INTRODUCTION PARTNERSHIPS

Transcription

1 NCEA LEVEL 3 ACCOUNTING By Elizabeth Pitu 2013 BOOK 1 INTRODUCTION and PARTNERSHIPS Teacher Manual

2 NCEA LEVEL 3 ACCOUNTING By Elizabeth Pitu 2013 BOOK 1 INTRODUCTION and PARTNERSHIPS Student Workbook STUDENT NAME:

3 CONTENTS Exercises Completed Topic Page OVERVIEW Course Information ii-v INTRODUCTION GST and Balance Day Adjustments Practice Example 1-3 Financial Statements 4-6 Introductory Exercises 7-12 PARTNERSHIP NOTES Achievement Criteria 13 Introduction Examples Partnerships Partnership Financial Statements Worked Example Island Style PRACTICE EXERCISES Partnership Formation Takeover a business 29 Sole proprietor admits a partner 30 Two partners join businesses 31 Profit Distribution and Current Accounts for partners Bringing it together 34 Financial Statements including Balance Day Adjustments Dealing with Interest on Average Capitals 38 Including salaries paid to partners in cash Partnership Formation and Financial Statements 41 Revision Tasks Partnership Assignments 45-49

4

5 NCEA LEVEL 3 AND SCHOLARSHIP ACCOUNTING COURSE INFORMATION

6 General Overview NCEA Level 3 Accounting covers partnership accounting, company accounting, company annual report interpretation, cost accounting, management accounting and decision making. The Accounting Scholarship Standard is one standard with a focus on reporting entities. Management accounting is also covered in Scholarship. This is assessed by a separate three hour examination at the end of the year and demands a very thorough and in-depth knowledge of the course content. Wider reading and independent study will be expected of any student wishing to undertake the Scholarship examination NCEA Level 3 Achievement Standards in Accounting Achievement Standard number Mode of Assessment & Credit Value Title of the Standard Main focus of the standard (3.1) External 4 Credits (3.2) Internal 4 Credits (3.3) External 5 Credits (3.4) Internal 5 Credits (3.5) External 4 Credits (3.6) Internal 4 Credits Demonstrate understanding of accounting concepts for a New Zealand reporting entity Demonstrate understanding of accounting for partnerships Demonstrate understanding of company financial statement preparation Prepare a report for an external user that interprets the annual report of a New Zealand reporting entity Demonstrate understanding of management accounting to inform decision making Process financial information for a manufacturing job cost subsystem Applying, explaining and justifying the conceptual basis of accounting for a New Zealand reporting entity so its stakeholders can make decisions. Preparing and explaining accounting entries for the formation and changes in equity, including profit distribution, of a partnership to enable the partnership to continue operations Preparing and/or explaining/justifying fit for purpose financial statements and related accounting entries for companies. Preparing a written report on a New Zealand reporting entity s annual report that meets the needs of a specified external user/stakeholder Financial and non-financial information needs of management to inform decision making including CVP analysis techniques, budgets and the preparation of a cash budget Preparing and explaining accounting entries for manufacturers who use a job cost system for costing jobs Level 3 Accounting OVERVIEW Course Information page ii

7 Section One Introduction Financial statements and balance day adjustments from Achievement Standard 91408, but using a sole proprietor context Partnership accounting Achievement Standard (3.2) internal 4 credits accounting concepts applied to formation of partnerships accounting entries for formation including goodwill accounting entries for profit distribution including reasons for different methods of profit distribution, current accounts, (drawings) and capital accounts financial statements including balance day adjustments for partnerships to include Income Statement, Profit Distribution Statement and Balance Sheet with accompanying notes Note: Teaching and learning includes balance day adjustments, income statements and full balance sheets with accompanying notes. Assessment does not include these except for the Equity section and note to the balance sheet. Section Two Job Costing Achievement Standard (3.6) internal 4 credits prepare accounting entries for a manufacturer using a job cost accounting system including entries on source documents, job cost sheets, general journal entries, general ledger control accounts, subsidiary ledger entries explain accounting entries including the controls related to and purpose of source documents and job cost sheets, the importance of correctly allocating costs to jobs, an explanation of the cost driver(s)/bases used in the job cost subsystem to allocate overhead to jobs, the reasons for under or over applied overhead. Section Three Company financial statements and associated accounting entries features and legal requirements of companies Achievement Standard (3.3) external 5 credits accounting entries specific for a company including revaluation of financial assets, revaluation of land and buildings upwards, issue of shares for cash including issue of shares for cash through a sharebroker, share repurchase, provisional tax payments, taxation expense and taxation payable, payment of final and interim dividends (after meeting the Solvency Test) explain the Solvency Test and the accounting entries specific to a company financial statements for companies including balance day adjustments and company accounting entries to include Income Statement/Statement of Comprehensive Income, Statement of Financial Position, Statement of Cash Flows and Notes to the Financial Statements. Section Four Annual report of a New Zealand reporting entity Achievement Standard (3.4) internal 5 credits Prepare a report on a New Zealand reporting entity s annual report to meet the specified needs of an external user/stakeholder. Level 3 Accounting OVERVIEW Course Information page iii

8 Section Five The Conceptual Framework as applied to a New Zealand reporting entity Achievement Standard (3.1) external 4 credits features of reporting entities including accountability, contents of annual reports, stakeholders statutory reporting requirements from the Companies Act 1993 and the Financial Reporting Act 1993 generally accepted accounting practice (GAAP or NZGAAP) general purpose financial statements and accounting policies including statement of comprehensive income, statement of financial position, statement of cash flows, notes to the financial statements Part A of the New Zealand Framework Section Six Decision Making Achievement Standard (3.5) external 4 credits Financial and non-financial information managers use to inform their decision making including budgets Cash budget preparation Comparison of actual results with budget Cost concepts including direct and indirect costs, variable, fixed and semi-variable costs, relevant range, contribution margin, break-even and margin of safety CVP analysis techniques including calculations, CVP graph, CVP profit statement, for one product or service Level 3 Accounting OVERVIEW Course Information page iv

9 SECTION 1a INTRODUCTION Notes, Examples & Exercises

10 GST and Balance Day Adjustments A quick summary Note: You are not required to learn any of these general journal entries They are provided for illustration purposes. Accrued Expenses For example the business has a flat rate mortgage of $40,000. Interest is 9.6% p.a. The trial balance has Interest on Mortgage as $3,520. This means that $320 is owing for interest on mortgage. The general journal entry is 31/3/13 Interest on Mortgage 320 Accrued Expenses 320 One month interest owing on mortgage. For expense invoices dated before balance day the full amount is credited to Accounts Payable, the amount of GST is debited to GST and the net amount is debited to the expense. For example a business has an invoice on hand for electricity dated 29 March 2013, $920 including GST. The general journal entry is 31/3/13 Electricity 800 GST 120 Accounts Payable 920 Account on hand for electricity owing for March. This entry IS NOT reversed. When the invoice is paid, Bank is credited and Accounts Payable is debited. Prepayments and Income in Advance As both of these adjustments relate to transactions which have already occurred, the GST relating to them will have already been accounted for as GST is always accounted for when the transaction occurs in the case of invoice basis GST this means the earlier of the money received or paid or the invoice being issued. We have already paid the money in the case of prepayments and we have already received the money in the case of income in advance so we have already accounted for the GST component of the transaction. The result is that Prepayments and Income in advance are always recorded at their GST exclusive amounts. Unless you are told you have a GST inclusive amount, you should assume that the amount of the prepayment or income in advance given is GST exclusive. Example Insurance paid in advance $400 excluding GST March 31 Prepayments 400 Insurance 400 For insurance paid in advance $400. Example Tour income received in advance $6900 including GST. Remember, remove and ignore the GST. March 31 Tour Income 6,000 Income in Advance 6,000 For tour revenue received in advance $6,000 Accrued Income For example dividends owing to the business 7c per share on 10,000 shares in Chorus Ltd March 31 Accrued Income 700 Dividends Received 700 For dividends received owing $700 Bad Debts Bad debts include GST and require an adjustment to GST if they are to be written off. The entry to write off $4,600 of further bad debts is March 31 Bad Debts 4,000 GST 600 Accounts Receivable 4,600 Bad debts written off. Level 3 Accounting INTRODUCTION page 1

11 Practice Example Income and Expense adjustments Example Kayak Tour and Hire Trial Balance extract as at 31 March 2013 Advertising 7,900 Dividends Received 8,000 Insurance 5,400 Tour fees Received 36,000 Accounts Receivable 9,600 Hire fees Received 12,000 Accounts Payable 12,500 GST 1,345 Adjustments required: 1. An invoice is on hand for advertising $552 including GST. 2. Invoice dated 31 March 2013 for hire fees $2,300 including GST has not yet been recorded. 3. Insurance is paid in advance $600 excluding GST. 4. $3,000 is owing for Dividends Received. 5. Tour fees of $3,450 including GST has been received in advance. Instructions: 1 For the invoice on hand for advertising including GST i) Add the GST inclusive figure to Accounts Payable ii) Increase advertising by the GST exclusive figure iii) Decrease the GST (payable/cr) by the amount of GST 2 For the invoice on hand for hire fees including GST i) Add the GST inclusive figure to Accounts Receivable ii) Increase hire fees by the GST exclusive figure iii) Increase the GST (payable/cr) by the amount of GST 3 For the prepaid insurance i) We have been given the GST exclusive figure which is the one we want to use. ii) Decrease insurance (by the GST exclusive amount) iii) Create Prepayments (Dr) for the same amount 4 For the Dividends Received owing i) There is no GST with dividends to worry about ii) Increase the Dividends Received by the amount owing. iii) Create an Accrued Income account (Dr) for the amount owing. 2 For the tour fees received in advance i) We have been given the GST inclusive figure we need to use the GST exclusive figure and ignore the GST ii) Decrease the tour fees received by the GST exclusive amount iii) Create an Income in Advance account (Cr) for the same amount. Level 3 Accounting INTRODUCTION page 2

