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Corporate Accounting and Financial Management · Related Aspects of Company Accounts

Profit or Loss Prior to Incorporation: How to Calculate It

Updated 11 October 2026 · Fact-checked

When a company takes over a running business from a date before it was incorporated, the year's profit is split into pre-incorporation and post-incorporation parts. Gross profit is split by sales ratio. Expenses are split by time ratio, sales ratio or charged wholly to one period. Pre-incorporation profit is a capital profit. Pre-incorporation loss goes to goodwill.

Understand Profit or Loss Prior to Incorporation

A company can agree to buy a business from a date earlier than its own incorporation. The business keeps running, and the company then prepares one set of accounts for the whole year. But the company did not exist before incorporation, so it cannot earn revenue profit for that time.

So you split the year's profit into two parts. Pre-incorporation profit is earned from the date of takeover to the date of incorporation. Post-incorporation profit is earned from incorporation to the year-end. Only the post-incorporation part is a normal revenue profit. It is available for dividend, subject to the law on dividends.

The pre-incorporation profit is a capital profit. It arises because the company bought the business at a price that already includes those earnings. It is usually credited to Capital Reserve. If the question says so, you can instead set it off against goodwill. A pre-incorporation loss is shown as part of Goodwill on the asset side.

The law also treats profits of a capital nature differently. Section 198(3)(c) of the Companies Act, 2013 says that, in computing net profit for section 197 (managerial remuneration), credit is not given for profits of a capital nature. Keep this idea in mind: capital profit is not ordinary trading profit.

The split uses two ratios. The time ratio compares months (or days) before and after incorporation. The sales ratio compares sales in the two periods. Gross profit follows sales. Fixed-time costs follow time. Some costs belong wholly to one period.

Key rules to remember

Time ratio
Time ratio = months (or days) from takeover to incorporation : months (or days) from incorporation to year-end
Use for costs that accrue with time, such as salaries, rent, insurance, general expenses and depreciation.
Sales ratio
Sales ratio = sales before incorporation : sales after incorporation
Use for gross profit and for costs that vary with sales, such as discount allowed, commission on sales, carriage outwards, bad debts and advertisement (unless told it is time based).
Gross profit split
Pre-incorporation gross profit = Total gross profit × pre-incorporation sales ÷ total sales
If the question gives separate trading accounts or the gross profit rate differs by period, use those figures instead.
Profit or loss for each period
Profit (or loss) for a period = Gross profit of that period − expenses charged to that period + income charged to that period
Pre-period profit plus post-period profit must equal total profit for the year. Use this as a check.
Expenses wholly post-incorporation
Charge 100% to the post-incorporation period
Typical items: directors' fees, debenture interest where debentures were issued after incorporation, preliminary expenses written off, company audit fees, debenture discount written off, dividend-related items.
Treatment of result
Pre-incorporation profit → Capital Reserve (or set off against Goodwill if directed). Pre-incorporation loss → Goodwill.
Post-incorporation profit goes to the Profit and Loss Account.

How to solve Profit or Loss Prior to Incorporation questions

Follow the same order every time. It keeps your working neat and earns you step marks even if one figure goes wrong.

  1. 1Find the dates. Note the takeover date, the incorporation date and the year-end. Count the pre and post periods in months or days, and write the time ratio.
  2. 2Write the sales ratio from the sales figures given for each period. If only total sales and one period's sales are given, find the other by subtraction.
  3. 3Open a columnar statement with three columns: Total, Pre-incorporation, Post-incorporation. List gross profit first and divide it by the sales ratio.
  4. 4Take each expense one by one. Decide: time ratio, sales ratio, or wholly post (or wholly pre). Write the basis next to each item so the examiner can see your reasoning.
  5. 5Add the pre column and the post column. Subtract expenses from gross profit in each column to get the pre and post profit or loss.
  6. 6Check that pre plus post equals the total profit for the year.
  7. 7State the treatment in a final line: pre profit to capital reserve (or goodwill if told), pre loss to goodwill, post profit to the Profit and Loss Account.

Quickest way: Ratio-first columnar method

When to use it: Use this for any numerical question when time is short. It suits questions that give a trial balance and a list of expenses.

  1. Write the two ratios at the top of the page before anything else.
  2. Draw three columns: Total, Pre, Post. Do not draw separate accounts.
  3. For every expense, tick one basis: T (time), S (sales), Post only, or Pre only. Then divide quickly.
  4. Do the cross-check: Pre + Post = Total in every row.
  5. Write the one-line treatment of the pre-incorporation result at the bottom.

Common mistakes in Profit or Loss Prior to Incorporation

  • Dividing gross profit by the time ratio instead of the sales ratio.

    Students see 'pre-incorporation' and assume everything is time based.

    Fix: Gross profit always follows sales. Only expenses that accrue with time follow the time ratio.

  • Charging directors' fees, debenture interest or preliminary expenses partly to the pre-incorporation period.

    Students apply a ratio to every item without thinking about whether the item could exist before the company did.

    Fix: Ask: could this cost arise before the company existed? If not, charge it wholly to the post-incorporation period.

  • Treating pre-incorporation profit as a normal revenue profit that can be distributed.

    The profit looks the same as any other profit in the working.

    Fix: It is a capital profit. Credit it to Capital Reserve, or set it off against goodwill if the question says so.

  • Showing a pre-incorporation loss as an expense in the Profit and Loss Account.

    Students treat a loss as a normal revenue loss.

    Fix: Add the loss to Goodwill on the asset side.

  • Counting the wrong number of months or days for the time ratio.

    Dates such as 'incorporated on 1 December' are read carelessly, or the year-end is wrongly assumed.

    Fix: Mark the three dates on a line. Count the months in each segment and check that they add up to the full period of the accounts.

  • Using total sales for the sales ratio, or not subtracting to find the missing period's sales.

    The question gives sales for only one period, and students rush.

    Fix: Write: Pre sales + Post sales = Total sales. Solve for the missing figure, then simplify the ratio.

Worked examples

Example 1

Alpha Traders Ltd was incorporated on 1 July 2025. It took over a running business with effect from 1 April 2025. Accounts are made up to 31 March 2026. Total sales were ₹30,00,000, of which ₹6,00,000 was for April to June 2025. Gross profit for the year was ₹6,00,000. Expenses for the year: salaries ₹1,20,000; rent ₹60,000; depreciation ₹48,000; discount allowed ₹30,000; advertisement ₹50,000 (to be treated as sales based); directors' fees ₹80,000; preliminary expenses written off ₹10,000; debenture interest ₹40,000 (debentures issued after incorporation). Find the pre- and post-incorporation profit.

Show the solution
  1. Time ratio: 1 April to 30 June is 3 months. 1 July to 31 March is 9 months. Time ratio = 3 : 9 = 1 : 3.
  2. Sales: pre = ₹6,00,000. Post = ₹30,00,000 − ₹6,00,000 = ₹24,00,000. Sales ratio = 6 : 24 = 1 : 4.
  3. Gross profit (sales ratio 1 : 4): pre = ₹1,20,000; post = ₹4,80,000.
  4. Salaries ₹1,20,000 (time 1 : 3): pre ₹30,000; post ₹90,000.
  5. Rent ₹60,000 (time): pre ₹15,000; post ₹45,000.
  6. Depreciation ₹48,000 (time): pre ₹12,000; post ₹36,000.
  7. Discount allowed ₹30,000 (sales 1 : 4): pre ₹6,000; post ₹24,000.
  8. Advertisement ₹50,000 (sales 1 : 4): pre ₹10,000; post ₹40,000.
  9. Directors' fees ₹80,000, preliminary expenses ₹10,000 and debenture interest ₹40,000 are wholly post-incorporation.
  10. Pre-incorporation expenses = 30,000 + 15,000 + 12,000 + 6,000 + 10,000 = ₹73,000. Pre profit = 1,20,000 − 73,000 = ₹47,000.
  11. Post-incorporation expenses = 90,000 + 45,000 + 36,000 + 24,000 + 40,000 + 80,000 + 10,000 + 40,000 = ₹3,65,000. Post profit = 4,80,000 − 3,65,000 = ₹1,15,000.
  12. Check: total expenses = ₹4,38,000. Total profit = 6,00,000 − 4,38,000 = ₹1,62,000 = 47,000 + 1,15,000.

