Accounting · Company Accounts

Profit Prior to Incorporation: Ratios, Expense Allocation and Treatment

Updated 1 October 2026 · Fact-checked

Profit prior to incorporation is profit earned between the date a business is taken over and the date the company is incorporated. You split the year's profit into pre- and post-incorporation parts using time, sales or weighted ratios, charge each expense to the right period, and transfer the pre-incorporation profit to Capital Reserve.

Understand Profit Prior to Incorporation

Sometimes a company buys a running business from a date earlier than its own incorporation. For example, the company is incorporated on 1 July but takes over the business from 1 April. The profits from 1 April to 30 June were earned before the company existed.

A company cannot earn profit before it exists. So that profit is treated as a capital profit. It is not available for dividend. The profit earned after incorporation is a revenue profit and can be distributed.

The accounts are usually prepared for the full year. You must then divide the year's profit into two parts: pre-incorporation and post-incorporation. You do this with a Statement of Profit Prior to Incorporation (or a Profit and Loss Account with pre and post columns).

Three ratios are used. Time ratio is the months before and after incorporation. Sales ratio is sales before and after incorporation. Weighted ratio is time multiplied by a weight, used when efforts or costs differ between the two periods. Gross profit is normally split in the sales ratio. Expenses are split by their nature: time-based, sales-based, wholly pre or wholly post.

If the result for the pre-incorporation period is a profit, it is credited to Capital Reserve. If it is a loss, it is treated as Goodwill in the balance sheet. The post-incorporation profit goes to the normal Profit and Loss balance and can be used for dividends.

Key rules to remember

Time ratio: Months (or days) before incorporation : Months (or days) after incorporation; Count from the date of takeover to the date of incorporation, and from incorporation to the year end. Use it for fixed, time-related expenses.
Sales ratio: Sales before incorporation : Sales after incorporation; Use it for gross profit and for expenses that vary with sales. If gross profit for each period is not given, split it in the sales ratio.
Weighted ratio: (Months × weight) pre : (Months × weight) post; Use only when the question gives weights or says efforts or costs differed between the periods.
Net profit for the year: Pre-incorporation profit + Post-incorporation profit; Always check that the two parts add up to the total profit.
Treatment of pre-incorporation result: Profit → Capital Reserve; Loss → Goodwill; Post-incorporation profit is revenue profit and is available for dividend.
Expenses charged wholly to post-incorporation: Directors' fees and remuneration, preliminary expenses written off, debenture interest, discount on issue of shares or debentures written off, company audit fee if stated; These arise only because the company exists. If the question says otherwise, follow the question.
Expenses charged wholly to pre-incorporation: Partners' or proprietor's salary, expenses of the old business that stopped on takeover, interest to the vendor up to incorporation; Apply these only when the question states them.

How to solve Profit Prior to Incorporation questions

Use the same sequence for any question. It keeps the working clean and earns step marks.

1Mark the dates: takeover date, incorporation date and year end. Count the months in each period and write the time ratio.
2Work out the sales ratio from the sales figures given for each period. Reduce both ratios to simple whole numbers.
3Draw a statement with columns: Particulars, Basis, Total, Pre-incorporation, Post-incorporation.
4Put gross profit first and split it in the sales ratio, unless separate figures for each period are given.
5List each expense. Decide its basis: time, sales, weighted, wholly pre or wholly post. Split it and write the basis in a column.
6Total the columns. Pre profit = pre gross profit minus pre expenses. Post profit = post gross profit minus post expenses.
7Check that pre profit plus post profit equals the total net profit.
8State the treatment: pre-incorporation profit to Capital Reserve (loss to Goodwill), post-incorporation profit to the Profit and Loss balance.

Quickest way: Basis column method

When to use it: Use it in the exam when many expenses are given. It cuts calculation time and shows the examiner your logic.

Write the two ratios at the top of the page before anything else.
For each expense, write T (time), S (sales), P (wholly post) or R (wholly pre) next to it in the question paper.
Take care of all P items first. They go straight to the post column, so no division is needed.
Divide the remaining items by the ratio parts. For a 1:3 ratio, divide by 4 and multiply by 1 and 3.
Add the columns and check that pre plus post equals the total profit before you write the final line.

Common mistakes in Profit Prior to Incorporation

Splitting every expense in the time ratio
It is the easiest ratio and students do not classify the items.
Fix: Ask of each expense whether it depends on time or on sales. Selling items such as carriage outward, commission and bad debts go in the sales ratio.
Splitting gross profit in the time ratio
Students link all profit with time passing.
Fix: Gross profit comes from sales, so use the sales ratio unless the question gives separate trading results for each period.
Charging directors' fees, preliminary expenses or debenture interest to the pre period
Students split everything in the ratio without thinking about when the cost arose.
Fix: Learn the list of wholly post items. These costs exist only after the company is formed.
Treating pre-incorporation profit as available for dividend
Students forget that it is a capital profit.
Fix: Transfer it to Capital Reserve. A pre-incorporation loss is shown as Goodwill.
Counting the wrong number of months
Students mix up the takeover date and the incorporation date, or use the calendar year instead of the accounting year.
Fix: Draw a short timeline with the three dates and count from it.
Ignoring a weight given in the question
Students rush and use the plain time ratio.
Fix: If the question gives efforts, weights or a higher cost in one period, multiply months by weights to get the weighted ratio.

