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CHAPTER - PROFIT PRIOR TO INCORPORATION

A newly incorporated company may take over a running business as from a certain date which is prior to the date of
incorporation. Thus company incorporated on 1st April, 2008 may take over the business of a partnership as from 1st
January, 2008. If the business is to be purchased from the date of incorporation, stock taking must be completed and
the balances of various assets and liabilities must be extracted, if this date does not coincide with the end of the
financial year for which the partnership has prepared its last final accounts. To avoid all this trouble, the business is
conveniently purchased from the date of last balance sheet. In order to calculate profit or loss prior to incorporation
date, the following steps are recommended:
(a) Prepare one trading account for the whole period falling between the date of purchase and date of final
accounts. The date of incorporation does not affect the calculation of gross profit.

(b) Calculate the following two ratios;

i. Time Ratio. This is calculated by considering the period falling between the last date of balance
sheet and the date of incorporation and the period between the date of incorporation and the
date of present final accounts.
ii. Sales Ratio. Ascertain sales for the pre-incorporation and post-incorporation periods and
calculate the sales ratio.
(c) Now prepare a statement for calculating the net profits for pre and post-incorporation periods separately.
This is done as follows:

i. Divide the gross profit of the full period into two parts on the basis of sales ratio. This gives gross
profit separately for pre- and post incorporation periods.
ii. Divide all expenses of fixed nature, viz., rent, salary, depreciation, interest in time ratio and other
expenses in sales ratio.
iii. There are certain expenses, i.e., salary of partners, salary of directors, preliminary expenses which
are not divided because they belong exclusively to a certain period. In the above cases the salary
of partners is debited to the pre-incorporation period and preliminary expenses and directors'
salary to the post-incorporation period.

Question:1 Ganesh Ltd. was incorporated on 1st August 1999. It took over the business of M/s Shanker and Siva
with effect from 1st April 1999. From the following figures relating to the year ending 31st March 2000 ascertain
profit prior to incorporation and profit after incorporation.

i. Sales for the year were Rs. 60, 00,000 out of which sales up to 1st August 1999 were Rs. 25, 00,000.
ii. Gross profit for the year was Rs. 18, 00,000.
iii. The expenses debited to profit and loss account were as follows:
Rent 90,000
Salaries 1,50,000
Directors fees 38,000
Interest of debentures 60,000
Audit fees 15,000
Discount on sales 36,000
Depreciation 2,40,000
General expenses 48,000
Advertising 1,80,000
Stationery and printing 36,000
Commission on sales 60,000
Interests to vendors on purchase consideration 30,000
Up to 1st October 1999
Bad debts 15,000
(Rs. 5,000 of bad debts mentioned above relate to debts created prior to incorporation.)
Question:2. A company incorporated on 1st April, 2000 took over a running business from 1st January, 2000. The
company prepared its first final accounts on 31st December, 2000. From the following information, you are required
to calculate the sales ratio of pre and post-incorporation periods:

(a) Sales from January 2000—December, 2000 Rs. 3,60,000, (b) Sales for the month of January twice the average
sales; for the month of February—equal to average sale; sales for four months from May to August—1/4th of the
average sale of each month; and sales for October and November three times the average sale.

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Question:3 New Ventures Ltd. was incorporated on 1st January, 2000 with an authorized capital consisting of 5,000
equity shares of Rs. 10 each to take over the running business of Rundown Brothers as from 1st October, 1999. The
following is the summarized profit and loss account for the year ended 30th September, 2000:

Rs. Rs.
Cost of sales for the year 16,000 Sales
Administration expenses 1,768 1st October, 1999 to
Selling commission 875 31st Dec, 1999 6,000
Goodwill written off 200 1st January, 2000 to
Interest paid to vendors (Loan 30th Sept., 2000 19,000 25,000
repaid on 1st February 373
Distribution expenses (60 per
cent variable) 1,250
Preliminary expenses written off 330
Debenture interest 320
Depreciation 444
Directors' fees 100
Net profit 3,340
25,000 25,000
The company deals in one type of product. The unit cost of sales was reduced by 10 per cent in the post-
incorporation period as compared to the pre-incorporation period in the year. You are required to apportion the net
profit amount between pre-incorporation and post-incorporation periods showing the basis of apportionment.

Question: 4 The partners of Maitri Agencies decided to convert the partnership into a private limited company called
MA (P) Ltd. with effect from 1st January, 2007. The consideration was agreed at Rs. 1,17,00,000 based on the firm's
Balance Sheet as at 31st December, 2006. However due to some procedural difficulties, the company could be
incorporated only on 1st April, 2007. Meanwhile the business was continued on behalf of the company and the
consideration was settled on that day with interest at 12% per annum. The same books of accounts were continued by the
company which closed its account for the first time on 31st March, 2008 and prepared the following summarized profit
and loss account.

