UNIT – II

PROFIT 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.
Method of Computation of Profits/Loss Prior to Incorporation:

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.

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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.
Method of Accounting of Profit/Loss Prior to Incorporation:

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 the 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.

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(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.

List of Expenses: Allocated on the basis of Sales/Turnover:

(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.

List of Expenses: Allocated on the basis of Time:

(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

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(h) Miscellaneous Expenses

(i) Distribution Expenses (Fixed Portion)

(j) Travelling Expenses (General)

(k) Interest of Debenture

(l) General Expenses

(m) Expenses Fixed in Nature.

Application/Accounting Treatment of Profit/Loss Prior to Incorporation:

(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.

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Illustration : 1

Ganesh Ltd., was registered on 01-07-1997 to acquire the running business of Suneel & Co.,
with effect from 1-1-97. The following was the Profit and Loss account of the company on
31-12-97.

Particulars Rs. Particulars Rs.

To Office expenses 54,000 By Gross Profit b/d 2,25,000
To Formation expenses 10,000
(written off)
To Stationery & Postage 5,000
To Selling Expenses 60,000
To Director‟s Fees 20,000
To Net Profit 76,000
2,25,000 2,25,000

You are required to prepare a statement showing profit earned by the company in
the pre and post-incorporation periods. The total sales for the year took place in the ratio
1:2 before and after incorporation respectively.

Illustration: 2
Pankajam Mills Ltd. was incorporated on 31st July 1977 to purchase the business of
Hemalatha & Co., as on 1st April 1977. The books of accounts disclosed the following on
31st March 1978.
1. Sales for the year Rs. 32,10,400 (1st April to 31st July‟77 Rs. 8,02,600; 1st July‟77
to 31st March 1978 Rs. 24,07,800)
2. Gross Profit for the year Rs. 4,12,800; Managing Directors‟ Salary Rs. 12,000;
Preliminary expenses written off Rs. 18,000. Company Secretary‟s salary
Rs.58,000.
3. Bad Debts are written off Rs. 14,890 (prior to 31st July Rs. 4,020, after 31st
July Rs.10,870)
4. Depreciation on Machinery Rs.25,200; general expenses Rs.51,500; Advertising
Rs. 7,400; Interest on debentures Rs. 20,000.
You are required to prepare a statement apportioning properly the net profit of the
company between
a) profits available for distribution; b) profits prior to incorporation
Illustration : 3

“A” Co.Ltd. was incorporated on May 1, 2008, to take over the business of “X & Co”
as a going concern from January 1, 2008 was as follows:

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 Profit and Loss account of “A” Co. Ltd for the year ended 31.12.83
Dr Cr
Particulars Rs. Particulars Rs.
To Rent and Taxes 12,000 By Trading account 1,55,000
To Insurance 3,000 (Gross Profit)
To Electricity Charges 2,400
To Salaries 36,000
To Director‟s fees 3,000
To Auditors‟ fees 1,600
To Commission 6,000
To Advertisement 4,000
To Discount 3,500
To Office Expenses 7,500
To Carriage 3,000
To Bank Charges 1,500
To Preliminary Expenses 6,500
To Bad debts 2,000
To Interest on Loan 3,000
To Net Profit 60,000
1,55,000 1,55,000
The total turnover for the year ending December 31, 2008 was Rs.5,00,000 divided into
Rs. 1,50,000 for the period upto May 1, 2008 and Rs. 3,50,000 for the remaining period.
Illustration : 4

A company was incorporated on 1st May 1984 acquiring the business of a sole trader with
effect from 1st January 1984. The accounts of the company were closed for the first time
on 30th September 1984, disclosing a gross profit of Rs.1,68,000. The establishment
expenses were Rs. 42,660, directors‟ fees Rs. 3,000 per month, preliminary expenses
written off Rs. 4000, rent upto June, 1984 was Rs. 300 per month which was thereafter
increased to Rs.750 per month. Salary to the manager was at Rs.1,500 per month who
was appointed a director at the time of incorporation of the company.
Prepare a statement showing profits prior and subsequent to incorporation assuming that
the net sales were Rs.24,60,000, the monthly average of which for the first four months
of 1984 was half of that of the remaining period.

Illustration : 5
A Company was incorporated on 1st May, 1994 to take over a business from the
preceding 1st January. The accounts were made upto 31st December, 1994 as usual and the
trading and profit and loss account gave the following result:
Particulars Rs. Particulars Rs.
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 To Opening Stock 1,40,000 By Sales 12,00,000
To Purchases 9,10,000 By Closing Stock 1,50,000
To Gross Profit c/d 3,00,000
13,50,000 13,50,000

To Rent, rates & Insurance 18,000 By Gross Profit b/d 3,00,000

To Director‟s fees 20,000
To Salaries 51,000
To Office Expenses 48,000
To Travellers Commission 12,000
To Discounts 15,000
To Bad debts 3,000
To Audit fees 8,500
To Depreciation 6,000
To Debenture interest 4,500
To Net Profit 1,14,000
1,55,000 1,55,000

It is ascertained that the sales for November and December are one and half times the
average of those for the year, whilst those for February and April are only half the
average, all the remaining months having average sales.
Apportion the year‟s profit between the pre and post incorporation periods.

