Goodwill
AVERAGE PROFIT METHOD: In this method goodwill is calculated on the basis of the
number of past years .Average of such profits is multiplied by the agreed number of years to
find out the value of goodwill.
Goodwill = Average Profit x No. of years Purchase
Note:
• Abnormal Income of a year should be deducted
• Abnormal Loss Should Be Added
• Closing Stock Over valued should be deducted to that year but Should be Added to
succeeding year.
• Closing stock Undervalued should be added to that year but should be Subtracted to
succeeding year.
• Average Profit = _Total Profit_
No. Of years
Question Based on Average Profit Method:
Q1. X purchased the business of Y from 1st April, 2023. For this purpose goodwill is to be valued at
100% of the average annual profits of the last four years. The profits shown by Y's business for the
last four years were :
Verification of books of accounts revealed the following:
Year Ended Rs
st
31 March 2020 Profit 1,00,000 (After Debiting loss of stock by fire
Rs 50,000
st
31 March 2021 Loss 1,50,000 (Includes Voluntary retirement
compensation Paid Rs 80,000)
st
31 March 2022 Profit 1,50,000
31st March 2023 Profit 2,00,000
(i) During the year ended 31st March, 2021, a machine got destroyed in accident and Rs 60,000 was
written off as loss in Profit & Loss Account.
(ii) On 1st July 2021, Two Computers costing Rs 40,000 each were purchased and were debited to
Travelling Expenses Account on which depreciation is to be charged @ 10% p.a. on Straight Line
Method.
Calculate the value of goodwill.
[Link] are the profits of a firm for the last 3 years:
2022- Rs 40,000 including profits on sale of land Rs 5,000
2023-Rs 50,000 including 10,000 loss on sale of Machinery.
2024- Rs 45,000 excluding Rs 5,000 payable for insurance premium.
Compute the value of goodwill of the firm on the basis of two years purchase of average profit of
the last three years.
Weighted Average Profit Method :
As per this method each year’s Profit is assigned a weight. Thereafter each year’s Profit is
multiplied by the weight assigned to it in order to find out the products and the total of products
is divided by the total of weights in order to calculate the weighted average profits.
Formula to calculate Goodwill :
Weighted Average Profit = ___Total of products of profits__
Total of weights
Goodwill = Weighted Average Profit x No. of years of Purchase
Question Based on Weighted Average Profit Method:
Q3. X proposes to purchase the business carried on by Y. Goodwill is agreed to be
valued at 3 years' purchase of the weighted average profits of the past 4 years. The
appropriate weights are-1, 2, 3 and 4 respectively.
The profits of 4 years are:
2021- Rs 24,000 ; 2022-Rs 29,000 ; 2023-Rs 23,000 and 2024-Rs 35,000
On scrutiny of accounts, we find that:
(i) On 1st October, 2023, a major repair was made in plant incurring ₹ 8,000 which
amount was charged to revenue. The said sum is agreed to be capitalised for
computation of goodwill subject to depreciation @ 10% p.a. on diminishing balance
method.
(ii) The closing stock of 2022 was over valued by Rs 2,000.
(iii) It is also agreed that 3,000 be charged on annual basis as management expenses
which have not been charged earlier.
Compute value goodwill of the business of Y.
SUPER PROFIT METHOD: In this method goodwill is calculated on the basis of
surplus (excess) profits earned by a firm in comparison to average profits earned by
other firms. If a business has no anticipated excess earnings, it will have no goodwill.
Such excess profits are called super profits and the goodwill is calculated on the basis
of super profits.
Goodwill = Super Profit x No. of years Purchase
Note:
• Normal Profit = Capital Invested x Normal Rate Of Return
100
• Super Profit = Average /Actual Profit – Normal Profit
• Capital Employed = Assets – Liabilities
OR
• Capital Employed = Partner’s Capital + Partners Current A/c (cr)
-Partners Current A/c(dr) + Reserves – Losses
Question Based on Super Profit Method:
[Link] capital of the firm of Anu and Benu is 1,00,000 and the market rate of interest is 15%.
Annual salary payable to partners is 6,000 each. The profits for the last 3 years were Rs 30,000
, Rs36,000 and Rs 42,000. Goodwill is to be valued at 2 years' purchase of the last 3 years
average super profit. Calculate goodwill of the firm.
Q5.A business earned average profit of Rs 3,00,000 during the last few years. The normal rate
of return in the similar type of business is 10%. The total value of assets and liabilities of the
business were 22,00,000 and 5,60,000 respectively. Calculate the value of goodwill of the firm
by super profit method, if the goodwill is valued at 2.5 years' purchase of super profit.
CAPITALISATION METHOD: Under this method ,goodwill can be calculated in
two ways :
i. By Capitalising the average profits
ii. By Capitalising the super profits
(i) Capitalising the average profits : Under this method first of all we calculate the
average profits and then we assess the capital needed for earning such average profits
on the basis of normal rate of return. Such capital is also called capitalised value of
average profits.
Goodwill = Capitalised Value of Average Profits – Actual Capital Employed
Goodwill = Capitalised Value of Average Profits – Actual Capital Employed
Note
• Capitalised Valued of Average Profits = Average Profits x______100________
Normal Rate of Return
Question Based on Capitalisation Method (Average Profit):
[Link] average profit of a firm is Rs 60,000. It has tangible assets amounting to Rs 5,00,000 and
outside liabilities amounting to Rs 1,50,000. The normal rate of earning is 10%. Find goodwill by
capitalisation of average profit method.
Q.7Anupma, Purnima and Ruchika are partners in a business. Balances in their Capital and Current
Accounts as on 31st March, 2023 were :
Capital A/c Current A/c
Anupma 6,00,000 60,000(Dr)
Purnima 5,00,000 30,000(Dr)
Ruchika 5,00,000 10,000(Cr)
The firm earned an average profit of Rs 2,40,000. If the normal rate of return is 12%, find the value of
goodwill by Capitalisation of Average Profit Method.
(ii) Capitalising the super profits: Under this method first of all we calculate the Super
Profits and then we assess the capital needed for earning such super profits on the basis of
normal rate of return.
Goodwill = Super Profit x ___100____
Normal Rate of Return
Question Based on Capitalisation Method (Super Profit):
Q8. Ram and Mohan are equal partners in a firm with the following balances in their Capital and
Current A/cs.
Particulars Capital A/c Current A/c
Ram 2,50,000 30,000(Cr)
Mohan 2,00,000 20,000(Dr)
The profit earned by the firm for the year ending 31st March, 2024 was 1,00,000 with cost
of Management 30,000 p.a.
Find the value of goodwill of the firm based on Capitalisation of Super Profit if the normal
rate of return on capital employed is 10%.
*************************************************************************