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 such profit is called as profit prior to incorporation. As for example, a company incorporated on 1st April, 2004 may purchase a business from 1st January, 2004, the date on which the accounting year of the vendor starts. Generally the business is purchased from vendor on the last date of the balance sheet so that assets and liabilities are taken 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 for distribution as dividend to the shareholders. Such profit is treated as capital profit and is transferred to Capital Reserve Account. If there is any loss prior to incorporation such loss is in the nature of capital loss and is debited to 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 to incorporation. Ascertainment of Profit or Loss Prior to Incorporation Profit or loss prior to incorporation can be ascertained only when fresh stocktaking and balancing of accounts is done on this date. But it will involve a great deal of inconvenience. In order to avoid this inconvenience, the following steps may be taken: (1) Prepare the trading account for the whole period i.e., from the date of purchase of business to the last date of accounts closing in order to calculate the gross profit. Date of incorporation will not affect the calculation of gross profit: (2) Calculate time ratio and sales ratio. Time ratio is calculated by taking into consideration the time falling from the last date of balance sheet to the date of incorporation and the period between the date of incorporation to .the last date of presenting [mal accounts. For example, if the business is purchased on 1st April 2006 and certificate of incorporation is granted on 1st July 2006 and final accounts are being prepared on 31st March 2007, then the time ratio is 3 months : 9 months or 1:3. Sales ratio is calculated taking into consideration the sales of pre-incorporation period to that of sales of post-incorporation period. For example, if sales of pre-incorporation period are Rs. 5,00,000 and that of post-incorporation Rs. 20,00,000, then the sales ratio is 1 : 4. (3) Prepare the profit and loss account for the pre-incorporation and post Incorporation periods separately. This is done on the following basis: a. Gross profit should be apportioned between the two periods on the basis of their respective sales ratio.

Financial Accounting


bad debts. depreciation. Fixed expenses such as salaries.JOINT STOCK COMPANIES b. find out the profits available for dividends: (a) Sales for the year were Rs. preliminary expenses. salary of partners is debited to the Preincorporation period. (b) Gross Profit for the year was Rs.80. audit fees.2.000.000 out of which sales up to 1st August were Rs. 2006 and received its certificate of commencement of business on 1st Dec. From the following figures relating to the year ending March 31.00. should be charged wholly to the period after incorporation. c. 2005.000.50. advertising. 2007. Expenses which are incurred after the incorporation of the company such as directors’ fees. etc. Such expenses which are directly related on sales such as commission on sales. The company bought the business of M/S BK & Co. 2006. (c) The expenses debited to the Profit and Loss Account were: Rent Salaries Directors' fees Interest on debentures Audit fees Discount on sales Depreciation General expenses Solution Workings:1> Time Ratio: Advertising Stationery and Printing Commission on sales Bad debts(500 relate to debts created prior to incorporation 1500 Interest to vendor on purchase consideration (up incorporation date Rs 2000) 3600 24000 4800 Rs 9000 15000 4800 5000 Rs 18000 3600 6000 1500 3000 Pre –incorporation period Post –incorporation period 4 Months 8 Months Financial Accounting 536 . should be apportioned on the basis of sales ratio of the two periods. Similarly expenses viz. 6. should be allocated on the basis of time ratio as these expenses are incurred on the basis of time. Illustration BK Ltd. rent. etc. 1. interest on debentures etc. with effect from 1st April. d. insurance. was incorporated on 1st August. discount allowed.

800 ** 5.So the ratio is 1:2 2> Sales Ratio.000 38. Financial Accounting 537 .500 1.05.000 2.000 1.000 3.000 Sales Time Time Sales Time Sales Actual Actual 1.000 ** 4.500 1.000 1.200 10.05.000 Time 500 1. Rs. Time 3.000 10.IncorIncorcation poration poration Rs.000 Rs 3.Directors' fees -Interest on debentures -Audit fees -Discount on sales -Depreciation -General expenses -Advertising -Stationery & Printing -Commission sales -Bad Debts -Interest to Vendor -Capital Profit -Net Profit Basis Prior to After of alto. Sales 75.100 16.200 2.500 8.500 1.500 500 2. Rs.000 Basis Prior to After of allo.000 41.000 75.50.500 2.000 ** Related to Post incorporation period only.600 7.IncorIncorcation poration poration Rs.000 1.50.700 75.000 6.000 To Rent -Salaries .000 By Gross Profit Time 5.000 1. Sales up to incorporation period Sales in post incorporation period So the ratio is 5:7 PROFIT AND LOSS ACCOUNT For the year ending March 31 2007 Rs 2.05.400 3.

the sales of month of October may be different from the month of December or January. and sales for October and November three times the average sales. But where the turnover fluctuates from month to month according to the nature of product (as woolen garments where the sales are more in the month of October.000 80.000 1 x Rs.000 538 Financial Accounting .000 Sales for the months of January February May June July August October November Total Sales for 8 Months 2 x Rs. 40. (a) Sales for January. incorporated on 1st April. November.000 10. From the following information.000 10. 40.000/12 =Rs. 40. December.000 10. the calculation of sales ratio becomes difficult Moreover. sales for four months May to August-1/4th of the average of each month. you are required to calculate the sales ratio of preincorporation and post-incorporation periods. 1995 to December. Under such’ circumstances the sales ratio is determined taking into consideration the relationship of monthly sales with that of total sales.000 1/4 x Rs. The company prepares its first final accounts on 31st December 2006. 40. took over running business from 1st January.JOINT STOCK COMPANIES Calculation of Sales Ratio The calculation of sales ratio may be simple in those cases where the turnover is spread during the whole financial period. 4. The following illustration may clarify the point more clearly. for the month of February equal to average sales. (b) The sales for the month of January twice of the average sales. 2006. and January as compared to other months).000 3 x Rs.. 40.000 10.000 1/4 x Rs.000 1. 40.80. 40. 40.000 40.00. 40.000 1/4 x Rs.000.000 1.000 3 x Rs.20.20. Solution Calculation of Average Sales per month Rs 4. Ludhiana woolen Mills Company Ltd. 1995 Rs.80. 2006.000 4.000 1/4 x Rs.

