Goodwill: Guide to simplified valuations

Accounting for goodwill has always been one of the more controversial issues faced by accountants for many years, explains Steve Collings.

AccountingWEB recently covered the issue concerning goodwill and intangible assets in an earlier article which addressed the accounting requirements for goodwill, as well as intangible assets.

Many accountants will associate goodwill as being the value inherent in the business due to a built upon reputation or the value attributed to a well-known brand or company name. Lord MacNaghten in the case of Commissioners of Inland Revenue v Muller & Co Margarine (1901) AC215 defined goodwill as follows:

“What is goodwill? It is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation and connection of the business.  It is the attractive force which brings in custom. It is the one thing which distinguishes an old established business from a new business at its first start. Goodwill is composed as a variety of elements. It differs in its composition in different trades and in different businesses in the same trade. One element pay preponderate here, and other there.”

Lord MacNaghten merely defined goodwill in his summing up, which is one thing. The challenge for accountants is how such goodwill is valued. 

Register with AccountingWEB for free to read the rest of the article, which includes:

  • Simple multiple approach
  • Turnover approach
  • Whole company approach
  • Illustrations
  • Conclusion

Continued...

» Register now

The full article is available to registered AccountingWEB members only. To read the rest of this article you’ll need to login or register.

Registration is FREE and allows you to view all content, ask questions, comment and much more.

Comments
cfield's picture

Ongoing contracts

cfield | | Permalink

Good article Steve, but it would be good to explore how goodwill is influenced by the value of ongoing contracts. Take a firm of estate agents for example. They may have have properties on their books that they've been instructed to sell as at the valuation date, but the fees are contingent on a) how much the property sells for, and b) whether it sells at all.

Firstly, you have to decide whether the contracts are part of the overall goodwill of the business or separate assets to be valued in their own right. That will be a subjective judgement based on the probability of sales materialising.

Secondly, how do the contracts not valued as separate assets affect goodwill? After all, if a new client enters the branch whilst the value of the business is being negotiated and instructs you to sell his house, that surely must affect the value somehow, but to what extent? Turnover and profit multiples are based on historic information and will not be affected by the new contract. Nonetheless, clearly the firm is worth at least a little bit more as any sales commission on that new contract will go to the buyer.

This is quite a relevant issue with most professional firms, including accountants. Let's imagine an Arab oil sheikh arrived in the midst of selling my practice and asked me to quote for his accounts, I would expect the buyer to increase his offer (assuming I could prove he wasn't my brother in a white sheet and a false beard). 

I wouldn't expect him to claim that goodwill was unchanged because the business had not actually been won yet. After all, how much would you pay for a lottery ticket if there was a 5-1 chance that you could win a million pounds?

It's beyond the scope of this article, but I also wonder whether ongoing contracts can qualify for Entrepreneurs Relief on the grounds they are part of the overall goodwill, or if you have to treat them as separate assets not qualifying for ER as they are usually less than a year old.

I'm inclined to say they do, as the only way they differ from all the other potential sources of future profit that make up goodwill is in their identifiability and the likelihood of profit materialising in the short term. I recently had a debate with HMRC on this point. Would be good to know what others think.

Galaxian's picture

ER

Galaxian | | Permalink

It is not necessary that the assets themselves have been owned for one year - it is the business that must be owned for that period.

Goodwill Valuation

newport daz | | Permalink

Hi all this is my first post after discovering this excellent site, so if my question is in the wrong place or is hijacking the thread I apologise and please delete me. However, it does regard goodwill valuation.

 

I'm an ACCA student that works for a CTA and a common manouvre he uses to gain tax relief for clients is as follows:-

 

Sole trader has plant and mchinery, vehicles etc then incorporatesw putting said assets into company. Large amounts of goodwill are generated on the balance sheet as a consequence.

 

This is what I don't understand. At college we're taught that :-

 

Consideration paid              x

less net assests aquired    (x)

Goodwill arising                  x

 

My question is, if the ltd compnay aquires the assets but doesn't pay anything for them, how does the goodwill arise and how do you put a value on the goodwill that has arisen?

 

Again i'm sorry if this is the wrong place, delete me.

There is no third party as such    1 thanks

G A Lyon | | Permalink

You don't have a consideration to start the calculation, you start with net asset value and add the calculated goodwill (on basis appropriate) to get to consideration. Usually on incorporating a sole trader this then is credited to the Directors Loan account.

 

jdm5454's picture

Not forgetting that the sole

jdm5454 | | Permalink

Not forgetting that the sole trader will then have a potential capital gain.

Owners remuneration

mtoms | | Permalink

This was a useful article.  We have had our goodwill valuation disputed by HMRC partly on the basis that they want to deduct an assumed owners remuneration from profits before applying a multiple to profits. This is a professional Chartered Surveyor firm and they are using the following:-   Net Profit less: £80,000 x 3. This article suggests that the profit before owners remuneration should be used as a basis. Does anyone have a similar experience and recommend a reply to HMRC

pbr0306's picture

The multiple is key

pbr0306 | | Permalink

Great article. We found that the key to HMRC agreement is getting the multiple right as well as the adjustments to pre-tax profit. Rejection first time round from HMRC so we outsourced to a specialist valuer - RA Valuation Services (www.ravaluationservices.com) who have a large database they get their comparable multiples and figures from. The came up with a similar figure of goodwill but it was accepted with their report.