Chapter 2 PDF

Preview

Summary

Chapter 2...

Description

Chapter 2 Profits Prior to Incorporation

It may happen in case of new companies that a running business is taken over from a certain date, whereas the company may be incorporated at a later date. The company would be entitled to all profits earned after the date of purchase of business unless the agreement with the vendors provides otherwise. But profits up to the date of incorporation of the company have to be treated as capital profits because these are the profits which have been earned even before the company came into existence. Such profits are known as profits prior to incorporation. It should be remembered that a public company cannot commence business till it receives the certificate of commencement of business. Therefore, it would be prudent to treat all profits earned before commencement of business as capital profits. However, strictly speaking, “Profit Prior to Incorporation” means only the profits earned up to the date of incorporation and not up to the date of the certificate of commencement of business. For correct allocation of profits, a profit and loss account should be prepared on the date of incorporation; but this would mean taking stock which is inconvenient. The usual practice, therefore, is to prepare the profit and loss account only at the end of the year and then to allocate the profit between the two periods—up to incorporation and after. Ascertainment of Profit or Loss Prior to Incorporation Following steps are taken for calculating the profit or loss prior to Incorporation :

1st Step : Make Trading Account of Whole Period

A Trading Account should be prepared at first for the whole period, i.e., between the date of purchase and the date of final accounts, in order to calculate the amount of gross profit.

2nd Step : Calculate Time Ratio and Sale Ratio (i) Sales Ratio: Amount of sales should be calculated for the pre-incorporation and post-incorporation periods.

(ii) Time Ratio: It is calculated after considering the time period, i.e., one is required to calculate the period falling between the date of purchase and the date of incorporation and the period between the date of incorporation and the date of presenting final accounts.

3rd Step : Make Profit and loss account prior and after incorporation in different Columns

a) Gross profit will divide on the basis of sale ratio

b) All expenses which are relating to sale will be divide on the basis of sale ratio

c) All fixed charges like salaries, rent, audit fees, insurance, depreciation, administrative expenses will divide on the basis of time ratio. All expenses which done after incorporation will be charged totally to after incorporation. List of Expenses: Allocated on the basis of Sales/Turnover: (a) Gross Profit (b) Selling Expenses (c) Advertisement (d) Carriage Outwards (e) Godown Rent (f) Discount Allowed

(g) Salesmen’s Salaries (h) Commission to Salesmen (i) Promotion Expenses for Sales (j) Distributions Expenses (Variable Portions) (k) Free Samples given (l) Expenses incurred for After-Sale Service, etc. (m) Delivery Van Expenses. List of Expenses: Allocated on the basis of Time: (a) Office and Administration Expenses (b) Salaries to Office Staff (c) Rent, Rates and Taxes (d) Depreciation on Fixed Assets (e) Printing and Stationery (f) Insurance (g) Audit Fees (h) Miscellaneous Expenses (i) Distribution Expenses (Fixed Portion)

(j) Travelling Expenses (General) (k) Interest of Debenture (l) General Expenses (m) Expenses Fixed in Nature.

Problems on calculate of time ratio and sales ratio 1. Calculate the sales ration from the following: X co. was incorporated on 1st May, 2011 and acquired a business with effect from 1st Jan, 2011. Total sales for the calendar year 2011 was ₹ 6,00,000. Sales for Jan and Feb is equal to one and half times the average monthly sales; Sales from March to July is equal to half of average monthly sale; Sales for August and Sep. is equal to one- fourth of average monthly sales and sales from Oct. to Dec. is equal to double the average monthly sales. Solution: a. Time Ratio:

1.1 .2011 Pre−Incorporated Period 1.5 .2011 ¿=4 Months ¿ 1.5 .2011 Post−Incorporated Period 31.12.2011 ¿=8 Months ¿ Time ratio = 4 : 8 or 1:2 Total sales = 6,00,000 6,00,000 =50,000 Average Sales = 12 Sales Ratio=2,00,000 :4,00,000 2 : 4 or 1 : 2 b. Sales ratio Pre-Incorporation Sales 1 January 50,000× 1 2 1 February 50,000× 1 2 1 March 50,000× 2 1 April 50,000× 2

Total Pre-Incorporation Sales

₹ 75,000 75,000 25,000 25,000

2,00,000

Post-Incorporation sales 1 May 50,000× 2 1 June 50,000× 2 1 July 50,000× 2 1 August 50,000× 4 1 September 50,000× 4 October 50,000 × 2 November 50,000 × 2 December 50,000 × 2 Post-Incorporation Sales

