Page 263 - DCOM201_ACCOUNTING_FOR_COMPANIES_I

Accounting for Companies-I

Notes 11.1 Meaning of Profit or Loss Prior to Incorporation
(Pre-incorporation Profit or Loss)

Generally, it is found that a newly-formed company may purchase a running business from a
certain date which is prior to incorporation.

Example 1: A company incorporated or registered on 1 May, 2011 may acquire the
st
business of a partnership firm from 31 December, 2010.
st
Usually it is found that this prior date coincides with the date of the Vendor’s previous Balance
Sheet. If this date does not coincide with the date of Vendor’s previous Balance Sheet, stock
taking has to be completed and balances of various assets and liabilities has to be extracted. To
avoid this trouble, the business is acquired, from the date of the previous Balance Sheet. As a
running business is acquired, profit or loss earned by the business from the date of purchase to
the date of incorporation is called Profit or Loss Prior to Incorporation. And profit or loss made
by the business from the date of incorporation to the date of closing of accounts at the end of first
financial year is called Profit or Loss Subsequent to Incorporation.

11.2 Nature & Use of Profit or Loss

As per the Companies Act, a company cannot earn profit before its incorporation. Therefore,
profits earned by the business from the date of acquisition to the date of its corporation cannot
be treated as profit earned by the company. But due to these profits the net assets acquired by the
company on its formation have been increased. Therefore, these profits cannot be treated as
revenue profit but should be treated as capital profits and should be placed in a special account
i.e., capital reserve. These profits will not be available for distribution as dividends to
shareholders. These profits can be utilized in writing off capital losses as goodwill, preliminary
expenses, discount on issue of shares and debentures, etc. In the absence of any writing off, these
profits are transferred to Capital Reserve and are shown in the Liability side of the Balance Sheet
under the heading ‘Reserve and Surplus’. It is therefore, necessary to calculate the amount of
such profits. If there is a loss during this period, it will be in the nature of a capital loss. This loss
should be added to the amount of goodwill (if given). If the amount of goodwill is not given
with this amount, goodwill account will be opened. Alternatively, this loss can be transferred to
a suspense account and will be shown in the Assets side of Balance Sheet under the heading
‘Miscellaneous Expenditure’, until it is completely written off against profits.

Did u know? Usually it is found that this prior date coincides with the date of the Vendor’s
previous Balance Sheet. If this date does not coincide with the date of Vendor’s previous
Balance Sheet, stock taking has to be completed and balances of various assets and liabilities
has to be extracted. To avoid this trouble, the business is acquired, from the date of the
previous Balance Sheet.

In the absence of any contrary information, profit prior to incorporation in both private and
public companies means the profit prior to incorporation and not to commencement of business.

Notes As per the Companies Act, a company cannot earn profit before its incorporation.
Therefore, profits earned by the business from the date of acquisition to the date of its
corporation cannot be treated as profit earned by the company.

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