Chapter 3 - Goodwill: Nature And Valuation

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, 2022. 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 2018 2019 2022 2021 2022 Profits ( `) 14,000 15,500 10,000 16,000 15,000

Calculate the value of goodwill.

Calculation of Average Profit for Five Years

 Year Profit 2014 – 15 14,000 2015 – 16 15,500 2019 – 17 10,000 2018 – 18 16,000 2019 – 19 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 2015 – 16 15,500 2019 – 17 10,000 2018 – 18 16,000 2019 – 19 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

Question 7: Asin and Shreyas were partners sharing profits and losses in the ratio of 2:1. They admitted Shyam as a partner for 1/5th share in profits. For this purpose Goodwill of the firm was to be valued on the basis of three years' purchase of last five years' average profit. Profits for the last five years ended 31st March, were:

 Year 2018 2019 2020 2021 2022 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 2018-19 was calculated after charging 25,000 for abnormal loss of goods by fire.

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

Question 8: Madhu and Vidhi are partners sharing profts in the ratio of 3:2. They decided to admit Manu as a partner from 1st April, 2022 on the following terms

(i) Manu will be given 2/5th share of the profit.

(ii) Goodwill of the firm will be valued at two years' purchase of three years' normal average profit of the firm.

Profits of the previous three years ended 31st March, were

2022-Profit `30,000 (after debiting loss of stock by fire `40,000).

2021-Loss `80,000 (includes voluntary retirement compensation paid `1,10,000).

2020-Profit `1,10,000 (including a gain (profit) of 30,000 on the sale of fixed assets).

Calculate the value of goodwill.

Goodwill= Average profit × no. of purchases years’

=Sum of three years Profit × no. of purchases years’/Total no. of years

=(first years profit+normal loss)+(Second years loss+Retirement compensation)+(Third years’ profit – gain on sale of fixed assets)×2year/3year

=(30,000+40,000)+(-80,000+1,10,000)+1,10,000-30,000)×2/3

=1,20,000

Tarang purchased Jyoti's business with effect from 1st April, 2022. Profits shown by Jyoti's business for the last three  financial years were:

 2020 : ` 1,00,000 (including an abnormal gain of  ` 12,500). 2021 : ` 1,25,000 (after charging an abnormal loss of  ` 25,000). 2022 : ` 1,12,500 (excluding  ` 12,500 as insurance premium on firm's property- now to be insured).

Calculate the value of firm's goodwill on the basis of two year's purchase of the average profit of the last three years.

Abhay, Babu and Charu are partners sharing profits and losses equally. They agree to admit Daman for equal share of profit. For this purpose, the value of goodwill is to be calculated on the basis of four years' purchase of average profit of last five years. These profits for the year ended 31st March, were:

 Year 2018 2019 2020 2021 2022 Profit/(Loss) ( `) 1,50,000 3,50,000 5,00,000 7,10,000 (5,90,000)

On 1st April, 2021, a car costing  ` 1,00,000 was purchased and debited to Travelling Expenses Account, on which depreciation is to be charged @ 25%. Interest of  ` 10,000 on Non-trade Investments is credit to income for the year ended 31st March, 2021 and 2022.
Calculate the value of goodwill after adjusting the above.

Normal Profits for the year ended 31st March, 2021:=Total Profits+Purchase of car wrongly debited - Depreciation on Car - Income from Non-trade Investments= `(7,10,000 + 1,00,000 - 25,000 - 10,000)=  ` 7,75,000
Normal Profits for the year ended 31st March, 2022:=(Total Loss + Income from Non-Trade Investments)=
`(5,90,000 + 10,000)= `6,00,000
Average Profits=Normal Profits from 31st March, 2018 to 31st March,2022/5
Average Profits=
` 1,50,000+3,50,000+5,00,000+7,75,000+(6,00,000)/5= `2,35,000
Goodwill=Average Profits for last 5 years×No. of years of purchase=
`(2,35,000×4)= `9,40,000