3

Profit or Loss Pre and Post Incorporation

Learning Objectives
After studying this chapter, you will be able to:
♦ Account for pre-incorporation profit.
♦ Learn various methods for computing profit or loss prior to incorporation.
♦ Understand the concept of Vendor’s debtors and creditors and the treatment thereof

1. Introduction
When a running business is taken over by the promoters of a company, from a date before the
company which is to manage and own is registered, the amount of profit or loss of such a
business for the period prior to the date the company came into existence is referred to as
pre-incorporation profits or losses. Such profits or losses, though belonging to the company or
payable by it, are of capital nature; it is necessary to disclose them separately from trading
profits or losses.
The general practice in this regard is that:
i. If there is a loss,
a) it is either written off by debit to the Profit and Loss Account or to a special
account described as “Loss Prior to Incorporation” and show as an “asset” in the
Balance Sheet: ,
b) in the alternative, it is debited to the Goodwill Account.
ii. On the other hand, if a profit has been earned by business prior to the same being
taken over and the same is not fully absorbed by any interest payable for the period, it
is credited to Capital Reserve Account or to the Goodwill Account, if any goodwill has
been adjusted as an asset. The profit will not be available for distribution as a dividend
among the members of the company.
2. Methods of Computing Profit or Loss Prior to Incorporation
The determination of such profit or loss would be a simple matter if it is possible to close the
books and take the stock held by the business before the company came into existence. In
such a case, the trial balance will be abstracted from the books and the profit or loss

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 3.2 Accounting

computed: Thereafter, the books will be either closed off or the balance allowed continuing
undistributed; only the amount of profit or loss so determined being adjusted in the manner
described above. When this is not possible, one or the other of the following methods will have
to be followed for the purpose.
(1) The simplest, though not always the most expedient method is to close off old books
and open new books with the assets and liabilities as they existed at the date of
incorporation. In this way, automatically the result to that date will be adjusted, the
difference between the values of assets and liabilities acquired and the purchase
consideration being accounted for either as goodwill or as reserve.
The accounts, therefore, would relate exclusively to the post-incorporation period and
any adjustment for the pre-incorporation period, whether an adjustment of profit or loss,
would not be required.
(2) Since the decision to take over a business is usually reached long after the date from
which it is agreed to be taken over it is normally not possible to follow any of the
method aforementioned. The only alternative left, in the circumstances, is to split up the
profit of the year of the transfer of the business to the company between ‘pre’ and ‘post’
incorporation periods. This is done either on the time basis or on the turnover basis or
by a method which combines the two.
3. Basis of Apportionment
• The amount of gross profit of a business is not dependent on time. It is, therefore,
more appropriate to distribute it on the basis of turnover. Similarly, the expenses
incurred in earning the gross profit, not having any direct relationship thereto,
should be distributed on a basis considered appropriate, having regard to the
circumstances of each case.
• Common charges which are fixed e.g., insurance, salaries, depreciation etc., are
allocated on time basis, while those which are fluctuating e.g., bad debts, discount
and carriage outwards are allocated according to turnover unless, in the light of
available information time at which these were incurred or in consideration of the
relationship that these bear to the profit of the two periods.
• For example, interest payable on the credit balance of vendors is charged against
the profit of the period before the business was taken over on the consideration
that it is in respect of that period before the business was taken over or on the
consideration that it is in respect of that period that the profit accrued to the
company, though the purchase consideration had not been discharged. But if the
purchase consideration is not paid on taking over the business, the interest for the
subsequent period is charged to the post-incorporation period.
• Again, preliminary expenses on the formation of the company though incurred in
point of time, before the company was incorporated are charged against the profit
of the period subsequent to incorporation.

