2Sometime 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’.
3EXAMPLE: 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.
5The 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.
6NOTE: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.
7ASCERTAINMENT OF PROFIT OR LOSS PRIOR TO INCORPORATION
8In order to ascertain the amount of profit or loss prior to incorporation, the following steps should be taken.STEP 1In 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.
9STEP 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.
10EXAMPLE 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
11TIME 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.
12Time 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.
13EXAMPLE: 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
14STEP 3Profit and loss account is prepared as follow separately for two periodsgross 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.
15EXPENSES 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.
16Expenses 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.
17TREATMENT 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:
18write off against the profits of the company. Treated as goodwill and debited to goodwill accountSuch loss can be treated as deferred revenue expenditure and written out of profits of the company over a period of years.
20Date 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
21Sales 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.
22CALCULATION 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
23Vendor 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…..
24CALCULATION OF GROSS PROFIT Net profit = gross profit- indirect expenses OR Gross profit= net profit+ indirect expensesCALCULATIONOFGROSS PROFIT
26Adarsh udhyog Ltd profit and loss for the year ending 31st march 2001
27PRE I POST I Total To deprecia 180000 360000 By sales 472000 1652000 To audit f866717333To dire;s f-60000To prelim exp(post)10000To Off exp80000160000To selling e44000154000To interest to vendor (4 : 1)40000To capital reserve119333(bal. Fig)To net profit880667(bal. Fig)Total
29LIABILITIES AMOUNT ASSETS TOTAL 9000000 SHARE CAPITAL(4000000+4000000) GOODWILL( )CAPITAL RESERVE119333PATENTS400000PROFIT AND LOSS ACCOUNT880667MACHINERY(DEPR)496000CLOSING STOCK600000OTHER ASSETSTOTAL
30NOTEThe 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.