UNIT IV
Ascertainment and Treatment of Profit Prior to Incorporation
From time to time, companies are made to buy a particular running or going concern. A company is born only after its registration, that is, its establishment. A company can only make a profit after it is founded, but not before it is founded. In many cases, the acquisition date of a business may not coincide with the establishment date.
For example, a company founded on May 1, 2004 may purchase a business from January 1, 2004, which is the start date of the fiscal year. In general, a going concern assumption is purchased based on the idea of the last record
It's more convenient for both-sellers, and therefore sellers. If you want to buy a business on a date other than the balance sheet date, you need to acquire and validate accounts such as stocks, assets, and liabilities. The process is a tedious task. To avoid this tedious task, you can also buy a business from the day the company creates its last final account.
Private companies can start their business immediately after they are established, but public companies can only start their business after obtaining a business start certificate. In other words, all profits earned before the establishment of a corporation in the case of a private company and before the start of a business in the case of a public company should be regarded as capital gains. However, keep in mind that the pre-establishment profit and loss calculation takes into account the date of establishment, not the date of business start.
For example, a company founded on January 4, 2004 agrees to require a business that has been running since January 1, 2004. The account will be closed on December 31st. The company is entitled to receive profits or losses from January 4, 2004 to December 31, 2004, as well as profits or losses from January 1, 2004 to 31.3.2004. The profits earned before incorporation, that is, from January 1, 2004 to 31.3.2004, are understood as pre-incorporation profits. This is not considered a profit, but it is a capital profit.
Such profits may be transferred to capital reserves or used to assess financial losses. If a loss occurs during the pre-establishment period, the loss must be debited to the goodwill account. The profits earned during the post period, that is, between January 4, 2004 and December 31, 2004 in the above example, are profits and profits that can be used for dividends.
Allocation of "profit / loss" to pre-establishment and post-establishment periods:
Pre-incorporated profits cannot be used for dividends and must be separated from divisible profits. This is possible if the income statement is prepared separately for the pre-establishment period and the post-establishment period. And this is only possible by closing the books and inventory for the two periods. These are tedious tasks. Therefore, profits or losses are estimated by allocating on a time, sales, impartial or practical reasonable basis.
In practice, an equivalent set of books is maintained throughout the fiscal year.
The P & L account is ready at the beginning of the year, after which profits or losses are allocated between the two periods.
- From the date of purchase to the date of establishment (pre-establishment period) and
- From the date of establishment to the end of the fiscal year (period after establishment).
Accounting method:
To find profits or losses before and after establishment:
1. We will have one trading account for the entire period. Do not consider the date of establishment. Therefore, you will receive one number of gross margins for the entire period.
2. Gross profit margin is distributed between two periods, pre-establishment and post-establishment, based on the concept of sales within the two periods.
The various costs shown on the income statement should be divided into pre-establishment and post-establishment periods on a logical and appropriate basis.
Sales ratio:
In a simple matter where sales are evenly distributed over the entire period, sales are distributed between pre-establishment and post-establishment periods at a rate of that period. However, in many cases sales fluctuate from time to time. Therefore, the sales ratio is recognized based on the concept of each sale, taking into account the pre-establishment and post-establishment periods. (Sales and time basis.)
Handling of pre-establishment results:
Profit or loss from the date of purchase of the business to the date of establishment belongs to the company. Such profits should not be considered transaction profits. Pre-establishment profits are treated as capital gains and cannot be distributed as dividends to the shareholders of the purchasing company.
The income statement is prepared at the end of the year and then the profit and loss is allocated between the two periods.
(I) from the date of purchase to the date of establishment (pre-establishment period) and
(II) From the date of establishment to the end of the fiscal year (period after establishment).
Accounting method:
Particulars | Basos of Apportioment |
5. All expenses relating to Post-incorporation period, such as, Preliminary Expenses, Director Fee, Interest on Debentures, under-writing Commissions, Subscription to Political parties, Donations given by company etc.
| Sales and Ratio Time Ratio
Sales Ratio
No allocation, The complete expenditures relating to pre-incorporation period. No allocation, Wholly to post-incorporation period. |
To find profits or losses before and after establishment:
1. Set up one trading account for the entire period. Do not consider the date of establishment. Therefore, you will reach one figure of gross profit for the entire period.
2. Gross profit is distributed to two periods, pre-establishment and post-establishment, based on sales in the two periods.
3. The various costs shown on the income statement should be divided into pre-establishment and post-establishment periods on a logical and appropriate basis.
They are shown below.
Sales ratio:
In a simple matter where sales are evenly distributed over the entire period, sales are distributed between pre-establishment and post-establishment periods at a rate of that period. However, in many cases sales fluctuate from time to time. Therefore, the sales ratio is calculated based on each sale, taking into account the pre-establishment and post-establishment periods. (Sales and time basis.)
Handling of pre-establishment results:
Gains and losses from the date of purchase of the business to the date of establishment belong to the company. Such profits should not be considered transaction profits. Pre-establishment profits are treated as capital gains and cannot be distributed as dividends to the shareholders of the purchasing company.
The handling of the results before the establishment is as follows.
(A) Profit before establishment:
1. Profit has the nature of capital gains.
2. Do not use capital gains to pay dividends.
3. Can be used to evaluate goodwill or capital loss.
4. The unused portion of profit can be transferred to capital reserve.
(B) Loss before establishment:
1. You can treat it as goodwill and add it to your goodwill account.
2. It may also be treated as a deferred revenue expense and amortized on profits over the years.
3. The special account (loss before establishment of corporation) may be debited.
Key takeaways:
|
Preparation of separate, combined and columnar Profit and Loss Account including different basis of allocation of expenses/ incomes
The article below details how to calculate your pre-establishment profit and loss.
1. Introduction of profit / loss before establishment
2. Calculation method of profit / loss before establishment
3. Accounting method
4. Accounting treatment
Pre-establishment profit / loss summary:
If you take over the business from a date before the establishment / start, the profits earned by the establishment / start date (established for a private company, started for a public company) are called “Profit before establishment”
The same is treated as capital gains, as these are the profits earned before the company was founded. In short, profits earned after the date of purchase of a business are called "profit after incorporation or acquisition", and profits earned before the date of purchase of a business are called "profit before incorporation". ..
