Question

The average profit earned by a firm is ₹ 75,000 which includes undervaluation of stock of ₹ 5,000 on an average basis. The capital invested in the business is ₹ 7,00,000 and the normal rate of return is 7%. Calculate goodwill of the firm on the basis of 5 times the super profit.

Answer 1

Average profit = ₹ 75,000

Since it includes undervaluation of stock of ₹ 5,000, the profit is understated. So add it back:

Adjusted Average Profit = ₹ 75,000 + ₹ 5,000 = ₹ 80,000

1. Normal Profit

Capital invested = ₹ 7,00,000

Normal rate of return = 7%

`7,00,000 xx 7/100 = 49,000`

2. Super Profit

Super Profit = Adjusted Average Profit − Normal Profit

= ₹ 80,000 − ₹ 49,000 = ₹ 31,000

3. Goodwill

Goodwill = 5 times the super profit:

₹ 31,000 × 5 = ₹ 1,55,000