Understanding the Capitalisation Method for Goodwill Valuation

The capitalization method is a fundamental accounting approach used to categorize certain expenditures as assets rather than immediate expenses. It involves spreading the cost of a long-term asset over its useful life instead of recognizing the entire cost as an expense in the period of acquisition. This method aligns with the matching principle, where expenses are matched with the revenues they generate over time.

Capitalisation method is a very important topic to be known for the UGC-NET Commerce Examination.

In this article, the readers will be able to know about the capitalisation method in detail along with certain other related topics in detail.

Read about Cost-and-management-accounting.

Capitalisation Method Formula

Explanation: This method involves capitalizing the average annual profits of a business to determine its overall value. It assumes that the average profits earned by the business are representative of future earnings.

Formula:

• Capitalized Value=Average Annual Profit/Rate of Capitalization
• Where:
  • Average Annual Profit
  • Average Annual Profit is the average profit over a specified period.
  • Rate of Capitalization
  • Rate of Capitalization is the capitalization rate, representing the rate of return expected by an investor.

Also, read about Audit-of-financial-statements-and-audit-report.

Capitalization of Average Profit Method

This method involves capitalizing the average annual profits of a business to determine its overall value. It assumes that the average profits earned by the business are representative of future earnings.

Capitalized Value= (Average Annual Profit/ Rate of Capitalization)

Where:

• Average Annual Profit=Average Annual Profit is the average profit over a specified period.
• Rate of Capitalization
• Rate of Capitalization is the capitalization rate, representing the rate of return expected by an investor.

Read about Scope-and-Importance-of-International-Business.

Capitalization of Super Profit Method

The capitalization of super profit method takes into account not only the average profits of a business but also the excess profits, known as super profits. Super profits are profits earned above the normal or expected level.

Capitalized Value= (Normal Annual Profit/Rate of Capitalization)

Conclusion

Capitalization method is a fundamental accounting approach that plays a crucial role in accurately reflecting the financial position and performance of a business. By capitalizing certain expenditures associated with long-term assets, companies can better align their financial statements with the economic benefits derived from these assets over time.

Capitalisation method is a vital topic as per several competitive exams. It would help if you learned other similar topics with the Testbook App.

Read about Liquidation-of-companies.