Profit/ Loss Prior to
Incorporation
IPCC Paper 1: Accounting Chapter 3
CA. S.S. Prathap
Learning Objectives
Pre & Post Incorporation
Introduction
Typical Computation Problems
Accounting Treatment
Problem Solving Approach
Allocation Basis
Practical Exam Problems
Introduction
Company Incorporation Date
A company technically comes into
existence only from this Date
Hence, Accounts have to be prepared
from that date
General Practice/ Practical
Situations
Running Business
Already existing, commercial business is
taken over & Subsequently Incorporated
as a company.
3
Two Important Dates
Takeover Date
The earlier date is the day in which the business
is been taken over say 1st January 2012
Company Incorporation Date
The second date is the day in which the
business is Incorporated as a company say 1st
April 2012
Pre Incorporation Profits
Profits Earned between Jan 1 & March 31, 2012
4
Pre-Incorporation Profit/ Loss
Pre Incorporated Profits
Is of a Capital Nature and
Has to be transferred to a
special Account
Capital Reserve A/c
Pre Incorporation Losses
Treated as Goodwill
5
Problem Solving Approach
6
An Intro.
Approach to the Sums 3 Dates
Date 1: Business Started
The date from which the existing business is
taken over
Date II: Company Incorporated
The subsequent date of Incorporation .
Date III: Date of Accounts
The date on which the accounts have to be
drawn up .
Splitting Revenues & Expenses
Period 1:
Date of business till
date of Incorporation
Period II:
Date from date of
Incorporation till date of
Closing Balance Sheet
(closing of Accounts)
8
Splitting Revenues & Expenses
Revenue/ Sales
Split on the basis of the facts of
each question
Expenses
Time Basis
(Example: Rent)
or
Sales Basis
(Example: Advertisement)
9
Illustration 1: ABC Ltd.
10
ABC Ltd
ABC Ltd was incorporated on 1.5.2010 to take over
the business of DEF and Co. from 1.1.2010.
The summarised Profit and loss Account as given by
ABC Ltd. for the year ending 31.12.2010 is as under :
11
Summarised P & L A/C
Rs.
To Rent & tax
To Salaries including
Managers Sal Rs.85000
To Carriage outwards
To Printing and stationery
To Interest on Debentures
To Sales commission
To Bad debts(related to sales)
To Underwriting commission
To Preliminary expenses
To Audit fees
To Loss on Sale of Investments
To Net Profit
90,000 By Gross Profit
3,31,000 By Interest on
14,000 Investments
18,000
25,000
30,800
91,000
26,000
28,000
45,000
11,200
3,90,000
Rs.
10,64,000
36,000
12
ABC Sum (Contd....)
Prepare a statement showing allocation of Pre-incorporation
and Post incorporation profits after considering the
following information :
G.P ratio was constant throughout the year.
Sales for January and October were 11/2 times the
average monthly sales , while Sales for December were
twice the average monthly sales.
Bad debts are shown after adjusting a recovery of
Rs.7,000 of Bad Debts for a sale made in July, 2007.
Managers salary was increased by Rs. 2,000 p.m. From
1.5.2010.
13
All investments were sold in April, 2010.
ABC Ltd
Important Dates
Date 1: Business Purchased
Date II: Company Incorporated
Date III : Date of Accounts
1st Jan 2010
1st May2010
31st Dec 2010
Pre Incorporation Period
4 months
Post Incorporation Period
8 months
14
Calculation of Sales Ratio
The sales for Jan and Oct were 1 times the average monthly sales and for Dec
it is twice the average monthly sales.
Let the average monthly sales be x .
Pre-Incorporation
Post-Incorporation
January
1.5x
May
x
February
x
June
x
March
x
July
x
April
x
August
x
September
x
October
1.5x
November
x
December
2x
TOTAL :
4.5x
Sales Ratio :
9.5x
4.5x : 9.5x = 9 : 19
15
Working Notes
Allocation Based upon Pre and Post Incorporation periods
Ratio of Sales 9 : 19
Typical Items: Gross Profit, Carriage Outwards, Sales Commission
and Bad Debts Written-off
Time Basis Allocation
Rent, Salaries, Printing and Stationery, Audit Fees
Post Incorporation Period Expenses
Interest on Debentures, Underwriting Commission and Preliminary
Expenses
Pre Incorporation Period Expenses
Interest on Investments, Loss on Sale of Investments and Bad debt
recovery(related to July 2007)
16
Gross Profit
Total = 10,64,000
It is apportioned on the basis of Sales ratio ( 9 : 19 )
10,64,000
Pre-Incorporation
10,64,000 * 9/28
=3,42,000
Post-Incorporation
10,64,000 * 19/28
= 7,22,000
17
Rent and Taxes
It should be apportioned on the basis of TIME.
