Comprehensive notes on Time Ratio and Sales Ratio in Corporate Accounting. Explore the methods of apportioning income and expenses between pre-incorporation and post-incorporation periods with practical illustrations and university exam-oriented content.
Learning Objectives
After studying this article, students will be able to:
- Understand the meaning and significance of Time Ratio and Sales Ratio.
- Calculate Time Ratio and Sales Ratio accurately.
- Distinguish between the situations where each ratio is used.
- Apply these ratios in the allocation of income and expenses between pre-incorporation and post-incorporation periods.
- Solve practical university examination problems confidently.
Introduction
One of the most important aspects of Profits or Loss Prior to Incorporation is the apportionment of income and expenses between the pre-incorporation period and the post-incorporation period. Since a company acquires a business before its legal incorporation, the financial results for the accounting year cover two different periods. Consequently, the total profit earned during the year cannot be treated as a single amount. It must be divided fairly between the period before incorporation and the period after incorporation.
To achieve this objective, accountants use two important methods of apportionment: Time Ratio and Sales Ratio. These ratios ensure that income and expenses are allocated according to the period to which they actually relate. They are fundamental tools in Corporate Accounting and frequently appear in university examinations.
Meaning of Time Ratio
The Time Ratio is the ratio of the duration of the pre-incorporation period to the duration of the post-incorporation period. It is used when an income or expense arises uniformly over time, irrespective of the volume of sales or business activity.
Many administrative expenses such as rent, salaries, office expenses, insurance, depreciation, and printing costs are incurred evenly throughout the accounting period. Therefore, these expenses should be divided according to the length of each period rather than the amount of sales.
In simple terms, Time Ratio answers the question:
“How long did each period last?”
The longer the period, the greater will be the share of expenses allocated to that period.
Formula of Time Ratio
The Time Ratio is calculated using the following formula:
Time Ratio = Pre-Incorporation Period : Post-Incorporation Period
Illustration 1
Suppose:
- Date of Purchase: 1 January 2026
- Date of Incorporation: 1 April 2026
- Financial Year Ends: 31 December 2026
The periods will be:
Pre-Incorporation Period
1 January 2026 to 31 March 2026
= 3 Months
Post-Incorporation Period
1 April 2026 to 31 December 2026
= 9 Months
Therefore,
Time Ratio = 3 : 9
or
1 : 3
This means that any expense distributed according to time will be divided in the ratio of 1:3.
Illustration 2
Business Purchased:
1 May 2026
Company Incorporated:
1 August 2026
Accounting Year Ends:
31 March 2027
Pre-incorporation period:
May, June and July
= 3 Months
Post-incorporation period:
August to March
= 8 Months
Therefore,
Time Ratio = 3 : 8
Importance of Time Ratio
Time Ratio ensures that expenses incurred evenly throughout the accounting year are allocated fairly between the two periods. It prevents overstatement or understatement of profits in either period and provides a true and fair presentation of financial statements.
Without Time Ratio, expenses such as rent or salaries may be allocated incorrectly, leading to inaccurate determination of capital profit and revenue profit.
Expenses Allocated on Time Ratio
The following expenses are generally apportioned on the basis of Time Ratio:
- Office Rent
- Salaries
- Office Expenses
- Depreciation
- Insurance
- Municipal Taxes
- Printing and Stationery
- Telephone Expenses
- Electricity Charges
- Repairs and Maintenance
- General Administrative Expenses
- Audit Fees (where applicable)
- Director’s Fees (if applicable after incorporation only)
- Office Maintenance Expenses
These expenses are assumed to arise uniformly throughout the accounting period.
Meaning of Sales Ratio
While some expenses depend on time, many incomes and selling expenses depend on the volume of business conducted. Such items should not be allocated according to the length of time but according to the proportion of sales made during each period.
This proportion is known as the Sales Ratio.
Sales Ratio represents the relationship between sales during the pre-incorporation period and sales during the post-incorporation period.
It answers the question:
“How much business was done during each period?”
Formula of Sales Ratio
Sales Ratio = Sales during Pre-Incorporation Period : Sales during Post-Incorporation Period
Illustration 1
Sales during Pre-Incorporation Period
₹6,00,000
Sales during Post-Incorporation Period
₹18,00,000
Therefore,
Sales Ratio
= 6,00,000 : 18,00,000
= 1 : 3
Thus, all items depending upon sales will be divided in the ratio of 1:3.
Illustration 2
Suppose the monthly sales are:
| Month | Sales (₹) |
|---|---|
| January | 2,00,000 |
| February | 3,00,000 |
| March | 5,00,000 |
| April | 6,00,000 |
| May | 7,00,000 |
| June | 8,00,000 |
Company incorporated on 1 April.
