Unit 2: Goodwill, share valuation & banking company accounts
Corporate Accounting notes · PTU syllabus (BCOM 401-18)
On this page
Unit summary
Goodwill and shares often need to be valued — on admission of partners, amalgamation or sale. Banks prepare accounts in a special format and follow RBI's prudential norms. This unit covers valuation of goodwill and shares, the differences between banking and non-banking company balance sheets, prudential norms, the asset structure of a commercial bank and non-performing assets.
After this unit you can
- Value goodwill by average profit, super profit and capitalisation methods
- Value shares by net assets, yield and fair value methods
- Explain the form of bank accounts and distinguish them from non-banking companies
- Explain prudential norms, asset structure and NPA classification and provisioning
PTU syllabus topics
- Valuation of goodwill and shares (simple problems)
- difference between banking and non-banking company balance sheets
- prudential norms
- asset structure of a commercial bank
- non-performing assets
Average profit
Average profit × number of years' purchase
Super profit
Super profit × years' purchase
Capitalisation
Capitalised value of average profit − net assets
Annuity
Present value of super profits
Topic 1
Valuation of goodwill
Goodwill is the value of a firm's reputation and the ability to earn more than normal profits.
Average profit method
Average profit × Number of years' purchase
Super profit method
Super profit × Number of years' purchase; super profit = Average profit − Normal profit
Normal profit
Capital employed × Normal rate of return
Capitalisation of average profit
(Average profit × 100 ÷ Normal rate) − Capital employed
Capitalisation of super profit
Super profit × 100 ÷ Normal rate
Annuity method
Super profit × Present value of annuity factor
Example
Capital employed ₹10,00,000; normal rate 10%; average profit ₹1,40,000. Normal profit = ₹1,00,000; super profit = ₹40,000. Goodwill at 3 years' purchase = ₹1,20,000; by capitalising super profit = 40,000 × 100 ÷ 10 = ₹4,00,000.
- Adjustments to profits: remove abnormal gains/losses and non-operating income; adjust for under/over-valuation of assets; deduct management remuneration if not charged; consider future tax.
Topic 2
Valuation of shares
Net assets (intrinsic value) method
(Net assets available for equity shareholders) ÷ Number of equity shares
Yield method
(Expected rate of return ÷ Normal rate of return) × Paid-up value
Fair value method
(Intrinsic value + Yield value) ÷ 2
Earnings (capitalisation) method
EPS × P/E ratio or Profit ÷ Capitalisation rate
Example
Net assets ₹12,00,000 (including goodwill, after paying liabilities and preference capital); 1,00,000 equity shares of ₹10. Intrinsic value = ₹12. Expected dividend 15% vs normal 12%: yield value = 15 ÷ 12 × 10 = ₹12.50. Fair value = (12 + 12.50) ÷ 2 = ₹12.25.
- Need for valuation: amalgamation and takeovers, unquoted shares, wealth/gift tax (historical), loans against shares, ESOP pricing, dissenting shareholders.
Topic 3
Banking company accounts vs non-banking companies
- Governed by the Banking Regulation Act, 1949 (Section 29 — accounts in Forms A and B of the Third Schedule) and RBI directions; also the Companies Act for matters not covered.
Format
Form A (balance sheet) and Form B (P&L) under BR Act
Schedule III of Companies Act
Schedules
16 schedules (capital, reserves, deposits, borrowings, advances, investments, etc.)
Notes to accounts
Reserve
At least 25% of net profit to statutory reserve (RBI direction; 20% under BR Act Section 17)
No compulsory transfer
Main liabilities
Deposits from public
Share capital, borrowings, trade payables
Main assets
Advances and investments
Fixed and current assets
Income recognition
Interest on NPAs not recognised until received
Accrual basis
- Special items: rebate on bills discounted (unexpired discount — a liability), acceptances, endorsements and other obligations shown as contingent liabilities, bills for collection.
Topic 4
Prudential norms and asset structure
Prudential norms (based on the Narasimham Committee, 1991) ensure safety and transparency:
- Income recognition: interest income on NPAs recognised only when actually received.
- Asset classification into standard, sub-standard, doubtful and loss.
- Provisioning against NPAs.
- Capital adequacy: CRAR minimum 9% (RBI) plus capital conservation buffer 2.5% under Basel III.
- Investment classification and valuation (from April 2024: held to maturity, available for sale, fair value through P&L).
Asset structure of a commercial bank
| Asset | Approximate role |
|---|---|
| Cash in hand and balances with RBI | CRR (currently around 3–4% of NDTL) — liquidity |
| Balances with banks and money at call | Short-term liquidity |
| Investments | SLR securities (government bonds, about 18% of NDTL) and others |
| Advances | Loans, cash credit, overdrafts, bills purchased — main income source |
| Fixed assets | Premises, equipment |
| Other assets | Interest accrued, deferred tax assets |
Exam tip
The trade-off in bank asset structure: liquidity (cash, CRR, SLR) vs profitability (advances) vs safety (provisioning, capital).
Topic 5
Non-performing assets (NPAs)
An asset becomes non-performing when it ceases to generate income — for a term loan, interest or principal remains overdue for more than 90 days; for an overdraft/cash credit, the account remains out of order for 90 days.
| Category | Criterion | Provision (general) |
|---|---|---|
| Standard asset | Performing | 0.25%–1% (0.40% general) |
| Sub-standard | NPA for up to 12 months | 15% (secured); 25% (unsecured) |
| Doubtful D1 | Up to 1 year in doubtful | 25% of secured portion + 100% of unsecured |
| Doubtful D2 | 1–3 years | 40% of secured + 100% unsecured |
| Doubtful D3 | Over 3 years | 100% |
| Loss asset | Identified as uncollectible | 100% |
Example
Advance ₹10 lakh, doubtful for 2 years, realisable security ₹6 lakh. Provision = 40% × 6,00,000 + 100% × 4,00,000 = ₹2,40,000 + ₹4,00,000 = ₹6,40,000.
- Recovery mechanisms: SARFAESI Act 2002, Debt Recovery Tribunals, Lok Adalats, IBC 2016, asset reconstruction companies (NARCL).
Key terms
- Super profit
- Excess of average profit over normal profit
- Intrinsic value
- Net assets per share available to equity shareholders
- Prudential norms
- RBI rules on income recognition, asset classification and provisioning
- NPA
- A loan where interest or principal is overdue for more than 90 days
- CRAR
- Capital to risk-weighted assets ratio
Quick revision
- Goodwill: average profit, super profit, capitalisation, annuity.
- Share value: intrinsic, yield, fair (average of both).
- Banks: Forms A and B, 16 schedules, statutory reserve.
- Prudential norms: income recognition, classification, provisioning, capital adequacy.
- NPA after 90 days; sub-standard → doubtful → loss.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.What is super profit?
- Q2.How is goodwill valued under the capitalisation method?
- Q3.What is the fair value of a share?
- Q4.What is rebate on bills discounted?
- Q5.Define a non-performing asset.
- Q6.State the classification of bank assets.
Long-answer questions
- Q1.Explain the methods of valuation of goodwill with illustrations.
- Q2.Explain the methods of valuation of shares.
- Q3.Distinguish the accounts of banking and non-banking companies and explain prudential norms.
- Q4.Explain NPA classification and provisioning norms with an example.
Stuck on this unit?
Message SBS on WhatsApp for help with Corporate Accounting, or to ask about studying B.Com at Synetic.