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Average Profits Method

Under this method, goodwill is calculated on the basis of the average of certain agreed number of past years’ profits. The average is then multiplied by the agreed number of years of purchase. This is the simplest and the most commonly used method of the valuation of goodwill.
 

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Note: To find out the average profits, either simple average or weighted average may be employed.

 

Before calculating the average profits, the following adjustments should be made in the profits of the firm to find the adjusted net profit:

  • Any abnormal profits should be deducted from the net profits of that year
  • Any abnormal loss should be added back to the net profits of that year
  • Non-operating incomes, like income from investments, should be deducted from the net profits of that year

Particulars

Net profit

xxx

Add: Abnormal loss if any

xxx

Less: Abnormal profits if any

xxx

Less: Non-operating incomes

xxx

Adjusted net profit

xxx





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