Profit Prior to Incorporation

BY NEHA GUPTA

(c) Neha Gupta, AGBS Mohali'

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.
(c) Neha Gupta, AGBS Mohali'

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.

(c) Neha Gupta, AGBS Mohali'

NATURE OF PROFIT PRIOR TO

INCORPORATION
(c) Neha Gupta, AGBS Mohali'

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.
(c) Neha Gupta, AGBS Mohali'

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.

(c) Neha Gupta, AGBS Mohali'

ASCERTAINMENT
OF
PROFIT OR LOSS

(c) Neha Gupta, AGBS Mohali'

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.

(c) Neha Gupta, AGBS Mohali'

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.

(c) Neha Gupta, AGBS Mohali'

EXAMPLE
Sales

from date of purchase to date of

incorporation is Rs 50000
Sales from date of incorporation to date
of balance sheet is Rs. 80000
Then sales ratio = sale in incorporation
period : ratio to post incorporation

= 50000:80000

i.e
=
5:8

(c) Neha Gupta, AGBS Mohali'

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.
(c) Neha Gupta, AGBS Mohali'

Time

ratio: time(pre incorporation

period)
:(post
incorporation period)
1.1.01 to 1.4.01: 1.4.01 to 31.12.01
3 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.
(c) Neha Gupta, AGBS Mohali'

EXAMPLE:
A

co. incorporated on 1st Jan,01

purchased a business running from
1.10.00 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

(c) Neha Gupta, AGBS Mohali'

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.
(c) Neha Gupta, AGBS Mohali'

EXPENSES CONNECTED WITH

SALES ARE :
discount on sales , commission on
(c) Neha Gupta, AGBS Mohali'

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 directors fees, debenture interest,
goodwill written off, provisions, preliminary
expenses etc.
(c) Neha Gupta, AGBS Mohali'

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:
(c) Neha Gupta, AGBS Mohali'

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.

(c) Neha Gupta, AGBS Mohali'

ILLUSTRATION
(c) Neha Gupta, AGBS Mohali'

Date

of incorporation is 1st may,2001

Purchase consideration is Rs. 5000000
of which Rs 1000000 was to be paid in
cash n 4000000 in the form of fully paid
shares.
Co. also issued shares for Rs. 4000000
for cash.
Machinery costing Rs 2500000 was
installed. Assets acquired from vendors
were :- machinery Rs. 300000, stock
Rs. 600000, patent Rs. 400000.
(c) Neha Gupta, AGBS Mohali'

Sales

during the year, 18000000

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 1000000.
Depreciation Rs 540000, audit fees Rs.
60000, preliminary expenses Rs 10000,
office expenses Rs 240000, selling
expenses Rs 198000, interest to vendors
up to 31st may,2001 Rs 50000.
Closing stock Rs. 700000. Prepare balance
sheet of the company as an 31st
December 2001.
(c) Neha Gupta, AGBS Mohali'


CALCULATION
TIME RATIO:
(D.O.P to D. O. I ):

OF RATIOS
(D.O.I to D.
O.Balance

sheet)
1.1.01- 1.5.01 :
1.5.01- 31.12.01
4 month
:
8 month
Time ratio 1 : 2
SALES RATIO:
100X2 + 200X6
200 + 1200 = 1400
Sales ratio 400 : 1400 = 2 : 7
(c) Neha Gupta, AGBS Mohali'

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..

(c) Neha Gupta, AGBS Mohali'

Net

profit = gross profit- indirect

expenses

OR
Gross profit= net profit+ indirect
expenses

CALCULATION
OF
GROSS PROFIT

(c) Neha Gupta, AGBS Mohali'

PARTICULARS
AMOUNT
Net profit
ADD: Depreciation
540000
audit fees
26000
directors fee
60000
Preliminary
240000
expenses
Office expenses
selling expenses

198000

Interest to vendor
Gross profit

50000

TOTAL
1000000

2124000
(c) Neha Gupta, AGBS Mohali'

Adarsh udhyog Ltd

profit and loss for the year ending
31st march 2001
(c) Neha Gupta, AGBS Mohali'

To deprecia
To audit f

PRE I

POST I

180000
8667

360000
17333

To dire;s f

60000

To prelim
exp(post)

10000

80000
44000

160000
154000

To Off exp
To selling e

To interest to 40000
vendor (4 : 1)
To capital
reserve

119333(ba
l. Fig)

To net profit

Total

PRE I

POST I

By sales 472000

1652000

10000
880667(b
al. Fig)

472000

1652000

(c) Neha Gupta, AGBS Mohali'

472000

165200

BALANCESHEET
AS ON 31ST DECEMBER, 2001
(c) Neha Gupta, AGBS Mohali'

LIABILITIES

AMOUNT

ASSETS

AMOUNT

SHARE
CAPITAL(4000000
+4000000)

8000000

GOODWILL(500
0000-3000000600000-400000)

1000000

CAPITAL
RESERVE

119333

PATENTS

400000

MACHINERY
5500000540000(DEPR)

496000

CLOSING
STOCK

600000

OTHER ASSETS

1940000

PROFIT AND
LOSS ACCOUNT

TOTAL

880667

9000000

TOTAL

(c) Neha Gupta, AGBS Mohali'

9000000

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.

(c) Neha Gupta, AGBS Mohali'