Page 65 - DEBKVOL-1

Chapter 3 Goodwill: Nature and Valuation 3.7
.
(iv) On the basis of Capitalisation of Average Profit:

Goodwill = Total Capitalised Value of Business – Net Assets

Average Normal Profit ¥ 100
Total Capitalised Value of Business =
Normal Rate of Return
` 50,000 ¥ 100
= = ` 4,16,666 or ` 4,16,667 (say)
12
Net Assets = Total Assets – Outside Liabilities
Outside Liabilities = Total Assets – Partners’ Capital
= ` 6,50,000 – ` 6,00,000 = ` 50,000
∴ Net Assets = ` 6,50,000 – ` 50,000 = ` 6,00,000
Value of Goodwill = ` 4,16,667 – ` 6,00,000 = (` 1,83,333)
The value of goodwill is nil since capitalised value of business is less than the net assets.

Illustration 10 (Weighted Average Profit when Past Adjustments are Made).
Akhil and Nikhil are partners sharing profits equally. They admitted Dinesh into partnership. It
was agreed to value goodwill at three years’ purchase following Weighted Average Profit Method
on the basis of past five years’ profits. Weights assigned to each year would be—years ended
31st March, 2014–1, 2015–2, 2016–3, 2017–4 and 2018–5.
The profits for these years were—` 90,000, ` 80,000, ` 1,25,000, ` 1,50,000 and ` 1,75,000
respectively.
Verification of books of account revealed the following:
1. There was an abnormal loss of ` 15,000 during the year ended 31st March, 2014.
2. There was an abnormal gain of ` 10,000 during the year ended 31st March, 2016.
3. Closing Stock as on 31st March, 2017 was overvalued by ` 15,000.

Calculate value of goodwill.
Solution:
1. CALCULATION OF NORMAL PROFIT

Year Ended Profit (`) Adjustment (`) Normal Profit (`)
31st March, 2014 90,000 15,000 1,05,000
31st March, 2015 80,000 ... 80,000
31st March, 2016 1,25,000 (10,000) 1,15,000
31st March, 2017 1,50,000 (15,000)* 1,35,000
31st March, 2018 1,75,000 15,000* 1,90,000
* Closing Stock being overvalued on 31st March, 2017 means that profit for the year is shown
at higher amount. It has effect on the profit for the next year. Profit for next year is shown at
lower amount as Closing Stock of previous year is carried forward as Opening Stock of next year.