What is the formula for calculating goodwill through Average profit method?
Answer & explanation
Correct answer: option 2
The correct answer is option 2- Average profit x No. of years purchase.
The average profits method of calculating goodwill operates on the assumption that a new business would not generate any profits in its initial years. Consequently, when someone acquires an existing business, they are expected to pay for the anticipated profits for the first few years in the form of goodwill. The steps to calculate the goodwill by average method is-
* Calculate the average profit by dividing the total profits with no of years of profit.
* Calculate goodwill by multiplying the average profits by the specified number of years' purchase.