Under the Average Profit Method, goodwill is valued by multiplying the average profit by the number of years for which the profit is expected to continue.
Formula: Goodwill = Average Profit × Number of Years' Purchase
Given:
- Average Profit = Rs. 20,000
- Number of Years' Purchase = 3 years
Goodwill = 20,000 × 3 = Rs. 60,000
The number of years' purchase represents the period for which the buyer is willing to pay for the future profits. Since profits are expected to continue for 3 more years, the goodwill captures the present value of these 3 years of profit at Rs. 20,000 per year.
Correct Answer: Option 1 - Rs. 60,000