The profit for the five years of a firm are as follows – year 2013 Rs. 4,00,000, year 2014 Rs. 3,98,000, year 2015 Rs. 4,50,000, year 2016 Rs. 4,45,000 and year 2017 Rs. 5,00,000. Calculate goodwill of the firm on the basis of 4 years purchase of 5 years average profits.

Explanation

`{:("Year","Profit(Rs.)),(2013,400000),(2014,398000),(2015,450000),(2016,445000),(2017,500000),(Total,2193000):}`
Average `=("Total Profit of Last 5 Years")/("No. of years") = Rs. (21,93,000)/(5) = Rs. 4,38,600`
Goodwill = Average Profits `xx` No. of years purchased
= Rs `4,38,600 xx 4 =` Rs. 17,54,400
The above calculation of goodwill is based on the assumption that no change in the overall situation of profits is expected in the future. The above illustration is based on simple average. Sometimes, if there exists an increasing on decreasing trend, it is considered to be better to give a higher weightage to the profits to the recent years than those of the earlier years. Hence, it is a advisable to work out weighted average based on specified weights like 1, 2, 3, 4 for respective year’s profit. However, weighted average should be used only if specified.