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OLevel

Accounting - 7707

Partnership

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Partnership

PARTNERSHIP

The partnership is an agreement between 2 to 20 people who join together with an intention of sharing, profits, and bearing losses. When the partnership is formed, a partnership agreement is made in which it is decided how much will be the interest of capital, interest on drawings, salary to partners, bonus or commissions, and whether any partners will be a dormant partner or not. And if the partner has provided a loan and its interest conditions.

Advantages of a partnership are that it is easy to form and requires low start-up cost, relatively higher capital with greater loan taking ability, business affairs are kept private, and flexible legal structure.

Disadvantages are that liability of partners is unlimited, partners are liable for actions of their partners and their debts, mismanagement, dissolution or a partner leaving is costly. 

In the absence of partnership agreement, the partnership Act 1890 will come under consideration and the contents of Partnership Act 1890 are:

1. No interest on capital.
2. No interest in drawings.
3. No salary to partners.
4. No bonus to partners.
5. No commissions to partner.
6. No partner to be treated as a dormant partner.
7. Interest on loan by the partner at the rate of 5%.
8. Residual profits to be distributed amongst partners equally.

Interest on Capital: 

It is given to the partner as an incentive to invest more into the partnership. Usually, this interest rate is equal to the market rate of interest so as to attract the partners so that by joining the partnership not only will they earn the normal interest, but they will also reap benefits of the partnership.

Interest on Drawings: 

It is charged to the partners as a restriction to withdraw unnecessarily, otherwise, the partners will withdraw huge amounts causing a liquidity crisis of the partnership. 

Salary to Partners: 

It is given to the partners against services provided by them.

Bonus/Commissions: 

It is given against their performance or the performance of the business. 

Interest on Loan by the Partners: 

When the partners provide loans to the partnership, they are not considered to be the partner for the amount of loan. Instead, they are the liability of the partnership, and hence interest on the loan is not the distribution of profit, it is an expense of the business. 

Residual Profit: 

Once the profits are distributed in the forms of interest, salary, bonus, commission. The remaining profits are residual profits that are to be distributed amongst the partners in their predetermined rates decided in the partnership agreement.

Dormant Partner: 

It is also known as “Sleeping Partners”, such a partner is not actively involved in the running of the partnership, but it is not part of the decision making process. Since the dormant partner is not actively involved, his liability is limited.

Limited Liability: 

It means that in case of bankruptcy or insolvency, the maximum amount that can be snatched from a partner is his investment. His personal belongings would not be affected.

In a partnership all partners cannot be sleeping partners there has to be at least one active partner, who will be responsible for running the business. The liability of the active partner is unlimited. Unlimited liability means that in case of bankruptcy or insolvency, the personal belongings of the partner would be at stake. 

Accounting treatment of partnership involves the preparation of:

Income statement
Profit and loss Appropriation account
Partners’ Current account
Partners’ Capital account
Statement of Financial Position

Income Statement: 

Made as normally like any other business, the only thing to be taken into consideration is interest on the loan by the partner will be treated as an expense, and hence it is not the distribution of profit.

Profit and Loss Appropriation Account: 

It shows the distribution of profit amongst the partners in the form of salary, bonus, and commission. It also identifies the distribution of residual profit and how it is distributed amongst the partners. 

Current Account: 

It is also known as fluctuating capital Account and shows movement in the capital account of the distribution of profits and drawings. The current account can have both a debit and credit balance. If the distribution of profit is more than drawings the current account will have a credit balance, whereas if the drawings are more than the distribution of profits then the current account will have a debit balance. Credit balance in the current account – the +ve balance and -ve balance in the current account is a debit balance. 

Partners Capital Account:  

It is also known as a fixed capital account because it usually does not change. And the changes in the capital account only occurs:

1. When partner introduces additional capital
2. When no separate current accounts are made (in this case all entries regarding the current account pass through the capital account)
3. When there is a partnership change (in case of a partnership change, we have to prepare and adjust goodwill accounts and revaluation accounts into capital account)

Statement of Financial Position: 

Made as normal except for the financial by the section in which we have to take into consideration the closing capital and current account balances. Moreover, if there’s any goodwill maintained in the books it has to be incorporated in the statement of financial position as intangible non-current assets. 

