Capital employed in a business is Rs 1,50,000. Profits are Rs 50,000 and the normal rate of profit is 20%. What will be the amount of goodwill as per capitalization of average profit method?
Answer & explanation
Correct answer: option 4
Capitalization method of valuing goodwill:
Under this method, the value of a whole business is determined by applying normal rate of return. If such value (arrived at by applying normal rate of return) is higher than the capital employed in the business, then the difference is goodwill. Calculation of goodwill under capitalisation method is:
Goodwill = (Average profit/ Normal rate of return) - Capital employed
Goodwill = Rs. (50000/ 20%) - Rs. 150000
Goodwill = Rs. 250000 - Rs 150000
Goodwill = Rs. 100000
Under this method, the value of a whole business is determined by applying normal rate of return. If such value (arrived at by applying normal rate of return) is higher than the capital employed in the business, then the difference is goodwill. Calculation of goodwill under capitalisation method is:
Goodwill = (Average profit/ Normal rate of return) - Capital employed
Goodwill = Rs. (50000/ 20%) - Rs. 150000
Goodwill = Rs. 250000 - Rs 150000
Goodwill = Rs. 100000