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Question
A partnership firm earned net profits during the last three years as follows:
2016: ₹ 20,000; 2017: ₹ 17,000 and 2018: ₹ 23,000
The capital investment of the firm throughout the above mentioned period has been ₹ 80,000. Having regard to the risk involved, 15% is considered to be a fair return on capital employed in the business. Calculate the value of goodwill on the basis of 2 years purchase of super profit.
Solution
Calculation of average profit Year Profit
| Year | Profit |
| 2016 | 20,000 |
| 2017 | 17,000 |
| 2018 | 23,000 |
| Total profit | 60,000 |
Average Profit = `"Total profit"/"Number of years"`
= `(60,000)/3`
= ₹ 20,000
Normal profit = Capital employed × Normal rate of return
= `80,000 xx 15/100`
= ₹ 12,000
Super profit = Average Profit – Normal profit
= 20,000 – 12,000
= 8,000
Valuation of goodwill = Super profit × No. of years purchase
= ₹ 8,000 × 2
= ₹ 16,000
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| Liabilities | Amount (₹) |
Assets | Amount (₹) |
|
| Capital A/cs: | Land and Building | 10,00,000 | ||
| Shyam | 5,00,000 | Furniture | 2,00,000 | |
| Sunder | 5,00,000 | 10,00,000 | Investments | 1,00,000 |
| Current A/cs: | Sundry Debtors | 5,00,000 | ||
| Shyam | 2,00,000 | Bills Receivable | 50,000 | |
| Sunder | 2,00,000 | 4,00,000 | Closing Stock | 3,00,000 |
| Reserves | 3,40,000 | Cash in Hand | 50,000 | |
| Sundry Creditors | 4,00,000 | Cash at Bank | 1,00,000 | |
| Bills Payable | 1,00,000 | |||
| Outstanding Expenses | 60,000 | |||
| 23,00,000 | | 23,00,000 | ||
Calculate the value of goodwill, if it is valued at three years' purchase of Super Profit.
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Under this method, the value of goodwill is ascertained by deducting the actual capital employed (net assets) in the business from the capitalized value of the average profits on the basis of the normal rate of return.
