value of the Purchase consideration over the fair value of the separable net assets acquired. The value of purchased goodwill is not necessarily equal to the inherent goodwill of the business acquired as the purchase price may reflect the future prospects of the entity as a whole As per AS-26 only purchased goodwill should be Fecognised in the accounts. 2. Non-Purchased Goodwill/Inherent Goodwill Non-purchased goodwill is any goodwill other than purchased goodwill. 5.0 WHAT ARE THE FACTORS AFFECTING GOODWILL? The factors giving rise to goodwill are as follows: 1. Producing/providing customers satisfying products. 2. Outstanding Quality of Products, 3. After Sales Service, 4. : like Outstanding Marketing Manager/Productio Manager/Customer Relation Manager/Suppliers Relation Manager eee Relation Good relations with, (a) Govt. b) Labour (c) Customers and (d) Suppliers. Economies of Scale (Production, advertising, distribution, research, Management). 7 Cost Savings (employing technol , M ivities: Inventors Ramen logy, transaction costs, co-ordinating activi ooValuation of Goodwill 12.3 9, Financial Resources, Of borrowings and lender's risk). jo. Fiscal Incentives 41. Efficiency of Management ie productivity and cost ‘efictoney an mmenagod firm usually enjoys the advantages of high will also be high. leads to higher profits and so the value of goodwill 42. Special Advantages The firm patents, trade marks, low rate o ee enjoys special advantages like import licences, supply of materials, well-known se ssuted Supply of electricity, long-term contracts for ‘own collaborators etc. enjoy higher value of goodwill. the business is centrally located or is at a place having some }odwill tends to be high, He ae able aan ltt which produces high valuo added products or having a stable is 'o earn more profits and therefore has more goodwill. 15. Market situation The monopoly condition or limited competition enables the concern to eam high profits which leads to higher value of goodwil. 16. Management's attitude towards fulfilment of commitments (e.g. Timely delivery of goods to customers, timely payment to creditors, delivery of goods to customers at committed prices inspite of increase in market prices). 17. Technical know how. 43. Favourable Location When heavy customer traffic, the go 18. Weakness in the management of Competitors. 6.0 WHAT ARE THE METHODS OF VALUATION OF GOODWILL? The various methods of valuing the goodwill are as follows: Methods of Valuation of Goodwill Future Maintainable Super Profit Capitalisation Profit Method Method Method Time Adjusted ‘Adjusted Super Profit on-time agusted | | yetnoaicoied Super Profit Method/Annuity Method Capitalisation of Capitalisation of Super Future Maintainable Profit Method Profit Method 7.0 AVERAGE PROFIT METHOD AVERAGE PROFIT METHOD : j tiplying the Average Future Maintainabi 1 ' ; is ascertained by mul 9 inable Prageoodel under ie Ta is asthaces, tis based on the assumption tata new business vill not be cera arm profits during the first few years of Ws operations. Hence the person who MEANING OFSF 12.4 Tulsian’s Corporate Accounting r purchases an existing business has to pay in the form of Goodwill a sum equal 10 Average | Future Maintainable Profits multiplied by the number of years during which he is likely to regain the profits forthe fist few years. While calculating past profits any abnormal gain is excludey yy deducting from and any abnormal loss is excluded by adding to the past profits. t HOW TO CALCULATE GOODWILL UNDER AVERAGE