Profit Prior to Incorporation
Sometimes a company purchases a running business from a date prior to its incorporation. If the company has earned any profit from the date of purchase to the date of incorporation suchprofit is called as profit prior to incorporation.As for example
a company incorporated on 1st April, 2004 may purchase a business from 1stJanuary, 2004, the date on which the accounting year of the vendor starts. Generally the businessis purchased from vendor on the last date of the balance sheet so that assets and liabilities aretaken over on the basis of the figures given in the Balance Sheet.Such profit cannot be said to have been earned by the company as it is not available fordistribution as dividend to the shareholders. Such profit is treated as capital profit and istransferred to Capital Reserve Account.If there is any loss prior to incorporation such loss is in the nature of capital loss and is debitedto Goodwill Account. It should be noted that, the date of incorporation and not the date of commencement of should be taken into consideration for calculating profit or loss prior toincorporation.
Ascertainment of Profit or Loss Prior to Incorporation
Profit or loss prior to incorporation can be ascertained only when fresh stocktaking and balancingof accounts is done on this date. But it will involve a great deal of inconvenience. In order toavoid this inconvenience, the following steps may be taken:(1)Prepare the trading account for the whole period
from the date of purchase of businessto the last date
accounts closing in order to calculate the gross profit. Date of incorporationwill not affect the calculation of gross profit:(2)Calculate time ratio and sales ratio.
is calculated by taking into considerationthe time falling from the last date of balance sheet to the date of incorporation and theperiod between the date of incorporation to .the last date of presenting [mal accounts. Forexample, if the business is purchased on 1st April 2006 and certificate of incorporation isgranted on 1st July 2006 and final accounts are being prepared on 31st March 2007, thenthe time ratio is 3 months : 9 months or 1:3. S
is calculated taking into considerationthe sales of pre-incorporation period to that of sales of post-incorporation period. Forexample, if sales of pre-incorporation period are Rs. 5,00,000 and that of post-incorporationRs. 20,00,000, then the sales ratio is 1 : 4.(3)Prepare the profit and loss account for the pre-incorporation and post Incorporation periodsseparately.This is done on the following basis:a.Gross profit should be apportioned between the two periods on the basis of their respectivesales ratio.