Accounting for Bonus Issue and Right Issue: Notes | Principles and Practice of Accounting - CA Foundation PDF Download

 Page 1


? 
LEARNING OUTCOMES 
*  
 
 
 
PROFIT OR LOSS PRE AND 
POST INCORPORATION 
 
After studying this chapter, you will be able to – 
? Understand the meaning of pre-incorporation profit or loss; 
? Account for pre-incorporation profit or loss; 
? Learn method for computing profit or loss prior to 
incorporation. 
 
 
 
 
 
 
 
 
 
CHAPTER 
5 
Page 2


? 
LEARNING OUTCOMES 
*  
 
 
 
PROFIT OR LOSS PRE AND 
POST INCORPORATION 
 
After studying this chapter, you will be able to – 
? Understand the meaning of pre-incorporation profit or loss; 
? Account for pre-incorporation profit or loss; 
? Learn method for computing profit or loss prior to 
incorporation. 
 
 
 
 
 
 
 
 
 
CHAPTER 
5 
 
 
5.2 
 
ACCOUNTING 
  
 
Pre and Post 
Incorporation 
Profits/ Losses 
? Profit or loss of a business for the period prior to the 
date the company came into existence is referred to as 
Pre-Incorporation Profits or Losses. The chapter deal 
with the computation of such profits or losses and 
treatment thereof. 
 
 
 1. INTRODUCTION 
When a running business is taken over by the promoters of a company, as at a 
date prior to the date of incorporation of company, the amount of profit or loss 
of such a business for the period prior to the date the company came into 
existence is referred to as pre-incorporation profits or losses. Such profits or 
losses, though belonging to the company or payable by it, are of capital nature; it 
is necessary to disclose them separately from trading profits or losses.  
The general practice in this regard is that: 
i. If there is a loss, 
(a) It is either written off by debit to the Profit and Loss Account or to a 
special account described as “Loss Prior to Incorporation” and show as 
an “asset” in the Balance Sheet, 
(b) Alternatively, it may be debited to the Goodwill Account.  
CHAPTER OVERVIEW 
Page 3


? 
LEARNING OUTCOMES 
*  
 
 
 
PROFIT OR LOSS PRE AND 
POST INCORPORATION 
 
After studying this chapter, you will be able to – 
? Understand the meaning of pre-incorporation profit or loss; 
? Account for pre-incorporation profit or loss; 
? Learn method for computing profit or loss prior to 
incorporation. 
 
 
 
 
 
 
 
 
 
CHAPTER 
5 
 
 
5.2 
 
ACCOUNTING 
  
 
Pre and Post 
Incorporation 
Profits/ Losses 
? Profit or loss of a business for the period prior to the 
date the company came into existence is referred to as 
Pre-Incorporation Profits or Losses. The chapter deal 
with the computation of such profits or losses and 
treatment thereof. 
 
 
 1. INTRODUCTION 
When a running business is taken over by the promoters of a company, as at a 
date prior to the date of incorporation of company, the amount of profit or loss 
of such a business for the period prior to the date the company came into 
existence is referred to as pre-incorporation profits or losses. Such profits or 
losses, though belonging to the company or payable by it, are of capital nature; it 
is necessary to disclose them separately from trading profits or losses.  
The general practice in this regard is that: 
i. If there is a loss, 
(a) It is either written off by debit to the Profit and Loss Account or to a 
special account described as “Loss Prior to Incorporation” and show as 
an “asset” in the Balance Sheet, 
(b) Alternatively, it may be debited to the Goodwill Account.  
CHAPTER OVERVIEW 
 
 
5.3 
 
PROFIT OR LOSS PRE AND POST INCORPORATION  
ii. On the other hand, if a profit has been earned by business prior to the same 
being taken over and the same is not fully absorbed by any interest payable 
for the period, it is credited to Capital Reserve Account or to the Goodwill 
Account, if any goodwill has been adjusted as an asset. The profit will not be 
available for distribution as a dividend among the members of the 
company. 
 
Example 1 
Y Ltd was incorporated on 1/7/20X1 to take over the business of Z Ltd from 
1/4/20X1. The year ended on 31/3/20X2.Calculate the pre incorporation period. 
Solution 
Business was taken over from 1/4/20X1 and incorporated on: 1/7/20X1  
Pre Incorporation period = 1/4/20X1 to 1/7/20X1 (3 months)  
Example 2 
Q Ltd was incorporated on 1/8/20X1 to take over the business of W Ltd from 
1/5/20X1. The year ended on 31/3/20X2. Which Period should be taken as the Pre- 
Incorporation Period and Post-Incorporation Period? 
Solution 
Date of Incorporation: 1/8/20X1 
Date of take over : 1/5/20X1  
Pre Incorporation Period = 1/5/20X1 to 1/8/20X1 (3 months) 
Post Incorporation Period = 1/8/20X1 to 31/3/20X2 (8 months) 
Page 4


? 
LEARNING OUTCOMES 
*  
 
 
 
PROFIT OR LOSS PRE AND 
POST INCORPORATION 
 
After studying this chapter, you will be able to – 
? Understand the meaning of pre-incorporation profit or loss; 
? Account for pre-incorporation profit or loss; 
? Learn method for computing profit or loss prior to 
incorporation. 
 
