Question

Assertion (A): Goodwill is valued on the basis of normal business profit. For ascertaining normal business profit, abnormal losses are added and abnormal profits are deducted.

Reason (R): Abnormal losses and abnormal profits are adjusted to net profit because they may or may not happen in future.

In the context of the above two statements, which of the following is correct?

Options

• (A) and (R) both are correct and (R) correctly explains (A).

• Both (A) and (R) are correct but (R) does not explain (A).

• Both (A) and (R) are incorrect.

• (A) is correct but (R) is incorrect.

Answer 1

(A) and (R) both are correct and (R) correctly explains (A).

Explanation:

Goodwill is valued on the basis of normal business profits, where abnormal losses are added back and abnormal profits are deducted to ascertain the “normal” profit level since these abnormal items are not expected to recur regularly. This adjustment is made because abnormal losses or profits may or may not happen in the future, thus they do not reflect the genuine earning capacity of the business.