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Chapter 2

Chapter 2
Course

accounts (ACC098)

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KLE University

Academic year: 2021/2022
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Chapter 2 Profits Prior to Incorporation

It may happen in case of new companies that a running business is taken over from a certain date,

whereas the company may be incorporated at a later date. The company would be entitled to all profits

earned after the date of purchase of business unless the agreement with the vendors provides otherwise.

But profits up to the date of incorporation of the company have to be treated as capital profits because

these are the profits which have been earned even before the company came into existence. Such profits

are known as profits prior to incorporation. It should be remembered that a public company cannot

commence business till it receives the certificate of commencement of business.

Therefore, it would be prudent to treat all profits earned before commencement of business as capital

profits. However, strictly speaking, “Profit Prior to Incorporation” means only the profits earned up to

the date of incorporation and not up to the date of the certificate of commencement of business.

For correct allocation of profits, a profit and loss account should be prepared on the date of incorporation; but this would mean taking stock which is inconvenient. The usual practice, therefore, is to prepare the profit and loss account only at the end of the year and then to allocate the profit between the two periods—up to incorporation and after.

Ascertainment of Profit or Loss Prior to Incorporation

Following steps are taken for calculating the profit or loss prior to Incorporation :

1st Step : Make Trading Account of Whole Period

A Trading Account should be prepared at first for the whole period, i., between the date of purchase

and the date of final accounts, in order to calculate the amount of gross profit.

2nd Step : Calculate Time Ratio and Sale Ratio

(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., 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.

3rd Step : Make Profit and loss account prior and after incorporation in different Columns

a) Gross profit will divide on the basis of sale ratio

b) All expenses which are relating to sale will be divide on the basis of sale ratio

c) All fixed charges like salaries, rent, audit fees, insurance, depreciation, administrative expenses will

divide on the basis of time ratio. All expenses which done after incorporation will be charged totally to

after

incorporation.

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

(j) Travelling Expenses (General)

(k) Interest of Debenture

(l) General Expenses

(m) Expenses Fixed in Nature.

Problems on calculate of time ratio and sales ratio

  1. Calculate the sales ration from the following: X co. was incorporated on 1st May, 2011 and acquired a business with effect from 1st Jan, 2011. Total sales for the calendar year 2011 was 6,00,000. Sales for Jan and Feb is equal to one and ₹ half times the average monthly sales; Sales from March to July is equal to half of average monthly sale; Sales for August and Sep. is equal to one- fourth of average monthly sales and sales from Oct. to Dec. is equal to double the average monthly sales. Solution: a. Time Ratio:

Pre − IncorporatedPeriod 1.1¿

1.5¿= 4 Months

Post − Incorporated Period 1.5¿

31.12¿= 8 Months

Time ratio = 4 : 8 or 1: Total sales = 6,00, AverageSales =

6,00,

12

=50,

SalesRatio =2,00,000:4,00, 2 : 4 or 1 : 2

b. Sales ratio

Pre-Incorporation Sales ₹ Post-Incorporation sales ₹ January 50,000 × 1

1

2

75,

May 50,000 ×

1

2

25,

February 50,000 × 1

1

2

75,

June 50,000 ×

1

2

25,

March 50,000 ×

1

2

25,

July 50,000 ×

1

2

25,

April 50,000 ×

1

2

25,

August 50,000 ×

1

4

September 50,000 ×

1

4

October 50,000 × 2 November 50,000 × 2 December 50,000 × 2

12,

12,

1,00,

1,00,

1,00,

Total Pre-Incorporation Sales 2,00,000 Post-Incorporation Sales 4,00,

  1. Calculate the Sales Ratio from the following:

X Co. was incorporated on 1st May,2012 and acquired a business with effect from 1st Jan, 2012.

Total sales for the calendar year 2012 was 7,20,000. Sales for Jan and Feb is equal to ₹ 1

1

2

times the

average monthly sales; Sales from March to July is equal to half of average monthly sales; Sales for August and Sep. is equal to one- fourth of average monthly sales and Sales from Oct. to Dec. is equal to double the average monthly sales.