© The Institute of Chartered Accountants of India

 Profit or Loss Pre and Post Incorporation 3.3

`
Suppose Sales in Pre-incorporation Period 6,000
Sales in Post-incorporation Period 19,000
25,000
The company deals in one type of product. The unit cost of sales was reduced by 10% in post
incorporation period as compared to the pre-incorporation period in the year. In this case the
cost of sales will be divided between the two periods in the ratio of 6,000: 17,100 i.e., 19,000–
1,900.
4. Pre-incorporation Profits & Losses
S. No Pre-incorporation Profits Pre-incorporation Losses
1. It is transferred to Capital Reserve It is treated as a part of business
Account (i.e. capitalized). acquisition cost (Goodwill).
2. It can be used for : It can be used for :
• writing off Goodwill on acquisition • setting of against Post-
• writing off Preliminary Expenses incorporation Profit
• writing down over-valued assets • addition to Goodwill on
• issuing of bonus shares acquisition
• paying up partly paid shares • writing off Capital Profit

Illustration 1
Bidyut Limited was incorporated on 1st July, 2012 to acquire from Bijli as and from
1st January, the individual business carried on by him. The purchase price of the fixed assets
and goodwill was agreed to be the sum equal to 80% of the profits made each year on
ascertainment of the sum due.
The following Trial Balance as on 31st Dec., 2012 is presented to you to enable you to
prepare a Balance Sheet as at that date. Also draft a statement of appropriation of profit
writing off the preliminary expenses∗.
Dr. Cr.
` `
Share Capital - 1,500 equity shares of
` 100 each, ` 80 paid up 1,20,000
Sundry Debtors 82,000
Stock on 31st Dec., 2012 67,000
Cash at bank and on hand 24,000

∗
As per para 56 of AS 26, preliminary expenses should be charged fully to the statement of profit
and loss of the year in which it is incurred.

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 3.4 Accounting

Directors’ fee 3,000

Preliminary expenses 24,000
Sundry Creditors 32,000
Net Profit for the year after providing for all
expenses under agreement entered into with Bijli 48,000
2,00,000 2,00,000

Solution
Balance Sheet of M/s Bidyut Ltd. as on 31st Dec., 2012
Particulars Notes `
Equity and Liabilities
1 Shareholders' funds
a Share capital 1 1,20,000
b Reserves and Surplus 2 21,000
2 Current liabilities
a Trade Payables 32,000
b Other current liabilities 38,400
Total 2,11,400
Assets
1 Non-current assets
a Fixed assets 3 38,400
2 Current assets
a Inventories 67,000
b Trade receivables 82,000
c Cash and cash equivalents 24,000
Total 2,11,400
Notes to accounts
`
1 Share Capital
Equity share capital
Issued & Subscribed Capital
1,500 Equity Shares of ` 100 each, ` 80 paid up 1,20,000
2 Reserves and Surplus
Capital Reserve (Pre incorporation profit) 24,000

© The Institute of Chartered Accountants of India

 Profit or Loss Pre and Post Incorporation 3.5

Profit and loss Account

Net Profit for the Year 24,000
Less: Directors’ fee 3,000
Preliminary Expenses 24,000 27,000 (3,000)
Total 21,000
3. Fixed assets
Goodwill and fixed assets∗ 38,400

Amount Payable to Bijli: `

Profit for the year 48,000
80% due as cost of goodwill, assets, etc. 38,400
Illustration 2
Inder and Vishnu, working in partnership registered a joint stock company under the name of
Fellow Travellers Ltd. on May 31, 2012 to take over their existing business. It was agreed that
they would take over the assets of the partnership for a sum of ` 3,00,000 as from January
1st, 2012 and that until the amount was discharged they would pay interest on the amount at
the rate of 6% per annum. The amount was paid on June 30, 2012. To discharge the purchase
consideration, the company issued 20,000 equity shares of ` 10 each at a premium of ` 1
each and allotted 7% Debentures of the face value of ` 1,50,000 to the vendors at par.
The summarized Profit and Loss Account of the “Fellow Travellers Ltd.” for the year ended
31st December, 2012 was as follows :
` `
Purchase, including stock 1,40,000 Sales:
Freight and carriage 5,000 1st January to 31st May 2012 60,000
Gross Profit c/d 60,000 1st June to 31st Dec., 2012 1,20,000
Stock in hand 25,000
2,05,000 2,05,000
Salaries and Wages 10,000 Gross profit b/d 60,000
Debenture Interest 5,250
Depreciation 1,000
Interest on Purchase

∗
In Travancore Sugars and Chemicals Ltd. v. CIT (62 CIT 566), the Supreme Court has held that such
payment is a revenue expenditure and deductible from the profits of the company, for tax purposes.