000 Sales for the Post incorporation period = Rs 4. interest on debentures and directors’ fees which are incurred after incorporation of the company should be charged wholly to post acquisition period. 2006.000 So the Sales Ratio between Pre and Post = 7:17 EXERCISE 1.000.000 per annum.40.40. 6.000 = Rs. State whether the following statements are true or false: a> Loss prior to incorporation is a capital loss and is debited to Goodwill Account.220. 56.Rs. preliminary expenses.80. Gross profit should be apportioned between prior to and after incorporation period on the basis of time ratio of the two periods. The gross profit for this period of 9 months was Rs. 12.000 . c> Answer : (1) True. Rent upto 30th September was Rs. 4.Sales for the remaining 4 months = Rs.000 the general expenses Rs. Financial Accounting 539 . 3. 14. 1.000. b> Expenses viz. after which it was increased to Rs.000 – 1. The first accounts are drawn up upto 31 st December.000 per annum. 80.000/4 = Rs 20. A company incorporated on 1st August. 1. 2006. formation expenses Rs.500.000 the directors’ fees Rs.000.200. 2006 acquires a business as from 1st April.00.000 Sales for Pre-incorporation Period: ` Rs January February March 80. (b) False.000. Salary of the manager who upon incorporation of the company became a director was Rs.000 per annum.000 1. 4. (c) True PROBLEMS 1.000 Average sales for remaining months: = Rs 80.000 40.000 per annum (since incorporation included in directors’ fees mentioned above).000.000 = Rs 3.

JOINT STOCK COMPANIES Show Profit and Loss Account assuming that the net sales were Rs. 7. 2005 by the allotment to the vendors 17.a.000.650. (c) Provision for Doubtful Debts to be made at Rs. 500. and a Balance Sheet as on that date after taking into account the following adjustments: (a) Stock on 31.000) Sundry Debtors Sundry Creditors Rent Received Rent and Taxes Repairs Directors' Fees Miscellaneous Expenses Interest to Vendors Cash in hand Cash at Bank 25. Kaipy Private Ltd. 2006.000 4.000 65.000.000 Cr (Rs’000) 2.50.800 48.000 30.000. 200. (d) Depreciate Buildings by 5 per cent and Furniture by 10 per cent.750 1. The profit was earned uniformly on sales.200 7. 2.25. Rs. [Profit prior to incorporation Rs.11. was satisfied on 1st October.050 7. 2006 was as follows: Dr (Rs’000) Share Capital Freehold land-at cost Building-at cost Furniture at cost Salaries Purchases (including stock taken over) Sales (including sales prior to incorporation Rs.000.000 equity shares fully paid and the balance in cash.280.000 45. The agreement for taking over provided that all profits made from 1st April.93. (b) Bad Debts. with interest @ 8.75. 500. The purchase consideration of Rs. 140.200 8.000 You are required to prepare the Profit and Loss Account of the company for the year ended 31st March.500 1.000. 10 each to take over a going concern as from 1st April 2005. was incorporated on 1st July.000 the monthly average of which for the first four months of 2003 being one half of that of the remaining period. Ans.000 3.000 7.000 6.000 4. 540 Financial Accounting .000 (including Rs. after incorporation Rs.000 1. 820. in equity shares of Rs.000.11. The Trial Balance of the company on 31st March.000 out of book debts taken over from the vendors) to be written off. 2005 should belong to the company.500.000 together.3.500.500 12.000 7. 200. 24.85. 2005 with an authorized capital of Rs. Rs.75 % p.

600 Lakh. 2005. Machinery costing Rs. It had acquired a running business from M/s PTA & Co. 1. 18.165 Lakh. Directors’ fees Rs. Selling expenses Rs. The company also issued shares for Rs.3.000 Lakh for cash. Financial Accounting 541 . 2. with effect from April 1. the total sales were Rs. incorporated on Aug 1. 60 lakh.000 Lakh . 1995 Rs. 2006. Audit fees Rs. Ascertain the pre-incorporation and post incorporation amount of profit. The purchase consideration was Rs. 1.000 Lakh of which Rs.000 Lakh in the form of fully paid shares. 9. Preliminary expenses Rs. 360 Lakh.[profit prior to incorporation Rs.500 lakh was then installed. Closing stock was valued at Rs. Post incorporation profit Rs.000. The net profit of the company after charging the following expenses was Rs. Patents Rs. received the certificate to commence business on August 31. Balance Sheet Total Rs. Depreciation Rs. 250 lakh. 5. Assets acquired from the vendors were: Machinery Rs. Ans. During the year 1995.000 Lakh Stock Rs. the sales per month in the first halfyear were one-half of what they were in the later half year. Office expenses Rs. 4. 2005. 25 Lakh. Rajasthan Udyog Limited. 4. 835 Lakh. 700 Lakh. 3. 000 Lakh].000 Lakh was to be paid in cash and Rs. Interest to vendors upto August 31. and prepare the Balance Sheet of the company as on 31st March. 390 lakh. 75 Lakh. 2005. 540 Lakh. 400 Lakh.

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