Super Profit Method: A firm earn its profits from the capital employed in the business. Capital employed means the shareholders’ fund. i.e. sum total of share capital and reserves and surplus (i.e. undistributed profits). It can also be defined as the difference between total assets (other than fictitious assets) and external liabilities of a firm.
Under Super Profit Method , goodwill is calculated on the basis of excess profit earned by a firm over the normal profit earned by its counterparts in the same industry. This excess of profit over the normal profit is termed as super profit. Therefore, to compute the value of goodwill under this method, super profits are multiplied by the number of years’ purchases.
The formula for calculating goodwill by this method is Godwill = Super Profit * Number of years’ purchase
Steps to Calculate Goodwill by Super Profit Method
Step 1: Calculate the Average Profit of the firm
Step 2: Calculate Capital Employed of the firm.
Capital Employed = Total Assets (other than fictitious assets) – External/Outside Liabilities
Or Capital Employed = Share Capital + Free Reserves – Fictitious Assets
Step 3: Calculate Normal Profits on Capital Employed on the basis of Normal Rate of Return
Step 4: Calculate Super Profit by deducting the Normal Profit from the Average Profit. Super Profit = Average Profit – Normal Profit
Step 5: Multiply the Super Profits by the Number of Years’ Purchase to get the value of goodwill.
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