ACCOUNTING SOLUTIONS
SCO: 209, First Floor, Sector-36/D. Chandigarh (M): 0172-4670390-5017149, 9876149390
Profit Prior To Incorporation
Meaning:
“ the profits earned b/w the date of acquisition and the date of incorporation are called profits prior to
incorporation. These profits are of capital nature and these are not available for distribution among
shareholders and transferred to capital reserve account. If there is any loss prior to incorporation, it is
capital loss and debited to goodwill account.
Under company’s act 1956, pre incorporation profits are capital profits and hence not available has the
declaration of the dividend.
A company comes into existence only when it receives the certificate of incorporation from the registrar
of companies. Sometimes a newly incorporated company acquires a running business from a date prior to
its incorporation. In such a case, the amount of profit earned by the company from the date of purchase
to the date of incorporation is called as “profit prior to incorporation.”
The profits prior to incorporation can be calculated by following procedure:
1. Prepare trading account. In order to ascertain the amount of gross profit, the trading a/c, for
the whole period should be prepared. The whole period means the period starting from the
date of incorporation to the last date of closing of accounts.
2. Calculation of time ratio. Calculate time ratio by taking into consideration the time falling
from the date of purchase of business to the date of incorporation and the period b/w the
date of incorporation to the last date of preparing final accounts.
3. Calculate sales ratio. It may be calculated as under:- sales ratio = sales of pre incorporation
period : sales of post incorporation period.
4. Prepare profit and loss a/c for pre incorporation and post incorporation periods immediately.
This is done on the following basis:
(a) Gross profit should be allocated b/w two periods on the basis of sales ratio.
(b) Expenses that are connected with sales should be allocated on the basis of sales ratio.
Examples of such expenses are : selling expenses are ; advertisement, discount allowed,
bad debts etc.
(c) Expenses that are incurred on the basis of time should be allocated on the basis of time
ratio. For example : admn expenses, audit fees, salaries, rent and taxes, misc. Expenses,
depreciation, insurance, electricity charges, general expenses, printing and stationary etc.
(d) Expenses which are incurred after the incorporation of the company like director fees,
preliminary expenses, debenture interest etc. Should be charged wholly to the post
incorporation period.
SCO:209, F.F. Sector-36/D Chandigarh. 0172-4670390-5017149, 9876149390
ACCOUNTING SOLUTIONS
SCO: 209, First Floor, Sector-36/D. Chandigarh (M): 0172-4670390-5017149, 9876149390
Purpose of profit and loss prior to incorporation
1. How many profits before incorporation or after incorporation of business. The profit before
incorporation is called capital profit and after incorporation profits are called net profit or
revenue profit.
2. A separate profit and loss account is prepared for the pre incorporation period as
distinguished from profit and loss account for post incorporation period which shows profits
separately.
3. In the books of the new company, acquisition entries are passed on the same date after
taking into considerations the assets and liabilities on the date of incorporation, which thus
would include the results up to the date.
4. For calculating net profit and loss of respective period after deducting apportioned expenses
and acquisition entries are passed at the end of the accounting year.
5. For the adjusted loss prior to incorporation of business, these losses would be adjusted as
follows:
(a) Debited to goodwill account.
(b) Debited to capital reserve account arising from acquisition of business.
(c) Debited to a suspense account which can be written off later as a fictitious asset.
From the above points, mainly purpose of company for calculating the profits or loss from
pre and post incorporation of business is that, how much profit is earned from pre
incorporation and post incorporation of business.
These both profits are adjusted in the balance sheet on the liability side.
To know about the profit earned by the company prior to its incorporation, company prepares its profit
and loss account in two columns i.e. one for pre incorporation and other for post incorporation item.
All the common expenses and incomes are divided in the following appropriate ratio.
1. In sales ratio. Expenses related to sales are apportioned in this ratio like, advertisement,
packing expenses, cartrage outward, commission to selling agent, discount allowed, variable
expenses etc.
2. In time ratio. Expenses such as rent, depreciation salaries, electricity, telephone, interest,
audit fees and other office and admn expenses.
3. In vendor ratio. Interest to vendor will be allocated in this ratio.
4. Post of incorporation. Like directors fees, interest to vendors, preliminary expenses (if written
off) are recorded in post to incorporation period.
If there is profit in the first column, such profit is known as profit prior to incorporation.
SCO:209, F.F. Sector-36/D Chandigarh. 0172-4670390-5017149, 9876149390
ACCOUNTING SOLUTIONS
SCO: 209, First Floor, Sector-36/D. Chandigarh (M): 0172-4670390-5017149, 9876149390
Company can use profit prior to incorporation for the following purposes.
1. To write off the capital losses and expenditure.
2. To write off goodwill account.
Profit or loss prior to incorporation, can be calculated by adopting the following steps
Step1. Calculation of time ratio. This ratio will be calculated by taking into consideration the
period b/w the date of purchase of the business to the date of incorporation of business and this
period b/w the date of incorporation to the last date of preparing the final account.
Step2. Calculation of sales ratio. This ratio will be calculated as, sales of pre-increperation period:
sales of post incorporation period.
Step3. Calculation of vendor ratio. This is another time ratio which is to be calculated by taking
into consideration the period b/w the date of purchase of business to the date of incorporation
and the period b/w the date of incorporation to the date payment of interest to the vendor.
Step4. Calculation of gross profit. For this purpose we have to prepare trading account for the
whole period i.e. period starting from the date of purchase of business to the last date of
purchase of business to the last date of closing of accounts.
Step5. Preparation of profit and loss account. Profit and loss account will be prepared in the
columnar form i.e. one column for pre incorporation form and other for post incorporation items.
Common expenses are to be divided b/w pre incorporation and post incorporation as under:
1. In sales ratio. Expenses related to sales and gross profit should be allocated on the basis of
sales ratio e.g. advertisement, packing expenses, cartrage outward, commission to agents,
discount allowed, bad debts, entertainment expenses, any variable expenses, travelling
expenses etc.
2. In time ratio. In this ratio expenses are to be allocated e.g. salary, interest (excluding interest
to vendor and debenture interest), rent, depreciation, fixed expenses, electricity, telephone,
audit fee, other office and administration expenses etc.
3. Vendor ratio. Interest to vendor will be allocated in this ratio.
4. Post to corporation. These expenses are to be recorded in post period column, these are
incurred by the company after incorporation e..g .director fee, preliminary expenses, or
formation expenses, debentures interest, any provisions created by the company etc.

If there is profit prior to incorporation, then it will be treated as capital profit.
If there is loss prior to incorporation then it will be treated as goodwill.

Profit or loss for the post incorporation period will be treated as revenue
profit or loss.
SCO:209, F.F. Sector-36/D Chandigarh. 0172-4670390-5017149, 9876149390