Solution:

a. Time Ratio: Pre − IncorporationPeriod 1.1¿

1.5¿= 4 Months

Post − IncorporartionPeriod 1.7¿

31.3¿= 9 Months

3 : 9 or 1 : 3

b. Sales Ratio: Pre-Incorporation Sales 1,00,000 Monthly ₹ Pre-Incorporation Period = 3 Months Pre-Incorporation Sales ₹ 1,00,000 × 3 =3,00, Post-Incorporation Sales 2,50,000₹ Post-Incorporation Period = 9 Months Post-Incorporation Period ₹ 2,50,000 × 9 =22,50, Sales Ratio = 3,00,000 : 22,50,000 or 6 : 45

c. Weighted Ratio: Pre-Incorporation Period 3 Months No of Workers in Pre-incorporation Period = 50 Pre-Incorporation Ratio 3 × 50 = 150 Post-Incorporation Period 9 Months No of Workers in Post-Incorporation Period = 70 Post-Incorporation Ratio 9 × 70 = 630 150:63015:63∨5: Statement of allocation of expenses between pre and post incorporation

Particulars Ratio Pre-Incorporation Post-Incorporation Rent 1 : 3 24,000 72, Salaries 5 : 21 60,000 2,52, Salesmen Commission

6 : 45 12,000 90,

Director’s fee Post - 25, Total 96,000 4,15,

  1. ABC Company Ltd. Was incorporated on 30 th June, 2011 to take over the business of Mohan as from 1st Jan,2011. The financial figures of the business for the year ended 31-12-2011 is as follows:

Particulars Amount Amount Sales; Jan to June July to Dec.

1,20,

1,80,000 3,00,

Less: Purchases Jan to June July to Dec.

75,

1,20,000 1,95,

Gross Profit 1,05,

Less Expenses: Salaries Selling Expenses Depreciation Director’s Remuneration Debentures Interest Administration Expenses

15,

3,

1,

750

90

4,500 24,

Net Profit 80,

You are required to prepare a statement showing pre-incorporation and post-incorporation period profits.

Solution: a. Time Ratio: Pre − IncorporationPeriod 1.1¿

30.6¿= 6 Months

Post − IncorporationPeriod 1.7¿

31.12¿= 6 Months

Time Ratio = 6 : 6 or 1 : 1 b. Sales Ratio: Pre-Incorporation Sales = 1,20, Post-Incorporation Sales = 1,80, Sales Ratio = 12 : 18 or 4 : 6 or 2 : 3

Statement showing profits for pre incorporation and post incorporation period for the year ending 31.

Particulars Ratio Pre-Incorporation Post-Incorporation Gross Profit 2 : 3 42,000 63, Total (A) 42,000 63, Expenses: Salaries 1 : 1 7,500 7, Selling Expenses 2 : 3 1,200 1, Depreciation 1 : 1 750 750 Director’s Remuneration Post - 750 Debentures interest Post - 750 Administration expenses 1 :1 2,250 2, Total (B) 11,700 13, Capital Reserves(A-B) 30,300 - Net Profit (A-B) - 49,

Statement Showing Pre and Post Incorporation profit for the year ended 31.

Particulars Ratio Pre-Incorporation Post-Incorporation Gross Profit 1 : 3 9,375 28, Total (A) 9,375 28, Expenses: Administration Expenses 1 : 3 2,250 6, Director’s Fee Post - 1, Selling Expenses 1 : 3 4,500 13, Audit fee 1 : 3 125 375 Preliminary Expenses Post - 1, Total (B) 6,875 23, Capital Reserves(A-B) 2,500 - Net Profit (A-B) - 4,

Note: Gross Profit arrived as follows Sales + ClosingStock (1,50,000)1,50,

¿ Gross Profit 37, Distribution between pre and post incorporation in the sales ratio of 1 : 3

  1. A company was incorporated on 30 th June which acquired a business as from 1 st Jan. the accounts for the year ended 31 st December disclosed the following: a. The gross profit was 2,40,000₹ b. The sales for the year amounted to 12,00,000₹ of which ₹5,40,000 were for 1st 6 Months. c. The expenses debited to P&L A/c included Director’s fees of 15,000₹ ; Bad Debt of 3,600₹ and Advertisement 12,000 (under a contract @ 1,000 p.);₹ ₹ Salaries and General Expenses ₹64,000; Preliminary Expenses written off 5,000₹ and Donation to a political party given by the company 5,000.₹

Prepare a statement showing the amount of profit made before and after incorporation.