Goodwill: 

It is the good reputation of the business and is an intangible non-current asset. Formula to calculate goodwill is:


Goodwill = Purchase price – fair value of the net asset acquired 


Goodwill is recorded amongst old partners in their old profit and loss sharing ratio and the double entries to record goodwill are:


Goodwill   DR
Partners’ Capital Account CR
B
C                       (Amongst old partner’s in their old profit and loss sharing ratio)

Once goodwill is recorded it can either be maintained in the books or will be written off. If the goodwill is maintained it is shown on the face of the Statement of Financial Position as an Intangible Non-Current asset and is treated just like any other non-current asset. If goodwill is maintained, then each year we need to check whether the value of goodwill has decreased or not. The decrease in the value of goodwill is called loss in the value of goodwill and loss in the value of goodwill occurs because of two reasons:

1. Impairment
2. Amortization

Impairment is the drastic fall in the value of goodwill because of an unforeseen event. Amortization is a slow and gradual fall in the value of goodwill just like depreciation. Whatever the reason is for the fall in goodwill, it is an expense for the business and the double entries to record for loss in the value of goodwill are: 

Income Statement   DR – Expense
Goodwill   CR – Asset is losing its value

If goodwill is not maintained in the books, then it is immediately written off and it is also termed as goodwill not recorded, goodwill is not to be kept in the books, or goodwill is written off. Goodwill is written off amongst the new partners in their new profit-loss sharing ratio and the double-entry to write off goodwill are:

Partners’ capital Account   DR
A
B
C
Goodwill   CR (Amongst new partner’s in their old profit and loss sharing ratio)



PARTNER’S CURRENT ACCOUNT


CAPITAL ACCOUNT



If interest on the loan is already paid to the partner, then it will not be part of a current account. If it is not yet paid, then it will only be part of Partner’s Current account but will not be part of Accruals in Current Liabilities. Whatever the situation is, it will always be part of the expense in the Income Statement.

MANUFACTURING ACCOUNTS

Some organizations do not indulge in trading activities instead they manufacture goods in order to sell them. The obvious reason to indulge in manufacturing activities is to earn higher profits but other reasons for manufacturing goods other than buying it from an outside vendor are:

To ensure a good quality product
To maintain the brand image
The products are not easily available in the market
To reduce dependence on the supplier
If the business has better manufacturing skills than trading skills
To introduce the product or service not available in the market
Availability of raw material 
Learning by doing – economies of scale
Diversification 

When the business indulges in manufacturing activities, it has to access its cost structure. The cost structure of any business is as follows:


Total Cost and Variable Cost are always parallel.

The vertical distance between Total Cost and Variable Cost is Fixed Cost.

When an output is an Output, Total Cost, and Fixed Cost. 

The accounting treatment of questions involving manufacturing business compromise of preparation of:

1. Preparation of manufacturing account
2. Income statement 
3. Statement of financial service

MANUFACTURING ACCOUNTS FOR THE YEAR ENDED …


INCOME STATEMENT: 

In manufacturing business is made as normal. It is very important that we only take into consideration those expenses that are not related to manufacturing.

STATEMENT OF FINANCIAL POSITION: 

Statement of financial position is made as normal except that the inventory in current assets will compromise of all 3 inventories i.e. (inventory of Raw material, inventory of work in progress, and inventory of finished goods. If the inventory of finished goods is given at transfer price, closing provision of unrealized profit will be deducted from it.



EXAMPLE: The following information is provided by Kane Manufacturing Company on 30 April 2006.


Prepare a manufacturing account (30 April 2006)



The following information was provided by the company on 30 April 2006


Prepare a manufacturing account (30 April 2006)


The business makes one identical product. The production cost of goods completed during the year ended 30 April 2006, was $475,000. 20,000 articles were completed. Calculate the unit cost. 


Unit cost = Production cost of goods completed/ number of units produced


= 475000/20000 = $23.75

The following information was provided on 30 April 2006.


Prepare a trading account section of the income statement of Kane Manufacturing Company (30 April 2006)


On 30 April 2006 the Kane Manufacturing Company had inventories valued as follows:


Prepare a relevant extract from the balance sheet of Kane Manufacturing Company.


NON-PROFIT ORGANIZATION

Some organizations come into the business, not to make profits but to serve people, such organizations are referred to as Non- Profit organizations and are usually clubs. Since there is no profit motive hence there are no owners thus there is no capital or drawings. Such organizations are financed by accumulating funds from members in order to run the club or non-profit organization. Furthermore, such organizations do not have a profit and loss account instead they have an Income and Expenditure Account with the help of which it is identified whether the business has a surplus of income over expenditure or a deficit of income over expenditure. 

The major source of income of the club is member subscription. Even if the club involves commercial activities or Trading activities the intention is still not to make profits but to facilitate the members. 

