Valuation of Goodwill

Goodwill is to be valued at three years' purchase of four years' average profit. Profits for last four years ending on 31st March of the firm were:
2020 −  ` 12,000; 2021 −  ` 18,000;2022 −  ` 16,000; 2023 −  ` 14,000.
Calculate amount of Goodwill.

 

Answer:

Goodwill= Average profit × no. of purchases years’

Average profit = total profit of past given years/number of years

Average profit =12,000+18,000+16,000+14,000/4=15,000

Number of years’ purchase = 3

Goodwill= Average profit × no. of purchases years’

Goodwill= 15,000 × 3=45,000

Profits for the five years ending on 31st March, are as follows:
Year 2019 −  ` 4,00,000; Year 2020 −  ` 3,98,000; Year 2021 −  ` 4,50,000; Year 2022 −  ` 4,45,000 and Year 2023 −  ` 5,00,000.
Calculate goodwill of the firm on the basis of 4 years' purchase of 5 years' average profit.

Answer:

Goodwill=Average Profit×Number of Years' Purchase

Average Profits = Total Profit÷Number of Years

Average Profits = 4,00,000+3,98,000+4,50,000+4,45,000+5,00,000÷5

Average Profits = 21,93,000÷5= ` 4,38,600

Goodwill =4,38,600×4= ` 17,54,400

 

Annu, Baby and Chetan are partners in a firm sharing profits and losses equally. They decide to take Deep into partnership from 1st April, 2022 for 1/5th share in the future profits. For this purpose, goodwill is to be valued at 100% of the average annual profits of the previous three or four years, whichever is higher. The annual profits for the purpose of goodwill for the past four years were:

Year Ended	Profit ( `)
31st March, 2023	2,88,000;
31st March, 2022	1,81,800;
31st March, 2021	1,87,200;
31st March, 2020	2,53,200.

Calculate the value of goodwill.

Answer:

Average Profits of Previous three years= 2,88,000+1,81,8000+1,87,200÷3= ` 2,19,000
Average Profits of Previous four years= 2,88,000+1,81,800+1,87,200+2,53,200÷4=  ` 2,27,550
Since, the average profits of previous four years is greater than the average profits of previous three years.
Hence, Goodwill = 100% of Average Profits of Previous four years =  ` 2,27,550

Purav and Purvi are partners in a firm sharing profits and losses in the ratio of 2 : 1. They decide to take Parv into partnership for 1/4th share on 1st April, 2023. For this purpose, goodwill is to be valued at four times the average annual profit of the previous four or five years, whichever is higher. The agreed profits for goodwill purpose of the past five years are:

Year	2019	2020	2021	2022	2023
Profits ( `)	14,000	15,500	10,000	16,000	15,000

Calculate the value of goodwill.

Answer:

Calculation of Average Profit for Five Years

Year	Profit
2019	14,000
2020	15,500
2021	10,000
2022	16,000
2023	15,000
Total Profit	70,500

 

Average Profit for Five Years=70,500/5=14,100

Calculation of Average Profit for Four Years

Year	Profit
2020	15,500
2021	10,000
2022	16,000
2023	15,000
Total Profit	56,500

 

 Average Profit for Five Years=56,500/4=14,125

Average Profit of four years is taken to compute the value of goodwill of the firm. This is because Average Profit of four years is more than the Average Profit of five years.

Goodwill= Average profit × no. of purchases years’

Goodwill= 14,125 ×4 =56,500

 

Year	2019	2020	2021	2022	2023
Profit (`)	1,25,000	1,00,000	1,87,500	(62,500)	1,25,000

Calculate Goodwill of the firm after adjusting the following:

Profit of 2019-20 was calculated after charging 25,000 for abnormal loss of goods by fire.

Answer;

Goodwill= Average profit × no. of purchases years’

=Sum of normal profit × no. of purchases years’/total no. of years

=1,25,000+1,00,000+25,000+1,87,500+(62,500)+1,25,000/5×3 (purchases years’)

=3,00,000