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Question
On 1st April, 2020, Anish started a business with a capital of ₹ 3,00,000.
During the three years ending 31st March, 2023, the results of his business were:
| Year | (₹) | |
| 2020-21 | Loss | 20,000 |
| 2021-22 | Profit | 34,000 |
| 2022-23 | Profit | 46,000 |
From the year 2020-21 to the year 2022-23, Anish withdrew ₹ 30,000 from the firm for his personal use.
On 1st April, 2023, he admitted Danish into partnership on the following terms:
- Goodwill of the firm to be valued at two years’ purchase of the average profits of the last three years.
- Danish to have a `1/4` share in the future profits.
- Danish’s capital is to be equal to `1/4` of Anish’s capital determined on 1st April, 2023, after the goodwill compensation has been taken into account.
You are required to give:
- The formula to calculate goodwill by the Average Profit Method.
- The value of self-generated goodwill of the firm.
- Danish’s capital contribution.
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Solution
i.
Formula to calculate goodwill by Average Profit method: `"Average Profit" = ("Total profits of given years")/("Total number of years")`
Goodwill = Average profit × Number of years purchase
ii.
Calculation of value of self-generated goodwill:
`"Average Profit" = ("Loss of (2020−21) + Profit of (2021−22) + Profit of (2022−23)")/3`
`= ((20,000) + 34,000 + 46,000)/3`
`= (80,000 - 20,000)/3`
`= (60,000)/3`
= ₹ 20,000
Average profit = ₹ 20,000
No. of years purchase = 2
Goodwill = 20,000 × 2
= ₹ 40,000
iii.
Calculation of Danish’s Capital contribution
Danish’s share of goodwill = `40,000xx1/4` = ₹ 10,000
Adjusted Capital of Anish on 1st April, 2023:
| Particulars | Amount (₹) |
| Capital as on 1st April 2020 | 3,00,000 |
| Add: Total Profit of last 3 Years | 60,000 |
| Add: Goodwill Compensation from Danish | 10,000 |
| 3,70,000 | |
| Less: Drawings of last 3 Years | 30,000 |
| 3,40,000 |
Danish’s capital contribution = `(3,40,000)/4`
= ₹ 85,000
RELATED QUESTIONS
Vikas, Vishal and Vaibhav were partners in a firm sharing profits in the ratio of 2:2:1. The firm closes its books 31st March every year. On 31-12-2015 Vaibhav died. On that date his Capital account showed a credit balance of Rs. 3, 80,000 and Goodwill of the firm was valued at 1, 20,000. There was a debit balance of Rs. 50,000 in the profit and loss account. Vaibhav's share of profit in the year of his death was to be calculated on the basis of the average profit of last five years. The average profit of last five years was Rs. 75,000.
Pass necessary journal entries in the books of the firm on Vaibhav's death.
For which share of Goodwill a partner is entitled at the time of his retirement?
How does the nature of business affect the value of goodwill of a firm?
Write a word/phrase/term which can substitute the following statement.
Reputation of business measured in terms of money.
State the ratio in which the old partner’s Capital A/c will be credited for goodwill when the new partner does not bring his share of goodwill in cash?
Madhav, Madhusudan and Mukund were partners in Jaganath Associates. They decided to dissolve the firm on 31st March 2021. Pass necessary journal entries for the following transactions after various assets (other than cash) and third-party liabilities have been transferred to realization account:
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- Stock of book value of ₹30,000 was taken by Madhav, Madhusudan and Mukund in their profit sharing ratio.
- The firm had paid realization expenses amounting to ₹5,000 on behalf of Mukund.
- There was a vehicle loan of ₹ 2,00,000 which was paid by surrender of asset to the bank at an agreed value of ₹ 1,40,000 and the shortfall was met from firm’s bank account.
Harry, Pammy and Sunny are partners sharing profits in the ratio of 3:2:1. Goodwill is appearing in the books at a value of Rs. 60, 000. What is the journal entry for the following case?
Goodwill is a/an ______ asset.
Calculate goodwill of a firm on the basis of three years purchases of the Weighted Average Profits of the last four years. The profits of the last four years were:
| Years (ending 31st march) | 2020 | 2021 | 2022 | 2023 |
| Amount | 28,000 | 27,000 | 46,900 | 53,810 |
- On 1st April, 2020 a major plant repair was undertaken for ₹ 10,000 which was charged to revenue. The said sum is to be capitalized for goodwill calculation subject to adjustment of depreciation of 10% on reducing balance method.
- For the purpose of calculating Goodwill the company decided that the years ending 31.03.2020 and 31.03.2021 be weighted as 1 each (being COVID affected) and for year ending 31.03.2022 and 31.03.2023 weights be taken as 2 and 3 respectively.
Goodwill is to be valued on the basis of 2 years purchases of last 5 years average profit. The profits and losses of last five years were as follows :
| Year | 1 | 2 | 3 | 4 | 5 |
| Amount (₹) | 30,000 (Profit) |
40,000 (Profit) |
70,000 (Profit) |
30,000 (Loss) |
50,000 (Profit) |
Find out value of Goodwill.