The accounting treatment of questions involving non-profit organization comprised of preparation of the following:

1. Accumulated funds account. 

It is an alternative for Capital Account and is prepared by deducting opening liabilities from opening assets. It is made as follows:


2. Receipts and Payments account:

It is an alternative for a bank account when cash comes into the business it is recorded as receipts when cash goes out of the business it is recorded as payments. Like Bank account receipts and payment accounts can have both a debit or credit balance, where debit balance is an asset and credit balance are a liability. 

Most clubs only prepare receipts and payment account and consider them sufficient to be presented to the members, but this is not an appropriate method and incomplete information is being provided to the members as there are many expenses and incomes that are either noncash, accrued, or prepaid. Receipts and payment account are made as follows:




3. Subscription Account

It is the major source of income for the club they are monthly or annual contributions made by the members to run the club. Subscriptions can either be paid in advance or can be accrued.

Arrears: 

They are the subscription earned but yet not received by the non-profit organization. These are current assets for the non-profit organization.

Advance: 

These are the subscription received but yet not earned by the non-profit organization and hence they are current liabilities for the business. 

Bad Debts: 

If a member fails to pay back his due subscription then he will consider being bad debts which will be treated as an expense by the nonprofit organization. 

NOTE: when making the subscription account we will consider all amounts of subscription received during the year as the receipt of subscription despite the fact whichever year it belongs to: 

Subscription Account is made as follows:


4. TRADING ACCOUNT

Some clubs or nonprofit organizations indulge in trading activities but the motive behind those trading activities is not to make profits but to serve. And sometimes they are purposely run at a loss so that members could take benefit of the facility. When making a trading account we only take into consideration those expenses that are directly associated with trading. Other expenses of the club are not part of the trading account. It is made as follows:


5. ADJUSTMENT OF EXPENSES & REVENUES: 

If expenses have prepayments or accruals and revenues have advanced or accruals then we need to adjust expenses and revenues then they need to be adjusted with the help of PAAP and APPA. And they are made as follows:


The depreciation needs to be adjusted even if it is not written in the question. In order to do so we need to apply the revaluation method of depreciation as follows:


6. PREPARATION OF INCOME AND EXPENDITURE ACCOUNT: 

In a nonprofit organization, an income and expenditure account is made instead of a Profit and Loss account as there is no profit motive, no profit and loss account is needed. Income and expenditure account help in identifying how much income is generated and through what sources and how much expenses are made and by what means. If incomes are more than expenses, we generate the surplus of income over expenditure whereas, if expenses are more than income, we have a deficit of income over expenditure. Income and expenditure account is made as: 


7. STATEMENT OF FINANCIAL POSITION

It is made as normal except for the Equity and Liability Section includes some capital receipts such as gifts, donations,s and legacy for a specific purpose, life subscription, and so on.
 
A loan to a member is treated as an asset whereas a loan from members is treated as a liability. If the club has made some investment it will be treated as an asset which will neither be treated as current nor non-current and hence will be recorded in between non-current and current asset.



TREATMENT OF GIFT/ DONATION OR LEGACY

If a gift, donation, and legacy are without any purpose then they are revenue receipts and are part of income and expenditure account but if a gift, donation, or legacy are for a specific purpose then they are capital receipts and are part of Statement of Financial Position.

COMMON ERRORS MADE:

When making accumulated funds Account students tend to forget the opening bank balance or opening receipt and payments account balance as it is usually written separately from other assets and liabilities.
When making receipts and payments account students tend to write the opening balances as a debit balance but there is a possibility that the opening balance might be an overdraft.
When making a subscription account, students do not differentiate between life members and ordinary members. Ordinary member's subscription account and life membership accounts should be made separately.
When making trading accounts, students usually incorrectly record purchases. It must be ensured that if there are any opening and closing payables then purchase ledger accounts should be made to calculate purchases.
When adjusting expenses and revenues, students fail to take into consideration the depreciation, if the question is silent regarding it. Instead, if nothing is mentioned regarding depreciation then we must apply the revaluation method of depreciation.
When making Income Statement & Statement of Financial Position, students do not distinguish between capital and revenue receipts specially gift, donation or legacy.

EXAMPLE:
John started a business on 1 November 2004. In the first year of transactions, no accounting records were maintained. The following information was provided about the business on 1 November 2005.
Assets: premises 56,000, fixtures 19,400, motor vehicles 12,500, inventory 3,100, trade receivables 4,700, cash 200
Liabilities: trade payables 5,600, bank overdraft 2,300
Prepare an opening journal entry for John on 1 November 2005.



