Question

A partnership firm earned net profits during the last three years as follows:

2016: ₹ 20,000; 2017: ₹ 17,000 and 2018: ₹ 23,000

The capital investment of the firm throughout the above mentioned period has been ₹ 80,000. Having regard to the risk involved, 15% is considered to be a fair return on capital employed in the business. Calculate the value of goodwill on the basis of 2 years purchase of super profit.

Answer 1

Calculation of average profit Year Profit

Year	Profit
2016	20,000
2017	17,000
2018	23,000
Total profit	60,000

Average Profit = `"Total profit"/"Number of years"`

= `(60,000)/3`

= ₹ 20,000

Normal profit = Capital employed × Normal rate of return

= `80,000 xx 15/100`

= ₹ 12,000

Super profit = Average Profit – Normal profit

= 20,000 – 12,000

= 8,000

Valuation of goodwill = Super profit × No. of years purchase

= ₹ 8,000 × 2

= ₹ 16,000