PROFIT METHOD The various steps involved under this method are given below: Step 1: Calculate Past Profits before tax. Step 2: Calculate Past Adjusted Profits before tax after making past adjustments (if any), Step 3: Calculate Average Past Adjusted Profits before tax. [Note: Take Weighted Average i Past Adjusted Profits show rising or declining trend] Step 4: Calculate Future Maintainable Profits after tax after making future adjustments (i any). Step 5: Calculate Goodwill as follows: Goodwill = Future Maintainable Profits after Tax x No. of years’ purchase. HOW TO CALCULATE PAST PROFITS BEFORE TAX Particulars Year! Year Il Year Il | Year iy z z z z A._ Closing Cr. Balance of Profits and Loss A/c see eee wee i B. Less: Opening Cr. Balance of Profit and te) () CIEE Loss A/c C._Add: Appropriations: (for example) | fs Goodwill Amortised : ee : Interim Dividend Final Preference Dividend Final Equity Dividend Transfer to Reserves D._ Profits after tax | E. Add: Tax at Actual Rate [Profit after tax/t” (1-0) F.__ Profits before tax ILLUSTRATION 1 [CALCULATION OF PAST PROFITS BEFORE TAX] | Calculate Past Profits before Tax from the following information: ‘Particulars Year! | Year! | Yeari | Year! z z z cl Closing Balance of Profit and Loss Ale _|4.03;100 | 468,250 | 2.48.05 3,283,825 Opening Balance of Profit and Loss Ale Opening Balance of Goodwill Alo 6% Preference Share Capital Equity Share Capital 50,500 40,000 1,00,000 | 1,00,000 | 4,00,000 | 1,00.0% 2,00,000 | 2,00,000 | 2,00,000 | 2,00.0%‘ eae Valuation of Goodwill 12.5 Dividend Rate of Equity, - (0% 12.50% 15% 20% 21% Transfer fo Reserves (% of Prof alter Tax) 2.5% 5%| 7.5% 10% ie fo fo 5% Tats chased Gini [40% 35% 30% 30%. Goodwill was purchased during the year | which has boon amorllsed over a period of 4 years. SOLUTION COMPUTATION OF PAST PROFITS BEFORE TAX Particulars. Year! | Year! | Yearili | YearIV L z z z z A,_Closing Balance of Profit and Loss A/c _| 1,03,100| 1,68,250| 2,48,225| 3,286,625 B. Se eee Balance of Profits and| (60,500) (1,03,100) | (1,68,250) | (2,48,225) oss Ac C._Add: Appropriations Goodwill written off [% 40,000/4] Preference Dividend Equity Dividend 10,000] 10,000] 10,000] _10,000 6,000 6,000 6,000 6,000 25,000] 30,000] 40,000] _ 42,000 D. Profits after Transfer to Reserves[A-B| 93,600] 111,150] 1,35,975| 1,38,600 +C) E. % of Profit T/F to Reserves 25 5 75 10 F._ Profits after Transfer to Reserves (in %) 97.5 95 + 92.5 90 G._Profits before T/f to Reserves [D/F] 96,000] 1,17,000] 1,47,000| _1,54,000 H. ‘Add: Tax at Actual Rate [Profits attertax| 64,000|. 63,000. 63,000] 66,000 U1 -1) \_ Profits before tax 1,60,000} 1,80,000} 2,10,000] 2,20,000 HOW TO CALCULATE ADJUSTED PAST PROFITS Adjusted Past Profits for the purpose of valuation of Goodwill are calculated after rectifying errors(if any, committed in past),excluding Abnormal Profits /Losses and Income from Non— Trade Investments. Particulars Year! | Yearl! | Yeariil | YearIV z z z z Profits before Adjustments ‘Add: Abnormal Losses (e.g. Loss on Sale of Fixed Assets) Less; Abnormal Profits (0.9. Profit on Sale of Fixed Assets) Less: Income from Non-Trade Investments. ‘Add; Capital Expenditure charged to Revenue (e.g. Purchase of Machinory wrongly charged to P&L A/c) Less: Depreciation on above Fixed Asset e] => o m12.6 Tulsian’s Corporate Accounting G. Less: Capital Receipt credited to Revenue (e.g. Sale Proceeds of Machinery wrongly credited to P&L A/c) ‘Add: Depreciation on above Fixed Asset Add: Over Valuation of Opening Inventories Less: Over