For example, X Ltd. was founded on April 1, 2006, acquired the operating business Y Ltd. from January 1, 2006, and closed its account on December 31, 2006. Currently X Ltd. Is Y Ltd from April 1st to December 31st, 2006, Y Ltd. from January 1, 2006 to March 31, 2006, as well as profits / losses due to Profit / loss .
Therefore, profits and losses generated before establishment are called "profit (loss) before establishment", are treated as capital gains, and cannot be distributed as business profits. Therefore, it cannot be distributed as a dividend.
The same can be transferred to capital reserves or adjusted for goodwill. "Pre-establishment loss" is treated as a capital loss, so the same thing appears under the "Other Expenditures" heading on the asset side of the balance sheet.
How to calculate profit / loss before establishment:
You need to prepare an income statement on the date of establishment to confirm the profit before the establishment. But in reality, the same books are maintained throughout the fiscal year.
The income statement is prepared at the end of the year, after which profits (or losses) are allocated between the two periods.
- From the date of purchase to the date of establishment or the period before establishment.
- From the date of establishment to the end of the fiscal year or the period after establishment.
Accounting method for profit and loss before establishment:
Procedures may be suggested to identify profits or losses prior to establishment.
Step I:
In order to calculate the gross profit amount, you must first create a trading account for the entire term, from the purchase date to the last account date.
Step II:
Calculate the following two ratios.
- Sales ratio Sales must be calculated for the pre-establishment and post-establishment periods.
- Time ratio: It is calculated considering the period. That is, you need to calculate the period from the date of purchase to the date of establishment and the period from the date of establishment to the date of presentation of the final account.
Step III:
You need to make a statement to calculate the net income before and after the establishment individually based on the following principles.
- Gross profit must be allocated to the two periods based on the sales ratio that represents the gross profit for the two separate periods. Before and after incorporation of company.
- Fixed or time-based costs, such as rent, salary, depreciation, and interest, must be allocated in two periods based on a time ratio.
- Variable or sales-related expenses must be distributed over two periods based on the sales ratio.
- Certain costs, such as partner salaries, director salaries, reserves, and corporate bond interest, are not allocated as they are related to a particular period. For example, partner salaries are billed for pre-acquisition profits, and director compensation, corporate bond interest, etc. are billed for post-acquisition profits.
List of Expenses: Assigned based on sales / sales:
(A) Gross profit
(B) Selling expenses
(C) Advertising
(D) Outward transportation
(E) Warehouse rent
(F) Discounts are allowed
(G) Salesman salary
(H) Commission to salesman
(I) Sales promotion expenses
(J) Distribution cost (variable part)
(K) Free sample provided
(L) Costs for after-sales service, etc.
(M) The cost of the delivery van.
List of Expenses: Allotted based on time:
(A) Administrative and administrative expenses
(B) Salary to office staff
(C) Rent, charges, taxes
(D) Depreciation of fixed assets
(E) Printing and stationery
(F) Insurance
(G) Audit fee
(H) Miscellaneous expenses
(I) Distribution costs (fixed part)
(J) Travel expenses (general)
(K) Interest on corporate bonds
(L) General expenses
List of Expenses: Allotted based on time:
(A) Administrative and administrative expenses
(B) Selling expenses
(C) Advertising
(D) Outward transportation
(E) Warehouse rent
(F) Insurance
(G) Audit fee
(H) Miscellaneous expenses
(I) Distribution costs (fixed part)
(J) Travel expenses (general)
(K) Interest on corporate bonds
(L) General expenses
(M)Fixed costs in nature.
Pre-establishment profit / loss application / accounting:
(A) Profit before establishment:
Since "pre-establishment profit" is a capital gain, the same must be amortized for:
- Reserve expense account
- Formation cost account
- Clearing expense account
- If the fixed asset is worth it, write it down
- Goodwill account
- If there is a balance, it will be transferred to the capital reserve.
(B) Loss before establishment:
The same is adjusted because "pre-establishment loss" is a capital loss.
- Capital gains
- Debit the goodwill account
- Depreciation of fictitious assets
- Capital reserve.
Figure 1:
Ruling/Format In the Books of……
Statement of Profit Pre- and Post-incorporation
Particulars | Total | Basis of Allocations/ Apportionment | Pre-incorporation profit | Post-incorporation profit | ||
|
|
| Dr. | Cr. | Dr. | Cr. |
Gross Profit Less: Expenses and Losses Fixed Expenses (Variable Expenses before incorporation) Expenses after Incorporation Net Profit c/d
Nat Profit b/d Dividend Any Income Net Profit -Transferred to Capital Reserve -Net Profit transferred to P & L A/c |
***
***
*** *** ***
|
Sales Ratio
Time Ratio Sales Ratio - -
Actual Actual
| Rs. -
*** *** *** - *** | Rs ***
- - - - - | Rs -
*** *** - *** *** | Rs ***
- - - - - |
*** | *** | *** | *** | |||
- -
*** - |
*** *** - -
|
- ***
|
*** *** - -
| |||
*** | *** | *** |
Problem 1:
S. Ltd was registered on January 1, 2000 to acquire the business of M / s P. Ltd. on October 1, 2008, and has a certificate of start of business on February 1, 2009. I got.
The company's accounting for the period ended September 30, 2009 disclosed the following facts:
- Sales for the entire period reached rupees. 3,000,000 rupees 50,000 related to the period from October 1, 2008 to February 1, 2009.
- The trading account showed gross profit of Rs. 1, 20,000.
- The following items are displayed in the income statement.
Director’s Fee Auditor’s fees Rent, Rate and Taxes etc. Bad Debts (of which Rs 1,000 related to Book debts created before 1st February 2009) Salaries Advertising Travelling Expenses and Salaries Commission on Sales General Expenses Preliminary Expenses Depreciation on Plant Printing and Stationery Interest to Vendors @ 12% on Rs 50,000 from 1.10.2008 to 31.5.2009 | Rs 2,000 1,000 5,400 3,000 18,000 6,000 9,000 1,200 2,100 4,000 2,000 1,200 1,500 4,000 |
Prepare a statement the amount of Profit made before incorporation and after incorporation.
