Weighted Average Profit Method: Goodwill With Corrected Profits

You have four years of profit, four weights and one goodwill figure to find. The multiplication looks easy. Then the question mentions an abnormal loss, an overvalued closing stock and a salary that will be paid in future.

Where do those adjustments go?

The weighted average profit method of goodwill becomes much easier when you separate the work into two tables. First, find the profit each year should contribute. Then apply the weights. Trying to do both in your head is where most mistakes begin.

Think of the past years as four voices describing a business. Correcting profit removes misleading noise. Weighting decides how loudly each voice speaks. These are different jobs, and you need both.

What is the weighted average profit formula?

For this method:

Weighted average profit = Total of (adjusted annual profit x its weight) / Total weights

Goodwill = Weighted average profit x Agreed years’ purchase

A weight is a measure of relative importance. A year with weight 4 contributes four times as much to the weighted total as an equally profitable year with weight 1.

Years’ purchase is the valuation multiplier specified in the question. It is separate from both the number of historical years and the sum of weights.

Suppose a question uses four past years, weights 1, 2, 3 and 4, and three years’ purchase. You have:

Number	What it means	Where it belongs
4	Number of historical years	Number of rows in your profit table
10	Total weights	Denominator of the weighted average
3	Years’ purchase	Final multiplier for goodwill

Do not divide by 4 simply because four years are given. That would turn a weighted calculation into the wrong calculation.

Why give recent profits greater weight?

A business may have expanded, developed repeat customers or improved its operations. In that situation, its recent earnings may say more about its present earning capacity than older results.

Textbook questions often give higher weights to later years, particularly when profits show an upward trend. But use the weights actually assigned. A question can specify 1, 2, 2 and 5, or list the latest year first.

Read the year beside each amount before writing any products. Do not attach weights mechanically to the order in which numbers appear on the page.

Weighting is also not a promise that profit will keep rising. It is a chosen way to summarise past earnings. One unusually successful year still needs scrutiny before it receives a large weight.

For a broader introduction to the alternatives, see our guide to goodwill valuation methods.

Example 1: understand the weighting before adding adjustments

Meera and Tara’s firm has these adjusted profits. Goodwill is valued at three years’ purchase, using the weights shown.

Year	Adjusted profit (Rs.)	Weight	Product (Rs.)
2022	80,000	1	80,000
2023	1,00,000	2	2,00,000
2024	1,20,000	3	3,60,000
2025	1,40,000	4	5,60,000
Total	4,40,000	10	12,00,000

Weighted average profit = Rs. 12,00,000 / 10 = Rs. 1,20,000.

Goodwill = Rs. 1,20,000 x 3 = Rs. 3,60,000.

For comparison, the simple average is Rs. 4,40,000 / 4 = Rs. 1,10,000. Using that average would give goodwill of Rs. 3,30,000.

Why is the weighted answer higher here? The higher profits receive the higher weights. If the same chronological weights were applied to a steadily declining series, the weighted average would be lower than the simple average.

How to correct profits before assigning weights

Ask a small question for every adjustment: Did this item make the reported profit too high or too low for the valuation basis required?

The direction usually follows from that answer.

Information in the question	Adjustment to the relevant reported profit
Non-recurring loss already charged	Add it back
Non-recurring gain already credited	Deduct it
Normal expense omitted	Deduct it
Expense recorded twice	Add back the duplicate amount
Closing stock overvalued	Deduct the overstatement
Closing stock undervalued	Add the understatement
Opening stock overvalued	Add the overstatement
Opening stock undervalued	Deduct the understatement

The words already charged, included and omitted matter. If an abnormal loss was never deducted from the stated profit, adding it back would invent profit.

Likewise, an expense does not become abnormal merely because it is large. Follow the facts about whether it is non-recurring or incorrectly recorded. Ordinary business expenses remain part of normal earnings.

Stock errors need a second-year check

Closing stock becomes opening stock in the following year. If an uncorrected overvaluation carries forward, it overstates profit in the first year and understates profit in the next.

For example, closing stock in 2023 was overstated by Rs. 8,000. The same error entered 2024’s opening stock, and 2024’s closing stock is correct.

• Deduct Rs. 8,000 from 2023 profit.
• Add Rs. 8,000 to 2024 profit.

This assumes the reported accounts have not already corrected the error. Do not make the correction twice.

With equal weights, those two adjustments cancel in the total for a period containing both years. With different weights, they need not cancel in the weighted total. We will calculate that effect shortly.

Example 2: abnormal items, stock error and future salary together

A firm’s reported profits are Rs. 90,000, Rs. 1,20,000, Rs. 1,45,000 and Rs. 1,70,000 for 2022 to 2025 respectively. Use weights 1, 2, 3 and 4, and value goodwill at three years’ purchase.

Additional information:

1. The 2022 profit includes a non-recurring gain of Rs. 10,000.
2. The 2023 profit is after charging an abnormal loss of Rs. 12,000.
3. Closing stock in 2023 was overvalued by Rs. 8,000. This carried into 2024 opening stock; subsequent closing stocks are correct.
4. A manager will be appointed at an annual salary of Rs. 18,000. The question requires this additional recurring cost to be allowed for when valuing goodwill. No such salary is included in the historical figures.

