what is the need for the valuation of goodwill?

The valuation of the Goodwill of a sole proprietorship is done when the business is being sold, but in case of a partnership firm and a joint stock company goodwill can be sold to some another business entity without selling the whole business. Hence when you are going to sell the goodwill of your business, you should be assured of the value of your goodwill at that particular time.

In case of a Partnership firm, there is a need for the valuation of Goodwill of the Firm in the following cases:

1) In the case of a change in the profit sharing ratio of the firm;

2) In case of admission of a new partner;

3) In case of retirement or death of an old partner;

4) In case of Sale / amalgamation of the firm.

In case of a Joint Stock Company, Goodwill is valued in the following circumstances:

1) In case of amalgamation of two or more companies;

2) In case of taking over of business of a company by another company;

3) In case of taking over the business of the company by Government;

4) In case of conversion of shares of one class into another;

5) If a company wants to acquire conrol of another company;

6) In case of valuation of shares of the company for taxation purposes, if stock exchange quotations are not available.

Methods of Valuation of Goodwill – Weighted Average Profit Method

Weighted Average Profit Method

The Weighted Average Profit Method is an improvement over Simple average Profit Method. Under this method Weights are assigned to each year’s profit.For calculating Goodwill, the Profits of each year are multiplied with the respective weight assigned to that particular year. Usually more weightage is assigned to recent years. The product of the profits with weights is added. This sum of products is then divided by the total number of weights. This method is suitable in case of a rising trend of profits.

Formula: Weighted Average Profit = Sum of Weighted profits / Sum of weights

Value of Goodwill = Weighted Average Profits × No. of Years’ Purchase