Simple Average Method - Goodwill Calculation

1. I. Average Profit Method
1. Simple Average Profit Method
2. Weighted Average Profit Method
Simple average Profit Method
Goodwill = Adjusted Average Profit x Number of Purchase of Years
*Adjusted Average Profit = Adjusted Profit of all years / No of Years
*Adjusted Profit = Net Profit+(Regular Incomes likely to occur +
abnormal expenses not likely to incur in Future) – (Irregular or
Capital income + regular Expenses likely to occur in future)

2. Profit Given xxxxxxx
Add : Expenses and Losses not likely to occur in future xxxxxxx
(Abnormal or irregular, loss, salary Capital exp etc)
Add : All profit likely to come in future xxxxxxx
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xxxxxxxx
Less : All Expenses and losses Expected to occur in future
(salary, insurance, Depreciation, Cost to Management etc) xxxxxxx
Less: Profit not likely to recur in future xxxxxxx
--------------------
Adjusted profit of the year xxxxxxx
Finding of Adjusted Profit

3. Problem No 1: G & Co. decided to purchase a business. Its
profits for the last 4 years were
 Year 1998 – Rs.40,000,
 Year 1999- Rs.50,000,
 Year 2000 – Rs.48,000,
 Year 2001 – Rs.46,000
The business was looked after by the management.
Remuneration from alternative employment if not engaged
in the business comes to Rs.6,000p.a.
Find out the amount of goodwill, if it is valued on the basis
of 3 years purchase at the average net profit for the last 4
years.
Avg Profit : Rs.40,000, Goodwill. Rs 1,20,000)

4. Step 1 : Calculation of Adjusted Profit
Particulars 1998 1999 2001 2001
Profit of the year 40,000 50,000 48,000 46,000
Less : Remuneration to Management 6,000 6,000 6,000 6,000
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Adjusted Profits 34,000 44,000 42,000 40,000
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Step 2 : Adjusted Average Profit = Total Profits of all years / No of years
= (34,000+44,000+42,000+40,000) / 4 years
= 1,60,000 / 4
= 40,000
Step 3 : Calculation of Goodwill
=Adjusted Average Profit x No of years of purchase
= 40,000 x 3 years
= 1,20,000

5. Problem No: 1. Mr. Amar has been doing business, intends to
sell his business on 1-12-2006.
From the following particulars ascertain the amount of
goodwill based on 3 years purchase of average profits of last 4
years. The profits during 4 years were as follows:
 a) 2003-Rs.2,00,000 ; b) 2004—Rs. 1,40,000 ; c) 2005-
Rs.3,00,000 d) 2006- Rs.3,60,000
Additional Information
1.At the time of acquisition of business, the buyer was
employed as a manager of business on a salary of Rs.6,000 per
month.
2.The profits of 2006 include income from investment of
Rs.20,000.
3.The profits of 2003 were reduced by Rs.60,000 being loss on
speculation.
4.Similarly, in 2005 profits were reduced by Rs.1,00,000 due to
loss from betting. Ans: Adj. Avg. Profit : Rs. 2,38,000
(188000+168000+328000+268000/4) , Goodwill : Rs 7,14,000

6. Step 1 : Calculation of Adjusted Profit
Step 2 : Calculation of Adjusted Average Profit
= (1,88,000 + 1,68,000 + 3,28,000 + 2,68,000) / 4 years
= 9,52,000 / 4
= 2,38,000
Step 3 : Calculation of Goodwill
= Average Profit x No of years of Purchase
= 2,38,000 x 3
= 7,14,000
Particulars 2003 2004 2005 2006
Profit (given) 2,00,000 2,40,000 3,00,000 3,60,000
Add: Speculation Loss 60,000 - - -
Add: Loss from Betting - - 1,00,000 -
Total 2,60,000 2,40,000 4,00,000 3,60,000
Less: Managerial Salary 72,000 72,000 72,000 72,000
Less : Income on Investment - - - 20,000
Adjusted Profit 1,88,000 1,68,000 3,28,000 2,68,000

7. Problem 5- (Weighted Average Profit Method)
Particulars 2001 2002 2003 2004
Profit Given 40,500 47,500 60,000 75,000
Expenses will not inccur
in future (Furniture –
capital exp)
- - 10,000 -
Less : Expenses occur in
future -Depreciation
- - 500 950
Administration Expenses 5000 5000 5000 5000
Less: over valuation
opening Stock
- 2500
Add: Over Valuation of
Closing Stock
- 2500
35500 45000 62000 69050

8. Step 2 - Calculation of Weighted Profit
35,500 X 1 35,500
45,000 x X 2.5 11,250
62,000 x X 3.8 2,35,600
69,050 x X 4.2 2,90,010
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Total Weighted Profit 6,73,110
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Step 3 - Weighted Average Profit
Total Profit of All Year / Total Weightage
= 6,73,110 / 11.5
=58,531
Step 4 – Calculation of Goodwill
Goodwill = Weighted Average Profit x No. of Years of Purchase
= 58,531 X 3 Years
= 1,75,593

9. Note ;
1. Cost of Furniture is Incurred for business. But it is not revenue
expenditure in nature. So Deducted one should be added again.
2. Depreciation – it should be calculated to the year concerned and
next year that immediately following.
Period of the furniture usage : From July to December=6 months ;
= 10,000 x 10/100 x 6/12
= 500
3. In the following year (2004) = 9500 x 10/100
= 950
4. Adjustment of Stock (Material Consumed) = ( opening St +
Purchase - Cl.Stock )
Take Reverse Action