Profit/ Loss Prior to Incorporation 1 IPCC Paper 1: Accounting Chapter 3 CA. S.S. Prathap
Learning Objectives Pre & Post Incorporation Introduction Typical Computation Problems Accounting Treatment Problem Solving Approach Allocation Basis Practical Exam Problems 2
Introduction Company Incorporation Date A company technically comes into existence only from this Date Hence, Accounts have to be prepared from that date General Practice/ Practical Situations Running Business Already existing, commercial business is taken over & Subsequently Incorporated as a company. 3
Two Important Dates Takeover Date The earlier date is the day in which the business is been taken over say 1 st January 2012 Company Incorporation Date The second date is the day in which the business is Incorporated as a company say 1 st April 2012 Pre Incorporation Profits Profits Earned between Jan 1 & March 31, 2012 4
Pre-Incorporation Profit/ Loss Pre Incorporated Profits Is of a Capital Nature and Has to be transferred to a special Account Capital Reserve A/c Pre Incorporation Losses Treated as Goodwill 5
Problem Solving Approach 6 An Intro.
Approach to the Sums 3 Dates Date 1: Business Started The date from which the existing business is taken over Date II: Company Incorporated The subsequent date of Incorporation. Date III: Date of Account s The date on which the accounts have to be drawn up. 7
Splitting Revenues & Expenses Period 1: Date of business till date of Incorporation Period II: Date from date of Incorporation till date of Closing Balance Sheet (closing of Accounts) 8
Splitting Revenues & Expenses Revenue/ Sales Split on the basis of the facts of each question Expenses Time Basis (Example: Rent) or Sales Basis (Example: Advertisement) 9
10 Illustration 1: ABC Ltd.
ABC Ltd ABC Ltd was incorporated on 1.5.2010 to take over the business of DEF and Co. from 1.1.2010. The summarised Profit and loss Account as given by ABC Ltd. for the year ending 31.12.2010 is as under : 11
Summarised P & L A/C Rs. Rs. To Rent & tax To Salaries including Manager s Sal Rs.85000 To Carriage outwards To Printing and stationery To Interest on Debentures To Sales commission To Bad debts(related to sales) To Underwriting commission To Preliminary expenses To Audit fees To Loss on Sale of Investments To Net Profit 90,000 3,31,000 14,000 18,000 25,000 30,800 91,000 26,000 28,000 45,000 11,200 3,90,000 By Gross Profit By Interest on Investments 10,64,000 36,000 12
ABC Sum (Contd...) Prepare a statement showing allocation of Pre-incorporation and Post incorporation profits after considering the following information : G.P ratio was constant throughout the year. Sales for January and October were 11/2 times the average monthly sales, while Sales for December were twice the average monthly sales. Bad debts are shown after adjusting a recovery of Rs.7,000 of Bad Debts for a sale made in July, 2007. Manager s salary was increased by Rs. 2,000 p.m. From 1.5.2010. All investments were sold in April, 2010. 13
ABC Ltd Important Dates Date 1: Business Purchased 1 st Jan 2010 Date II: Company Incorporated 1 st May2010 Date III : Date of Account s 31 st Dec 2010 Pre Incorporation Period 4 months Post Incorporation Period 8 months 14
Calculation of Sales Ratio The sales for Jan and Oct were 1½ times the average monthly sales and for Dec it is twice the average monthly sales. Let the average monthly sales be x. Pre-Incorporation Post-Incorporation January 1.5x May x February x June x March x July x April x August x September x October 1.5x November x December 2x TOTAL : 4.5x 9.5x Sales Ratio : 4.5x : 9.5x = 9 : 19 15
