Unit 2
PROFITS/LOSSES PRIOR TO INCORPORATION
When a running business is taken over from a date prior to its incorporation/commencement, the profit earned up to the date of incorporation/commencement (incorporation, in case of private company; and commencement, in case of public company) is known as ‘Pre-incorporation profit’.
The same is to be treated as capital profit since these are profits which have been earned before the company came into existence. In short, the profit earned after the date of purchase of business is called ‘Post-incorporation or Post-acquisition profit’ and the profit earned before the date of purchase of business is termed as ‘Pre-incorporation profit’.
For example, X Ltd. was incorporated on 1st April 2006, took over a running business, Y Ltd., from 1st January 2006 and it closed its accounts on 31st December 2006. Now, the company X Ltd. is entitled not only to the profit/loss made by Y Ltd. from 1st April to 31st December 2006 but also to the profit/loss made by Y Ltd. from 1st January 2006 to 31st March 2006.
Thus, any profit/loss made before the incorporation is known as “Profit (Loss) Prior to Incorporation” which is treated as a capital profit and the same cannot be distributed as business profit. Hence, it cannot be distributed by way of dividend.
The same is to be transferred to Capital Reserve or may be adjusted against Goodwill. “Loss prior to incorporation” is treated as a capital loss and, hence, the same is shown under the head “Miscellaneous Expenditure” in the assets side of the Balance Sheet.
In order to ascertain the profit prior to incorporation a Profit and Loss Account is to be prepared at the date of incorporation. But in practice, the same set of books of accounts is maintained throughout the accounting year.
A Profit and Loss Account is prepared at the end of the year and thereafter the profits (or losses) between the two periods are allocated:
(i) From the date of purchase to the date of incorporation or pre-incorporation period;
(ii) From the date of incorporation to the closing of the accounting year or post-incorporation period.
Steps may be suggested for ascertaining profit or loss prior to incorporation:
Step I:
A Trading Account should be prepared at first for the whole period, i.e., between the date of purchase and the date of final accounts, in order to calculate the amount of gross profit.
Step II:
Calculate the following two ratios:
i) Sales Ratio:
Amount of sales should be calculated for the pre-incorporation and post-incorporation periods.
(ii) Time Ratio:
It is calculated after considering the time period, i.e., one is required to calculate the period falling between the date of purchase and the date of incorporation and the period between the date of incorporation and the date of presenting final accounts.
Step III:
A statement should be prepared for calculating the amount of net profit before and after incorporation separately on the following principle:
(i) Gross Profit should be allocated for the two periods on the basis of sales ratio which will present the gross profit for the two separate periods, viz. pre-incorporation and post- incorporation.
(ii) Fixed Expenses or expenses incurred on the basis of time, viz., Rent, Salary, Depreciation, Interest, etc. should be allocated for the two periods on the basis of time ratio.
(iii) Variable Expenses or expenses connected with sales should be allocated for the two periods on the basis of sales ratio.
(iv) Certain expenses, viz., partners’ salary, directors’ salary, preliminary expenses, interest on debentures, etc. are not apportioned since they relate to a particular period. For example, partners’ salary is to be charged against pre-acquisition profit whereas directors’ remuneration, debenture interest, etc. are to be charged against post-acquisition profit.
(a) Gross Profit
(b) Selling Expenses
(c) Advertisement
(d) Carriage Outwards
(e) Godown Rent
(f) Discount Allowed
(g) Salesmen’s Salaries
(h) Commission to Salesmen
(i) Promotion Expenses for Sales
(j) Distributions Expenses (Variable Portions)
(k) Free Samples given
(l) Expenses incurred for After-Sale Service, etc.
(m) Delivery Van Expenses.
(a) Office and Administration Expenses
(b) Salaries to Office Staff
(c) Rent, Rates and Taxes
(d) Depreciation on Fixed Assets
(e) Printing and Stationery
(f) Insurance
(g) Audit Fees
(h) Miscellaneous Expenses
(i) Distribution Expenses (Fixed Portion)
(j) Travelling Expenses (General)
(k) Interest of Debenture
(l) General Expenses
(m) Expenses Fixed in Nature.
