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Simple Average Method

If there is no clear trend of profit, it is better to follow simple average. Simple average method implies that such profit will be maintained for a given number of years and the partner(s) who gain in terms of profit sharing ratio should contribute for such gains in profit to the partners who make the sacrifice. Average profit may be calculated as follows:

 

Description: 24873.jpg 


Illustration 1

 

The following were the profits of a firm for the last three years.
 

Year

Profit (₹)

Additional information

2011

10,00,000

(Including an abnormal gain of ₹ 3,00,000)

2012

8,00,000

(After charging an abnormal loss of ₹ 4,00,000)

2013

12,00,000

(Excluding unrecorded expense of ₹ 4,00,000)


Required:
 Calculate the value of the firm’s goodwill on the basis of four years’ purchase of the average profits for the last three years.


Solution:

 

Step 1 – Calculation of average maintainable profits
 

Year Ended

Profits

2011

(10,00,000 - 3,00,000)

7,00,000

2012

(8,00,000 + 4,00,000)

12,00,000

2013

(12,00,000 - 4,00,000)

8,00,000

 

Total

27,00,000


Step 2 – Average profit = Description: 24947.png


Step 3 – Goodwill at 4 years’ purchase of average profit = ₹ 9,00,000 x 4
= ₹ 36,00,000





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