Valuation of Closing Inventories Add: Revenue Incomes relating to previous years not yet credited L. Less: Revenue Expenses relating to previous years not yet provided M._ Adjusted Past Profits ILLUSTRATION 2 [CALCULATION OF ADJUSTED PAST PROFITS] The result of operations during the years |, II, II and IV were: Profit € 100,000, Profit & 2,00,09) | {including an insurance claim received of % 2,50,000),Loss % 3,00,000 (after charging Loss en sale of a fixed asset of € 4,00,000), Profit € 3,25,000 (excluding % 15,000 payable for the insurance of Assets) respectively. Calculate Adjusted Past Profits of last three years, SOLUTION Al=]-]= CALCULATION OF ADJUSTED PAST PROFITS Particulars Year I Year Ill Year lV z z z Profits(Loss) 2,00,000} (3,00,000)} —_3,25,000 Less: Insurance claim received (2,50,000) ae Add: Loss on sale of a fixed asset 4,00,000 Less: Insurance Premium payable (15,000), Adjusted Past Profits (Loss) (50,000) | 1,00,000] 3, 10,000) ILLUSTRATION 3 [CALCULATION OF ADJUSTED PAST PROFITS] The result of operations during the years |, II, IIl and IV were: | Profit ¥ 12,00,000, Il Proft % 13,50,000 , Ill Profit = 18,00,000, IV Profit 22,50,000 respectively. Incomes from non-tade investments: year II ¥ 36,000, year Ill 72,000, year IV % 72,000. Calculate Adjusted Past Profi of last three years. SOLUTION CALCULATION OF ADJUSTED PAST PROFITS Particulars Year I Year lil z z Profits 13,50,000 | _48,00,000 Less: Incomes from Non-trade Investments (36,000) | (72,000) Adjusted Past Profits 13,14,000| _17,28,000 ILLUSTRATION 4 [CALCULATION OF ADJUSTED PAST PROFITS] The result of operations during the years |, Il, Ill and IV were: | Profit 12,00,000, |! rt % 13,50,000 , Ill Profit ¥ 18,00,000, 1V Profit ¥ 22,50,000 respectively.Closing inventories, Valuation of Goodwill 12.7 rer-valued by & 9,00,000 in Year I, by k Orated Past Profits of last three yea y ‘ 8,10,000 in Year Il, by % 7,29,000 in Year IV.Calculate SOLUTION CALCULATION OF ADJUSTED PAST PROFITS Particule hd Year It Year | Year IV }— S, z z Profits 13,50,000| 18,00,000| _22,50,000 Tess: Over Valuation of Closing Inventories {9,00,000) | _(6,10,000) | _(7.29,000) “Aad: Over Valuation of Opening Inventories 9,00,000| _ 8,10,000 ‘Adjusted Past Profits 4,50,000[ 18,90,000| _23,31,000 ILLUSTRATION 5 [CALCULATION OF ADJUSTED PAST PROFITS] The result of operations during the years |, I, Ill and IV were: | Profit % 12,00,000, II Profit 2 13,50,000 , III Profit % 18,00,000, IV Profit ¥ 22,50,000 respectively. Closing Inventories were under-valued by % 9,00,000 in Year 1, by % 8,10,000 in Year Ill, by % 7,29,000 in Year WV. Calculate Adjusted Past Profits of last three years. SOLUTION CALCULATION OF ADJUSTED PAST PROFITS Particulars Year Il Year Ill Year IV z z z Profits 13,50,000| _18,00,000| _22,50,000 9,00,000| _ 8,10,000| _7,29,000 (9,00,000) | _(8,10,000) 22,50,000| 17,10,000] _21,69,000 ‘Add: Under Valuation of Closing Inventories Less: Under Valuation of Opening Inventories ‘Adjusted Past Profits ILLUSTRATION 6 [CALCULATION OF ADJUSTED PAST PROFITS] The result of operations during the years |, Il, ll and IV were: | Profit 12,00,000, II Profit 7 18,50,000 , Ill Profit ¥'18,00,000, IV Profit € 22,50,000 respectively. Closing Inventories were over-valued by € 9,00,000 in Year I, under-valued by % 8,10,000 in Year Ill, over-valued by 77,29,000 in Year IV. Calculate Adjusted Past Profits of last three years. SOLUTION CALCULATION OF ADJUSTED PAST PROFITS Particulars Year! | Yearill | YearlV g z z Profits 13,50,000] 18,00,000| _22,50,000 Less; Over Valuation of Closing Inventories (9,00,000) (7,29,000) ‘Add: Over Valuation of Opening Inventories 9,00,000 ‘Add: Under Valuation of Closing Inventories. 