The law assumes that the assets of a corporation are valued at cost and that, after the deduction of liabilities, the remaining equity in the assets is represented by capital stock.

The truth of the case is, as we have seen, that capitalization - at least for the companies with marketable securities - is determined on the basis of earning power, and that the book valuation of a company's assets is then adjusted to the capitalization. This makes the valuation of assets for accounting purposes, in part at least, an arbitrary process. Whenever it is not thought desirable to place a purely arbitrary value upon tangible assets, or whenever the capitalization is so large that any arbitrary value within reason will still leave a gap, then we have "Patents," "Copyrights," "Organization," "Good-will," or some other intangible asset entered upon the books and appearing in the balance sheet at a valuation sufficient to offset the nominal value of outstanding capital stock.

As an illustration, take a case, which came to the writer's attention some years ago, of a company publishing a well-known popular magazine, which had issued stock only for an equivalent amount of cash paid in. The magazine had outstanding $300,000 of common stock; had assets over and above the liabilities (except stock) of approximately $250,000; and showed also on the asset side of the balance sheet an accumulated deficit of practically $50,000. Its balance sheet in this highly condensed and simplified form would appear as follows:

Assets

Liabilities

Net Capital and Current

Assets..........

$250,000.00

Capital Stocks..........

$300,000.00

Accumulated Deficit....

50,000.00

Total .............

$300,000.00

$300,000.00

Just about the time when the magazine had reached this stage and its proprietors were greatly discouraged, it started to run a series of feature articles which suddenly became immensely popular. The circulation and advertising receipts suddenly jumped to figures previously unthought of. In the first year after this sudden change of fortune, the corporation earned profits of approximately $40,000, and the directors desired to distribute dividends of $30,000. But there was no surplus out of which to declare dividends; on the contrary, the balance sheet still showed an impairment of capital which must be made up before dividends could legally be declared. In this predicament they called in an experienced accountant who solved the difficulty by directing that a very simple entry be put into the company's journal, debiting a new account to be called "Good-will" to the amount of $100,000 and crediting Surplus for a like amount. Thereafter the company's balance sheet in its highly simplified form, appeared as follows:

Assets

Liabilities

Net Capital and Current

Assets..........

$290,000.00

Capital Stock..........

$300,000.00

Surplus.................

90,000.00

Good-will ......................

100,000.00

Total .............

$390,000.00

$390,000.00

There was then nothing to prevent the immediate distribution of cash profits in the form of dividends.*

Good-will is not necessarily valued in quite so arbitrary and casual a fashion. Where a corporation has accumulated out of earnings a substantial surplus, and where there is genuine good-will which it is desirable to show in one form or another in the balance sheet, a careful valuation may be made. For example, a case of this nature arose in connection with the appraisal in September, 1914, of the estate of the late Joseph Pulitzer, former proprietor of the New York World and of the St. Louis Post-Despatch. The appraiser, first of all, made a careful estimate of the earning power of each one of the newspaper properties. For this purpose he took the average annual earnings of each corporation for four years preceding Mr. Pulitzer's death. From this average figure, however, he deducted a considerable sum by reason of certain very favorable contracts for the purchase of white print paper which were about to expire, and he further deducted $100,000 as being a reasonable estimate of the value of the services of Mr. Pulitzer himself. He deducted, also, 6% on the actual capital invested. This left average net earnings of $196,411 for the St. Louis Post-Despatch, and $81,180 for the New York World, both of which the appraiser capitalized on a 10% basis, making his valuation of the good-will of the first-named paper $1,964,110, and of the second-named paper, $811,800.

* The case just cited is actual but the figures have been much changed in order to simplify the statement and to avoid identification.

The above case is one of the most important precedents for methods of valuing good-will that have been established in this country. In England it is customary to calculate the good-will as the present worth of the profits from three to ten years ahead, the length of time depending upon the stability and transferability of the business.

The following remarks on this point were made by the writer in connection with an inquiry as to how to determine the value of an insurance agency business:

Having arrived at the value of all the other assets of an insurance agency, i.e., furniture and fixtures, insurance in force, real estate, etc., it would then be necessary to estimate the worth of its insurance business itself. The personal equation plays a great share in agency insurance, and the withdrawal of the man or men who have been actively identified with the establishment and with the running of the agency is likely to affect seriously the earnings of the concern, especially if the business has been confined to a particular locality, which is often the case. There is also to be considered the value which attaches to its sub-agency force as well as the volume of business the agency is doing, since the rates of commission paid by the insurance companies and the credits extended by them in the collection of premiums are by no means uniform. An additional point to be considered is that in many instances insurance agents also act in the capacity of adjusters in fixing losses of their clients. The earnings from this source are often not to be found on the books of insurance agents, and it is an item to be considered.

