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CS Executive · Corporate Accounting and Financial Management · Related Aspects of Company Accounts

A company takes over a running business from a date earlier than its date of incorporation. How is a net profit earned for the period before incorporation normally treated in the company's books?

Profit for the period before incorporation is a capital profit and is transferred to Capital Reserve. The company had not yet come into existence when it was earned, so it cannot be treated as revenue profit or used for dividend distribution.

  1. ATransferred to Capital Reserve as a capital profitCorrect
  2. BTransferred to General Reserve as a revenue profit
  3. CDistributed as dividend to shareholders
  4. DCredited to the Statement of Profit and Loss as ordinary income

Explanation

Profit earned before the company existed was not earned by the company through its own trading, so it is a capital profit. It is credited to Capital Reserve and is not available for dividend. Treating it as revenue profit, in a general reserve or a dividend, is wrong. A pre-incorporation loss is instead shown as goodwill.

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