Step 1: prepare the adjusted-profit statement

All figures in this table are rupees. Parentheses indicate deductions.

Particulars	2022	2023	2024	2025
Reported profit	90,000	1,20,000	1,45,000	1,70,000
Remove non-recurring gain	(10,000)	0	0	0
Add back abnormal loss	0	12,000	0	0
Correct closing stock	0	(8,000)	0	0
Correct opening stock	0	0	8,000	0
Allow annual manager’s salary	(18,000)	(18,000)	(18,000)	(18,000)
Adjusted profit	62,000	1,06,000	1,35,000	1,52,000

The salary row is a valuation adjustment: it puts every year’s earnings on the specified future cost basis. It does not claim that the manager actually worked in those earlier years.

Step 2: apply the weights

Year	Adjusted profit (Rs.)	Weight	Product (Rs.)
2022	62,000	1	62,000
2023	1,06,000	2	2,12,000
2024	1,35,000	3	4,05,000
2025	1,52,000	4	6,08,000
Total		10	12,87,000

Weighted average profit = Rs. 12,87,000 / 10 = Rs. 1,28,700.

Goodwill = Rs. 1,28,700 x 3 = Rs. 3,86,100.

Step 3: understand why the stock correction matters

The net correction to the weighted total is:

(-Rs. 8,000 x 2) + (Rs. 8,000 x 3) = Rs. 8,000.

That increases the weighted average by Rs. 800 and goodwill by Rs. 2,400 compared with leaving both stock errors uncorrected, holding everything else constant.

Writing “the stock errors cancel” would therefore give the wrong goodwill.

Can the future salary be deducted after averaging?

Yes, when the same annual adjustment applies uniformly to every year used in the average.

Before the salary adjustment, the corrected profits are Rs. 80,000, Rs. 1,24,000, Rs. 1,53,000 and Rs. 1,70,000. Their weighted total is Rs. 14,67,000, giving Rs. 1,46,700 as the weighted average.

Deduct the annual salary once from that average:

Rs. 1,46,700 - Rs. 18,000 = Rs. 1,28,700.

Both routes agree. Choose one route and show it clearly. Do not subtract salary in every year’s table and then subtract it again after averaging.

A year-specific correction, such as the 2023 abnormal loss, cannot be handled as though it were a uniform annual expense.

Example 3: capital expenditure wrongly charged as an expense

Now consider a different firm with reported profits of Rs. 1,00,000, Rs. 1,10,000 and Rs. 1,40,000 for 2023, 2024 and 2025.

On 1 January 2024, a machine costing Rs. 30,000 was wrongly charged entirely as an expense. The accounts follow calendar years. For this question, capitalise the machine and charge depreciation at 10% per year on original cost, with no residual value adjustment. No depreciation on this machine was otherwise recorded.

Use weights 1, 2 and 3 and two years’ purchase.

In 2024, reverse the incorrect expense and charge the correct annual depreciation:

Rs. 1,10,000 + Rs. 30,000 - Rs. 3,000 = Rs. 1,37,000.

In 2025, there is no purchase expense to reverse. Only the omitted depreciation needs to be deducted:

Rs. 1,40,000 - Rs. 3,000 = Rs. 1,37,000.

Weighted total = (Rs. 1,00,000 x 1) + (Rs. 1,37,000 x 2) + (Rs. 1,37,000 x 3) = Rs. 7,85,000.

Weighted average = Rs. 7,85,000 / 6 = Rs. 1,30,833.333…

Goodwill = Rs. 7,85,000 / 6 x 2 = Rs. 2,61,666.67, rounded to paise at the end.

A repair is not automatically capital expenditure. Reclassify it only when the facts or an explicit valuation instruction justify doing so.

Example 4: a loss year and non-consecutive weights

Suppose the adjusted results are a loss of Rs. 20,000, a profit of Rs. 60,000 and a profit of Rs. 90,000. The specified weights are 1, 2 and 5. Goodwill is valued at two years’ purchase.

Weighted total = (-Rs. 20,000 x 1) + (Rs. 60,000 x 2) + (Rs. 90,000 x 5) = Rs. 5,50,000.

Total weights = 1 + 2 + 5 = 8.

Weighted average = Rs. 5,50,000 / 8 = Rs. 68,750.

Goodwill = Rs. 68,750 x 2 = Rs. 1,37,500.

Keep the loss negative. Do not omit the year because it is inconvenient, and do not replace the given weights with 1, 2 and 3.

If the final maintainable profit is negative, show the calculation and explain that this earnings basis does not support a positive goodwill value. Do not turn the negative number into a positive asset by dropping its sign.

How this differs from super profit and capitalisation

In the weighted average profit method described here, the final step is multiplication by years’ purchase. You do not subtract normal profit unless the question asks for a super-profit calculation.

You also do not multiply by 100 and divide by a normal rate of return. That belongs to capitalisation. Our capitalisation of average profit and super profit guide explains that separate route.

