MCom I Semester Corporate Accounting Profit Loss Prior Incorporation Study Material Notes

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MCom I Semester Corporate Accounting Profit Loss Prior Incorporation Study Material Notes

MCom I Semester Corporate Accounting Profit Loss Prior Incorporation Study Material Notes: Accounting treatment profit loss prior Incorporations Profit and Loss Account Statement showing apportionment of Profit Balance Sheet Discussion Questions Short Answer Questions Numerical Questions ( Most Important notes For MCom Students )

Profit Loss Prior Incorporation
Profit Loss Prior Incorporation

CTET Paper Level 2 Previous Year Science Model paper II in Hindi

Profit or Loss Prior to Incorporation

Meaning of Profit or Loss Prior to Incorporation

Legally a company comes into existence only on receiving the certificate of incorporation. Sometimes, a new company is formed by taking over an existing business as a going concern. The newly formed company may take over the business of the vendor as at a date prior to the date of its incorporation. The profit or loss of the business so acquired, for the period from the date of purchase till the date of incorporation of the company is called ‘profit or loss prior to the incorporation. Unless the agreement with the vendor provides otherwise, such a profit or loss belongs to the company. But, as no company can earn profit or incur loss before it comes into existence, profit or loss prior to incorporation can not be regarded as trading profit or loss of the company. In fact, such profit or loss is of capital nature and must have been taken into consideration while determining the purchase consideration. As such, it is necessary to ascertain such profit or loss as accurately as possible. Here, it is important to note that for calculating such profit or loss, the date of incorporation (and not the date of receiving the certificate of commencement of business) is considered.

Accounting Treatment of Profit or Loss Prior to Incorporation

Profit prior to incorporation is of capital nature and hence can not be credited to Profit and Loss Account. Thus, ordinarily such profit can not be used for payment of dividends. If interest is paid to the vendor for the delay in payment of purchase consideration then the amount of interest to the date of incorporation will be the first charge on such profit and the remaining will be transferred to Capital Reserve Account which can be utilised for writing off capital losses of the company, e.g. preliminary expenses, discount on issue of shares or debentures, goodwill etc. Until it is fully utilised, the balance of Capital Reserve Account has to be shown in the liabilities side of the Balance Sheet under the heading “Reserves and Surplus’.

Loss prior to incorporation, being a capital loss, is debited to ‘Loss Prior to Incorporation Account’. It can be written off against other capital profits of the company. Alternatively, it may be treated as deferred revenue expenditure and written off out of the profits of the company over a period of years. Until such loss is completely written off, it must be shown in the assets side of the Balance Sheet under the heading ‘Miscellaneous Expenditure’. Pre-incorporation loss may also be treated as goodwill and debited to Goodwill Account

Ascertainment of Profit or Loss Prior to Incorporation

Profit or loss prior to incorporation can be ascertained accurately only when a separate Trading and Profit and Loss Account is prepared on the date of incorporation but this will require balancing of the books and stock taking on the date of incorporation. But this is very inconvenient as it will adversely affect the normal functioning of the business. Hence, in practice this procedure is not generally adopted.

The usual practice, therefore, is to prepare a Trading and Profit and Loss Account for the whole period as at the end of the accounting year and then profit or loss thus ascertained is apportioned between the reincorporation and post-incorporation periods on time or turnover basis. But as neither the profits are earned by the business evenly throughout the year nor the turnover is spread evenly throughout the year, hence the apportionment of profit or loss only on time basis or on turnover basis is not at all satisfactory. The most equitable method to apportion the gross profit or gross loss of the whole accounting period is on the basis of the two periods and the expenses are apportioned between the two per respective merits as follows: are apportioned between the two periods on their (1) On time basis : All expenses of fixed nature (viz. salaries, rent, rates and expenses, printing and stationery, telephone, postage and telegrams, nature (viz. salaries, rent, rates and taxes, insurance, general

stationery, telephone, postage and telegrams, electricity charges, office expenses, compulsory whereas there is no such compulsion for a sole trade bus etc.) are apportioned between two periods on time basis. As company audit is were is no such compulsion for a sole trade business and partnership firm, the whole amount of audit fee may be treated of post-incorporation period. As such Incorporation period. As such while solving question the students are advised to append a note relating to the treatment given to this item

