Question

X and Y are partners in a firm. They admit Z into partnership for equal share. It was agreed that goodwill will be valued at three years' purchase of average profit of last five years. Profits for the last five years were:

Year Ended	31st March, 2014	31st March, 2015	31st March, 2016	31st March, 2017	31st March, 2018
Profit (₹)	90,000 (Loss)	1,60,000	1,50,000	65,000	1,77,000

Books of Account of the firm revealed that:
(i) The firm had gain (profit) of ₹ 50,000 from sale of machinery sold in the year ended 31st March, 2015. The gain (profit) was credited in Profit and Loss Account.
(ii) There was an abnormal loss of ₹ 20,000 incurred in the year ended 31st March, 2016 because of a machine becoming obsolete in accident.
(iii) Overhauling cost of second hand machinery purchased on 1st July, 2016 amounting to ₹ 1,00,000 was debited to Repairs Account. Depreciation is charged @ 20% p.a. on Written Down Value Method.
Calculate the value of goodwill.

Answer 1

$\begin{array}{l}\text{Goodwill}=\text{Average Profit}\times \text{No. of years' purchase}\\ =1,00,000\times 3=\text{Rs 3,00,000}\end{array}$

Working Notes:

WN: 1 Calculation of Normal Profits

Year	Profit/(Loss) (Rs)	Adjustment	Normal Profit (Rs)
31 March, 2014	(90,000)	-	(90,000)
31 March, 2015	1,60,000	(50,000)	1,10,000
31 March, 2016	1,50,000	20,000	1,70,000
31 March, 2017	65,000	85,000*	1,50,000
31 March, 2018	1,77,000	(17,000)	1,60,000
			5,00,000

* Adjustment Amount

Overhauling cost of second hand machinery wrongly accounted as expense instead of capital expenditure. Profit to be increase by Rs 1,00,000	1,00,000
Depreciation to be debited from P&L A/c $(1,00,000\times \frac{20}{100}\times \frac{9}{12})$	(15,000)
Amount to be added back	85,000

WN: 2 Calculation of Average Profit

$\begin{array}{l}\text{Average Profit}=\frac{\text{Total Profit for past given years}}{\text{Number of Years}}\\ =\frac{5,00,000}{5}=\text{Rs 1,00,000}\end{array}$