Students, here are the answers for the book back exercises in Chapter 4 Goodwill in Partnership Accounts. If you have any doubts, please reach out to us in the comments section.
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Important Formulas, Accounts Formats and Notes for Chapter 4
I Multiple choice questions
Choose the correct answer:
1. Which of the following statements is true? | |
(a) Goodwill is an intangible asset | (b) Goodwill is a current asset |
(c) Goodwill is a fictitious asset | (d) Goodwill cannot be acquired |
2. Super profit is the difference between | |
(a) Capital employed and average profit | (b) Assets and liabilities |
(c) Average profit and normal profit | (d) Current year’s profit and average profit |
3. The average rate of return of similar concerns is considered as | |
(a) Average profit | (b) Normal rate of return |
(c) Expected rate of return | (d) None of these |
4. Which of the following is true? | |
(a) Super profit = Total profit / number of years | (b) Super profit = Weighted profit / number of years |
(c) Super profit = Average profit – Normal profit | (d) Super profit = Average profit × Years of purchase |
5. Identify the incorrect pair | |
(a) Goodwill under Average profit method - Average profit × Number of years of purchase | (b) Goodwill under Super profit method - Super profit × Number of years of purchase |
(c) Goodwill under Annuity method - Average profit × Present value annuity factor | (d) Goodwill under Weighted average - Weighted average profit × Number of years of profit method purchase |
6. When the average profit is Rs. 25,000 and the normal profit is ` 15,000, super profit is | |
(a) Rs. 25,000 | (b) Rs.5,000 |
(c) Rs.10,000 | (d) Rs.15,000 |
7. Book profit of 2017 is Rs. 35,000; non-recurring income included in the profit is Rs. 1,000 and abnormal loss charged in the year 2017 was Rs. 2,000, then the adjusted profit is | |
(a) Rs. 36,000 | (b) Rs. 35,000 |
(c) Rs. 38,000 | (d) Rs. 34,000 |
8. The total capitalised value of a business is Rs. 1,00,000; assets are Rs. 1,50,000 and liabilities are Rs. 80,000. The value of goodwill as per the capitalisation method will be | |
(a) Rs. 40,000 | (b) Rs. 70,000 |
(c) Rs. 1,00,000 | (d) Rs. 30,000 |
II Very short answer questions
1. What is goodwill?
Answer: Goodwill is the good name or reputation of the business which brings benefit to the business. It is the present value of a firm’s future excess earnings. It is an intangible asset as it has no physical existence.
2. What is acquired goodwill?
Answer: Goodwill acquired by making payment in cash or kind is called acquired or purchased goodwill. When a firm purchases an existing business, the price paid for purchase of such business may exceed the net assets of the business acquired. The excess of purchase consideration over the value of net assets acquired is treated as acquired goodwill.
3. What is super profit?
Answer: Super profit is the excess of average profit over the normal profit of a business.
Super profit = Average profit – Normal profit
4 What is normal rate of return?
Answer: Normal rate of return = It is the rate at which profit is earned by similar business entities in the industry under normal circumstances.
5 State any two circumstances under which goodwill of a partnership firm is valued.
Answer: Two circumstances under which goodwill of a partnership firm is valued are:
- when a new partner is admitted into a firm.
- when an existing partner retires from the firm
III Short answer questions
1. State any six factors determining goodwill.
Answer: Six factors determining goodwill are:
(i) Profitability of the firm
(ii) Favourable location of the business
(iii) Good quality of goods or services
(iv) Tenure of the business enterprise
(v) Efficiency of management
(vi) Degree of competition
2. How is goodwill calculated under the super profits method?
Answer: Under this method, super profit is the base for calculation of the value of goodwill. Super profit is the excess of average profit over the normal profit of a business.
Super profit = Average profit – Normal profit
Average profit is calculated by dividing the total of adjusted actual profits of certain number of years by the total number of such years.
Normal profit is the profit earned by the similar business firms under normal conditions.
