7 :- Sumit purchased Amit’s business on 1st April, 2025. Goodwill was decided to be valued at two years’ purchase of average normal profit of the last four years. The profits for the past four years were:
Books of account revealed that:
- Abnormal loss of Rs 20,000 was debited to the Profit and Loss Account for the year ended 31st March, 2022.
- A fixed asset was sold in the year ended 31st March 2023, and a gain (profit) of Rs 25,000 was credited to Profit and Loss Account.
- In the year ended 31st March 2023 assets of the firm were not insured due to oversight. The insurance premium not paid was Rs 15,000.
Calculate the value of goodwill.
Solution:-
Calculation of normal profit after adjustments
2022 = 80,000 + 20,000 = Rs 1,00,000
2023 = 1,45,000 – 25,000 = Rs 1,20,000
2024 = 1,60,000 – 15,000 = Rs 1,45,000
2025 = 2,00,000 – 0 = Rs 2,00,000
Calculation of average profit of last 4 years
Average profit of last 4 years = 1,00,000 + 1,20,000 + 1,45,000 + 2,00,000/4
= 5,65,000/4
= Rs 1,41,250
Calculation of goodwill of the firm
Goodwill = Average profit x No. of years purchased
= 1,41,250 x 2
= Rs 2,82,500