What is the main difference between the average profits method and the super profits method of calculating goodwill?
Answer & explanation
Correct answer: option 2
The correct answer is option 2- The average profits method uses actual profits, while the super profits method uses excess profits.
The main difference between the average profits method and the super profits method of calculating goodwill is that average profits method uses actual profits, while the super profits method uses excess profits.
The main difference between the average profits method and the super profits method lies in the type of profits considered in the valuation of goodwill. The average profits method values goodwill based on the actual profits earned by the firm over a specific period of time, typically the past few years. It assumes that the firm's past average profits are a reliable indicator of its future profitability. This method does not focus specifically on excess profits but considers the overall profit performance of the firm. On the other hand, Super profit is earned by a firm when the actual profit is more than the normal profit i.e. profit earned by a similar business. This method considers the additional profits earned by the firm, which are deemed to be above the expected or normal rate of return.