Working Notes Allocation Based upon Pre and Post Incorporation periods Ratio of Sales 9 : 19 Typical Items: Gross Profit, Carriage Outwards, Sales Commission and Bad Debts Written-off Time Basis Allocation Rent, Salaries, Printing and Stationery, Audit Fees Post Incorporation Period Expenses Interest on Debentures, Underwriting Commission and Preliminary Expenses Pre Incorporation Period Expenses Interest on Investments, Loss on Sale of Investments and Bad debt recovery(related to July 2007) 16
Gross Profit Total = 10,64,000 It is apportioned on the basis of Sales ratio ( 9 : 19 ) 10,64,000 Pre-Incorporation Post-Incorporation 10,64,000 * 9/28 10,64,000 * 19/28 =3,42,000 = 7,22,000 17
Rent and Taxes It should be apportioned on the basis of TIME. (4 months : 8 months) Total Rent = 90,000 Pre Incorporation Post Incorporation 90,000 * 4/12 90,000 * 8/12 = 30,000 = 60,000 18
Manager s Salary Total = 85,000 His salary was increased from 1 st May, 2010 by 2000 per month, 2,000 * 8 months = 16,000 relates to Post Incorporation So, the position now is, Total Salary = 85,000 ( ) Post Incorp Salary = 16,000 69,000 Time basis 4m : 8m = 1:2 Pre Incorporation Post Incorporation 23,000 46,000 Adding the total manager s salary (Post) = 16,000 + 46,000 = 62,000 The final division of 85,000 is, Pre Incorporation = 23,000 Post Incorporation = 62,000 19
Other Salaries From the total salaries given excluding Manager s Salary, we have the other Salaries as, 3,31,000 - (85,000) 2,46,000 Time basis 4m : 8m = 1: 2 2,46,000 * 1 / 3 2,46,000 * 2 / 3 = 82,000 = 1,64,000 Pre Incorporation = 82,000 Post Incorporation = 1,64,000 20
Working Note Printing & Stationery : It is apportioned on TIME basis ( 1 : 2 ) Total = 18,000 6,000(pre) 12,000 (post) Auditor s Fee : It is also apportioned on TIME basis (1 : 2) Total = 45,000 15,000 (pre) 30,000(post) 21
Carriage Outwards Total = 14,000 It is apportioned on the basis of Sales ratio ( 9 : 19 ) 14,000 Pre-Incorporation Post-Incorporation 14,000 * 9/28 14,000 * 19/28 = 4,500 = 9,500 22
Sales Commission Total = 30,800 It is apportioned on the basis of Sales ratio ( 9 : 19 ) 30,800 Pre-Incorporation Post-Incorporation 30,800 * 9/28 30,800 * 19/28 = 9,900 = 20,900 23
Bad Debts However, it is after adjusting a recovery of Rs.7,000 Bad Debts for a sale made in July 2007. This is a wrong treatment, so Bad Debts have to be taken 91,000 + 7,000 = 98,000 Sales basis 9 : 19 31,500 66,500 And the Bad Debts recovered of Rs.7,000 will be credited to Pre- Incorporation Period 24
Working Note 100 % Post Incorporation Expenses : Interest on Debentures : Total = 25,000 Underwriting expenses : Total = 26,000 Preliminary Expenses: Total = 28,000 25
Loss on sale of investment Total = 11,200 As Investment was sold in April 2010, it is 100 % Pre Incorporation loss, also the Interest on Investment received 36,000 is credited to Pre Incorporation period. 26
Summarised statement of P & L year ended 31.12.2010 Pre Incorp (4 months) Post Incorp (8 months) Pre- Incorp (4 months) Post Incorp (8 months) To rent & tax To Salaries Manager s Salary Other Salaries To Printing and stationery To Audit fees To carriage outwards To Sales commission To Bad debts To interest on debentures 30,000 23,000 82,000 6,000 15,000 4,500 9,900 31,500-60,000 62,000 1,64,000 12,000 30,000 9,500 20,900 66,500 25,000 By Gross Profit By Interest on Investments By Bad debts recovery 3,42,000 36,000 7,000 7,22,000 27 - -
Summarised statement of P & L year ended 31.12.2010 To Underwriting commission Pre Incorp (4 months) - Post Incorp (8 months) 26,000 Pre- Incorp (4 months) Post Incorp (8 months) To Preliminary expenses To Loss on sale of investments To Net Profit - 11,200 1,71,900 28,000-2,18,100 TOTAL 3,85,000 7,22,000 TOTAL 3,85,000 7,22,000 28
Result Allocation of Pre-Incorporation & Post-Incorporation profits after considering all information given is apportioned finally as, Pre Incorporation : Rs.1,71,900 Post Incorporation : Rs.2,18,100 29
Illustration 2: Alag Sum 30 November,2011 (6 Marks)