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 3.6 Accounting

Consideration (up to 30-6-2012) 9,000

Selling Commission 9,000
Directors’ Fees 600
Preliminary Expenses 900
Provision for taxes 6,000
Dividend on equity shares @ 5% 5,000
Balance c/d 13,250
60,000 60,000
Prepare draft statement apportioning the balance between the ‘post’ and ‘pre-incorporation’
periods and also show how these figures would appear in the Balance Sheet of the company.
Solution:
Fellow Travellers Ltd.
Draft Statement showing apportionment of profit between periods prior to and since
incorporation
Pre- Post-
Ratio incorporation incorporation
Gross profit allocated on the basis of sale 1:2 20,000 40,000
Administrative Expenses allocated
On time basis:
(i) Salaries and wages 10,000
(ii) Depreciation 1,000
11,000 5:7 4,583 6,417
Selling Commission on the basis of sales 1:2 3,000 6,000
Interest on Purchase Consideration
(Time basis) 5:1 7,500 1,500
Expenses applicable wholly to the
Post-incorporation period:
Debenture Interest 5,250
Director’s Fee 600 5,850
Preliminary expenses 900
Balance c/d to Balance Sheet 4,917 19,333
20,000 40,000

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 Profit or Loss Pre and Post Incorporation 3.7

Fellow Travellers Ltd.

Extract from the Balance Sheet as on 31st Dec., 2012
Particulars Notes `
Equity and Liabilities
1 Shareholders' funds
a Share capital 1 2,00,000
b Reserves and Surplus 2 33,250
2 Non-current liabilities
a Long-term borrowings 3 1,50,000
3 Current liabilities
a Short term provisions 4 6,000
Total 3,89,250
Notes to accounts
`
1. Share Capital
20,000 equity shares of ` 10 each fully paid 2,00,000
2. Reserves and Surplus
Profit Prior to Incorporation 4,917
Securities Premium Account 20,000
Profit and loss Account 19,333
Less: Provision for Tax (6,000)
Dividend on equity share (5,000) 8,333
Total 33,250
3. Long term borrowings
Secured
7% Debentures 1,50,000
4. Other Current liabilities
Provision for Taxes 6,000
Illustration 3
The partners of Maitri Agencies decided to convert the partnership into a private limited
company called MA (P) Ltd. with effect from 1st January, 2010. The consideration was agreed
at ` 1,17,00,000 based on the firm’s Balance Sheet as at 31st December, 2009. However,

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 3.8 Accounting

due to some procedural difficulties, the company could be incorporated only on 1st April,
2010. Meanwhile the business was continued on behalf of the company and the consideration
was settled on that day with interest at 12% per annum. The same books of account were
continued by the company which closed its account for the first time on 31st March, 2011 and
prepared the following summarized profit and loss account.
`
Sales 2,34,00,000
Cost of goods sold: 1,63,80,000
Salaries 11,70,000
Depreciation 1,80,000
Advertisement 7,02,000
Discounts 11,70,000
Managing Director’s remuneration 90,000
Miscellaneous office expenses 1,20,000
Office-cum-show room rent 7,20,000
Interest 9,51,000 2,14,83,000
Profit 19,17,000
The company’s only borrowing was a loan of ` 50,00,000 at 12% p.a. to pay the purchase
consideration due to the firm and for working capital requirements.
The company was able to double the average monthly sales of the firm, from 1st April, 2010
but the salaries trebled from that date. It had to occupy additional space from 1st July, 2010
for which rent was ` 30,000 per month.
Prepare a summarised statement of profit and loss in a columnar form apportioning cost and
revenue between pre-incorporation and post-incorporation periods. Also, suggest how the pre-
incorporation profits are to be dealt with.
Solution
MA (P.) Ltd.
Statement of Profit & Loss for 15 months ended 31st March, 2010
Pre-inc. Post-inc. Pre-inc. Post-inc.
` ` ` `
To Cost of goods sold 18,20,000 1,45,60,000 By Sales 26,00,000 2,08,00,000
” Salaries 90,000 10,80,000 ” Loss 19,000
” Depreciation 36,000 1,44,000
” Advertisement 78,000 6,24,000
” Discounts 1,30,000 10,40,000