₹ 25,000 25,000 25,000 12,500 12,500 1,00,000 1,00,000 1,00,000 4,00,000

2. Calculate the Sales Ratio from the following: X Co. was incorporated on 1st May,2012 and acquired a business with effect from 1st Jan, 2012. Total 1 sales for the calendar year 2012 was ₹ 7,20,000. Sales for Jan and Feb is equal to 1 times the 2 average monthly sales; Sales from March to July is equal to half of average monthly sales; Sales for August and Sep. is equal to one- fourth of average monthly sales and Sales from Oct. to Dec. is equal to double the average monthly sales. Solution: a. Time Ratio:

1.1.2012 Pre−Incorporation Period 1.5 .2012¿=4 Months ¿ 1.5 .2012 Post−Incorporation Period 31.12.2012 ¿=8 Months ¿ Time Ratio = 4 : 8 or 1 : 2 b. Sales ratio: Total Sales for the year = 7,20,000 Average Monthly Sale =

7,20,000 =60,000 12

Pre-Incorporation Sales 1 January 6 0,000 ×1 2 1 February 6 0,000 × 2 1 March 6 0,000 × 2 1 April 6 0,000 × 2

Total Pre-Incorporation Sales

₹ 90,000 90,000 30,000 30,000

2,40,000

Post-Incorporation sales 1 May 6 0,000 × 2 1 June 6 0,000 × 2 1 July 6 0,000 × 2 1 August 6 0,000 × 4 1 September 6 0,000 × 4 October 6 0,000 × 2 November 6 0,000 × 2 December 6 0,000 × 2 Post-Incorporation Sales

₹ 30,000 30,000 30,000 15,000 15,000 1,20,000 1,20,000 1,20,000 4,80,000

3. SS Ltd. Was incorporated on 1-7-2012 to take over the running business of M/s. SK and Co., with effect from 1-4-2012. The company closes its accounts on 31-3-2013. There were 50 employees during the pre-incorporation period and its increased to 70 during the post-incorporation period. Average monthly sales during pre-incorporation period was ₹1,00,000 and the average monthly sales of post-incorporation period was ₹2,50,000. Prepare a statement showing how the following expenses are allocated between pre and postincorporation periods. Rent-₹ 96,000, Salary- ₹ 3,12,000, Salesman Commission- ₹1,02,000 and Directors fess₹25,000. Solution: a. Time Ratio:

1.4 .2012 Pre−Incorporation Period 1.7 .2012¿=3 Months ¿ 1.7.2012 Post−Incorporartion Period 31.3.2013 ¿=9 Months ¿ 3 : 9 or 1 : 3 b. Sales Ratio: Pre-Incorporation Sales ₹1,00,000 Monthly Pre-Incorporation Period = 3 Months Pre-Incorporation Sales ₹ 1,00,000 × 3=3,00,000 Post-Incorporation Sales ₹2,50,000 Post-Incorporation Period = 9 Months Post-Incorporation Period ₹ 2,50,000 × 9=22,50,000 Sales Ratio = 3,00,000 : 22,50,000 or 6 : 45 c. Weighted Ratio: Pre-Incorporation Period 3 Months No of Workers in Pre-incorporation Period = 50 Pre-Incorporation Ratio 3 ×50= 150 Post-Incorporation Period 9 Months No of Workers in Post-Incorporation Period = 70 Post-Incorporation Ratio 9 ×70 =630 150 :63015 :63∨5 : 21 Statement of allocation of expenses between pre and post incorporation Particulars Rent Salaries Salesmen Commission Director’s fee Total

Ratio 1:3 5 : 21 6 : 45 Post

Pre-Incorporation 24,000 60,000 12,000 96,000

Post-Incorporation 72,000 2,52,000 90,000 25,000 4,15,000

4. ABC Company Ltd. Was incorporated on 30th June, 2011 to take over the business of Mohan as from 1st Jan,2011. The financial figures of the business for the year ended 31-12-2011 is as follows: Particulars Jan to June

Sales; July to Dec. Less: Purchases

Amount 1,20,000 1,80,000 Jan to June 75,000 July to Dec. 1,20,000

Amount 3,00,000 1,95,000

Gross Profit

1,05,000

Less Expenses: Salaries Selling Expenses Depreciation Director’s Remuneration Debentures Interest Administration Expenses

