Accounting For A Partnership

ACCOUNTING FOR A PARTNERSHIP
1.1 The Nature of a Partnership

A partnership is a voluntary association of two or more persons to carry on, as co-
owners, a business for profit. A partnership is easily formed. The partnership
agreement may be oral, although it is good business practice to have a written
contract, which spells out, among other things, the investment of each partner,
limitations on drawings, and the division of profits. A written partnership agreement
is referred to as the articles of partnership or the partnership agreement.
1.2 Characteristics of a Partnership

Although a partnership is an accounting entity, it is not a legal entity separate from
its owners. Several characteristics—in addition to ease of formation—relate to this
aspect of partnerships.
 Mutual Agency
Mutual agency means that every partner is an agent for the firm, with the authority
to bind the partnership to contracts. This authority applies to all acts typical of a
partner engaging in the usual activities of the firm. Although the partners may limit
the authority of one or more partners to act on customary matters, a partner acting in
contravention of a restriction may still contractually bind the partnership if the other
party to the contract is unaware of the limitation. The partnership would not be
bound, however, if the other party knew of the restriction.
 Unlimited Liability
Most partnerships are general partnerships, in which each partner is individually
liable for the obligations of the firm, regardless of the amount of personal
investment. Thus creditors of a general partnership unable to pay its debts may
obtain payment from the personal assets of individual partners. Also, each general
partner is an agent of the firm and can bind the partnership to contracts. In contrast,
a limited partnership has two classes of partners, general partners and limited
partners. There must be at least one general partner to assume unlimited liability for
the obligations of the firm. Normally, the limited partners are only investors, who
participate in the profits or losses of the firm, but their liability for losses is limited
to the amount of their investment. Limited partners do not participate actively in the
management of the firm.
 Limited Life
Because a partnership is a voluntary association of persons, many events may cause
its dissolution. These events include the expiration of the agreed-on partnership
term; the accomplishment of the business objective; the admission of a new partner;
the withdrawal, death, or bankruptcy of an existing partner; and the issuance of a
court decree because of a partner’s incapacity or misconduct. Even though a change
in membership dissolves a partnership, business continuity is often unaffected. A
new partnership continues the operations of the former partnership without
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interruption.
 Co-ownership of Property
Assets contributed by partners become partnership property jointly owned by all
partners. Individual partners no longer separately own the specific resources
invested in the firm. Unless an agreement to the contrary exists, each partner has an
equal right to the firm’s property for partnership purposes.
 Nontaxable Entity
Although a partnership must file an information return for income tax purposes, the
organization itself is not a taxable entity. The information return shows the
distributive shares of the partnership’s net income that the partners include on their
individual tax returns. The individual members must pay income taxes on their
respective shares of partnership earnings whether these amounts have been
withdrawn from the firm or not.
2.1 Partnership Accounting: General

For accounting purposes, a partnership is considered as an entity distinct from the
partners. The day-to-day record keeping used by partnerships is similar to that used
by sole proprietors up to the point of determining the net income/loss of the
business. The net amount is divided among the partners in any agreed fashion. In
some cases, partners have may not have agreement on a division of profit or loss, in
which case we divide income/loss equally to the partners.
There should be a capital account and a drawing (or personal) account for each
partner. Each partner’s capital is increased by his share of profits or income and is
decreased by his drawings and his share of partnership losses. Of course, a partner’s
capital account would also be increased by additional investments, and would be
immediately decreased by any withdrawal of capital.
In general, a partner invests property, time, and effort for the purpose of earning a
share of the profits of the firm. The partner is not entitled to compensation for his or
her time or for interest on an investment of cash or other property, though such
factors may be considered in devising a profit sharing arrangement. There are,
however, situations where a partner may make a loan to the partnership. In such
cases, the loan should be segregated in the accounts, and that partner will be entitled
to interest from the firm. Such interest should be treated as expense of the business.
Loans to or from partners should be separately classified in a balance sheet, as there

is the general presumption that they are repayable before capital balances may be
withdrawn. On the other hand, capital balances are generally invested for indefinite
periods. Any priority of loans over capital realistically applies only to a going,
solvent business, during dissolution, only outside creditors have meaningful priority.
2.2 Accounts Maintained

