PROJECT REPORT

“VALUATION OF GOODWILL & SHARES : IT’S METHODS &

APPLICATION IN CORPORATE SECTOR”

A PROJECT REPORT SUBMITTED TO UNIVERSITY OF MUMBAI IN

PARTIAL FULFILLMENT OF THE REQUIREMENT FOR M.COM

SEMESTER 2

IN SUBJECT OF ADVANCED FINANCIAL ACCOUNTING

BY

NAME OF THE STUDENT: GAURAV BHAURAM JADHAV

ROLL NO: 14-7280

COLLEGE NAME: K.V.PENDHARKAR COLLEGE

BATCH : 2014-2015

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DECLARATION BY STUDENT

I GAURAV BHAURAM JADHAV, ROLL NO.14-7280, The student of

M.Com (Accountancy) Semester2(2014),K.V.PNDHARKAR COLLEGE,

Affiliated to University of Mumbai, hereby declare that the project

for the

Subject of ADVANCED FINANCIAL ACCOUNTING

“VALUATION OF GOODWILL & SHARES : IT’S METHODS &

APPLICATION IN CORPORATE SECTOR”

Submitted by me to University of Mumbai, for Semester – II

examination is based on actual work carried by me.

I further state that this work is original and not submitted anywhere

else for any examination.

Place : Dombivli Signature Of The Student

Date :

Roll No : 14-7280 Name : Gaurav B Jadhav

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ACKNOWLEDEMENT

AT BEGINNING I WOULD LIKE TO THANK GOD FOR HIS BLESSING. I

AM VERY MUCH THANKFUL TO MY TEACHER MRS.TEJASHREE

GAWADE AND MY PRINCIPAL FOR THEIR GUIDANCE, SUPPORT &

ENCOURAGEMENT.

I ALSO LIKE TO THANK MY FAMILY MEMBERS AND FRIENDS FOR

THEIR CO-OPERATION & HELP AND ALSO WOULD EXPRESS MY

GRAITUDE TO ALL THOSE WHO HELPED ME DIRECTLY OR

INDIRECTLY TO COMPLETE MY PROJECT.

I ALSO TAKE THE OPPORTUNITY TO SHOW MY SINCERE GRATITUDE

TO MY PARENTS.

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INDEX

Sr. No. Title Page No.

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OBJECTIVES OF THE STUDY

The objectives of our project is -

To find out the meaning of Goodwill & Shares.

To find out it’s importance in corporate sector.

To study how to find out it’s value.

To study about it’s different methods.

To find out it’s use in different corporate sector.

The Institute of Chartered Accountants of India defines goodwill as ‘an intangible assets arising from business connections or trade name or reputation of an enterprise.’ In this context, some of the definitions forwarded by various authors and experts in accounting are given below. According to Barden and Allyn “Goodwill is an intangible asset compounded from a variety of successful business ingredients – competent and energetic management, customer acceptance, a favorable location, a quality and profitable product, efficient production methods, an outstanding reputation, plus the expectation that these ingredients will continue to produce an above – normal rate of return for an indefinite period of time.”

According to Spicer and Pegler goodwill is defined as, “goodwill is said tobe that element rising from the reputation, connection 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.” Thus goodwill is the value of the reputation of the

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Introduction & Meaning of Goodwill

concern, it consists the benefits a business enjoys in connection with its customer, employees and other third party. It is also said that, “goodwill is the present value of a firm’s anticipating excess earning.”

Goodwill may be described as extra saleable value attaching to a prosperous business beyond the intrinsic worth of the net assets. Being of the nature of extra value or advantage, it is considered as an intangible asset like patents, trademarks and copyrights. It is not a fictitious asset.

