PROFIT OR LOSS PRIOR TO INCORPORATION :

Generally, it happens 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. The profit or loss of the business, thus acquired, the period from the date of purchase till the date of incorporation* is called Profit or Loss Prior to Incorporation. Unless the agreement with the vendors provides otherwise, such a profit or loss belongs to the company. But profit or loss prior to incorporation should not be regarded as trading profit or loss of the company since the company cannot earn profit or incur loss before it comes into existence. In fact, such profit or loss increases or decreases the net assets acquired by the company on its formation and comes to it not as revenue but as capital. Thus, profit or loss prior to incorporation is of capital nature and as such it is necessary to ascertain such profit or loss as accurately as possible.

The profit or loss prior to incorporation should be treated in the books of accounts in the following manner:

(i) Profit prior to incorporation: Such a profit, being of capital nature, cannot be credited to the Profit and Loss Account and thus it cannot ordinarily be used for the purpose of payment of dividend. Hence, such a profit should be credited to Capital Reserve Account which can be utilised in writing off capital losses like preliminary expenses, discount on issue of shares or debentures or in writing down the value of fixed assets including goodwill. Until it is fully utilized, Capital Reserve Account has to be shown in the liabilities side of the Balance Sheet under the heading “Reserve and Surplus”.

(ii) Loss prior to incorporation: Such a loss, being of capital nature, should be debited to a separate account called “Loss Prior to Incorporation Account” which can be written off against other capital profits of the company. It can also be written off against the profit revenue profit of the company.