Which method of calculating goodwill is based on the assumption that a new business will not be able to earn profits during the initial years as compared to an established business by a partnership firm?

Average Profit Method

The correct answer is option 2- Average Profit Method.

Average Profit Method  is based on the assumption that a new business will not be able to earn profits during the initial years as compared to an established business by a partnership firm.

Goodwill is valued at agreed number of ‘years’ purchase of the average profits of the past few years. It is based on the assumption that a new business will not be able to earn any profits during the first few years of its operations. Therefore, it should be calculated by multiplying the past average profits by the number of years during which the anticipated profits are expected to accrue.