It may happen with a newly formed company that an existing business is taken over as a going concern as at a date prior to the date of incorporation of the company. In such event, the profit of the business, thus acquired, for the period from the date of purchase till the date of incorporation is called profit prior to incorporation. Unless the agreement with the vendors provides otherwise, such a profit belongs to the transferee company.
But profit prior of incorporation should not be regarded as trading profit of the company since the company cannot earn profit before it comes into existence and a company comes into existence only on obtaining the certificate of incorporation. Thus all profits prior to incorporation of a business are capital profits. The apportionment of profit or loss, between the pre incorporation and post incorporation periods can be done on any one of the following basis:
Time Basis The profit or loss for the whole accounting period is apportioned between the periods prior to and after incorporation on the basis of time.
Turn over basis The profit or loss for the whole accounting period is apportioned between the periods prior to and after incorporation on the basis of turnover.
Equitable basis The manner of apportionment of the profit or loss between the periods prior to and after incorporation actually depends upon the nature of each particular item. The most equitable method is normally to apportion the gross profit or gross loss of the whole accounting period on the basis of the turnover and the expenses on heir respective merits, those, varying with turnover being apportioned on that basis and those which depends on time being apportioned on the basis of time.
What is actually to be done in this case is to prepare a trading account for the whole period and to find out the gross profit or loss in the usual way. The Profit and Loss Account is split up into the two periods ( pre and post incorporation) and all the items
appearing in the Profit and Loss Account are then apportioned on the basis of their respective merits.