Alag Sum A firm M/s Alag, which was carrying on business from 1 st July,2011 gets itself Incorporated as a Company on 1st November,2011. The first accounts are drawn up to 31 st March 2012. Gross Profit for the period : Rs.56,000. General Expenses : Rs.14,220. Director s fee : Rs.12,000 p.a. Incorporation expenses : Rs.1,500. Rent up to 31 st December was Rs.1,200 p.a. after which it is increased to Rs.3,000 p.a. Salary of the manager, who upon incorporation of the company was made a director, is Rs.6,000 p.a. His remuneration thereafter is included in the above figure of fees to the Directors. 31
Alag Sum (contd...) Give Profit or Loss account showing Pre and Post Incorporation profit. The Net sales are Rs.8,20,000, the monthly average of which for the first four months is one-half of that of the remaining period. The Company earned a uniform profit. Interest and tax may be ignored. 32
Alag Sum - Solution Important Dates Date 1 : Business started 1 st July 2011 Date II : Company Incorporated 1 st Nov 2011 Date III : Date of Account s 31 st Mar 2012 Gross Profits on Sales Ratio Between Pre and Post Incorporation period, based From 1 st July 2011 till 31 th October 2011 (4 months) and From 1 st November till 31 st March 2012.(5 months) Post Incorporation Period Expenses Director s Fees, Formation Expenses will go 100 % These expenses relate totally to the newly formed company Actual Basis or Time Proportionate Basis Rest of the expenses will be split as incurred 33
Working Notes: Calculation of sales ratio Let the average monthly sales of first four months be x, then the next five months will be 2x. Total sales of first four months = 4 * x = 4x Total sales of next five months = 5 * 2x = 10x The ratio of sales is given as = 4x : 10x = 2 : 5 34
Working Notes: Calculation of Rent Till 31 st December, rent was Rs.1,200p.a. (i.e.,) Rs.100 per month. Therefore Pre Incorporation rent = Rs.100* 4 months = Rs.400 Post Incorporation rent = Rs.100 *2 months + Rs.250* 3 months = Rs. 950 35
Gross Profit It should be apportioned on the basis of Sales Ratio( 2:5 ) Total = 56,000 56,000 * 2/7 56,000 * 5/7 = 16,000 =40,000 36
General Expenses It should be apportioned on the basis of TIME ( 4:5 ) Total = 14,220 14,220 * 4/9 14,220 * 4/9 = 6,320 (pre) = 7,900(post) 37
Working notes Director s fee : 100 % post Incorporation expense. Total = 5,000 Formation Expense : It is the other name of Incorporation Expense. It is also 100% post Incorporation expense. Total = 1,500 38
Managers salary Salary of the manager, who upon incorporation of the company was made a director, is Rs.6,000 p.a. His remuneration thereafter is included in the figure of fees to the Directors. 6,000 * 4 / 12 = Rs. 2,000 39
Profit & Loss A/c for 9 months ended on 31.03.2012 Particulars Pre Incorp To General Expenses To Director s fee To Formation expenses To Rent (600+750) To Manager s salary To Net Profit Transferred to Capital Reserve P&L Appr a/c TOTAL 6,320 - - 400 2,000 7280-16,000 Post Incorp 7,900 5,000 1,500 950-24,650 40,000 Total 14,220 5,000 1,500 1,350 2,000 31,930 - - 56,000 Particu lars By Gross Profit Pre Incorp 16,000 16,000 Post - Incorp 40,000 40,000 total 56,000 40 56,000
Result The profits of 7,280 which are Pre Incorporation profits have to be transferred to Capital Reserve. & Post - Incorporation profits Rs.24,680 transferred to P&L Account of Alag Ltd. 41
Illustration 3: Rama Sum 42 November, 2009 (6 Marks)
Rama Sum Rama Udyog Ltd was incorporated on August 1, 2011. It had acquired a running business of Rama & Co. With effect from April 1, 2011. During the year 2011 2012, the total sales were Rs. 36,00,000. The net profit of the company, Rs.2,00,000 was worked out after charging the following expenses: 43