Illustration : 6

Kaveri Ltd. was incorporated on 1.5.96 to take over the running business of M/s. Saveri
Bros. with effect from 1.196. From the following details for the year ended 31.12.96,
prepare a statement showing profit or loss made during pre and post incorporation
periods:

Particulars Rs. Particulars Rs.

Gross Profit 3,00,000 Underwriting commission 20,000
Salaries 48,000 Insurance premium paid for
Advertising 6,000 the year ending 31.3.97 12,000
Commission to Partners 8,000 Interest on loans taken
Carriage outward 16,000 (including Rs.2,000 on loan
Depreciation 18,000 taken after incorporation) 14,000
Provision for doubtful debts 6,000
The following additional data is also available
(i) Average monthly sales during the first four months of the year was twice
the average monthly sales during each of the remaining eight months.
(ii) 20% of the underwriting commission is to be written off.
(iii) Commission to partners was paid for their work before incorporation
(iv) Salaries includes salary paid to a director of the company Rs. 6,000.
Illustration : 7
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 S & R Co., Ltd was incorporated on July 1, 1992 to purchase the business of Nisha Bros.,
as on 1-4-92. Certificate of Commencement of business was received on 1-8-92. The
accounts for the year ended 31-3-93 disclosed net profits of Rs.80,000 after charging the
following:
(1) Directors‟ salary – Rs. 10,000.
(2) Salaries – Rs. 20,000 (4 employees in pre incorporation period and six employees
in post incorporation period).
(3) Wages – Rs. 10,200 (5 workers at Rs. 80 per month in pre incorporation period and
10 workers at Rs. 100 per month in post incorporation period).
The sales were Rs. 3,00,000 of which Rs. 75,000 were in pre incorporation period.
Calculate profit earned in the pre and post incorporation periods.

Illustration : 8

A firm which was carrying on business from 1 st January, 1988 gets itself incorporated as a
company on 1st May 1988. The first accounts are drawn upto 30 th September 1988. The
gross profit for the period is Rs. 56,000. The general expenses are Rs.14,220; director‟s
fees Rs. 12,000 per annum, formation expenses Rs. 1,500. Rent upto 30 th June was Rs.
1,200 per annum, after which it was increased to Rs.3,000 per annum. Salary of the
Manager, who, upon incorporation of the company was made a director, was Rs. 6,000 per
annum. His remuneration thereafter was included in the above figure of fees to directors.
Give profit and loss account showing pre and post incorporation profits. The net sales were
Rs.8,20,000, the monthly average of which for the first four months of 1988 being one half
of that of the remaining period. The company earned an uniform profit. Interest and tax
may be ignored.

Illustration 9:
S. Ltd was registered on 1st January 2000 to buy over the business of M/s P. Ltd. as on 1st
October 2008 and obtained its certificate for commencement of business on 1st February
2009.

The accounts of the company for the period ended 30th September 2009 disclosed the
following facts:

(i) The turnover for the whole period amounted to Rs. 3,00,000 of which Rs. 50,000 related
to the period from 1st October 2008 to 1st February 2009.

(ii) The Trading Account showed a Gross Profit of Rs. 1,20,000.

(iii) The following items appear in the Profit and Loss Account:

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Illustration 10:

Moon Ltd., which was incorporated on 1st June 2009, took over the business of N, a

proprietary concern, from 1st January 2009, for Rs. 1,00,000 on the condition that all profits

earned from 1.1.2009 shall belong to the company. Following are the data for the Profit and

Loss Account for the year ended 31st December 2009:

Gross Profit Rs. 2,00,000; Salaries and Bonus Rs. 15,000; Rent Rs. 1,000; Bad Debts

Rs. 5,000; Preliminary Expenses Rs. 9,000; Commission on Sales Rs. 12,000; Interest

payable to or against purchase consideration Rs. 1,000; Directors‟ fees Rs. 3,000; Managing

Directors‟ Remuneration Rs. 14,600; Establishment Charges Rs. 21,000; Depreciation Rs.

10,000; and Advertisement Rs. 27,000.

(a) Sales for the first six months amounted to Rs. 10,00,000; the rate of gross profit being

12% on sales. In the second six months, the rate of gross profit was 8% on sales. Commission

on sales was at 6% throughout the year. Question of stock and work-in-progress does not

arise in the business.

(b) N used to carry out the business up to 31.5.2009 in their own premises without any

depreciable assets on a cash sales basis only.

(c) Advertisement for the first six months was at the rate of Rs. 4,000 per month.

Prepare a Statement of Profit Account for pre-incorporation and post-incorporation

periods in columnar form stating against each items the basis of segregation. How much was
the pre-incorporation profit? Take calendar months as of equal length. Confine to the data
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given only.

Illustration 11:

Mr. X formed a private limited company under the name and style of Exe. Pvt. Ltd. to take

over his existing business as from 1st April 2006 but the company was not incorporated till

1.7.2006. No entries relating to transfer of the business was entered in the books, which were

carried on without a break till 31st March 2007.

