Patricia (C.S.- Professional) (sdd) (197 Points)
24 November 2009Hi. How to determine Goodwill by Annuity method. Pl advise in simple language.
thanks.
Monika Singhal
Ashish Ojha
(Chartered Accountant)
(469 Points)
Replied 24 November 2009
1 Rupee today in not equal to 1 rupee one year later.. This is The Concept of Time value of money. In calculating the goodwill by Annuty method the same concept is used.. We take a discount rate which takes into effect inflation, risk & other factors.. then we discount our future super profits/ Future maintainable profits by this Rate... Then we sum up all the discounted figures..
There are mathematical Formulas for above computation...
Goodwill = FMP/ Future Super profits * PVAF ( No of years, rate of discount)
Goodwill = Super Profit X Present Value of Annuity
Here,
Super Profit = average maintainable profit after tax – normal/reasonable return on capital employed
Calculation of maintainable profit (Example)
|
|
2004 |
2005 |
2006 |
|
Profit before tax |
*** |
*** |
*** |
|
Add: Abnormal Loss |
*** |
*** |
*** |
|
Less: Abnormal Income |
*** |
*** |
*** |
|
Add/Less: Stock Adjustment |
*** |
*** |
*** |
|
Add: Capital Expenditure charged to revenue |
10000.00 |
|
|
|
(-) depreciation – say 10% |
(1000.00) |
(900.00) |
(810.00) |
|
Less: Income from non trade investment (shares, securities, bond, certificate) |
*** |
*** |
*** |
|
Less: Estimated future expenditure |
*** |
*** |
*** |
|
Maintainable profit before tax |
*** |
*** |
*** |
|
|
Traditional Approach |
Leverage Approach |
|
Average Maintainable profit before tax(simple/weighted) |
*** |
*** |
|
Less: Provision for taxation (Assume 50%, if not mentioned) |
*** |
*** |
|
Add: Debenture Interest |
Net of Tax |
Full Interest |
|
Average Maintainable Profit after Tax |
*** |
*** |
Calculation of Capital Employed
|
|
|
Rs. |
|
Fixed Assets (Revalued Figure) |
|
*** |
|
Trade Investment (Market Value) |
|
*** |
|
Current Assets (Revalued Figure) |
|
*** |
|
Less: Current Liabilities (creditor, bills payable, outstanding expenses, Bank OD etc.) |
|
*** |
|
Capital Employed |
|
*** |
|
Less: ½ of current year profit after tax |
|
*** |
|
Average Capital Employed |
|
*** |
Note:
1. Income from non – trade investment is not to be considered in calculating maintainable profit
2. Debenture being long term liability, it is a part of capital employed. Hence, debenture interest is to be added back with maintainable profit
3. Current year profit should not include income from non-trade investment
4. Average capital employed is calculated when current year profit given in the balance sheet or undistributed.
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