Question

Following information is available about the business of a firm:

1. Profits: In 2022, ₹ 40,000; In 2023, ₹ 50,000; In 2024, ₹ 60,000.
2. Nonrecurring income of ₹ 1,000 is included in the profits of 2023.
3. Profits of 2022 have been reduced by ₹ 6,000 because goods were destroyed by fire.
4. Goods have not been insured but it is thought to insure them in future. The insurance premium is estimated at ₹ 400 per year.
5. Reasonable remuneration of the proprietor of business is ₹ 6,000 per year, but it has not been taken into account for calculation of above mentioned profits.
6. Profits of 2024 include ₹ 5,000 income on investment.

Goodwill is agreed to be valued at two year’s purchase of the weighted average profits of the past three years. The appropriate weights to be used are 2022 - 1; 2023 - 2; 2024 - 3.

Answer 1

Calculation of profits for the purpose of goodwill:

2022 = 40,000 + 6,000 − 400 − 6,000

= ₹ 39,600

2023 = 50,000 − 1,000 − 400 − 6,000

= ₹ 42,600

2024 = 60,000 − 400 − 6,000 − 5,000

= ₹ 48,600

Calculation of Weighted Average Profit of the firm:

Year	Profits (₹)	Weights	Weighted Profits
2022	39,600	1	39,600
2023	42,600	2	85,200
2024	48,600	3	1,45,800
Total		6	2,70,600

Weighted Average Profit of last 3 year’s = `"Sum of Weighted Profits of last 3 years"/"Sum of Weights"`

= `(2,70,600)/6`

= ₹ 45,100

Calculation of Goodwill of the firm:

Goodwill of the firm = Weighted Average Profit of last 3 year’s × 2 year’s of purchase

= 45,100 × 2

= ₹ 90,200