Pre-incorporation sales
= January + February + March
= ₹10,00,000
Post-incorporation sales
= April + May + June
= ₹21,00,000
Sales Ratio
= 10,00,000 : 21,00,000
= 10 : 21
Importance of Sales Ratio
Sales Ratio ensures that selling expenses and sales-related incomes are distributed according to the business actually conducted during each period.
If sales increase significantly after incorporation, allocating expenses merely on the basis of time would be unfair. Sales Ratio provides a more realistic and logical basis for apportionment.
Items Allocated on Sales Ratio
The following items are generally apportioned according to Sales Ratio:
- Gross Profit
- Sales Commission
- Discount Allowed
- Discount Received (where related to sales)
- Carriage Outward
- Selling Expenses
- Advertisement Expenses
- Bad Debts
- Salesmen’s Salary
- Delivery Expenses
- Cash Discount
- Freight Outward
- Collection Expenses
These items vary with the volume of sales.
Difference Between Time Ratio and Sales Ratio
| Basis | Time Ratio | Sales Ratio |
|---|---|---|
| Meaning | Ratio of time periods | Ratio of sales |
| Basis of Calculation | Number of months | Sales Value |
| Used For | Time-related expenses | Sales-related incomes and expenses |
| Depends On | Duration | Business Activity |
| Example | Rent, Salary | Gross Profit, Selling Expenses |
| Objective | Fair allocation based on time | Fair allocation based on sales |
Practical Illustration
Suppose a company purchased a business on 1 January 2026 and was incorporated on 1 April 2026. During the year, total rent amounted to ₹1,20,000 and gross profit amounted to ₹24,00,000.
The Time Ratio is 1:3, while the Sales Ratio is 2:5.
Since rent is incurred evenly throughout the year, it will be apportioned using the Time Ratio of 1:3. Gross profit, however, depends on sales and will therefore be divided using the Sales Ratio of 2:5.
This example clearly demonstrates that selecting the correct basis of apportionment is essential for accurate accounting.
Common Mistakes Made by Students
Students often make errors while solving problems related to Time Ratio and Sales Ratio. Some common mistakes include:
- Using Time Ratio instead of Sales Ratio for Gross Profit.
- Allocating Rent on Sales Ratio.
- Calculating the number of months incorrectly.
- Ignoring changes in sales pattern during the accounting year.
- Forgetting to simplify ratios.
- Confusing Date of Purchase with Date of Incorporation.
- Assuming that all expenses are allocated on the same basis.
Avoiding these mistakes can significantly improve accuracy in examinations.
Examination Tips
- Always identify the Date of Purchase and Date of Incorporation before calculating ratios.
- Prepare the Time Ratio first.
- Calculate Sales Ratio separately using actual sales figures.
- Read the question carefully to identify whether sales are uniform or vary month by month.
- Allocate each item according to its correct basis.
- Show complete calculations to earn full marks.
Key Points to Remember
- Time Ratio is based on the duration of each period.
- Sales Ratio is based on the volume of sales.
- Administrative expenses are generally allocated on Time Ratio.
- Selling expenses and Gross Profit are generally allocated on Sales Ratio.
- Correct allocation is essential for determining Capital Profit and Revenue Profit.
- Time Ratio and Sales Ratio are the most important concepts in the chapter Profits or Loss Prior to Incorporation.
Examination-Oriented Questions
Very Short Answer Questions
- What is Time Ratio?
- Define Sales Ratio.
- On what basis is Gross Profit apportioned?
- Which expenses are allocated using Time Ratio?
- Why is Sales Ratio used in Corporate Accounting?
Short Answer Questions
- Explain the concept of Time Ratio with an example.
- Explain the meaning and importance of Sales Ratio.
- Distinguish between Time Ratio and Sales Ratio.
Long Answer Question
Explain the concepts of Time Ratio and Sales Ratio in detail. Discuss their importance, methods of calculation, and application in the apportionment of profits and expenses between pre-incorporation and post-incorporation periods with suitable illustrations.
Summary
Time Ratio and Sales Ratio are the two fundamental methods used to allocate income and expenses between the pre-incorporation and post-incorporation periods in Corporate Accounting. Time Ratio is applied to expenses that accrue evenly over time, such as rent, salaries, and administrative expenses, whereas Sales Ratio is used for items that vary with the level of business activity, such as gross profit, selling expenses, commission, and advertisement. Proper understanding and application of these ratios ensure accurate determination of capital profit and revenue profit, facilitate fair presentation of financial statements, and help students solve university examination problems with confidence.
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