Question

Abha and Sara were partners in a firm. Their capitals were: Abha ₹ 3,00,000 and Sara ₹ 2,00,000. The normal rate of return in similar business is 10%. The profits of the firm of Abha and Sara for the last three years were:
2021–22 $\Rightarrow $₹ 60,000
2022–23 $\Rightarrow $₹ 90,000
2023–24 $\Rightarrow $₹ 1,20,000
Calculate goodwill of the firm on the following basis:

[(i)] Four years purchase of the average profits for the last three years
[(ii)] Capitalisation of super-profits

Hint:

Use average profits for both methods; super profit method adjusts for excess returns over normal expectations.

Answer 1

(i) Four years purchase of average profits:
Total profit for 3 years = ₹(60,000 + 90,000 + 1,20,000) = ₹2,70,000
Average profit = ₹$\dfrac{2,70,000}{3} = ₹90,000$
Goodwill = Average Profit × No. of Years Purchase
$⇒ \text{Goodwill} = ₹90,000 \times 4 = ₹3,60,000$

(ii) Capitalisation of Super Profits:
Average profit = ₹90,000
Capital employed = ₹(3,00,000 + 2,00,000) = ₹5,00,000
Normal profit = ₹$5,00,000 \times 10\% = ₹50,000$
Super profit = Average Profit – Normal Profit
$⇒ \text{Super profit} = ₹90,000 - ₹50,000 = ₹40,000$
Goodwill = Super Profit × $\left(\dfrac{100}{\text{Normal Rate}}\right)$
$⇒ \text{Goodwill} = ₹40,000 \times \dfrac{100}{10} = ₹4,00,000$