The partnership should maintain several accounts for each partner in its accounting
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records. These partners’ accounts are as follows:
Capital Accounts – Capital accounts are maintained in each partners’ name. Capital
accounts are used to record the initial investment of a partner; any subsequent
capital contributions; profit or loss distributions; and any withdrawals of capital by
the partner are ultimately recorded in the partner’s capital account. The capital
accounts usually have credit balance. On occasion, a partner’s capital account may
have a debit balance, called a deficiency or deficit. The capital account balance
represents the partner’s share of the net assets of the partnership. If the capital
account has a credit balance, it shows the claim of the partner on the net assets of
the partnership. If there is a debit balance, it represents the claim of the business
over the personal assets of the partner.
Drawing Accounts – Partners generally make withdrawals of assets from the

partnership during the year in anticipation of profits. A separate drawing account is
used to record the periodic withdrawals and is then closed to the partner’s capital
account at the end of the period.
Loan Accounts - The partnership may look to its present partners for additional
financing. A loan from a partner is shown as a payable on the partnership’s books.
Alternatively, the partnership may lend money to a partner, in which case it records
a loan receivable from the partner.
2.3 Accounting for Formation of a Partnership
At the formation of a partnership, it is necessary to assign a proper value to the non-
cash assets and the liabilities contributed by the partners. An item contributed by a
partner becomes partnership property co-owned by all partners.
The individual partners must agree to the percentage of equity that each will have in
the net assets of the partnership. Generally, the proportionate share of each partner’s
capital contribution determines the capital balance. For example, if A contributes 60
percent of the partnership’s net assets, then A will have a 60 percent interest in the
net assets of the partnership and B will have a 40 percent capital share. In
recognition of intangible factors such as where one partner has special expertise or
necessary business associations, partners may agree to any proportion of capital.
Therefore, before recording the initial capital contribution, all partners must agree
on the valuation of the net assets and on each partner’s capital share.
For example, assume that Mr A, a sole proprietor, has been developing software for
several types of microcomputers. The business has the following account balances
as of December 31, 20X0:
A Company
Trial Balance
Accounts title Debit Credit
At Dec 31, 20x0
Cash 3000
Inventory 7000
Equipment 20000
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Accumulated Depreciation – Equipment 5,000
Liabilities 10,000
A, Capital 15,000
Total 30,000 30,000
Mr A needs additional technical assistance to meet the increasing sales and offers B
an interest in the business. A and B agree to form a partnership. A’s business is
audited, and its net assets are appraised. The audit and appraisal disclose that Br.
1000 of liabilities has not been recorded, inventory has a market value of Br. 9000,
and the equipment has a fair value of Br. 19,000.
A and B prepare and sign articles of partnership that include all significant operating
policies. B will contribute Br.10,000 cash for a one-third capital interest. The AB
Partnership is to acquire all of A’s business assets and assume its debts.
The journal entry to record the initial capital contribution by Mr A would be

recorded as follows:
Date Accounts Debit Credit

20X1
Januar 1 Cash 3000
Inventory 9000
Equipment 19,000
Liabilities 11,000
A, Capital 20,000
  Mr B’s contribution of Br 10,000 is recorded as follows:

20X1
Januar 1 Cash 10,000
B, Capital 10,000
2.4 Withdrawal of Assets by Partners

Partners may withdraw cash or non-cash assets from a partnership. Upon
withdrawal of assets by a partner, the Drawing account of the partner withdrawing
the assets would be debited and the assets withdrawn are credited for the fair value.
 For example if partner B made a Br. 3,000 cash withdrawal on May 1, 20X1,
the entry would be:
20X1
May 1 B, Drawing 4 3000
Cash 3000
2.5 Loans to/from Partners
If a partner gives loan to the partnership, the Loan account to that partner is credited.
For example, if a partnership signs a Br. 4,000, 10 percent, 1-year loan agreement
with partner A on July 1, 20Xl it would be recorded as follows:

