Question

Average profit earned by a firm is ₹ 1,00,000 which includes undervaluation of stock of ₹ 40,000 on an average basis. The capital invested in the business is ₹ 6,30,000 and the normal rate of return is 5%. Calculate goodwill of the firm on the basis of 5 times the super profit.

Answer 1

Average normal Profit = (Average Profit + Undervaluation of stock on average basis*)
= Rs. ( 1,00,000 + 40,000) = Rs. 1,40,000

Capital Employed in the business = Rs. 6,30,000
Normal Profits = `( "Capital Employed" xx "Normal Rate of Return"/100)`
= Rs. ( 6,30,000 x `5/100`) = Rs. 31,500

Super Profits = Average Normal Profits - Normal Profits
= Rs. ( 1,40,000 - 31,500) = Rs. 1,08,500

Goodwill = Super Profits x No. of Years of purchase
= Rs. ( 1,08,500 x 5) = Rs. 5,42,500

* Stock has been taken to be closing stock if nothing is specified in the question.