Having in mind all these factors, the test to be applied in determining the worth of the business itself is: How much earning power could be transferred to other individuals who might take over the business? Capitalize this earning power at whatever rate is agreed upon, say 15%, and you have the transferable good-will of the business.

In this discussion, no attempt has so far been made to give an accurate definition of the vague term "good-will." It is, in fact, almost incapable of definition for the reason that it is continually used in many varying senses. The term arose undoubtedly in connection with retail trade and with professional practice, where it referred to the habit that had been established on the part of many people who were accustomed to trading with a good shop or with an established professional practitioner. Experience has shown that this habit will continue to carry people to a shop or to a physician's or lawyer's office even after the original proprietor or practitioner has withdrawn. The vendor of a business or a practice of this nature usually contracted, for a given consideration, to recommend his successor and thus literally sold to him his "good-will." As it is used in a great majority of present-day transactions, the term has little perceptible relation to its original meaning.*

When a modern corporation transfers good-will or enters good-will upon its books, the asset which is thus represented consists of something even more intangible than the kind of good-will that accompanied the sale of the little retail shop. A corporation's "good-will" may consist in part of established trade and of the habits of people who desire to buy its prod-ucts; it may consist in part of having created an efficient, smoothly working internal organization; it may consist in part of having driven off all rivals and monopolized its field; it may consist in part of well-known trade-marks or of patents. An adequate definition of "good-will" in its modern sense must cover all the above and many other similar variations of intangible assets. The one definition which seems to the writer to cover everything is this: Good-will is the capitalization of that portion of the earning power of a business which is not credited to other assets.

* The classical definition of good-will, according to Withers, was contributed by Dr. Johnson, when, as executor of a friend's estate, he assisted at the sale of a brewery to two Quaker gentlemen. Being asked to place a value on the real assets, he replied: "We are not here to sell a parcel of boilers or vats, but the potentiality of growing rick beyond the dreams of avarice".

With this definition in mind, the question as to the right method of valuation of "good-will" in any given case is simplified. It is necessary to follow the same method that was used by the appraiser of the Pulitzer properties, that is, to eliminate from average earnings those which are to be ascribed to the ownership of tangible assets or to temporary causes; the remaining earning power may then be capitalized on whatever basis is suitable for the business under consideration. In some lines of business this percentage might be as low as 6 or 8%; in others 10%, and in others 12, 15, and even 20%.

The definition just suggested carries with it a ready explanation of the fact that "good-will" is a much more permanent asset in some lines of business than in others. Those lines of business which employ an overwhelming proportion of fixed capital assets, ordinarily attribute their earnings almost wholly to these assets, and there is seldom any occasion for entering such an item as good-will. On the other hand, those corporations that are engaged chiefly in trading, their earnings being dependent to a great extent upon the rapidity of their turnover or upon popular favor, may find, if they are successful, that their earnings mount far beyond any sum that can reasonably be attributed to their capital assets.

In this latter class belong such concerns as the F. W. Wool-worth Company, with its great chain of 5 and 10-cent stores, which carries a Good-will account of $50,000,000. Many publishing companies quite properly carry good-will as one of their most important assets. The Butterick Company, out of total assets of $19,236,467, has $9,786,065, or over one-half, included under the heading "Patents, Good-will, Contracts, Copyrights, Trade-marks, etc." Messrs. Silver-Burdett and Company carry "Publishing Rights, Contracts, Copyrights, etc.," at $1,024,820 out of total assets of $1,944,665.

There are many cases, also, where highly profitable and rapidly growing companies may have trouble in valuing their assets at a figure high enough to offset the amount of stock which their directors feel should properly be outstanding. This is the case, for instance, with the Hendee Manufacturing Company of Springfield, Mass., which on August 31, 1914, carried a Good-will account of $8,300,000 out of total assets of $13,-367,502. The American Chicle Company carries "Good-will, Trade-marks, etc.," at $8,128,607 out of total assets of $13,-592,997. In spite of this enlarged capitalization, the company has paid 18% dividends on its common stock regularly since 1907. On the other hand, the highly successful and long-established Eastman Kodak Company, which is paying dividends that average over 40%, and is earning in the neighborhood of 70% on common stock, does not carry a cent of good-will or other intangible asset accounts.