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Question
Purav and Purvi are partners in a firm, sharing profits and losses in the ratio of 2 : 1. They decide to take Parv into partnership for 1/4th share on 1st April, 2019. For this purpose, goodwill is to be valued at four times the average annual profit of the previous four or five years, whichever is higher. The agreed profits for goodwill purpose of the past five years are:
| Year | 2014-15 | 2015-16 | 2016-17 | 2017-18 | 2018-19 |
| Profits (₹) | 14,000 | 15,500 | 10,000 | 16,000 | 15,000 |
Calculate the value of goodwill.
Solution
Calculation of Average Profit for Five Years and Four Years.
| Year | Profit (5 Years) | Profit (4 Years) |
| 2014 – 15 | 14,000 | − |
| 2015 – 16 | 15,500 | 15,500 |
| 2016 – 17 | 10,000 | 10,000 |
| 2017 – 18 | 16,000 | 16,000 |
| 2018 – 19 | 15,000 | 15,000 |
| Total Profit | 70,500 | 56,500 |
Average Profit of the Five Years = `[70,500]/5`
= Rs. 14,100
Average Profit of the Four Years = `[56,500]/4`
= Rs. 14,125
Average Profit of four years is taken to compute the value of the goodwill of the firm. This is because Average Profit of four years is more than the Average Profit of five years.
∴ Goodwill = Average Profit x Number's of year's purchase
= 14,125 × 4
= Rs. 56,500.
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