(a) Pre-incorporation Profit:
Since “Profit prior to Incorporation” is a Capital Profit the same should be written off against:
(i) Preliminary Expenses Account
(ii) Formation Expenses Account
(iii) Liquidation Expenses Account
(iv) Write down the value of Fixed Assets, if any
(v) Goodwill Account
(vi) Balance, if any, transferred to Capital Reserve.
(b) Pre-incorporation Loss:
Since “Pre-incorporation Loss” is a Capital Loss the same is adjusted against
(i) Any Capital Profit
(ii) Debited to Goodwill Account
(iii) Writing-off Fictitious Assets
(iv) Capital Reserve.
Q1) The Promoters of the ITC Company Ltd. Purchased a running business on 1st January,2018 from Mr. Dhaval. The new company was incorporated on 1st May,2018. The Profit and Loss Account for the year ended 31st December, 2018 was as under :
PARTICULARS | AMOUNT | PARTICULARS | AMOUNT |
Rent, Rates, Insurance, Electricity | 24,000 | Gross Profit | 3,00,000 |
Directors sitting Fees | 7,200 | Discount Received | 12,000 |
Preliminary Expenses | 9,800 |
|
|
Selling Expenses | 11,000 |
|
|
Interest paid to Vendors | 20,000 |
|
|
Net Profit | 2,40,000 |
|
|
TOTAL | 3,12,000 | TOTAL | 3,12,000 |
Following further information available :
Sales up to 30th April, 2018 was Rs.6,00,000 out of total sales of Rs.30,00,000 for the year. Purchase up to 30th April, 2018 was Rs.6,00,000 out of total purchase of Rs.18,00,000 of the year. Interest paid to vendors was @ 12% on Rs.2,00,000 p.a. till the payment was made.
From the above information, prepare Statement of Profit & Loss for the year ended 31st December, 2018. Showing the pre and post- incorporation profits and how it will be treated in accounts.
SOLUTION:-
STATEMENT OF PROFIT & LOSS FOR THE YEAR ENDING 31st December, 2015.
PARTICULARS | TOTAL | BASIS OF ALLOCATION | PRE-INC (AMOUNT) | POST-INC (AMOUNT) |
INCOME |
|
|
|
|
Gross Profit | 3,00,000 | Sales | 60,000 | 2,40,000 |
Discount Received | 12,000 | Purchase | 4,000 | 8,000 |
TOTAL INCOME | 3,12,000 |
| 64,000 | 2,48,000 |
LESS : EXPENSES |
|
|
|
|
Rent, Rates, Insurance, Electricity | 24,000 | Time | 8,000 | 16,000 |
Directors sitting Fees | 7,200 | Post |
| 7,200 |
Preliminary Expenses | 9,800 | Post |
| 9,800 |
Selling Expenses | 11,000 | 1:4 | 2,200 | 8,800 |
Interest paid to Vendors | 20,000 | Actual | 8,000 | 12,000 |
TOTAL EXPENSES | 72,000 |
| 18,200 | 53,800 |
|
|
|
|
|
NET PROFIT | 2,40,000 |
| 45,800 | 1,94,200 |
Notes to Accounts: Net profit for pre-incorporation period will be transferred to Capital Reserve and the post-incorporation period will be transferred to Profit and Loss A/c
WORKING NOTES:
- Sales Ratio = 6,00,000 : 24,00,000 = 1:4
- Time Ratio = 4 months : 8 months = 1:2
- Purchase Ratio = 6,00,000 : 12,00,000 = 1:2
- Interest paid to vendors = 2,00,000 X 12% = 24,000 per year = Rs. 2,000 p.m. Paid Rs. 20,000 i.e. for 10 months. So payment was on 31-10-2018. Pre- incorporation (Jan- Apr = 4 months );(May- Oct= 6 months).