Dr. Canning defines goodwill as “the present value of a firm’s anticipated excess earnings.” According to Lord Eldon, “Goodwill in nothing more than the profitability that the old customers will resort to the old place.” Another important explanation of goodwill comes from Lord Lindley. He says, “it is generally used to denote the benefit arising from connection and reputation and its value is what can be got for the chance of being able to keep that connection and improve it. Upon the sale of an established business its goodwill has a marketable value…… But it is plain that goodwill has no meaning expect in connection with a continuing business……..”Therefore, it may be concluded that-

(a) Goodwill is a capacity to retain its customer, to attract more customers and to sale more of its goods or services than what can be sold normally.

(b)Goodwill is a capacity to earn super profit which is more than normal profit in the concern industry.

(c) Goodwill is an asset which is not visible but which raises the worth of a business firm. Thus with goodwill the worth of the firm will be more than its book value.

Goodwill is required to be valued under the following circumstances,

(a) On Admission/Death/Retirement of a partner.(b) On Conversion of partnership firm into a limited company or sale of

business.(c) On Amalgamation of firms.(d) On Amalgamation Absorption / Internal Reconstruction & External

Reconstruction of Companies.

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Various factors affecting the value of goodwill are as follows:

1. Nature of business. It means the prevailing competition, level of risk involved, govt. Regulations, nature of demands etc. If the existing business units are earning more than normal profits and have secured monopolistic position, they will be enjoying more goodwill.

2. Favorable location. It is very well known that certain cities or places are most suitable for particular industries, business having units falling under same areas can enjoy the goodwill by selling more products. It must be noted that goodwill arises in a particular locality only because shopping space is limited in relation to demand for it.

3. Capital requirements. Amount of capital required for a business is also influence the value of goodwill. The business requiring less capital can realize higher amount of goodwill than another business earning less profits with a huge amount of capital.

4. Life of the business. Time also increases the value of goodwill. Business running on profitable lines for the last many year enjoys more goodwill as compared to the recent started business.

5. Trade name. A firm which possesses the necessary patents and trademarks for selling its products will have built up good reputation and enjoys goodwill.

6. Special contracts. Where a business is having special contracts in hand giving exceptional profits, the goodwill of the business will be much higher.

7. Managerial ability. The efficiency, skill and ability of the managerial personnel is also an important factor on which value of goodwill depends. The efficient management helps in increasing profits in the business which in turn, increases the value of goodwill.

8. Risk involved in the business. The value of goodwill is likely to be higher in the low risk business. On the contrary, if the business is purely of speculative nature and is very risky, the goodwill will have very little value.

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Factors determining the value of Goodwill

9. Profit trends. When the last year’s records of the business shows the constantly increasing profits, it will lead to attract higher value for its goodwill.

10. Nature and extent of competition. The value of goodwill of a business is is greatly affected by the degree of competition. If the competition is negligible or if there is no competition, the value of goodwill will be more or vice-versa.

11. Quality of products. The business units which enjoys good commercial reputation for the quality of their products, they have a high value of goodwill.

12. Money market conditions. When easy money market conditions prevail, there would be more buyers willing to buy an established business and pay a higher price for the goodwill or vice-versa.

13. Types of customers. Commercial value of goodwill depends upon the types of customers. They may be classified according to the distinctive features viz. Cat, dog and rat. The valuation will depend upon the degree of attachment of business with personnel character of the owner.

14. Miscellaneous factors. Besides these above mentioned factors, the value of goodwill is also affected by employer-employee relation. Technical know-how possessed by the business, future prospects of the industry, research and development efforts, and govt. Policies etc.

It depends on the form of business organization.:-

Sole traders : under the sole traders form of business organization the need for

the valuation of goodwill may arise in the following circumstances:

a. When the business is sold.

b. When a new person is admitted in the firm and the firm becomes a partnership Firm.

c. When the business is converted into a company. Partnership firm : Under the partnership form of business organization the

need for the valuation of goodwill may arise in the following circumstances:

a. When a new partner is admitted to a partnership firm.

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Need for valuation of Goodwill

b. When an existing partner retires or dies.

c. When there exists any change in the profit sharing ratio of the existing partners.

d. When whole of the partnership firm is sold out to any other firm or person.

e. When a partnership firm is converted into a company.

f. When there is a case of amalgamation of two firms.

