Q.The capital of the firm of Anuj and Benu is ₹ 10,00,000 and the market rate of interest is 15%. Annual salary to the partners is ₹ 60,000 each. The profit for the last three years were ₹ 3,00,000, ₹ 3,60,000 and ₹ 4,20,000. Goodwill of the firm is to be valued on the basis of two years purchase of last three years average super profits. Calculate the goodwill of the firm.
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Start your 14-day free trial to unlock the full solution →Goodwill of the firm is ₹1,80,000, calculated as two years' purchase of average super profit of ₹90,000.
Concept: Super Profit Method of Goodwill Valuation
Goodwill represents the value of a firm's reputation and its ability to earn profits above what would be considered normal for the capital employed. The Super Profit Method captures this by:
- Normal Profit = Capital Employed × Normal Rate of Return (market rate of interest)
- Average Actual Profit = Mean of past years' profits
- Super Profit = Average Actual Profit − Normal Profit
- Goodwill = Super Profit × Number of Years' Purchase
The logic: if a firm consistently earns more than the normal return on its capital, that excess earning power has a present value — goodwill. We multiply the super profit by a certain number of years to arrive at a lump-sum valuation.
Treatment of Partners' Salaries
Partners' salaries are an appropriation of profit, not a charge against profit (they are not expenses). Since the question states "the profit for the last three years were ₹3,00,000, ₹3,60,000 and ₹4,20,000," these figures represent the distributable profit after all business expenses but before appropriations like salary and interest on capital.
For goodwill valuation, we need the maintainable profit — the profit the firm can sustain going forward. Because partners' salaries are a regular appropriation that will continue, we must deduct them from the given profits to find the true surplus available for return on capital. This adjusted profit is then compared with the normal profit.
A common mistake is to treat the given profits as "after salary" or to ignore salary altogether. Always read the question carefully: here the profits are before appropriations, so salary must be deducted to find maintainable profit for super profit calculation.
Solution
Working Note 1: Calculation of Average Actual Profit (before salary)
| Year | Profit (₹) |
|---|---|
| Year 1 | 3,00,000 |
| Year 2 | 3,60,000 |
| Year 3 | 4,20,000 |
| Total | 10,80,000 |
Average Profit = Total Profit ÷ Number of Years
= ₹10,80,000 ÷ 3
= ₹3,60,000
Working Note 2: Adjustment for Partners' Salaries
Total annual salary to partners = ₹60,000 (Anuj) + ₹60,000 (Benu) = ₹1,20,000
Maintainable Profit (after deducting salary appropriation):
= Average Profit − Total Salary
= ₹3,60,000 − ₹1,20,000
= ₹2,40,000
Working Note 3: Calculation of Normal Profit
Capital Employed = ₹10,00,000
Normal Rate of Return (market rate of interest) = 15%
Normal Profit = Capital × Normal Rate …
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