Q2) Thoriya Ltd. Was incorporated to take over the running business of Sharma Bros. w.e.f. 1st April,2014. The company was incorporated on 1st August, 2014. And it commenced its business on 1st October, 2014. The following information was available from the books of accounts which were closed on 31st March, 2015.
PARTICULARS | AMOUNT | AMOUNT |
Gross Profit |
| 3,50,000 |
Less : Office Salaries | 1,35,000 |
|
Office Expenses | 45,000 |
|
Travelling Expenses | 24,600 |
|
Office Rent | 48,000 |
|
Salesman’s Commission | 24,500 |
|
Depreciation | 10,500 | 2,87,600 |
NET PROFIT |
| 62,400 |
ADDITIONAL INFORMATION :-
- Sales were Rs. 2,50,000 p.m. during pre-incorporation period, while total sales for the year were Rs.35,00,000. The Sales arose evenly throughout the concerned period.
- Office Rent was Rs.42,000 p.a. It became Rs.54,000 p.a. from the date of commencement of business.
- Travelling Expenses include Rs.3,600 incurred by the office Staff and balance by the Sales Staff.
- Depreciation include Rs. 3,000 for the assets acquired in post incorporation period.
- Salaries include partners salaries Rs. 30,000 while the remaining salary was for the office staff.
From the above information, prepare Statement of Profit & Loss for the year ended 31st March, 2015. Showing the pre and post- incorporation profits and how it will be treated in accounts.
SOLUTION:-
IN THE BOOKS OF THORIYA Ltd.
STATEMENT OF PROFIT & LOSS FOR THE YEAR ENDING 31st March, 2015.
PARTICULARS | TOTAL | BASIS OF ALLOCATION | PRE-INC (AMOUNT) | POST-INC (AMOUNT) |
INCOME |
|
|
|
|
Gross Profit | 3,50,000 | Sales | 1,00,000 | 2,50,000 |
TOTAL INCOME | 3,50,000 |
| 1,00,000 | 2,50,000 |
LESS : EXPENSES |
|
|
|
|
Salaries (Partner’s) | 30,000 | Pre- Inc. | 30,000 |
|
Salaries | 1,05,000 | Time | 35,000 | 70,000 |
Office Expenses | 45,000 | Time | 15,000 | 30,000 |
Travelling Expenses (Office) | 3,600 | Time | 1,200 | 2,400 |
Travelling Expenses (Sales) | 21,000 | Sales | 6,000 | 15,000 |
Office Rent | 48,000 | WN3 | 14,000 | 34,000 |
Salesman’s Commission | 24,500 | Sales | 7,000 | 17,500 |
Depreciation (Post Period) | 3,000 | Post-Inc | - | 3,000 |
Depreciation | 7,500 |
| 2,500 | 5,000 |
TOTAL EXPENSES | 2,87,600 |
| 1,10,700 | 1,76,900 |
NET PROFIT/ (LOSS) | 62,400 |
| (10,700) | 73,100 |
Notes to Accounts : Net Loss for pre-incorporation period will be transferred to Goodwill and the post-incorporation period will be transferred to Profit and Loss A/c.
WORKING NOTES :
- Time Ratio (TR) = 1-4-2015 to 31-7-2015 : 1-8-2015 to 31-3-2016
4 months : 8 months
1 : 2
2. Sales Ratio (SR) = (Total Sales = Rs.35,00,000)
A M J J A S O N D J F M
2.5 2.5 2.5 2.5
Pre- Inc. 10,00,000 Post Inc. 25,00,000
Sales Ratio= 2:5
3. Office Rent : 48,000
A M J J A S O N D J F M
3.5 3.5 3.5 3.5
Pre- Inc. 14,000 Post Inc. 34,000
Q3) Ramesh & Rajesh working in partnership, registered a joint Stock company under the name of Sad Ltd. On May 31st 2017 to take over their existing business. The summarized Profit and Loss A/c are given by Sad Ltd. For the year ending 31st March,2018 as under.
