Profit Prior to Incorporation

A company comes into existence after its incorporation. Incorporation is the first step in establishing a company. The founders of a company need to keep certain preliminary documents ready before going for its registration. After applying for registration, the Registrar of Companies (ROC) issues the company registration certificate. 

The company comes into existence after the issue of the company registration certificate. A company can commence its business and earn profits after its incorporation. Sometimes, a company earns profits when the founders do business in the company name before its incorporation, i.e. before receiving the registration certificate. Such profits are profits prior to the incorporation of a company. 

Pre-Incorporation Period Profits of a Company

The period before incorporation is the pre-incorporation period of the company, and the period after its incorporation is the post-incorporation period of the company.

A private company can commence business after its incorporation, but a public company can commence business after receipt of the certificate of commencement of business. Thus, any profits made by a private company before incorporation and a public company before commencement of business, respectively, are the pre-incorporation period profits. 

The pre-incorporation profits made by the company are capital profits and not legally available for distribution as dividends, as a company cannot earn profits before it comes into existence. The profits earned by the company after incorporation are revenue profits and will be available for distribution as dividends. 

Allocation of Profit in the Pre-Incorporation Period

Since the pre-incorporation period profits of a company are not available for dividends, they need to be separated from divisible profits. The profit and loss account has to be prepared separately for the pre-incorporation period and post-incorporation period. 

The profit and loss account prepared separately for the pre and post-incorporation period separates the profits earned or losses incurred between both the periods of a company. It is possible to prepare separate profit and loss accounts for the pre and post-incorporation period only by closing the books and stock-taking for the two periods. 

However, closing the books and stock-taking for the pre and post-incorporation periods involve tedious work. Thus, the profit or loss is calculated or estimated by apportioning on some reasonable basis such as turnover, time, actual or equitable. The profit and loss account is done at the end of the accounting year, and they are allocated as follows:

• Profits/loss from the date of purchase to the date of incorporation (Pre-incorporation period).
• Profits/loss from the date of incorporation to the closing of the accounting year (Post-incorporation period).

The profits earned during the pre-incorporation period are transferred to the capital reserve account. If the company incurs losses prior to incorporation, it will be treated as a capital loss and transferred to the goodwill account.

Steps to Determine Pre-Incorporation Profits of a Company

Step 1: Prepare a trading account for the whole accounting period.

Step 2: Calculate the time ratio and sales ratio. 

Step 3: Prepare a net profit statement separately for pre and post-incorporation periods based on the following principles:

• Gross profits should be allocated separately for the pre and post-incorporation period based on the sales ratio.
• Divide the fixed expenses such as rent, printing and stationery, postage and telegram, depreciation, telephone charges, etc., on a timely basis and be allocated for the two periods based on time ratio.
• Divide the variable expenses such as advertisement, carriage outwards, brokerage, commission, bad debts, etc., on a sales basis and be allocated for the two periods based on the sales ratio.
•  Interest on purchase consideration, the salary of partners, interest on vendor capital are to be charged to the pre-incorporation period. 
• Certain expenses belong only to the post-incorporation period, such as director’s fees, managing director’s salary, debenture interest, discount on issue of debenture, discount on issue of shares, etc., have to be charged for the post-incorporation period. 
• The audit fees can be divided for the pre-incorporation period or post-incorporation period based on the time ratio. 

Treatment of Pre-Incorporation Profits of a Company

The profits made by a company before incorporation cannot be distributed as dividends to the shareholder of the incorporated company because it is treated as capital profit. It can be used for writing down capital losses or goodwill. The unutilised portion of the capital profit can be transferred to the capital reserve account.

Disclaimer: The materials provided herein are solely for information purposes. No attorney-client relationship is created when you access or use the site or the materials. The information presented on this site does not constitute legal or professional advice and should not be relied upon for such purposes or used as a substitute for legal advice from an attorney licensed in your state.

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