Profit or Loss Pre and Post Incorporation

  • By TeamKoncept
  • 27 May, 2023
Profit or Loss Pre and Post Incorporation

Profit or Loss Pre and Post Incorporation

Table of Content

1. INTRODUCTION

When a running business is taken over by the promoters of a company, as at a date prior to the date of incorporation of company, the amount of profit or loss of such a business for the period prior to the date the company came into existence is referred to as pre-incorporation profits or losses. Such profits or losses, though belonging to the company or payable by it, are of capital nature; it is necessary to disclose them separately from trading profits or losses.

The general practice in this regard is that:

i. If there is a loss,
  1. It is either written off by debit to the Profit and Loss Account or to a special account described as “Loss Prior to Incorporation” and show as an “asset” in the Balance Sheet,
  2. Alternatively, it may be debited to the Goodwill Account.
ii. On the other hand, if a profit has been earned by business prior to the same being taken over and the same is not fully absorbed by any interest payable for the period, it is credited to Capital Reserve Account or to the Goodwill Account, if any goodwill has been adjusted as an asset. The profit will not be available for distribution as a dividend among the members of the company.




2. COMPUTING PROFIT OR LOSS PRIOR TO INCORPORATION

The determination of such profit or loss would be a simple matter if it is possible to close the books and take the stock held by the business before the company came into existence. In such a case, the trial balance will be abstracted from the books and the profit or loss computed. Thereafter, the books will be either closed off or the balance allowed continuing undistributed; only the amount of profit or loss so determined being adjusted in the manner described above.

The simplest, though not always the most expedient method is to close off old books and open new books with the assets and liabilities as they existed at the date of incorporation. In this way, automatically the result to that date will be adjusted, the difference between the values of assets and liabilities acquired and the purchase consideration being accounted for either as goodwill or as reserve. The accounts, therefore, would relate exclusively to the post-incorporation period and any adjustment for the pre-incorporation period, whether an adjustment of profit or loss, would not be required.

Since the decision to take over a business usually takes time from the date when it is agreed to be taken over it is practically not possible to follow any of the method aforementioned.

The only alternative left, in this condition is to split up the profit of the year of the transfer of the business to the company between ‘pre’ and ‘post’ incorporation periods. This is done either on the time basis or on the turnover basis or by a method which combines the two.


TIME BASIS

Under this method we calculate the Pre and Post Incorporation time Period and split some items of expenses and Incomes in the time ratio.

SALES BASIS

Some expenses and Incomes are divided between the pre and post period items on the basis of sales /Turnover.


3. BASIS OF APPORTIONMENT

Item Basis of Apportionment between pre and Post incorporation period
Gross profit or Gross Loss

Variable expenses linked with Turnover [e.g. Carriage / Cartage outward, Selling and distribution expenses, Commission to selling agents/tarvelling agents, advertisements expenses, Bad debts, Brokerage, Sales Promotion]		 Sales Ratio - On the basis of turnover in the respective periods (first preference)

Or

On the basis of cost of goods sold in teh respective periods in the absence of any information regarding turnover (second prefernce)

Or

Time Ratio - On the basis of time in the respective periods in the absence of any information regarding turnover and cost of good sold (third prefernce)
Fixed Common charges [e.g., Salaries, Office and Administration Expenses, Rent, Rates and Taxes, Printing an dStationery, Telephone, telegram and postage, Depriciation, Miscellaneous Expenses] Time Ratio
Expenses exclusively relating to pre-Incorporation period [e.g. Interest on Vendor's Capital] Charge to Pr-incorporation period (but if the purchase consideration is not paid on taking over of business, interest for the subsequent period is charged to post incorporation period)
Expenses exclusively relating to post-incorporation period [e.g. Formation expenses, interest on debentures, director's fees, Directors' remuneration, Preliminary Expenses, Share issue Expenses, Underwriting commission, Discount on issue of securities] Charge to Post-incorporation period
Audit Fees
  1. For Company's Audit under the Companies Act
  2. For Tax Audit under section 44 AB of the income tax Act, 1961
 Charge to Post-incorporation period
On the basis of turnover in the respective periods
Interest on purchase consideration to vendor
  1. For the period from the date of acquisition of business to date of incorporation
  2. From the date of incorporation
 Charge to Pre-incorpiration period
Charge to Post-incorporation period


4. PRE-INCORPORATION PROFITS & LOSSES
Pre-incorporation Profits Pre-incorporation Losses
It is transferred to Capital Reserve Account (i.e. capiatlised) It is treated as a part of business acquisition cost (Goodwill)
It can be used for:
  • writing off Goodwill on acuisition
  • writing off Preliminary Expenses
  • writing down over-valued assets
  • issuing of bonus shares
  • paying up partly paid shares
 It can be sued for:
  • setting off against Post-incorporation Profit
  • addition to Goodwill on acquisition
  • writing off Capital Profit

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