WHAT IS GOODWILL

Goodwill is an intangible asset and an important aspect for an enterprise. It is something which places an enterprise at an advantageous position due to which the enterprise is able to earn higher profits without putting in extra efforts. It is so because the efforts have already been made in the past which have now put the enterprise in an advantageous position. For example, if the enterprise has rendered good service to its customers, the customers will be satisfied from the quality of service, which in all likelihood will bring them back to the enterprise. In turn, the enterprise will achieve higher sales and, thus, higher profits.

"Goodwill is nothing more than the probability that the old customers will resort to the old place."-Lord Eldon

Characteristics/Nature/Features of Goodwill:-- On the basis of above definitions, the characteristics of goodwill that emerge are:

1. It is an intangible asset, i.e., an asset which cannot be seen or touched.

2. It cannot have an existence separate from that of an enterprise.

3. Its value depends on the subjective judgment of the valuer.

4. It helps to earn higher profits.

5. It is an attractive force which brings in customers to old place of business.

6. It comes into existence due to various factors such as locational advantages, favourable contracts, brands, location and market reputation.

Need for Valuing Goodwill: -- The need for valuation of goodwill arises in the following circumstances:

1. When there is a change in the profit-sharing ratio.

2. When a new partner is admitted.

3. When a partner retires or dies.

4. When partnership firm is sold as a going concern.

5. When two firms amalgamate.

Factors Affecting the Value of Goodwill:- The goodwill of a firm is affected by all the factors which increase the earning capacity of the firm. These factors are: 

1. Efficient Management: If the management is capable and competent, the firm will earn high profits which will increase the value of goodwill.

2. Location: If the business is located at a favourable place, resulting in increased customer walk-in and, therefore increased sales.

3. Favourable Contracts: Sometimes, a firm enters into long-term contracts for sale and purchase of goods at favourable prices. This will also affect profits and goodwill of the firm.

4. Advantage of Patents: Normally, patents are necessary for the manufacture or production of certain types of articles. A firm which possesses the necessary patents will have a good value for its goodwill.

5. Access to Supplies: When supplies of materials are difficult to get, there will be a high value for goodwill for a firm which has good arrangements for getting supplies.

6. Quality: If a firm enjoys good reputation for the quality of its products, there will be a ready sale and the value of its goodwill, therefore, will be high.

7. Market Situation: If a firm is in a business wherein demand for the products dealt in is higher than the supply, it will lead to lower capital requirement and higher profit. It will thus, increase the value of goodwill.

8. Nature of Business: If the business of a firm is of the nature where the products dealt in are in high demand although not short in supply, the profit will be higher. It will, thus, increase the value of goodwill.

9. Other Factors: (a) After sale service, (b) Past performance of the enterprise, (c) Good customer relations, and (d) Good labour relations, etc.

Classification of Goodwill:-- Goodwill can be classified into two categories:

1. Purchased Goodwill; and 2. Self-generated Goodwill.

1. Purchased Goodwill: It is the Goodwill that is acquired by making a payment. For example, when a business is purchased, the excess of purchase consideration of its Net Assets (i.e., Assets — Liabilities) is the Purchased Goodwill. As per AS-26, only purchased goodwill can be shown in books of account.

Features of Purchased Goodwill

It arises on the purchase of a business or purchase of a brand, etc.  Since the consideration is paid for it, it is recorded in the books of accounts. It is shown in the Balance Sheet as an asset.

Value of Goodwill is a subjective judgment but it is ascertained when both purchaser and seller agree to its valuation.

It is amortised at the earliest but not later than its useful life.
2. Self-generated Goodwill: It is an internally generated goodwill which arises from a wide variety of elements (such as properly location, efficient management, right quality of products, etc.) that a running business possesses due to which it is able to earn higher profit.
Features of Self-generated Goodwill
It is generated internally, generally over the years. As per AS-26, internally generated goodwill is now not to be recorded in the books of accounts. Valuation relies upon on the subjective judgment of the valuer.

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