An organization comes into existence after it is incorporated. Incorporating is the first step in establishing a company. In order for the company to be registered, certain preliminary documents must be available. A company registration certificate is issued by the Registrar of Companies (ROC) after it has been applied for.
After the company registration certificate is issued, it becomes a legal entity. After incorporation, the company can start a business and earn profits. It is possible for a company to earn profits before its incorporation if its founders do business under the company name before the company’s registration certificate is issued, i.e. before it is incorporated.
A Company’s Pre-incorporation Profits
- Incorporation occurs before the company’s pre-incorporation period, and its post-incorporation period occurs after it has been incorporated.
- Public companies can begin doing business after receiving a certificate of commencement of business, whereas private companies can begin doing business immediately after incorporation. The profits made by a private company before incorporation and those of a public company before commencement are the profits made during the pre-incorporation period.
- Pre-incorporation profits are capital profits and aren’t legally available for distribution as dividends since a company cannot earn profits before it exists. Upon incorporation, the company will earn revenue profit prior to incorporation, which are eligible for distribution as dividends to shareholders.
Profit Allocation Prior to Incorporation
Dividends cannot be paid on the profits derived from a company’s pre-incorporation period, which entails separating them from the divisible profits. Profit and loss accounts must be prepared separately for pre-incorporation and post-incorporation periods.
In the profit and loss account of a company, profits and losses are separated between the pre-incorporation and post-incorporation periods. In order to prepare separate profit and loss accounts for the pre-incorporation and post-incorporation periods, the books must be closed and stock took for both periods.
- From the date of purchase until incorporation (pre-incorporation period), profits and losses.
- Incorporated profit/loss from incorporation to accounting year end (post-incorporation period).
Profits earned prior to incorporation are placed in the capital reserve account. Losses prior to incorporation are placed in the goodwill account
A Step-by-Step Guide To Determining a Company’s Profits Before Incorporation
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 a net profit statement separately for pre- and post-incorporation periods is based on the following principles:
- It is advisable to allocate gross profits based on the sales ratio separately for pre-incorporation and post-incorporation periods.
- Assign fixed expenses such as rent, printing and stationery, postage and telegram, depreciation, telephone charges, etc., for the two periods based on the ratio of time.
- Based on the sales ratio, divide variable expenses such as advertising, carriage, commission, bad debts, etc., into two periods.
- It is necessary to charge interest on purchase consideration, the salaries of partners, and interest on vendor capital to the pre-incorporation period.
- There are expenses that must be charged for the post-incorporation period, such as director’s fees and managing director’s salary, debenture interest, discount on debenture issue, discount on share issue, etc.
- As a result of the time ratio, audit fees can be divided into pre-incorporation and post-incorporation periods.
Profits of a Company Before Incorporation
Profits made by an incorporated company before incorporation cannot be distributed to its shareholders as dividends because they are treated as capital profits. Capital profits can be transferred to the capital reserve account if they are not fully utilized. They can be used to write down capital losses or goodwill.