20X1
July 1 Cash 4000
Loan Payable to A 4000
 On the other hand, a partnership may extend a loan to a partner, in which case
a Loan to Partner (asset) account is debited.
2. 6 Allocating Profit or Loss to Partners
Profit/loss is allocated to the partners in accordance with the partnership agreement.
If no partnership agreement exists, profits and losses are to be shared equally by all
partners. The agreement must be followed precisely, and if it is unclear, then the
accountant should make sure that all partners agree to the profit or loss distribution.
There is no limit to the variety of plans partners may adopt to divide the profits
(income) or losses of a business. No matter what the plan, however, the accounting
procedure is the same: At year-end, in the partners’ respective capital accounts,
income is recorded as a credit and loss as a debit. At the same time, the partners’
drawing accounts should be closed to their capital accounts.
Most partnerships use one or more of the following distribution methods:
1. Pre-selected ratio;
2. Interest on capital balances;
3. Salaries to partners; and
4. Bonuses to partners.
Pre-selected ratios are usually the result of negotiations between the partners. Ratios
for profit distributions may be based on the percentage of total partnership capital,
time and effort invested in the partnership, or a variety of other factors. Often,
smaller partnerships split profits evenly among the partners. In addition, some
partnerships have different ratios if the firm suffers a loss versus earns a profit. The
partnership form of business allows a wide selection of profit distribution ratios to
meet the individual desires of the partners.
Distributing partnership income based on interest on capital balances recognizes the

contribution of the partners’ capital investments to the profit-generating capacity of
the partnership. This capital interest is not an expense of the partnership; it is a
distribution of profits. If one or more of the partners’ services are important to the
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partnership, the profit distribution agreement may provide for salaries or bonuses.
Again, these salaries paid to partners are a form of profit distribution and are not an
expense of the partnership. Occasionally, the distribution process may depend on the
size of the profit or may differ if the partnership has a loss for the period. For
example, salaries to partners may be paid only if revenue exceeds expenses by a
certain amount. The accountant must carefully read the articles of partnership to
determine the precise profit distribution plan for the specific circumstances at the
time.
The profit or loss distribution is recorded with a closing entry at the end of each
period. The revenue and expenses are closed into an Income Summary account or
directly into the partners’ capital accounts. In the following examples, an Income
Summary account is used, whose balance is net income or net loss after the revenue
and expense accounts are closed, and before the income or loss is distributed to the
partners’ capital accounts.
To illustrate profit allocation, assume that during 20X1, the AB Partnership earns
Br. 45,000 of revenue and incurs Br. 35,000 in expenses, leaving a profit of Br.
10,000 for the year. A maintains a capital balance of Br. 20,000 during the year, but
B’s capital investment varies during the year as follows:
Date Debit Credit Balance

January 1 Br. 10,000
May 1 Br. 3,000 7,000
September 1 Br. 500 7,500
November 1 1,000 6,500
December 31 6,500
The debits of Br. 3,000 and Br. 1,000 are recorded in B’s drawing account, while
the additional investment is credited to the partner’s capital account.
Case 1: If A and B share profits or losses in the ratio of 60 percent to A and 40

percent to B, the net income is to be distributed using a 3:2 profit sharing ratio:
A B Total
Net income Br.10, 000
Allocate 60:40 percent Br. 6,000 Br. 4,000 (10,000)
Total Br. 6,000 Br. 4,000 Br. -0-
This schedule shows how net income is to be distributed to the partners’ capital
accounts. The actual distribution is accomplished by closing the Income Summary
account. In addition, the drawing accounts are also closed to the capital accounts at
the end of the period. The following entries are prepared:
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20X1
Dec 31 B, Capital 3000
B, Drawing 3000
Revenue 45,000
Expenses 35,000
Income Summary 10,000
Income Summary 10,000
A, Capital 6,000
B, Capital 4,000
Case 2: A and B agreed to allow interest of 15 percent on the weighted-average
capital balances with any remaining profit to be distributed in the 60:40 percent
ratio.
It is rarely equitable to divide net income according to the ratio of capitals as of the
beginning of the year or as of any other particular date. If capital is an important
factor in achieving net income, it would be better to give appropriate weight to the
length of time that the firm had the use of the respective capital balances.
One method of ascertaining average capital balances is simply to list the partners’
respective monthly capital balances, total each list, and divide by 12. A more
sophisticated and more widely used method is to determine the number of months in
which the capital balance remains unchanged and then to use that number as a
multiple of the balance. In this way, each balance is given its proper weight.
The average capital balance for B is computed as follows:
Date Debit Credit Balance Months Months Times
Maintained Dollar Balance
January 1 Br. 10,000 4 Br. 40,000
May 1 Br. 3,000 7,000 4 28,000
September 1 Br. 500 7,500 2 15,000
November 1 1,000 6,500 2 13,000
Total 12 Br. 96,000
Average capital (Br. 96,000 ÷ 12 months) Br. 8,000
The distribution of the Br. 10,000 profit would be calculated as follows:
A B Total
Net income Br.10,000
Interest on average cap. (15%)Br. 3,000 Br.1,200 (4,200)
Residual income Allocate 3:2 3,480 2,320 (5,800)
Total Br. 6,480 Br. 3,520 Br. -0-
Therefore, the closing entry would be:
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20X1
July 1 Income Summary 10,000
A, Capital 6,480
B, Capital 3,520
Case 3: The partnership agreement provides for salaries of Br. 2,000 to A and Br.
5000 to B. Any remainder is to be distributed in the profit and loss sharing ratio of
60:40 percent. The profit distribution is calculated as follows:
A B Total
Net income Br. 10,000
Salary Br. 2,000 Br. 5,000 (7,000)
Residual income 3:2 1,800 1,200 (3,000)
Total Br. 3,800 Br.6,200 Br. -0-
Closing Date Accounts Debit Credit

