Valuation of Assets
Valuation
is the act of determining the value of assets and critical examination of these
values on the basis of normally accepted accounting standard. Valuation of
assets is to be made by the authorized officer and the duty of auditor is to
see whether they have been properly valued or not. For ensuring the proper
valuation, auditor should obtain the certificates of professionals, approved
values and other competent persons. Auditor can rely upon the valuation of
concerned officer but it must be clearly stated in the report because an
auditor is not a technical person.
The
accuracy of Balance sheet depends on the correctness of estimation of value of
assets. A company’s Balance sheet is not drawn for the purpose o showing what
the capital would be worth if the assets were realized and liabilities paid off
but to show how the capital stands invested. It’s the responsibility of the
auditor that items in the Balance sheet are neither over valued nor
undervalued.
An
auditor is not a valuer, and can’t be expected to act as such. All that he can
do is to verify the original cost price and to ascertain as far as possible the
current values are fair and reasonable and are in accordance with accepted
principles. It must be borne in mind that the actual valuations are made by
officials who have a practical knowledge of such assets and that an auditors
duty is confined to testing the valuations as far as he can and in this way
satisfy himself with correctness of the Balance sheet position. However, he
can’t guarantee the accuracy of valuations.
In
simple words, In the absence of suspicious circumstances he can rely on the
trusted officials of the company but this will not relive him from his
responsibilities if assets are incorrectly valued. He should exercise
reasonable care and skill, analysis critically all the facts and satisfy
himself that generally accepted. Accounting principles are followed. He should
not certify what he believes to be incorrect.
Methods of Valuation of
Goodwill:
a)
Average profits method
b)
Weighted average profit method
c)
Super profit method
d)
Capitalisation method
Average Profits Method:
In this method, normal profits of business of a number of years are taken into
account. Such profits are totaled up and their average is arrived at. The
average profits are multiplied by the number year’s purchases to arrive at the
value of goodwill.
For calculation of goodwill following steps are to be followed
a)
Calculate past normal profit. Past
Normal Profit = Net Profit + Abnormal loss – Abnormal Gain
b)
Calculate Average normal Profit =
Total Past normal profit/no of years
c)
Calculate goodwill = Average
normal profit x no. of year’s purchase
Weighted average method:
This method is a modified version of average profit method. In this method each
year profit is assigned a weight i.e. 1, 2, 3, 4 etc. Thereafter each year
profit is multiplied by the weight and find product. The total of products is
divided by the total of weight. As a result we find the weighted average
profit. After this the value of goodwill is calculated by multiplying the
weighted average profit with the agreed number of year’s purchase. Thus the
goodwill is calculated as follows
Weighted average profit = (Weighted Average Total / Total of Weights)
Value of goodwill = Weighted average profit × number of year
of purchase
Super Profit Method: Super
Profits means profits earned in excess of the normal Profit, i.e., Actual Profit
–Normal. Normal profits mean the profit which the firms could normally earns in
a particular business.
Under this method, the following steps are to be followed for
calculation of goodwill:
a)
Calculate average normal profit of
business as mentioned above
b)
Calculate normal profit
c)
Calculate super profit. Super
profit is the excess of average normal profit over normal profit
d)
Calculate goodwill = super profit
x no. of year’s purchase
Capitalization Method:
Under this method, the value of goodwill is obtained by capitalizing the average
profit or super profit of the basis of normal rate.
Value of goodwill under capitalization of average profit is
Goodwill =
(Average normal profit of the business/ rate of return) – capital employed
Value of goodwill under capitalization
of super profit is
Goodwill = Super profit/ rate of return
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