Goodwill

Goodwill is the value of reputation and customer connection of a firm. In exams treat it as an intangible asset.

Reliable cost of self generated goodwill is difficult to measure. Hence it is generally not recorded.

Purchased goodwill is valued on the basis of the actual consideration paid to acquire it, so it can be recorded in the books at cost. A mere estimate by the partners is not sufficient for recording goodwill. Exam tip: internally generated goodwill is generally not recorded, whereas purchased goodwill is recorded on the basis of payment made.

Direct answer: Option A, ₹50,000. Under the average profit method, add the profits of all the given years and divide the total by the number of years. The three profits are ₹40,000, ₹50,000 and ₹60,000. Step 1: add them: ₹40,000 + ₹50,000 + ₹60,000 = ₹150,000. Step 2: there are three years, so divide by 3: ₹150,000 ÷ 3 = ₹50,000. Therefore average profit is ₹50,000. Option A is correct. Option B, ₹60,000, is only the highest individual yearly profit, not the average. Option C, ₹45,000, results from an incorrect total or division. Option D, ₹150,000, is the total profit for all three years, not the average. The average is useful in goodwill valuation because it represents a normal yearly earning based on the available past results. Memory cue: average profit equals total adjusted profits divided by the number of years; do not stop after adding.

Goodwill = Average Profit × Years’ Purchase. Therefore, Goodwill = ₹70,000 × 3 = ₹2,10,000. Option B represents the profit for only one year, whereas the question requires three years’ purchase. Exam tip: When years’ purchase is given, multiply the average profit by that number.

Recent years better show current earning capacity. So they may get more importance in weighted average.

The weighted-average method gives greater importance to the profit carrying the greater weight. Calculate the weighted total as ₹30,000×1 + ₹40,000×2 + ₹50,000×3 = ₹2,60,000. The total weight is 1+2+3=6. Therefore, weighted average profit = ₹2,60,000÷6 = ₹43,333.33, approximately ₹43,333. Option B is only the middle profit, while option D is the weighted total, not the average.

Super profit is excess profit earned above normal profit. Remember (super profit = average profit - normal profit).

Super profit means the amount by which actual or average profit is greater than normal profit. It is not the total profit and it is not the normal profit alone. This idea is useful in goodwill valuation because goodwill may depend on the extra earning capacity of the firm.

Here, average profit is ₹90,000 and normal profit is ₹60,000. Therefore, super profit is calculated as average profit minus normal profit: ₹90,000 − ₹60,000 = ₹30,000. Thus, option A is correct. The other amounts either add the two figures or repeat one of them, so they do not represent only the excess profit.

Direct answer: Option A, ₹100,000. In the super-profit method, goodwill is calculated as super profit multiplied by the number of years’ purchase. Here super profit is ₹25,000 and the firm is valued at four years’ purchase. Step 1: identify super profit: ₹25,000. Step 2: identify years’ purchase: 4. Step 3: multiply: ₹25,000 × 4 = ₹100,000. Therefore goodwill is ₹100,000. Option A is correct. Option B, ₹25,000, is only the super profit and does not multiply it by four. Option C, ₹6,250, divides the super profit by four, which is the reverse of the required operation. Option D, ₹75,000, has no basis in the formula. The method assumes that the stated super profit is already correctly calculated as actual average profit minus normal profit. Memory cue: super-profit goodwill equals extra profit times the number of years purchased.

Normal profit = ₹8,00,000 × 12% = ₹96,000. Super profit = Average profit − Normal profit = ₹1,20,000 − ₹96,000 = ₹24,000. Therefore, option A is correct. Option B is the normal profit, not the super profit. Exam tip: First calculate normal profit on the capital employed at the normal rate, then subtract it from the average profit.

In this method capitalised value of average profit is found first. Then actual capital is deducted to get goodwill.

Capitalised value = Average Profit ÷ Normal Rate of Return. Therefore, ₹1,00,000 ÷ 0.10 = ₹10,00,000. Option B is merely the average profit, not the capitalised value. Exam tip: convert the percentage into a decimal before dividing; 10% = 0.10.