12 Practice Example - Adjustments including bad debts, doubtful debts and depreciation. Example: Accounts Receivable 27,230 Allowance for doubtful debts 300 Bad debts 400 Office Equipment 32,000 Accumulated depreciation Office Equipment Accumulated depreciation Shop Fittings 8,000 14,000 Shop Fittings 50,000 GST 3,255 Adjustments required 1. Write off further bad debts of $230 including GST. 2. Adjust the Allowance for Doubtful Debts to 2% of Accounts Receivable. 3. Provide for depreciation on office equipment 10% straight line. (SL) 4. Provide for depreciation on shop fittings 10% diminishing value (DV) Instructions 1 To write off further bad debts i) Decrease the accounts receivable by the GST inclusive figure for bad debts. ii) Increase bad debts by the GST exclusive figure iii) The GST (Cr) account is decreased by the amount of GST. 2 To adjust the allowance for doubtful debts i) Use the new figure for accounts receivable and the percentage for the allowance to calculate what the allowance for doubtful debts should be. In this case * % = ii) Change the Allowance for Doubtful debts to this figure. iii) By what amount did you change the allowance? iv) If your answer to (iii) is positive you create a doubtful debts (financial) expense (Dr) for this amount. v) If your answer to (iii) is negative you create a doubtful debts credit (Cr) for this amount. A doubtful debts credit is recorded in the (administrative) expense section of the Income Statement as a negative number. 3 For the straight line (SL) depreciation i) Calculate the amount of depreciation expense by multiplying the % by the cost of the asset in the trial balance ii) Add this amount to the Accumulated Depreciation account (Cr) for this asset. iii) Create a Depreciation on expense (Dr) account for this asset. 4 For the diminishing value (DV) depreciation i) Calculate the amount of depreciation expense by multiply the % by the cost less the current amount of accumulated depreciation for the asset (the carrying amount of the asset). iv) Add this amount to the Accumulated Depreciation account (Cr) for this asset. ii) Create a Depreciation on expense (Dr) account for this asset. Level 3 Accounting INTRODUCTION page 3

13 Financial Statements Financial statements at Level 3 require a number of items to be shown by way of notes to the financial statements. The following is a model of an Income Statement, Balance Sheet and accompanying notes for a sole proprietor. You will be introduced to additional statements for partnerships and companies in the units on these during the course of the year. Income Statement Note: In the income statement expenses have been classified as per Level 2 accounting. Expense classifications are not assessed at Level 3 but will be used in this introductory unit and in the partnership unit. Teachers with no scholarship students or students new to accounting may choose to omit the expense classifications. This will not affect the total expenses or the profit for the year. However if expenses are not classified, cost of goods sold is included in expenses and gross profit is not shown. The Firm Income Statement for the year ended 31 March 2013 Sales 290,000 Less Cost of Sales 150,000 Gross Profit 140,000 Add Other operating income Dividends Received 1,000 Commission Received 24,000 25,000 Less Distribution expenses Advertising 12,000 Delivery expenses 14,000 Depreciation on shop fittings 8,000 Sales Salaries 29,000 63,000 Administrative expenses Accountancy Fee 7,000 Bad debts 500 Depreciation on office equipment 6,000 Doubtful debts 100 Office Expenses 27,000 Rates and Insurance , ,000 Less Finance costs Interest on loan 3,400 Total expenses 125,000 Profit for the year $40,000 Level 3 Accounting INTRODUCTION page 4

14 Balance Sheet or Statement of Financial Position Note: In the partnership unit Balance Sheet will be used. In the company unit Statement of Financial Position will be used. Either term is acceptable for this statement. External assessments use Statement of Financial Position but students may use Balance Sheet without penalty. Disclosure requirements to be shown by: Assets divided into Current and Non-current Liabilities divided into Current and Non-current Equity Appropriate notes The Firm Balance Sheet as at 31 March 2013 Note Assets Current Assets Bank 1,000 Accounts Receivable 1 7,800 Inventory 18,000 Prepayments 700 Accrued Income 600 Total Current Assets 28,100 Non-current Assets Property, Plant and Equipment 2 85,000 Goodwill 8,000 Shares The Warehouse 3 6,900 Total Non-current Assets 99,900 Total Assets 128,000 Less Liabilities: Current Liabilities GST Payable 1,400 Accounts Payable 9,000 Accrued Expenses 1,600 Income in Advance 2,000 Total current liabilities 14,000 Non-current Liabilities Loan (10% due 2015) 34,000 Total Non-current Liabilities 34,000 Total Liabilities 48,000 NET ASSETS $80,000 Equity Closing Capital 4 $80,000 Level 3 Accounting INTRODUCTION page 5

15 Notes to the Balance Sheet 1. Accounts Receivable Accounts Receivable 8,000 Less Allowance for doubtful debts 200 7, Property, plant and equipment Shop Fittings Office Equipment Totals Opening carrying amount 72,000 27,000 99,000 Depreciation 8,000 6,000 14,000 Carrying amount 64,000 21,000 85,000 As at 31 March 2013 Cost or valuation 80,000 30, ,000 Accumulated depreciation 16,000 9,000 25,000 Carrying amount 64,000 21,000 85,000 There have been no additions or disposals of shop fittings or office equipment during the year. Depreciation is calculated on a straight-line basis at the following rates Shop Fittings 10% per annum Office Equipment 20% per annum. 3. Investments Shares in The Warehouse have a current market value, which is considered to be their fair value, of $6, Equity Opening Capital 70,000 Plus Profit for the year 40,000 less Drawings -30,000 Closing Capital $80,000 Level 3 Accounting INTRODUCTION page 6

16 PRACTICE EXERCISES Exercise One Trial Balance of Crazy Crafts as at 31 March 2013 Cost of Goods Sold 131,500 Sales 241,500 Inventory 19,200 Dividends Received 700 Salaries office 13,500 Accounts Payable 10,100 Advertising 4,800 Rent Received 1,500 General Expenses 3,900 Accumulated Depreciation: Discount Allowed 1,000 - Shop fittings 16,000 Freight out 2,800 - Office Equipment 1,600 Bad Debts Buildings 12,000 Sales wages 16,100 Bank 1,700 Rates and insurance 1,500 GST 1,160 Interest on mortgage 3,600 Allowance for doubtful debts 700 Accounts Receivable 18,460 Capital 141,000 Shares in PWL 16,000 Mortgage (10% p.a. due 2016) 40,000 Shop fittings 40,000 Office Equipment 18,000 Buildings 120,000 Land 30,000 Drawings 27,000 $467,960 $467,960 Additional information (a) Dividends owing $300 (b) Insurance paid in advance $200 excluding GST (c) Office salaries due $500 (d) Interest on mortgage is 10% p.a. (e) Rent received in advance $300 excluding GST (f) Write off further bad debts of $460 including GST. (g) Adjust the allowance for doubtful debts to equal 5% of accounts receivable. (h) Provide for depreciation on: Shop fittings at 10% D.V. Office equipment 10% S.L. Buildings 2% S.L. (i) Shares in PWL have a current market value, considered to be fair value, of $17,200 Level 3 Accounting INTRODUCTION page 7

17 Required Practical aspects (a) Prepare journal entries for the adjustments. (b) Prepare an Income Statement (c) Prepare a Balance Sheet with accompanying notes Conceptual Aspects Under the New Zealand Framework the following are definitions of assets, liabilities, income and expenses: Assets are resources controlled by the entity as a result of past events (usually transactions), from which future economic benefits are expected to flow to the entity Liabilities are present obligations of the business as a result of past events (usually transactions) which are expected to result in an outflow of resources representing economic benefits when settled (in the future) Incomes are increases in economic benefits in the form of inflows or enhancements of assets or decreases in liabilities that result in increases in equity, other than owner s contribution Expenses are decreases in economic benefits in the form of outflows or depletions of assets or increases in liabilities that result in decreases in equity, other than drawings. You are required to Discuss fully how you have applied each of the following financial elements/concepts in the preparation of your financial statements. Financial elements (a) Shop Fittings as an asset (b) Mortgage as a liability (c) (d) Rent received as income Advertising as an expense Concepts (e) Accounting Entity (f) (g) (h) (i) (j) Monetary Measurement Going-Concern Accrual Basis Historical Cost Relevance Level 3 Accounting INTRODUCTION page 8

18 Exercise Two Trial Balance of Waihaha Treasures as at 31 March 2013 Accounts Receivable 12,230 Sales 210,000 Accountancy Fee 5,900 Interest Received 200 Advertising 6,900 Accounts Payable 12,000 Bad Debts 100 Commission Received 7,200 Cost of Goods Sold 120,000 Accumulated Depreciation: Delivery expenses 2,800 - Shop Fittings 16,000 Discount Allowed Office Equipment 7,500 Drawings 27,000 Bank 1,100 Interest on Loan 1,500 GST 930 Inventory 42,000 Allowance for doubtful debts 200 Office Equipment 25,000 Loan (8% due July 2013) 25,000 Office Expenses 2,100 Capital 69,000 Office Salaries 12,800 Insurance 1,500 Sales Salaries 24,800 Term Deposit 4,000 Shop Fittings 40,000 Goodwill 20,000 $349,130 $349,130 Adjustments are required as follows (a) Insurance paid in advance $400 (b) Office salaries owing $200 (c) Interest is owing on the loan. (d) Write off further bad debts of $230 including GST. (e) Adjust the allowance for doubtful debts to equal 2.5% of accounts receivable. (f) Provide for depreciation on: Shop fittings at 10% D.V., Office equipment 10% S.L. Required Prepare the financial statements Level 3 Accounting INTRODUCTION page 9

