Question

A and B are partners in a firm sharing profits and losses in the ratio of 2 : 1. They decide to take C into partnership for 1/4th share on 1st April, 2018. For this purpose, goodwill is to be valued at four times the average annual profit of the previous four or five years whichever is higher. The agreed profits for goodwill purpose of the past five years are:

Year	2013–14	2014–15	2015–16	2016–17	2017–18
Profit (₹)	14,000	15,500	10,000	16,000	15,000

Answer 1

Calculation of Average Profit for Five Years

Year	Profit
2013 – 14	14,000
2014 – 15	15,500
2015 – 16	10,000
2016 – 17	16,000
2017 – 18	15,000
Total Profit	70,500

Calculation of Average Profit for Four Years

Year	Profit
2014 – 15	15,500
2015 – 16	10,000
2016 – 17	16,000
2017 – 18	15,000
Total Profit	56,500

Average Profit of four years is taken to compute the value of goodwill of the firm. This is because Average Profit of four years is more than the Average Profit of five years.