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 Profit or Loss Pre and Post Incorporation 3.9

” M.D.’s remuneration — 90,000

” Misc. Office Expenses 24,000 96,000
” Rent 90,000 6,30,000
” Interest 3,51,000 6,00,000
” Net Profit — 19,36,000
26,19,000 2,08,00,000 26,19,000 2,08,00,000
Working Notes:
(1) Calculation of ratio of sales:
Let the average sales per month in pre-incorporation period be x. Then the average sales
in post-inc. period are 2x. Thus total sales are (3 × x) + (12 × 2x) or 27x. Ratio of sales
will be 3x : 24x or 1:8.
Time ratio is 3 months : 12 months or 1:4
(2) Expenses apportioned on turnover ratio basis are cost of goods sold, advertisement,
discounts.
(3) Expenses apportioned o n time ratio basis are Depreciation, and misc. office expenses.
(4) Ratio for apportionment of Salaries:
If pre-incorporation monthly average is x, for 3 months 3x.
Average for balance 12 months 3x, for 12 months 36x.
Hence ratio for division, 1:12.
(5) Apportionment of Rent:
`
Total Rent 7,20,000
Additional rent for 9 months (From 1st July to 31st March, 2011) 2,70,000
Rent for old premises for 15 months or ` 30,000 p.m. 4,50,000
Pre-inc. Post-inc.
Old Premises 90,000 3,60,000
Additional rent — 2,70,000
90,000 6,30,000
Note on treatment
Since the profits prior to incorporation are in the negative, they would:
(a) Either be considered as a reduction from any capital reserve accruing in relation to the
transaction, or
(b) Be treated as goodwill.

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 3.10 Accounting

Illustration 4
ABC Ltd. was incorporated on 1.5.2010 to take over the business of DEF and Co. from
1.1.2010. The summarised Profit and Loss Account as given by ABC Ltd. for the year ending
31.12.2009 is as under:
Summarised Profit and Loss Account
` `
To Rent and Taxes 90,000 By Gross Profit 10,64,000
To Salaries including manager’s By Interest on Investments 36,000
salary of ` 85,000 3,31,000
To Carriage Outwards 14,000
To Printing and Stationery 18,000
To Interest on Debentures 25,000
To Sales Commission 30,800
To Bad Debts (related to sales) 91,000
To Underwriting Commission 26,000
To Preliminary Expenses 28,000
To Audit Fees 45,000
To Loss on Sale of Investments 11,200
To Net Profit 3,90,000 ________
11,00,000 11,00,000
Prepare a Statement showing allocation of pre-incorporation and post-incorporation profits
after considering the following information:
(i) G.P. ratio was constant throughout the year.
(ii) Sales for January and October were 1½ times the average monthly sales while sales for
December were twice the average monthly sales.
(iii) Bad Debts are shown after adjusting a recovery of ` 7,000 of Bad Debt for a sale made
in July, 2007.
(iv) Manager’s salary was increased by ` 2,000 p.m. from 1.5.2010.
(v) All investments were sold in April, 2010.
Solution
Pre-incorporation period is for four months, from 1st January, 2010 to 30th April, 2010. 8
months’ period (from 1st May, 2010 to 31st December, 2010) is post-incorporation period.

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 Profit or Loss Pre and Post Incorporation 3.11

Summarised Statement of Profit and Loss for the year ended 31st December, 2010
Pre-Inc Post –Inc Pre-Inc Post inc
` ` ` `
To Rent and Taxes 30,000 60,000 By Gross Profit 3,42,000 7,22,000
To Salaries By Interest on
Manager’s Salary 23,000 62,000 Investments 36,000 −
Other Salaries 82,000 1,64,000 By Bad Debts 7,000 −
To Printing and Stationery 6,000 12,000 Recovery
To Audit fees 15,000 30,000
To Carriage Outwards 4,500 9,500
To Sales Commission 9,900 20,900
To Bad Debts 31,500 66,500
(91,000 + 7,000)
To Interest on Debentures − 25,000
To Underwriting − 26,000
Commission
To Preliminary Expenses − 28,000
To Loss on sale of 11,200 −
investments
To Net Profit 1,71,900* 2,18,100 ______ ______
3,85,000 7,22,000 3,85,000 7,22,000

* Pre-incorporation profit is a capital profit and will be transferred to Capital Reserve.

