Allocation of expense in pre and post incorporation period

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Asif Shaikh (Querist)
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19 February 2016 Hello,
Myself Asif Shaikh, I am a teacher by profession. In Ty BCOM SEM VI FINANCIAL ACCOUNTING text book (Manan Prakashan, first edition - Nov 2014, pg.43 worksheet 3, chapter 2) It shows "salary to salesman" be allocated on the "ratio of sales" however salary being fixed in nature we should allocate it on the basis of time. After discussing with the publishers I got the answer as below:
The division of ALL REVENUE ITEMS (Income and Expenses) between pre-inc and post-inc. is first done on the basis of specific details available. It is only when the details are not available that the Time Ratio or Sales Ratio is used for dividing the items. As a rule Time Ratio is used for all administrative expenses; and Sales ratio for all Sales expenses. "In our opinion depreciation on delivery van and showroom rent should be divided in Sales ratio."
However, as per common understanding both depreciation and rent would be fixed irrespective of the amount of sales. The main objective here is to find out the pre and post incorporation profits and thus even if no sales took place in pre incorporation, the expenditure of rent and depreciation will be charged to profit and loss account, and thus all the fixed expenses which are irrespective of sales must be charged to the profit and loss account on time basis.
Can you please help me get an appropriate answer for the above.

Thanks and Regards,
Asif Shaikh.

Aashok Kumar Sharma

Aashok Kumar Sharma (Expert)
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14 July 2024 Hello Asif,

I understand your concern regarding the allocation of expenses such as salary, depreciation, and rent in the context of pre-incorporation and post-incorporation profits in financial accounting. Let's address the principles and considerations involved in this scenario:

### Principles of Expense Allocation:

1. **Nature of Fixed Expenses**:
- Fixed expenses such as rent, depreciation, and salaries are incurred regardless of the level of sales. These expenses contribute to the operational costs of the business and are necessary to generate revenue over time.

2. **Allocation Basis**:
- **Time Basis**: Expenses that are fixed and do not vary with sales should generally be allocated based on time (months, days, etc.). This is because these expenses are incurred continuously and are necessary to maintain the business operations, regardless of sales activity.

- **Sales Ratio**: While sales-related expenses like commissions or sales incentives are typically allocated based on the ratio of sales, fixed administrative expenses are not directly tied to sales volume.

3. **Pre-incorporation vs. Post-incorporation**:
- When preparing financial statements for a period that spans pre-incorporation and post-incorporation phases, it's essential to distinguish between expenses incurred before and after incorporation.
- Pre-incorporation expenses (if any) are charged to the pre-incorporation period's profit and loss account, while post-incorporation expenses are charged accordingly.

### Practical Approach:

- **Depreciation and Rent Example**: If depreciation on delivery van and showroom rent are fixed monthly expenses, they should indeed be allocated on a time basis (e.g., monthly). This ensures that these expenses are properly attributed to the periods in which they contribute to the business operations, regardless of sales.

- **Salesman's Salary**: Even though salaries to salesmen are often allocated based on sales ratio in certain cases (especially if they have a sales incentive component), basic fixed salaries should be allocated based on time (monthly, yearly, etc.).

### Conclusion:

In conclusion, your understanding aligns with common accounting principles that fixed expenses (like rent, depreciation, and basic salaries) should generally be allocated on a time basis. This approach accurately reflects the ongoing costs of operations and ensures that expenses are matched with the periods they benefit. Allocating such expenses on a sales ratio basis might not accurately represent their nature and could distort the financial statements, especially when determining pre-incorporation vs. post-incorporation profits.

If you encounter specific scenarios or guidelines provided in your textbook or by the publishers that differ, it's advisable to seek clarification from a qualified accounting professional or academic resource to ensure consistency and accuracy in your understanding and application of financial accounting principles.

I hope this explanation helps clarify your concerns. If you have any further questions or need additional assistance, feel free to ask.

Best regards,

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