Sales 2,34,00,000

Cost of goods sold: 1,63,80,000

Salaries 11,70,000

Depreciation 1,80,000

Advertisement 7,02,000

Discounts 11,70,000

Managing Director's remuneration 90,000

Miscellaneous office expenses 1,20,000

Office-cum-show room rent 7,20,000

Interest 9,51,000

2,14,83,000

Profit 19,17,000

The company's only borrowing was a loan of Rs. 50,00,000 at 12% p.a. to pay the purchase consideration due to the
firm and for working capital requirements.

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The company was able to double the average monthly sales of the firm, from 1st April, 2007 but the salaries trebled
from that date. It had to occupy additional space from 1st July, 2007 for which rent was Rs. 30,000 per month.

Prepare a profit and loss account in a columnar form apportioning cost and revenue between ore-incorporation and
post-incorporation periods. Also, suggest how the pre-incorporation Profits are to be dealt with.

Question:5 ABC Ltd. was incorporated on 1.5.2006 to take over the business of DEF and Co. from 1.1.2006. The
Profit and Loss Account as given by ABC Ltd. for the year ending 31.12.2005 is as under:

Profit and Loss Account

To Rent and Taxes 90,000 By Gross Profit 10,64,000

To Salaries including manager's 3,31,000 By Interest on Investments 36,000
salary of Rs. 85,000 14,000
To Carriage Outwards

To Printing and Stationery 18,000

To Interest on Debentures 25,000
To Sales Commission 30,800
To Bad Debts (related to sales) 91,000
To Underwriting Commission 26,000
To Preliminary Expenses 28,000
To Audit Fees 45,000
To Loss on Sale of Investments 11,200
To Net Profit 3,90,000
11,00,000 11,00,000
Prepare a Statement showing allocation of pre-incorporation and post-incorporation profits after considering the
following information:

(i) G.P. ratio was constant throughout the year.

(ii) Sales for January and October were 1 ½ times the average monthly sales while sales for December were
twice the average monthly sales.
(iii) Bad Debts are shown after adjusting a recovery of Rs. 7,000 of Bad Debt for a sale made in July, 2003.
(iv) Manager's salary was increased by Rs. 2,000 p.m. from 1.5.2006.
(v) All investments were sold in April, 2006.

Question 6: The partners of Shri Enterprises decided to convert the partnership firm into a Private Limited
st st
Shreya (p) Ltd. with effect from 1 January 2008 however, company could be incorporated only on 1 June,
2008. The business was continued on behalf of the company and the consideration of Rs. 6, 00,000 was settled
on that day along with interest @ 12% per annum. The company availed loan of Rs. 9, 00,000 @ 10% per
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annum on 1 June, 2008 to pay purchase consideration and for working capital. The company closed its
accounts for the first time on 31st March, 2009 and presents you the following summarized profit and loss
account:

Sales 19,80,000

Cost of goods sold 11,88,000

Discount to dealers 46,200

Directors' remuneration 60,000

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Salaries 90,000

Rent 1,35,000

Interest 1,05,000

Depreciation 30,000

Office expenses 1,05,000

Sales promotion expenses 33,000

Preliminary expenses

(To be written off in first year itself) 15,000

Profit 1,72,800

Sales from June, 2008 to December, 2008 were 2 ½ times of the average sales, which further increased to 3 ½
times in January to March quarter, 2009. The company recruited additional work force to expand the business.
The salaries from July, 2008 doubled. The company also acquired additional showroom at monthly rent of Rs.
10,000 from July, 2008.

You are required to prepare a Profit and Loss Account showing apportionment of cost and revenue
between pre-incorporation and post-incorporation periods. Also suggest how the pre-incorporation
profits/losses are to be dealt with. (CA- MAY 2008) 10 MARKS
Answer:
Particulars Pre. inc. Pos. inc. Particulars Pre. inc. Pos. inc.

(5 months) (10 months) (5 months) (10 months)

To Cost of sales 1,80,000 10,08,000 By-Sales (W.N.1) 3,00,000 16,80,000

To Gross profit 1,20,000 6,72,000

3,00,000 16,80,000 3,00,000 16,80,000

To Discount to dealers 7,000 39,200 By G.P. 1,20,000 6,72,000

To Directors' remuneration — 60,000 By Loss 750

To Salaries (W.N.2) 18,750 71,250

To Rent (W.N.3) 15,000 1,20,000

To Interest (W.N.4) 30,000 75,000

To Depreciation 10,000 20,000

To Office expenses 35,000 70,000

To Preliminary expenses — 15,000

To Sales promotion expenses 5,000 28,000

To Net profit — 1,73,550

1,20,750 6,72,000 1,20,750 6,72,000

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Treatment of pre-incorporation loss: Pre-incorporation loss may, either be considered as a reduction from any
capital reserve accruing in relation to the transaction or be treated as goodwill.

