GOODWILL

MEANING

Goodwill means the ‘Good-Name’ or the reputation of the firm. The management and employees earn this by their hard work and honesty. It is like a magnet that attracts the customers towards the business. It helps in earning higher profits in comparison to the normal profits earned by the other firms in the same line of business.

DEFINITION

ACCORDING TO ERIC L KOHLER

It is the present value of expected future income in excess of a normal return on the investment in the tangible assets.

ACCORDING TO JO MAGEE

The capacity of a business to earn profits in future is basically what is meant by the term goodwill.

ACCORDING TO LORG MACHNAUGHTON

Goodwill is a thing very easy to describe, but very difficult to define. It is the benefit and advantage of name, reputation and connections of a business. and the one thing which distinguishes an old established business from new business as it first starts, is composed of variety of elements. It differs in its composition in different trades and in different businesses in the same trade.

ACCORDING TO LORD LINDLEY

The term goodwill is generally used to denote the benefit arising from connection and reputation.

ACCORDING TO LORD ELDON

It is nothing more than the probability that the old customers will resort to the old place.

ACCORDING TO SPICER AND PEGLER

It may be said to be that element arising from the reputation, connections or other advantages possessed by a business which enables it to earn greater profits than the return normally to be expected on the capital represented by the net tangible assets employed in the business.

ACCORDING TO DICKSEE

When a man pays for goodwill, he pays for something which places him in the position of being able to earn more than he would be able to do by his own unaided efforts.

NATURE

It is an intangible asset because it has no physical existence and it cannot be seen or touched. But it is not a fictitious asset. It is so because fictitious assets do not have a value whereas goodwill has a value in case of profit making business organisations. It can be sold by selling the entire business.

FEATURES

1. INTANGIBLE ASSET: Goodwill belongs to the category of intangible assets such as patents, trademarks, copyrights etc. Intangible assets are those assets which cannot be touched and seen but can be felt only.  It does not suffer wear and tear and as such the question of depreciation does not arise on it, as is the case of other assets.
2. ITS VALUE IS LIABLE TO CONSTANT FLUCTUATIONS: While goodwill does not depreciate, its value is liable to constant fluctuations. It is always present as a silent asset in a business where there are super profits but declines in the value with the decline in the earnings.
3. VALUABLE ONLY WHEN THE ENTIRE BUSINESS IS SOLD: Goodwill cannot be sold in part. It can be sold with the entire business only. The only exception is at the time of the admission and retirement of a partner.
4. IT IS DIFFICULT TO PLACE AN EXACT VALUE ON GOODWILL: This is because its value may fluctuate from time to time due to changing circumstances which are internal and external to business.
5. HELPS IN EARNING EXCESS PROFITS: Goodwill is the good name of the business. It helps in earnings excess revenues by capturing more market share. This incurs excess profits to the firms.
6. A VALUABLE ASSSET: Goodwill is a valuable asset. Its value differs from estimator to estimator. The various methods for its calculation are: Average Profits Method, Weighted Average Method, Super Profits Method, Capitalization of Average profits method and Capitalization of Super Profits method are used for its calculation.

FACTORS AFFECTING GOODWILL

• FAVOURABLE LOCATION OF THE BUSINESS: If the business is located at a convenient or prominent place, it will attract more customers and therefore will have more goodwill.
• EFFICIENCY OF MANAGEMENT: If the business is run by experienced and efficient management, its profits will go on increasing, which increases the value of goodwill.
• LONGEVITY OF THE BUSINESS: An older business is better known to the customers; therefore it is likely to have more goodwill. When a business enterprise has built up good reputation over a period of time, the number of customers will be more in comparison to the customers of new entrants. Number of customers is an indicator of profit earning capacity of the business.
• NATURE OF GOODS: If a business deals in goods of daily use, it will have steady profits as the demand for these goods will be stable. Such business will have more goodwill. But if it deals in fancy goods, its profits will be uncertain and as such the value of the goodwill will be less.