15,000 3,000 1,500 750 90 4,500

Net Profit

24,840 80,160

You are required to prepare a statement showing pre-incorporation and post-incorporation period profits. Solution: a. Time Ratio: 1.1 .2011 Pre−Incorporation Period 30.6 .2011 ¿=6 Months ¿ 1.7 .2011 Post−Incorporation Period 31.12.2011 ¿=6 Months ¿ Time Ratio = 6 : 6 or 1 : 1 b. Sales Ratio: Pre-Incorporation Sales = 1,20,000 Post-Incorporation Sales = 1,80,000 Sales Ratio = 12 : 18 or 4 : 6 or 2 : 3

Statement showing profits for pre incorporation and post incorporation period for the year ending 31.12.2011 Particulars Gross Profit

Ratio 2:3 Total (A)

Expenses: Salaries Selling Expenses Depreciation Director’s Remuneration Debentures interest Administration expenses Total (B) Capital Reserves(A-B)

1:1 2:3 1:1 Post Post 1 :1

Pre-Incorporation 42,000 42,000 7,500 1,200 750 2,250 11,700 30,300

Post-Incorporation 63,000 63,000 7,500 1,800 750 750 750 2,250 13,140 -

Net Profit (A-B)

-

49,860

5. Gajendra Ltd. Was incorporated on 1-7-2011 to take over the business of G.K. Enterprises and a going concern with effect from 1-4-2011. The P & L A/c for the year ended 31-3-2012 of the company was as follows: Particulars The opening stock To purchases To administration Expenses To Director’s Fees To Selling Expenses To Audit fees To Preliminary Expenses To Net Profit

Amount Particulars 60,000 By sales 87,500 By closing Stock 9,000 1,500 18,000 500 1,500 7,000 1,85,000 Prepare a statement showing the profit earned prior to and after incorporation.

Solution: a. Time Ratio 1.4 .2011 Pre−Incorporation Period 1.7 .2011¿ 3 Months ¿ 1.7 .2011 Post−Incorporation Period 31.3.2012 ¿ 9 Months ¿ 3 : 9 or 1 : 3 b. Sales Ratio Total Sales = 1,50,000 1,50,000 =₹ 12,500 12 Pre−Incorporation Sales =37,500 ₹ 12,500 ×3 Months

Average Monthly sale=

Post−Incorporation Sales =1,12,500 ₹ 12,500 ×9 Sales Ratio=375 =1125∨75=225 ∨1:3

Amount 1,50,000 35,000

1,85,000

Statement Showing Pre and Post Incorporation profit for the year ended 31.3.2012 Particulars Gross Profit

Ratio 1:3 Total (A)

Expenses: Administration Expenses Director’s Fee Selling Expenses Audit fee Preliminary Expenses Total (B) Capital Reserves(A-B) Net Profit (A-B)

1:3 Post 1:3 1:3 Post

Pre-Incorporation 9,375 9,375

Post-Incorporation 28,125 28,125

2,250 4,500 125 6,875 2,500 -

Note: Gross Profit arrived as follows Sales +Closing Stock ( 1,50,000 ) 1,50,000 −¿ ¿ ¿ Gross Profit Distribution between pre and post incorporation in the sales ratio of 1 : 3

6,750 1,500 13,500 375 1,500 23,625 4,500

37,500

6. A company was incorporated on 30th June which acquired a business as from 1st Jan. the accounts for the year ended 31st December disclosed the following: a. The gross profit was ₹2,40,000 b. The sales for the year amounted to ₹12,00,000 of which ₹5,40,000 were for 1st 6 Months. c. The expenses debited to P&L A/c included Director’s fees of ₹15,000; Bad Debt of ₹3,600 and Advertisement ₹ 12,000 (under a contract @ ₹1,000 p.m.); Salaries and General Expenses ₹64,000; Preliminary Expenses written off ₹5,000 and Donation to a political party given by the company ₹5,000. Prepare a statement showing the amount of profit made before and after incorporation.