Working Notes
(i) Calculation of ratio of Sales
Let average monthly sales be x.
Thus Sales from January to April are 4½ x and sales from May to December are 9½ x.
Sales are in the ratio of 9/2x : 19/2x or 9 : 19.
(ii) Gross profit, carriage outwards, sales commission and bad debts written off have been
allocated in pre and post incorporation periods in the ratio of Sales i.e. 9 : 19.
(iii) Rent, salaries, printing and stationery, audit fees are allocated on time basis.
(iv) Interest on debentures, underwriting commission and preliminary expenses are allocated
in post incorporation period.
(v) Interest on investments, loss on sale of investments and bad debt recovery are allocated
in pre-incorporation period.

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 3.12 Accounting

Illustration 5
A company was incorporated on 1st July, 2011 to take over the business of Mr. M as and from
1st April, 2011. Mr. M’s summarised Balance Sheet, as at that date was as under:
Liabilities ` Assets `
Trade Creditors 36,000 Building 80,000
Capital 1,94,000 Furniture and Fittings 10,000
Debtors 90,000
Stock 30,000
Bank 20,000
2,30,000 2,30,000
Debtors and Bank balances are to be retained by the vendor and creditors are to be paid off
by him. Realisation of debtors will be made by the company on a commission of 5% on cash
collected. The company is to issue M with 10,000 equity shares of ` 10 each, ` 8 per share
paid up and cash of ` 56,000.
The company issued to the public for cash 20,000 equity shares of ` 10 each on which by
31st March, 2012 ` 8 per share was called and paid up except in the case of 1,000 shares on
which the third call of ` 2 per share had not been realized. In the case of 2,000 shares, the
entire face value of the shares had been realized. The share issue was underwritten for 2%
commission, payable in shares fully paid up.
In addition to the balances arising out of the above, the following were shown by the books of
accounts of the company on 31st March, 2012:
`
Discount (including ` 1,000 allowed on vendor’s debtors) 6,000
Preliminary expenses 10,000
Directors’ fee 12,000
Salaries 48,000
Debtors (including vendor’s debtors) 1,60,000
Creditors 48,000
Purchases 3,20,000
Sales 4,60,000
Stock on 31st March, 2012 was ` 52,000. Depreciation at 10% on Furniture and Fittings and
at 5% on Building is to be provided. Collections from debtors belonging to the vendor were
` 60,000 in the period.
Prepare summarised Trading and Profit & Loss for the period ended 31st March, 2012 of the
limited company and its Balance Sheet as at that date.

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 Profit or Loss Pre and Post Incorporation 3.13

Solution
Summarised Trading and Profit and Loss for the year ended 31.03.12
Dr. Dr.
` `
To Opening Stock 30,000 By Sales 4,60,000
To Purchases 3,20,000 By Closing Stock 52,000
To Gross Profit c/d 1,62,000
5,12,000 5,12,000
Pre- Post- Pre- Post-
Incorpo Incorpo Incorpo Incorpo
ration ration ration ration
` ` ` `
To Salaries 12,000 36,000 By Gross Profit 40,500 1,21,500
c/d
To Directors’ fee - 12,000 By Commission - 3,000
To Discount 1,250 3,750
To Depreciation:
Building 1,000 3,000
Furniture 250 750
To Pre-
incorporation
Profit
transferred to
26,000 -
Capital Reserve
Account
To Preliminary 10,000
expenses∗
To Net Profit - 59,000
40,500 1,24,500 40,500 1,24,500
Note: Apportionment has been made in the Statement of Profit and Loss between pre-
incorporation and post-incorporation period using the following basis.
Item Base Ratio
Gross Profit Time 1:3
Salaries Time 1:3

∗
As per para 56 of As 26, preliminary expenses do not appear in the balance sheet.

