If customer loyalty is strong but profit is reduced by abnormal expense what should be done first in goodwill valuation?

Correct answer: Adjust profit for abnormal expense

Goodwill represents the value of advantages that help a firm earn better profits in the future. Customer loyalty is one such advantage, so strong loyalty should not be ignored merely because one year’s profit is low. An abnormal expense is unusual or non-recurring and does not represent the firm’s normal earning capacity. If it has reduced the reported profit, that expense should first be removed or added back while finding adjusted profit. Therefore option A is correct.

For example, suppose reported profit is ₹90,000 and it includes an abnormal expense of ₹10,000. The adjusted profit for goodwill purposes will be ₹100,000, assuming there are no other adjustments. The adjusted profits of the relevant years can then be averaged or used under the method specified in the question. Treating goodwill as nil would wrongly ignore customer loyalty, while making customers debtors or reducing capital has no connection with correcting profit. Thus adjustment of profit for the abnormal expense must come first.