Q.A firm's reported profits for three years were: 2021 – ₹1,00,000 (this includes an abnormal loss of ₹20,000 due to theft); 2022 – ₹1,20,000 (this includes ₹10,000 interest received on non-trade investments); 2023 – ₹1,00,000 (no abnormal item). Calculate the goodwill of the firm at 3 years' purchase of the average profit, after making the necessary adjustments.

Before averaging, each year's profit must be corrected for items that do not reflect normal, recurring trading — the theft loss must be added back and the non-trade interest income must be removed, since neither belongs in the firm's ongoing trading profit.

2021: 1,00,000 + 20,000 (loss by theft added back) = 1,20,000. 2022: 1,20,000 − 10,000 (non-trade interest deducted) = 1,10,000. 2023: 1,00,000 (unchanged). Total = 3,30,000; Average = 1,10,000; Goodwill = 1,10,000 × 3 = 3,30,000.

Step 1 — Adjust each year's profit for the abnormal/non-trade item:

Step 2 — Compute Average Profit:

Average Profit = 3,30,000 ÷ 3 = ₹1,10,000

Step 3 — Apply the formula:

Goodwill = Average Profit × Number of Years' Purchase = 1,10,000 × 3 = ₹3,30,000

Cross-check by adjusting the total directly instead of each year: Total reported profit (1,00,000 + 1,20,000 + 1,00,000 = 3,20,000) + abnormal loss added back (20,000) − non-trade interest removed (10,000) = 3,30,000, matching the year-by-year adjustment.

The most frequent error is adding the abnormal loss and interest on non-trade investments the wrong way round — an abnormal LOSS is added back (it reduced profit, so removing its effect increases profit), while non-trade INCOME is deducted (it increased profit, so removing it decreases profit). Reversing these directions gives a completely wrong average.