1 Chapter-4 Pre-incorporation Profit Financial Statements

2 Pre-incorporation profit Limited Co. take over other businesses. It takes p period of time before they can be incorporated. A company cannot earn profits before it legally comes into existence through incorporation. The profits generated after the takeover and before the incorporation are knows as pre-incorporation profits Pre-incorporation profits are capital in nature. They must be transferred to a capital reserve account which is not available for dividend distribution.

3 Pre-incorporation Profits Accounting entries Dr. Profit and LossWith the pre-incorporation profits earned Cr. Capital Reserve/Goodwill Dr. GoodwillWith the pre-incorporation loss Cr. Profit and Loss After incorporation, the company legally comes into existence. The profits generated after incorporation are known post-incorporation profits The profits which can be transferred to the profit and loss appropriation account and is also available for the distribution of dividends.

4 Allocation of profits between different parties

5 Allocation of Profits between Different Parties Case 1 A partnership was taken over by a limited company on 1 April. The company was incorporated on 1 June. 1/1 Date of takeover 1/41/6 31/12 Apportionment of profits: 1/1 to 31/3Partnership 1/4 to 31/5Pre-incorporation Profits 1/6 to 31/12Limited company(Post-incorporation profits) Date of incorporation Financial year end

6 Allocation of Profits between Different Parties Case 2 A partnership was taken over by a limited company on 1 January. The company was incorporated on 1 April. 1/1 1/4 31/12 Apportionment of profits: 1/1 to 31/3Pre-incorporation Profits 1/4 to 31/12Limited company (Post-incorporation profits) Date of takeover Date of incorporation Financial year end

7 Allocation of Profits between Different Parties Case 3 A partnership was taken over by a limited company on 1 April. The company was incorporated on the same date. 1/1 1/4 31/12 Apportionment of profits: 1/1 to 31/3Partnership 1/4 to 31/12Limited company (Post-incorporation profits) Date of takeover of incorporation Financial year end

8 Apportionment of revenues and expenses Theoretically, a separate set of records should be dept for each period. However, a business may not have stock-take or may not close the accounts when there is a change in ownership of the business Therefore the income and expenditures must be apportioned over different periods in order to compute the pre-incorporation profits and the post- incorporation profits The income and expenditures of the business should each be apportioned on a different basis

9 Basis of ApportionmentExamples SalesVariable expenses and Revenues - They would increase proportionally to the increase in turnover - e.g. gross profit, selling and distribution expenses, carriage outwards, cost of goods sold, bad debts, discounts allowed, etc. TimeFixed expenses and revenues - They would increase proportionally to time - e.g. rent and rates, interest, administrative exp., office salaries, depreciation, etc. Actual- There is no need to apportion these expenses and revenues as they are incurred in a particular period.

10 Apportionment of Revenues and Expenses Basis of ApportionmentExamples Actual- Partnership e.g. Interest on drawings, interest on capital, partners’ salaries, etc. - Pre-incorporation period e.g. interest on purchase consideration - Post-incorporation period e.g. preliminary expenses, interest on purchase consideration, debenture interest, directors’ remuneration, etc.

11 Example 5 Refer to textbook P

12 Example 5