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Ch 2 · Partnership · T.S. Grewal — Double Entry Book Keeping

Goodwill — Nature
and Valuation

75 MCQs 50 Flashcards T.S. Grewal Class 12 Updated May 2026
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Chapter Overview

Chapter 2 introduces Goodwill — the monetary value of a firm's reputation. Goodwill is an INTANGIBLE asset that lets a firm earn more than the normal rate of return on its capital, and it arises from factors like customer loyalty, location, quality of products, management efficiency and capital adequacy. The chapter distinguishes self-generated goodwill (built up over years and never recorded) from purchased goodwill (paid for when one business buys another and recognised in the books at cost).

The bulk of the chapter is the valuation of goodwill, applied at every reconstitution event — admission of a partner, retirement or death of a partner, change in PSR, or sale of the firm. Four methods are taught: Average Profit Method (Goodwill = Average Profit × Years' Purchase), Super Profit Method (Goodwill = Super Profit × Years' Purchase, where Super Profit = Average Profit − Normal Profit), Capitalisation of Average Profit (Goodwill = Capitalised Value of business − Capital Employed), and Capitalisation of Super Profit (Goodwill = Super Profit × 100 / NRR). The Weighted Average Profit Method is preferred when profits show an upward or downward trend.

Before any method is applied, past profits must be adjusted — abnormal losses (e.g., fire) are added back, abnormal gains (e.g., insurance claims) are deducted, non-trade investment income is excluded, and a reasonable manager's salary is charged if not already done. Capital Employed is computed by EXCLUDING goodwill, fictitious assets and non-trade investments from total assets, then deducting outside liabilities. The chapter sets up the goodwill adjustments used in Chapters 3, 4, 5 and 6.

What You'll Learn
Key Concepts
Definition
Goodwill
Monetary value of the firm's reputation — an intangible asset that enables the firm to earn higher than the normal rate of return on its capital.
Drivers
Factors affecting Goodwill
Nature of business, location, customer loyalty / quality of products, efficient management, and capital adequacy. Higher business risk lowers goodwill.
When?
When goodwill is valued
Admission, retirement, death, change in PSR, sale or amalgamation of the firm, and on dissolution. Routine year-end accounting does NOT need it.
Method 1
Average Profit Method
Goodwill = Average Profit × Number of Years' Purchase. Simplest method; ignores Capital Employed.
Method 2
Super Profit Method
Super Profit = Avg Profit − Normal Profit. Goodwill = Super Profit × Years' Purchase. Accounts for capital employed via Normal Profit.
Inputs
Normal Profit & NRR
Normal Profit = Capital Employed × NRR / 100. NRR (Normal Rate of Return) = the return earned by similar businesses in the industry.
Method 3
Capitalisation of Average Profit
Capitalised Value = Avg Profit × 100 / NRR. Goodwill = Capitalised Value − Capital Employed.
Method 4
Capitalisation of Super Profit
Goodwill = Super Profit × 100 / NRR. Equivalent to Cap-Avg method on consistent data — no years' purchase needed.
Method 5
Weighted Average Profit
Σ(Profit × Weight) ÷ Σ Weights. Use when profits show a trend; recent years get higher weights (e.g., 1, 2, 3, 4).
Adjust
Past-profit adjustments
Add back abnormal losses; deduct abnormal gains and non-trade income; deduct manager's salary if not already charged.
Sample MCQs
Q1. Goodwill needs to be valued in a partnership firm in all of the following situations EXCEPT:
A. Admission of a new partner
B. Year-end posting of routine interest on capital
C. Retirement or death of a partner
D. Change in the profit-sharing ratio of existing partners
Routine year-end interest on capital is a regular appropriation and does not require any valuation of goodwill. Goodwill is valued only on reconstitution events — admission, retirement, death, change in PSR, sale or dissolution.
Q2. Profits of the last three years were ₹3,00,000 ; ₹3,60,000 ; ₹3,90,000. Goodwill is valued at 3 years' purchase of the average profit. Goodwill is:
A. ₹3,50,000
B. ₹10,80,000
C. ₹10,50,000
D. ₹7,00,000
Average Profit = (3,00,000 + 3,60,000 + 3,90,000) / 3 = 10,50,000 / 3 = ₹3,50,000. Goodwill = 3,50,000 × 3 = ₹10,50,000.
Q3. Capital Employed ₹8,00,000; Normal Rate of Return 12%; Average Profit ₹1,40,000. Goodwill at 3 years' purchase of Super Profit is:
A. ₹1,32,000
B. ₹4,20,000
C. ₹1,80,000
D. ₹2,40,000
Normal Profit = 8,00,000 × 12/100 = ₹96,000. Super Profit = 1,40,000 − 96,000 = ₹44,000. Goodwill = 44,000 × 3 = ₹1,32,000.
Frequently Asked Questions
What is goodwill in accounting?
Goodwill is the monetary value of a firm's reputation. It is an intangible non-current asset that enables the firm to earn higher than the normal rate of return on its capital. Goodwill arises from factors such as customer loyalty, location, quality of products, management efficiency and capital adequacy. Self-generated goodwill is not recorded in the books; only purchased goodwill is recognised under Ind AS 38.
Why does goodwill need to be valued?
Goodwill is valued at every reconstitution event in a partnership: admission of a new partner, retirement or death of a partner, change in the profit-sharing ratio of existing partners, sale or amalgamation of the firm, and on dissolution. It is needed so that the gainer compensates the sacrificer (or executor) for the share of future profits being transferred.
How does the Super Profit Method differ from the Average Profit Method?
The Average Profit Method only multiplies the firm's average profit by a number of years' purchase — it ignores the capital employed. The Super Profit Method first deducts a Normal Profit (Capital Employed × NRR / 100) to arrive at the Super Profit (the firm's excess earning capacity), and then multiplies that by the years' purchase. The Super Profit Method gives a fairer comparison between firms with different capital bases.
How does Capitalisation of Super Profit differ from Capitalisation of Average Profit?
Capitalisation of Average Profit: Goodwill = (Average Profit × 100 / NRR) − Capital Employed. Capitalisation of Super Profit: Goodwill = Super Profit × 100 / NRR. Algebraically, both formulas give the same answer when consistent inputs are used. The capitalisation methods do not need a 'years' purchase' multiplier — they capitalise the relevant profit at the Normal Rate of Return.
When are weighted averages preferred over simple averages?
When past profits show a clear upward or downward trend, recent years are more representative of future earnings than older years. The Weighted Average Profit Method gives higher weights to the most recent years (typically 1, 2, 3, 4 — with 4 for the most recent year). Weighted Average Profit = Σ(Profit × Weight) ÷ Σ Weights. Goodwill = Weighted Average Profit × Number of Years' Purchase.
What adjustments are made to past profits before calculating average profit?
Past profits are adjusted to reflect the firm's NORMAL recurring earning capacity: (i) ADD BACK abnormal losses such as loss by fire or theft; (ii) DEDUCT abnormal gains such as insurance claims received or profit on sale of fixed assets; (iii) EXCLUDE income from non-trade investments; (iv) DEDUCT a reasonable manager's salary if a working partner has not been charged any. Only after these adjustments should the average (or weighted average) be computed.