Refer to the Category on Goodwill Valuation, you will see many methods of computing goodwill.
This article deals with one of the normal way of computing or valuing goodwill particularly in a partnership whether at the time of a new partner, or the retiring or death of an old partner.
|In this case, the goodwill valuation is based on the following steps:|
Illustration No 1:
Say Partnership A registered the following annual profits:
Year 1 : Profits $10,000 Year 2: Profits $20,000 Year 3: Profits $30,000
If goodwill is agreed to be valued as:(a) two years’ purchase of average profit for the last three years
(a) Average profit = $10,000+$20,000+$30,000 / 3 = $20,000
(b) Goodwill = $20,000 x 2 agreed years = Illustration No 2
:In the Partnership, the three partners A B C has the profit/loss sharing ratio of 2/5 ,2/5 and 1/5 respectively.In the partnership agreement, it states that in the event of death or retirement of a partner, goodwill should be valued on the basis of two years’ purchase of the average net profits for the preceding three years. Eventually Mr A retires on 31 /12 /xx.
Compute the goodwill due to Mr A.
Following net profits registered:
Year 1 : $10,000 Year 2 : $20,000 Year 3 : $30,000
Total profits for preceding 3 years = $10,000+$20,000+$30,000=$60,000
Average profit = $60,000/3 = $20,000
Total goodwill = $20,000 x 2 = $40,000
Mr A’s share of goodwill = $40,000 x 2/5 =