(4 months : 8 months)
Total Rent
90,000
Pre Incorporation
Post Incorporation
90,000 * 4/12
= 30,000
90,000 * 8/12
= 60,000
18
Managers Salary
Total
85,000
His salary was increased from 1st May, 2010 by 2000 per month ,
2,000 * 8 months
16,000 relates to Post Incorporation
Total Salary
85,000
Post Incorp Salary
16,000
So , the position now is ,
()
69,000
Time basis
Pre Incorporation
Post Incorporation
23,000
Adding the total managers salary (Post)
4m : 8m = 1:2
46,000
=
16,000 + 46,000
62,000
The final division of 85,000 is ,
19
Pre Incorporation
23,000
Post Incorporation
62,000
Other Salaries
From the total salaries given excluding
Managers Salary , we have the other Salaries as ,
3,31,000
- (85,000)
2,46,000
Time basis
4m : 8m = 1: 2
2,46,000 * 1 / 3
= 82,000
Pre Incorporation
Post Incorporation
2,46,000 * 2 / 3
= 1,64,000
=
=
82,000
1,64,000
20
Working Note
Printing & Stationery :
It is apportioned on TIME basis ( 1 : 2 )
Total
=
18,000
6,000(pre)
12,000 (post)
Auditors Fee :
It is also apportioned on TIME basis (1 : 2)
Total
=
45,000
21
15,000 (pre)
30,000(post)
Carriage Outwards
Total =
14,000
It is apportioned on the basis of Sales ratio ( 9 : 19 )
14,000
Pre-Incorporation
14,000 * 9/28
= 4,500
Post-Incorporation
14,000 * 19/28
= 9,500
22
Sales Commission
Total =
30,800
It is apportioned on the basis of Sales ratio ( 9 : 19 )
30,800
Pre-Incorporation
30,800 * 9/28
= 9,900
Post-Incorporation
30,800 * 19/28
= 20,900
23
Bad Debts
However , it is after adjusting a recovery of Rs.7,000 Bad
Debts for a sale made in July 2007 . This is a wrong
treatment , so Bad Debts have to be taken
91,000 + 7,000 = 98,000
Sales basis
31,500
9 : 19
66,500
And the Bad Debts recovered of Rs.7,000 will
be credited to Pre- Incorporation Period
24
Working Note
100 % Post Incorporation Expenses :
Interest on Debentures :
Total =
25,000
Underwriting expenses :
Total
Preliminary Expenses:
Total =
28,000
26,000
25
Loss on sale of investment
Total =
11,200
As Investment was sold in April
2010 , it is 100 % Pre Incorporation loss , also the
Interest on Investment received 36,000 is credited to
Pre Incorporation period .
26
Summarised statement of P & L year
ended 31.12.2010
Pre
Post
Incorp
Incorp
(4 months) (8 months)
To rent & tax
To Salaries
Managers Salary
Other Salaries
To Printing and
stationery
To Audit fees
To carriage
outwards
To Sales
commission
To Bad debts
To interest on
debentures
30,000
23,000
82,000
6,000
15,000
60,000 By Gross Profit
By Interest
62,000 on Investments
1,64,000 By Bad debts
recovery
12,000
30,000
4,500
9,500
9,900
31,500
20,900
66,500
PrePost
Incorp
Incorp
(4 months) (8 months)
3,42,000
7,22,000
36,000
7,000
27
25,000
Summarised statement of P & L year ended
31.12.2010
Pre
Post
Incorp
Incorp
(4 months) (8 months)
To Underwriting
commission
26,000
To Preliminary
expenses
28,000
To Loss on sale of
investments
11,200
To Net Profit
1,71,900
2,18,100
TOTAL
3,85,000
7,22,000
PrePost
Incorp
Incorp
(4 months) (8 months)
TOTAL
3,85,000
28
7,22,000
Result
Allocation of Pre-Incorporation & Post-Incorporation
profits after considering all information given is
apportioned finally as ,
Pre Incorporation :
Post Incorporation :
Rs.1,71,900
Rs.2,18,100
29
Illustration 2: Alag Sum
30
November,2011 (6 Marks)
Alag Sum
A firm M/s Alag, which was carrying on business from 1st July,2011
gets itself Incorporated as a Company on 1st November,2011.