19 Exercise Three Trial Balance of Fergusons Furniture as at 31 March 2013 Accounts Receivable 25,690 Capital 274,000 Accountancy Fees 8,000 Accounts Payable 35,000 Bad Debts 300 Bank 1,050 Cost of Sales 250,000 Mortgage (7.5%. due 2017) 80,000 Vehicle and delivery expenses 35,000 Dividends Received 15,000 Sales salaries 54,000 Accumulated Depreciation Goodwill 10,000 - Fixtures and Equipment 25,000 Interest on Mortgage 5,400 Accumulated Depreciation Repairs and maintenance 12,600 - Vehicles 12,000 Drawings 54,000 GST 2,440 Inventory 40,000 Allowance for Doubtful Debts 700 Land and Buildings 200,000 Sales 473,000 Vehicles 60,000 Rent Received 40,000 Fixtures and Equipment 85,000 Office Expenses 21,000 Rates and Insurance 17,200 Shares in PKR Ltd 80,000 $958,190 $958,190 Adjustments required 1. Interest on the mortgage is owing 2. Two months rent at $2,300 including GST per month, has been received in advance. 3. An invoice, dated 28 March 2013, is on hand for repairs and maintenance $1,150 including GST 4. Rates of $1,600 excluding GST have been paid in advance. 5. Further bad debts of $690 including GST are to be written off. 6. The allowance for doubtful debts should be 2% of Accounts Receivable. 7. Provide for depreciation 10% SL on Fixtures and Equipment 8. Provide for depreciation 20% DV on Vehicles. 9. Shares in PKR have a current market value, considered to be fair value of $84,000 Required Prepare the financial statements Level 3 Accounting INTRODUCTION page 10

20 Exercise Four Just Joking Trial Balance as at 30 June 2013 Accounts Receivable 7,526 Accounts Payable 8,800 Advertising 7,700 Rent Received 39,000 Bad Debts 300 Accumulated Depreciation Buildings 140,000 - Shop Fittings 20,000 Cash on Hand 200 Capital 142,000 Cost of Goods Sold 70,000 Accumulated Depreciation Drawings 35,000 - Buildings 6,000 Goodwill 8,000 GST 2,006 Interest on Mortgage 5,700 Sales 179,000 Inventory 27,000 Mortgage (8% due 2017) 95,000 Land 50,000 Bank 3,120 Office Expenses 9,200 Allowance for Doubtful Debts 100 Rates and Insurance 6,000 Sales Salaries 30,000 Shop Electricity 8,400 Shop Fittings 90,000 $495,026 $495,026 Additional information 1. An invoice dated 28 June 2013 is on hand for June s electricity, $460 including GST. 2. An invoice dated 30 June 2013 has not been recorded for sales $1,150 including GST. 3. $2,000 is owing for Sales Salaries. 4. Three months interest (flat rate) is owing on the mortgage. 5. Advertising of $1,600 excluding GST, has been paid in advance for advertisements to appear in The Daily Prophet during July and August. 6. George rents part of his building to Hogsmeade Tavern for $3,000 (excluding GST) per month. The building has been rented for the whole year. 7. D Malfoy has left the country and his debt of $276 is to be written off. 8. Adjust the allowance for doubtful debts to 2.5% of accounts receivable. 9. Depreciation on Buildings is $1,000 p.a. 10. Depreciation on Shop Fittings is 10% D.V. Required Prepare the financial statements. Level 3 Accounting INTRODUCTION page 11

21 SECTION 1b PARTNERSHIPS Notes, Examples & Exercises

22 ACHIEVEMENT CRITERIA Achievement Standard (3.2) Demonstrate understanding of accounting for partnerships Achievement Achievement with Merit Achievement with Excellence Demonstrate an understanding of accounting for partnerships. Demonstrate in-depth understanding of accounting for partnerships. Demonstrate comprehensive understanding of accounting for partnerships From the explanatory notes: 2 Demonstrate understanding involves applying partnership accounting elements to enable the partnership to continue operations. Demonstrate in-depth understanding involves explaining the application of partnership accounting elements to enable the partnership to continue operations. Demonstrate comprehensive understanding involves justifying the application of partnership accounting elements to enable the partnership to continue operations. 3 Partnership accounting elements are: entries for the formation of a partnership using agreed values of assets, liabilities and capital contributions Partnership Agreement Partnership Act 1908 entries for partners capital and current accounts Profit Distribution Statement equity section and note to financial statements. Level 3 Accounting Partnerships Notes, Examples & Exercises page 13

23 Introduction The Partnership Act 1908 defines a partnership as a group of persons carrying on a business with a view to profit. In order for a business to continue operations, ultimately it needs to make a profit. Businesses that persistently make losses with no view to making a profit will not survive. The Partnership Act 1908 recognises that a partnership exists when the group of persons carry on a business with the intention of making a profit so the partnership business can continue operations. In 1908 when this definition was created, profit for most businesses was based on cash accounting and represented a cash profit. This adds to the need for businesses to have positive cash from operations as well as making an accrual based profit to ensure continuing operations. Generally partnerships are relatively small with 2 or 3 partners, except for large professional partnerships which have many partners. Accounting firms like Price Waterhouse Coopers and KPMG are international firms with many partners in each office. Advantages ease of formation - no legal requirements but a Partnership Agreement is desirable more capital available than a sole proprietor so that a sole proprietor business that has reached the limit of its owner s ability to fund its future can continue operations with an injection of additional capital from a partner who will share the risks and rewards of the business complementary skills brought together - partners can specialise in different parts of the business which can allow the business to grow in different directions or more readily grow its client base so that it can continue operations Disadvantages each partner jointly and severally liable for the debts of the partnership as with a sole proprietor business, unlimited liability applies to each partner, so each partner is personally liable for the debts of the partnership if the partnership experiences financial difficulty and is unable to meet its debts each partner is bound by the acts of each other partner in the course of business and personally liable if the partnership is in debt as a result partnership has a limited life - unless specifically provided for in the Agreement the partnership dissolves on the death or retirement of a partner Partnership Agreement A partnership agreement is a written agreement (sometimes called a Deed) setting out the rights, liabilities and duties of the partners. It is important to have a legally binding Partnership Agreement so that each partner is aware of their rights, liabilities and duties in relation to the partnership so that when disputes arise, as inevitabily they will, they can be resolved and the partnership can continue its operations. This agreement should contain clauses covering such things as: name of the partnership names of the partners objectives or purposes of the partnership so partners know why they are operating the business and can ensure that the business continues to operate in such a way as to meet the partnership objectives and purposes rights, liabilities and duties of the partners capital introduced by each partner capital contributions by a number of partners allow for the business to continue operation. Some partnerships have sleeping partners who contribute capital so that the business is able to be set up/grow/expand in new directions but who take no other part in the operations of the business. Sleeping partners capital contribution can be very useful for a partnership just starting out with limited access to capital as it allows the business to establish and continue its operations without needing to resort to excessive external debt finance which can be very costly for businesses starting out. whether capital is to remain fixed Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 14

24 how profits and losses are to be divided so different contributions to the business can be recognised for example a sleeping partner may only receive interest on capital and may be happy with this as their capital contribution may be significant and the interest may be set at a higher rate than bank interest rates as the capital contribution is a riskier investment whether drawings, salaries to partners, interest on drawings, current or capital accounts and interest on advances(loans) are to be allowed explanations of these and how they contribute to the partnership continuing operations are found in the profit distribution notes below. voting and decision-making procedures to be followed so that the business can continue operations without getting bogged down in arguments among partners procedures to be followed on death or retirement of partners (outside the scope of this course) Partnership Act 1908 Where a partnership agreement does not exist or is silent on any of the following the Partnership Act applies. partners will share equally in profits and losses of the business no partners salaries, interest on drawings, current or capital accounts is allowed where a partner has made an advance or loan to the partnership beyond the amount of their capital they are entitled to interest at the rate of 5% p.a. from the date of the advance mutual agency exists, ie each partner can act on behalf of the firm in normal business transactions a majority decision is required on ordinary business matters all partners must consent before a new partner can join the firm on the death of a partner the partnership is dissolved Formation of a Partnership A partnership is a new entity created when the partners agree to start up in business together. In fact, unlike companies, every time a new partner joins a partnership, a new entity is formed. For our purposes we only consider the formation of new partnerships from two (or three) people joining together to form a new business, most often to take over the current sole proprietor business of one or two of the partners. Because a new business is being formed, there is an opportunity to revalue assets of any existing sole proprietor business being taken over. This ensures the assets enter the new business at a fair value of their expected future economic benefit to the partnership so that it is able to use the assets as security if necessary to fund its continuing operations. Formation Issues Asset Revaluation on establishment of a new partnership A partnership is a new business when a sole proprietor (or two or more) join with others. Assets of existing businesses can therefore be revalued to their current fair value which the partners agree to - current value could be current market value or current (replacement) cost. The value agreed to should be the fair value of the probable future economic benefit to the partnership from having control over the asset. For property, plant and equipment the agreed fair value of each asset is then the historical cost of each asset to the new business as this is the acquisition cost of each asset to the new partnership; any previous accumulated depreciation is ignored when a new set of books is being opened. The partnership will begin with assets recognised at the amount fairly representing their future economic benefit to the continuing operations of the partnership. For Accounts Receivable a revaluation which recognises the existence of doubtful debts, cannot simply be recorded in the new business at the agreed fair value. An allowance for doubtful debts must be created or adjusted as required. Your claim to the money debtors owe must be shown in full until you have identified specifically which debtor(s) will turn bad, at which point the debt is written off. In the mean time the business must be able to report its assets at their probable future economic benefit (recognition criterion of an asset) so we need an allowance for doubtful debts. This then ensures that when accounts receivable is reported in the balance sheet it will be shown at the amount of cash actually likely to flow to the partnership from the debtors. It is only this cash that can benefit the continuing operations of the partnership. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 15

