Question

The average profit of a firm during the last few years is ₹ 8,00,000. In a similar business, the normal rate of return is 10% of the capital employed. Assets of the business were ₹ 60,00,000, and its external liabilities were ₹ 20,00,000. Calculate the value of goodwill by:

1. Capitalisation of super profits method
2. Super profit method if the goodwill is valued at four years’ purchase of super profits.

Answer 1

1. Calculate Capital Employed and Normal Profit:

Capital Employed = Total Assets − External Liabilities

= 60,00,000 − 20,00,000

= 40,00,000

Normal Profit = Capital Employed × Normal Rate of Return

= `40,00,000 xx 10/100`

= 4,00,000

2. Calculate Super Profit:

Super Profit = Average Profit − Normal Profit

= 8,00,000 − 4,00,000

= 4,00,000

(i) Capitalisation of super profits method:

Goodwill = `("Super profit" xx 100)/"Normal rate of return"`

= `(4,00,000 xx 100)/10`

= 40,00,000

(ii) Super Profit Method (4 Years’ Purchase):

Goodwill = Super profit × Normal of the year’s purchase

= 4,00,000 × 4

= 16,00,000