Question

Sumit purchased Amit's business on 1st April, 2019. Goodwill was decided to be valued at two years' purchase of average normal profit of last four years. The profits for the past four years were:

Year Ended	31st March, 2016	31st March, 2017	31st March, 2018	31st March, 2019
Profits (₹)	80,000	145,000	160,000	200,000

Books of Account revealed that:
(i) Abnormal loss of ₹ 20,000 was debited to Profit and Loss Account for the year ended 31st March, 2016.
(ii) A fixed asset was sold in the year ended 31st March, 2017 and gain (profit) of ₹ 25,000 was credited to Profit and Loss Account.
(iii) In the year ended 31st March, 2018 assets of the firm were not insured due to oversight. Insurance premium not paid was ₹ 15,000.
Calculate the value of goodwill.

Answer 1

Goodwill = Average Profits x No. of Years of Purchase
               = 1,41,250 x 2 = Rs. 2,82,500.

Working Notes:
WN: 1 Calculation of Normal Profits

Year	Profit/(Loss) (₹)	Adjustment	Normal Profit (₹)
31 March, 2016	80,000	20,000	1,00,000
31 March, 2017	1,45,000	(25,000)	1,20,000
31 March, 2018	1,60,000	(15,000)	1,45,000
31 March, 2019	2,00,000	-	2,00,000
			5,65,000

WN: 2 Calculation of Average Profit
Average Profit = `"Total Profit for past given years"/"Number of Years"`

= `[5,65,000]/4`

= Rs. 141,250.