lesson 2 partnership

Click here to load reader

download lesson 2  partnership

of 18

Transcript of lesson 2 partnership

  • 1.UNIT 1: MODULE 2
    Objective 8, 9
    PREPARATION OF FINANCIAL STATEMENTS:CHANGES IN OWNERSHIP STRUCTURES

2. The Partnership Agreement
To avoid complications in the future, partners in a business venture should make a formal agreement on certain issues, such as:
The rational for formation
Capital contributions
Opportunity cost (interests or penalties)
Profit & loss sharing ratios
Admission of new partners (goodwill or bonus)
Exit of old partners (retirement)
Dissolution of the partnership
Interest on a partners loan to the firm
3. Capital contribution
Partners agree on the (total amount of) capital needed to operate the business effectively.
The capital is essentially a pooling of the assets and liabilities of the individual partners.
The assets and liabilities are generally recorded at their fair values (what they are valued at if sold on the current market)
The capital is recorded as a simple journal entry in the (new) business.
4. Opportunity costs
Partners should agree on
Interest rate (if any) to be given on capital invested before the profits are shared.
They should state whether it is the opening, closing or average capital
This represents the opportunity benefit for not investing the capital in another project.
Interest rate (if any) to be charged on drawings on the capital base before the profits are shared.
This represents the opportunity penalty for reducing the capital due to personal reasons.
5. Remunerations
Partners should agree on
Which partner(s) should be paid a salary[it is usually the general partner(s)]
Which partner(s), if any, would receive a bonus
Whether on income before the allocations
OR on the income after the allocations
6. Profit/loss sharing
Partners should agree on how they will share the profits or losses of the business.
This might be by fixed ratio
OR by the ratio of their capital balances
7. 8. Admission of a new partner
9. By private interest acquisition
Where a direct payment is made to an individual partner
It is not recorded on the books
calculate the interest acquired from the partner(s)
Account for the acquisition by adjusting the capital accounts of thepartners [debit OLD partners; credit NEW partner]
Adjust the Balance Sheetto reflect the redistribution of the capitals
[note] the amount paid does not appear on the books
10. by purchasing interest in the business
When an interest stake involves the acquisition /introduction of assetsin the business itself one of two methods are used to reflect the change
bonus method
goodwill method
11. Reflecting the investment by the bonus method
Record the investment made by the new partner in the journal
Calculate the book value of the business after the investment was made [OLD + NEW capital]
Calculate the amount of capital the new partner has actually acquired[new book value *% interest bought]
Calculate the bonus resulting from the activity
[investment-acquisition]
Distribute the bonus to the OLD partners
ifthe bonus is positivecredit OLD debit NEW
if the bonus is negativedebit OLD credit NEW
12. Reflecting the investment by the goodwill method
Record the investment made by the new partner in the journal
Calculate the implied value of the business base on the investment was made [investment/% interset]
Calculate the book value of the business after the investment was made [OLD +investment]
Calculate the goodwill resulting from the activity
[implied value - book value]
Distribute the goodwill to the OLD partners
ifthe bonus is positivecredit OLDdebit goodwill
if the bonus is negativedebit OLD
Any revaluation in the assets must be shared by OLD
13. Where goodwill is not recorded
Sometimes a business [normal practice] may decide to write down acquired goodwill for various reasons.
Allocate the goodwill to theOLD partners
Write down the goodwill in the new profit sharing ratio
Credit the goodwill a/c to write off from books
14. Sharing the profits after the change
When the change in the partnership share ratio occurs during its common financial year the distribution of profits must be time apportioned.
Some of the expenses incurred may also be subject to this adjustment [such must be specified under exam rules and conditions]
It is useful to use the columns of the profit & loss account to allocate the time-periods; and the profit appropriation.
15. Dissolution of a partnership
Partnerships can be dissolved or liquidated for several reasons, ranging from
Bankruptcy of a partner
Partner misconduct or serious disagreement
Deathor retirement of a partner
Operation has become illegal
Operating at a continuous loss
16. The dissolution (liquidation)
LIQUIDATION
IMMEDIATELY
PIECEMEAL
ASSETS SOLD AT A GAIN OR LOSS
INSOLVENT PARTNERS
PARTNERS DEBIT BALANCES
17. Using the realisation account
18. record entry of new partners capital
goodwill distributed in capital accounts
share revaluation in capital accounts (OLD only)
Prepare the T, P& L on time apportioned basis
Appropriate the profits on time basis
Present partners current account (note interest on loan is credited here)