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


FEEDBACK ABOUT ANY MISTAKE WILL HIGHLY BE APPRECIATED.


 

Goods or Merchandises:

Something that has been purchased or manufactured by the trader for resale purpose is called goods or merchandises e.g you deals in sugar and for this purpose you bought sugar, this sugar will be called goods or merchandises.

Going Concern Concept:

In this concept it is assumed that business will remain in continue for an indefinite time period, there is no plan to liquidate the business in the foreseeable future.

Fluctuating Capital:

The capital account of partners which do not remain constant. In this method entries relating to interest on capital, interest on drawings, or partners salaries are passed through capital accounts of partners.

Financial Statements:

The statements that show the financial position of the business entity is known  as financial statements e.g Cash flow statement, Trading & Profit & Loss A/C, Balance Sheet.

Factitious Assets:

The assets having no market value is called factitious assets e.g preliminary expenses, loss on issue of shares, bonds etc.

Fixed Liabilities:

The liabilities which are repayable after a long period of time is called fixed liabilities e.g bonds, loans etc.

Fixed Assets:

The assets which are having long life and are used in business for long period of time e.g Land, Building, Vehicle, Furniture & Fixture etc.

Error of Casting:

An error which is made during making the total of an account e.g we made total more or less instead of actual.

Error of Principle:

Error which is made in the fundamental principles of accounting is called error of principle. e.g we bought machinery and we record in purchase account instead of machinery account.

Error of Trial Balance:

An error which is made during the preparation of trial balance is called error of trial balance.

Error of Book Keeping:

An error which is made in the original books of account or in original documents is called error of book keeping.

Error of Posting:

If amount is posted on the wrong side of same account is known as error of posting e.g we sold goods to Aslam and we post the sale amount on the credit side of Aslam account instead of Debit side.

Error of Commission:

If a transaction is recorded in wrong account instead of right account of same class, is known as error of commission e.g we sold goods to Naveed and record in Zahid account.

Error of Omission:

If a transaction totally omitted to record in the original books of accounts is called error of omission e.g if we purchase some merchandise and we omit to record this transaction in the books it will be called an error of omission.

External Liabilities:

The amount that is payable by the business to the outsiders is called external liabilities.