Answer: Pre-incorporation profit is ₹47,000. It is a capital profit, so credit it to Capital Reserve (or set it off against goodwill if directed). Post-incorporation profit is ₹1,15,000, which goes to the Profit and Loss Account.

Example 2

Beta Foods Ltd was incorporated on 1 December 2025 and took over a business from 1 October 2025. Accounts are made up to 31 March 2026. Sales were ₹3,00,000 before incorporation and ₹9,00,000 after it. Gross profit for the year was ₹2,00,000. Expenses: salaries ₹1,20,000; rent ₹36,000; commission on sales ₹24,000; audit fees ₹6,000; directors' remuneration ₹12,000. Ascertain the pre- and post-incorporation result and state its treatment.

Show the solution
  1. Time ratio: 1 October to 30 November is 2 months. 1 December to 31 March is 4 months. Time ratio = 2 : 4 = 1 : 2.
  2. Sales ratio = 3,00,000 : 9,00,000 = 1 : 3.
  3. Gross profit ₹2,00,000 (sales 1 : 3): pre ₹50,000; post ₹1,50,000.
  4. Salaries ₹1,20,000 (time 1 : 2): pre ₹40,000; post ₹80,000.
  5. Rent ₹36,000 (time): pre ₹12,000; post ₹24,000.
  6. Commission ₹24,000 (sales 1 : 3): pre ₹6,000; post ₹18,000.
  7. Audit fees ₹6,000 and directors' remuneration ₹12,000 are wholly post-incorporation.
  8. Pre expenses = 40,000 + 12,000 + 6,000 = ₹58,000. Pre result = 50,000 − 58,000 = loss of ₹8,000.
  9. Post expenses = 80,000 + 24,000 + 18,000 + 6,000 + 12,000 = ₹1,40,000. Post result = 1,50,000 − 1,40,000 = profit of ₹10,000.
  10. Check: total expenses = ₹1,98,000. Total profit = 2,00,000 − 1,98,000 = ₹2,000 = 10,000 − 8,000.

Answer: There is a pre-incorporation loss of ₹8,000. Add it to Goodwill on the asset side. The post-incorporation profit is ₹10,000, which is shown in the Profit and Loss Account.

Exam tips

  • Write the time ratio and sales ratio at the top of your answer, and state the basis for every expense. Examiners give marks for the right basis even if arithmetic slips.
  • If the question says an expense is to be treated on a specific basis (for example, advertisement on sales basis), follow it even if you would choose differently.
  • Always cross-check that pre plus post equals the total profit. It takes ten seconds and catches most errors.
  • Close with a clear conclusion line on treatment: pre profit to capital reserve (or goodwill if directed), pre loss to goodwill.
  • Read the question for items that belong wholly to one period, such as directors' fees, debenture interest or preliminary expenses, and for hints like 'debentures were issued after incorporation'.

Practice questions from Related Aspects of Company Accounts

Profit or Loss Prior to Incorporation in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Profit or Loss Prior to Incorporation: frequently asked questions

What is the difference between time ratio and sales ratio?

The time ratio compares the length of the pre and post periods and is used for costs that accrue over time, such as rent and salaries. The sales ratio compares sales in the two periods and is used for gross profit and sales-linked costs such as commission and discount. Choose the ratio by asking what drives the cost.

How is pre-incorporation profit treated in the books?

It is a capital profit. It is normally credited to Capital Reserve. If the question asks, it can be set off against goodwill arising on the purchase of the business. It is not used as a normal revenue profit for dividend.

How is a pre-incorporation loss treated?

It is treated as part of the cost of acquiring the business. You add it to Goodwill on the asset side. It does not go to the Profit and Loss Account.

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

Expenses that can arise only after the company exists, such as directors' fees, debenture interest where debentures were issued after incorporation, preliminary expenses written off and company audit fees. The question usually gives hints. Read the wording carefully.

Does the Companies Act, 2013 give a formula for pre-incorporation profit?

No. The split is an accounting method based on time and sales. The Act does deal with profits of a capital nature when computing net profit for managerial remuneration: section 198(3)(c) says credit is not given for them. That matches the capital nature of pre-incorporation profit.