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Difficulty: EasyTreatment and Valuation of Goodwill

The net profits of a partnership firm for the last three years were ₦70,000\text{₦}70,000, ₦80,000\text{₦}80,000, and ₦90,000\text{₦}90,000. If goodwill is to be valued at 22 years' purchase of the average annual profit of the past three years, what is the total value of the firm's goodwill in Naira?

Answer: 160000 ₦

Answer

The total value of the firm's goodwill is ₦160,000\text{₦}160,000.
The average annual profit is calculated by taking the total profit of ₦240,000\text{₦}240,000 and dividing by 3 years, giving ₦80,000\text{₦}80,000. Multiplying this average annual profit by 2 years' purchase yields ₦160,000\text{₦}160,000.

Step-by-Step Solution

1
Calculate total profits for the three-year period
Total Profit = ₦70,000+₦80,000+₦90,000=₦240,000\text{₦}70,000 + \text{₦}80,000 + \text{₦}90,000 = \text{₦}240,000
Summing annual profits is the first step in determining average profit.
2
Calculate the average annual profit
Average Profit = ₦240,0003=₦80,000\frac{\text{₦}240,000}{3} = \text{₦}80,000
Dividing total profits by the number of years gives the mean annual profit.
3
Multiply average profit by the number of years' purchase
Goodwill = ₦80,000×2=₦160,000\text{₦}80,000 \times 2 = \text{₦}160,000
Goodwill is agreed to be valued at 2 years' purchase of the average annual profit.

Key Concept

Valuation of Goodwill using the Average Profit Method
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Topics

Treatment and Valuation of Goodwill

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