Simple Average Profit method is the simplest method for the calculation of the Goodwill of a concern.
Goodwill = Average Future Maintainable Profits X No. of years’ purchase
1. Calculate Average Future Maintainable Profits of the given number of past years.
2. Multiply the Average Future Maintainable Profits with the number of years’ purchase.
Alpha Ltd. acquire the business of Beta Ltd. Goodwill for this purpose is to valued on 4 years’ purchase of average of previous 5 years’ adjusted profits. The profits for the last 5 years from 2006 to 2010 were as follow: $ 4 million; $ 3.7 million; $ 5.2 million; $ 4.64 million; $ 5.8 million subject to the follwing adjustments.
a) The closing stock for the year 2006 was overvalued by $ 15000.
b) In 2007, expenditure on a major repair work to plant and machinery for $ 250000 was charged to revenue
Calculation of Adjusted Profits
Total profits for the last five years ( 4+3.7+5.2+4.64+5.8 ) 23,340,000
Add: overvaluing of opening stock for 2007 15,000
Add: Expenditure on plant wrongly debited to Profit and Loss Account in 2007 250,000
Less: overvaluing of closing stock for 2006 15,000
Total adjusted Profits for five years 23,590,000
Average Adjusted Profits =23,590,000 / 5 = 4,718,000
Goodwill = Number of years’ purchase X Adjusted Profits
= 4 X 4,718,000 = $ 1,887,2000