8,10,000 Less: Under Valuation of Opening Inventorios (8,10,000) Adjusted Past Profits 4,50,000| 35,10,000[ _7,11,00012.8 Tulsian’s Corporate Accounting ILLUSTRATION 7 [CALCULATION OF ADJUSTED PAST PROFITS] The result of operations during the years 1, II, Ill and IV were: | Profit ¥ 12,00,000, 11 Py, %13,50,000 , Ill Profit 18,00,000, IV Profit & 22,50,000 respectively. In the beginning of Yo, a new machine costing ¥ 10,00,000 was purchased but wrongly charged 10 revenue. (No er, has yet been given for rectifying the same),Depreciation is charged on machine @ 1%, ¢, reducing balance method. Calculate Adjusted Past Profits of last three years. SOLUTION CALCULATION OF ADJUSTED PAST PROFITS Particulars Yearll | Yearil | Yearw z x; z Profits 13,50,000 18,00,000 22,50,000 ‘Add: Purchase of Machinery charged to P&L A/c | _10,00,000 Less: Depreciation on above machinery (1,00,000)| _(90,000)| (81,000) Adjusted Past Profits 22,50,000 17,10,000 21,69,000 ILLUSTRATION 8 [CALCULATION OF ADJUSTED PAST PROFITS] The result of operations during the years |, Il, Ill and'IV were: | Profit = 12,00,000, 1! Proft % 13,50,000, III Profit % 18,00,000, IV Profit % 22,50,000 respectively. In the beginning of Yeer 11a machine having a book value of % 10,00,000 was sold for % 13,00,000 but the proceeds were wrongly credited to Profit and Loss Account. (No effect has yet been given for rectifying Ahe same). Depreciation is charged on machine @ 10% on reducing balance method. Calculate Adjusted Past Profits of last three years. SOLUTION | CALCULATION OF ADJUSTED PAST PROFITS | Particulars Year Il Year it | YearlV z z z Profits 13,50,000| 18,00,000] —22,50,000, Less: Sale of Machinery Cr to P&L Alc (13,00,000) [es ‘Add: Depreciation on above machinery 1,00,000 90,000 81,000 Adjusted Past Pri its 1,50,000} 18,90,000| —23,31,000 The result of operations during the years |, II, Ill and IV were: | Profit % 12,00,000, I Prof % 13,50,000 , Ill Profit % 18,00,000, IV Profit ¥ 22,50,000 respectively. 10% Investments (Fac? Value % 8,00,000) appear in the balance sheet as at Year /Vat ¥ 10,00,000. Of the Investmen's 10% is trade and the balance non-trade. 50% of the non-trade Investments were acquired on the beginning of Year III and the rest in the beginning of Year I. Calculate Adjusted Past Profits | I | ILLUSTRATION 9 [CALCULATION OF ADJUSTED PAST PROFITS] | of last three years. |a Valuation of Goods c ‘ALCULATION OF ADJUSTED PAST PROFITS Particulars Year I Year ill Year IV z z z 13,50,000| 18,00,000 | _22,50,000 | (36,000) | _(72,000)| __(72,000) 13,14,000[ 17,286,000] _21,78,000 Profits Tess:incomes from Non-trade Investments ‘adjusted Past Profits ILLUSTRATION 10 [CALCULATION OF ADJUSTED PAST PROFITS] From the following information Calculate Adjusted Past Profits of last three years: (a) The result of operations during the years 1,1, Ill and IV were: | Profit % 12,00,000, I! Profit % 13,50,000 , III Profit % 18,00,000, IV Profit % 22,50,000 respectively. (0) 10% Investments (Face Value ® 8,00,000) appear in the balance sheet as at Year IV at % 10,00,000. Of the Investments 10% is trade and the balance non-trade. 