25 Goodwill Where the agreed value of the net assets to be taken over by a new partnership is less than the agreed value of the partner s contribution, goodwill is recorded as the difference. Goodwill recognises that the partner is contributing not only the value of their (tangible) net assets, but also the value of their business reputation, established client base, location and the expectation of future profits from the fact the business being taken over is a going concern. Goodwill therefore represents future economic benefit to the new business that will assist its continuing operations. For example if two plumbers join their sole proprietor businesses in a partnership, each will bring an established group of clients so the business has a much larger starting client base from which to grow and continue its operations. Each plumber may bring different specialised skills so that the business can expand in different directions such as small household plumbing jobs and larger building site development jobs. Goodwill can only be recorded when a business is purchased and the purchase price or in the case of a sole proprietor converting to a partnership, the agreed fair value of the business as a going concern is greater than the value of net tangible assets. Formation entries Because we now have more than one owner it is very important that every equity account is named with the correct partner s name. When a partnership is formed there is a separate general journal entry for each partner and a separate capital account for each partner. Each capital account must be labelled with the partner s name. We can no longer have a capital account or a drawings account without a name attached. For example if Ari and Maia are in partnership they will have capital accounts called Capital Ari Capital Maia and drawings accounts called Drawings Ari Drawings Maia Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 16

26 PARTNERSHIP FORMATION Example One S Henry invites M Watson to join him in partnership. S Henry has a successful sports store he wants to expand. His assets and liabilities on 1 March 2013 are as follows Value in S Henry s books Agreed Value Bank 1,200 1,200 Accounts Receivable 7,200 6,800 Inventory 34,000 32,000 Fittings and Equipment 50,000 42,000 (Less Accumulated Depreciation) (5,000) - Accounts Payable 12,000 12,000 Loan (8%, due 2016) 20,000 20,000 It is agreed that S Henry s contribution will be valued at $70,000. M Watson will contribute sufficient cash for a one third share in the total capital. General Journal 01/03/13 Bank 1,200 Accounts Receivable 7,200 Inventory 32,000 Fittings and Equipment 42,000 Goodwill 20,000 Allowance for Doubtful Debts 400 Accounts Payable 12,000 Loan 20,000 Capital - S Henry 70,000 Contribution of assets and liabilities by S Henry Bank 35,000 Capital - M Watson 35,000 Cash contributed by M Watson IMPORTANT POINTS Accounts Receivable stays at its original value. An Allowance for Doubtful Debts establishes the agreed value. Other assets are simply recorded at their agreed values. Accumulated depreciation is ignored. Goodwill is calculated as the difference between the value placed on S Henry s contribution $70,000 and the agreed value of the net assets taken over $50,000. Capitals MUST be labelled with the partners names Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 17

27 Henry and Watson Balance Sheet as at 1 March 2013 Note Assets Current Assets Bank 36,200 Accounts Receivable 1 6,800 Inventory 32,000 75,000 Non-current Assets Property, plant and equipment 2 42,000 Goodwill 20,000 62,000 Total assets 137,000 Less Liabilities Current Liabilities Accounts Payable 12,000 Non-current Liabilities Loan 3 20,000 Total liabilities 32,000 Net assets $105,000 Equity Contributed Capital 4 $105,000 Notes 1. Accounts Receivable Accounts Receivable 7,200 Less Allowance for doubtful debts -400 $6, Property, plant and equipment Fittings and Equipment Cost 42, Loan The loan has an interest rate of 8% and is due for repayment in Equity Capital S Henry 70,000 M Watson 35,000 $105,000 Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 18

28 Example Two C Scott and A Peri decide on 14 February 2013 to join their two florist shops in a partnership. The following are their sole proprietor business assets and liabilities as at 14/02/13 C Scott Assets and Liabilities as at 14 February 2013 Assets Liabilities Bank 1,300 Accounts Payable 6,600 Accounts Receivable 4,500 Loan (due 7.5%) 7,000 Inventory 9,800 Equity Plant and equipment (note 1) 21,000 Capital 23,000 $36,600 $36,600 Fittings & Delivery Note 1 Plant and equipment Equipment Vehicle Cost 23,000 17,000 Accumulated depreciation (9,000) (10,000) Assets A Peri Assets and Liabilities at 14 February 2013 Liabilities Accounts Receivable 12,000 Bank 2,400 -Allowance for doubtful debts (200) 11,800 Accounts Payable 11,800 Inventory 27,000 Loan (due 7.5%) 15,000 Plant and equipment (note 1) 32,000 Equity Note 1 Plant and equipment Fittings & Equipment Capital 41,600 $70,800 $70,800 Delivery Vehicle Cost 31,000 20,000 Accumulated depreciation (11,000) (8,000) Scott and Peri have agreed to the following revaluations: C Scott s business is agreed to have a value of $35,000 as a going concern. The following revaluations need to take place Accounts Receivable $4,300, Inventory $9,000, Fittings and Equipment $15,000 and Delivery Van to its carrying amount. A Peri s business is agreed to have a value of $52,000 as a going concern. The following revaluations need to take place Accounts Receivable $11,700, Inventory $25,000, Fittings and Equipment at their carrying amount and Delivery Van $9,000. In the spaces provided on the next page complete the general journal entries and the opening Balance Sheet for C Scott and A Peri s partnership to be called CAPS Florists Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 19

29 CAPS Florists General Journal 14/02/13 Bank Accounts Receivable Inventory Fittings and Equipment Delivery Van Goodwill Allowance for Doubtful Debts Accounts Payable Loan Capital C Scott Contribution of assets and liabilities by C Scott Contribution of assets and liabilities by A Peri Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 20

30 CAPS Florists Balance Sheet as at 14 February 2013 Assets Current Assets Note Accounts Receivable 1 Inventory Non-current Assets Property, plant and equipment 2 Intangible asset Goodwill Total assets Less Liabilities Current Liabilities Bank Accounts Payable Non-current Liabilities Loan 3 Total liabilities Net Assets Equity 4 Contributed Capital Notes: 1. Accounts Receivable Accounts Receivable Less Allowance for doubtful debts 2. Property, plant and equipment Cost Fittings and Equipment Delivery Vans Totals 3. Loan The loan has an interest rate of 7.5% and is due for repayment in Equity Capital C Scott A Peri Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 21

31 Partnership Financial Statements Sharing the profit Partnerships prepare an Income Statement the same as a sole proprietor. A Profit Distribution Statement is then prepared to share out the profit for the year to the partners. Because partnerships are not separate legal entities, partnerships are not taxed; individual partners are each taxed on their share of the profit, so all the profit must be shared out to the partners. Partners usually keep some of their profit share in the partnership usually in a current account see below. Current accounts are equity accounts and must be named with each partner s name. Profit sharing often takes into account: Recognition for capital contribution - interest on capital is a reward for each partner s fixed capital contribution which provides the equity funding to secure the partnership business s ability to continue operations. Without sufficient capital contributions from the partners the business would struggle to obtain any external debt finance such as loans to expand and grow the business. Interest on capital can be important for sleeping partners who only provide capital contribution. This is the reward for risking capital in the business rather than placing it in safter investments such as a fixed term deposit at the bank. Businesses all need equity finance in the form of capital contribution to continue operating. Recognition for work in the partnership - salaries to partners. Partners often include fixed salaries to each partner who works in the business to recognise that this work is the partner s way of earning income. Partners with a fair salary for their work contribution to the partnership will want to run the partnership in a way that its operations will continue so the partners can continue to earn a fair salary for their efforts. Recognition for risk-taking residual profit share. Partners have unlimited liability for the partnership debts if the partnership cannot pay its debts the partners are each personally liable for those debts. There is a risk in this and the residual profit share recognises the risk the partners are taking with their capital and time in operating as a partnership. Residual profit share may be equal if the partners agree that the risk after providing interest on capital and salaries is an equal risk. However any agreed residual profit sharing ratio can be used by the partnership as long as the partners all agree that it is fair. The following are also often considered in profit sharing arrangements: Interest may also be given on current account credit balances and charged on current account debit balances. Current account balances represent profit not withdrawn from the partnership by each partner. This is to encourage partners to retain some profit in the partnership as profit retention is necessary to ensure the business can continue operating. Interest on drawings may be charged when drawings exceed salaries or other agreed amount. This discourages partners from taking more drawings than agreed so that cash is retained in the business. Cash is essential for the day to day operations of the business such as paying expenses to keep the business running. It is important that partners do not withdraw cash from the business that is needed for paying operating expenses and making debt repayments. Cash can also be needed for the purchase/replacement of assets that enable the business to continue operations. If the interest charged is greater than what banks are charging for borrowing money, then there is more incentive to keep the cash above the agreed drawings, in the business. Bonuses may be awarded for some kind of contribution to the partnership such as contribution to revenue. This will encourage partners to look to grow the revenue base of the business so that profit is increased allowing the business to continue operating and providing a good return for the partners. If profit is not increasing over time one or more of the partners may no longer wish to be associated with the business or may no longer be prepared to risk their money and time for the partnership so the partnership would not continue operating. Capital and Current Accounts Partnerships often keep partners capital contribution fixed and separate from their retained profit (profit earned less drawings). Retained profit is kept in a current account for each partner. This allows for ready calculation of interest on capital invested and if it is in the agreement, interest on current accounts recognising the amount of profit kept in the business by each partner. Salaries and drawings Most partnerships recognise that salaries to partners form part of their share of the profit. Salaries are then credited to each partners current account at the end of the year while withdrawals of cash or assets for personal use are recorded in each partner s drawings account during the year. Each partner s drawings account is then closed to each partner s current account at the end of the year after the profit share has been credited based on profit sharing clauses in the partnership agreement. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 22