Entry: 20X1
July 1 Income Summary 10,000
A, Capital 3,800
B, Capital 6,200
Case 4: The agreement provides that a bonus of 10 percent of income in excess of

Br. 5,000 is to be credited to B’s capital account before distributing the remaining
profits in the 40:60 percent ratio.
In this case, there are two Alternatives to compute bonus, depending on the
agreement among the partners: as a percentage of income before subtracting the
bonus; and as a percentage of income after subtracting the bonus. The two
alternatives are shown below:
 In alternative 1, where bonus is a percentage of income before subtracting the

bonus, we use the following formula:
Bonus = X%(NI — MIN)
Where X% = the bonus percentage

NI = net income before bonus
MIN = minimum amount of income
Bonus = 0.10(Br. 10,000 — Br. 5,000) = Br. 500
 In alternative 1, we compute bonus as follows:
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Bonus = X%(NI — MIN — bonus)
= 0.l0 (Br. 10,000 — Br. 5,000 — bonus)
= 0.10(Br. 5,000 — bonus)
= Br. 500 — .10 bonus
1.10 bonus = Br. 500
Bonus = Br. 454.55
 The distribution of net income based on Alternative 2 is calculated as follows:

A B Total
Net income Br. 10,000
Bonus to partner Br. 455 (455)
Remainder 3:2 Br. 5,727 3,818 (9,545)
Total Br. 5,727 Br. 4,273 Br. -0-
Case 5: The profit and loss agreement of the AB Partnership specifies the following
allocation method:
1. Interest of 15 percent on weighted-average capital balances.
2. Salaries of Br. 2,000 for A and Br. 5,000 for B.
3. A bonus of 10 percent to be paid to B on partnership income exceeding Br.
5,000.
4. Any residual to be allocated in the ratio of 60 percent to A and 40 percent to
B.
A B Total
Net income: Br. 10,000
Interest on average
capital (15 %) Br. 3,000 Br. 1,200 (4,200)
Remaining Br.5,800
Salary 2,000 5,000 (7,000)
Deficiency Br.(1200)
Bonus 500 (500)
Deficiency Br.(1700)
Allocate 60:40 percent (1,020) (680) 1700
Total Br. 3,980 Br. 6,020 Br. -0-
2.7 Preparing the Statement of Partners Capital
Partnership financial statements are similar to proprietorship financial statements.
The three financial statements—income statement, balance sheet, and statement of
cash flows—are typically prepared for the partnership at the end of each reporting
period. In addition to the three basic financial statements, a statement of partners’
capital is usually prepared to present the Changes in the partners’ capital accounts
for the period. The statement of partners’ capital for the AB Partnership for 20X1
under the multiple-base profit distribution plan above is presented below:
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AB Partnership
Statement of Partners’ Capital
For the Year Ended December 31, 20X1
A
B Total
Balance, January 1, 19X1 Br. 20,000 Br. 10,000 Br.30,000
Add: Additional investment 500 500
Net income distribution 3,980 6,020 10,000
Br. 23,980 Br.16,520 Br.40,500
Less: Withdrawal (4,000) (4,000)
Balance, December 31, 20X1 Br. 23,980 Br. 12,520 Br. 36,500
Partnership Dissolution
3.1 Admission of a New Partner – General
When a person is admitted to a partnership, a new entity is commenced and the old
entity is dissolved. As a practical matter, however, formal dissolution is not always
necessary or practical. Frequently the business is carried on with a change or
changes only in the equity accounts. As a general rule, it is advisable for the partners
to draw up a new partnership agreement.
Basically, there are two ways by which a new partner may be admitted to an
existing partnership: either the new partner purchases all or part of an interest from
one or more of the existing partners or the new partner makes an investment in the
firm which increases the net assets and the capital of the partnership. When an
interest is purchased from one or more partners, the assets of the firm are generally
unchanged, since the consideration usually passes outside the business.
Occasionally, a person may be admitted as a partner without any specific