(1) On turnover basis: All variable expenses (viz. commission, discount, brokerage, salesmen’s salaries, Statement, travelling expenses, carriage outwards, bad debts, etc.) are apportioned between two periods on the basis of their respective turnovers.

(111) Pre-incorporation expenses : All expenses wholly applicable to the period prior to incorporation (viz. vendor’s salary, interest on. capital, interest on purchase consideration upto the date of incorporation etc.) are shown exclusively in the pre-incorporation period.

(iv) Post-incorporation expenses : All expenses wholly applicable to the post-incorporation period (viz. directors’ fee, debenture interest, discount on issue of shares or debentures, preliminary expenses, formation expenses etc.) are shown exclusively in post-incorporation period.

(v) Seasonal nature expenses : If certain expenses are incurred only in certain season, such expenses should be charged only to the period in which they are incurred.

Illustration 1. Mahesh Ltd. was incorporated on 1st May 2001 to buy over the business of M/s Mahesh Bros. as from 1st January 2001 and obtained its certificate for commencement of business on 1st June 2001.

The accounts of the company for the period ended on 31st December 2001 disclosed the following facts:

(i) The turnover for the whole period amounted to Rs. 2,40,000 of which Rs. 40.000 related to the period from 1st January 2001 to 30th April 2001.

(ii) The Trading Account showed a gross profit of Rs. 96,000.

(iii) The following items appeared in the Profit and Loss Account:

Notes: 1. Preliminary expenses could, alternatively, be charged against capital reserve arising out of profit before incorporation. So long as these expenses are not written off, they will be shown in the assets side of balance sheet under the heading Miscellaneous Expenditure.

2. The sales ratio is worked out as follows:

If a sale for the first 4 months on the average is Re, 1. then the monthly average for the remaining months is Rs. 2. So, sale upto 1st May = 1 x 4 = Rs. 4 and sale for the remaining five months 2 x 5 = Rs. 10. The ratio, therefore, is 4 : 10 or 2:5.

Illustration 4. Ideal Products Ltd. was registered on January 1, 2001, to buy the business of Messrs Din Deal as on October 1, 2000 and obtained its certificate for commencement of business on February 1, 2001.

The accounts of the company for the period of 12 months ended September 30, 2001 disclosed the net profit of Rs. 67,540 after having charged the following amounts:

Salary Rs. 15,000 (There were 4 employees in the pre-incorporation period and 7 in the post incorporation period).

Wages Rs. 5,460 (There were 4 workers in the pre-incorporation period and 5 workers in the post incorporation period and the wages were Rs. 80 and Rs. 100 per month per worker in the pre and post incorporation periods, respectively.)

Directors’ salary Rs. 8,000. Sales during the year amounted to Rs. 2,40,000. The trend of sales was as under: October and November 2000 half the average sales in each month. Feb., March, April and July 2001 average sales in each month. August and September 2001 half the average sales in each month.

You are required to calculate profits separately for the pre and post-incorporation periods.

Discussion Questions

Long Answer Questions

1 Why and how are pre and post-incorporation profits and losses calculated?

2. What is the concept of Pre and Post Incorporation Profit? How will you calculate such profit?

3. Describe the method of finding out profit or loss prior to and after

Short Answer Questions

(1) What is profit or loss prior to incorporation? How is it ascertained?

(ii) How profit or loss prior to incorporation is dealt with?

(iii) How is profit or loss computed for the pre-incorporation period?

(iv) Explain the rules regarding profit prior to incorporation in preparation of Final Accounts.

 

 

 

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