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Goodwill: average profit and super profit methods

Average profit method: Goodwill = Average profit × years’ purchase. Super profit = Average profit − Normal profit (capital employed × normal rate); Goodwill = Super profit × years’ purchase.

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Worked examples

Example 1 · level 1

Goodwill of Bansal Steels is to be valued at 4 years’ purchase of the average profits of the last 3 years. Year 1: ₹1,16,000, Year 2: ₹96,000, Year 3: ₹1,00,000. Find goodwill.

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Total = ₹3,12,000; average = ₹1,04,000.
Goodwill = ₹1,04,000 × 4 = ₹4,16,000.

Answer: ₹4,16,000

Example 2 · level 2

Goodwill of Sharma Traders is to be valued at 2 years’ purchase of the average profits of the last 4 years. Year 1: ₹2,52,000, Year 2: loss ₹17,000, Year 3: ₹1,15,000, Year 4: ₹1,30,000. Find goodwill.

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Total = ₹4,80,000; average = ₹1,20,000.
Goodwill = ₹1,20,000 × 2 = ₹2,40,000.

Answer: ₹2,40,000

Example 3 · level 3

Reddy Agro: average profit of the last 3 years ₹1,11,000 (Year 1: ₹1,18,000, Year 2: ₹1,06,000, Year 3: ₹1,09,000). Capital employed ₹7,40,000; normal rate of return 12%. Value goodwill at 2 years’ purchase of super profit.

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Normal profit = ₹7,40,000 × 12% = ₹88,800.
Super profit = ₹1,11,000 − ₹88,800 = ₹22,200.
Goodwill = ₹22,200 × 2 = ₹44,400.

Answer: ₹44,400