Goodwill is the value of the reputation of a firm built over time with respect to the expected future profits over and above the normal profits. The valuation of goodwill is based on the assumption obtained by the valuer. Goodwill is an intangible asset that arises as a result of the acquisition of one company by another for a premium value.
Necessities for the Valuation of Goodwill
The need for a valuation of goodwill arises in various circumstances. Some of the circumstances are as follow:
(1) In the case of sole trading concern, the valuation of goodwill is needed at the time of selling a business, to take any person as a partner, to convert sole trading concern into a company. In the Case of a Sole-Proprietorship Firm:
- If the firm is sold to another person;
- If it takes any person as a partner and
- If it is converted into a company.
(2) In the case of a partnership, when there is an admission, retirement, death or amalgamation, or a change in the profit-sharing ratio take place, the valuation of goodwill becomes necessary. In the case of a Partnership Firm:
- If any new partner is taken;
- If any old partner retires from the firm;
- If there is any change in profit-sharing ratio among the partners;
- If any partner dies.
(3) In the case of a company, goodwill is valued at the time of amalgamation of two or more companies, absorption of company, reconstruction, and holding company. The valuation of goodwill also becomes necessary, if the shares have to be valued on the basis of intrinsic value, market value, or fair value and if the stock exchange quotation of the value of shares of a company is not available. In the case of a Company –
- If different partnership firms are amalgamated;
- If any firm is sold and
- If any firm is converted into a company.
(4) For taxation purposes such as wealth tax also, the valuation of goodwill is necessary. In the case of a sole trader concern, goodwill is valued at the time of selling die business, to decide the purchase consideration. If the goodwill has already been written-off in the past but the value of the same is to be recorded further in the books of accounts.
(5) In the case of individuals, goodwill is valued for the purpose of Estate Duty, Death Duty, etc. On the death of a person.
- If an existing company is being taken with or amalgamated with another existing company;
- If the Stock Exchange Quotation of the value of shares of the company is not available in order to compute gift tax, wealth tax, etc.; and
- If the shares are valued on the basis of intrinsic values, market value, or fair value methods.