Under the capitalisation method, goodwill = capitalised value − actual capital employed. Therefore, goodwill = ₹9,00,000 − ₹7,50,000 = ₹1,50,000. Hence, option A is correct. Option B represents the actual capital employed, not goodwill. In the exam, remember to find the difference between the two capital amounts under this method.

In this method super profit is capitalised at normal rate. Formula is (goodwill = \frac{super profit}{normal rate}).

Under the capitalization of super profit method, goodwill = super profit ÷ normal rate of return. Therefore, goodwill = ₹30,000 ÷ 15% = ₹30,000 ÷ 0.15 = ₹2,00,000. Hence, option A is correct. ₹4,500 results from multiplying the super profit by the rate, which is not the formula for this method. In an exam, convert the percentage into decimal form before dividing.

Super profit measures the excess of average profit over normal profit. The governing formula is: Super Profit = Average Profit − Normal Profit. If average profit is less than normal profit, the subtraction produces a negative amount. For example, if average profit is ₹80,000 and normal profit is ₹1,00,000, super profit is ₹80,000 − ₹1,00,000 = −₹20,000. In elementary goodwill questions, such a negative excess is commonly described as nil because there is no positive excess earning; strictly, the calculated figure is negative. Thus, option A is the best answer. Options B, C, and D do not follow the formula and confuse super profit with average profit or capital. Positive goodwill generally requires sustainable excess earning capacity.

Goodwill is valued mainly on the basis of the business’s sustainable and expected future earning capacity. Abnormal profit is an unusual gain caused by a special, non-recurring event, such as an exceptional transaction or temporary circumstance. Because it is not expected to continue regularly, including it without adjustment would inflate the average profit and consequently overstate goodwill. The abnormal profit is therefore removed or otherwise adjusted before a reliable maintainable average profit is calculated. Hence, option A is correct. Option B is wrong because abnormal profit is not always a cash loss; by definition it is an unusual profit. Option C confuses profit with capital, and option D has no necessary connection with the adjustment. The objective is to measure normal recurring performance fairly.

The abnormal profit must be deducted from the second year’s profit: ₹70,000 − ₹10,000 = ₹60,000. Therefore, the adjusted total profit is ₹50,000 + ₹60,000 + ₹90,000 = ₹2,00,000. ₹2,10,000 is the unadjusted total and therefore is incorrect. Exam tip: Adjust abnormal items before calculating total or average profit for goodwill.

Direct answer: Option A, ₹95,000. The first year shows a reported profit of ₹80,000, but that year also contains an abnormal loss of ₹15,000. An abnormal loss is not expected to occur regularly, so it should be added back while finding the maintainable or adjusted profit for goodwill. Step 1: take the reported first-year profit of ₹80,000. Step 2: add back the abnormal loss of ₹15,000 because it had reduced the reported profit unusually. Step 3: adjusted first-year profit = ₹80,000 + ₹15,000 = ₹95,000. Option A is correct. Option B, ₹65,000, wrongly subtracts the abnormal loss again. Option C, ₹80,000, leaves the unusual loss adjustment out. Option D, ₹15,000, is only the abnormal loss and not the adjusted profit. The other years would remain ₹60,000 and ₹70,000 unless the question gives further adjustments. Memory cue: abnormal loss lowered the reported profit, so add it back; abnormal gain is usually deducted.

Regular remuneration is adjusted to find future earning capacity. It makes profit more realistic.

The total adjusted profit for the three years is ₹2,25,000. Average profit = Total profit ÷ Number of years = ₹2,25,000 ÷ 3 = ₹75,000, so option A is correct. ₹65,000 and ₹85,000 are the profits for individual years, while ₹2,25,000 is the total profit, not the average. In exams, divide the total adjusted profit by the number of years to find average profit.

A new partner shares future profits. Therefore he compensates old partners for sacrificed profit.

On admission old partners sacrifice part of profit. Goodwill is given to them in sacrificing ratio.

C’s 1/5 share is sacrificed equally by A and B, so each sacrifices 1/10. Therefore, their sacrificing ratio is 1/10:1/10 = 1:1. The ratio 3:2 is the old profit-sharing ratio, not the sacrificing ratio. Exam tip: Determine the sacrificing ratio from the shares surrendered by the old partners for the incoming partner.