investment. Here, too, it is important that the partnership agreement spell out the
division of profits, losses, and other arrangements. Such a partner will usually have
a capital balance after the first formal division of profits.
If A and B have been partners for any length of time, it is likely that the net assets
(assets minus liabilities) per the firm’s books may be worth more or less than the
current fair value. As long as A and B continue in business, it is generally
considered as proper to utilize the historical cost basis with appropriate
modifications. If C is to be admitted to the partnership, however, the current fair
value of the net assets will undoubtedly be the basis for the admission of C.
In some situations, the real value of the net assets of a going business is equal to the
book value but the firm’s business has unusually high earning power. The existing
partners would undoubtedly insist that this factor be recognized in determining the
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amount a new partner must invest. When a business is valued at an amount greater
than its book value due to exceptionally high earning power, the excess over the
book value is generally referred to as goodwill. (It is also possible that the new
partner may bring in goodwill attributable to herself or himself.)
In some other situations, either the new partner or the existing partners may consider
that the potential earning power of the combination is so great that one or the others
will pay a bonus in order to effectuate the association.
3.1.1 Admission through Purchase of an Interest
A new partner may be admitted by acquiring part of an existing partner’s interest
directly in a private transaction with the selling partner or by investing additional
capital in the partnership. In this type of transaction, cash or other assets are
exchanged outside the partnership, and the only entry necessary on the partnership’s
books is a reclassification of the total capital of the partnership. The book value of a
partnership, simply the total value of the capital, which is also the difference
between total assets and total liabilities, will be the same before and after admission.
To illustrate, assume that after operations and partners’ withdrawals during 20X1
and 20X2, AB Partnership has a book value of Br. 30,000 and profit percentages on
January 1, 20X3, as shown below:
Capital Profit
Balance Percentage
A Br. 20,000 60
B Br. 10,000 40
Total Br. 30,000 100
On January 1, 20X3, A and B invited C to become a partner in their business. C

purchases a one-fourth interest in the partnership capital directly from A and B for a
total cost of Br. 9,000, paying Br. 6900 to A and Br. 3,100 to B. C will be entitled to
a 25 percent interest in the profits or losses of the partnership. The remaining 75
percent interest will be divided between A and B in their old profit ratio of 60:40
percent.
 The journal entry for the admission of C will be recorded as follows:

20X1
Dec 31 A, Capital 5,000
B, Capital 2,500
C, Capital 7,500
(From A: Br. 5,000 = Br. 20,000 x .25)
(From B: Br. 2,500 = Br. 10,000 x .25)
  The profit or loss-sharing ratio of the new partnership would be as
follows:
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Partner Profit Percentage
A 45 (75% of 0.60)
B 30 (75% of 0.40)
C 25
Total 100
The amount paid by the new partner to A and B is a result of private dealings and it
will not be considered in recording the admission. However, the partners may use
the information to revalue their assets. The increase in the fair value of the AB
partnership is computed as follows:
Br. 9,000 = Fair value x .25
Br. 36,000 = Fair value
Increase in fair value = Br. 36000 – Br. 30000 = Br. 6000
 Assuming that the Br. 6,000 difference was due to increase in value of land,
the following entry would be recorded upon admission:

20X1
Dec 31 Land 6,000
A, Capital (Br. 6,000 x .25) 3,600
B, Capital (Br. 6,000 x .25) 2,400
 The increase of Br 6000 may also be due to the existence of unrecorded

goodwill. With this assumption, the admission of C would be recorded as
follows:

20X1
Dec 31 Goodwill 6,000
A, Capital (Br. 6,000 x .25) 3,600
B, Capital (Br. 6,000 x .25) 2,400
3.1.2 Admission with Investment in the Partnership