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 3.14 Accounting

Discount Time 1:3

Directors’ Fees 100% to post-incorporation period
Commission 100% to post-incorporation period
Balance Sheet as on 31.3.2012
Particulars Notes `
Equity and Liabilities
1 Shareholders' funds
a Share capital 1 2,42,000
b Reserves and Surplus 2 69,000
2 Current liabilities
a Trade Payables 3 52,000
Total 3,63,000
Assets
1 Non-current assets
a Fixed assets
Tangible assets 4 85,000
2 Current assets
a Inventories 52,000
b Trade receivables 1,31,000
c Cash and cash equivalents 91,000
d Other current assets 5 4,000
Total 3,63,000
Notes to accounts
`
1. Share Capital
Equity share capital
30,000 equity shares of ` 10 each ` 8 called-up 2,40,000
Less: Calls in Arrear (of the above 10,000 shares
are allotted pursuant to a contract without
payments being received in cash) 2,000 2,38,000
Share Suspense A/c (400 shares to be issued to the
underwriter in consideration of under-writing
commission on completion of share issue) 4,000
Total 2,42,000
2. Reserves and Surplus
Capital Reserve 26,000
Less: Goodwill w/o 16,000 10,000
Profit and loss Account 59,000
Total 69,000

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 Profit or Loss Pre and Post Incorporation 3.15

3. Trade payables
Sundry Creditors 48,000
Calls in advance 4,000 52,000
4. Fixed assets
Building 80,000
Less: Depreciation 4,000 76,000
Furniture & Fittings 10,000
Less: Depreciation 1,000 9,000
Total 85,000
5. Other current assets
Underwriting Commission 4,000
Working Notes:
(1) Goodwill on acquisition
Purchase consideration: ` `
10,000 equity shares of ` 10 each, ` 8 paid up 80,000
Cash 56,000
1,36,000
Less: Assets taken over
Building 80,000
Furniture and Fittings 10,000
Stock 30,000 1,20,000
Goodwill 16,000
(2) Cash Inflows from public issue of equity shares
`
20,000 equity shares of ` 10 each ` 8 called up 1,60,000
Less: Calls in arrear on 1,000 shares @ ` 2 per share 2,000
1,58,000
Add: Calls-in-advance on 2000 shares @ ` 2 4,000
1,62,000
(3) Underwriting Commission 2% on face value ` 2,00,000 4,000
Underwriting Commission becomes due on completion of the job relating to shares
underwritten. It appears that the job relating to public issue was not finished till
31st March, 2010. So a Share Suspense Account should be created showing the amount
of shares to be issued to the underwriter in discharge of his claim for commission
(4) Cash collection from Company’s debtors
Total Debtors Account
Vendor’s Company’s Vendor’s Company’s
Debtors Debtors Debtors Debtors
` ` ` `
To Balance b/d 90,000 - By Discount 1,000 5,000

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 3.16 Accounting

To Sales 4,60,0001 By Cash 60,000 3,24,0002

By Balance c/d 29,000 1,31,0003
90,000 4,60,000 90,000 4,60,000
(5) Cash payment for purchases
Dr. Total Creditors Account Cr.
` `
To Cash (Balancing figure) 2,72,000 By Purchases 3,20,0004
To Balance c/d 48,000
3,20,000 3,20,000
(6) Summary Cash Book
` `
Share Capital A/c 1,62,000 By Total Creditors A/c
Total Debtors A/c: Payment to creditors 2,72,000
Collection from company’s By Vendor’s A/c:
debtors 3,24,000 Purchase consideration 56,000
Collection from vendor’s By Preliminary Expenses 10,000
debtors 60,000 By Directors’ Fees 12,000
By Salaries 48,000
By Vendor’s A/c
(Collection less commission `
3,000) 57,000
By Balance c/d 91,000
5,46,000 5,46,000

5. Debtors and Creditors Suspense Accounts

As mentioned already, a company taking over a running business may also agree to collect its
debts as an agent for the vendors and may further undertake to pay the creditor on behalf of
the vendors. In such a case, the debtors and creditors of the vendors will be included in the
accounts for the company by debit or credit to separate Total Accounts in the General Ledger
to distinguish them from the debtors and creditors of the business and contra entries will be
made in corresponding Suspense Accounts. Also details of debtors’ and creditors’ balance will
be kept in separate ledgers. In order that the collections from debtors and payments of
creditors of vendors may not get mixed up with those of the company, it is a desirable
procedure further to distinguish them by having separate columns for them in the Cash Book.

