What is the first step in calculating the value of goodwill through the capitalization of average profits method?

Ascertain the average profits based on the past few years' performance

The correct answer is option 1- Ascertain the average profits based on the past few years' performance.

Ascertain the average profits based on the past few years' performance is the first step in calculating the value of goodwill through the capitalization of average profits method.

Capitalisation of Average Profits: Under this method, the value of goodwill is ascertained by deducting the actual firm’s capital in the business from the capitalized value of the average profits on the basis of normal rate of return. This involves the following steps:
(i) Ascertain the average profits based on the past few years’ performance.
(ii) Capitalize the average profits on the basis of the normal rate of return to ascertain the capitalised value of average profits as follows: Average Profits × 100/Normal Rate of Return
(iii) Ascertain the actual firm’s capital (net assets) by deducting outside liabilities from the total assets (excluding goodwill and fictitious assets).
Firms’ Capital = Total Assets (excluding goodwill) – Outside Liabilities. Where outside Liabilities include both long term and short term Liabilities.
(iv) Compute the value of goodwill by deducting net assets from the capitalised value of average profits, i.e. (ii) – (iii).