Unlike admission by purchase of interest, the partnership receives assets from the
new partner. Also, many partnerships use the transactions surrounding the change as
new evidence for revaluing the existing assets of the partnership or for recording
previously unrecognized goodwill. The justification given to revaluing assets at the
time of the Change in the membership of the partnership is to state fully the true
economic condition of the partnership at the time of the change in membership and
to assign the Changes in asset values and goodwill to the partners who have been
managing the business during the time the Changes in values occurred.
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Usually, the new partner may pay a premium to the old partners or the old partners
may provide a premium to the new partner. The existence of the premium to either
party indicates the need to revalue assets, recognize goodwill, or record bonus to
either the old partners or to the incoming partner. Hence, when a new partner
acquires a share of the partnership by investing assets in the business, the following
three cases can exist:
Case 1: The new partner’s investment is equal to the proportionate book value.
Proportionate book vale is computed as follows:
If the amount invested by the partner is equal to the proportionate share of book
value, no bonus or goodwill exists and also there is no need to record revaluation of
assets.
Case 2: The investment is for more than the proportionate book value. This
indicates that the partnership’s prior net assets are undervalued on the
books or that unrecorded goodwill exists.
Case 3: The investment is for less than the proportionate book value. This suggests
that the partnership’s prior net assets are overvalued on the books of the
partnership or that the new partner is contributing goodwill in addition to
other assets.
The determination of book value is central to the accounting for the admission of a
new partner. Book value of the new partner’s interest is the total of the partners
capital account balances.
The new partner’s proportionate book value is compared with the amount of the
investment made by the new partner to determine the procedures to be followed to
account for the admission of the partner.
Step 1: Compare the new partner’s investment with the new partner’s proportiona1
book value. This is done before any revaluations or recognition of
goodwill.
Step 2: Determine the specific admission method. The partners may wish to revalue
assets, recognize goodwill, or use bonus method: it is the partners’
choice.
The steps and the three different cases are summarized below:
Step1: Compare proportionate Step 2: Alternative methods to account for
book value and investment admission
of New Partner
Case 1: Investment cost equal to (1) Assign no bonus or goodwill
proportionate book value
Case 2: Investment cost greater than (1) Revalue net assets up to market value
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proportionate book value and allocate to prior partners
(2) Record unrecognized goodwill and
allocate to prior partners
(3) Assign bonus to prior partners
Case 3: Investment cost less than (1) Revalue net assets down to market
proportionate book value value and allocate to prior partners
(2) Recognize goodwill brought in by
new partner
(3) Assign bonus to new partner
To illustrate, assume that the January 1, 20X3, capital of the AB

Partnership is Br. 30,000. A’s balance is Br. 20,000, and B’s balance is
Br. 10,000. A and B share profits in the ratio of 60:40 percent. C is
invited into the partnership. C will have a one-fourth capital interest and
a 25 percent share of profits. A and B will share the remaining 75
percent in the ratio of 60:40 percent.
 The accounting treatment of the transaction is shown below with
different assumptions.
1. The total book value of the partnership before the admission of the new partner
is Br. 30000, and the new partner, C, is buying a one-fourth capital interest for,
Br 10000.
C’s proportionate BV = (Br. 30,000 + Br. 10,000) x 0.25 = Br. 10,000

20X3
Jan. 1 Cash 10,000
C, Capital 10,000
In this case, no bonus or goodwill is assigned since the proportionate book value is
equal to the amount invested.
2. C invests Br. 11,000 for a one-fourth capital interest in the resulting ABC
Partnership.
a. C paid an excess over his proportionate book value because the part-
nership owns land the value of which has appreciated.
C’s proportionate BV = (Br. 30,000 + Br. 11,000) 0.25 = Br. 10,250
 The following entry is therefore prepared:

20X3
Jan. 1 Cash 11,000
Land 3,000
A, Capital [300 x 0.6] 1,800
B, Capital [3,000 x 0.4] 1,200
C, Capital 11,000
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This entry records the asset contributed by the C and recognizes appreciation in
value of land.
b. C is investing Br. 11,000 for a one-fourth interest. The negotiation
shows that the excess is goodwill.
c.
Step 1: Estimate total capital after admission
25% of estimated total resulting capital Br.11,000
Estimated total resulting capital [Br 11,000 /0.25] Br. 44,000
Step 2: Estimate goodwill
Estimated total resulting capital Br. 44,000
Less: Total assets at book value:
Total net assets not including goodwill Br.30,000
Plus invested by C Br. 11,000 (41,000)
Estimated goodwill Br. 3,000
So, the entry would be recorded as follows:

