Profit Prior to Incorporation – Accounting Treatment

Introduction

Once we have allocated the Net Profit into "Pre-Incorporation" and "Post-Incorporation" using the Columnar P&L, we must record them in the books.

1. Accounting Entries

A. For Pre-Incorporation Profit (Capital Profit)

This amount is credited to Capital Reserve Account.

Profit & Loss Suspense A/c ...Dr       (Pre-Profit Amount)
    To Capital Reserve A/c                 (Pre-Profit Amount)

B. For Pre-Incorporation Loss (Capital Loss)

This amount is debited to Goodwill Account.

Goodwill A/c ...Dr                     (Pre-Loss Amount)
    To Profit & Loss Suspense A/c          (Pre-Loss Amount)

(Alternatively, it can be adjusted against Annual Profit, but showing it as Goodwill is better presentation).

C. For Post-Incorporation Profit

This is the normal Revenue Profit.

Profit & Loss Suspense A/c ...Dr       (Post-Profit Amount)
    To Surplus in Statement of P&L         (Post-Profit Amount)

2. Weighted Ratios (Advanced)

Sometimes, sales are not uniform.

• Example: "Sales in Post period are TWICE the sales in Pre period."
• Let Pre Period = 4 months, Post Period = 8 months.
• Let Sales per month in Pre = 1. Total Pre Sales = 4x1 = 4.
• Let Sales per month in Post = 2. Total Post Sales = 8x2 = 16.
• Weighted Sales Ratio = 4 : 16 or 1 : 4. (Instead of plain time ratio).

3. Treatment in Balance Sheet

1. Capital Reserve (Pre-Profit): Shown under Reserves and Surplus.
2. Net Profit (Post-Profit): Added to Surplus.
3. Goodwill (Pre-Loss): Shown under Intangible Assets.

Exam Notes: Writing the Answer

Question: "Can Pre-Incorporation Profit be used to declare dividend?" (2 Marks)

Answer: No. Pre-Incorporation profit is a Capital Profit. Dividend can only be declared out of Revenue Profits. Hence, it is transferred to Capital Reserve.

Comparison: Pre vs Post Profit

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Summary

• Pre Profit -> Capital Reserve.
• Pre Loss -> Goodwill.
• Weighted Ratio: Used when sales trend varies.

Quiz Time! 🎯

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