The first accounts are drawn up to 31st March 2012.
Gross Profit for the period :
Rs.56,000.
General Expenses
:
Rs.14,220.
Directors fee
:
Rs.12,000 p.a.
Incorporation expenses
:
Rs.1,500.
Rent up to 31st December was Rs.1,200 p.a. after which it is
increased to Rs.3,000 p.a.
Salary of the manager, who upon incorporation of the company was
made a director, is Rs.6,000 p.a.
His remuneration thereafter is included in the above figure of fees to
31
the Directors.
Alag Sum (contd....)
Give Profit or Loss account showing Pre and Post
Incorporation profit .
The Net sales are Rs.8,20,000, the monthly average of
which for the first four months is one-half of that of the
remaining period.
The Company earned a uniform profit.
Interest and tax may be ignored.
32
Alag Sum - Solution
Important Dates
Date 1 : Business started
Date II : Company Incorporated
Date III : Date of Accounts
1st July 2011
1st Nov 2011
31st Mar 2012
Gross Profits on Sales Ratio
Between Pre and Post Incorporation period, based
From 1st July 2011 till 31th October 2011 (4 months) and
From 1st November till 31st March 2012.(5 months)
Post Incorporation Period Expenses
Directors Fees, Formation Expenses will go 100 %
These expenses relate totally to the newly formed company
Actual Basis or Time Proportionate Basis
Rest of the expenses will be split as incurred
33
Working Notes: Calculation of sales ratio
Let the average monthly sales of first four months be
x , then the next five months will be 2x .
Total sales of first four months = 4 * x = 4x
Total sales of next five months = 5 * 2x = 10x
The ratio of sales is given as
= 4x : 10x
= 2 : 5
34
Working Notes: Calculation of Rent
Till 31st December, rent was Rs.1,200p.a.
(i.e.,) Rs.100 per month. Therefore
Pre Incorporation rent
=
=
Post Incorporation rent =
=
Rs.100* 4 months
Rs.400
Rs.100 *2 months
+ Rs.250* 3 months
Rs. 950
35
Gross Profit
It should be apportioned on the basis of Sales Ratio( 2:5 )
Total =
56,000 * 2/7
= 16,000
56,000
56,000 * 5/7
=40,000
36
General Expenses
It should be apportioned on the basis of TIME ( 4:5 )
Total =
14,220
14,220 * 4/9
= 6,320 (pre)
14,220 * 4/9
= 7,900(post)
37
Working notes
Directors fee :
100 % post Incorporation expense.
Total =
5,000
Formation Expense :
It is the other name of Incorporation Expense.
It is also 100% post Incorporation expense.
Total =
1,500
38
Managers salary
Salary of the manager, who upon incorporation of
the company was made a director, is Rs.6,000 p.a.
His remuneration thereafter is included in the figure
of fees to the Directors.
6,000 * 4 / 12
Rs. 2,000
39
Profit & Loss A/c for 9 months ended
on 31.03.2012
Particulars
To General
Expenses
To Directors
fee
To Formation
expenses
To Rent
(600+750)
To Managers
salary
To Net Profit
Transferred to
Capital
Reserve
P&L
Appr a/c
TOTAL
Pre
Incorp
Post
Incorp
Total
Particu Pre
lars
Incorp
6,320
7,900
5,000
1,500
1,500
400
950
1,350
2,000
2,000
14,220 By
Gross
5,000 Profit
16,000
Post Incorp
40,000
total
56,000
31,930
7280
-
24,650
16,000
40,000
56,000
40
16,000
40,000
56,000
Result
The profits of 7,280 which are
Pre Incorporation profits have to be transferred to
Capital Reserve .
&
Post - Incorporation profits
Rs.24,680 transferred to P&L Account of Alag Ltd.
41
Illustration 3: Rama Sum
42
November, 2009 (6 Marks)
Rama Sum
Rama Udyog Ltd was incorporated
on August 1, 2011.
It had acquired a running business of
Rama & Co. With effect from April 1, 2011.
During the year 2011 2012,
the total sales were Rs. 36,00,000.
The net profit of the company, Rs.2,00,000
was worked out after charging the
following expenses:
43
Rama Sum (contd....)
I.
II.
III.
IV.
V.
VI.
VII.
Depreciation
Audit Fee
Directors fee
Preliminary expenses
Office expenses
Selling expenses
Interest to vendors
upto Aug 31,2011
Rs.1,08,000
Rs.15,000
Rs. 50,000
Rs. 12,000
Rs. 78,000
Rs. 72,000
Rs. 5,000.