20X3
Jan. 1 Cash 11,000
Goodwill 3,000
A, Capital [300 x 0.6] 1,800
B, Capital [3,000 x 0.4] 1,200
C, Capital 11,000
d. C, invested Br 11000 for a one-fourth interest in the partnership the

excess paid by C is a bonus to the prior partners.
If the premium is treated as bonus to the existing partners, the amount will be
deducted from the new partner’s investment and added to the old partners.
C’s proportionate BV = (Br. 30,000 + 11, 000) x 0.25 = Br 10,250
The entry:
Cash 11,000
A, Capital 450
B, Capital 300
C, Capital 10,250
20X3
Jan. 1 Cash 11,000
A, Capital [750 x 0.6] 450
B, Capital [750 x 0.4] 300
C C, Capital 10,250 may dislike
the bonus method because his capital balance is Br. 750 less than his investment in
the partnership. This is one of the disadvantages of the bonus method.
2. C invests Br. 8,000 for a one-fourth capital interest in the resulting ABC
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Partnership.
a. Inventory currently recorded at a book value of Br. 14,000 has a fair
market value of only Br. 8000 because of the obsolescence of several items.
C’s proportionate BV = (Br. 30,000 + 8,000) 0.25 = Br. 9,500

The decline in value of the inventories will be recorded as follows:
20X3
Jan. A, Capital [6,000 x 0.6] 3,600
1
B, Capital [6,000 x 0.4] 2,400
Inventory 6,000
The total capital of the partnership has now been reduced from Br. 30,000 to Br.
24,000 as a result of the Br. 6,000 write-down. The value of C’s investment in the
ABC Partnership, after the write-down, is calculated as:
New partner’s share of total resulting capital = (Br. 24,000 + Br. 8,000) 0.25 = Br.
8,000
 The entry to record the admission of C as a partner in the ABC Partnership is
20X3
Jan. Cash 8,000
1
C, Capital 8,000
6,000
C’s recorded capital credit is equal to her investment because the total partnership
capital of Br. 32,000 (Br. 24,000 + Br. 8,000) now represents the fair value of the
partnership.
b. The prior partners agreed to recognize goodwill to partner C.
The amount invested may be greater than the proportionate book value if the
admission of the partner creates goodwill to the partnership. Therefore, we compute
and recognize goodwill as follows:
Step 1: Estimate total resulting capital:

75% of estimated total resulting capital Br. 30,000
Estimated total resulting capital (Br. 30,000 / 0.75) Br. 40,000
Step 2: Estimate goodwill
Estimated total resulting capital Br.40,000
Total net assets not including goodwill
(Br. 30,000 + Br. 8,000) (38,000)
16
Estimated goodwill Br. 2,000
 Hence the journal entry would be:
20X3
Jan. 1 Cash 8,000
Goodwill 2,000
C, Capital 10,000
C. Bonus is given to C.
The excess of the proportionate book value over the amount invested could also be
bonus to the incoming partner. The bonus is reduces the capital of the old partners
based on their profit/loss sharing percentages.
C’s proportionate BV = (Br 30,000 + Br 8,000) x 0.25 = Br 9,500

20X3
Jan. Cash 8,000
1
A, Capital [1,500 x 0.6] 900
B, Capital [1,500 x 0.4] 600
C, Capital 9,500
3.2 Retirement of a Partner

