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How to use Average profit method in Goodwill?


Simple Average profit method:
Simple average profit method = adjusted profit / number of years
Goodwill = Average profit* number of years purchases
Example: Company ABC is well established Company.  Company 6 years profit is given below:
Years
Profit
2006
2,50,000
2007
2,65,000
2008
3,00,000
2009
4,85,000
2010
3,25,000
2011
5,00,000

Find out the goodwill value with the help of Average profit method if the number of years purchase is 2.
Solution: Average profit = (2,50,000 + 6, 65,000 + 3,00,000 + 4,85,000 + 3,25,000 + 5,00,000) / 6
= 21, 25,000/ 6
= Rs.3, 54, 166.667
Goodwill = 3, 54, 166.667*2
= Rs. 7, 08,333
Example: Company PQR 5 years profit is given below:
Years
Profit
2010
50,000
2011
1,25,000
2012
1,70,000
2013
2,65,000
2014
3,25,000

Find out the goodwill value with the help of Average profit method if the number of years purchase is 3. Company provides some other information which is as given below:
Rs.2000 is added in 2010 profit as loss due to fire.
Investment included in 2012 profit and interest received Rs. 10,000 also included.
Solution:
Adjusted profit:

Years
Profit
Abnormal profit (-)
Abnormal loss (+)
Adjusted profit
2010
50,000

2000
52,000
2011
1,25,000


1,25,000
2012
1,70,000
10000

1,60,000
2013
2,65,000


2,65,000
2014
3,25,000


3,25,000
Total



9,27,000

Average profit = 9, 27,000 /5 = 1, 85,400
Goodwill = 1, 85, 400* 3
= Rs. 5, 56, 200
Weighted average method
Weight average profit = Total of product of profit with weights / Total of weights
Goodwill = Weighted average of profit*Number of years purchase
Example: Find out the goodwill of the Company if the number of years of purchases is 1.5 years and with the help of given information:
Years
Profit
2008
70,000
2009
,85,000
2010
1,54,000
2011
1,65,000
2012
2,25,000
2013
3,60,000

Use weighted average method to calculate the goodwill and the weights are assigned from 2008 to 2013 is from 1 to 6 respectively.
Solution:
Years
Profit
Weights
Weighted profit
2008
70,000
1
70,000
2009
85,000
2
1, 70,000
2010
1,54,000
3
4,62,000
2011
1,65,000
4
6,60,000
2012
2,25,000
5
11,25,000
2013
3,60,000
6
21,60,000
Total

21
46,47,000

Weighted average profit = 46, 47,000 / 21
= Rs. 2, 21,285.7
Goodwill = Rs. (2, 21, 285.7 * 1.5)
= Rs. 3, 31,928.55
Example: Company ABC has 2 partners and company wants to expand the business. So the management decided to become partner with C who has invested huge amount in ABC Company. So, Company decided to calculate the goodwill of the company with the help of weighted average method.
Years
Profit
Weights
2011
20,000
1
2012
(45,000)
2
2013
84,000
3
2014
1,25,000
4
2015
1,40,000
5
2016
2,60,000
6
Total

21

The number of years of purchase is 4 and other information is as follows:
Closing stock of 2015 is overvalued by Rs. 20,000
Abnormal loss Rs. 10, 000 is wrongly debited in profit and loss A/c in 2013
In 2011 profit sale of fixed assets is also included which is Rs. 5,000.
Voluntary retirement of Rs. 1, 50,000 are paid in 2012.
Solution:
Adjusted profit:
Years
Profit
Adjustment
Adjusted profit
2011
20,000
(5,000)
15000
2012
(45,000)
1,50,000
1,05000
2013
84,000
10,000
94,000
2014
1,25,000
-
1,25,000
2015
1,40,000
(20,000)
1,20,000
2016
2,60,000
20,000
2,80,000
Total




Weighted average:


Years
Profit
Weights
Profit*weights
20011
15,000
1
15,000
20012
1,05,000
2
2,10,000
2013
94,000
3
2,82,000
2014
1,25,000
4
5,00,000
2015
1,20,000
5
6,00,000
2016
2,80,000
6
16,80,000
Total

21
32,87,000

Weighted average method = 32, 87,000/21
= Rs. 1, 56,523.80
Goodwill = Rs. (1, 56,523.80*4)
= Rs. 6, 26,095.2






































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