If past profits include one time legal compensation income how will it be treated for goodwill valuation?

Correct answer: It will be deducted from profit

The direct answer is option D: deduct the one-time legal compensation income from profit. Goodwill is based on normal and sustainable earning capacity, not on an exceptional receipt that is unlikely to occur again. Legal compensation received once is income in the reported accounts, but it is not ordinary operating income. Therefore, when adjusting past profit, begin with the reported profit and subtract the compensation amount. This gives a more realistic normal profit for goodwill valuation. Option D is correct because it removes the temporary income from profit. Option A is wrong because adding it to profit would make the exceptional income count twice or increase an already reported profit. Option B is wrong because the adjustment is made in the profit figure, not by deducting the receipt from partners’ capital. Option C is wrong because goodwill is calculated after adjusted profit is found; the compensation is not directly added to the goodwill balance. The reasoning is parallel to the abnormal-gain rule: abnormal gain is deducted, while abnormal loss is added back. The memory cue is “one-time income is taken out before averaging.” This answer assumes the compensation is genuinely non-recurring, as stated.