Q.A firm's profits for four years were: 2020 – ₹80,000; 2021 – ₹88,000; 2022 – ₹1,00,000 (closing stock for this year was overvalued by ₹12,000); 2023 – ₹92,000. Calculate the goodwill of the firm at 2.5 years' purchase of the average profit.

An overvalued closing stock overstates that year's profit, so the amount of the overvaluation must be deducted from the reported profit of that year before the years are averaged.

2022 adjusted = 1,00,000 − 12,000 = 88,000. Total = 80,000 + 88,000 + 88,000 + 92,000 = 3,48,000. Average = 3,48,000 ÷ 4 = 87,000. Goodwill = 87,000 × 2.5 = 2,17,500.

Step 1 — Correct the year with the overvalued closing stock:

An overvalued closing stock overstates that year's profit by the amount of the overvaluation, so the profit for 2022 must be reduced by ₹12,000.

2022 Adjusted Profit = 1,00,000 − 12,000 = ₹88,000

Step 2 — Tabulate the adjusted profits:

Step 3 — Compute Average Profit:

Average Profit = 3,48,000 ÷ 4 = ₹87,000

Step 4 — Apply the formula:

Goodwill = Average Profit × Number of Years' Purchase = 87,000 × 2.5 = ₹2,17,500

Cross-check: 87,000 × 2.5 can also be found as 87,000 × 2 + 87,000 × 0.5 = 1,74,000 + 43,500 = 2,17,500, confirming the multiplication.

Students often add back the overvaluation instead of deducting it — remember an OVERVALUED closing stock means profit was shown TOO HIGH, so the correction must reduce that year's profit; only an UNDERVALUED closing stock would need an addition.