Question

Abhay, Babu and Charu are partners sharing profits and losses equally. They agree to admit Daman for equal share of profit. For this purpose, the value of goodwill is to be calculated on the basis of four years' purchase of average profit of last five years. These profits for the year ended 31st March, were:

Year	2015	2016	2017	2018	2019
Profit/(Loss) (₹)	1,50,000	3,50,000	5,00,000	7,10,000	(5,90,000)

On 1st April, 2018, a car costing ₹ 1,00,000 was purchased and debited to Travelling Expenses Account, on which depreciation is to be charged @ 25%. Interest of ₹ 10,000 on Non-trade Investments is credit to income for the year ended 31st March, 2018 and 2019.
Calculate the value of goodwill after adjusting the above.

Answer 1

Normal Profits for the year ended 31st March, 2018:$$\begin{gathered} =\left(\mathrm{Total}\mathrm{Profits}+\mathrm{Purchase}\mathrm{of}\mathrm{car}\mathrm{wrongly}\mathrm{debited}-\mathrm{Depreciation}\mathrm{on}\mathrm{Car}-\mathrm{Income}\mathrm{from}\mathrm{Non}-\mathrm{trade}\mathrm{Investments}\right) \\ =₹(7,10,000+1,00,000-25,000-10,000)=₹7,75,000 \end{gathered}$$
Normal Profits for the year ended 31st March, 2019:
$$\begin{gathered} =(\mathrm{Total}\mathrm{Loss}+\mathrm{Income}\mathrm{from}\mathrm{Non}-\mathrm{Trade}\mathrm{Investments}) \\ =₹(5,90,000+10,000)=₹6,00,000 \end{gathered}$$
$\mathrm{Average}\mathrm{Profits}=\frac{\mathrm{Normal}\mathrm{Profits}\mathrm{from}31\mathrm{st}\mathrm{March},2015\mathrm{to}31\mathrm{st}\mathrm{March},2019}{5}$
$\mathrm{Average}\mathrm{Profits}=₹\left(\frac{1,50,000+3,50,000+5,00,000+7,75,000+6,00,000}{5}\right)=₹2,35,000$
$\mathrm{Goodwill}=\mathrm{Average}\mathrm{Profits}\mathrm{for}\mathrm{last}5\mathrm{years}\times \mathrm{No}.\mathrm{of}\mathrm{years}\mathrm{of}\mathrm{purchase}$$=₹(2,35,000\times 4)=₹9,40,000$