32 Loans by partners Partners may loan money in excess of their capital contribution, to the partnership. The Partnership Act provides that in absence of agreement to the contrary, partners loans will receive 5% interest p.a. treated as a distribution of profits. However, if the loan is an arms-length transaction between the partner and the partnership that is it is a loan on similar terms to current bank loans then the interest expense on the loan is a business expense and not a distribution of profit. Loans to partners are complex and are not required to be assessed so have been excluded from this unit of work. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 23

33 Example Profit Sharing, Current Accounts, Balance Sheet extract Kate and Bret are in partnership sharing profits in a ratio of 3:2. Their partnership agreement has the following clauses: 1. Salaries as appropriations of profit Kate $20,000, Bret $15, Interest on capitals 10% p.a. 3. Interest on currents given/charged at 5% p.a. 4. Interest charged on drawings on the amount above salary 10% p.a. Kate and Bret Trial Balance extract as at 31 March 2013 Current Account - Bret 2,000 Capital - Kate 60,000 Drawings - Kate 25,000 Capital - Bret 45,000 Drawings - Bret 18,000 Current Account - Kate 4,000 Profit for the period before appropriation for the year ended 31 March 2013 $46,000 The profit distribution statement records each of the profit sharing clauses separately, recording the amounts for each partner separately as well. The profit for the year is a credit entry in the profit distribution statement. Salaries, interest on capital, bonuses, interest on credit balance current accounts are all debit entries and are subtracted from the profit for the period. Interest on a debit current account balance and interest on drawings are both credit entries and are therefore added to the profit for the year. You can separately add interest on a debit current account balance or if there is only one, use a double negative. The final item is always share of the residual profit (or residual loss if negative) split in the profit sharing ratio so that the statement ends with zero. Note that drawings are NOT included in the profit distribution statement. Here is a profit distribution statement and equity note of the Balance Sheet for Kate and Bret. Relevant journal entries and current accounts are shown on the next page. Kate and Bret Profit Distribution Statement for the year ended 31 March 2013 Profit for the period 46,000 Add Interest on Drawings Kate 500 Bret ,800 Less Salaries Kate 20,000 Bret 15,000 35,000 11,800 Less Interest on Capitals Kate 6000 Bret ,500 1,300 Less Interest on Currents Kate 200 Bret Less Share of Residual Profit Kate 720 Bret Kate and Bret Balance Sheet as at 31 March 2013 (Extract) Equity (note) Capital Current Total Kate 60,000 5,420 $65,420 Bret 45,000 (420) $44,580 $105,000 $5,000 $110,000 Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 24

34 Current Account - Kate 01/04/12 Balance 4,000 Cr 31/03/13 Salary 20,000 24,000 Cr Interest on Capital 6,000 30,000 Cr Interest on Current ,200 Cr Share of residual profit ,920 Cr Interest on Drawings ,420 Cr Drawings 25,000 5,420 Cr Current Account - Bret 01/04/12 Balance 2,000 Dr 31/03/13 Salary 15,000 13,000 Cr Interest on Capital 4,500 17,500 Cr Interest on Current ,400 Cr Share of residual profit ,880 Cr Interest on Drawings ,580 Cr Drawings 18, Dr General Journal entries for the profit distribution and current accounts 31/03/13 Income summary 46,000 Profit distribution summary 46,000 Transfer of Profit for the period Profit distribution (salaries) 35,000 Current Kate 20,000 Current Bret 15,000 Transfer of salaries Profit distribution (interest on capital) 10,500 Current Kate 6,000 Current Bret 4,500 Transfer of interest on capitals Profit distribution (interest on current) 200 Current Kate 200 Transfer of interest on credit current Current Bret 100 Profit distribution (interest on current) 100 Transfer of interest on debit current Current Kate 500 Current Bret 300 Profit distribution (interest on drawings) 800 Transfer of interest on drawings Profit distribution 1,200 Current Kate 720 Current Bret 480 Transfer of residual profit share Current Kate 25,000 Current Bret 18,000 Drawings Kate 25,000 Drawings Bret 18,000 Transfer of drawings Important: Notice that drawings do not appear in the profit distribution statement but they are transferred as debit entries to the current accounts to recognise that the partners have taken this much of their profit share out of the business. The basic nature of the current accounts is credit as they are equity accounts so profit share items are credited and withdrawals are debited. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 25

35 Example fully worked Anita and Lana own Island Style a fashion shop located in Manukau. Adjusted Trial Balance of Island Style as at 31 March 2013 Bank 2,000 Accounts Payable 20,000 Accounts Receivable 37,000 Accrued Expenses 3,000 Rent - shop 17,800 Accumulated depreciation Sales Salaries 45,000 - Shop fittings 12,000 Office expenses 12,000 Accumulated depreciation Insurance 8,000 - Office Equipment 2,000 Interest on loan 1,500 Sales 420,000 Bad Debts 1,000 GST 1,500 Depreciation - Shop fittings 6,000 Loan (7%, due 2013) 15,000 Depreciation - Office Equipment 1,000 Current - Anita 2,500 Doubtful debts 300 Current - Lana 4,000 Drawings - Anita 24,600 Captial - Anita 45,000 Drawings - Lana 28,400 Capital - Lana 50,000 Inventory 22,000 Allowance for doubtful debts 600 Prepayments 4,000 Cost of Goods Sold 260,000 Shop Fittings 60,000 Office Equipment 20,000 Goodwill 25,000 $575,600 $575,600 Anita and Lana s Partnership Agreement includes 1. Interest on Capitals 10% p.a. on opening balance 2. Interest of 10% charged on the amount of drawings above $20, Salaries as appropriations of profit $20,000 each 4. Residual profits are shared equally Required Financial Statements for Anita and Lana Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 26

36 Island Style Income Statement Island Style Profit Distribution Statement for the year ended 31 March 2013 for the year ended 31 March 2013 Sales 420,000 Net profit 67,400 Less Cost of Goods Sold 260,000 Add Interest on drawings Gross Profit 160,000 Anita 460 Less Expenses Lana 840 1,300 Distribution 68,700 Shop rent 17,800 Less Interest on capital Depreciation - shop fittings 6,000 Anita 4,500 Sales Salaries 45,000 68,800 Lana 5,000 9,500 Administration 59,200 Office Expenses 12,000 Less Salaries Insurance 8,000 Anita 20,000 Depreciation - office equipment 1,000 Lana 20,000 40,000 Bad Debts 1,000 19,200 Doubtful Debts ,300 91,100 Share of residual profit Operating profit before interest 68,900 Anita 9,600 Less Financial expenses Lana 9,600 19,200 Interest on Loan 1,500 1,500 0 Profit for the period $67,400 Current Account - Anita 01/04/12 Balance 2,500 Cr 31/03/13 Salary 20,000 22,500 Cr Interest on Capital 4,500 27,000 Cr Share of residual profit 9,600 36,600 Cr Interest on Drawings ,140 Cr Drawings 24,600 11,540 Cr Current Account - Lana 01/04/12 Balance 4,000 Cr 31/03/13 Salary 20,000 24,000 Cr Interest on Capital 5,000 29,000 Cr Share of residual profit 9,600 38,600 Cr Interest on Drawings ,760 Cr Drawings 28,400 9,360 Cr Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 27

37 Island Style Balance Sheet as at 31 March 2013 Assets Current Assets Notes Bank 2,000 Accounts Receivable 1 36,400 Inventory 22,000 Prepayments 4,000 64,400 Non-current Assets Property, plant and equipment 2 66,000 Intangible Asset Goodwill 25,000 91,000 Total assets 155,400 Less Liabilities Current Liabilities Accounts Payable 20,000 Accrued Expense 3,000 GST 1,500 Loan (7%, 2013) 15,000 Total liabilities 39,500 Net Assets $115,900 Equity Contributed capital 3 95,000 Current capital 3 20,900 $115,900 Notes: 1 Accounts Receivable Accounts Receivable 37,000 Less Allowance for doubtful debts 600 $36,400 2 Property, plant and equipment Shop Fittings Office Equipment Totals Opening carrying amount 54,000 19,000 73,000 Depreciation 6,000 1,000 7,000 Carrying amount 48,000 18,000 66,000 As at 31 March 2006 Cost or valuation 60,000 20,000 80,000 Accumulated depreciation 12,000 2,000 14,000 Carrying amount 48,000 18,000 66,000 3 Equity Capital Current Total Anita 45,000 11,540 56,540 Lana 50,000 9,360 59,360 $95,000 $20,900 $115,900 Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 28

