Average and Super Profits; The valuation of goodwill depends upon assumptions made by the valuer. Meaning; The average profit is the average of the profits in the past few years; Or, super profit is an excess of average profit over normal profit. This article explains the difference between Average and Super profit; Methods to adopt in the valuation of goodwill would depend on the circumstances of each case and are often based on the customs of the trade.
The distinction/difference between Average profit and Super profit.
Methods of Goodwill Valuation; Goodwill is the value of the reputation of a firm built over time concerning the expected future profits over and above the normal profits. Also, Goodwill is an intangible real asset which cannot see or felt but exists in reality and can buy and sell. In partnership, goodwill valuation is very important. Thus, we will here discuss the various methods of Goodwill Valuation.
The various methods that can adapt to the valuation of goodwill are the following:
- Average Profit Method.
- Super Profit Method.
Now, explain each one;
Average Profit:
Average profit is the average of all the agreed profits of past years. It calculates by dividing the total profits by the number of years. This is the most common method of calculating goodwill.
Average Profits = Total Profits/Number of years
A buyer always wants to estimate the future profits of the business. Also, Future profits always depend upon the performance of the business in the past. Past profits indicate what profits are likely to accrue in the future. Therefore, past profits are averaged.
The first step under this method is the calculation of average profit based on the past few years’ profits. As well as, Past profit adjust in respect of any abnormal items of profit or loss which may affect future profit. Also, Average profit may be based on a simple average or weighted average.
If profits are constant, equal weight-age may give in calculating the average profits i.e., the simple average may calculate. However, if the trend shows increasing or decreasing profit, it is necessary to give more weight-age to the profits of recent years.
Types of Average Profits Method:
- Simple Average: Under this method, the goodwill values at the agreed number of years of the purchase of the average profits of the past years.
- Simple Average: Under this method, the goodwill values at the agreed number of years of the purchase of the average profits of the past years.
Super Profit:
This Profit is the excess of average profit over the normal profit. It shows the exceptional ability of the firm to earn more profits in comparison to other firms in the industry.
Super Profits = Actual Profits – Normal Profits
It calculates by deducting the normal profits from average profits. Super profit is the excess of estimated future maintainable profits over normal profits. Super profit represents the difference between the average profit earned by the business and the normal profit i.e., the firm’s anticipated excess earnings. As such, if there is no anticipated excess earning over normal earnings, there will be no goodwill.
An enterprise may possess some advantages which enable it to earn extra profits over and above the normal profit that would earn if the capital of the business was invested in some other business with similar risks. Also, the goodwill under this method ascertains by multiplying the super-profits by a certain number of year’s purchases.
Types of Super Profits Method:
- The Number of Years Purchase Method: Under this method, the goodwill values at the agreed number of years’ purchase of the super-profits of the firm.
- Annuity Method: This method considers the time value of money. Here, we consider the discounted value of the super profit.
References:
- commerceiets.com/average-profit-vs-super-profit/
- www.toppr.com/guides/principles-and-practice-of-accounting/treatment-of-goodwill/methods-of-goodwill-valuation/
- www.yourarticlelibrary.com/accounting/goodwill/accounting-procedure-for-valuation-of-goodwill-4-methods/57243