Solution:

a. Time Ratio: Pre − IncorporationPeriod 1 Jan ¿

30 June ¿ 6 Months

Post − IncorporationPeriod 1 July ¿

31 december ¿ 6 Months

TimeRatio 6:6∨1:

b. Sales Ratio: Pre-Incorporation Sales = 5,40,000₹ Post-Incorporation Sales (12,00,000 – 5,40,000) = 6,60,000₹ 54 : 66 or 9 : 11

Statement Showing Pre and Post Incorporation profit for the year ended 31.

Particulars Ratio Pre-Incorporation Post-Incorporation Gross Profit 9:11or 54 : 66

1,08,000 1,32,

Total (A) 1,08,000 1,32, Expenses: Director’s fee Post - 15, Bad debts 9:11 1,620 1, Advertisement 1:1 6,000 6, Salary and General Expenses 1:1 32,000 32, Preliminary Expenses Post - 5, Donation (paid by Company) Post - 5,

Post − IncorporationPeriod 1.5¿

31.12¿ 8 Months

Time Ratio = 4 : 8 or 1 : 2

b. Sales Ratio: Pre-Incorporation sales = 3,00,000₹ Post-Incorporation sales = 7,00,000₹ Sales ratio = 3 : 7

Statement Showing Pre incorporation and Post incorporation period profit for the year ended 31.

Particulars Ratio Pre-Incorporation Post-Incorporation Gross Profit 3 : 7 93,000 2,17, Total (A) 93,000 2,17, Expenses: To Rent and Taxes To Insurance To Electricity Charges To Salaries To Director’s Fees To Auditor’s Fees To Commission To Advertisement To Office expenses To Carriage To Bank charges To Preliminary expenses To Bad Debts To Interest on loan

1:

1:

1:

1:

Post 1: 3: 3: 1: 3: 1: Post 3: 1:

8,

2,

1,

24,

-

1,

3,

2,

2,

1,

1,

-

1,

2,

16,

4,

3,

48,

6,

2,

8,

5,

4,

4,

2,

13,

2,

4,

Total (B) 51,000 1,24, Capital reserve (A-B) Net Profit (A-B)

42,

-

-

93,

  1. Naveen Enterprise Ltd., purchased from Praveen his business on 1-1-2011. But the company was incorporated on 1-4-2011. From the following information find out the profits earned by the company prior to and the after incorporation: a. For the year 2011 the total sales was 2,40,000₹ and the trend of sales was as follows:

Jan and Feb – half the average monthly sales; May, June and October – Average Sales for each month and Nov and Dec, - Half the average Sales for each month. b. COGS 60,000₹ c. Salary and other expenses 6,000₹ d. Bad debts 2,400₹ e. Interest on PC which was paid on 1-8-2011 2,100₹ and f. Expenses exclusively related to the company 8,900.₹

Solution:

a. Calculation of Time Ratio Pre − IncorporationPeriod 1.1¿

1.4¿ 3 Months

Post − IncorporationPeriod 1.4¿

31.12¿ 9 Months

Time ratio = 3: b. Sales Ratio: Augustmonthlysales =

2,40,

12

=20,

Pre-Incorporation Sales ₹ Post-Incorporation sales ₹

January 20,000 ×

1

2

10,000 May 20,000 × 1 20,

February 20,000 ×

1

2

10,000 June 20,000 × 1 20,

March 20,000 × 1

1

2

30,000 July 20,000 × 1 20,

April 20,000 × 1

1

2

30,

August 20,000 × 1

1

2

September 20,000 × 1

1

2

October 20,000 × 1 November 20,000 ×

1

2

December 20,000 ×

1

2

30,

30,

20,

10,

10,

Total Pre-Incorporation Sales 80,000 Post-Incorporation Sales 1,60,

Sales Ratio = 80,000 : 1,60,000 or 1 : 2 Sales for the months of March, April, August and September is arrived as follows:

Total sales (-) Sales as calculated except for above period

2,40,

1,20,

Remaining sales 1,20,

To depreciation To net profit

1,

13,

20,000 20,

It was found that of the bad debts written off 100 related to debts taken over by the company.₹ Calculate the pre and post Incorporation.

