(Super Profit Method, Undervaluation of Stock).
Average profit earned by a firm is Rs. 75,000 which includes undervaluation of stock of Rs. 5,000 on average basis. The capital invested in the business is Rs. 7,00,000 and the normal rate of return is `7%`. Calculate goodwill of the firm on the basis of 5 times the super profit.

Explanation

Actual Average Profit - Rs. 75,000 + Rs. 5,000 (undervalued stock) = Rs. 80,000
Normal Profit = Capital Employed (Investment) `xx` Normal Rate of Return/100
` " " ` = Rs. 7,00,000 `xx` 7/100 = Rs. 49,000
Super Profit = Actual Average Profit - Normal Profit
` " " ` = Rs. 80,000 - Rs. 49,000 = Rs. 31,000
Goodwill = Rs. 31,000 `xx` 5 = Rs. 1,55,000.
Note : Undervaluation of stock decreases net profit: Hence, it is added to determine actural average profit.