Question

A firm earned profits of ₹ 80,000, ₹ 1,00,000, ₹ 1,20,000 and ₹ 1,80,000 during 2010-11, 2011-12, 2012-13 and 2013-14 respectively. The firm has capital investment of ₹ 5,00,000. A fair rate of return on investment is 15% p.a. Calculate goodwill of the firm based on three years' purchase of average super profits of last four years.

Answer 1

By using Super Profit Method:

Goodwill = Average Super Profit × Years’ Purchase

1. Calculate Average Profit

Profits of last four years:

₹ 80,000 + ₹ 1,00,000 + ₹ 1,20,000 + ₹ 1,80,000 = ₹ 4,80,000

Average Profit:

`(₹ 4,80,000)/4 = ₹ 1,20,000`

2. Calculate Normal Profit

Capital employed = ₹ 5,00,000

Normal rate of return = 15%

Normal Profit = `₹ 5,00,000 xx 15/100 = ₹ 75,000`

3. Calculate Super Profit

Super Profit = Average Profit − Normal Profit 

= ₹ 1,20,000 − ₹ 75,000 = ₹ 45,000

4. Calculate Goodwill

Goodwill is based on 3 years' purchase:

₹ 45,000 × 3

= ₹ 1,35,000