1 Assumed that all sales were on credit.

2 Balancing figure.
3 Total Debtors ` 1,60,000 minus Vendor’s Debtors ` 29,000.
4 Assumed that all purchases were on credit.

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 Profit or Loss Pre and Post Incorporation 3.17

The book entries that should be passed for debtors in such a case are shown below:
Debit Sundry Debtors Account for opening balance
Credit Debtors suspense A/c
Debit Cash for cash received from debtors
Debit Debtors’ Suspense A/c for allowance etc. to debtors
Credit Sundry Debtors A/c for cash and allowance etc.
Debit Debtors’ Suspense A/c for cash received from debtors
Credit Vendor A/c & payable to vendors.
The vendor is thus treated as a creditor for the cash received by the purchasing company in
respect of the debts due to the vendor, just as if he has himself collected cash from his
debtors and remitted the proceeds to the purchasing company.
For entries in respect of creditors, the reverse of those outlined in respect of debtors will be
passed. The vendor is considered a debtor in respect of cash paid to his creditors by the
purchasing company. The balance of the cash collected, less paid, will represent the amount
due to or by the vendor, arising from debtors and creditors’ balances which have been taken
over, subject to any collection expenses. The balance in the suspense accounts will be always
equal to the amount of debtors and creditors taken over remaining unadjusted at any time.
Illustration 6
Messrs. X, Y & Z, the balance sheet of whose business is given below transferred their
business to a limited company with the same name on January 1, 2010. It was agreed that the
company would take over the assets except cash and book debts at their book values, would
pay ` 20,000 for the goodwill of business and would collect the book debts at a commission
of 5%. Out of the collection from the debtors, the liabilities to sundry creditors would be first
discharged as and when the amount is available, and the balance, if any, would be paid to
vendors after six months. The partners undertook to pay off bank overdraft.
You are required to show the computation of the purchase consideration and the Vendors
Collection Account, assuming that only ` 65,000 colected out of debtors’ balance and the
remaining debtors were taken over by the vendors at the end of six months. Collection from
debtors were : January, ` 30,000; February, ` 15,000; March, ` 10,000; April, ` 5,000;
May, ` 5,000, June Nil.
Summarised Balance Sheet of M/s X, Y, Z as on 31st December, 2009
Liabilities ` ` Assets `
Capital Accounts of Partners: Land & Building 25,000
X 75,000 Machinery 1,50,000
Y 60,000 Stock 60,000
Z 40,000 1,75,000 Book Debts 75,000
General Reserve 80,000 Cash 5,000
Sundry Creditors 56,000

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 3.18 Accounting

Bank Overdraft 4,000

3,15,000 3,15,000
Solution
Purchase consideration payable:
`
Total of Assets 3,15,000
Add: Amount of Goodwill 20,000
: 3,35,000
Less: Assets not taken over
Cash Balance 5,000
Book Debts 75,000 80,000
2,55,000
Vendors Debtors’ Account
Dr. Cr.
2010 ` 2010 `
Jan. 1 To Balance of Debtors 75,000 Jan.31 By Cash (Amount collected) 30,000
taken over for Feb 28 By Cash (Amount collected) 15,000
collection Mar. 31 By Cash (Amount collected) 10,000
Apr. 30 By Cash (Amount collected) 5,000
May 31 By Cash (Amount collected) 5,000
June 30 By Balance transferred to
Debtors’ Suspense
Account 10,000
75,000 75,000
Debtors’ Suspense Account
2010 ` 2010 `
Jan. 31 To Amount transferred to 28,500 Jan. 1 By Balance of vendors’ 75,000
Vendors’ Collection A/c debtors taken over
To Commission A/c 1,500 for collection
Feb. 28 To Amount transferred to 14,250
Vendor’s Collection A/c
To Commission A/c 750
Mar. 31 To Amount transferred to 9,500
Vendors’ Collection A/c
To Commission A/c 500
Apr. 30 To Amount transferred to 4,750
Vendors’ Collection A/c

