Question

On 1^st April, 2020, Anish started a business with a capital of ₹ 3,00,000.
During the three years ending 31^st March, 2023, the results of his business were:

Year		(₹)
2020-21	Loss	20,000
2021-22	Profit	34,000
2022-23	Profit	46,000

From the year 2020-21 to the year 2022-23, Anish withdrew ₹ 30,000 from the firm for his personal use.
On 1st April, 2023, he admitted Danish into partnership on the following terms:

1. Goodwill of the firm to be valued at two years' purchase of the average profits of the last three years.
2. Danish to have 1/4 share in the future profits.
3. Danish's capital to be equal to 1/4 of Anish's capital determined on 1^st April, 2023, after the goodwill compensation has been taken into account.

You are required to give:

1. The formula to calculate goodwill by the Average Profit Method.
2. The value of self-generated goodwill of the firm.
3. Danish's capital contribution.

Answer 1

i.

Formula to calculate goodwill by Average Profit method: `"Average Profit"=("Total profits of given years")/("Total number of years")`

Goodwill = Average profit × Number of years purchase

ii.

Calculation of value of self generated goodwill

`"Average Profit" = ("Loss of (2020−21) + Profit of (2021−22) + Profit of (2022−23)")/3`

`= ((20,000) + 34,000 + 46,000)/3`

`= (80,000 - 20,000)/3`

`= (60,000)/3`

= ₹ 20,000

Average profit = ₹ 20,000

No. of years purchase = 2

Goodwill = 20,000 × 2

= ₹ 40,000

iii.

Calculation of Danish's Capital contribution

Danish's share of goodwill = `40,000xx1/4` = ₹ 10,000

Anish's capital on 31^st March 2023 = Opening capital − loss of (2020-21) + Profit of (2021-22) + Profit of (2022-23) − Drawings

= 3,00,000 − 20,000 + 34,000 + 46,000 − 30,000

= ₹ 3,30,000

Anish's capital on 1^st April 2023 after goodwill compensation has been accounted = 3,30,000 + 10,000

= ₹ 3,40,000

Danish's capital contribution = `(3,40,000)/4`

= ₹ 85,000