1. profit prior to incorporation

2. Sometime a company purchased a running business from data prior to its incorporation. For example:- A company incorporated on 1st April,2008 purchased an already running business from 1st January, 2008 the date on which accounting year of vendor starts. Generally, the business is purchased on the last date of balance sheet, so that assets and liabilities are taken over on the basis of figures of balance sheet. Thus, when a company earns profit from date of purchase to the date of its incorporation, it is called ‘profit prior to incorporation’.

3. EXAMPLE: Green limited is incorporated on 1st April 2008 to take over the running business of M/S black and white as from 1st January,2008. In this case the profit earned by Green limited from 1st Jan to 1st April i.e from date of purchase to date of incorporation is called PROFIT PRIOR TO INCORPORATION.

4. NATURE OF PROFIT PRIOR TO INCORPORATION

5. The profit earned by the company prior to its incorporation is of capital nature. Such profits are not treated as the profits of the company because they are not available for distribution as dividend to shareholders. Such profits are treated as CAPITAL PROFITS and are transferred to CAPITAL RESERVE ACCOUNT. If there is any loss then such loss is of capital nature and is debited to GOODWILL ACCOUNT.

6. NOTE:
It should be noted that it is the “Date of incorporation” not the date of commencement, which is taken into consideration for the calculation of profit or loss prior to incorporation.

7. ASCERTAINMENT OF PROFIT OR LOSS PRIOR TO INCORPORATION

8. In order to ascertain the amount of profit or loss prior to incorporation, the following steps should be taken.
STEP 1
In order to ascertain the amount of gross profit, the trading account for the whole period i.e. the date of purchase to the date of balance sheet is prepared.

9. STEP 2: Three Ratio calculated : Sale ratio Time ratio Vendor ratio SALES RATIO: Sales ratio is calculated on the basis of sales made between date of purchase to date of incorporation and date of incorporation to the date of balance sheet.

10. EXAMPLE Sales from date of purchase to date of incorporation is Rs Sales from date of incorporation to date of balance sheet is Rs Then sales ratio = sale in incorporation period : ratio to post incorporation = 50000:80000 i.e = 5:8

11. TIME RATIO: It is calculated by taking into consideration the time from the date of purchase of business to the date of incorporation and from date from incorporation to the date of balance sheet. EXAMPLE: Date of incorporation on 1st April,01 to take over the already existing business from 1January,01. Z ltd prepares its final accounts on 31st December,01.

12. Time ratio: time(pre incorporation period) :(post incorporation period) to : to months : 9 months Ratio is 3:9 or 1:3 VENDOR RATIO: It is calculated on the basis of date of purchase, date of incorporation and date of settlement of claims.

13. EXAMPLE: A co. incorporated on 1st Jan,01 purchased a business running from claim are settled on 1st April, 01 Vendor ratio= date of purchase to date of incorporation : date of incorporation of date of settlement of claims. 3 months : 3 months 1 : 1

14. STEP 3
Profit and loss account is prepared as follow separately for two periods
gross profit should be allocated on the basis of sales ratio.
expenses that are connected with sales should be allocated on the basis of sales ratio.
expenses incurred on the basis of time should be allocated on the basis of time ratio.

15. EXPENSES CONNECTED WITH SALES ARE : discount on sales , commission on sales , discount allowed , bad debts , advertising , selling expenses, carriage outwards etc. EXPENSES CONNECTED WITH TIME ARE : audit fees , salaries , rent and taxes , depreciation , insurance , general expenses , printing and stationary , administration expenses etc.

16. Expenses which are either completely comes under pre or post period
Expenses which are either completely comes under pre or post period. They are not allocated on the basis of any ratio. Whole amount goes to the respective period i.e. pre or post .
Expenses wholly related to pre – period are salaries of partners , interest on capital etc.
Expenses wholly related to post - period are director’s fees, debenture interest, goodwill written off, provisions, preliminary expenses etc.

17. TREATMENT OF LOSS PRIOR TO INCORPORATION Loss prior to incorporation being of capital nature shall be debited to separate account called ‘loss prior to incorporation account’ and shown under miscellaneous expenditure on the asset side of the balance sheet to the extent not written off. Loss prior to incorporation can be dealt in any of the following manner:

18. write off against the profits of the company.
Treated as goodwill and debited to goodwill account
Such loss can be treated as deferred revenue expenditure and written out of profits of the company over a period of years.

19. ILLUSTRATION

20. Date of incorporation is 1st may,2001 Purchase consideration is Rs
Date of incorporation is 1st may,2001 Purchase consideration is Rs of which Rs was to be paid in cash n in the form of fully paid shares. Co. also issued shares for Rs for cash. Machinery costing Rs was installed. Assets acquired from vendors were :- machinery Rs , stock Rs , patent Rs

21. Sales during the year, Sales per month in the first half being one half of what they have in later half year. Net profit after charging following expenses was Depreciation Rs , audit fees Rs , preliminary expenses Rs 10000, office expenses Rs , selling expenses Rs , interest to vendors up to 31st may,2001 Rs Closing stock Rs Prepare balance sheet of the company as an 31st December 2001.

22. CALCULATION OF RATIOS TIME RATIO: (D. O. P to D. O. I ): (D. O. I to D
CALCULATION OF RATIOS TIME RATIO: (D.O.P to D. O. I ): (D.O.I to D. O.Balance sheet) : month : 8 month Time ratio 1 : 2 SALES RATIO: 100X X = 1400 Sales ratio 400 : 1400 = 2 : 7

23. Vendor ratio:- D. O. P to D. O. I : D. O. I to D. O
Vendor ratio:- D. O. P to D.O.I : D.O.I to D. O.Settlement of claim 4 months : 1 months Vendors ratio= 4 : 1 SOLUTION OF ABOVE QUERY…..

24. CALCULATION OF GROSS PROFIT
Net profit = gross profit- indirect expenses OR Gross profit= net profit+ indirect expenses
CALCULATION OF
GROSS PROFIT

25. PARTICULARS
AMOUNT
TOTAL
Net profit
ADD: Depreciation
540000
audit fees
26000
director’s fee
60000
Preliminary expenses
240000
Office expenses selling expenses
198000
Interest to vendor
50000
Gross profit

26. Adarsh udhyog Ltd profit and loss for the year ending 31st march 2001

27. PRE I POST I Total To deprecia 180000 360000 By sales 472000 1652000
To audit f
8667
17333
To dire;s f -
60000
To prelim exp(post)
10000
To Off exp
80000
160000
To selling e
44000
154000
To interest to vendor (4 : 1)
40000
To capital reserve
119333(bal. Fig)
To net profit
880667(bal. Fig)
Total

28. BALANCESHEET AS ON 31ST DECEMBER, 2001

29. LIABILITIES AMOUNT ASSETS TOTAL 9000000 SHARE CAPITAL(4000000+4000000)
GOODWILL( )
CAPITAL RESERVE
119333
PATENTS
400000
PROFIT AND LOSS ACCOUNT
880667
MACHINERY
(DEPR)
496000
CLOSING STOCK
600000
OTHER ASSETS
TOTAL

30. NOTE
The profit prior to incorporation can be utilized in writing of goodwill or capital loss. The balance, if any should be transferred to capital reserve account.