Solution:
In the Books of S. Ltd.
Statement of Profit Pre-and Post-incorporation
Particulars | Amount | Basis of Apportion | Profit for pre-incorporation period | Profit for post-incorporation period | ||
|
|
|
| |||
Gross Profit Less: Expense and Losses Director’s Fee Auditor’s Fee Rent, Rate and Taxes etc. Bad Debts Salaries Advertising Travelling Expenses Commission on Sales General Expenses Preliminary Expenses Depreciation on Plant Printing and Stationery Interest to vendors Net Profit Transferred to: -Capital Reserve -P & L Appropriate
| Rs 1,20,000
2,000 1,000 5,400 3,000 18,000 6,000 9,000 1,200 2,100 4,000 2,000 1,200 1,500 4,000 |
Turnover (1:5)
Actual “ Time (1:2) Actual Time (1:2) Turnover(1:5) “ “ “ “ Time (1:2) Actual “ Time(1:2) Time(1:2) Time(1:1) | Rs
- - 1,800 1,000 6,000 1,000 1,500 200 700 - - 400 500 2,000
4,900 - | Rs 20,000
| Rs
2,000 1,000 3,600 2,000 12,000 5,000 7,500 1,000 1,400 400 2,000 8,000 1,000 2,000
- 54,700 | Rs 1,00,000
|
20,000 | 20,000 | 1,00,000 | 1,00,000 |
Note:
1. Sales-related costs are allocated based on sales (that is, 1: 5).
2. Other costs will be allocated based on time only (i.e. 1: 2).
3. From the profit before establishment, you can also charge a reserve cost for the capital reserve.
Problem 2:
Moon Ltd was established on June 1, 2009. He has taken over the business of N, which is the ownership of Rs, from January 1, 2009. All profits earned after January 1, 2009 are 100,000, provided they belong to the company. The following is the income statement data for the year ended December 31, 2009.
Gross profit Rs. 2,00,000; salary and bonus Rs. 15,000; Rent Rs. 1,000; Bad debt Rs. 5,000; Reserve Rs. 9,000; Committee of Sales Rs. 12,000; Interest paid on or against the purchase price Rs. 1,000; Board membership fee Rs. 3,000; Managing Director Reward Rs. 14,600; Establishment cost Rs. 21,000; Depreciation Rs. 10,000; and advertising Rs. 27,000.
(A) Sales for the first 6 months were rupees. 10, 00,000; Gross profit margin is 12% of sales. Gross profit margin was 8% in the second half. The sales commission was 6% throughout the year. Inventory and work in process issues do not occur in business.
(B) Until March 1, 2009, N was operating on its premises with only cash sales and no depreciable assets.
(C) The ads for the first 6 months were at Rs rates. 4,000 per month.
Create pre-incorporation and post-incorporation period profit accounts in a column format that provides the basis for separation for each item. How much was the profit before the establishment? It takes calendar months of the same length limit to the given data only.
How it works:
Therefore, the profit before the establishment reached rupees. 57,082. Gross profit reached rupees 2, 00,000 or 12 months. Profit for the first 6 months reached rupees. At 1,20,000 (Rs. 10,00,000 x 12/100), the profit for the next 6 months remains, that is, Rs. 80,000 (Rs. 2,00,000 – Rs. 1,20,000) is 8% of sales. Sales Rs for the next 6 month, assume 10, 00,000 (Rs. 80,000 x 100/8), sales evenly distributed by month. The sales ratio for the two periods is 5: 7. Sales commissions will be allocated accordingly.
Solution:
In the Books of Moon Ltd.
Statement of Profit
Pre and Post-incorporation
Particulars | Amount | Basis of Apportion | Profit |
| ||
Pre-incorporation period 1.11.2009 to 31.05.2009 | Post-incorporation period 1.6.2009 to 31.12.2009 | |||||
Gross Profit1 Less: Expenses and Losses Salaries and Bonus Rent Bad Debts Preliminary Expenses Commission on Sales1 Interest on Purchase Consideration Director’s Fees Managing Directors Remuneration Establishment Charges Depreciation Advertisement Net Profit transferred to -Capital Reserve -P & L App. A/c | Rs 2,00,000
15,000 1,000 5,0000 9,000 12,000
1,000 3,000
14,600 21,000
10,000 27,000
|
Actual
Time(5:7) Time(5:7) Sales (5:7) Actual Time(5:7)
Time(5:7) Actual
Actual Time(5:7)
Actual Actual | Rs
6,250 416 2,084 - 5,000
417 - -
8,750
- 20,000 42,918 57,082 - | Rs 1,00,000
- | Rs
8,750 583 2,916 9,000 7,000
583 3,000
14,600 12,250
10,000 7,000 75,682 - 24,318 | Rs 1,00,000
- |
1,00,000 | 1,00,000 | 1,00,000 | 1,00,000 |
Problem 3:
Mr. X founded a limited company under the name and style of Exe. Pvt. It will take over the existing business from April 1, 2006, but was not established until January 7, 2006. There was no mention of the business transfer in the books that continued until March 31, 2007.
As of March 31, 2007, the following balances have been extracted from the books.
You too:
(A) Shares on March 31, 2007 reached Rupees. 44,000.
(B) The gross profit margin is constant, and monthly sales in April 2006, February 2007, and March 2007 are twice the average monthly sales for the year.
(C) It was agreed that the purchase price would be met by the issuance of shares of Rs 3,000. 100 each
(D) Reserve costs are amortized.
(E) Outbound shipping and traveller fees must be assumed to change in direct proportion to sales.
You need to prepare a trading account and a profit and loss account for the fiscal year ending March 31, 2007, to allocate the profit and loss for the period before and after the establishment. Depreciation shall be provided at an annual rate of 25% about fixed assets.