Solution: a. Time Ratio: 1 Jan Pre−Incorporation Period 30 June ¿ 6 Months ¿ 1 July Post−Incorporation Period 31december ¿ 6 Months ¿ Time Ratio6 :6 ∨1 :1 b. Sales Ratio: Pre-Incorporation Sales = ₹5,40,000 Post-Incorporation Sales (12,00,000 – 5,40,000) = ₹6,60,000 54 : 66 or 9 : 11

Statement Showing Pre and Post Incorporation profit for the year ended 31.3.2012 Particulars Gross Profit

Ratio 9:11or 54 : 66 Total (A)

Pre-Incorporation 1,08,000 1,08,000

Post-Incorporation 1,32,000 1,32,000

Expenses: Director’s fee Bad debts Advertisement Salary and General Expenses Preliminary Expenses Donation (paid by Company) Total (B) Capital Reserves(A-B) Net Profit (A-B)

Post 9:11 1:1 1:1 Post Post

1,620 6,000 32,000 39,620 68,380 -

15,000 1,980 6,000 32,000 5,000 5,000 64,980 67,020

7. Victory Ltd. was incorporated on May 1st ,2011 to take over business of Camlin Co., as a going concern from 1-1-2011. The P and L Ac for the year ending 31-12-2011 was as follows: Particulars To Rent and Taxes To Insurance To Electricity Charges To Salaries To Director’s Fees To Auditor’s Fees To Commission To Advertisement To Office expenses To Carriage To Bank charges To Preliminary expenses To Bad Debts To Interest on loan To Net Profit

Particulars Amount 24,000 By Gross Profit 3,10,000 6,000 4,800 72,000 6,000 3,200 12,000 8,000 7,000 6,000 3,000 13,000 4,000 6,000 1,35,000 3,10,000 3,10,000 st st The total turnover for year ended 31 Dec. 2011 was ₹ 10,00,000 divided into ₹3,00,000 upto 1 May and ₹ 7,00,000 for the remaining period. Ascertain the profits earned prior to and post incorporation periods. Solution:

Amount

a. Time Ratio: 1.1.2011 Pre−Incorporation Period 1.5 .2011 ¿ 4 Months ¿ 1.5 .2011 Post−Incorporation Period 31.12.2011 ¿ 8 Months ¿ Time Ratio = 4 : 8 or 1 : 2 b. Sales Ratio: Pre-Incorporation sales = ₹3,00,000 Post-Incorporation sales = ₹7,00,000 Sales ratio = 3 : 7

Statement Showing Pre incorporation and Post incorporation period profit for the year ended 31.12.2011 Particulars Gross Profit

Ratio 3:7 Total (A)

Expenses: To Rent and Taxes To Insurance To Electricity Charges To Salaries To Director’s Fees To Auditor’s Fees To Commission To Advertisement To Office expenses To Carriage To Bank charges To Preliminary expenses To Bad Debts To Interest on loan Total (B) Capital reserve (A-B)

Pre-Incorporation 93,000 93,000

1:2 1:2 1:2 1:2 Post 1:2 3:7 3:7 1:2 3:7 1:2 Post 3:7 1:2

Post-Incorporation 2,17,000 2,17,000 16,000 4,000 3,200 48,000 6,000 2,133 8,400 5,600 4,667 4,200 2,000 13,000 2,800 4,000

8,000 2,000 1,600 24,000 1,067 3,600 2,400 2,333 1,800 1,000 1,200 2,000 51,000 42,000

1,24,000 -

Net Profit (A-B)

-

93,000

8. Naveen Enterprise Ltd., purchased from Praveen his business on 1-1-2011. But the company was incorporated on 1-4-2011. From the following information find out the profits earned by the company prior to and the after incorporation: a. For the year 2011 the total sales was ₹2,40,000 and the trend of sales was as follows: Jan and Feb – half the average monthly sales; May, June and October – Average Sales for each month and Nov and Dec, - Half the average Sales for each month. b. COGS ₹60,000 c. Salary and other expenses ₹6,000 d. Bad debts ₹2,400 e. Interest on PC which was paid on 1-8-2011 ₹2,100 and f. Expenses exclusively related to the company ₹8,900. Solution: a. Calculation of Time Ratio 1.1 .2011 Pre−Incorporation Period 1.4 .2011 ¿ 3 Months ¿ 1.4 .2011 Post−Incorporation Period 31.12.2011 ¿ 9 Months ¿

Time ratio = 3:9 b. Sales Ratio: August monthly sales= Pre-Incorporation Sales 1 January 2 0,000 × 2 1 February 2 0,000 × 2 1 March 2 0,000 ×1 2 1 April 2 0,000 ×1 2