Companies : In case of a company, the need for valuation of goodwill may arise in the following circumstances:

a. When there is a situation of amalgamation of two companies.

b. When the business of the company is sold to another existing company.

c. When one class of the shares is converted to another.

d. When a company acquires the controlling interest in the company and becomes a holding company.

e. When there arises a need for the valuation of the shares of the company.

f. When shares of the company are not listed on the stock exchange and they have to be valued for taxation purposes.

1. Simple Profit Method : It is mainly divided into three categories,

A. Average Profit Method.

B. No. of years purchased of Average Profit Method.

C. Annuity of Average Profit Method.

A. Average Profit Method:- It is further divided into two types,

I)Simple Average Method :- It is calculated by the following formula.

Goodwill = Simple Average = Total Profit/ No. of years

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Methods of valuation of Goodwill

II)Weighted Average Method :- It is calculated by the following formula.

Goodwill = Weighted Average Profit = Total Weighted Profit/Total of Weight

B. No. of years purchased of Average Profit Method:-

Goodwill = Average Profit * No. of years Purchased

C. Annuity of Average Profit Method:-

Goodwill = Average Adjusted Annuity Value – Net Tangible Asset

2. Super Profit Method : It is divided into four groups,

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A. No of years purchased of super profit method:-

Goodwill = Super Profits * No. of years purchased

B. Annuity of super profit method:-

Goodwill = Super Profit * Annuity Value

C. Capitalization of super profit method:-

Goodwill = Super Profit * 100/N.R.R

D. Sliding Scale of super profit method:-

Goodwill = Super Profit * No. of years purchased

Where Super Profit is calculated in the following manner,

Step 1 :- Calculation of Average Profit

Step 2 :- Calculation of Normal Profit (Capital Employed *N.R.R/100)

Step 3 :- Calculation of Super Profit (Average Profit – Normal Profit)

3. Capitalization of F.M.P Method :

Goodwill = Capital Value of F.M.P - Net Tangible Trading Asset

Where,

Capitalized Value of F.M.P = F.M.P * 100/N.R.R

Net Tangible Trading Asset = Total Tangible Trading Asset – Outside liabilities

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Valuation of Shares

Shares are valued according to various principles in different markets, but a

basic premise is that a share is worth the price at which a transaction would be

likely to occur were the shares to be sold. The liquidity of markets is a major

consideration as to whether a share is able to be sold at any given time. An actual

sale transaction of shares between buyer and seller is usually considered to provide

the best prima facie market indicator as to the "true value" of shares at that

particular time.

Shares outstanding are those that are authorized, issued, and held by third

parties. The number of shares outstanding times the share price gives the market

capitalization of the company, which if the trading price held constant would be

sufficient to purchase the company. Treasury shares are authorized, issued, and

held by the company itself. Issued shares is the sum of shares outstanding and

treasury shares. Shares authorized include both issued (by the Board of Directors

or shareholders) and unissued but authorized by the company's constitutional

documents.

1. Ordinary Shares : Most shares traded on ASX ‘ordinary’ shares. Ordinary

shares carry no special or preferred rights. Holders of ordinary shares will

usually have the right to vote at a general meeting of the company, and to

participate in any dividends or any distribution of assets on winding up of the

company on the same basis as other ordinary shareholders.

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Types of Shares

2. Preference Shares : Preference shares usually give their holder a priority or

‘preference’ over ordinary shareholders to payments of dividends or on winding up

of the company. There are different kinds of preference shares with different

rights and characteristics. Holders of preference shares usually have voting rights

which are restricted to particular circumstances or particular resolution, however

this will depend on the term of the shares.

Cumulative Preference share:

Shares give holders the right that, if a dividend cannot be paid one year, it will be

carried forward to successive years. Dividends on Cumulative preference shares

must be paid, despite the earning levels of the business, provided the company has

distributable profits.