Heads of Account | Debit | Credit |
Opening Stock Purchase Carriage Outwars Sales Traveller’s Commission Office Salaries Administration Expenses Rent and Rates Director’s Fees X’s Capital on 1.4.2006 Fixed Assets Current Assets (other than stock) Preliminary Expenses Current Liabilities | Rs 43,000 1,89,000 3,00
7,500 21,000 19,900 12,000 18,000
1,00,000 34,000 5,200 | Rs
2,78,000
2,30,000
37,000 |
Following information is given:
(A) Shares on March 31, 2007 reached Rupees. 44,000.
(B) The gross profit margin is constant, and monthly sales in April 2006, February 2007, and March 2007 are twice the average monthly sales for the year.
(C) It was agreed that the purchase price would be met by the issuance of shares of Rs 3,000 100 each.
(D) Reserve costs are amortized.
(E) Outbound shipping and traveller fees must be assumed to change in direct proportion to sales.
You need to prepare a trading account and a profit and loss account for the fiscal year ending March 31, 2007, to allocate the profit and loss for the period before and after the establishment. Depreciation shall be provided at an annual rate of 25% about fixed assets.
Solution:
In the Books of Exe. Pvt. Ltd.
Trading Account
For the year ended 31st March 2007
Dr. Cr.
To Opening Stock “ Purchase “ Gross Profit (bal.fig) | Rs 43,000 1,89,000 90,000 3,22,000 |
By Sales “ Closing Stock | Rs 2,78,000 44,000
3,22,000 |
Profit & Loss Account
For the year ended 31st March 2007
Dr. Cr.
| Basis of Allocation | Pre-incor- Poration {1.4.06 to 31.3.07) | Post Incor- Poration {1.7.06 to 31.3.07} |
| Basis of Allocation | Pre-incor- Poration {1.4.06 to 31.3.07) | Post Incor- Poration {1.7.06 to 31.3.07 |
To Carriage Outwards
* Travellers Commission
*Office Salaries Final *Rent & Rates *Depreciation *Adm. Expenses Expenses fully App to. P & T incorporate *Director’s Fee *Preliminary Expenses *Net Profit trans. To -Capital Reserve
|
Sales (4:11) (4:11) Final
(1:3) * * *
| Rs 880
2,000
5,250 3,000 6,250 4,975
- -
1,645 | Rs 2,4203
5,500
15,7504 9,000 18,750 14,925
18,0005 5,200
- |
By Gross Profit
“ Net Loss transferred to
P & L App. A/c |
Sales (4:11)
| Rs 24,000
-
| Rs 66,0002
23,545
|
24,000 | 89,545 |
|
| 24,000 | 89,545 |
Workings
(1) Time Ratio
Pre-incorporation Period: From 1.4.1996 to 30.6.1996 = 3moths
Post0incorporation Period = From 1.7.1996 to 31.3.1997 = 9months
Therefore, Time Ratio between Pre- and Post-incorporation is 3 : 9 or 1 : 3
(2) Gross Profit = Sales + Closing Stock – Opening Stock – Purchase
= Rs 2,78,000 + Rs 44,000 – Rs 43,000 – Rs 1,89,000
= Rs 90,000
Gross Profit will be apportioned on the basis of sales ratio which is calculated as:
(3) Sales Ratio
If any other month’s sales is Re. 1, monthly sales of April 2006 and Feb. & March 2007 are Rs. 2(i.e., doubled)
So, the Pre-incorporation Sales = 2 + 1 + 1 = 4
Similarly, Post-incorporation Sales = 1 + 1 +1 +1 +1 +1 +1 + 2 + 2 = 11
Therefore, the sales ratio before and after establishment is 4:11
(4) Outward transportation and Travellers’ Com. = Sales ratio, that is, 4:11.
(5) Other time-based costs:
Salary; Administration costs; Rent, fees, depreciation costs (Rs. 25,000, or Rs. 1, 00,000 x 25/100)
(6) The remaining costs will be charged for the profit after the acquisition.
Problem 4:
New Ventures Ltd. was founded on January 1, 2008 and has authorized capital of Rs 5,000. R. Bros since October 1, 2007 10 each to take over the operating business of Bros. The following is a summary of the income statement for the fiscal year ended September 30, 2008.
Cost of Sales for the year Administrative Expenses Selling Commission Goodwill written-off Interest paid to vendors (Loan repaid on 1st Feb.) Distribution Expenses (60% variable) Preliminary Expenses Debentures Interest Depreciation Net Profit | Rs 16,000 1,768 875 200
3,73 1,250
330 320 444 100 3,340 |
Sales 1st Oct.2007 to 31st Dec. 2007 6,000 1st Jan. 2008 to 30th Sept. 2008 19,000
| Rs
25,000
|
25,000 | 25,000 |
The company handles one type of product. When compared to the pre-establishment period, the unit sales price for the post-establishment period decreased by 10%. Between the pre-establishment and post-establishment periods, the amount of net income that provides the basis for the apportionment must be apportioned.
Income statement before and after establishment
In the Books of New Ventures Ltd.
Statement of Profit
Pre- and Post-incorporation
Particulars | Total | Basis of Apportion | Profit | |||
|
|
| Pre-incorporation period: from 1st Oct. 2007 to 31st Dec.2007 | Post-incorporation period: from 1st Jan.2008 to 30th Sept. 2008 | ||
Sales Less: Costs, Expenses and Losses Cost of Sales Admin Expenses Selling Commission |
Rs 25,000
16,000 1,768 875 |
Actual
(See note)2 Time (1:3) Sales (6:19) | Dr. Rs. -
4,156 442 210 | Cr. Rs 6,000 | Dr. Rs -
11,844 1,326 665 | Cr. Rs. 19,000 |
Problem 5:
Jalajga Ltd. was established as a privately held company on March 1, 1995 to take over the business as a going concern from January 1, 2005. Vendors will receive 75% of the profits earned before March 1, 2015. The trading and P & L accounts for the year ended December 31, 2015 are as follows:
To Material Consumed “ Manufacturing Wages “ Manufacturing Expenses “ Carriage Inwards “ Gross Profit c/d
To Salaries and Establishment “ Office Expenses “ Director’s Fees “ Bad Debts “ Debenture Interest “ Com. & Discount “ Cariiage Outwards “ Depreciation “ Net Profit for the year | Rs 1,80,000 48,000 12,200 7,000 52,800 |
By Sales “ Closing Stock
By Gross Profit b/d | Rs 2,60,000 40,000
|
3,00,000 | 3,00,000 | ||
15,000 6,000 1,800 2,300 1,150 8,000 1,600 10,200 6,750 | 52,800
| ||
52,800 | 52,800 |
Sales in March and April are 1.5 times higher, with average monthly sales. Sales in September and October are twice the average monthly sales. Bad debt of 1,110 rs cases were amortized in June. Make statements showing pre- and post-establishment benefits. It also indicates the disposal of such profits.
