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PROFIT PRIOR TO INCORPORATION

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PROFIT PRIOR TO INCORPORATION

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Nature of-Profit or Loss

CA/CMA SANTOSH KUMAR

A newly incorporated company may take over a running business as from a certain date which is prior to the date of incorporation. Thus company incorporated on 1st April, 2008 may take over the business of a partnership as from 1st January, 2008. If the business is to be purchased from the date of incorporation, stock taking must be completed and the balances of various assets and liabilities must be extracted, if this date does not coincide with the end of the

financial year for which the partnership has prepared its last final accounts. To avoid all this trouble, the business is conveniently purchased from the date of last balance sheet. Calculation. In order to calculate profit or loss prior to incorporation date, the following steps are recommended:

(a)

(b)

Prepare one trading account for the whole period falling between the date of purchase and date of final accounts. The date of incorporation does not affect the calculation of gross profit.

Calculate the following two ratios;

i. Time Ratio. This is calculated by considering the period falling between the last date of balance sheet and the date of incorporation and the period between the date of incorporation and the date of present final accounts.

ii. Sales Ratio. Ascertain sales for the pre-incorporation and post-incorporation periods and calculate

the sales ratio.

Now prepare a statement for calculating the net profits for pre and post-incorporation periods separately. This is done as follows:

i. Divide the gross profit of the full period into two parts on the basis of sales ratio. This gives gross profit separately for pre- and post incorporation periods.

ii. Divide all expenses of fixed nature, viz., rent, salary, depreciation, interest in time ratio and other expenses in sales ratio.

iii. There are certain expenses, i.e., salary of partners, salary of directors, preliminary expenses which are

not divided because they belong exclusively to a certain period. In the above cases the salary of partners is debited to the pre-incorporation period and preliminary expenses and directors' salary to the post-incorporation period. Question:1 Ganesh Ltd. was incorporated on 1st August 1999. It took over the business of M/s Shanker and Siva with effect from 1st April 1999. From the following figures relating to the year ending 31st March 2000 ascertain profit prior to incorporation and profit after incorporation.

(c)

i. Sales for the year were Rs. 60, 00,000 out of which sales up to 1st August 1999 were Rs. 25, 00,000.

ii. Gross profit for the year was Rs. 18, 00,000.

iii. The expenses debited to profit and loss account were as follows:

 

Rs.

Rent

90,000

Salaries

1,50,000

Directors fees

38,000

Interest of debentures

60,000

Audit fees

15,000

Discount on sales

36,000

Depreciation

2,40,000

General expenses

48,000

Advertising

1,80,000

Stationery and printing

36,000

Commission on sales

60,000

Interests to vendors on purchase consideration

30,000

Up to 1st October 1999 Bad debts (Rs. 5,000 of bad debts mentioned above relate to debts created prior to incorporation.)

15,000

Question:2. A company incorporated on 1st April, 2000 took over a running business from 1st January, 2000. The company prepared its first final accounts on 31st December, 2000. From the following information, you are required to calculate the sales ratio of pre and post-incorporation periods:

(a) Sales from January 2000December, 2000 Rs. 3,60,000, (b) Sales for the month of January twice the average sales; for the month of Februaryequal to average sale; sales for four months from May to August1/4th of the average sale of each month; and sales for October and November three times the average sale.

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PROFIT PRIOR TO INCORPORATION

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Question:3 New Ventures Ltd. was incorporated on 1st January, 2000 with an authorized capital consisting of 5,000 equity shares of Rs. 10 each to take over the running business of Rundown Brothers as from 1st October, 1999. The following is the summarized profit and loss account for the year ended 30th September, 2000:

 

Rs.

 

Rs.

Cost of sales for the year Administration expenses Selling commission Goodwill written off Interest paid to vendors (Loan repaid on 1st February Distribution expenses (60 per cent variable) Preliminary expenses written off Debenture interest Depreciation Directors' fees Net profit

16,000

Sales 1st October, 1999 to

   

1,768

875

31st Dec, 1999

6,000

200

1st January, 2000 to 30th Sept., 2000

19,000

25,000

373

 

1,250

330

320

444

100

3,340

 

25,000

25,000

The company deals in one type of product. The unit cost of sales was reduced by 10 per cent in the post-incorporation period as compared to the pre-incorporation period in the year. You are required to apportion the net profit amount between pre-incorporation and post-incorporation periods showing the basis of apportionment.

Question: 4 The partners of Maitri Agencies decided to convert the partnership into a private limited company called MA (P) Ltd. with effect from 1st January, 2007. The consideration was agreed at Rs. 1,17,00,000 based on the firm's Balance Sheet as at 31st December, 2006. However due to some procedural difficulties, the company could be incorporated only on 1st April, 2007. Meanwhile the business was continued on behalf of the company and the consideration was settled on that day with interest at 12% per annum. The same books of account were continued by the company which closed its account for the first time on 31st March, 2008 and prepared the following summarized profit and loss account.

Rs.

