Profit or loss prior to incorporation can be ascertained only when fresh stocktaking and balancing of accounts is done on this date but it will involve a great deal of inconvenience. In order to avoid this inconvenience, and to calculate profit or loss prior to incorporation, the following steps may be taken ;
(1) Prepare the trading account for the whole period i.e., from the date of purchase of business to the last date of accounts closing in order to calculate the gross profit. Date of incorporation will not affect the calculation of gross profit.
(2) Calculate time ratio and sales ratio. Time ratio is calculated by taking into consideration the time falling from the last date of balance sheet to the date of incorporation and the period between the date of incorporation to the last date of presenting final accounts. For example, if (he business is purchased on 1st January 1998 and certificate of incorporation is granted on 1st May 1998 and final accounts are being prepared on 31st December, 1998, then the time ratio is 4 months : 8 months or 1 : 2. Sales ratio is calculated taking into consideration the sales of pre-incorporation period to that of sales of post-incorporation period. For example, if sales of pre-incorporation period are Rs. 1,00,000 and that of post-incorporation Rs. 3,00,000, then the sales ratio is 1 : 3.
(3) Prepare the profit and loss account for the pre-incorporation and post-incorporation periods separately. This is done on the following basis :
(i) Gross profit should be apportioned between the two periods on the basis of their respective sales ratio.
(ii) Such expenses which are directly related on sales such as cost of sales, discount or commission on sales, discount allowed, bad debts, advertising, selling expenses, etc. should be apportioned on the basis of sales ratio of the two periods.
(iii) Fixed expenses such as salaries, rent, audit fees, insurance, general expenses, stationery, printing, depreciation and administrative expenses, etc. should be allocated on the basis of time ratio as these expenses are incurred on the basis of time.
(iv) Expenses which are incurred after the incorporation of the company such as directors’ fees, preliminary expenses, interest on debentures, goodwill written off etc. should be charged wholly to the period after incorporation. Similarly expenses as salary of partners is debited lo the pre-incorporation period.
Calculation of Sales Ratio :
The calculation of sales ratio may be simple in those cases where the turnover is spread during the whole financial period. But where the turnover fluctuates from month lo month according to the nature of product (as woolen garments where the sales are made in the month of October, November, December, and January as compared to other months), the calculation of sales ratio becomes difficult. Moreover, the sales of month of October may be different from the month of December or January. Under such circumstances the sales ratio is determined taking into consideration the relationship of monthly sales with that of total sales.
Calculation of Weighted Ratio :
The total amount of certain expenses such as salary, wages etc. does not remain the same throughout the year. If the expenses remain the same throughout the year, these can be easily divided in the time ratio. But if the expenses change as salary due to more number of workers employed because of conversion of partnership business into a limited company, then weighted ratio is to be calculated by taking into consideration time and the number of workers in pre and post-incorporation periods. For example, a company is incorporated on 1st May, 1998. The total amount of wages paid is Rs. 90,000. Number of workers employed in pre-incorporation period 6, post-incorporation period 24. The wages for pre-incorporation period will be 90,000 x 1/9 = Rs. 10,000 and post-incorporation wages are 90,000 x 8/9 = Rs. 80,000. The ratio is calculated as under:
Simple time ratio = 4 month : 8 months or 1 : 2
Weighted time ratio = (1 x 6): (2 x 24) = 6 : 48 or 1 : 8