Pre-acquisition profit in subsidiary company is considered as :

The correct answer is - Capital profit

Key Points

• Pre-acquisition profit refers to the profits earned by a subsidiary company before the parent company acquires control over it.
• Such profits are classified as capital profit, not revenue profit, because:
  • They are generated prior to the acquisition date and are not related to the normal operating activities of the parent company after acquisition.
  • These profits represent a capital reserve that belongs to the parent company and minority shareholders in proportion to their shareholding.
• In consolidated financial statements, pre-acquisition profits are added to the capital reserve or goodwill, depending on the purchase consideration and net assets acquired.

Additional Information

• Classification of profits in a subsidiary company:
  • Revenue profit: Profits earned after the acquisition date and are part of the normal operational activities.
  • Capital profit: Profits earned before the acquisition date and are treated as reserves of the holding company upon consolidation.
• Goodwill and Capital Reserve:
  • If the purchase consideration paid by the parent company exceeds the net assets (including pre-acquisition profit) of the subsidiary, the excess is recognized as Goodwill.
  • If the purchase consideration is less than the net assets (including pre-acquisition profit), the difference is recognized as a Capital Reserve.
• Importance in Consolidated Financial Statements:
  • Correct classification of pre-acquisition profits ensures accurate representation of reserves and surplus in the consolidated balance sheet.
  • Misclassification can lead to errors in the computation of goodwill, capital reserve, and minority interest.