John’s financial year ends on 31 October. Prepare the journal entries to record the following transactions on 1 September 2006.
Purchased additional fixtures, $1300, on credit from Office Supplies 
Sold the motor vehicle (cost $12,500) for $7,400 on credit to Umar Vehicles Limited.


John’s financial year ends on 31 October. Prepare journal entries to record the following. 
On 30 September 2006, he wrote off $50 owing by Aaron Stores as a bad debt. On 31 October 2006 John’s ledger accounts include the following – 
Purchases for the year $39,000
Bad Debts for the year $190
Insurance $1500, which includes a prepayment of $300 
Inventory at 1 November 2005 $3100



On 31 October 2006
Inventory was valued at $3900
Fixtures are to be depreciated by $270 
A provision for doubtful debts is to be created of $250



John's financial year ends on 31 October.
The totals of the trial balance prepared on 31 October 2007 agreed, but the following errors were later discovered.
(a) The purchase of stationery, $30, had been debited to the purchases account.
(b) A Cheque, $500, received from K Singh had been credited to the account of H Singh.
(c) The wages account had been undercast by $100 and the purchases account had been overcast by $100.


John's financial year ends on 31 October.
The total of the trial balance prepared on 31 October 2008 failed to agree. The difference of $260 was a shortage on the debit side. This was entered in a suspense account.
The following errors were later discovered
(a) The purchases account had been overcast by $110
(b) No entry had been made for office expenses, $20, paid in cash.
(c) Credit Sales, $630, to Anil had been correctly entered in the sales account but debited as $360 in Anil’s Account.
(d) Capital introduced by John, $5000 (paid into the bank), has been debited to the capital account and credited back to the bank account
(e) A cheque, $200, received from a debtor, Yuvi, has been correctly entered in the bank account but no other entry has been made.
(f) Sales returns, $150, have been correctly entered into the debtor's account but have been credited to the purchases returns account.
Prepare the necessary journal entries to correct these errors.
Write up the suspense account in Johns Ledger
.


Johns
Nominal Ledger
Suspense Account


John's financial year ends on 31 October.
The totals of the trial balance prepared on 31 October 2008 failed to agree. The difference was entered in a suspense account and draft financial statements were prepared. The net profit was $15,000.
The following errors were later discovered.
(a) The purchases account had been overcast by $110.
(b) No entry had been made for office expenses, $20, paid in cash. 
(c) Credit Sales, $630, to Anil had been correctly entered in the sales account but debited as $360 in Anil’s Account.
(d) Capital introduced by John, $5000 (paid into the bank), has been debited to the capital account and credited back to the bank account
(e) A cheque, $200, received from a debtor, Yuvi, has been correctly entered in the bank account but no other entry has been made.
(f) Sales returns, $150, have been correctly entered into the debtor's account but have been credited to the purchases returns account.
Prepare a statement to show the corrected profit for the year ended 31 October 2008.

Johns
Statement of corrected profit for the year ended 31 October 2008


INCOMPLETE RECORDS

The benefit of maintaining all sets of records is that it allows the owner of the business to have all the information of assets, liabilities, revenues, and expenses making it easier to create financial statements. It is very common for some businesses, mostly small ones to have an incomplete set of records which requires certain calculations to be done to create a full set of Financial Statement.

STATEMENT OF AFFAIRS:

It is not possible to prepare an income statement when the only records available are of assets and liabilities. The assets and liabilities in the statement of affairs are the same as of balance sheet. The only difference is that in the statement of affairs the asset and liability records are made without the double entry.
 
There are a few ways to calculate profit using limited information. When profits are made capital increases and it decreases when losses are incurred. The formula for determining profit is:

Closing Capital – Opening Capital = Profit

The formula will require an addition if drawings were made by the owner during the financial period:

Closing Capital – Opening Capital + Drawing = Profit

If capital has been inducted into the business the formula would be:

Closing Capital – Opening Capital + Drawing – Capital Introduced = Profit

A capital account can also be made to determine profits over the financial period:


The 1st and 31St of Dec signify the first and last dates of a financial period.

Sometimes, businesses do not maintain double-entry records yet are still able to provide additional details regarding assets and liabilities. Financial statements can be prepared if details of money received and paid are available. 

QUESTION
Anna is a sole trader. She maintains a bank account, but not a full set of double-entry records. The following information is provided.


