Question

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 1/4^th share on 1st April, 2019. 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	2014-15	2015-16	2016-17	2017-18	2018-19
Profits (₹)	14,000	15,500	10,000	16,000	15,000

Calculate the value of goodwill.

Answer 1

Calculation of Average Profit for Five Years and Four Years.

Year	Profit (5 Years)	Profit (4 Years)
2014 – 15	14,000	−
2015 – 16	15,500	15,500
2016 – 17	10,000	10,000
2017 – 18	16,000	16,000
2018 – 19	15,000	15,000
Total Profit	70,500	56,500

Average Profit of the Five Years = `[70,500]/5`

= Rs. 14,100

Average Profit of the Four Years = `[56,500]/4`

= Rs. 14,125

Average Profit of four years is taken to compute the value of the goodwill of the firm. This is because Average Profit of four years is more than the Average Profit of five years.
∴  Goodwill = Average Profit x Number's of year's purchase
= 14,125 × 4

= Rs. 56,500.