PROFIT AND LOSS A/c FOR THE YEAR ENDING MARCH 31, 2018
PARTICULARS | AMOUNT | PARTICULARS | AMOUNT |
To Salaries | 1,44,000 | By Gross Profit | 4,50,000 |
To Int on Debenture | 36,000 |
|
|
To Sales Commission | 18,000 |
|
|
To Bad Debts | 49,000 |
|
|
To Depreciation | 19,250 |
|
|
To Rent | 38,400 |
|
|
To Audit Fees | 12,000 |
|
|
To NET PROFIT | 1,33,350 |
|
|
TOTAL | 4,50,000 | TOTAL | 4,50,000 |
- Depreciation includes Rs. 1,250 for the assets acquired in post incorporation period
- Bad debts recovered amounting to Rs. 14,000 for a sales made in 2013-2014 has been deducted from bad debts mentioned above.
- Total Sales were Rs.18,00,000 of which Rs.6,00,000 were for April to September.
- Sad Ltd. Had occupied additional space from 1st Oct, 2017. For which rent was Rs.2,400 p.m.
- Audit fees are for audit under the companies Act.
SOLUTION:-
Pre-Inc period is for Two months, from 1st April,2017. To 31st May,2017. 10 months period (from 1-6-2017 to31-3-2018)is Post- Incorporation.
STATEMENT OF PROFIT & LOSS FOR THE YEAR ENDING 31st March, 2018.
PARTICULARS | TOTAL | BASIS OF ALLOCATION | PRE-INC (AMOUNT) | POST-INC (AMOUNT) |
Gross Profit | 4,50,000 | Sales | 50,000 | 4,00,000 |
Bad Debts Recovery | 14,000 | Pre | 14,000 |
|
TOTAL INCOME | 4,64,000 |
| 64,000 | 4,00,000 |
LESS : EXPENSES : |
|
|
|
|
Salaries | 1,44,000 | Time | 24,000 | 1,20,000 |
Int on Debenture | 36,000 | Post | - | 36,000 |
Sales Commission | 18,000 | Sales | 2,000 | 16,000 |
Bad Debts (49,000 + 14,000) | 49,000 |
| 7,000 | 56,000 |
Depreciation | 19,250 | Note | 3,000 | 16,250 |
Rent | 38,400 | Time | 4,000 | 34,400 |
Audit Fees | 12,000 | Post | - | 12,000 |
TOTAL EXPENSES | 3,11,400 |
| 40,000 | 2,90,650 |
NET PROFIT | 1,52,600 |
| 24,000 | 1,09,350 |
Notes to Accounts : Net profit for pre-incorporation period will be transferred to Capital Reserve and the post-incorporation period will be transferred to Profit and Loss A/c.
WORKING NOTE :-
- Calculation of Sales Ratio
Sales from April to September = 6,00,000 (1,00,000 p.m. on avg basis)
October to March = 12,00,000 (2,00,000 p.m. on an avg basis)
Thus, sales for pre-incorporation period = 2,00,000
Post – incorporation period = 16,00,000
Sales are in the Ratio of 1:8
- Audit fees charged to post incorporation period since relating to company audit.
- Deprecation of Rs. 18,000 divided in the ratio of 1:5 (TR) and Rs.1,250 charged to post incorporation period.
- Bad Debt recovery of Rs.14,000 is allocated in pre- incorporation period, being sales made in 2013-2014
- Rent (38,400-Additional rent for 6 months)
[38,400-14,400 (2,400 * 6)] = 24,000
1-4-17 – 31-5-17 (2,000*2) = 4,000
1-6-17 – 31-3-18 – (2,000*10)+ 14,400 = 34,400
TOTAL = 38,400
Q4) From the given information, ascertain the profit for the pre incorporation and post incorporation period separately.
Net Profit before making adjustment given below :
Pre incorporation profit Rs.76,000
Post incorporation profit Rs.1,07,000
Sales Ratio = 4:5
Time Ratio = 1:1
Transaction to be recorded:
- Debenture interest paid Rs.20,000
- Discount allowed to customer Rs.4,500
- Depreciation is Rs.50,000 out of which depreciation of Rs. 10,000 Is on assets purchased during the post incorporation period.
- Share transfer fees received Rs.5,000
SOLUTION:-
REVISED PRE AND POST PROFITS
PARTICULARS | BASIS OF ALLOCATION | PRE-INC (PROFITS) | POST-INC (PROFITS) |
Profit Before Transaction | Given | 76,000 | 1,07,000 |
LESS : Debenture Interest | Post | - | (20,000) |
LESS : Discount Allowed | Sales | (2,000) | (2,500) |
LESS : Depreciation | Post |
| (10,000) |
Depreciation | Time | (20,000) | (20,000) |
ADD : Share Transfer Fees | Post |
| 5,000 |
NET PROFIT |
| 54,000 | 59,500 |
Notes to Accounts : Net profit for pre-incorporation period will be transferred to Capital Reserve and the post-incorporation period will be transferred to Profit and Loss A/c.
Q5) Krishna Ltd. Was incorporated on August 1,2015. It had acquired a running business of Rama & Co. with effect from April 1, 2015. During the year 2015-2016 the total sales were Rs.36,00,000. The sales p.m. in the first half of year were half of what they were in the latter half year. The net profit of the company Rs.2,00,000 was worked out after charging the following list of expenses.
PARTICULARS | AMOUNT |
Depreciation | 1,08,000 |
Audit fees | 15,000 |
Director’s fees | 50,000 |
Preliminary Expenses | 12,000 |
Office expenses | 78,000 |
Selling Expenses | 72,000 |
Interest to vendors up to 31-08-2015 | 5,000 |
Please ascertain pre – incorporation and post – incorporation profit for the year ended 31st March,2016.
SOLUTION :-
STATEMENT OF PROFIT & LOSS FOR THE YEAR ENDING 31st March, 2016.
PARTICULARS | TOTAL | BASIS OF ALLOCATION | PRE-INC (AMOUNT) | POST-INC (AMOUNT) |
INCOME |
|
|
|
|
Gross Profit | 5,40,000 | Sales | 1,20,000 | 4,20,000 |
TOTAL INCOME | 5,40,000 |
| 1,20,000 | 4,20,000 |
LESS : EXPENSES |
|
|
|
|
Depreciation | 1,08,000 | Time | 36,000 | 72,000 |
Audit fees | 15,000 | Time | 5,000 | 10,000 |
Director’s fees | 50,000 | Post | - | 50,000 |
Preliminary Expenses | 12,000 | Post | - | 12,000 |
Office expenses | 78,000 | Time | 26,000 | 52,000 |
Selling Expenses | 72,000 | Sales | 16,000 | 56,000 |
Interest to vendors | 5,000 | Actual | 4,000 | 1,000 |
TOTAL EXPENSES | 3,40,000 |
| 87,000 | 2,53,000 |
NET PROFIT/ (LOSS) | 2,00,000 |
| 33,000 | 1,67,000 |
Notes to Accounts: Net profit for pre-incorporation period will be transferred to Capital Reserve and the post-incorporation period will be transferred to Profit and Loss A/c.
WORKING NOTES:-
- SALES RATIO
A M J J A S O N D J F M
0.5 0.5 0.5 0.5 0.5 0.5 1 1 1 1 1 1
Pre-incorporation = 0.5 X 4 = 2
Post – incorporation = (0.5 X 2 )+ (1 X 6 )= 7
SALES RATIO = 2 :7
- TIME RATIO
1-4-2015 to 31-7-2015 : 1-8-2015 to 31-3-2016
4 months : 8 months
1 : 2
- GROSS PROFIT
Gross profit = Net Profit + All Expenses
= 2,00,000 + (1,08,000 + 50,000 + 12,000 + 78,000 + 72,000 + 5,000)
= 2,00,000 + 3,40,000
=5,40,000
References
1. Corporate Accounting by B.B.Dam
2. Corporate Accounting by K.R.Das