A weighted average can be used as an earnings estimate in other valuation methods when instructed. The important distinction is between how you estimate profit and which method converts that profit into goodwill.

Finally, the goodwill of the entire firm is not automatically the incoming partner’s premium. If a new partner is to bring a proportionate premium for a one-fourth share, calculate one-fourth of the firm’s goodwill after completing the valuation. Journal entries are a further step governed by the question’s treatment of goodwill.

A short practice set

Try these without looking at the answers. All profit figures are already adjusted unless an adjustment is stated.

1. Profits are Rs. 50,000, Rs. 70,000 and Rs. 90,000, with weights 1, 2 and 3. Find goodwill at three years’ purchase.
2. The latest of those profits includes a non-recurring gain of Rs. 12,000. Find revised goodwill on the same basis.
3. A weighted average of Rs. 1,10,000 has been calculated before allowing a new recurring annual expense of Rs. 14,000. Find goodwill at two years’ purchase.
4. Closing stock is overvalued by Rs. 6,000 in a year weighted 2. The error carries into the next year’s opening stock, weighted 4. Both years are included, total weights are 10 and years’ purchase is 3. How much does correcting the error change goodwill?
5. Adjusted profits of Rs. 40,000, Rs. 80,000 and Rs. 1,00,000 have weights 2, 3 and 5. Find goodwill at two and a half years’ purchase.
6. A firm’s goodwill is Rs. 2,40,000 at three years’ purchase. What weighted average profit was used?

Answers with the key working

1. Weighted total = Rs. 50,000 + Rs. 1,40,000 + Rs. 2,70,000 = Rs. 4,60,000. Goodwill = Rs. 4,60,000 / 6 x 3 = Rs. 2,30,000.
2. The latest corrected profit is Rs. 78,000. Revised weighted total = Rs. 4,24,000. Goodwill = Rs. 4,24,000 / 6 x 3 = Rs. 2,12,000.
3. Maintainable annual profit = Rs. 96,000. Goodwill = Rs. 96,000 x 2 = Rs. 1,92,000.
4. Change in weighted total = -Rs. 12,000 + Rs. 24,000 = Rs. 12,000. Goodwill increases by Rs. 3,600: Rs. 12,000 / 10 x 3.
5. Weighted total = Rs. 80,000 + Rs. 2,40,000 + Rs. 5,00,000 = Rs. 8,20,000. Goodwill = Rs. 82,000 x 2.5 = Rs. 2,05,000.
6. Weighted average profit = Rs. 2,40,000 / 3 = Rs. 80,000.

Your final answer check

Before moving on, trace every adjustment to a year, confirm which weight belongs to that year, and add the weight column independently. Make sure a loss still has its minus sign. Label the average and goodwill separately, and leave rounding until the last step.

If those checks pass, you have a solution another person can follow from the reported profits to the final valuation. That is much more dependable than memorising a long list of plus and minus signs.

Further reading

The explanations above draw on the INFLIBNET lesson on goodwill valuation for profit adjustments, the IGNOU unit on goodwill for the weighted method, and the NIOS admission-of-a-partner lesson for the partnership setting. The Institute of Cost Accountants of India valuation material also discusses weighted earnings and adjustments. The worked figures and practice questions here are original illustrations.

Frequently asked questions

What is the weighted average profit method of goodwill?

It values goodwill by multiplying a weighted average of adjusted annual profits by the agreed years’ purchase. Each year’s profit receives the importance specified by its weight.

Should I adjust profits before or after multiplying by weights?

Make year-specific corrections first, then apply that year’s weight. A uniform annual adjustment can instead be made once to the resulting average, provided it has not already been included.

What is the denominator in the weighted average formula?

The sum of the weights. For weights 1, 2, 3 and 4, divide total products by 10, not by the four years in the table.

Is weighted average profit always greater than simple average profit?

No. It depends on which profits receive larger weights. Higher weights on relatively low profits can reduce the weighted average below the simple average.

Why do we add back an abnormal loss?

If a non-recurring loss has already reduced reported profit, adding it back removes that exceptional reduction when estimating normal earning capacity. Do not add it back if it was never charged.

Does a closing-stock error affect the following year?

Yes, when it carries into opening stock and has not been corrected. Overvalued closing stock overstates the first year’s profit; the same overvalued opening stock understates the following year’s profit.

Can I ignore a year that shows a loss?

No. Include its adjusted loss as a negative number and apply the specified weight, unless the question explicitly excludes that year.

Are weights and years’ purchase the same thing?

No. Weights determine relative importance within the average. Years’ purchase converts the resulting annual profit figure into goodwill under this method.

What if the question gives no weights?

Check whether it actually asks for a simple average, supplies a weighting rule elsewhere or refers to a table. Do not silently invent weights. If the question is incomplete, state the missing information or clearly identify any assumption you are required to make.

Should I subtract capital employed from this answer?

Not in the weighted average profit times years’ purchase method. Subtracting capital employed is a step in capitalisation of average profit, which is a different valuation method.