Working Notes: 1.Computation of sales ratio:

Let the average sales per month in pre-incorporation period be a Average Sales (Pre-incorporation) = a x5 = 5a
Sales (Post incorporation) from June to December, 2008 = 2 ½ a x 7 = 17.5a
From January to March, 2009 =3 ½ ax3= 10.5a
Total Sales 28.0a
Sales ratio of pre-incorporation & post incorporation is 5a : 28a

2. Computation of ratio for salaries :

Let the average salary be a
Pre-incorporation salary = a x 5 = 5a
Post incorporation salary
June, 2008= a
July to March, 2009 = a x 9 x 2 = 18a
19a Ratio is 5:19
3. Computation of Rent:
Total rent 1,35,000
Less/Additional rent for 9 months @ 10,000 p.m. 90,000
Rent of old premises apportioned in time ratio 45,000
Apportionment Pre Inc. Post Inc.
Old premises rent 15,000 30,000
Additional Rent 90,000
15,000 1,20,000
4. Computation of interest:
Pre-incorporation period from January, 2008 to May 2008
( )
Post incorporation period from June, 2008 to March 2009
( )
= 1, 05,000
Question 7: A firm M/s. Alag, which was carrying on business from 1st July, 2010 gets itself incorporated as a
st
company on 1 November, 2010. The first accounts are drawn up to March 31, 2011. The gross profit for the
period is Rs. 56,000. The general expenses are Rs. 14,220; Director's fees 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 the directors.

Give Profit and 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. (CA-IPCC GROUP 1)

Question 8: Sutanu formed a private Limited Company under the name of Sutanu(P)Ltd.to take over his
st st
existing business as from 1 January,2015 but the Company was not incorporated until 1 April,2015.No
entries relating to transfer of the business were entered in the books, which were carried on without a break
st st
until 31 December,2015. The following trial balance was extracted from the books as on 31 December (end
of the year)

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Particulars Debit Credit

st
Stock in Trade as at 1 January 4,300
Purchases and sales 18,900 27,800
Carriage Outwards 330
Travelers` Commission 750
Office Salaries and Expenses 21,00
Rent and Rates 1,200
st
Sutanu`s Capital Account as 1 January 23,000
Directors` fee 1,800
Fixed Assets 13,400
Current Liabilities 3,700
Current Assets(Other than Stock-in-Trade) 11,200
Preliminary Expenses 520
Total 54,500

You are also given the following information:

(1) Stock as at 31.12.15(end of the year) is.4,400

(2) Purchase Consideration was agreed at 30,000 to be settled by issue of 3,000 Equity Shares of 10 each.
(3) The Gross Profit Margin is constant and the monthly sales in January, November and December are
double the monthly sales for the remaining months of the year.
(4) Assume that Carriage Outwards and traveler`s Commission vary in direct proportion to sales.
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You are required to prepare Trading and profit and Loss Account for the year ended 31 December
apportioning the periods before and after incorporation and a balance sheet as on that date. Ignore
depreciation and taxation.
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Question.9 MOURYA LTD. incorporated on 1 may 2015 received the certificate to commence business. On
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31 may,2015 It had acquired a running business from Gopal and Co with effect from 1 January,2015.The
Purchase Consideration was Rs.50,00,000 of which Rs.10,00,000 was to be paid in cash and Rs.40,00,000 in
the form of fully paid shares.

The company also issued shares for Rs.40,00,000 for cash. Machinery Costing Rs.25,00,000 was then installed.
Assets acquired from the vendors were :Machinery Rs.30,00,000;Stock Rs.6,00,000;and patents Rs.4,00,000.
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During the year ended 31 December,2015 the total sales ware Rs.1,80,00,000. The sales per month in the first
half year being one half of what they were in the latter half year.

The net profit of the company, after charging the following expenses, was Rs.10,00,000:

Particulars Rs.

Depreciation 5,40,000

Director`s fees 86,000

Preliminary Expenses 10,000

Office Expenses 2,40,000

Selling Expenses 1,98,000

Interest to vendors 50,000

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Ascertain the pre-incorporation and post-incorporation Profits and prepare the Balance Sheet of the Company
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as on 31 December,2015. The Closing Stock was valued at Rs.7,00,000. Purchase consideration was settled on
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31 may,2015.

Question.10. A,B and C are in partnership sharing Profit and Losses in the ration 1/2:1/3:1/6.The Partnership
Deed states that each partner is entitled to 6% Interest on Capital. The firm was taken over by Swagata ltd for
a total consideration of Rs.8,10,000.On the date of takeover, the Firm`s net Assets, represented by the
partner`s Capital Accounts were-A-Rs.3,10,000;B-Rs.2,50,000 and C-Rs.1,90,000.

The firm wants to indicate the mode of settlement of purchase Consideration to the company, keeping in mind
that the partner`s interests should be equitably retained in the company. The company can issue Equity
shares of Rs.10 each and preference shares(rate to be decided)of Rs.100 each. You are required to decide
upon the scheme for settlement of purchase consideration.

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