PROFIT OR LOSS PRIOR TO INCORPORATION

1. PROFIT OR LOSS PRIOR TO INCORPORATION

2. INTRODUCTION In many cases, a new company is formed exclusively to acquire an existing business unit and take it over as a going concern, from a date prior to incorporation. In such cases, the business unit is purchased first and then the registration of the acquiring company takes place later. FOR EXAMPLE- Sarvottam pvt. Ltd. Is incorporated on 1st APRIL, 2017 to takeover the running business of Uttam Bros. from 1st January 2017 to 1st April 2017 is called profit (loss) prior to incorporation. Legally ,this profit is not available for distribution as dividend, since a company cannot earn profit before it comes into existence. However, profit earned after incorporation is available for distribution as dividend.

3. Profit earned before incorporation is a capital profit and profit earned after incorporation is a revenue profit. After incorporation, a public limited company is required to obtain a certificate of commencement business. Here, the question may arise as to whether the pre acquisition profit to be calculated based on the date of incorporation or date of obtaining certificate of commencement? It is a common practice that the date of incorporation should be taken as the basis for calculation of pre acquisition profit since obtaining a certificate of commencement of business is purely a legal formality. The accounting treatment of pre incorporation profit (or loss) is totally different from post incorporation profit (or loss). Thus, it is necessary to compute both the amount of pre and post incorporation profit (loss).

4. 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.

5. METHODS OF COMPUTING PROFIT PRIOR TO INCORPORATION FIRST METHOD Under this method, a separate profit and loss account is prepared for the pre incorporation period as distinguished from profit and loss account for post incorporation period. On the incorporation date, stock is taken, a final account is prepared, and the old books of accounts are closed. This method of profit determination, through simple and accurate, is inconvenient and expensive because the business activities have to be suspended for a few days for stock taking. For the above reasons, this method is not generally followed in practice. In the books of the new company, acquisition entries are passed on the same date after taking into consideration the assets and liabilities on the date of incorporation, which thus would include the results up to that date.

6. The entries are : Land and building a/c dr. At the value Plant and machinery a/c dr. On the date Sundry debtors a/c dr. Of Stock account dr. incorporation Cash at bank dr. Cash in hand dr. To Liabilities account At the value on To vendors account the date of incorporation purchase consideration

7. Vendors account Dr. To Equity share capital account SECOND METHOD Under this method profit is calculated as follows : STEP 1 : Prepare a trading account for the entire period ( pre and post incorporation periods combined ). STEP 2 : Allocate gross profit and expenses (indirect) Between pre and post incorporation period on the basis of following principles: Gross profit is allocated in the ratio of sales of each period. Fixed portion of an expense is allocated on the basis of time.

8. Expenses related to sales, e.g., Traveler's commission ,discount allowed, advertisement, salaries of salesman, carriage outward, after sales service cost etc are allocated on the basis of sales. Expenses related to time e.g. rent, rates and taxes, insurance, depreciation, salaries of general staff , etc are allocated on the basis of time. Expenses which are exclusively related to pre or post incorporation period must be charged entirely to that period’s profit. Some examples are : Preliminary expenses, director’s fees, debenture interest, etc are to be charged against post-incorporation profit. Partner ‘s salaries, interest on partners’ capital, etc are to be charged against the profit of pre incorporation period.

9. List of Expenses: Allocated on the basis of  Allocated on the basis of Time: Sales/Turnover: • Gross Profit • Selling Expenses • Advertisement expenses • Carriage Outwards • Discount Allowed • Salesmen’s Salaries • Commission to Salesmen • Promotion Expenses for Sales • Variable Distributions Expenses • Free Samples given • Expenses incurred for After- Sale Service, etc. • Delivery Expenses. • Bad debts • Office and Administration Expenses • Salaries to Office Staff • Rent, Rates and Taxes • Depreciation • Printing and Stationery • Insurance • Audit Fees • Miscellaneous Expenses • Distribution Expenses (Fixed) • Travelling Expenses (General) • General Expenses • Expenses Fixed in Nature. • Interest on purchase consideration

10. Calculate time ratio Calculate time ratio by taking into consideration the time falling from the date of purchase of business to the date of incorporation and The period between the date of incorporation to the last date of preparing final accounts Example (time ratio) - Z ltd. Is incorporated on 1st April 2017 to take over the existing business of M/s X & Y from 1st January 2017. Z ltd. Prepares its first accounts as on 31st December 2017. The ratio would be calculated as under: Time ratio = Time falling from date Time falling from of purchase of business : the date of incorporation to to the date of incorporation the last date of presenting final accounts

11. From 1st january2017to : from 1st April 2017 1st April 2017 to 31st December 2017 (3 months) : (9months) thus time ratio is 1 : 3 Calculate Sales ratio Sales ratio may be calculated as under: sales ratio = Sales of pre-incorporated period : sales of post-incorporated period Suppose the sales of pre-incorporation period is Rs. 50,000 and that of post-incorporation period is Rs. 2,00,000. Then sales ratio will be 1:4. Step 3 : Net profit/ loss of respective periods are calculated after deducting apportioned expenses and acquisition entries are passed at the end of accounting year.

12. Accounting treatment of pre incorporation profit/loss PROFIT PRIOR TO INCORPORATION Any profit prior to incorporation may be dealt with as follows: Credited to Capital Reserve Account Credited to goodwill account to reduce the amount of goodwill arising from acquisition of business. Utilized to write down the value of fixed assets acquired. LOSS PRIOR TO INCORPORATION Any loss prior to incorporation may be dealt with as follows: Debited to goodwill account Debited to capital Reserve Account arising from acquisition of business Debited to a suspense Account, which can be written off later as a fictitious asset.

13. Accounting Treatment Of Post Incorporation Profit/Loss Any profit/loss after incorporation is transferred to profit and loss appropriation account. Post incorporation profit can be distributed as dividend.