50% of the non-trade Investments were acquired on in the beginning of Year Ill and the rest in the beginning of Year II (0) Inthe beginning of Year Ila new machine costing % 10,00,000 was purchased but wrongly charged to revenue. (No effect has yet been given for rectifying the same).Depreciation is charged on machine @ 10% on reducing balance method. (@) In the beginning of Year Il a machine having a book value of % 10,00,000 was sold for % 13,00,000 but the proceeds were wrongly, credited to Profit and Loss Account. (No effect has yet been given for rectifying the same). Depreciation is charged on machine @ 10% on reducing balance method. (e) Closing Inventories were over-valued by € 9,00,000 in Year I, under-valued by & 8,10,000 in Year Ill, over-valued by & 7,29,000 in Year IV. SOLUTION CALCULATION OF ADJUSTED PAST PROFITS Particulars Year I! Year Ii Year IV z z z Profits 13,50,000| _18,00,000| 22,50,000 Less: Incomes from Non-trade Investments (36,000) (72,000) | __ (72,000) ‘Add: Purchase of Machinery charged to P&L A/c] 10,00,000 Less: Depreciation on above machinery (1,00,000) (90,000) | (81,000) Less: Sale of Machinery Cr to P&L Ac (13,00,000) Add: Depreciation on above machinery 1,00,000 90,000| 81,000 Less: Over Valuation of Closing Inventories _| _(9,00,000) (7,29,000) ‘Add: Over Valuation of Opening Inventories 9,00,000 ‘Add: Under Valuation of Closing Inventories. 8,10,000 | Less: Under Valuation of Opening Inventories (8,10,000) Adjusted Past Profits 1,14,000 | _34,38,000| _6,39,00012.12 Tulsian’s Corporate Accounting | Vv 2,05,990 4 8,23,960 ~ | 7 10 19,66,460 >} | | Weighted Average of Past Adjusted Profits = Total Weighted Profits/Total of Weights = 19,66,460/10 = 1,96,646 Note: The loss during the year | occurred due to a prolonged strike and hence the year | bein abnormal year has been ignored while computing average. HOW TO CALCULATE FUTURE MAINTAINABLE PROFITS (FMP) AFTER TAX Future Maintainable Profits after Tax for the purpose of valuation of Goodwill are calculated ate, excluding Incomes eamed in the past but not likely to be eared in the future and Expense, incurred in the past but not likely to be incurred in the future but including Incomes not eame d in the past but likely to be eared in the future and Expenses not incurred in the past but likely to be incurred in the future, Particulars ie Average Past Adjusted Profits ‘Ada: Incomes not earned in the past but likely to be earned in the future (e.g. Advantage from any future contract) | | | | C. Less: Incomes earned in the past but not likely to be earned in the future (e.g. | Discontinuance of Advantage from any past contract) | D. Add: Expenses incurred in the past but not likely to be incurred in the future | | (e.g. Rent of a Rented Building after the purchase of owned Building) | E. Less: Expenses not incurred in the past but likely to be incurred in the future | (e.g. Increase in managerial remuneration, Additional Depreciation on increase | in value of Fixed Assets) F. Future Maintainable Profits before Tax (FMPBT) Less: Tax at likely Future Rate on(FMPBT + Additional Depreciation) H. Future Maintainable Profits after Tax | | | | Note: Additional depreciation on increase in value of fixed assets is not deductible u/s 32 fo Tax purposes. ILLUSTRATION 14 [CALCULATION OF FUTURE MAINTAINABLE PROFITS (FMP) AFTER TAX) Caloulate Future Maintainable Profits after Tax (as on 1.4,2023) from the following information: (a) Average’ Adjusted Past Profits before Tax % 23,00,000. (6) (c) Additional Revenue Expenditure with effect from 1st April, 2023. % 1,00,000 p.a. Profits till 2022-2023 have been ascertained after debiting % 10,00,000 as remuneration to the managing director. The Government has approved a remuneration of @ 12,0000 with effect from 1st April, 2023. (4) The company has been able to secure a contract for supply on materials at advantageo!