Capitalization Method + Exam Strategy

Capitalization Method of Goodwill Valuation

The Capitalization Method determines goodwill by calculating the total value of the business and comparing it with its net assets.

This method is commonly used in business valuation and partnership reconstitution.

Method 1: Capitalization of Average Profit

Formula

Capitalized Value of Business = (Average Profit × 100) ÷ Normal Rate of Return

Goodwill = Capitalized Value − Net Assets

Example

Average Profit = ₹50,000
Normal Rate = 10%

Capitalized Value = (50,000 × 100) ÷ 10
Capitalized Value = ₹5,00,000

Net Assets = ₹2,75,000

Goodwill = ₹5,00,000 − ₹2,75,000
Goodwill = ₹2,25,000

Method 2: Capitalization of Super Profit

Formula:

Goodwill = (Super Profit × 100) ÷ Normal Rate of Return

This method calculates the present value of super profits in perpetuity.

How to Identify the Correct Method in Exams

Students should identify the method based on clues in the question.

No normal rate given | Average Profit |
Normal rate mentioned | Super Profit |
Value of firm asked | Capitalization |

Common Mistakes Students Make

Students often make these mistakes:

• Including fictitious assets in capital employed
• Ignoring current liabilities
• Forgetting to adjust abnormal items
• Confusing years purchase with number of years

Avoiding these mistakes improves accuracy.

Final Thoughts

The capitalization method is slightly more advanced but very useful in business valuation and partnership accounting problems.

With proper understanding and practice, students can easily solve goodwill valuation questions in board exams and competitive exams.