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Question
Annu, Baby and Chetan are partners in a firm sharing profits and losses equally. They decide to take Deep into partnership from 1st April, 2019 for 1/5th share in the future profits. For this purpose, goodwill is to be valued at 100% of the average annual profits of the previous three or four years, whichever is higher. The annual profits for the purpose of goodwill for the past four years were:
| Year Ended | Profit (₹) |
| 31st March, 2019 | 2,88,000; |
| 31st March, 2018 | 1,81,800; |
| 31st March, 2017 | 1,87,200; |
| 31st March, 2016 | 2,53,200. |
Calculate the value of goodwill.
Solution
Average Profits of Previous three years = `[2,88,000 + 1,81,800 + 1,87,200]/3` = Rs. 2,19,000.
Average Profits of Previous Four years = `[2,88,000 + 1,81,800 + 1,87,200 + 2,53,200 ]/4` = Rs. 2,27,550.
Since, the average profits of previous four years is greater than the average profits of previous three years.
Hence, Goodwill = 100% of Average Profits of Previous four years = ₹2,27,550.
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Which of the following is true?
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Identify the formula for calculating goodwill with the help of the Average Profit Method.
