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Friday, March 14, 2014

IGNOU SOLVED ASSIGNMENTS: ECO - 12

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