Given Information:
- Average Profits = Rs. 1,00,000
- Normal Rate of Return = 10%
- Net Assets = Rs. 8,20,000
Under the Capitalisation of Average Profits Method, goodwill is calculated by finding the difference between the capitalised value of profits and actual net assets.
Capitalised Value of Average Profits = Normal Rate of ReturnAverage Profits × 100
Capitalised Value = 101,00,000×100 = Rs. 10,00,000
This represents the total capital that should be invested in the business to earn Rs. 1,00,000 at 10% return.
Goodwill = Capitalised Value of Average Profits - Net Assets
Goodwill = Rs. 10,00,000 - Rs. 8,20,000 = Rs. 1,80,000
The business is generating profits that justify a capital of Rs. 10,00,000, but the actual net assets are only Rs. 8,20,000. The difference of Rs. 1,80,000 represents the value of goodwill (the intangible advantage that enables the business to earn higher profits with lower capital investment).