® prices. The advantage has been valued at % 4,00,000 P.a. for the next five years. (e). The income tax rate is likely to be 25% from 1st April, 2023 onwards.ft rea Particulars ‘A._ Average Past Adjusted Profits s B._Less: Additional Revenue Expenditu re ed G._Less: Increase in M.D remuneration oe D._ Add: Advantage from contract “0a000 on zn a (6,00,000) G._Future Maintainable Profits after Tax 18,00,000 ILLUSTRATION 15 Bharat Tulsian Ltd. provides you the following information: 1. Profits/Losses after tax @ 40%: 2018-2019 2019-2020 2020-2021 2021-2022 2022-2023 Losses Profits Profits Profits Profits 5,50,000 9,04,320 12,04,320 15,04,320 18,04,320 The loss in 2018-2019 occurred due to a prolonged strike. 2. Incomes from non-trade investments % 7,200 p.a. 3. In 2020-2021 a machine having a book value of ¥ 10,000 was sold for € 11,000 but the proceeds were wrongly credited to Profit and Loss Account. (No effect has yet been given for rectifying the same). Depreciation is charged on machine @ 10% on reducing balance method. 4. Closing Inventories were undervalued by € 10,000 in 2020-2021, by ¥ 9,100 in 2021- 2022, by % 8,290 in 2022-2023. 5. With effect from 1st April, 2023, there will be increase in manager’s remuneration of % 2,00,000 p.a. and Advantage from new contract for supply of goods of ¥ 4,00,000 p.a. 6. Rate of Income Tax 30% with effect from 1st April, 2023. Required: Calculate the Value of Goodwill at 3 years’ purchase of average profits. SOLUTION Note: The year 2018-2019 has been treated as abnormal year and hence ignored. STEP 1: CALCULATION OF PAST ADJUSTED PROFIT BEFORE TAX Particulars 2019-2020 | 2020-2021 | 2021-2022 | 2022-2023 zg g Stu g [Profits after tax 9,04,320 | 12,04,320| _15,04,320| 18,04,320 Profits before tax [A/60%] 15,07,200 | 20,07,200 | _25,07,200] _30,07,200 Less: Income from non-trade (7,200) (7,200) (7,200) (7,200) L__investments12.14 Tulsian's Corporate Accounting Less: Sale proceeds of machinery —J| (11,000) _ i wrongly credited nis Add: Depreciation on above machinery = 1,000 za a Add: Under valuation of Closing = 10,000 , 8.209 Inventories = Less: Under valuation of Opening pe —| (10,000) (9,109) Inventories Past Adjusted Profit 15,00,000[ 20,00,000 | 25,00,000 | _30,00,099 OFITS ‘STEP 2: CALCULATION OF AVERAGE PAST ADJUSTED PRI [WEIGHTED AVERAGE SINCE PAST ADJUSTED PROFITS SHOW RISING TREND) Year Profits Weights Weighted Profits A B c. D=B‘C 2019-2020 15,00,000 1 15,00,000 2020-2021 20,00,000 2 40,00,000 2021-2022 25,00,000 3 75,00,000 2022-2023 30,00,000 4 1,20,00,000 Total 10 2,50,00,000 Weighted average of Past adjusted profits = Total Weighted Profits/Total of Weights = 2,50,00,000/10 = ¥ 25,00,000 ‘STEP 3: CALCULATION OF FUTURE MAINTAINABLE PROFITS AFTER TAX Particulars z Average Past Adjusted Profits 25,00,000 Less: Increase in manager's remuneration p.a. (2,00,000) Add: Advantage from contract p.a. 4,00,000 Future Maintainable Profits before Tax 27,00,000 Less: Tax @ 30% (8,10,000) LF. Future Maintainable Profits afler Tax 18,90,000 Step 4: Goodwill = Future Maintainable Profits x No. of years’ purchase = % 18,90,000 * 3 = % 56,70,000 ILLUSTRATION 16 Mr. X purchased a building for ® 10,00,000 and let out to Mr. Y on a rent of & 10,500 p.m for business the profits of which are as follows: Year | Profit after tax @ 40 % | [3,60,000 (excluding % 2,00,000 payable for the insurance of Plant and Machinery) II {600,000 (including profit of ®1,50,000 on sale of fixed asset) {il | 3,00,000 (after charging loss of € 2,00,000 on sale of a fixed asset) building.Valuation of Goodwill 12.15 peau! alculate the value of goodwil ofits for the last three years if Landlord On the b; Feome tax rate is likely to be 30%, wants to ‘Asis of four years’ purchaso of the average Irom year WV ony Purchase the business of tenant. Assuming wards, OLUTION STEP 1; CALCULATE PAST PROFITS BEFORE TAX. Particular % Year! | Year | Year it ‘A. Profits after tax & x z 3,60,000| 6,00,000 | _3,00,000 B._Add: Tax (profits after tax x 40%/60%) zvan goollaia ov pooll a2 001000 fits before T ail 0 001 G._ Profs Ls 6,00,000 | 10,00,000} 5,00,000 STEP 2: PAST ADJUSTED PROFITS BEFORE TAX vom Profit | (6,00,000 — 2,00,000) = 4,00,000, MN (10,00,000 = 1,50,000) = 8,50,000 MW (5,00,000 + 2,00,000) = 7,00,000 Total 19,50,000 Step 3: Average Past Adjusted Profits = % 19,50,000/3 = & 6,50,000 Step 4: Future Maintainable Profits Future Maintainable Profits = € 6,50,000 + ® 1,26,000 (Rent) 750,000 (Dep.)| _% 7,20,000 76,000 (Ins.) Less: Tax @ 30% Future Maintainable Profits after tax %2,16,000 %5,04,000 Step 5: Goodwill at 4 years’ purchase of Average Profit = % 5,04,000 x 4 = € 20,16,000 Note: Rent is no longer payable and depreciation & insurance are likely to be claimed. ILLUSTRATION 17 Tushar Tulsian Ltd. provides you the following information: 1. Profits and Losses after tax @ 40%: 2018-2019 2019-2020 2020-2021 (2021-2022 2022-2023. Losses Profits Profits Profits Profits 5,50,000 9,00,000 12,02,160 15,04,320 18,04,320 The loss in 2016-2019 occurred due to a prolonged strike, 8% z 1,00,000) appear in the balance shoot as at 31.12.2022 at F 80,000 OF stmente were acquitod on 1.4.2021 and tho rest on 1.4.2020, All rade Investments are to be valued al 10% bolow cost. machine costing & 1,00,000 was purchased but wrongly charged to a 20202021 a ret nas yot boon givon for rocying the same) Depraciation is charged revenue. (NO ee “@ 10% on raducing balance mothod.42.16 Tulsian's Corporate Accounting 4. Closing Inventories were over-valued by £90,000 in 2020-2021, 2022, by % 72,900 in 2022-2023. ,000 not yet provided in the acco 5. Disputed Bonus claim of % 1,00 expected to be settled. 6. In 2022-2023 some ol % 1,50,000. 7. With effect from ‘st April, 2023, there €2,00,000 p.a.,Advantage from new con! ‘Additional Revenue Expenditure of € 1,50,000 p.a. 8. Rate of Income Tax 30% with effect from 1st April, 2023. 4 Furniture having a book value of will be increase in mana: Required: Calculate the Value of Goodwill at 3 years’ purcha: SOLUTION Note: The year 2018-2019 has been treated as abnormal year and he! STEP 1: CALCULATION OF PAST ADJUSTED PROFIT BE! tract for supply of goods of & by % 81,000 in 299, ints for 2022-2029 , % 2,50,000 Was sold fo, \gor’s remuneration ¢ 4,00,000 pa. ang se of average profits. nce ignored. FORE TAX Particulars LLUSTRATION 19 [Calculation of Capital Employed and Average Capital Employed When only one year’s Assets and Liabil ies are given] Given below are the extracts from the Balance Sheets of TULSIAN Ltd. as at 31st March, 2022 BE Particulars z Equity Share Capital (Shares of ® 10 each) 40, 00,000 12% Preference Share Capital (Shares of ® 100 each) 10,00,000 | eserves and Surplus . 20,00,000) ! 10% Debentures[60% Debentures are to be redeemed prior to valuation of 20,000" | Goodwill] Current Liabilities 40,00,000 Goodwill Propel lant & Equipment [10% Trade Investments [Face Value ® 6 00,000] Current Assets