Super Profits Method

The Super Profits Method is built on a different idea from the Average Profits Method. The Average Profits Method assumes the buyer pays for the total profits the business will earn in the first few years. But the Super Profits Method argues that the real benefit to the buyer is only the profit that exceeds what they could earn by investing the same capital in any similar business. That extra profit is called super profit. Goodwill is then valued based on this super profit, not the total profit.

What is Super Profit?

Super Profit = Actual (Average) Profit – Normal Profit

• Normal Profit is the profit a business of the same size would ordinarily earn. It is calculated as:

  Normal Profit = (Firm's Capital × Normal Rate of Return) / 100

• Firm's Capital for this calculation includes partners' capital and reserves and surplus. It excludes fictitious assets (like preliminary expenses) and any existing goodwill.

• Actual Profit used in this method is the average profit (simple or weighted) of the past few years.

Steps to Calculate Goodwill under the Super Profits Method

1. Calculate the average profit of the business for the agreed number of past years.
2. Calculate the normal profit on the firm's capital using the normal rate of return.
3. Calculate super profit by subtracting normal profit from the average profit.
4. Calculate goodwill by multiplying the super profit by the agreed number of years' purchase.

Goodwill = Super Profit × Number of Years' Purchase

Accounting Treatment

When a new partner brings in their share of goodwill in cash, and the existing partners withdraw it, the journal entry is:

Then, this amount is distributed to the old partners in their sacrificing ratio: