Question

Jeevan and Kavi were partners in a firm with capitals of ₹12,00,000 and ₹15,00,000 respectively. Annual salary of the partners was ₹2,00,000 each. The market rate of interest was 10%. During the previous three years the profits were ₹8,00,000, ₹9,00,000 and ₹7,00,000. The goodwill of the firm is to be valued at 2 years’ purchase of the last 3 years’ average super profits.
Calculate the goodwill of the firm.

Hint:

In super profit method, always add partner salaries back before comparing with normal profit to get true super profit.

Answer 1

Step 1: Calculate average profit
Total profit of 3 years = ₹8,00,000 + ₹9,00,000 + ₹7,00,000 = ₹24,00,000
Average profit = ₹24,00,000 $\div$ 3 = ₹8,00,000
Step 2: Calculate normal profit
Capital employed = ₹12,00,000 + ₹15,00,000 = ₹27,00,000
Normal rate of return = 10%
Normal profit = ₹27,00,000 × 10% = ₹2,70,000

Step 3: Adjust for partner’s salaries
Total salaries = ₹2,00,000 + ₹2,00,000 = ₹4,00,000
Normal profit after salary = ₹2,70,000 + ₹4,00,000 = ₹6,70,000
Step 4: Calculate super profit
Super profit = Average profit – Normal profit
$\Rightarrow$ Super profit = ₹8,00,000 – ₹6,70,000 = ₹1,30,000
Step 5: Calculate goodwill
Goodwill = Super profit × Number of years’ purchase
$\Rightarrow$ Goodwill = ₹1,30,000 × 2 = ₹2,60,000