2,40,000 =20,000 12 ₹ 10,000

Post-Incorporation sales May 2 0,000 × 1

₹ 20,000

10,000

June 2 0,000 × 1

20,000

30,000

July 2 0,000 × 1

20,000

30,000

August 2 0,000 ×1

30,000 30,000

1 2

September 2 0,000 ×1 October 2 0,000 × 1 November 2 0,000 ×

1 2

1 2

20,000 10,000 10,000

1 2 Post-Incorporation Sales December 2 0,000 ×

Total Pre-Incorporation Sales

80,000

1,60,000

Sales Ratio = 80,000 : 1,60,000 or 1 : 2 Sales for the months of March, April, August and September is arrived as follows: Total sales (-) Sales as calculated except for above period Remaining sales 1,20,000 =30,000is equal ¿ 1.5 month sales 4 months

2,40,000 1,20,000 1,20,000

Statement showing Pre incorporation and post incorporation profits for the year ending 31.12.2011 Particulars Gross Profit

Ratio 1:2

Total (A) Expenses: Salaries and other expenses Bad debts Interest on PC (Note 3) Expenses related to company Total (B) Capital Reserves(A-B) Net Profit (A-B)

1:3 1:2 3:4 Post

Pre-Incorporation 60,000 60,000

Post-Incorporation 1,20,000 1,20,000

1,500 800 900 3,200 56,800

4,500 1,600 1,200 8,900 16,200 1,03,800

Note 2: Calculation of Gross Profit Total sales (-) Cost of Goods Sold Gross profit

2,40,000 60,000 1,80,000

Note 3: Interest on PC Ratio Pre-Incorporation period Post Incorporation Period

1.1.2011 to 1.4.2011 = 3 Months 1.4.2011 to 1.8.2011 = 4 Months

Ratio = 3:4

9. The T Co., Ltd. was formed on 1st April 2011 to take over the business formerly carried on by M/s. B and Co. as and from 1st Jan,2011. It was agreed that all profits made subsequently to this latter date should belong to the company, but interest on PC (₹ 50,000) at the rate of 6% p.a.

should be paid to the vendors until the final settlement which took on 1st June, 2011. The following was the P and L A/c as prepared on 31st Dec., 2011. Particulars To management expenses To Director’s fees To preliminary expenses To Bad debts To interest to vendors To depreciation To net profit

Amount Particulars Amount By gross profit 20,000 3,000 1,000 500 200 1,250 1,000 13,050 20,000 20,000 It was found that of the bad debts written off ₹ 100 related to debts taken over by the company. Calculate the pre and post Incorporation. Solution: a. Calculation of Time Ratio: 1.1 .2011 pre−Incorporation period 1.4 .2011 ¿=3 months ¿ 1.4 .2011 Post−Incorporation period 31.12.2011 ¿=9 months ¿ Time Ratio = 3:9 or 1:3

b. Vendor Ratio: 1.1 .2011 pre−Incorporation period 1.4 .2011 ¿=3 months ¿ 1.4 .2011 Post−Incorporation period 1.6 .2011 ¿=2 months ¿ Vendor Ratio = 3:2

Statement showing Pre incorporation and Post incorporation profit for the period ended 31.12.2011 Particulars Gross Profit

Ratio 1:3 Total (A)

Expenses: Management expenses Director’s fees Preliminary Expenses

1:3 Post Post

Pre-Incorporation 5,000 5,000 1,000 -

Post-Incorporation 15,000 15,000 2,000 1,000 500

Bad debts Intern to vendor Depreciation

Given 3:2 1:3

100 750 250 2,100 2,900 -

Total (B) Capital Reserves(A-B) Net Profit (A-B)

100 500 750 4,850 10,150

10. RKS Ltd., was incorporated on 1-9-2012 to take over the running business of M/s. SK and Co., with effect from 1-4-2012. The company closed its accounts on 31-3-2013. Particulars

Amount

Particulars

Amount

Gross profit Discount earned Interest on investments Salaries and wages Discount allowed Preliminary expenses written off General expenses Carriage outward Bad debts

24,00,00 0 1,14,000 1,20,000 3,60,000 2,16,000 10,000 24,000 5,400 3,600

Interest to vendors (up to 31-12013) Rent paid Selling expenses Director’s ...