During the year ended 30 June 2005, Anna took goods costing $4000 for her own use.
On 30 June 2005 equipment should be depreciated by 10% on the cost of equipment owned at the date. On this date, it was decided to create a provision for doubtful debts of 2.5% of the trade receivables.
Prepare the income statement of Anna for the year ended 30 June 2005 and a balance sheet at 30 June 2005.


SOLUTION


Sales for the Year


Credit Sales


The amount to be collected from debtors don’t always equal the sales, some of the money received is to settle previous financial year amounts. Money is owed at the end of the year for all the goods sold in the present financial year. 

Credit sales can be calculated as follows:


The credit sales can be found by another way through total trade receivables account:


Purchases for the Year


Credit Purchases

The amount paid to creditors is not necessarily equal to the actual purchases. Some of the money paid is to settle the amount owed to the creditors for goods purchased in the previous financial year.


Credit Purchases can also be calculated through the trade payables account:


The total purchases are equal to credit purchases as there are no cash purchases. 

Closing Bank Balance

The Bank balances are given and so with the help of receipts and payments closing bank balances can be calculated. 


Anna
Income Statement for the year ended 30 June 2004



General Expense (19620-200-340)

Provision for Doubtful Debts (2.5% * 26800)

Depreciation of Equipment (10% * (22500 + 8000))

Anna
Balance Sheet at 30 June 2005



Depreciation to date on equipment (4500+3050)

Drawings (38400 + 4000)

Cash discounts given or received will affect the calculations for credit purchases and sales.

QUESTION 
Anna is a sole trader. She maintains a bank account, but not a full set of double-entry records. The following information is provided.

Receipts from Debtors $331,600 after deduction of 8200 cash discounts.
Payments to creditors $249,400 after deduction of $6780 cash discounts.
Calculate credit sales and credit purchases for the year ended on 30 June 2005.


Sales and purchase amounts would show up in trading accounts in the income statement.

Discount allowed and received would show up in profit and loss account in the income statement. 

Rate of Inventory Turnover

This is the number of times a business buys/ reorders or replaces its inventory in a given period of time.

Cost of Sales/ Average Inventory

MARGIN, MARK UP AND INVENTORY TURNOVER


Margin and Mark up are a measure of gross profit as a percentage.

Margin = Gross Profit/Sales * 100

Mark up = Gross Profit/ Cost of Sales * 100

EXAMPLE: 
The financial year for Nemo Traders ends on 30 November. The following information is provided

The markup is at a standard rate of 25%. 
Calculate by means of a trading account section of an income statement, the purchases for the year ended 30 November 2003.


SOLUTION


Mark up is 25%. The selling Price is 125%. The gross profit is therefore 25/125. 20% of $72,000. The gross profit is 14,400. The cost is, therefore, 57,600. The cost of Sales added with opening inventory was 62,800 and so purchases accounted for 58,200.


REVALUATION AND REALISATION:

At the time of partnership change, all assets and liabilities must be revalued so that each partner could be aware of the net worth of the business.


UPWARDS REVALUATION OF THE ASSET:

If the asset increases over and above its net book value it is called upward revaluation of asset and the double entries to record upward revaluation of an asset are:

Asset   DR

Revaluation   CR


Example: Inventory increases from 1200 to 1500


Inventory 300

Revaluation 300


If the asset that is being revalued has appropriation attached to it, we will first write off depreciation then revalue the asset and hence double entries to record revaluation will be:


Depreciation DR

Asset DR

Revaluation CR


Revalued to 90,000

Depreciation DR 30,000
Asset DR 10,000
Revaluation CR 40,000

Revaluation to 75,000

Depreciation DR 30,000
Asset CR 5,000
Revaluation CR 25,000

Revalued to 80,000

Depreciation DR 30,000
Revaluation CR 30,000

Revalued to 50,000

Depreciation DR 30,000
Asset CR 30,000


Revalued by 60,000

Depreciation DR 30,000
Asset DR 30,000
Revaluation CR 60,000

DOWNWARD REVALUATION OF ASSET:

If the value of an asset falls below its Net Book Value, it is called downward revaluation of assets, and hence the double entries to record downward revaluation of assets are:

Revaluation DR
Asset CR

Example: Receivables 35,000 revalued to 30,000

Revaluation DR 5,000
Receivables CR 5,000

If the asset which is being revalued, has depreciation attached to it then it is referred to as double entries to record depreciation will be:

Depreciation DR
Revaluation DR
Asset CR 

Example:


Revalued to 25,000
Depreciation DR 30,000
Revaluation DR 25,000
Asset CR 55,000


Sam and Vick are in Partnership. The following balances were extracted from the books of the partnership on 31 October 2015: