Arrange the steps of method, Capitalization of Average for the calculation of goodwill, in the correct sequence:
(A) Capitalize the average profits on the basis of the normal rate of return to ascertain the capitalized value of average profits as follows: Average Profits × 100/Normal Rate of Return
(B) Ascertain the average profits based on the past few years' performance.
(C) Ascertain the actual firm's capital (net assets) by deducting outside liabilities from the total assets (excluding goodwill and fictitious assets). Firms' Capital = Total Assets (excluding goodwill) - Outside Liabilities
Where outside Liabilities include both long term and short term Liabilities
(D) Compute the value of goodwill by deducting net assets from the capitalized value of average profits,
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → (B), (A), (C), (D)
Under the capitalisation of average profits, goodwill is the amount by which the value of the business worked out from its profits exceeds the net assets actually employed, so the profit figure has to be found and capitalised before it can be compared with the net assets.
(B) Ascertain the average profits based on the past few years' performance. — the method starts from the profit the business earns, so the average profit comes first.
(A) Capitalize the average profits on the basis of the normal rate of return to ascertain the capitalized value of average profits as follows: Average Profits × 100/Normal Rate of Return — this turns the average profit into the capital that would be needed to earn it at the normal rate, which needs the average profit from (B).
(C) Ascertain the actual firm's capital (net assets) by deducting outside liabilities from the total assets (excluding goodwill and fictitious assets). Firms' Capital = Total Assets (excluding goodwill) - Outside Liabilities Where outside Liabilities include both long term and short term Liabilities — this gives the capital actually employed, the figure the capitalised value is compared with.
(D) Compute the value of goodwill by deducting net assets from the capitalized value of average profits, — the last step, as it uses the results of (A) and (C): goodwill = capitalised value − net assets.
NCERT (2026-27 edition):
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