Solution:
In the Books of Jalajoga Ltd.
Statement of Profit
Pre- and Post-incorporation
Particulars | Basis of Apportion | Amount | Profit | |||
|
|
| Pre-incorporation period | Post-incorporation period | ||
Gross Profit Less: Expenses: Wages & Salaries |
Sales (9 : 7)1
Time(2 : 1) | Rs
52,800
15,000 | Dr. Rs
10,000 | Cr. Rs. 29,700
| Dr, Rs.
5,000 | Cr. Rs 23,100
|
Office Expenses Depreciation Commission and Disc. Carriage Outwards Bad Debts Directors Fees Debenture Interest
Net Profit: Less: Vendors Share @ 75% trans. To Capital Reserve
Trans, to P & L A/c | Time(2 : 1) “ Sales(9 : &) “ Actual
Post Post | 6,000 10,200 8,000 1,600 2,300
1,800 1,150 | 4,000 6,800 4,500 900 1,100
- - |
27,300 | 2,000 3,400 3,500 700 1,200
1,800 1,150
- -
|
18,750 |
| ||||||
2,400 1,800 | ||||||
600 |
| |||||
|
4,350 |
Workings
- Calculation of Sales Ratio
Pre-incorporation Period (from 1.1.2005 to 31.8.2005) = 8 months
Post-incorporation Period (1.9.2005 to 31.12.2005) = 4 months
Therefore, The Ratio is 8 months : 4 months
Or 2 : 1
Let us assume the average monthly sale is x
So, Sales for 12months will be x × 12 = 12x
Sales for March and April = (x × 3/2) + (x × 3/2)
= (3/2 x) + (3/2 x)
= 3x
Sales for Sept. and Oct. = 2x + 2X = 4x
Thus, sales for the remaning 8 months = 12x – (3x + 4x) = 5x
Therefore, Average monthly sales for 8 months 5x/8
Sales for the Post-incorporation period 54x/8
Sales for the Post-incorporation Period 42x/8
Therefore, The Ratio is 54x/8 : 42x/8
Or, 9 : 7
2. Time Ratio between Pre- and Post-incorporation is 2 : 1, i.e., 8 months : 4 months
To sum up:
(A) Gross profit must be distributed between pre-establishment and post-establishment periods based on the ratio of sales. If you're not given gross profit, you can do the same by creating a trading account.
(B) It is necessary to calculate the time ratio between the period before establishment and the period after establishment. Fixed costs are usually allocated based on a time ratio. Rent, taxes, insurance, depreciation, interest, salaries to clerical staff, etc.
(C) The ratio of sales must be known before and after the establishment, and selling, or variable costs are usually allocated based on the ratio of sales. Advertising, warehousing rent, storage and discount permits, freight costs, salesman salaries and commissions, etc.
(D) The costs excluding the period after establishment are as follows.
- Board membership fees, corporate bond interest, reserve funds, tax reserves, dividend proposals, etc.
(E) The costs excluding the period before establishment are as follows.
- Interest on the partner's capital, partner salary, etc.
(F) Expenses related to both pre-establishment and post-establishment must be billed for both periods on an hourly basis. Audit fees, interest paid to vendors, etc.
Problem 6:
The owners of a major retailer wanted to see the net income of the X, Y, and Z divisions individually for the three months ended March 31, 2006. It is not realistic to actually acquire the shares on that day, but the proper system accounting of the department is used, and the normal gross profit margin of the three departments involved is the sales before the direct cost is charged at 40%, 30%, and 20% respectively. Overhead is billed in proportion to the department's sales.
Below are the numbers for the department.
| X Rs | Y Rs | Z Rs |
Opening stock (1-1-2006) Purchase Sales Direct expenses | 10,000 12,000 20,000 2,000 | 14,000 13,500 18,000 1,500 | 7,000 9,700 16,000 700 |
The total overhead costs during the period (including those related to other departments) were rupees. The total sale of Rs is 5,400 1, 08,000. Create a statement showing approximate net income with a 10% stock reserve for each sector against the March 31, 2006 estimate
Solution:
Department Trading & Profit & Loss A/c for three months ended 31st March 2006
| X | Y | Z |
| X | Y | Z |
To Opening Stock To Purchase To Gross profit c/d To Direct expenses To Indirect expenses To Stock reserve @ 10% To Net profit (bal. fig) | Rs 10,000 12,000 8,000 | Rs 14,000 13,500 5,400 | Rs 7,000 9,700 3,200 |
By Sales By Closing stock (bal. fig) By Gross profit | Rs 20,000 10,000 30,000 8,000
| Rs 18,000 14,900 32,900 5,400
| Rs 16,000 3,900 19,900 3,200
|
30,000 | 32,900 | 19,900 | |||||
2,000 1,000 1,000 4,000 | 1,500 900 1,490 1,510 | 700 800 390 1,310 | |||||
8,000 | 5,400 | 3,200 | 8,000 | 5,400 | 3,200 |
Note:
(1) Indirect expenses applicable to the three departments.
54,000 /1,08,000 × 5,400 = Rs 2,700 to be apportioned in the ratio of 10 : 9 : 8 (Rs. 1,000 : 900 : 800)
(2) Direct expenses are not shown in Trading A/c because rates of gross profit given are before charging the direct expenses.
