A company comes into existence in its name only after its incorporation and as such, can act then in its name. It may be that the company might have taken over a concern from the vendors of a business from a date prior to the incorporation of the company itself.
If any profits are earned before incorporation, they cannot be regarded as profits available for dividend but are of a capital nature. The vendors on their part are not entitled to such profits but to interest as purchase consideration.
Such profits can be utilized for the following purposes:
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Paying interest to vendors on the amount of purchase consideration. Such interest should be calculated up to the date of incorporation and after this date, it should be charged to the company’s Profit and Loss Account.
Writing of Goodwill, if any, taken over from the vendors.
Writing off some other fixed assets.
And then, carrying forward the remaining balance to a Capital Reserve.
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There are difficulties in calculating such a profit. The basis of calculation may be as given hereunder:
(i) Gross profits on the basis of turnover of the two periods.
(ii) Direct expenses, such as advertising, commission, etc., on the basis of turnover.
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(iii) Indirect expenses, such as salaries, rent, taxes, etc., on the basis of the time of each period.
Such profits may, thus, be profits prior to incorporation and subsequent to incorporation.
If there is any loss prior to incorporation, it should be (i) debited to Goodwill Account, or (ii) transferred to Suspense Account which may be adjusted or written off out of the Capital Profits.