Solution: a. Calculation of Time Ratio: pre − Incorporationperiod 1.1¿

1.4¿= 3 months

Post − Incorporationperiod 1.4¿

31.12¿= 9 months

Time Ratio = 3:9 or 1:

b. Vendor Ratio:

pre − Incorporationperiod 1.1¿

1.4¿= 3 months

Post − Incorporationperiod 1.4¿

1.6¿= 2 months

Vendor Ratio = 3:

Statement showing Pre incorporation and Post incorporation profit for the period ended 31.

Particulars Ratio Pre-Incorporation Post-Incorporation Gross Profit 1:3 5,000 15, Total (A) 5,000 15, Expenses: Management expenses 1:3 1,000 2, Director’s fees Post - 1, Preliminary Expenses Post - 500 Bad debts Given 100 100 Intern to vendor 3:2 750 500 Depreciation 1:3 250 750 Total (B) 2,100 4, Capital Reserves(A-B) 2,900 - Net Profit (A-B) - 10,

  1. RKS Ltd., was incorporated on 1-9-2012 to take over the running business of M/s. SK and Co., with effect from 1-4-2012. The company closed its accounts on 31-3-2013.

Particulars Amount Particulars Amount

Gross profit Discount earned Interest on investments Salaries and wages Discount allowed Preliminary expenses written off General expenses Carriage outward Bad debts

24,00,

0

1,14,

1,20,

3,60,

2,16,

10,

24,

5,

3,

Interest to vendors (up to 31-1- 2013) Rent paid Selling expenses Director’s fees Auditor’s fees Depreciation Insurance Carriage inward Interest on debentures

60,

96,

54,

30,

24,

1,44,

12,

2,

24,

Additional Information: a) Average monthly purchase during the pre-incorporation period was 1,50,000₹ and the average monthly purchases during the post incorporation period was 3,00,000.₹ b) Average monthly sales during the pre-incorporation period was 2,00,000₹ and the average monthly sales during the post-incorporation period was 5,00,000₹. Prepare a statement showing the allocation of above items between pre and post incorporation periods and state how the pre and post incorporation profits and dealt with in the books of accounts.

Solution:

a. Time Ratio

Pre − Incorporationperiod 1.4¿

1.9¿= 5 months

Post − Incorporationperiod 1.9¿

31.3¿= 7 months

b. Sales Ratio

Pre-Incorporation Sales:

Average Monthly sales 2,00,

Pre-Incorporation Period 5 Months

Pre-Incorporation Sales = 2,00,000 X 5 = 10,00,

Post-Incorporation Sales:

Average Monthly sales 5,00,

Capital reserve (A-B) 2,46,333 -

  • Auditors fees 5:7 10,000 14,
  • Depreciation 5:7 60,00 84,
  • Insurance 5:7 5,000 7,
  • Internal on debentures Post - 24, - Total (B) 3,67,000 6,96,
    • Net Profit(A-B) - 13,24,
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Chapter 2

Course: accounts (ACC098)

12 Documents
Students shared 12 documents in this course

University: KLE University

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Chapter 2
Profits Prior to Incorporation
It may happen in case of new companies that a running business is taken over from a certain date,
whereas the company may be incorporated at a later date. The company would be entitled to all profits
earned after the date of purchase of business unless the agreement with the vendors provides otherwise.
But profits up to the date of incorporation of the company have to be treated as capital profits because
these are the profits which have been earned even before the company came into existence. Such profits
are known as profits prior to incorporation. It should be remembered that a public company cannot
commence business till it receives the certificate of commencement of business.
Therefore, it would be prudent to treat all profits earned before commencement of business as capital
profits. However, strictly speaking, “Profit Prior to Incorporation” means only the profits earned up to
the date of incorporation and not up to the date of the certificate of commencement of business.
For correct allocation of profits, a profit and loss account should be prepared on the date of
incorporation; but this would mean taking stock which is inconvenient. The usual practice, therefore, is
to prepare the profit and loss account only at the end of the year and then to allocate the profit between
the two periods—up to incorporation and after.
Ascertainment of Profit or Loss Prior to Incorporation
Following steps are taken for calculating the profit or loss prior to Incorporation :
1st Step : Make Trading Account of Whole Period
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.
2nd Step : Calculate Time Ratio and Sale Ratio
(i) Sales Ratio:
Amount of sales should be calculated for the pre-incorporation and post-incorporation periods.

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