Normal profit = Capital employed × Normal rate of return
Capital employed = Fixed assets + Current assets – Current liabilities
Normal rate of return = It is the rate at which profit is earned by similar business entities in the industry under normal circumstances.
3. How is the value of goodwill calculated under the capitalisation method?
Answer: Under this method, goodwill is the excess of capitalised value of average profit of the business over the actual capital employed in the business.
Goodwill = Total capitalised value of the business – Actual capital employed
The total capitalised value of the business is calculated by capitalising the average profits on the basis of the normal rate of return.
Actual capital employed = Fixed assets (excluding goodwill) + Current assets – Current liabilities
4. Compute average profit from the following information.
2016: Rs. 8,000; 2017: Rs. 10,000; 2018: Rs. 9,000
Answer:
IV Exercises
Simple average profit method
1. The following are the profits of a firm in the last five years:
2014: Rs.10,000; 2015: Rs.11,000; 2016: Rs.12,000; 2017: Rs.13,000 and 2018: Rs.14,000
Calculate the value of goodwill at 2 years purchase of average profit of five years.
Answer: Goodwill = Average profit × Number of years of purchase
Goodwill = Average profit × Number of years of purchase
=12,000 x 2
=Rs. 24,000
2. From the following information, calculate the value of goodwill on the basis of 3 years purchase of average profits of last four years.
Year | Result | Amount |
---|---|---|
2015 | Profit | 5,000 |
2016 | Profit | 8,000 |
2017 | Loss | 3,000 |
2018 | Profit | 6,000 |
Answer:
Goodwill = Average profit × Number of years of purchase
=4000 x 3
=Rs.12,000
3. From the following information relating to a partnership firm, find out the value of its goodwill based on 3 years purchase of average profits of the last 4 years:
(a) Profits of the years 2015, 2016, 2017 and 2018 are Rs.10,000, Rs.12,500, Rs.12,000 and Rs.11,500 respectively.
(b) The business was looked after by a partner and his fair remuneration amounts to Rs.1,500 per year. This amount was not considered in the calculation of the above profits.
Answer:
Average profit before adjusting remuneration | 11,500 |
Less : Remuneration to the partner | 1500 |
Average Profit | 10,000 |
Goodwill = Average profit × Number of years of purchase
= 10,000 x3
=Rs. 30,000
4. From the following information relating to Sridevi enterprises, calculate the value of goodwill on the basis of 4 years purchase of the average profits of 3 years.
(a) Profits for the years ending 31st December 2016, 2017 and 2018 were Rs.1,75,000, Rs.1,50,000 and Rs.2,00,000 respectively.
(b) A non-recurring income of Rs.45,000 is included in the profits of the year 2016.
(c) The closing stock of the year 2017 was overvalued by Rs.30,000.
Answer:
Particulars | 2016 | 2017 | 2018 |
---|---|---|---|
Profit | 175,000 | 150,000 | 200,000 |
Less. Non-recurring income | 45,000 | ||
Less: Overvaluation of closing stock | 30,000 | ||
Add: Overvaluation of opening stock | 30,000 | ||
Profit | 130,000 | 120,000 | 230,000 |
Overvaluation of closing stock in 2017 will result in over valuation of opening stock in 2018 |
Goodwill = Average profit × Number of years of purchase
= 160,000 x4
=Rs. 640,000
5. The following particulars are available in respect of the business carried on by a partnership firm:
(i) Profits earned: 2016: Rs.25,000; 2017: Rs.23,000 and 2018: Rs.26,000.
(ii) Profit of 2016 includes a non-recurring income of Rs.2,500.
(iii) Profit of 2017 is reduced by Rs.3,500 due to stock destroyed by fire.
(iv) The stock was not insured. But, it is decided to insure the stock in future. The insurance premium is estimated to be Rs.250 per annum.
You are required to calculate the value of goodwill of the firm on the basis of 2 years purchase of average profits of the last three years.
