Under Average Profit Method , Valuation of Goodwill is done by two ways :
(i) Simple Average Profit Method : Under this Method of Valuation of Goodwill , Average of Past Profits of a Number of years is Calculated and is Multiplied by Agreed Number of years (Such as 1 , 2 , 3 , 4 , 5) to find out the Value of Goodwill . It is Computed as :
- Average Profit = Total Pr of its of Past Years/Number of Years
- Value of Goodwill = Average Profit x Number of Years’ Purchase
(ii) Weighted Average Profit Method : It is a Modified Version of Simple Average Profit Method. In this Method each year’s profit is assigned a weight in a manner so that the recent year’s profit is given Highest Weight and the Least Weight is given to Starting year . Weights will be Assigned as 1 , 2 , 3 and 4 .
Steps for calculating Weighted Average Profit are :
- Abnormal Profits / Losses are Adjusted to find out the Normal Profit in that Year .
- Normal Profits are Multiplied with Respective Weights .
- Thereafter , Weighted Average Profits is Computed as :
- Goodwill = Weighted Average Profits x Number of Years’ Purchase