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 Profit or Loss Pre and Post Incorporation 3.19

To Commission A/c 250

May. 31 To Amount transferred to 4,750
Vendors’ Collection A/c
To Commission A/c 250
June 30 To Amount transferred from
Vendors’ Debtors A/c 10,000
75,000 75,000
Creditors’ Suspense Account
Dr. Cr.
2010 ` 2010 `
Jan. 1 To Amount recoverable from 56,000 Jan. 31 By Vendors’ Collection A/c 28,500
vendors in respect of Feb. 28 By Vendors’ Collection A/c 14,250
liabilities taken over Mar. 31 By Vendors’ Collection A/c 9,500
Apr. 30 By Vendors’ Collection A/c 3,750
56,000 56,000
Vendors’ Creditors’ Account
2010 ` 2010 `
Jan. 31 To Cash 28,500 Jan. 1 By Amount payable on behalf of vendors 56,000
Feb. 28 To Cash 14,250
Mar. 31 To Cash 9,500
Apr. 30 To Cash 3,750
56,000 56,000
Vendors’ Collection Account
2010 ` 2010 `
Jan. 31 To Amount transferred to 28,500 Jan. 31 By Amount transferred 28,500
Creditors’ Suspense A/c from Debtors’
Feb. 28 To Amount transferred to Suspense A/c
Feb. 28 To Creditors’ Suspense A/c 14,250 Feb. 28 By Amount transferred 14,250
Mar. 31 To Amount transferred to from Debtors’
Creditors’ Suspense A/c 9,500 Suspense A/c
Apr. 30 To Amount transferred to 3,750 Mar. 31 By Amount transferred 9,500
Creditors’ Suspense A/c from Debtors’
Suspense A/c
June 30 To Cash (amt. paid to 5,750 Apr. 30 By Amount transferred 4,750
vendors) from Debtors’
Suspense A/c

© The Institute of Chartered Accountants of India

 3.20 Accounting

May 31 By Amount transferred 4,750

from Debtors’
Suspense A/c
61,750 61,750

Summary
• Profit or loss of a business for the period prior to the date the company came into
existence is referred to as Pre-Incorporation Profits or Losses.
• Generally there are two methods of computing Profit & Loss prior to Incorporation
i. One is to close off old books and open new books with the assets and liabilities as
they existed at the date of incorporation. In this way, automatically the result to that
date will be adjusted.
ii. One is to close off old books and open new books with the assets and liabilities as they
existed at the date of incorporation. In this way, automatically the result to that date will be
adjusted. Other is to split up the profit of the year of the transfer of the business to the
company between ‘pre’ and ‘post’ incorporation periods. This is done either on the time
basis or on the turnover basis or by a method which combines the two.
• A company taking over a running business may also agree to collect its debts as an agent for
the vendor and may further undertake to pay the creditor on behalf of the vendors. In such a
case, the debtors and creditors of the vendors will be included in the accounts for the
company by debit or credit to separate total accounts in the General, Ledger to distinguish
them from the debtors and creditors of the business and contra entries will be made in
corresponding Suspense Accounts. Also details of debtors and creditors balance will be kept
in separate ledger
• The vendor is treated as a creditor for the cash received by the purchasing company in
respect of the debts due to the vendor, just as if he has himself collected cash from his
debtors and remitted the proceeds to the purchasing company.
• The vendor is considered a debtor in respect of cash paid to his creditors by the
purchasing company. The balance of the cash collected, less paid, will represent the
amount due to or by the vendor, arising from debtors and creditors balances which have
been taken over, subject to any collection expenses.
• The balance in the suspense accounts will be always equal to the amount of debtors and
creditors taken over remaining unadjusted at any time.

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