Answer:
Particulars | 2016 | 2017 | 2018 |
---|---|---|---|
Profit | 25,000 | 23,000 | 26,000 |
Less. Non-recurring income | 2500 | ||
Add: Stock destroyed by fire | 3500 | ||
Profit | 22,500 | 26,500 | 26,000 |
Weighted average profit method
6. Find out the value of goodwill at three years purchase of weighted average profit of last four years.
Year | Profit | Weight |
---|---|---|
2015 | 10,000 | 1 |
2016 | 12,000 | 2 |
2017 | 16,000 | 3 |
2018 | 18,000 | 4 |
Answer:
Years | Profit | Weight | Weighted Profit |
---|---|---|---|
2015 | 10,000 | 1 | 10,000 |
2016 | 12,000 | 2 | 24,000 |
2017 | 16,000 | 3 | 48,000 |
2018 | 18,000 | 4 | 72,000 |
Total | 10 | 154,000 |
Goodwill = Weighted average profit × Number of years of purchase
=15,400 x 3
=Rs. 46,200
Purchase of super profit method
7. From the following details, calculate the value of goodwill at 2 years purchase of super profit:
(a) Total assets of a firm are Rs.5,00,000
(b) The liabilities of the firm are Rs.2,00,000
(c) Normal rate of return in this class of business is 12.5 %.
(d) Average profit of the firm is Rs.60,000.
Answer: Capital employed = Fixed assets + Current assets – Current liabilities
=Rs. 500,000 – Rs.200,000
=Rs.300,000
Normal profit = Capital employed × Normal rate of return
Goodwill = Super profit × Number of years of purchase
= 22500 x 2
= Rs. 45,000
8. A partnership firm earned net profits during the last three years as follows:
2016 : Rs.20,000; 2017 : Rs.17,000 and 2018 : Rs.23,000
The capital investment of the firm throughout the above mentioned period has been Rs.80,000. Having regard to the risk involved, 15% is considered to be a fair return on capital employed in the business. Calculate the value of goodwill on the basis of 2 years purchase of super profit.
Answer: Normal profit = Capital employed × Normal rate of return
Super Profit = Average profit – Normal profit
=Rs. 20,000 – Rs. 12,000
=Rs. 8000
Goodwill = Super profit × Number of years of purchase
= 8000 x 2
= Rs. 16,000
Annuity method
9. From the following information, calculate the value of goodwill under annuity method:
(i) Average profit Rs.14,000
(ii) Normal Profit Rs.4,000
(iii) Normal rate of return 15%
(iv) Years of purchase of goodwill 5
Present value of Rs.1 for 5 years at 15% per annum as per the annuity table is 3.352
Answer:
Goodwill = Super profit × Present value annuity factor
Super Profit = Average profit – Normal profit
= Rs.14,000 – Rs. 4000 = Rs.10,000
Goodwill = Super profit × Present value annuity factor
= Rs.10,000 x 3.352
=Rs. 33,520
Capitalisation of super profit method
10. Find out the value of goodwill by capitalising super profits:
(a) Normal Rate of Return 10%
(b) Profits for the last four years are Rs.30,000, Rs.40,000, Rs.50,000 and Rs.45,000.
(c) A non-recurring income of Rs.3,000 is included in the above mentioned profit of Rs.30,000.
(d) Average capital employed is Rs.3,00,000.
Answer:
Profit for 1st year | Rs. 30,000 |
Less: non recurring income | Rs. 3000 |
Profit | Rs.27,000 |
Normal profit = Capital employed × Normal rate of return
= 300,000 x 10%
= Rs. 30,000
Super Profit = Average profit – Normal profit
=Rs. 40,500 – Rs. 30,000
=Rs. 10,500
Capitalisation method
11. From the following information, find out the value of goodwill by capitalisation method:
(i) Average profit Rs.20,000
(ii) Normal rate of return 10%
(iii) Capital employed Rs.1,50,000
Answer:
Actual capital employed = Fixed assets (excluding goodwill) + Current assets – Current liabilities
= Rs. 220,000 – Rs.70,000
=Rs. 150,000
Goodwill = Total capitalised value of the business – Actual capital employed
= Rs. 200,000 – Rs. 150,000
= Rs. 50,000
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