Goodwill

Goodwill is the firm's reputation and ability to earn extra profit. In exams treat it as an intangible asset.

Goodwill represents the value arising from a firm’s reputation, customer loyalty and ability to earn higher profits. It has economic value but no physical form, so it is classified as an intangible asset. A tangible asset has a physical form, while a current liability is an obligation payable within the short term. Exam tip: Reputation, brand value and goodwill are common examples of intangible assets.

A good reputation builds customer trust, attracts new customers and helps the firm earn relatively higher profits. Therefore, the firm's goodwill increases. Option D is incorrect because reputation is a major basis of goodwill. Exam tip: Goodwill is an intangible asset, not a liability.

Goodwill represents the value of favourable factors that help a business earn better profits than an ordinary business. A stable customer base supports regular demand, repeat sales and continuing business relationships. These features make future revenues and profits more predictable and may also reduce the cost of attracting new customers. Consequently, the firm enjoys an economic advantage, which is reflected in the value of goodwill. A stable customer base does not automatically reduce the partners’ capital, increase liabilities or prevent drawings; those are separate accounting matters. Since the question asks about the benefit relevant to goodwill, the statement about improved future-profit potential is the only suitable answer. Therefore, option A is correct.

Purchased goodwill is paid for so it is recorded in the books. Remember the difference from self generated goodwill.

Self generated goodwill arises from the firm's own reputation and has no purchase cost. So it is generally not shown.

In average profit method the usual formula is average profit multiplied by years purchase. Always check years purchase in the question.

Under the average profit method, goodwill = average profit × years’ purchase. Therefore, ₹50,000 × 2 = ₹1,00,000, so option A is correct. Exam tip: multiply the average profit by the specified number of years; do not divide or add them.

Average profit = Total profit ÷ Number of years = (₹30,000 + ₹45,000 + ₹60,000) ÷ 3 = ₹1,35,000 ÷ 3 = ₹45,000. Therefore, option A is correct. ₹1,35,000 is the total profit for the three years, not the average. Exam tip: Always divide the total profit by the number of years to find average profit.

Under the average profit method, goodwill = average profit × number of years’ purchase. Therefore, goodwill = ₹80,000 × 3 = ₹2,40,000. Option B represents only one year’s average profit; it must be multiplied by 3 for three years’ purchase. Exam tip: Whenever ‘n years’ purchase’ is given, multiply the average profit by n.

Weighted average method gives different importance to different years. It is useful when profits are rising or falling.

Weighted average profit is calculated by multiplying each profit by its assigned weight, adding the weighted amounts and dividing by the sum of the weights. The first weighted amount is ₹20,000 × 1 = ₹20,000. The second is ₹30,000 × 2 = ₹60,000. Thus, total weighted profit is ₹80,000 and total weight is 1 + 2 = 3. Weighted average profit = ₹80,000 ÷ 3 = ₹26,666.67, which is approximately ₹26,667. Option B is the simple average and ignores the different weights, option C is the total weighted amount, and option D ignores the first profit. Therefore, option A is correct.

Super profit is the profit earned above normal profit. Goodwill can be calculated on this basis.

Super profit is the excess of the actual or average maintainable profit over the normal profit expected from the capital employed at the normal rate of return. The governing formula is: Super Profit = Average Profit − Normal Profit. Substituting the given values gives ₹90,000 − ₹70,000 = ₹20,000. This means the business earns ₹20,000 more than the return regarded as normal for similar investments. Option B is only the normal-profit figure, option C is the average-profit figure, and option D incorrectly adds the two amounts instead of finding the excess. Therefore, option A correctly states the super profit.

Under super profit method goodwill is super profit multiplied by years purchase. So ₹25000 multiplied by 4 equals ₹100000.

Normal profit is calculated by applying normal rate of return on capital employed. It is used to find super profit.

Normal profit = Capital employed × Normal rate of return. Therefore, ₹400000 × 10/100 = ₹40000, so option A is correct. Option B represents the entire capital employed, not the profit. In such questions, convert the percentage into a fraction or decimal and multiply it by the capital employed.

The governing method is the super-profit method of goodwill valuation. First calculate super profit by subtracting normal profit from average profit: ₹65,000 − ₹50,000 = ₹15,000. “Three years’ purchase” means that the super profit is multiplied by three, because the purchaser is considered to pay for three years of expected excess earnings. Goodwill = Super Profit × Number of Years’ Purchase = ₹15,000 × 3 = ₹45,000. Option B gives only the super profit and stops before applying the years’ purchase, while options C and D use incorrect operations. Therefore, option A is correct.

When a new partner is admitted old partners sacrifice part of their reputation benefit. So valuation of goodwill may be needed.

A new partner benefits from the existing reputation. Therefore he compensates old partners for goodwill.

At admission goodwill is given in the ratio in which old partners sacrifice. This is called sacrificing ratio.

The sacrificing ratio measures the share of existing profit that an old partner gives up in favour of a new partner, usually at the time of admission. For each old partner, the formula is Sacrificing Ratio = Old Profit-Sharing Ratio − New Profit-Sharing Ratio. A positive difference shows that the partner has sacrificed part of the former share. The new partner compensates the sacrificing partners for this benefit through goodwill, in proportion to their sacrifice. New ratio minus old ratio instead identifies a gaining share, while the other two options are unrelated accounting calculations. Hence option A states the correct formula.

To identify sacrifice, compare each partner’s old fraction with the corresponding new fraction. Under the old ratio 3:2, A’s share was 3/5 and B’s share was 2/5. Under the new ratio 2:1, A’s share becomes 2/3 and B’s share becomes 1/3. A’s share rises from 3/5 to 2/3, so A gains. B’s share falls from 2/5 to 1/3, so B gives up part of the former share. Therefore B is the sacrificing partner. The conclusion is not based on the ratio numerals alone; the fractions must be compared. Hence option A is correct.

When old partners sacrifice in their old ratio the sacrificing ratio remains the old ratio. Identify it directly.

On retirement remaining partners gain share. Therefore goodwill adjustment is made in gaining ratio.