Problem 7:
From the details below, you need to prepare a trading and P & L account for the year ended December 31, 2005, showing the gross and net income of each sector. Allocate general business expenses based on sales. You will also create a balance sheet. Stock in-hand inventory on December 31, 2005 Division A Rs 30.000 and B Rs 20,500.
The total sales are 1.20.000 rupees, that is, department A is 80.000 rupees and B is 40.000 rupees. Percentage of general or indirect expenses charged to A2 / 3 and B1 / 3. (B.Com. Madurai. MS. Bharathiar)
Solution:
Tradingand Profit and Loss Account
for the year ended 31st Dec. 2005
Dr. Cr.
| Dept. A Rs | Dept. B Rs | Total Rs |
| Dept. A Rs | Dept. B Rs | Total Rs |
| 25,000 45,320 11,600 7,530 20,550 | 19,000 21,350 5,260 3,230 11,560 | 44,000 66,670 16,960 10,760 32,110 | By Sales By Stock: Closing
By Gross Profit | 80,000 30,000
1,10,000 20,550
| 40,000 20,500
60,500 11,560
| 1,20,000 50,500
1,70,500 32,110
|
1,10,00 | 60,500 | 1,70,500 | |||||
2,500 6,300 2,500 1,360 1,020 500 6,370 |
1,250 3,150 1,250 680 510 250 4,470 |
3,750 9,450 3,750 2,040 1,530 750 10,840 | |||||
20,550 | 11,560 | 32,110 | 20,550 | 11,560 | 32,110 |
Problem 8:
The following purchases were made by a business house having three Departments:
Department A – 1,000 units
Department B – 2,000 units [ at a total cost of Rs 1,00,000 ]
Department C – 2,400 units
Stocks on 1st January were:
Department A – 120 units
Department B – 80 units
Department C – 152 units
The Sales were:
Department A – 1,020 units @ Rs 20 each
Department B – 1,920 units @ Rs 22.50 each
Department C – 2,496 units @ 25 rupees each
The gross profit margin is the same in both cases. Set up a department trading account.
Solution:
Department Trading Account
for the year ended…
Dr. Cr.
| Dept A | Dept B | Dept C |
| Dept A | Dept B | Dept C |
To Stock To Purchase To Gross Pfrofit c/d | Rs 1,920 16,000 4,080 | Rs 1,440 36,000 8,640 | Rs 3,040 48,000 12,480 |
By Sales By Stock | Rs 20,400 1,600
| Rs 43,200 2,880
| Rs 62,400 1,120
|
22,000 | 63,520 | 63,520 | 22,000 | 46,080 | 63,520 |
Workings:
Closing Stock (in units)
Opening Stock Add: Purchase
Less: Sales Closing Stock | Dept. A Units 120 1,000 | Dept. B Units 80 2,000 | Dept. C Units 152 2,400 |
1,120 1,020 | 2,080 1,920 | 2,552 2,496 | |
100 | 160 | 56 |
We know that the total purchase price of the following units:
Department A – 1,000 units
Department B – 2,000 units [ Cost comes to Rs. 1,00,000 ]
Department C – 2,400 units
If the purchased units would have been sold at a given rate, then the total selling price of the above (complete) units:
Department A – 1,000 units @ Rs. 20 = Rs 20,000
Departmnt B – 2,000 units @ Rs. 22.50 = Rs. 45,000
Department C – 2,400 units @ Rs 25 = Rs 60,000
1,25,000
Thus, the total profit is 25% of cost price or 20% of selling price.
Rate of Gross Profit is the same in each case. So, we can find out the cost price:
Department A 20% of Department B 20% of Department C 20% of | Selling Price Rs 20.00 22.50 25.00 | Profit Rs 4.00 4.50 5.00 | Cost Price Rs 16.00 18.00 20.00 |
Proof:
Department A – 1,000 units @ Rs 16 = 16,000
Departmetn B – 2,000 units @ Rs 18 = 36,000
Department C – 2,400 units @ Rs 20 = 48,000
1,00,000
Problem 9:
The company has two divisions: piece goods and ready-made dresses. All merchandise purchased by the ready-made department from the Peace Merchandise Department will be billed at normal selling prices.
From the details below, create a departmental transaction and income statement for the year ended December 31, 2005.
Stock 1.1.2005 Purchases Sales Transfer to Readymade Expenses: Manufacturing Selling Stock on 31.12.2005 | Piecegoods Rs 1,00,000 10,00,000 11,00,000 1,50,000
10,000 1,00,000 | Readymade RS 25,000 7,500 2,25,000
30,000 3,000 30,000 |
Peace goods and ready-made
The ready-made department inventory is considered to consist of 75% cloth supplied by the Peace Goods department. And 25% cost and cloth from the outside. The Peace Goods division made gross profits in 2004 at the same rate as in 2005. The general cost of the entire business in 2005 was Rs 45,000.
Solution:
Departmental Trading and Profit and Loss Account
For the year ended 31st Dec. 2005
Dr. Cr.
| Piece-goods | Ready-made | Total |
| Piece-goods | Ready-made | Total |
Stock Opening Purchase Transfer from Piece-goods | Rs 1,00,000 10,00,000 | Rs 25,000 7,500
1,50,000 | Rs 1,25,000 10,07,000
1,50,000 |
Sales Transfer to Ready made Stock: Closing | Rs 11,00,000
1,50,000 1,00,000 | Rs 2,25,000
- 30,000 | Rs 13,25,000
1,50,000 1,30,000 |
Manufacturing Expenses Gross Profit c/d
Selling Expenses Net Profit |
- 2,50,000 |
30,000 42,500 |
30,000 2,92,500 |
Gross Profit b/d |
|
|
|
13,50,000 | 2,55,000 | 16,05,000 | 13,50,000 | 2,55,000 | 16,05,000 | ||
10,000 2,40,000 | 3,000 39,500 | 13,000 2,79,500 | 2,50,000 | 42,500 | 2,92,500 | ||
2,50,000 | 42,500 | 2,92,500 | 2,50,000 | 42,500 | 2,92,500 |
Rate of Gross Profit on Sale (Piecegoods) = Gross Profit x 100 / (Sales + Transfer)
= 25,000 x 100 / (12,50,000) = 20%
75% of Rs 30,000 (closing) is from Piecegoods = Rs 22,500
Therefore unrealised profit = 22,500 x 20 / 100 = Rs 4,500
Less: Existing Provision on Opening Stock:
(Piecegoods) = 25,000 x 75 / 100 x 20/100 = Rs 3,750
750*
Problem 10:
From the following balances extracted from the company's books, create a department transaction and general profit and loss account for the year ended December 31, 2005, and a balance sheet for that day after adjusting for unrealized department profits.
