This articles talks about profit prior to incorporation. The detail information and the basis of computing the profit thus mentioned here.
Profit prior to Incorporation
Profit of a business for the period prior to the date company into existence is referred to as Pre-Incorporation profit. Hence prior period item are those item which is done before incorporation of the company. Profit prior to incorporation is the profit earned or loss suffered during the period before incorporation. It is a capital profit and not legally available for distribution as dividend because a company cannot earn a profit before it comes into existence.
Profit earned after incorporation is revenue profit, which is available for dividend. Profit of prior period and post period however divided separately because the prior period profit and loss hence always credited and charged from capital reserve A/c. Post period profit and loss thus credited and charged from Profit & Loss A/c.
Methods of computing profit and loss prior incorporation
One is to close the old books and open new books with the assets and liabilities as the existed at the date of incorporation. In this way, automatically the result to that willhowever adjusted.
The second method is to split up the profit for the year of the transfer of the business to the company between “pre-Incorporation” and “Post-Incorporation” periods. This also done either on time basis or on turnover basis or by a method which combines two.
Basis of allocation of items between ‘pre’ and ‘post’ incorporation period
Some type of expense and income which thus divided between pre and post period item on basis of time ratio.
For example-Depreciation, salary & wages, Rent and trade expenses etc.
Some type of expense and income thus divided between pre and post period item on the basis of turnover.
For example-sales promotion expenses,bad debts, sales commission and selling expenses.
- Some expenses which therefore treated as always pre-Incorporation period like promoters remuneration, survey report and expenses regarding articles of association and memorandum of association.
- Some expenses which however treated as always post-Incorporation period like directors fees and debenture interest.
Debtors & Creditors Suspense Accounts
- 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 creditors on behalf of the vendors in such a case, the debtors and creditors of a vendors will include in the accounts for the company by debit or credit separate total accounts in the general ledger to distinguish them from the debtors and creditors of the business and contra entries will make in corresponding suspense account. Also details of debtors and creditors balance will thus kept in separate ledger.
- The vendor hence treated as a creditors 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 vendor thus consider a debtors in respect of cash paid to his creditors by the purchasing company. The balance of cash collected , less paid, will represent the amount due to or by the vendor, arising from debtors and creditors balances which have taken over, subject to any collection expenses.
- Balance in suspense account will be equal to the amount of debtor and creditors taken over remaining unadjusted at anytime.