Shweta purchased a business on 1st April, 2019. It was agreed to value goodwill at three years' purchase of average normal profits of the last 4 years. The profits are as follows:
Year ended Profit Rs.
31st March 2016 90,000
31st March 2017 1,60,000
31st March 2018 1,80,000
31st March 2019 2,20,000
Answer (1)
To calculate the goodwill value that Shweta needs to pay for the business, we follow these steps:
Understand the Method : Goodwill is valued at three years' purchase of average normal profits of the last 4 years. This means we first need to find the average profit over the past four years and then multiply it by three.
Calculate Average Profit :
Year ended 31st March 2016: Profit = Rs. 90 , 000
Year ended 31st March 2017: Profit = Rs. 1 , 60 , 000
Year ended 31st March 2018: Profit = Rs. 1 , 80 , 000
Year ended 31st March 2019: Profit = Rs. 2 , 20 , 000
First, sum these profits:
Total Profit = 90 , 000 + 1 , 60 , 000 + 1 , 80 , 000 + 2 , 20 , 000 = 6 , 50 , 000
Next, calculate the average profit by dividing the total by the number of years:
Average Profit = 4 6 , 50 , 000 = 1 , 62 , 500
Calculate Goodwill : Since goodwill is valued at three years' purchase of the average profit, we multiply the average profit by three:
Goodwill = 3 × 1 , 62 , 500 = 4 , 87 , 500
Therefore, Shweta should consider the goodwill value of the business to be Rs. 4,87,500.