38 PRACTICE EXERCISES Partnerships formation Exercise One On 1 March 2013 Raymond Paki and Mere Walters decide to form a partnership to take over Raymond Paki s RP s Sports Store. Mere contributes $35,000 in cash. Raymond contributes his business RP s Sports Store which has the following assets and liabilities. RP's Sports Store Balance Sheet as at 1 March 2013 Assets Liabilities Accounts Receivable 1,200 Bank overdraft 500 Inventory 14,000 Accounts Payable 2,100 Pant and equipment (1) 41,000 Loan 6,000 Equity 47,600 Note 1. Plant and equipment Fixtures and Equipment Fittings Cost 42,000 10,000 Accumulated depreciation -8,000-3,000 The Agreement with Raymond for the contribution of his business includes the following clauses: 1. The partnership will take over RP s Sports Store with the exception of the bank overdraft, as a going concern with a fair value of $60,000, being Raymond s contribution. 2. The partnership will take over the assets and liabilities at carrying amounts except for the following two revaluations: Accounts Receivable $1,100 and Equipment $9,000. Required: 1. General journal entries for the formation of the partnership. 2. A partnership Balance Sheet as at 3 March Include notes for Accounts Receivable and Equity only. Exercise Two Lowe and Crawford set up a partnership 1 May 2013 to take over Crawford s sole proprietor business. They agree that Crawford s business has a fair value of $185,000 as a going concern. Lowe will contribute $100,000 cash. The agreed values of Crawford s assets and liabilities are shown below. The bank account will not be taken over. Crawford s Balance Sheet as at 30 April 2013 $ Agreed $ Agreed Value Value Bank 5,000 - Accounts Payable 25,000 25,000 Accounts Receivable 70,000 68,000 Loan (6%, due 2017) 15,000 15,000 Inventory 75,000 72,000 Capital 175,000 - Plant and Equipment 100,000 (Accumulated depreciation) (35,000) 80,000 Required: 1. Prepare the General Journal entries formation of the partnership. 2. Show the Balance Sheet as at 1 May Include notes for Accounts Receivable and Equity only. For Exercises Three to Five below: 1. Prepare the General Journal entries for the formation of the partnership. 2. Show the equity section of the balance sheet and accompanying equity note. Level 3 Accounting Partnerships Notes, Examples & Exercises page 29

39 Exercise Three No Goodwill Keri has asked Tim to join her as a partner. Keri will contribute her business assets and liabilities as follows (agreed values in brackets) Accounts Receivable $2,000 ($1,800), Inventories $10,000 ($9,000), Fixed Assets $60,000 ($62,000), Accounts Payable $3,800, Loan $19,000 Tim will contribute $20,000 cash. Exercise Four Including Goodwill Ray and Carl agree to form a partnership. Ray will contribute $35,000 cash. Carl will contribute the assets and liabilities of his business, which it is agreed has a value of $45,000 as a going concern. Carl s assets and liabilities are as follows (agreed values in brackets) Bank $3,800, Accounts Receivable $2,500 ($2,300), Inventories $8,000 ($7,500), Fixed Assets $36,000 ($38,000), Accounts Payable $2,600, Loan $10,000 Exercise Five - Goodwill Bennett and Robinson enter a partnership with Bennett contributing $60,000 cash and Robinson the assets and liabilities of his present business agreed to have a value of $65,000 as a going concern. Robinson s assets and liabilities are as follows (agreed values in brackets) Bank $500, Accounts Receivable $12,200 ($12,000), Inventory $21,000 ($19,000), Equipment $15,000 ($16,000), Vehicle $20,000 ($18,500), Accounts Payable $10,000 Exercise Six Regan Porter, a panelbeater, has agreed to form a partnership with Hone Jackson on 1 July Regan Porter has the following assets and liabilities on 30 June 2013 Assets and Liabilities of Regan Porter Panelbeater as at 30 June 2013 Assets Liabilities Accounts Receivable 15,400 Bank overdraft 3,600 Spare Parts 10,000 Accounts Payable 9,300 Tools (cost) 26,000 GST owing 1,100 Equipment (cost) 46,000 Mortgage 50,000 (Accumulated depreciation) -18,400 Equity Premises (cost) 100,000 Capital 111,000 (Accumulated depreciation) -4,000 $175,000 $175,000 The following are the terms of agreement between Regan Porter and Hone Jackson 1. The assets and liabilities of Regan Porter will be taken over at carrying amounts except a) Accounts Receivable to be revalued to $14,900 b) Equipment to be revalued to $30, Regan Porter will personally pay the GST owing 3. Regan Porter s contribution will be valued at $120, Hone Jackson will invest a van valued at $20,000 and sufficient cash to make his capital contribution one third of the total capital of the partnership. You are required to: 1. Prepare general journal entries to open new books for the partnership. 2. Prepare a Balance Sheet for the new Partnership, to be known as PJs Panelbeating. Notes are only required for Accounts Receivable and Equity. 3. Discuss briefly the valuations placed on Accounts Receivable, Equipment and Goodwill for the new partnership and how they contribute to the continuing operations of the new partnership. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 30

40 Two partners join their businesses Exercise Seven Curley and Fred to form a partnership joining their businesses on 9 July They agree that Curley s contribution will be valued at $50,000 and Fred s at $60,000 Assets and Curley s Contribution Fred s Contribution Liabilities Carrying Agreed Carrying Agreed Amount Value Amount Value Bank 1,000 1,000 2,000 2,000 Accounts Receivable 14,500 13,500 30,000 28,000 Inventory 22,500 21,000 35,000 35,000 Property, plant and equipment 60,000 35,000 85,000 50,000 (Accumulated Depreciation) -20,000-35,000 Accounts Payable 11,500 11,500 22,000 22,000 Loan 15,000 15,000 40,000 40,000 Required: 1. Prepare the General Journal entries for the formation of the partnership. 2. Show the Equity section of the Balance Sheet and accompanying note at 9 July Exercise Eight Anita Stuart and Alex Lodge decide to form a partnership from their two businesses on 1 May The following are relevant clauses from their agreement: 1. The partnership will take over the assets and liabilities of each partner except their bank accounts. 2. Anita s Accounts Receivable will be revalued to $8,200 and her property, plant and equipment to $150, Alex s Accounts Receivable will be revalued to $2,000 and her inventory to $12, All other assets will be taken over at their carrying amounts. 5. The agreed valuations of the two businesses are: Anita s $120,000 and Alex s $54, Alex will introduce sufficient cash to make her capital one third of the total capital The Assets and Liabilities of Anita and Alex as at 1 May 2013 are as follows: Assets and Liabilities of A Stuart as at 1 May 2013 Assets Liabilities Accounts Receivable 8,500 Bank 100 (Allowance for doubtful debts) ,300 Accounts Payable 9,200 Inventory 22,000 Mortgage 60,000 Property, plant and equipment 140,000 Equity (Accumulated depreciation) -20, ,000 Capital 81,000 $150,300 $150,300 Assets and Liabilities of A Lodge as at 1 May 2013 Assets Liabilities Bank 500 Accounts Payable 3,000 Accounts Receivable 2,200 Loan 10,000 Inventory 12,500 Property, plant and equipment 60,000 Equity (Accumulated depreciation) -12,000 48,000 Capital 50,200 $63,200 $63,200 You are required to: 1. Prepare General Journal entries for the formation of the partnership. 2. Show the equity section of the balance sheet and accompanying note as at 1 May Write a paragraph discussing the reasons for the valuations placed on the assets including goodwill of the new partnership including relevant concepts and links to continuing operations of the partnership in your answer. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 31

41 Profit Distribution and Current Accounts for partners Class example P North, Q West, and R East are in partnership sharing profits in the ratio of 1:2:3. Their business is called All Directions. Balances of their Capital and Current Accounts at 1 July 2013 were: Capitals P North $ Currents P North $2 000 Q West $ Q West $1 500 R East $ R East $800 DR Their partnership deed provides: 1. Salaries to partners P North $30 000, Q West $30 000, R East $ Interest on capitals to be provided at 10% p.a. 3. Interest on drawings only on any amount exceeding agreed salaries charged at 5% p.a. For the year ended 30 June 2013 partners drawings were P North $32 000; Q West $30 000; R East $ Net Profit for the year ended 30 June 2013 was $ Required: (a) Profit Distribution Statement for the year ended 30 June (b) Partners current accounts for the year ended 30 June (c) Equity note to the balance sheet as at 30 June (d) Explain why the partners have included interest on capitals in their profit sharing clauses in terms of the continuing operations of All Directions. Exercise Nine P Maxwell, S Noel, and K Oliver are in partnership sharing profits in the ratio of 2:3:5. Their business is called Max s Marvells. Balances of their capital and current accounts at 1 July 2013 were: Capitals P Maxwell $ Currents P Maxwell $ S Noel $ S Noel $ K Oliver $ K Oliver $1 200 DR Their partnership deed provides: 1. Salaries to partners P Maxwell $40 000, S Noel $40 000, K Oliver $ Interest on capitals to be provided at 10% p.a. on opening balances. 3. Interest on drawings only on any amount exceeding agreed salaries charged at 15% p.a. 4. Interest on currents given/charged at 5% of opening balances. For the year ended 30 June 2013 partners drawings were: P Maxwell $46 000; S Noel $40 000; K Oliver $ Net Profit for the year ended 30 June 2013 was $ Required: (a) Profit Distribution Statement for the year ended 30 June (b) Partners current accounts for the year ended 30 June (c) Equity note to the Balance Sheet as at 30 June (d) Explain why the partners have included interest on drawings in their profit sharing clauses in terms of the continuing operations of Max s Marvells. Note assume interest rates for borrowing money from the bank are around 8-10% for personal loans. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 32

42 Exercise Ten Kams Cameras Kelly Marsh and Kim Andrews own Kams Cameras. Kelly works full time in their camera shop while Kim works every Monday and alternate Saturday mornings as well as providing evening camera lessons for customers two nights a week. Their partnership agreement has the following clauses: 1. Salaries to partners are Kelly Marsh $35,000 and Kim Andrews $28, Further appropriations of profit to include the following: (a) (b) (c) Interest on fixed capital at 10% of the opening balance. Interest on drawings charged at 5% on the closing balance. Remaining profits to be shared 3:2 respectively. Kams Cameras net profit for the year ended 30 June 2013 was $79,000. Each partner had contributed a further $10,000 capital on 1 April Extract from Kams Cameras Post Closing Trial Balance as at 30 June 2013 Drawings K Marsh 40,000 Capital - K Marsh 60,000 Drawings K Andrews 30,000 Capital K Andrews 30,000 Current K Marsh 2,800 Current K Andrews 200 You are required to: 1 Prepare the Profit Distribution Statement. 2 Show the partners current accounts for the year. 3 Show the Equity note for Kams Cameras Balance Sheet. 4 Explain why the partners have included salaries to partners in their profit sharing clauses in terms of the continuing operations of Kams Cameras. Exercise Eleven Pretty Cool Fashions Paula and Kay own Pretty Cool Fashions. Their Partnership Agreement includes the following clauses: 1. Salaries, to be treated as an appropriation of profit, $ to Paula and $ to Kay. 2. Further appropriations of profit to include the following: (a) Interest on fixed capital at 10% of the opening capital balance (b) Interest on Current Accounts given or charged at 10% p.a. on the opening balance. (c) Interest on drawings charged at 12.5% only on any amount above the agreed salaries. (d) Remaining profits to be shared 3:2 respectively. Pretty Cool Fashions net profit for the year ended 31 March 2013 was $ Extract from Pretty Cool Fashions Post Closing Trial Balance as at 31 March 2013 Drawings - Paula Capital - Paula Drawings - Kay Capital - Kay Current - Paula Current - Kay You are required to: (a) Prepare the Profit Distribution Statement, the partners current accounts and the Equity note to the Balance Sheet (b) Explain why Paula and Kay have each of the different profit sharing clauses in their agreement in terms of ensuring the continuing operations of Pretty Cool Fashions. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 33

43 Bringing it together Tritops Motels Teri and Rae Henare trading as Tritops Motels have a Partnership Agreement with the following clauses: 1. Salaries to partners to be treated as appropriations of profit are: Teri $43,000 and Rae $37, Further appropriations of profit to include the following: (a) (b) (c) Interest on fixed capital at 10% p.a. Interest on current accounts given/charged at 10% of the opening balance Remaining profits to be shared 3:2 respectively. Trial Balance of Tritops Motels as at 31 March 2013 Bank 1,900 Capital - Teri Henare 100,000 Current - Teri Henare 300 Capital - Rae Henare 92,000 Drawings - Teri Henare 50,000 Current - Rae Henare 4,400 Drawings - Rae Henare 45,000 Mortgage 95,000 Cleaning supplies on hand 2,500 Accommodation income 278,000 Breakfast Supplies on hand 1,800 Breakfast income 42,800 Cleaners wages 34,500 Accumulated depreciation Bad debts 3,600 - Buildings 18,000 Breakfast expenses 21,900 Accumulated depreciation Electricity 29,500 - Furniture and Fittings 21,000 Interest on mortgage 7,600 Accounts Payable 6,000 Office expenses 24,000 Allowance for doubtful debts 60 Rates and Insurance 40,000 GST 1,000 Repairs and maintenance 15,000 Replacement linen 17,000 Accounts Receivable 1,660 Linen 52,000 Buildings 180,000 Furniture and Fittings 90,000 Land 40,000 Further information: The following balance day adjustments have yet to be taken into account: (a) $658,260 $658,260 Depreciation to be provided at 20% p.a. on Furniture and Fittings and at 1% p.a. on Buildings. (b) An invoice dated 31 March 2013 for accomodation income $2,300, including GST, has not been recorded. (c) A further $460, including GST, of bad debts is to be written off and the Allowance for Doubtful Debts is to be adjusted to 2% of Accounts Receivable. (d) Neither partner contributed further capital during the year. You are required to: 1 Prepare general journal entries for profit distribution and to close drawings. 2 Prepare partners current accounts. 3 Complete the financial statements. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 34

44 Partnership Financial Statements including Balance Day Adjustments Exercise Twelve Tanya and Bryan are in partnership sharing residual profits in the ratio 2:3. Their partnership agreement allows for interest on capitals of 8% of opening balances, interest on currents charged or allowed at 5% of opening balances and salaries as appropriations of profit Tanya $20,000 and Bryan $15,000. Tanya and Bryan s business is called Westwater Holdings. It supplies computer equipment to personal computer stores and leases computers to large businesses. The following trial balance was prepared as at 31 March 2013: Trial Balance of Westwater Holdings as at 31 March 2013 Accounts Receivable 45,920 Accounts Payable 16,800 Advertising 8,500 Computer Lease Revenue 28,700 Bad Debts 500 Dividends Received 1,200 Bank 6,300 Mortgage (10%, due 2015) 50,000 Buildings 70,000 Sales 356,900 Delivery expenses 3,400 Capital - Tanya 100,000 Drawings - Tanya 20,000 Capital - Bryan 70,000 Drawings - Bryan 12,000 Current - Tanya 6,000 Cost of Goods Sold 174,300 Current - Bryan 4,000 Insurance and Rates 4,500 Allowance for Doubtful Debts 800 Interest on Mortgage 4,500 Accumulated Depreciation Land 54,000 - Office Equipment 6,300 Office Equipment 63,000 Accumulated Depreciation Office Expenses 4,700 - Buildings 3,500 Office Salaries 32,000 GST 20 Sales salaries 84,700 Inventory 45,900 Shares in WEL 10,000 $644,220 $644,220 Additional Information 1. Interest on mortgage (flat rate) is owing. 2. Computer Lease Revenue received in advance $ Insurance and Rates paid in advance $300 excluding GST. 4. Write off further bad debts of $920 including GST. 5. Adjust the Allowance for Doubtful Debts to 2% of Accounts Receivable. 6. Depreciation on Office Equipment 5% p.a. and on Buildings 1% p.a. 7. Shares in WEL have a current market value $10,900. You are required to: Prepare the financial statements and current accounts. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 35

45 Exercise Thirteen The following trial balance was prepared for Computers Unlimited as at 31 March Louise Martin and Karl Rand own Computers Unlimited in partnership. Trial Balance of Computers Unlimited as at 31 March 2013 Accounts Receivable 32,460 Accounts Payable 23,200 Advertising 7,600 Computer Lease Revenue 37,200 Bad Debts 1,200 Dividends Received 600 Bank 2,400 Loan (8.5%, due 2015) 20,000 Delivery Vehicle 25,000 Sales 370,000 Delivery expenses 4,200 GST 1,560 Drawings - Louise Martin 35,000 Capital - Louise Martin 65,000 Drawings - Karl Rand 38,000 Capital - Karl Rand 35,000 Cost of Goods Sold 180,000 Current - Louise Martin 1,600 Rent and Insurance 16,400 Current - Karl Rand 2,000 Interest on Loan 1,300 Allowance for Doubtful Debts 900 Goodwill 20,000 Accumulated Depreciation Fittings and Equipment 56,000 - Delivery Vehicle 12,200 Office Expenses 6,700 Accumulated Depreciation Office Salaries 27,000 - Fittings and Equipment 18,400 Sales salaries 67,000 Inventory 50,000 Shares in Telecom 17,400 Additional Information: Computer Lease Revenue has been received in advance $8,000. $587,660 $587,660 An invoice dated 28 March 2013 is on hand for delivery expenses $1,840, including GST. Interest is owing on the loan. The loan is Interest only Telecom have declared a dividend of 10c per share to be paid on 20 April The Shares in Telecom were purchased at $5.80 each. Their current market value, considered to be their fair value is $6.10 each. Depreciation is 25% DV on Delivery Vehicle and 20% p.a. on Fittings and Equipment. Write off further bad debts of $460 including GST. Adjust the allowance for doubtful debts to 2.5% of remaining debtors. Louise and Karl s partnership agreement includes the following clauses: 1. Interest on capitals 8% p.a. 2. Interest on drawings charged at 12% p.a. on the amount above agreed salaries of $30,000 each. 3. Interest on currents charged or allowed at 10% p.a. on opening balance. 4. Share residual profit equally. You are required to: 1 Prepare the financial statements and current accounts. 2 Explain why the partners have included interest on current accounts in their profit sharing clauses in terms of the continuing operations of Computers Unlimited. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 36

46 Exercise Fourteen Trial Balance of CD Enterprise as at 31 March 2013 Shop Fittings 18,000 Capital H Clark 80,000 Delivery Van 15,000 Capital P Davis 40,000 Land & Buildings 125,000 Sales 415,000 Inventory 27,000 Rent Received 14,000 Cost of goods sold 278,000 Commission 7,400 Accountancy fee 1,500 Mortgage (12%, due 2015) 45,000 Delivery Van Expenses 8,000 Accounts Payable 9,400 Rates 3,100 Bank 2,000 Interest on Mortgage 5,000 GST 2,670 Advertising 4,900 Accumulated depreciation: Office Salaries 28,000 Shop Fittings 5,600 Sales Salaries 32,000 Accumulated depreciation: Insurance 3,600 Delivery Van 3,000 Drawings H Clark 35,000 Allowance for Doubtful Debts 160 Drawings P Davis 32,000 Current H Clark 2,400 Accounts Receivable 13,230 Current P Davis 3,000 Bad Debts 300 Adjustments should be made for the following: 1. Insurance prepaid $400 excluding GST. 2. Interest on the Mortgage is 12% p.a. flat rate. $629,630 $629, An invoice dated 27 March 2013, for advertising during March, is on hand $230 including GST. 4. Rent Received in advance $2,300 including GST. 5. Depreciation on Shop Fittings 5% p.a. on cost 6. Depreciation on Delivery Van 10% D.V. 7. Write off further bad debts $230 including GST 8. Adjust the allowance for doubtful debts to 2% of accounts receivable. Clark and Davis share residual profits in the ratio of 3:2. Their agreement includes the following clauses 1. Salaries to partners Clark $25,000, Davis $20, Bonus to Clark 20% of the amount of sales above $400, Interest on capitals 10% on closing balance. 4. Interest on drawings 10% on the amount above agreed salaries. You are required to: (a) Prepare the financial statements and current accounts. (b) Explain why the partners have the bonus to Clark in their profit sharing clauses in terms of the continuing operations of CD Enterprise. Note Clark is responsible for the marketing and sales of CD Enterprise. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 37

47 Dealing with interest on Average Capitals Exercise Fifteen Kiwi Treks Bret and Kate Tennent own Kiwi Treks as a partnership. Their Partnership Agreement has the following clauses: Salaries to partners Bret $40 000, Kate $ Interest on fixed capital at 10% of the average monthly capital balance Interest on drawings charged at 5% only on any amount above the agreed salaries. Interest on currents given/charged at 5% of the opening balance Remaining profits to be shared 3:2 respectively. Extract from Kiwi Treks Post Closing Trial Balance as at 30 June 2013 Drawings - Bret Capital - Bret Drawings - Kate Capital - Kate Current - Kate Current - Bret Performance Summary Further Information: Bret invested $ as further capital on 1 October You are required to: 1. Prepare the Profit Distribution Statement for the year ended 30 June Show the Partners Capital Accounts from 1 July 2012 to 30 June Show the Partners Current Accounts for the year 4. Show the Equity note to Kiwi Treks Balance Sheet as at 30 June Exercise Sixteen Pasta Haven S Pita and P Hare are in partnership owning and operating Pasta Haven. Their Partnership Agreement has the following clauses: 1. Salaries to partners S Pita $ and P Hare $ Further appropriations of profit to include the following: (a) Interest on fixed capital at 9% of the average monthly capital balance (b) Interest on drawings charged at 5% only on any amount above the agreed salaries. (c) Remaining profits to be shared 2:1 respectively. Extract from Pasta Haven s Post Closing Trial Balance as at 30 June 2013 Drawings - S Pita Capital - S Pita Drawings - P Hare Capital - P Hare Current - S Pita Current - P Hare Performance summary Further information: On 1 March 2013, S Pita and P Hare both invested a further $10,000 in the business. You are required to: 1. Prepare the Profit Distribution Statement. 2. Show the partners capital and current accounts for the year. 3. Show the Equity note to Pasta Haven s Balance Sheet. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 38

48 Exercise Seventeen Cable Bay Motel Sara and Paul Evans are in partnership as owners of Cable Bay Motel. Their partnership agreement includes the following clauses: 1. Salaries to partners: Sara $30 000, Paul $ Interest on average monthly capital at 5% p.a. 3. Interest on current accounts 10% p.a. on opening credit balances. 4. Remaining profits shared 3:2 The following is the post closing trial balance for Cable Bay Motel as at 31 March 2013 before the appropriation of profit. Cable Bay Motel Post Closing Trial Balance as at 31 March 2013 Bank Capital - Sara Evans Accounts Receivable Capital - Paul Evans Drawings - Sara Evans Current - Sara Evans Drawings - Paul Evans GST Current - Paul Evans Mortgage Cleaning Supplies on Hand Accumulated depreciation Breakfast Supplies on Hand Land and Buildings Linen Furniture and Fittings Land Accounts Payable Buildings Allowance for doubtful debts 100 Furniture and Fittings Income Summary $ $ Note: Treat Linen as an item of PPE. Additional Information: On 1 January 2013 Paul introduced a further $ capital You are required to: (c) Prepare Cable Bay Motel s Profit Distribution Statement. (d) Prepare the general journal entries for the profit distribution (e) Prepare the general journal entries to close the drawings accounts. (f) Prepare the partners current accounts for the year. (g) Show Paul s Capital account for the year. (h) Prepare Cable Bay Motel s Balance Sheet. Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 39

49 Exercise Eighteen MM Mechanics Mere and Marama trading as MM Mechanics have a Partnership Agreement with the following clauses: 1. Salaries to partners Mere $ and Marama $ Interest on fixed capital at 6% p.a. on opening capital balance 3. Interest on current accounts given/charged at 8% of the opening balance 4. Interest on drawings charged at 5% of the amount of drawings above the agreed salaries. 5. Remaining profits to be shared 3:2 respectively. MM Mechanics Trial Balance as at 31 March 2013 Accounts Receivable 7,930 Accounts Payable 3,000 Bank 3,000 Accumulated Depreciation Drawings - Mere 39,000 - Plant and Machinery 17,000 Drawings - Marama 32,000 Accumulated Depreciation General office expenses 9,700 - Tools and Equipment 3,000 General workshop expenses 122,000 Allowance for doubtful debts 100 Goodwill 14,000 Capital - Mere 80,000 Interest on loan 1,800 Capital - Marama 45,000 Mechanics wages 78,600 Current - Mere 3,500 Office wages 21,000 Current - Marama 4,000 Plant and Machinery 90,000 GST 1,130 Spare parts expense 56,000 Loan (3 years) 20,000 Spare Parts on Hand 18,000 Repair Revenue 413,200 Tools and Equipment 60,000 Workshop electricity 10,900 Workshop rent 26,000 Further information: On 1 October 2012 each partner contributed an extra $5 000 capital. The following balance day adjustments have yet to be taken into account: (a) (b) (c) 589, ,930 Depreciation to be provided at 10% D.V. on Plant and Machinery and at 10% straight line on Tools and Equipment Repair revenue charged to customers on 31 March 2013 $2,070 including GST has not been recorded. Allowance for doubtful debts to be adjusted to 2% of Accounts Receivable (d) Workshop rent paid in advance $2,000 (e) An invoice dated 31 March 2013 for workshop electricity $460 including GST has not been recorded. You are required to prepare: 1. Income Statement 3. Profit Distribution Statement 4. Capital and Current accounts for the year 5. Balance Sheet Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 40

50 Partnership Formation and Financial Statements Exercise Nineteen Part A J Stuart and M Watson form a partnership on 1 July J Stuart contributes the assets and liabilities of his music store as a going concern for an agreed value of $180,000. M Watson contributes sufficient cash to make his capital one third of the total capital. The new partnership will be called JM Music Store. J Stuart s Assets and Liabilities and their agreed values are as follows: Carry Amount Agreed Value Bank Accounts Receivable 13,100 13,000 Inventory 42,000 40,000 Fixed Assets 98, ,000 Accounts Payable 14,500 14,500 GST Payable 3,500 3,500 Loan (7,9%, due 2015) 30,000 30,000 Required: 1. Journal entries to establish the partnership. 2. A Balance Sheet of the new partnership as at 1 July 2013 Part B J Stuart and M Watson drew up a Partnership Agreement on 1 July 2013, which included the following clauses: 1. Interest on capital 10% of the average monthly capital balance 2. Salaries to partners agreed to be appropriations of profit: J Stuart $50,000 and M Watson $40, Interest charged/given on current accounts on the opening balance at 6% p.a. 4. Remaining profits/losses shared 2:1 respectively The partnership trial balance two years later included the following balances: Extract from Trial Balance of JM Music Store as at 30 June 2015 Capital J Stuart 180,000 Drawings J Stuart 64,000 Capital M Watson 100,000 Drawings M Watson 55,000 Current M Watson 5,000 Current J Stuart 7,500 During the year ended 30 June 2015 the following transactions had occurred: 2014 Oct 1, 2015 Jan 1, M Watson contributed a further $10,000 capital M Watson s salary was increased to $45,000 (he gets half of his old salary plus half of his new salary for the year) For the year ended 30 June 2015 the partnership net profit was $118,000 Required: 1. General Journal entries for the Profit Distribution 2. Profit Distribution Statement for JM Music Store for the year 3. Capital and Current Accounts for J Stuart and M Watson for the year 4. Equity note to the Balance Sheet Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 41

51 Partnership Revision Exercise Twenty Formation Jayne, Robert and Michelle decide to form a partnership to open a bookshop in Hamilton s Downtown Plaza. Jayne currently owns a bookshop in a local shopping centre, Robert is in his third year of a degree in English and Michelle is a part time accountant. Jayne will work full time in the book shop and Robert will work weekends. Michelle will help out with the bookwork but otherwise will not be involved in the day to day running of the shop. The partnership will take over the assets and liabilities of Jayne s current business for an agreed consideration of $30,000. Robert will not contribute any capital to begin with, while Michelle will contribute $10,000. Jayne s current business has the following assets and liabilities on 1 June 2013: Assets Carry amount Agreed Value Bank Inventory 14,000 13,500 Accounts Receivable 1, Shop Fittings 17,000 15,700 Office Equipment 5,000 6,000 Accounts Payable 7,000 7,000 Bank Loan 9,000 9,000 Required: (a) Prepare General Journal entries for the formation of the Partnership and a Balance Sheet as at 1 June (b) Explain how you have applied the historical cost and the recognition criteria for assets to the revaluation of Jayne s assets on the formation of the partnership. (c) Recommend with reasons, how profit should be distributed in the partnership in order to ensure the partnership will be in a position to continue operations. Exercise Twenty One Financial Statements Kate, Anita and Stuart are in partnership as KAS Couriers. Their partnership agreement includes the following clauses: 1. Interest on opening capital 10% p.a. 2. Interest on current accounts opening balance 10% p.a. 3. Interest on drawings 6% p.a. 4. Salaries Kate $25,000, Anita $20,000, Stuart $25, Remaining profit shared equally. The following information relates to the year ended 30 June 2013: Balances 1 April 2012: Capital Account Current Account Kate 60,000 Cr 4,000 Cr Anita 40,000 Cr 2,000 Dr Stuart 50,000 Cr 1,000 Cr On 1 October 2012: Anita contributed a further $10,000 capital Drawings for the year ended 31 March 2013 Kate $35,000 Anita $25,000 Stuart $40,000 Profit for the year ended 31 March 2013 $105,000. Required: (a) Prepare KAS Couriers Profit Distribution Statement. (b) Show the partners capital and current accounts for the year. (c) Show the Partners Equity in the Balance Sheet as at 31 March Level 3 Accounting PARTNERSHIPS NOTES, EXAMPLES & EXERCISES page 42