Super Profit Method, Capitalization of Super Profit Method

The Super Profit Method is based on the idea that goodwill arises when a business earns more than the normal expected profit. The difference between the actual (or average) profit and the normal profit is called Super Profit. Goodwill is then valued as a multiple of this super profit.

$$\text{Super Profit }=\text{Average Profit }-\text{Normal Profit}$$

Goodwill = Super Profit × Years’ Purchase

Steps

1. Calculate Average Profit of the business (adjust past profits for abnormal items).

2. Compute Normal Profit:

Normal Profit = Capital Employed × Normal Rate of Return / 100​

4. Find Super Profit = Average Profit – Normal Profit.

5. Multiply Super Profit by Years’ Purchase to get goodwill.

Capitalization of Super Profit Method

This method capitalizes the super profit at the normal rate of return to calculate goodwill. Instead of multiplying super profit by years’ purchase, we directly calculate how much capital is required to earn that excess profit at the normal rate of return.

Goodwill = [Super Profit×100] / Normal Rate of Return

Steps:

1. Calculate Average Profit.

2. Calculate Normal Profit = Capital Employed × NRR.

3. Find Super Profit = Average Profit – Normal Profit.

4. Capitalize the Super Profit at the normal rate of return.

​Difference Between the Two Methods