3. Redeemable Shares : Shares come with an agreement that the company can

buy them back at a future date- this can be at a fixed date or at the choice of the

business. A company cannot issue only redeemable shares.

4. Partly Paid Shares : Partly-paid shares (also known as contributing shares) are

issued without the company requiring payment of the full issue price. At a

specified future date or dates , the company is entitled to call for all or part of the

outstanding issue price, and the shareholder at the time the call is due is legally

obliged to pay the call.

1. The basic or principle factor in the valuation of shares is the dividend yield that the investor expects to get as compared to the normal rate prevailing in the market in the same industry.

2. Growth prospects of the company.

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Factors Affecting valuation of Shares

3. Demand and supply of shares.

4. The nature of the business of the company concerned.

5. Dividend policy of the company and %age of dividend declared in the part.

6. Part performance of the company.

7. Govt. Policies in relation to company’s business.

8. Accumulated reserves of the company.

9. Economic climate

10. The income yielding capacity of the company.

11. Size of the business.

12. Net asset position of the company.

13. Availability of the ready market for future sale.

14. Management of the company.

15. Prospects of bonus or right issue.

16. Political factors prevalent peace and prosperity in the country and govt.’s attitude towards the industry.

Following are the circumstances, necessitating valuation of shares: 1. At the time of amalgamation and absorption.

2. When unquoted shares are to be bought or sold.

3. At the time of converting preference shares or debentures into equity shares.

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Needs For Valuation of Shares

4. Where a portion of shares is to be given by a member of proprietary company to another member as a member cannot sell it in the open market it become necessary to certify the fair price.

5. For the valuation of the assets of a finance or investment trust company.

6. At the time of assessment by the income tax authorities for the purpose of estate duty, capital gain, wealth tax and gift tax.

7. When the company is nationalized and the compensation is payable by the govt.

8. When a company acquires majority shares of another company for the purpose of acquiring a controlling interest in another company.

9. When shares are pledged as a security against loan.

10. At the time of paying court fees.

11. When shares are purchased by the employees of a company to be kept by them during the tenure of their service.

12. At the time of purchase and sale of shares in private companies.

13. When partners hold shares of a company for ascertaining the amount to be distributed amongst them on dissolution of firm.

14. For satisfying dissentient shareholders in the case of reconstruction of a company under section 494.

1. Intensic Value Method :- This is also called as ‘Net Asset Value’ or

‘Liquidation Value’ or ‘Break up Value’ or ‘Asset Backing Value Method’.

This method is based on the assumption that the company will be liquidate.

Therefore, value of a share depends on the amount that would be available to

equity share holder. Amount available to equity shareholders depends on the

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Methods of valuation of Shares

market value of all Assets & Liabilities to be paid for. Assets & Liabilities

recorded or unrecorded in balance sheet at present value are to be

considered.

Intensic Value per = Amount available to eq.shareholders Per eq. share No. of eq. shares

2. Yield Value Method :- It is also referred to as ‘Market Value Method’. This

method is based on assumption that the company is a growing concern. It

will continue it’s activities year after year Therefore, value of a share is

based on the amount of profit that would be available to eq. shareholders for

dividend.

Yield Value per = Rate of F.M.P * Paid up value perEq. share N.R.R eq. share

3. Fair Value Method :-

Fair Value per = Intensic Value per share + Yield Value per shareEq. share 2

4. Earning Capacity Method :- Under this method, value of share is decided

on the basis of earning capacity of a company. The majority shareholders are

interested in disposable profits.

Earning Value per = Rate of Earning * Paid up value per shareEq. share N.R.R

Where,

Rate of earnings = Earnings (profit earned) * 100 Capital Employed

5. Capitalization of F.M.P Method :-

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Value per eq. share = Capitalised Value of F.M.P * 100 No. of eq. shares

Where,

Capitalised Value of F.M.P = F.M.P * 100 N.R.R

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