Rama Sum (contd...) I. Depreciation Rs.1,08,000 II. Audit Fee Rs.15,000 III. Director s fee Rs. 50,000 IV. Preliminary expenses Rs. 12,000 V. Office expenses Rs. 78,000 VI. Selling expenses Rs. 72,000 VII. Interest to vendors upto Aug 31,2011 Rs. 5,000. Ascertain pre-incorporation and post incorporation profit for the year ended 31 st March, 2012. 44
Problem Statement Rama Sum Important Dates Business Purchased 1 st Apr 2011 Company Incorporated 1 st Aug 2011 Date of Account s 31 st Mar 2012 Pre & Post Incorporation Periods Pre Incorporation Period = 4 months Post Incorporation period = 8 months 45
Working Notes: Calculation of Sales Ratio The sales per month in the first half year were half of what they were in the later half year. Let the sales per month in the later half be 2x, then the sales per month will be x. Pre-Incorporation Post-Incorporation April x August x May x September x June x October 2x July x November 2x December 2x January 2x February 2x March 2x TOTAL : 4x 14x Sales Ratio : 4x : 14x = 2 : 7 46
Working Notes: Time Ratio Pre Incorporation Period 1st April, 2011 to 31st July, 2011(Pre) 4 Months Post Incorporation Period 1st August, 2011 to 31st March, 2012 (Post) 8 Months Hence Ratio: 4 Months : 8 Months Time Ratio is 1 : 2 47
Working Notes: Gross Profit Gross Profit = Net Profit + All Expenses = Rs.2,00,000 + (Rs.1,08,000 +15,000 +50,000 +12,000+78,000+72,000+5,000) = Rs,2,00,000 + Rs.3,40,000 = Rs.5,40,000 48
Gross Profit It is apportioned on the basis of sales ratio.( 2 : 7 ) 5,40,000 Pre Incorporation Post Incorporation 5,40,000 * 2/9 5,40,000 * 7/9 = 1,20,000 = 4,20,000 49
Depreciation Time basis allocation : It is apportioned on time basis. ( 1 : 2 ) 1,08,000 Pre Incorporation Post Incorporation 1,08,000* 1/3 1,08,000* 2/3 = 36,000 = 72,000 50
Audit Fee Time basis allocation : It is apportioned on time basis. ( 1 : 2 ) 15,000 Pre Incorporation Post Incorporation 15,000* 1/3 15,000* 2/3 = 5,000 = 10,000 51
Working notes Director s Fee : It is 100% post Incorporation expense. Total = 50,000 Preliminary expense : It is also 100% post Incorporation expense. Total = 12,000 52
Office Expense It is apportioned on the basis of Time. (1 : 2 ) 78,000 Pre Incorporation Post Incorporation 78,000 * 1/3 78,000 * 2/3 = 26,000 = 52,000 53
Selling Expense It is apportioned on the basis of Sale. (2:7 ) 72,000 Pre Incorporation Post Incorporation 72,000 * 2/9 72,000 * 7/9 = 16,000 = 56,000 54
Interest to vendors 5 months Pre-Incorporation period = 4 months Post-Incorporation period = 1 month (1 Aug to 31 Aug) 5,000 Pre Incorporation Post Incorporation 5,000 * 4/5 5,000 * 1/5 = 4,000 = 1,000 55
Pre and Post Incorporation Profit year ended 31.03.2012 Particulars Total amount Basis of Allocation Pre Incorp Post - Incorp Gross Profit Less : Depreciation Audit Fee Director s fee Prelim. Exp Office Exp Selling Exp Interest to vendors 5,40,000 1,08,000 15,000 50,000 12,000 78,000 72,000 5,000 2 : 7 1 : 2 1 : 2 post post 1 : 2 2 : 7 Actual 1,20,000 36,000 5000 26,000 16000 4000 4,20,000 72,000 10,000 50,000 12,000 52,000 56,000 1,000 Net Profit 2,00,000 33,000 1,67,000 56
Lesson Summary First pay attention to the dates (i.e.) Date of taking over of business Incorporation Date The date of Accounts All revenues and expenses connected to sales have to be apportioned in the sales ratio, which will depend upon facts of each sum. 57
Summary (contd ) All expenses connected to a company have 100 % Post- Incorporation Example : Director s fee, Underwriting Commission, Incorporation Expenses ( Preliminary expenses ). All other expenses will be apportioned on Time Basis. The profits before Incorporation are capital in nature & have to be transferred to a special A/c called Capital Reserve A/c. 58
59 Thank You Hope you have a better understanding of this topic and it helps you in qualifying this paper with flying colors.