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Weighted Average Method

If there exists a clear increasing or decreasing trend of profits, it is better to give more weight to the profits of the recent years than those of earlier years, i.e. to follow the weighted average method.
 

Illustration 2

 

The profits of a firm for the year ended 31st March for the last 5 years were as follows:
 

Year

Profit (₹)

1

40,000

2

60,000

3

75,000

4

90,000

5

1,05,000


Required:
 Calculate the value of goodwill on the basis of three years’ purchase of weighted average profits after assigning weights 1,2,3,4 and 5 respectively to the profits for years 1,2,3,4 and 5.
 

Year

Profit (₹) [A]

Weights [B]

Product (₹) C = A × B

1

40,000

1

40,000

2

60,000

2

1,20,000

3

75,000

3

2,25,000

4

90,000

4

3,60,000

5

1,05,000

5

5,25,000

 

Total

15

12,70,000


Weighted average profit
= ₹ 12,70,000/15 = ₹ 84,667

Goodwill = ₹ 84,667 × 3 = ₹ 2,54,000





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