Goodwill:

The benefit or advantage of good reputation of business, which a buyer is ready to pay the seller in response of good business reputation. It is calculated as Total Assets - Total Liabilities  (Total liabilities = External liabilities + Internal liabilities) e.g
              Total Assets        =   US$ 1000
              Total Liabilities    =   US$   600
              Net Assets value =   US$   400
 But the buyer is ready to pay the seller the amount of US$ 600 the difference between the buying price and net assets value US$ 200 is goodwill. It is written in the balance sheet as an intangible asset.

They buyer will make the following entry:-
     Total Assets          1000
     Good will                200
               Total Liabilities          600
               Capital (Net asset)    400
               Cash                         200

There are three methods of calculating the goodwill:-
1)  Average Profit Method.
2)  Super Profit Method.
3) Capitalization.

AVERAGE PROFIT METHOD. 
This is most simple method of calculating goodwill. First of all average of profit is calculated on the basis of few past years and then the result (average) is multiplied by number as 2, 3, 4, etc as agreed between both parties (seller & buyer). For example the profit of 5 years is as follow:- 20000+30000+15000+35000+20000= 120000/5 = 24000
Goodwill will be 24000 x 3 = 72000

SUPER PROFIT METHOD.
Super profit is the above of actual average profit over normal profit. Above profit means the amount which can be earned if the capital of the business was invested any other place with similar risk. Here we use super profit to calculate goodwill instead of average profit. For example you invested US$ 100000 and you can earn profit at the rate of 10% your normal profit will be US$ 10000 while your average profit is US$ 15000 then the super profit will be average profit less normal profit say 15000 - 10000 = 5000
Goodwill = 5000 x 3
We multiply super profit with 3 suppose it is agreed between seller & buyer, the 3 may be 2, 4 or 5 etc but as agreed.

CAPITALIZATION METHOD.
Here we calculate goodwill by using the following formula:-
Average profit multiply by 100 divides by %age of market rate of return.
SUPPOSE:-
Average profit                        =      25000
Market rate of return              =         16%
Capital of the firm                   =    150000
Capitalization using the formula  = 25000 x 100 / 16     =  156250
GOODWILL                           = Capitalization - Capital
                                                =      156250    -  150000   = 6250


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