• POSSESSION OF LICENSE: If a firm holds an import license, the goodwill of the firm will be more as it will be very difficult for other firms to enter their business in the absence of license.
• MONOPOLISTIC AND OTHER RIGHTS: If a business enjoys monopoly market, it will have assured profits. Similarly, if it holds some special rights such as patents, trademarks, copyrights or concessions, etc., it will have more goodwill.
• RISK INVOLVED: If there is more risk involved in the business, the value of the goodwill will be less.
• TREND OF PROFITS: If the profits of a business are increasing continuously, the value of its goodwill will be more. If the profits are declining or if the profits are uncertain, the value of its goodwill will be less.
• FUTURE COMPETITION: The likelihood or possibility of increased competition in future would definitely reduce the value of goodwill.
• CAPITAL REQUIRED: The amount of capital required for a business will also influence the value of goodwill. If two business enterprises earn the same rate of profit, the business with lesser capital requirement shall enjoy more goodwill.
• TRADE NAME: If the goods, dealt in enjoy worldwide recognition by a trade name or trademark, it will favorably influence the value of goodwill.
• GOVERNMENT PATRONAGE: Where the business enjoys the patronage of Government, people are willing to buy the product of such a company. Thus, goodwill increases.
• MONEY MARKET CONDITIONS: Where money market conditions are easy, more buyers will be available in the market and the value of goodwill may go up. On the other hand if money is scarce the value of it may come down

• OTHER FACTORS: The other factors are as follows:

1. Good industrial relations.
2. Stable political conditions.
3. Research and development centers
4. Effective advertising to establish brand popularity.
5. Popularity of products in term of quality.

TYPES OF GOODWILL

ACCOUNTING CLASSIFICATION

1. PURCHASED GOODWILL:

It is the one which is acquired by making a payment. For example, when a business is purchased, the excess of purchase consideration over its net assets is referred to as purchased goodwill.

FEATURES

• Arises on purchase of a business.
• Recorded in the books of accounts because consideration is paid for it.
• Shown in the Balance Sheet as an asset.
• Amortized over its useful economic life.

2. SELF-GENERATED GOODWILL:

This goodwill is generated internally and arises from a number of characteristics or attributes which an on-going business possesses.

FEATURES

• It is internally generated over a long period of time.
• A true cost cannot be placed on this type of goodwill. Its valuation depends on the subjective judgement of the valuer.
• As per Accounting Standard-26 (Intangible Assets), it is not recorded in the books of accounts because consideration in money or money’s worth has not been paid for it.

ZOOLOGICAL CLASSIFICATION

Goodwill is an attractive force which brings in customers. In White Man Smith Motor Company V Chaplin, the variety of customers were classified zoologically i.e. cats, dogs, rats and rabbits.

1. DOG GOODWILL:

The faithful dog attaches to the person rather than to the place. It will follow the outgoing owner, if he does not go too far. It is sort of personal goodwill and is generally found in professions.

2. CAT GOODWILL:

The cat prefers the old home of the person who keeps it, and stays in the old home although the person who has kept the home leaves and so it represents the person who goes to the old shop whoever keeps it.

3. RAT GOODWILL:

The rat has no attachment either with the owner of the house or with the place. Rat is interested only in filling its stomach no matter from where things come. So certain type of customers which are neither attached to any owner of the business nor to any shop. Such type of goodwill has small value or no value.

4. RABBIT GOODWILL:

Rabbit has the habit of living close and is afraid of going too far. There are customers who neither attract value to the owner nor shop but to the nearness of the shop. Such type of goodwill has a low market value.

WHEN THE GOODWILL IS VALUED??????

• When there is a change in the profit sharing ratio among the existing partners.
• If a new partner is admitted.
• In case, a partner retires or dies.
• When the firm is sold
• If the firm is amalgamated with another firm.