 
 
 
 
 
 
 
 
CHAPTER 
5 
 
 
5.2 
 
ACCOUNTING 
  
 
Pre and Post 
Incorporation 
Profits/ Losses 
? Profit or loss of a business for the period prior to the 
date the company came into existence is referred to as 
Pre-Incorporation Profits or Losses. The chapter deal 
with the computation of such profits or losses and 
treatment thereof. 
 
 
 1. INTRODUCTION 
When a running business is taken over by the promoters of a company, as at a 
date prior to the date of incorporation of company, the amount of profit or loss 
of such a business for the period prior to the date the company came into 
existence is referred to as pre-incorporation profits or losses. Such profits or 
losses, though belonging to the company or payable by it, are of capital nature; it 
is necessary to disclose them separately from trading profits or losses.  
The general practice in this regard is that: 
i. If there is a loss, 
(a) It is either written off by debit to the Profit and Loss Account or to a 
special account described as “Loss Prior to Incorporation” and show as 
an “asset” in the Balance Sheet, 
(b) Alternatively, it may be debited to the Goodwill Account.  
CHAPTER OVERVIEW 
 
 
5.3 
 
PROFIT OR LOSS PRE AND POST INCORPORATION  
ii. On the other hand, if a profit has been earned by business prior to the same 
being taken over and the same is not fully absorbed by any interest payable 
for the period, it is credited to Capital Reserve Account or to the Goodwill 
Account, if any goodwill has been adjusted as an asset. The profit will not be 
available for distribution as a dividend among the members of the 
company. 
 
Example 1 
Y Ltd was incorporated on 1/7/20X1 to take over the business of Z Ltd from 
1/4/20X1. The year ended on 31/3/20X2.Calculate the pre incorporation period. 
Solution 
Business was taken over from 1/4/20X1 and incorporated on: 1/7/20X1  
Pre Incorporation period = 1/4/20X1 to 1/7/20X1 (3 months)  
Example 2 
Q Ltd was incorporated on 1/8/20X1 to take over the business of W Ltd from 
1/5/20X1. The year ended on 31/3/20X2. Which Period should be taken as the Pre- 
Incorporation Period and Post-Incorporation Period? 
Solution 
Date of Incorporation: 1/8/20X1 
Date of take over : 1/5/20X1  
Pre Incorporation Period = 1/5/20X1 to 1/8/20X1 (3 months) 
Post Incorporation Period = 1/8/20X1 to 31/3/20X2 (8 months) 
 
 
5.4 
 
ACCOUNTING 
 2. COMPUTING PROFIT OR LOSS PRIOR TO 
INCORPORATION  
The determination of such profit or loss would be a simple matter if it is possible 
to close the books and take the stock held by the business before the company 
came into existence. In such a case, the trial balance will be abstracted from the 
books and the profit or loss computed. Thereafter, the books will be either closed 
off or the balance allowed continuing undistributed; only the amount of profit or 
loss so determined being adjusted in the manner described above. 
The simplest, though not always the most expedient method is to close off old 
books and open new books with the assets and liabilities as they existed at the 
date of incorporation. In this way, automatically the result to that date will be 
adjusted, the difference between the values of assets and liabilities acquired and 
the purchase consideration being accounted for either as goodwill or as reserve. 
The accounts, therefore, would relate exclusively to the post-incorporation period 
and any adjustment for the pre-incorporation period, whether an adjustment of 
profit or loss, would not be required. 
Since the decision to take over a business usually takes time from the date when 
it is agreed to be taken over it is practically not possible to follow any of the 
method aforementioned. 
The only alternative left, in this condition is to split up the profit of the year of the 
transfer of the business to the company between ‘pre’ and ‘post’ incorporation 
periods. This is done either on the time basis or on the turnover basis or by a 
method which combines the two. 
 
 
Page 5


? 
LEARNING OUTCOMES 
*  
 
 
 
PROFIT OR LOSS PRE AND 
POST INCORPORATION 
 
After studying this chapter, you will be able to – 
? Understand the meaning of pre-incorporation profit or loss; 
? Account for pre-incorporation profit or loss; 
? Learn method for computing profit or loss prior to 
incorporation. 
 
 
 
 
 
 
 
 
 
CHAPTER 
5 
 
 
5.2 
 
ACCOUNTING 
  
 
Pre and Post 
Incorporation 
Profits/ Losses 
? Profit or loss of a business for the period prior to the 
date the company came into existence is referred to as 
Pre-Incorporation Profits or Losses. The chapter deal 
with the computation of such profits or losses and 
treatment thereof. 
 
