PROFIT PRIOR TO THE INCORPORATION

As has been discussed earlier (Section 14.6) the acquisition of business usually
commences from the beginning of the accounting year of the business. But, the
incorporation of the company which takes over the said business may not commence
on the same date. It may be much later. Hence, the profit of such business has to be
divided into two parts: (1) Profits from the date of the beginning of the accounting year
of the business up to the date of incorporation of the company, and (2) Profits from the
date of incorporation of the company up to the closing of the accounting year of the
business. The former is known as 'profits prior to Incorporation' and the latter as
'Profits after Incorporation'.

The whole amount of profits belongs to the company, But since legally it cannot do
any business before its incorporation, the profits earned by the company for the period
falling before the date of incorporation is regarded as capital profit and is transferred
to Capital Reserve. This amount can be utilized only for writing off the losses of capital
nature. They are not available for declaring dividend to shareholders. Thus you can
appreciate the need to calculate the profits prior to incorporation.

If the company could prepare the final accounts separately for the two periods, there
will be no problems in ascertaining the profits prior to incorporation. But, it is neither
convenient nor economical to prepare the final accounts twice. Hence, the company
prepares its final accounts in the usual manners at the end of accounting year, work
out its profits for the whole year and then divide them into two periods on some
appropriate basis. Thus the whole problem of ascertaining the profits prior to
incorporation relates to the Choice of appropriate basis which can be used for dividing
the whole year's profits into two parts. For this purpose we divide first the gross profit
on the basis of sales during the two periods.

For example, if the gross profit for the year works out at Rs. 105000 and we find that
sales during the pre-incorporation and post-incorporation periods were Rs. 6, 00,000
and Rs. 15, 00,000 respectively. The gross profit can be divided in the ratio of 2:5.
This means that the gross profit for pre-incorporation period is Rs. 30,000 and for the
post-incorporation' period Rs. 75,000. Then we 'divide the indirect expenses between
the two periods on some rational basis, taking each item of expense separately.
Certain expenses like advertising, travelling expenses, etc. are related to sales, they
can be divided in this sales ratio. Similarly certain expenses like rent, salaries etc. are
related to time, they can be divided in the time ratio. Then there are some expenses
which may be related purely to pre-incorporation period or to post -incorporation
period. These will have to be charged accordingly. Thus we can adopt the following
bases f r dividing various expenses between the two periods.

 Expenses related to sales should be divided in the ratio of sales. These are:
carriage or cartage outward, cartage or carriage on sales, selling expenses,
commission to selling agents or travelling agents, advertisement expenses,
discount allowed, bad debts (if actual bad debts for the two periods are not
given), etc.
 Expenses of a fixed nature are related to time and should be charged according
to time ratio. These are: rent and rates, salaries, office expenses. General
charges, printing and stationery, depreciation, sundry or miscellaneous
expenses, postage and telegrams, telephone charges, etc.
 Expenses relating to pre-incorporation period should be charged to pre
-incorporation period such as partners' salaries. '
 Expenses that are solely for the company should be charged to post-
incorporation period such as interest on debenture directors' fees, managing
director's remuneration, share issue expenses, preliminary expenses, etc. ,
 Audit fee or auditor's remuneration can be charged on the basis of time or to
the post incorporation period only.
 Interest to vendors shall be charged on the basis of time falling in the two
periods but this time ratio will be quite different from the usual time ratio
because the date of payment may be earlier than the close of the accounting
year.
 To calculate the profits for the two periods a columnar Profit and Loss Account
with two amount columns on each side, one for pre -incorporation and the
other for post -incorporation period is prepared. The pre-incorporation profit is
transferred to Profit prior to Incorporation Account and the post -incorporation
profit is transferred to Profit & Loss Appropriation Account.
 Time Ratio = Date of Purchase to Date of Incorporation (Pre) : Date of
Incorporation to Date of Final Accounting (Post)
 Sale Ratio – Sale from Date of Purchase to Date of Incorporation (Pre) : Sale
from Date of Incorporation to Date of Final Accounting (Post)