Worked examples

Example 1

A company was incorporated on 1 July 2024 and took over a business from 1 April 2024. For the year ended 31 March 2025, sales were ₹12,00,000, of which ₹3,00,000 were made before incorporation. Gross profit was ₹4,00,000. Expenses: salaries ₹1,20,000; rent ₹60,000; carriage outward ₹24,000; directors' fees ₹36,000; preliminary expenses written off ₹10,000. Find the profit before and after incorporation.

Show the solution

Time ratio: 1 April to 30 June is 3 months, and 1 July to 31 March is 9 months. Ratio is 3:9 = 1:3.
Sales ratio: pre sales ₹3,00,000, post sales ₹9,00,000. Ratio is 1:3.
Gross profit ₹4,00,000 in sales ratio 1:3: pre ₹1,00,000, post ₹3,00,000.
Salaries ₹1,20,000 in time ratio: pre ₹30,000, post ₹90,000.
Rent ₹60,000 in time ratio: pre ₹15,000, post ₹45,000.
Carriage outward ₹24,000 in sales ratio: pre ₹6,000, post ₹18,000.
Directors' fees ₹36,000 and preliminary expenses ₹10,000 are wholly post.
Pre expenses: 30,000 + 15,000 + 6,000 = ₹51,000. Pre profit = 1,00,000 − 51,000 = ₹49,000.
Post expenses: 90,000 + 45,000 + 18,000 + 36,000 + 10,000 = ₹1,99,000. Post profit = 3,00,000 − 1,99,000 = ₹1,01,000.
Check: 49,000 + 1,01,000 = ₹1,50,000, which equals 4,00,000 − 2,50,000 total expenses.

Answer: Profit prior to incorporation is ₹49,000, transferred to Capital Reserve. Profit after incorporation is ₹1,01,000, available for dividend.

Example 2

A company was incorporated on 1 August 2024 and took over a business from 1 April 2024. For the year ended 31 March 2025, sales were ₹20,00,000, of which ₹5,00,000 were before incorporation. Gross profit was ₹5,00,000. Expenses: staff salaries ₹1,80,000; advertisement ₹40,000; depreciation ₹30,000; debenture interest ₹12,000; managerial staff salaries ₹90,000, to be split in a weighted ratio where pre-incorporation time carries weight 1 and post-incorporation time carries weight 2. Find the profit before and after incorporation.

Show the solution

Time ratio: April to July is 4 months, August to March is 8 months. Ratio is 4:8 = 1:2.
Sales ratio: ₹5,00,000 : ₹15,00,000 = 1:3.
Weighted ratio: pre 4 × 1 = 4, post 8 × 2 = 16. Ratio is 4:16 = 1:4.
Gross profit ₹5,00,000 in sales ratio 1:3: pre ₹1,25,000, post ₹3,75,000.
Staff salaries ₹1,80,000 in time ratio 1:2: pre ₹60,000, post ₹1,20,000.
Advertisement ₹40,000 in sales ratio 1:3: pre ₹10,000, post ₹30,000.
Depreciation ₹30,000 in time ratio 1:2: pre ₹10,000, post ₹20,000.
Debenture interest ₹12,000 is wholly post.
Managerial salaries ₹90,000 in weighted ratio 1:4: pre ₹18,000, post ₹72,000.
Pre expenses: 60,000 + 10,000 + 10,000 + 18,000 = ₹98,000. Pre profit = 1,25,000 − 98,000 = ₹27,000.
Post expenses: 1,20,000 + 30,000 + 20,000 + 12,000 + 72,000 = ₹2,54,000. Post profit = 3,75,000 − 2,54,000 = ₹1,21,000.
Check: 27,000 + 1,21,000 = ₹1,48,000, which equals 5,00,000 − 3,52,000 total expenses.

Answer: Profit prior to incorporation is ₹27,000, transferred to Capital Reserve. Profit after incorporation is ₹1,21,000.

Exam tips

Write the time ratio and sales ratio at the top, and show the basis of every expense in its own column. Examiners give marks for the basis.
Learn the wholly post list by heart: directors' fees, preliminary expenses written off, debenture interest, discount on issue written off. Items like these are tested again and again.
Always verify that pre plus post equals the total profit. This one check catches most arithmetic errors.
Read the question for special instructions, such as a different ratio for a particular expense. The question overrides your default rule.
End the answer with the treatment line: pre-incorporation profit to Capital Reserve (or loss to Goodwill). Many students lose a mark by leaving it out.

Practice questions from Company Accounts

Profit Prior to Incorporation: frequently asked questions

Why is profit prior to incorporation a capital profit?

The company did not exist when the profit was earned, so it cannot be seen as the company's trading profit. It is treated as a gain connected with acquiring the business. That is why it goes to Capital Reserve and is not used for dividends.

How do I calculate the time ratio and the sales ratio?

For the time ratio, count the months from the takeover date to the incorporation date and from incorporation to the year end. For the sales ratio, use the sales made in each period. Reduce both to the simplest whole numbers.

Which expenses are charged wholly to the post-incorporation period?

Directors' fees and remuneration, preliminary expenses written off, debenture interest, and discount on issue of shares or debentures written off are the standard ones. They arise only after the company is formed. Always read the question for any special instruction.

What happens if there is a loss before incorporation?

A pre-incorporation loss is treated as Goodwill and shown in the balance sheet. Compare this with a pre-incorporation profit, which goes to Capital Reserve.

When do I use a weighted ratio?

Use it only when the question says efforts or costs differed between the periods, or gives weights. Multiply the months of each period by its weight, then reduce the two results to a ratio.