| Rs |
| Rs |
Land and Buildings Furniture Opeing Stock: Dept. A Dept. B Purchase: Dept. A Dept. B General Expenses Debtors Drawings Cash at Bank
| 12,500 2,500 3,000 4,000 1,00,000 1,50,000 1,40,000 20,000 28,000 1,00,000 | Capital Sales: Dept. A Dept. B Creditors | 30,000 2,00,000 3,20,000 10,000
|
5,60,000 | 5,60,000 |
Additional Information:
1. Close inventory in department A – Rs 13,000 including Rs 4,000 products at costs from department B to department A.
2. Final inventory of department B – Rs26,000-Includes goods from department AR 9,000 to department B.
3. Sales department A includes the transfer of goods worth 20,000 rupees to department B, and sales of department B include the transfer of goods worth 30,000 rupees to department A at the market price included.
4. The starting inventory of department A and department B includes goods from department B and department A worth Rs 1,000 and Rs 1,500 respectively at cost to the transfer department.
5. Depreciate land and buildings by 5% and depreciate furniture by 10% annually.
Solution:
Departmental Trading Account
for the year ended 31st December 2005
Dr. Cr.
| Dept A | Dept B | Dept C |
| Dept A | Dept B | Dept C |
To Stock To Purchase To Transfer To Gross Pfrofit | Rs 3,000 70,000 30,000 1,10,000 | Rs 4,000 1,30,000 20,000 1,92,000 | Rs 7,000 2,00,000 50,000 3,02,000 |
By Sales By Transfer By Closing Stock | Rs 1,80,000 20,000 13,000 | Rs 2,90,000 30,000 26,000 | Rs 4,70,000 50,000 39,000 |
2,13,000 | 3,46,000 | 5,59,000 | 2,13,000 | 3,46,000 | 5,59,000 |
General Profit and Loss Account
for the year ended 31st Dec. 2005
Dr. Cr.
TO General Expense TO Depreciation Land & Building 625 Furniture 250 To Provision for unrealised Profit: Dept. A 2,400 Dept. B 4,950 To Net Profit | Rs 1,40,000
875
7,350 1,53,775 |
By Gross Profit Dept. A Dept. B | Rs
1,10,000 1,92,000
|
3,02,000 |
3,02,000 |
Workings:
Calculations of provisions for unrealised profit on stock:
Dept. A: Rate of Gross Profit = 1,10,000 / 2,00,000 x 100 = 55%
Dept. B: Rate of Gross Profit = 1,92,000 / 3,20,000 x 100 = 60%
Provision required on closing stock:
Dept. A : 60% of Rs 4,000 = Rs 2,400
Dept. B: 55% of Rs 9,000 = Rs 4,950
No adjustment of opening inventory, including N.B. inter-departmental transfers, is required. This is because the goods are valued at cost to the transfer department rather than the transferee department.
Problem 11:
The company has two departments. Peace goods and tailoring. All merchandise purchased by the tailoring department from the piece goods department will be sold at the same normal market price as the price charged to external customers.
From the details below, create a department transaction and income statement and balance sheet as of March 31, 2005.
| Piecegoods Dept. | Tailoring Dept. |
Opening Stock Purchases Goods from Piecegoods dept. Wages Salaries (Departments) Closing Stock (at cost to the Dept.) Printing and Stationery Machinery | Rs 20,000 2,20,000 - 600 4,800 38,600 2,43,000 1,000 - | Rs Nil 10,000 60,000 6,400 1,200 14,000 1,36,000 600 1200 |
Further information:
Advertisement Salaries (General) Capital Debtors Creditors Drawings Cash at Bank Cash in Hand | Rs 10,000 18,000 1,20,000 54,000 7,000 1,00,000 41,000 6,400 |
Depreciate the machine by 10%. Typical unallocated costs are allocated in a ratio of piece merchandise-3 to tailoring-2.
Solution:
Departmental Trading and Profit and Loss Account
for the year ended 31st March, 2005
Dr. Cr.
| Piecegoods Dept | Tailoring Dept | Total |
| Piecegoods Dept | Tailoring Dept | Total |
To Opening Stock To Purchase To Goods from piecegoods To Wages To Gross Profit
To Salaries (Departmetnal) To Salaries (General) (3 : 2) To Printing & Stationery To Advertisement ( 3: 2) To Depreciation To Net Profit | Rs 20,000 2,20,000
- 600 1,01,000 3,41,600 4,800
10,800
1,000
6,000 - 78,400 | Rs - 10,000
60,000 6,400 73,600 1,50,00 1,200
7,200
600
4,000 12,00 59,400 | Rs 20,000 2,30,000
60,000 7,000 1,74,600 4,91,600 6,000
18,000
1,600
10,000 1,200 1,37,800 |
By Sales By Goods to tailoring By Closing Stock
By Gross Profit | RS 2,43,000 60,000
38,600 | Rs 1,36,000 -
14,000 | Rs 3,79,000 60,000
52,600 |
3,41,600
| 1,50,00
| 4,91,600
| |||||
1,01,000
| 73,600
| 1,74,600
| |||||
1,01,000 | 73,600 |
1,74,600 | 1,01,000 | 73,600 | 1,74,600 | ||
To Provision for unrealised Profit To Net Profit Transferred to Capital
| 4,000 1,33,800 | By Net Profit: Piecegoods Tailoring |
78,400 59,400 |
|
1,37,800 | ||
1,37,800 | |||||||
1,37,800 |
Note: The rate of Gross Profit of Piecegoods Department is calculated as follows:
Gross Profit × 100 / Sale to Outside + Sales to Tailoring Dept.
