Calculate goodwill of a firm on the basis of three year' purchase of the weighted average profits of the last four years. The profit and the weights assigned to each of the last four years were:
| Year | Profit (₹) | Weight |
|---|---|---|
| 2012 | 20,200 | 1 |
| 2013 | 24,800 | 2 |
| 2014 | 20,000 | 3 |
| 2015 | 30,000 | 4 |
You are supplied the following information:
- On September 1, 2014 a major plant repair was undertaken for ₹6,000, which was charged to revenue. The said sum is to be capitalised for goodwill calculation subject to adjustment of depreciation of 10% p.a. on reducing balance method.
- The Closing Stock for the year 2013 was overvalued by ₹2,400.
- To cover management cost an annual charge of ₹4,800 should be made for purpose of goodwill valuation.
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Start your 14-day free trial to unlock the full solution →Adjust each year's profit for management cost, the capitalised plant repair with its depreciation, and the stock overvaluation to get adjusted profits of ₹15,400 / ₹17,600 / ₹23,400 / ₹24,620. Weighting these 1:2:3:4 gives a weighted average of ₹21,928, and 3 years' purchase makes goodwill ₹65,784.
Concept
This is the most demanding form of the NCERT Class 12 goodwill valuation problem, because the profits supplied are not yet fit for valuation. Before averaging, they must be adjusted so each year shows the true, normal earning of the business. The recurring lesson is: an amount that belongs to capital must not sit in revenue, a real annual cost (management charge) must be provided, and a stock valuation error distorts two years — the year it occurs and the following year.
Working Notes
- Management cost of ₹4,800 is deducted from every year.
- Plant repair (2014): ₹6,000 was wrongly charged to revenue, so it is added back to 2014 profit and treated as an asset.
- Depreciation on the capitalised repair (10% p.a., reducing balance):
- 2014: on ₹6,000 for 4 months (Sept–Dec) = ₹6,000 × 10/100 × 4/12 = ₹200.
- 2015: on ₹6,000 − ₹200 = ₹5,800 for one year = ₹5,800 × 10/100 = ₹580.
- Closing stock 2013 overvalued by ₹2,400: 2013 profit was overstated, so deduct ₹2,400 from 2013. That same overvalued stock is the opening stock of 2014, which overstates the cost of goods sold and understates 2014 profit, so ₹2,400 is added back to 2014.
Solution
Calculation of Adjusted Profits
| Particulars | 2012 (₹) | 2013 (₹) | 2014 (₹) | 2015 (₹) |
|---|---|---|---|---|
| Given Profits | 20,200 | 24,800 | 20,000 | 30,000 |
| Less: Management Cost | (4,800) | (4,800) | (4,800) | (4,800) |
| 15,400 | 20,000 | 15,200 | 25,200 | |
| Add: Capital Expenditure charged to Revenue | — | — | 6,000 | — |
| 15,400 | 20,000 | 21,200 | 25,200 | |
| Less: Unprovided Depreciation | — | — | (200) | (580) |
| 15,400 | 20,000 | 21,000 | 24,620 | |
| Less: Overvaluation of Closing Stock (2013) | — | (2,400) | — | — |
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