As a Last Minute Revision before CA IPCC Accounts Exam, we have provided this Short 2 Minute Summary of ‘Profit Prior to Incorporation Chapter’.
There are two methods for calculating Profit or Loss Prior to Incorporation.
1. Closing Old Books and Opening New Books: This is a very simple method and very rarely used one. Here, Only the assets values are written in the books. The Difference between Assets Value and Amount written in the books is treated as Reserve or Goodwill, accordingly.
2. Split Profit: Under this method, Profit is split between Pre and Post Incorporation Periods. This is one of the widely used methods (and the one that will be asked in the exam).
Basis of Apportionment
Each of the following items are apportioned between Pre-Incorporation and Post-Incorporation on the basis of the following:
Gross Profit & Loss: Turnover (or) Cost of Goods Sold (or) Time.
Variable Expenses: Turnover Basis
Fixed Expenses : Time Basis
Post-Incorporation Expenses like Directors Remuneration, Underwriting Commission, Incorporation Expenses – Charge entirely to Post Incorporation Period
Company Audit Fees : Charge entirely to Post-Incorporation
Tax Audit Fee : Apportion on Turnover Basis
Interest on Purchase Consideration: Time Basis
Other Misc Points
#Pre-Incorporation Profits are transferred to Capital Reserve Account (i.e. capitalized). Pre-incorporation Losses shall be treated as a part of business acquisition cost (Goodwill).
#The vendor is treated as a creditor for the cash received by the purchasing company in respect of the debts due to the vendor, just as if he has himself collected cash from his debtors and remitted the proceeds to the purchasing company.
#The balance in the suspense accounts will be always equal to the amount of debtors and creditors taken over remaining unadjusted at any time.
#A company taking over a running business may also agree to collect its debts as an agent for the vendor and may further undertake to pay the creditor on behalf of the vendors.
In such a case, the trade receivables and trade payables of the vendors will be included in the accounts for the company.