 
 1. INTRODUCTION 
When a running business is taken over by the promoters of a company, as at a 
date prior to the date of incorporation of company, the amount of profit or loss 
of such a business for the period prior to the date the company came into 
existence is referred to as pre-incorporation profits or losses. Such profits or 
losses, though belonging to the company or payable by it, are of capital nature; it 
is necessary to disclose them separately from trading profits or losses.  
The general practice in this regard is that: 
i. If there is a loss, 
(a) It is either written off by debit to the Profit and Loss Account or to a 
special account described as “Loss Prior to Incorporation” and show as 
an “asset” in the Balance Sheet, 
(b) Alternatively, it may be debited to the Goodwill Account.  
CHAPTER OVERVIEW 
 
 
5.3 
 
PROFIT OR LOSS PRE AND POST INCORPORATION  
ii. On the other hand, if a profit has been earned by business prior to the same 
being taken over and the same is not fully absorbed by any interest payable 
for the period, it is credited to Capital Reserve Account or to the Goodwill 
Account, if any goodwill has been adjusted as an asset. The profit will not be 
available for distribution as a dividend among the members of the 
company. 
 
Example 1 
Y Ltd was incorporated on 1/7/20X1 to take over the business of Z Ltd from 
1/4/20X1. The year ended on 31/3/20X2.Calculate the pre incorporation period. 
Solution 
Business was taken over from 1/4/20X1 and incorporated on: 1/7/20X1  
Pre Incorporation period = 1/4/20X1 to 1/7/20X1 (3 months)  
Example 2 
Q Ltd was incorporated on 1/8/20X1 to take over the business of W Ltd from 
1/5/20X1. The year ended on 31/3/20X2. Which Period should be taken as the Pre- 
Incorporation Period and Post-Incorporation Period? 
Solution 
Date of Incorporation: 1/8/20X1 
Date of take over : 1/5/20X1  
Pre Incorporation Period = 1/5/20X1 to 1/8/20X1 (3 months) 
Post Incorporation Period = 1/8/20X1 to 31/3/20X2 (8 months) 
 
 
5.4 
 
ACCOUNTING 
 2. COMPUTING PROFIT OR LOSS PRIOR TO 
INCORPORATION  
The determination of such profit or loss would be a simple matter if it is possible 
to close the books and take the stock held by the business before the company 
came into existence. In such a case, the trial balance will be abstracted from the 
books and the profit or loss computed. Thereafter, the books will be either closed 
off or the balance allowed continuing undistributed; only the amount of profit or 
loss so determined being adjusted in the manner described above. 
The simplest, though not always the most expedient method is to close off old 
books and open new books with the assets and liabilities as they existed at the 
date of incorporation. In this way, automatically the result to that date will be 
adjusted, the difference between the values of assets and liabilities acquired and 
the purchase consideration being accounted for either as goodwill or as reserve. 
The accounts, therefore, would relate exclusively to the post-incorporation period 
and any adjustment for the pre-incorporation period, whether an adjustment of 
profit or loss, would not be required. 
Since the decision to take over a business usually takes time from the date when 
it is agreed to be taken over it is practically not possible to follow any of the 
method aforementioned. 
The only alternative left, in this condition is to split up the profit of the year of the 
transfer of the business to the company between ‘pre’ and ‘post’ incorporation 
periods. This is done either on the time basis or on the turnover basis or by a 
method which combines the two. 
 
 
 
 
5.5 
 
PROFIT OR LOSS PRE AND POST INCORPORATION  
TIME BASIS  
Under this method we calculate the Pre and Post Incorporation time Period and 
split some items of expenses and Incomes in the time ratio. 
Let us see few examples to understand the time ratio. 
Example 3 (Determination of pre and post incorporation periods) 
The partners of Omega Ltd. decided to convert their partnership into a private 
limited company called Omega (P) Ltd. with effect from 1
st
 April, 20X1. However, 
due to some procedural difficulties, the company could be incorporated only on 1st 
July, 20X1. The accounts of the business continued for the accounting year ended 
31
st
 March, 20X2. Determine the pre and post incorporation periods and 
corresponding time ratio. 
Solution 
Pre-incorporation period (1.4.20X1 to 1.7.20X1) = 3 months 
Post incorporation period (1.7.20X1 to 31.3.20X2) =9 months 
Time Ratio = 3:9 = 1:3  
Example 4  
M Ltd which was incorporated on 1st June 20X1, took over the business of N, a 
proprietary concern from 1st April 20X1. The accounts of the business continued for 
the accounting year ended 31st March, 20X2. Determine the time basis on which 
the amount of salaries will be split as pre and post incorporation periods. 
Solution 
Pre Incorporation period (1 April 20X1 to 1 June 20X1) = 2 months 
Post Incorporation Period (1 June 20X1 to 31 March, 20X2) = 10 months  
Time Ratio = 1:5 
SALES BASIS  
Some expenses and Incomes are divided between the pre and post period items on 
the basis of sales /Turnover.