Sales Cost of goods sold:

2,34,00,000

1,63,80,000

Salaries Depreciation Advertisement Discounts Managing Director's remuneration Miscellaneous office expenses Office-cum-show room rent Interest

11,70,000

1,80,000

7,02,000

11,70,000

90,000

1,20,000

7,20,000

9,51,000

 

2,14,83,000

Profit

19,17,000

The company's only borrowing was a loan of Rs. 50,00,000 at 12% p.a. to pay the purchase consideration due to the firm and

for working capital requirements. The company was able to double the average monthly sales of the firm, from 1st April, 2007 but the salaries trebled from that date. It had to occupy additional space from 1st July, 2007 for which rent was Rs. 30,000 per month. Prepare a profit and loss account in a columnar form apportioning cost and revenue between ore-incorporation and post- incorporation periods. Also, suggest how the pre-incorporation Profits are to be dealt with.

Question:5

and Loss Account as given by ABC Ltd. for the year ending 31.12.2005 is as under:

ABC Ltd. was incorporated on 1.5.2006 to take over the business of DEF and Co. from 1.1.2006. The Profit

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Profit and Loss Account

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To

Rent and Taxes

90,000

By

Gross Profit

10,64,000

To

Salaries including manager's salary of Rs. 85,000 Carriage Outwards

Printing and Stationery

 

By

Interest on Investments

36,000

3,31,000

 
To To
To
To

14,000

 
To To 14,000  

18,000

18,000

To

Interest on Debentures

25,000

 

To

Sales Commission

30,800

 

To

Bad Debts (related to sales)

91,000

 

To

Underwriting Commission

26,000

To

Preliminary Expenses

28,000

 

To

Audit Fees

45,000

 

To

Loss on Sale of Investments

11,200

 

To

Net Profit

3,90,000

 
 

11,00,000

 

11,00,000

Prepare a Statement showing allocation of pre-incorporation and post-incorporation profits after considering the following information:

(i)

G.P. ratio was constant throughout the year.

(ii)

Sales for January and October were 1 ½ times the average monthly sales while sales for December were twice the average monthly sales.

(iii)

Bad Debts are shown after adjusting a recovery of Rs. 7,000 of Bad Debt for a sale made in July, 2003.

(iv)

Manager's salary was increased by Rs. 2,000 p.m. from 1.5.2006.

(v)

All investments were sold in April, 2006.

Question 6:

The partners of Shri Enterprises decided to convert the partnership firm into a Private Limited Shreya (p) Ltd. with effect from 1 st January 2008 however, company could be incorporated only on 1 st June, 2008. The business was

continued on behalf of the company and the consideration of Rs. 6, 00,000 was settled on that day along with interest @ 12% per annum. The company availed loan of Rs. 9, 00,000 @ 10% per annum on 1 st June, 2008 to pay purchase consideration and for working capital. The company closed its accounts for the first time on 31st March, 2009 and presents you the following summarized profit and loss account:

 

Rs.

Rs.

Sales Cost of goods sold Discount to dealers Directors' remuneration Salaries Rent Interest Depreciation Office expenses Sales promotion expenses Preliminary expenses (To be written off in first year itself) Profit

19,80,000

11,88,000

46,200

60,000

90,000

1,35,000

1,05,000

30,000

1,05,000

33,000

15,000

18,07,200

 

1,72,800

Sales from June, 2008 to December, 2008 were 2 ½ times of the average sales, which further increased to 3 ½ times in January to March quarter, 2009. The company recruited additional work force to expand the business. The salaries from

July, 2008 doubled. The company also acquired additional showroom at monthly rent of Rs. 10,000 from July, 2008.

You are required to prepare a Profit and Loss Account showing apportionment of cost and revenue between pre -

incorporation and post-incorporation periods. Also suggest how the pre-incorporation profits/losses are to be

dealt with.

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Answer:

PROFIT PRIOR TO INCORPORATION

CA/CMA SANTOSH KUMAR

Particulars

Pre. inc.

Pos. inc.

Particulars

Pre. inc.

Pos. inc.

(5 months)

(10 months)

(5 months)

(10 months)

 

Rs.

Rs.

 

Rs.

Rs.

To Cost of sales To Gross profit

1,80,000

10,08,000

By-Sales (W.N.1)

3,00,000

16,80,000

1,20,000

6,72,000

 

3,00,000

16,80,000

3,00,000

16,80,000

To Discount to dealers To Directors' remuneration To Salaries (W.N.2) To Rent (W.N.3) To Interest (W.N.4) To Depreciation To Office expenses To Preliminary expenses To Sales promotion expenses To Net profit

7,000

39,200

By G.P.

1,20,000

6,72,000

60,000

By Loss

750

18,750

71,250

15,000

1,20,000

30,000

75,000

10,000

20,000

35,000

70,000

15,000

5,000

28,000

1,73,550

 

1,20,750

6,72,000

 

1,20,750

6,72,000

Treatment of pre-incorporation loss: Pre-incorporation loss may, either be considered as a reduction from any capital reserve accruing in relation to the transaction or be treated as goodwill. Working Notes:

1.Computation of sales ratio :

Let the average sales per month in pre-incorporation period be a Average Sales (Pre-incorporation) = a x5 = 5a Sales (Post incorporation) from June to December, 2008 = 2 ½ a x 7 = 17.5a

From January to March, 2009 =3 ½ ax3= Total Sales Sales ratio of pre-incorporation & post incorporation is 5a : 28a 2.Computation of ratio for salaries :

10.5a

28.0a

Let the average salary be a Pre-incorporation salary = a x 5 = 5a Post incorporation salary June, 2008= July to March, 2009 = a x 9 x 2 = 18a

a

19a

Ratio is 5:19 3.Computation of Rent:

Total rent Less/Additional rent for 9 months @ 10,000 p.m. Rent of old premises apportioned in time ratio Apportionment Old premises rent Additional Rent

1,35,000

90,000

45,000

Pre Inc.

Post Inc.

15,000

30,000

90,000

 

15,000

1,20,000

1. Computation of interest:

Pre-incorporation period from January, 2008 to May 2008

Pre-incorporation period from January, 2008 to May 2008 Post incorporation period from June, 2008 to March

Post incorporation period from June, 2008 to March 2009

2008 Post incorporation period from June, 2008 to March 2009 = 1, 05,000 Question 7 :

= 1, 05,000 Question 7: A firm M/s. Alag, which was carrying on business from 1st July, 2010 gets itself incorporated as a company on 1 st November, 2010. The first accounts are drawn up to March 31, 2011. The gross profit for the period is Rs. 56,000. The general expenses are Rs. 14,220; Director's fees Rs. 12,000 p.a.; incorporation expenses Rs.1, 500. Rent up to 31st 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. Give Profit and 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. (CA-IPCC GROUP 1)

Question8: Sutanu formed a private Limited Company under the name of Sutanu(P)Ltd.to take over his existing business as from 1 st January,2015 but the Company was not incorporated until 1 st April,2015.No entries relating to transfer of the

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business were entered in the books, which were carried on without a break until 31 st December,2015. The following trial balance was extracted from the books as on 31 st December(end of the year)

Particulars Stock in Trade as at 1 st January Purchases and sales Carriage Outwards Travelers` Commission Office Salaries and Expenses Rent and Rates Sutanu`s Capital Account as 1 st January Directors` fee Fixed Assets Current Liabilities Current Assets(Other than Stock-in-Trade) Preliminary Expenses

Debit

Cr edit

4,300

18,900

27,800

330

750

21,00

1,200

 

23,000

1,800

13,400

 

3,700

11,200

520

Total Accounting for Business Acquisitions- You are also given the following information:

54,500

(1)

Stock as at 31.12.15(end of the year)is.4,400

(2)

Purchase Consideration was agreed at 30,000 to be settled by issue of 3,000 Equity Shares of 10 each.

(3)

The Gross Profit Margin is constant and the monthly sales in January,November and December are double the

(4)

monthly sales for the remaining months of the year. Assume that Carriage Outwards and traveler`s Commission vary in direct proportion to sales. You are required to prepare Trading and profit and Loss Account for the year ended 31 st December apportioning the periods before and after incorporation and a balance sheet as on that date. Ignore depreciation and taxation.

Question.9 MOURYA LTD.incorporated on 1 st may 2015 received the certificate to commence business. On 31 st may,2015 It had acquired a running business from Gopal and Co with effect from 1 st January,2015.The Purchase Consideration was Rs.50,00,000 of which Rs.10,00,000 was to be paid in cash and Rs.40,00,000 in the form of fully paid shares. The company also issued shares for Rs.40,00,000 for cash. Machinery Costing Rs.25,00,000 was then installed. Assets acquired from the vendors were :Machinery Rs.30,00,000;Stock Rs.6,00,000;and patents Rs.4,00,000. During the year ended 31 st December,2015 the total sales ware Rs.1,80,00,000. The sales per month in the first half year being one half of what they were in the latter half year. The net profit of the company, after charging the following expenses, was Rs.10,00,000:

Particulars

Rs.

Depreciation

5,40,000

Director`s fees

86 ,000

Preliminary Expenses

10,000

Office Expenses

2,40,000

Selling Expenses

1,98,000

Interest to vendors

50,000

Ascertain the pre-incorporation and post-incorporation Profits and prepare the Balance Sheet of the Company as on 31 st

December,2015.The Closing Stock was valued at Rs.7,00,000. Purchase consideration was settled on 31 st may,2015.

Question.10. A,B and C are in partnership sharing Profit and Losses in the ration 1/2:1/3:1/6.The Partnership Deed states that each partner is entitled to 6% Interest on Capital.The firm was taken over by Swagata ltd for a total consideration of Rs.8,10,000.On the date of takeover, the Firm`s net Assets, represented by the partner`s Capital Accounts were-A- Rs.3,10,000;B-Rs.2,50,000 and C-Rs.1,90,000. The firm wants to indicate the mode of settlement of purchase Consideration to the company, keeping in mind that the partner`s interests should be equitably retained in the company. The company can issue Equity shares of Rs.10 each and preference shares(rate to be decided)of Rs.100 each. You are required to decide upon the scheme for settlement of purchase consideration.

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