Question

A business has earned average profits of Rs. 1,00,000 during the last few years and the normal rate of return in similar business is 10%. If the total assets of the business are Rs. 10,00,000 and external liabilities are Rs. 1,80,000, calculate goodwill by the Capitalisation of Super Profits Method.

Hint:

Under this method, goodwill depends entirely on extra profits earned above the normal expected return.

Answer 1

In the capitalisation of super profits method, goodwill is calculated by capitalising the super profits at the normal rate of return. The first step is to compute the capital employed. Capital employed is equal to total assets minus external liabilities.
Here, total assets are Rs. 10,00,000 and external liabilities are Rs. 1,80,000. Therefore, capital employed becomes Rs. 10,00,000 – Rs. 1,80,000 = Rs. 8,20,000.
Next, we calculate the normal profit by applying the normal rate of return. Normal profit = 10% of capital employed = 10% of Rs. 8,20,000 = Rs. 82,000. Super profit is the excess of actual average profit over normal profit.
Since the actual average profit is Rs. 1,00,000, super profit equals Rs. 1,00,000 – Rs. 82,000 = Rs. 18,000.
Finally, goodwill is found by capitalising the super profit at the normal rate of return using the formula: Goodwill = Super Profit × 100 / Normal Rate. Hence, Goodwill = 18,000 × 100 / 10 = Rs. 1,80,000.