The following Balances were extracted from the books as on 31st March 2007:

You are also given:

(a) Stock on 31st March 2007 amounted to Rs. 44,000.

(b) The Gross Profit Ratio is constant and monthly sales in April ‟06, Feb. ‟07 and March

‟07 are double the average monthly sales of the year.

(c) The purchase consideration was agreed to be satisfied by the issue of 3,000 Equity Shares

of Rs. 100 each.

(d) The Preliminary Expenses are to be written-off.

(e) You are to assume that carriage outwards and travellers‟ commission vary in direct

proportion to sales.

You are required to prepare the Trading Account and the Profit and Loss Account for the year

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ended on 31st March 2007 apportioning the profit or loss of the periods before and after

incorporation. Depreciation shall be provided at 25% p.a. on Fixed Assets.

Illustration 12:

New Ventures Ltd. was incorporated on 1st January 2008, with an authorised capital

consisting of 5,000 Equity Shares of Rs. 10 each, to take-over the running business of R.

Bros, as from 1st Oct. 2007. The following is the summarised Profit and Loss Account

for the year ended 30th Sept. 2008:

The company deals in one type of product. The unit cost of sales was reduced by 10% in the

post- incorporation period as compared to the pre-incorporation period in the year. You are

required to apportion the net profit amount between pre-incorporation and post- incorporation

periods showing the basis of apportionment.

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Illustration 13:

Jalajga Ltd. Was incorporated as a private company on 31.8.1995 to take over a

business as a going concern as from 1.1.2005. Vendors would get 75% of the profit earned

prior to 31.8.2015. Trading and Profit and Loss Account for the year ended 31.12.2015 was:

Sales for March and April are one and half times have average monthly sales. Sales

for September and October are twice the average monthly sales. Bad Debts of Rs. 1,110 were

written-off in June. Prepare a Statement showing pre-incorporation and post-incorporation

profits. Also indicate the disposal of such profits.

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 Other Exercise

1. Explain the meaning of profits prior to incorporation.

2. What is the need for calculating profit prior to incorporation
3. What is the treatment for Loss prior to incorporation in accounts?
4. Enumerate the expenses which are exclusively charged to post incorporation period.
5. How do you apportion various expenses and incomes between Pre and
Post incorporation periods?

6. Raja Ltd., was incorporated on 1st July, 2004, which took over a running
concern with effect from 1st January, 2004. The sales for the period up to 1st July,
2004 was Rs. 2,70,000 and the sales for 1 st July, 2004 to 31st December, 2004
amounted to Rs. 3,30,000. The expenses debited to Profit and Loss account included

7. A company was incorporated on 1st July 2006 to acquire a running business from 1 st
April 2006. When accounts were finalized on 31st March 2007, the following facts
were noted.
(i) Sales for the year were Rs. 4,80,000
(ii) The trends of sales were as under during the specified months.
April, July, September, December – Average sales. May, August, October and
February 50% of average sales.
You are required to find out the sales ratio for the purpose of ascertaining profits prior
to incorporation.

8. ABC limited was incorporated on 1.7.2005, which took over a running concern with
effect from 1.1.2005. The sales for the period up to 1.7.2005 was Rs. 2,70,000 and the
sales from 1.7.2005 to 30.12.2005 amounted to Rs. 3,30,000
The expenses debited to Profit and Loss account included
Rs.
Director fees 15,000
Bad debts 1,800
Advertisement ( Rs. 500 per month) 6,000
Salaries and General expenses 32,000
Preliminary expenses written off 3,000
Gross profit was 1.1.2005 to
31.12.2005 2,40,000
Ascertain the profit prior to incorporation

9. From the following particulars, ascertain Profit prior to and after incorporation.
(i) Time Ratio – 3: 5
(ii) Sales Ratio – 4: 6
(iii) Gross Profit – Rs. 10,00,000
Expenses debited to Profit and Loss account were
Rs.
Salaries 96,000
General Expenses 12,000
Discount on sales 40,000

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 Advertisement 50,000
Preliminary expenses 70,000
Rent and rates 15,000
Printing and Stationery 65,000

Income credited to Profit and Loss account were

Rent received 18,000
Interest received 50,000
10. A company was incorporate on 1st May 1984 to take over a business as a going
concern from 1st January of the same year. The turnover for the year ended 31 st
December was Rs. 2,00,000, namely Rs. 60,000 for the first period upto 1 st
May and Rs. 1,40,000 for the following period. From the profit and loss
account given below for the year ended 31 st December 1984, you are required
to ascertain profits prior to incorporation.
Rs. Rs.
To Rent & Rates 3,240 By Gross profit 70,000
To Insurance 720
To Lighting 2,040
To Salaries 7,800
To Director's fees 2,000
To Sales Discount 5,000
To Sales Commission 10,000
To General expenses 2,400
To Carriage outwards 3,000
To Bank charges 420
To Repairs 1,380
To Bad debts 600
To Loan interest 1,200
To Net profit 30,200
70,000 70,000

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