Goodwill ~ Weighted average profit method

 

(b) Weighted average profit method

Under this method, goodwill is calculated by multiplying the weighted average profit by a certain number of years of purchase.

Goodwill = Weighted average profit × Number of years of purchase

In this method, weights are assigned to each year’s profit. Weighted profit is ascertained by multiplying the weights assigned with the respective year’s profit. The sum of the weighted profits is divided by the sum of weights assigned to determine the weighted average profit.

Weighted average profit  =  Total of weighted profits 

                                                Total of weights

This method is used when the profits show an increasing or decreasing trend. More weight is generally given to the profits of the recent years.

For the purpose of admitting a new partner, a firm has decided to value its goodwill at 3 years purchase of the average profit of the last 4 years using weighted average method. Profits of the past 4 years and the respective weights are as follows:

 

Particulars	2015	2016	2017	2018
Profit (`)	20,000	22,000	24,000	28,000
Weight	1	2	3	4

Compute the value of goodwill.

Solution

Calculation of weighted average profit

Year	Profits (a) `	Weights (b)	Weighted profits (a × b) `
2015	20,000	1	20,000
2016	22,000	2	44,000
2017	24,000	3	72,000
2018	28,000	4	1,12,000
Total		10	2,48,000

Weighted average profit =  Total of weighted profits 

                                               Total of weights

                                                =  2,48,000 / 10

                                                = Rs. 24,800

 

Goodwill                              = Weighted average profit × Number of years of purchase

= 24,800 × 3 = Rs. 74,400

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