Pre-incorporation is the period before the company is incorporated, and post-incorporation is the period after.
After incorporation, a private company can commence business, but after receiving a certificate of incorporation, a public company can begin business. The profits made by a private company before incorporation and by a public company before commencement of business are, therefore, the pre-incorporation period profits.
Profits made by the company before its incorporation are capital profits, which cannot be distributed as dividends because a company cannot earn profits before it is founded. As soon as the company has been incorporated, it will earn revenue profits that can be distributed as dividends to shareholders.
Profit Allocation Prior to Incorporation
Dividends cannot be distributed from pre-incorporation profits, so they have to be separated from divisible profits. The pre-incorporation and post-incorporation profit and loss accounts should be kept separately.
Separation of profits and losses between the pre-incorporation and post-incorporation periods of a company is provided by a what is profit prior to incorporation and loss account prepared separately. In order to prepare separate profit and loss accounts for pre- and post-incorporation periods, the books must be closed and stocktakes taken for the two periods must be conducted.
Closing the books and taking stock during the pre-and post-incorporation periods, however, is a tedious process. The profit or loss is therefore determined by apportioning it based on some reasonable basis such as turnover, time, actual, or equitable basis. The profit and loss account is calculated at the end of the accounting year, and the following allocations are made:
- The profits/losses during the pre-incorporation period are the profits/losses before and after the incorporation date.
- During the period after incorporation (Post-incorporation period), profits/losses are realized.
During the pre-incorporation period, profits are transferred to the capital reserve account, and losses are transferred to the goodwill account if they occur.
Calculating a Company’s Pre-incorporation Profits
Preparation of a trading account for the entire accounting period is the first step.
The second step is to calculate the time ratio and the sales ratio.
Preparation of separate net profit statements for pre- and post-incorporation periods is step three:
- Pre- and post-incorporation gross profits should be allocated separately.
- Divide the fixed expenses such as rent, printing, stationery, postage, telephone charges, etc., as soon as possible and allocate them for the two periods based on a time ratio.
- Based on the sales ratio, divide variable expenses like an advertisement, carriage outwards, brokerage, commissions, bad debts, etc., and assign them to the two periods.
- To be charged to the pre-incorporation period are interest on purchase consideration, partners’ salaries, and vendor capital interest.
- Incorporated expenses such as director’s fees, managing director’s salaries, debenture interest, discount on debenture issuance, discount on share issuance, etc., must be charged post-incorporation.
- In accordance with the time ratio, the audit fees can be allocated to the pre-incorporation period or the post-incorporation period.
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