= Rs 1,01,000 x 100 / Rs 2,43,000 + 60,000 = 33 1/3%
Calculation of reserve for unrealized gains:
The composition of the tailoring department's closing stock is not shown. The tailoring department owns a stake of Rs 14,000. There is no doubt that the inventory consists of piece products and external products. You can assume that your inventory consists of both piece goods and external types of goods.
Therefore, the value of the goods in the piece merchandise department in the final inventory of the tailoring department can be calculated as follows:
Value of Purchase from Piece goods Dept / Value of Total Purchase × Total Closing Stock of . Tailoring Dept.
= Rs 60,000 / Rs 70,000 x 14,000 = Rs 12,000
So, unrealised profit thereof = 33 1/3% of Rs 12,000 = Rs 4,000
Balance Sheet as on 31st March 2005
Liabilities |
| Rs | Assets |
| Rs |
Capital Add: Profit
Less: Drawings Creditors | 1,20,000 1,33,800 2,53,800 1,00,000 |
1,53,800 7,000
| Machinery Less; Depreciation Closing Stock Piecegoods Tailoring
Less: Provision for unrealised Profit Sundry Debtors Cash at Bank Cash in Hand | 12,000 1,200
38,600 14,000 52,600
4,000 |
10,800
48,600 54,000 41,000 6,400 |
1,60,800 | 1,60,800 |
Problem 12:
Following is the trail Balance of M. Rajan as on 31st December 2006
| Dr Rs | Cr Rs |
Capital A/c Drawings A/c Opening Stock Dept. A Dept. B Dept. C Purchase Dept. A Dept. B Dept. C Sales Dept. A Dept. B Dept. C Sales Returns Dept. A Dept. B Dept. C Freight and Carriage Dept. A Dept. B Dept. C Wages Dept. A Dept. B Dept. C Furniture & fixtures Plant and Machinery Bills Receivable Bills Payable Motor Vehicle Sundry Debtor Sundry Creditor Salaries Power and Water Telephone Charges | - 1,500 8,500 5,700 1,200 22,000 17,000 8,000 - - - 4,000 3,000 1,000 1,400 800 200 800 550 150 4,600 20,000 4,200 - 40,000 8,000 - 4,500 1,200 2,100
| 40,000 - - - - - - - 54,000 33,000 21,000 - - - - - - - - - - - - 8,000 - - 7,000 - - - |
Bad Debts Rent and Taxes Insurance Printing and Stationery Advertising Bank overdraft Cash in hand
| 750 6,000 1,500 2,000 3,500 - 850 | - - - - - 12,000 - |
1,75,000 | 1,75,000 |
Prepare Departmental Trading and Profit and Loss A/c and th Balance Sheet taking into account the following adjustments:
a) Outstanding Wages Dept. B = Rs. 150
Dept. C = Rs. 50
b) Salaries payable = Rs 500
c) Depreciate plant & machinery and motor vehicle @ 10%
d) Create a Reserve of 5% for bad and doubtful debts.
e) Each Department shall share the expenses in proportion to their sales .
f) Closing stock: Dept. A = Rs 3,500
Dept. B = Rs 2,000
Dept. C = Rs 1,500
Solution:
Departmeantal Trading A/c of Mr. Rajan for the year ending 31st December 2006
| A Rs | B Rs | C Rs |
| A Rs | B Rs | C Rs |
To Salaries (5,000) (including due) TO Telephone charges To Bad Debts To Rent & taxes To Insurance To Printing & Stationery To Advertising To Depreciation On Plant & machinery On Motor vehicles To Provisions for Debtors To Net Profti |
2,500 1,050 375 3,000 750 1,000
1,750
1,000 2,000 200
6,575 |
1,500 630 225 18,00 450 600
1,050
600 12000 120
|
1,000 420 150 1200 300 400
700
400 800 80
6,210 | By Gross Profit
By Net Loss | 20,200
- | 7,440
735 | 11,660
- |
20,200 | 8,175 | 11,660 | |||||
20,220 | 8,175 | 11,660 |
| A Rs | B Rs | C RS |
| A Rs | B Rs | C RS |
To Opening stock To Purchase To Freight & Carriage To Wages Add: Wages due To Power & water [sales ratio 5:3:2] To Gross Profit c/d | 8,500 22,000
1,400
800
600 20,200 | 5,700 17,000
800
700
360 7,440 | 1,200 8,000
200
200
240 11,660 | By Sales Less: Sales Returns Nat Sales
By Closing Stock | 54,000 4,000
| 33,000 3,000
| 21,000 1,000
|
50,000
3,500
| 30,000
2,000
| 20,000
1,500
| |||||
53,500 | 32,000 | 21,500 |
| 53,500 | 32,000 | 21,500 |
Departmental Profit and Loss of Mr. Rajan for the year ending 31st Dec. 2006
Note: All costs will be split by sales ratio as instructed.
Sales ratio = A – Rs. 50.000, B – Rupee 30,000 C – Rupee 20,000 or 5: 3: 2
Balance Sheet of Mr. Rajan as on 31st December 2006
Liabilities | Rs | Assets | RS |
Capital 40,000 Less: Drawings 1,500 38,500 Add: Nat profti (6,575 + 6,210) 12,785 51,285 Less: Net loss (Dept. B) 735 Salary due Outstanding wages Dept. B 150 Dept. C 50 Bills payable Sundry creditors Bank overdraft |
50,550 500
200 8,000 7,000 12,000
| Fixture & Furniture Plant & Machinery 20,000 Less: 10% Depreciation 2,000 Motor Vehicle 40,000 Less: 10% Depreciation 4,000 Bills receivable Sundry Debtors 8,000 Less: 5% provision 400 Cash in hand Stock: Dept. A 3,500 Dept. B 2,000 Dept. C 1,500 | 4,600
18,000
36,000 4,200
7,600 850
7,000 |
78,250 |
| 78,250 |
Key takeaways:
|
References:
- Financial Accounting by B.B. Dam
- Financial Accounting K.R DAS