Question

Following information is available about the business of a firm:

1. Profits: In 2020, ₹ 40,000; In 2021, ₹ 50,000; In 2022, ₹ 60,000.
2. Nonrecurring income of ₹ 1,000 is included in the profits of 2021.
3. Profits of 2020 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 2022 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 2020 - 1; 2021 - 2; 2022 - 3.

Answer 1

Calculation of profits for the purpose of goodwill:

2020 = 40,000 + 6,000 − 400 − 6,000

= ₹ 39,600

2021 = 50,000 − 1,000 − 400 − 6,000

= ₹ 42,600

2022 = 60,000 − 400 − 6,000 − 5,000

= ₹ 48,600

Calculation of Weighted Average Profit of the firm:

Year	Profits (₹)	Weights	Weighted Profits
2020	39,600	1	39,600
2021	42,600	2	85,200
2022	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