Page 264 - DCOM201_ACCOUNTING_FOR_COMPANIES_I

Unit 11: Profit and Loss Prior to Incorporation

11.3 Method of Ascertainment of Profit or Loss Prior to Incorporation Notes

There are two methods-
1. By preparation of separate profit and loss account for pre-incorporation and post-
incorporation periods: When a running business is acquired, its separate profit and loss
account can be prepared up to the date of incorporation. It will give the accurate amount
of profit for pre-incorporation period and post-incorporation period. But this method is
not easy, because to prepare separate profit and loss account, stocking and balancing of
books is required. It would create a number of problems in the normal functioning of
business and would increase cost unnecessarily. Hence this method for the determination
of pre and post-incorporation profits or losses is rarely used by a company.
2. By apportioning the whole profits of the year into pre-incorporation period and post-
incorporation period: Under this method, first of all trading account for the whole
accounting year is prepared to find out the gross profit. Then, the following two ratios are
calculated:

(i) Time Ratio: This ratio is calculated on the books of time falling between the last date
of the Balance Sheet and the date of incorporation or registration and the date of
current final account.

Example 2: If a company acquires a business on 1st April, 2010 and is incorporated on 1 st
June, 2010 and final accounts are prepared on 31 March 2010, time ratio will be 2:10 or 1:5.
st
(ii) Sales Ratio or Turnover Ratio: On the basis of pre-incorporation period sales and post-
incorporation period sales this ratio is calculated.
Gross profit calculated by the preparation of profit and loss account is divided into two parts (for
pre-incorporation period and post-incorporation period) on the basis of time ratio. And then a
statement is prepared to find out the net profit. In this statement, all the items appearing in the
debts side (expenses) and credit side (income) are shown. These items are apportioned on the
basis of their characteristics. These can be as follows:
(i) Some expenses are distributed on the basis of Time Ratio: All those expenses which have
fixed or standing nature, should be distributed on the basis of time ratio in pre-acquisition
period and post-acquisition period e.g., salary of staff or workers, rent, depreciation, etc.
(ii) Some expenses are distributed on the basis of Sales/Turnover Ratio: All those expenses
which are related to sales, are distributed on the basis of sales ratio e.g., commission on
sales, discount allowed to customers, selling expenses, etc.
(iii) Some expenses are exclusively for prior to incorporation period: Some expense are
exclusively incurred in the pre-incorporation period, and are therefore these are not
apportioned but charged completely in the pre-incorporation period e.g., salaries payable
to vendors and interest payable on purchase price for the pre-incorporation period.

Did u know? Gross profit calculated by the preparation of profit and loss account is divided
into two parts (for pre-incorporation period and post-incorporation period) on the basis
of time ratio.
(iv) Some expenses are exclusively for post-incorporation period: Some expenses are incurred
exclusively in the post acquisition period, therefore these are not apportioned but charged
completely in the post-acquisition period e.g., directors’ fees, preliminary expenses, interest
on debentures, etc.

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