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Question

Sumit purchased Amit's business on 1st April, 2019. Goodwill was decided to be valued at two years' purchase of average normal profit of last four years. The profits for the past four years were:
Year Ended 31st March, 2016 31st March, 2017 31st March, 2018 31st March, 2019
Profits (₹) 80,000 1,45,000 1,60,000 2,00,000
Books of Account revealed that:
(i) Abnormal loss of ₹ 20,000 was debited to Profit and Loss Account for the year ended 31st March, 2016.
(ii) A fixed asset was sold in the year ended 31st March, 2017 and gain (profit) of ₹ 25,000 was credited to Profit and Loss Account.
(iii) In the year ended 31st March, 2018 assets of the firm were not insured due to oversight. Insurance premium not paid was ₹ 15,000.
Calculate the value of goodwill.

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Solution

Goodwill=Average Profit×No. of years' purchase =1,41,250×2=₹ 2,82,500


Working Notes:

WN: 1 Calculation of Normal Profits

Year

Profit/(Loss) (₹)

Adjustment

Normal Profit (₹)

31 March, 2016

80,000

20,000

1,00,000

31 March, 2017

1,45,000

(25,000)

1,20,000

31 March, 2018

1,60,000

(15,000)

1,45,000

31 March, 2019

2,00,000

-

2,00,000

5,65,000

WN: 2 Calculation of Average Profit

Average Profit=Total Profit for past given years Number of Years =5,65,0004=₹ 1,41,250


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