Question

On 1st April, 2019, an existing firm had assets of ₹ 75,000 including cash of ₹ 5,000. Its creditors amounted to ₹ 5,000 on that date. The firm had a Reserve of ₹ 10,000 while Partners' Capital Accounts showed a balance of ₹ 60,000. If Normal Rate of Return is 20% and goodwill of the firm is valued at ₹ 24,000 at four years' purchase of super profit, find average profit per year of the existing firm.

Answer 1

Average Profit = Normal Profit + Super Profit

Capital Employed = Total Assets - Creditors
= Rs. ( 75,000 - 5,000) = Rs. 70,000

Normal Profits = `("Capital Employed" xx "Normal Rate of Return"/100)`

= Rs. `( 70,000 xx 20/100 )` = Rs. 14,000

Goodwill of the firm = Rs 24,000
Number of years’ purchase = 4

Goodwill = Super Profits x No. of Years of Purchase
Or, 24,000 = Super Profit × 4

Or, Super Profit = `[24,000]/4` = Rs. 6,000.

∴ Average Profit = Normal Profit + Super Profit
= 14,000 + 6,000 = Rs. 20,000.