Under the Capitalization of Average Profit Method, the relationship between goodwill, capitalized value, and net assets is:
Goodwill = Capitalized Value of Average Profits - Net Assets
Given:
- Goodwill = Rs 1,80,000
- Net Assets = Rs 8,20,000
Substituting in the formula:
Rs 1,80,000 = Capitalized Value of Average Profits - Rs 8,20,000
Capitalized Value of Average Profits = Rs 1,80,000 + Rs 8,20,000
Capitalized Value of Average Profits = Rs 10,00,000
The logic is that when we capitalize the average profits (by dividing by normal rate of return), we get the total value of the business. The goodwill is simply the excess of this capitalized value over the actual net assets employed. Hence, capitalized value = net assets + goodwill.