Ascertain pre-incorporation and post incorporation
profit for the year ended 31st March, 2012.
44
Problem Statement Rama Sum
Important Dates
Business Purchased
1st Apr 2011
Company
Incorporated
Date of Accounts
31st Mar 2012
1st Aug 2011
Pre & Post Incorporation Periods
Pre Incorporation Period
Post Incorporation period
4 months
8 months
45
Working Notes: Calculation of Sales Ratio
The sales per month in the first half year were half of what they
were in the later half year.
Let the sales per month in the later half be 2x , then the sales
per month will be x .
Pre-Incorporation
Post-Incorporation
April
x
August
x
May
x
September
x
June
x
October
2x
July
x
November
2x
December
2x
January
2x
February
2x
March
2x
TOTAL :
4x
Sales Ratio :
4x : 14x = 2 : 7
14x
46
Working Notes: Time Ratio
Pre Incorporation Period
1st April, 2011 to 31st July, 2011(Pre)
4 Months
Post Incorporation Period
1st August, 2011 to 31st March, 2012 (Post)
8 Months
Hence Ratio:
4 Months : 8 Months
Time Ratio is 1 : 2
47
Working Notes: Gross Profit
Gross Profit = Net Profit + All Expenses
=
Rs.2,00,000 + (Rs.1,08,000 +15,000
+50,000 +12,000+78,000+72,000+5,000)
Rs,2,00,000
Rs.5,40,000
Rs.3,40,000
48
Gross Profit
It is apportioned on the basis of sales ratio .( 2 : 7 )
5,40,000
Pre Incorporation
5,40,000 * 2/9
= 1,20,000
Post Incorporation
5,40,000 * 7/9
= 4,20,000
49
Depreciation
Time basis allocation :
It is apportioned on time basis. ( 1 : 2 )
1,08,000
Pre Incorporation
1,08,000* 1/3
= 36,000
Post Incorporation
1,08,000* 2/3
= 72,000
50
Audit Fee
Time basis allocation :
It is apportioned on time basis. ( 1 : 2 )
15,000
Pre Incorporation
15,000* 1/3
= 5,000
Post Incorporation
15,000* 2/3
= 10,000
51
Working notes
Directors Fee :
It is 100% post Incorporation expense.
Total
=
50,000
Preliminary expense :
It is also 100% post Incorporation expense.
Total
=
12,000
52
Office Expense
It is apportioned on the basis of Time. (1 : 2 )
78,000
Pre Incorporation
78,000 * 1/3
= 26,000
Post Incorporation
78,000 * 2/3
= 52,000
53
Selling Expense
It is apportioned on the basis of Sale. (2:7 )
72,000
Pre Incorporation
72,000 * 2/9
= 16,000
Post Incorporation
72,000 * 7/9
= 56,000
54
Interest to vendors
5 months
Pre-Incorporation period
Post-Incorporation period
=
=
4 months
1 month
(1 Aug to 31 Aug)
5,000
Pre Incorporation
5,000 * 4/5
= 4,000
Post Incorporation
5,000 * 1/5
= 1,000
55
Pre and Post Incorporation Profit
year ended 31.03.2012
Particulars
Gross Profit
Less :
Depreciation
Audit Fee
Directors fee
Prelim. Exp
Office Exp
Selling Exp
Interest to
vendors
Net Profit
Total
Basis of
Pre
amount Allocation
Incorp
5,40,000
2 : 7 1,20,000
Post Incorp
4,20,000
36,000
5000
1,08,000
15,000
50,000
12,000
78,000
72,000
1:2
1:2
post
post
1:2
2:7
26,000
16000
72,000
10,000
50,000
12,000
52,000
56,000
5,000
Actual
4000
1,000
2,00,000
33,000
1,67,000
56
Lesson Summary
First pay attention to the dates
(i.e.) Date of taking over of business
Incorporation Date
The date of Accounts
All revenues and expenses connected to sales
have to be apportioned in the sales ratio , which will
depend upon facts of each sum.
57
Summary (contd)
All expenses connected to a company have 100 %
Post- Incorporation
Example : Directors fee , Underwriting
Commission , Incorporation Expenses ( Preliminary
expenses ).
All other expenses will be apportioned on Time
Basis.
The profits before Incorporation are capital in
nature & have to be transferred to a special A/c
called Capital Reserve A/c.
58
Thank You
59
Hope you have a better understanding of this topic
and it helps you in qualifying this paper with flying
colors.