When a partner withdraws from a partnership, the partnership is dissolved. The
primary accounting issue when a partner retires is the proper measurement of the
retiring partner’s capital account. This sometimes requires a determination of the
market value of the partnership at the time the partner retires, including the
computation of partnership income since the end of the last fiscal period.
The retiring partner is personally liable for any partnership debts accumulated
before the withdrawal date, but is not responsible for any partnership debts incurred
after the retirement date. Therefore, it is especially important to determine all
liabilities that exist on the retirement date.
A partner who retires from a firm is entitled to receive cash or other property
equivalent to the balance in his capital account after closing of the partnership books
as of the date of the retirement. Although such an action would mean the end of the
existing firm, a new firm consisting of the remaining partners frequently carries on
the business. Often there is no formal dissolution; the remaining partners simply
continue the business with a reduced capital and a concurrent reduction in assets.
17
In those instances where the retired partner is to be paid off over a period of time,
any balance due should be removed from the partner’s capital account and
transferred to a liability account, which distinctly describes his or her status as a
former partner.
The partnership contract may spell out the method for determining the amount to be
paid to the retiring partner, or the partners may agree on an amount and terms. If a
revaluation of assets has been agreed upon by the partners, there are three basic
methods of recognizing the revaluation:
(a) record the entire revaluation; (b) record only a portion of the revaluation
equivalent to the fractional interest of the retiring partner; or (c) adjust the capital
accounts of the partners who remain in the business.
For example, assume that on Dec. 31, 20x3, A, B, and C are partners with capital
balances of Br 45,000, Br 30,000 and Br 25,000, respectively, and C wishes to
retire. They have been sharing profits and losses equally. The three partners agree
that the recorded net asset balances approximate their fair market values, except that
goodwill in the amount of Br 30,000 should also be recognized. The following cases
illustrate three common approaches to recognizing the increment in the asset
goodwill.
Case 1: The entire amount of goodwill is placed on the books
Goodwill, developed by the three partners should be divided among them in their
profit- and-loss ratio, which is equally. The general journal entry to recognize
goodwill is as follows:

20X3
Dec.31 Goodwill 30,000
A, Capital [1,500 x 0.6] 10,000
B, Capital [1,500 x 0.4] 10,000
C, Capital 10,000
 The entry for the settlement with C, in general journal form, is as follows:

20X3
Dec. 31 C, Capital [Br 25,000 + Br 10,000] 35,000
Cash 35,000
Frequently the partnership is not in a position to liquidate in one cash distribution
18
the entire amount due to a retiring partner. Any amount due to a retired partner
should be removed from his or her capital account and should be transferred to a
liability account. Assume that A, B, and C agree on the retirement of C as above,
except that Br 12,000 is to be paid immediately, and the balance is in the form of
an interest-bearing note due in eight months. The journal entry for the retirement
of Clark would be as follows:

20X3
Dec. C, Capital [Br 25,000 + Br 35,000
31 10,000]
Cash 12,000
Notes Payable 23,000
Case 2: Retiring Partner’s Share of Goodwill Placed on Books
In this case, the partners may be reluctant to record goodwill unless it has been
specifically bought and paid for. In such a case, only Br 10,000 of Br 30,000 is to be
recorded. The journal entry for the retirement of C will then be as follows:

20X3
Dec. C, Capital [Br 25,000 + Br 25,000
31 10,000]
Goodwill 10,000
Cash 35,000
Case 3: The capital balances of remaining partners to be adjusted in lieu of

recording goodwill
Many accountants feel that goodwill should not be recorded unless it has been
acquired in an arm’s-length transaction. They may question the objectivity of
partners determining the goodwill of a business, which they had been operating
for some length of time. If C is to receive Br 10,000 more than his capital balance,
the only other procedure to be followed would be to charge the remaining partners
with a bonus of Br 10,000 divided between them in their profit- and loss-sharing
ratio. The entry for the retirement of Clark, in general journal form, is as follows:

20X3
Dec. 31 C, Capital 25,000
A, Capital 5,000
B, Capital 5,000
Cash 35,000
19
Partnership Liquidation
4.1 Priority of Claims to Assets
At the point of partnership liquidation, the partnership’s assets and liabilities are
directly intertwined with the individual partners’ personal assets and liabilities
because of the unlimited liability of partners. Two concepts are important in setting
priority of claims: (1) the marshaling of assets and (2) the right of offset.
Marshaling of assets presents the order of creditors’ rights against the partnership’s
assets and the personal assets of the individual. The order in which claims against
the partnership’s assets will be marshaled, or satisfied is:
1. Partnership creditors other than partners
2. Partners’ claims other than capital and profits
3. Partners’ claims to capital or profits to the extent of credit balances in capital
accounts
The order of claims against the personal assets of individual partners is
1. Personal creditors of individual partners
2. Partnership creditors for unpaid partnership liabilities, regardless of partner’s
capital balance in partnership
These priorities are illustrated with the liquidation of the ABC Partnership, whose
partners, A, B, and C decide to terminate the business on May 1, 20X5. The AB
Partnership was formed on January 1, 20Xl. C was admitted into the partnership on
January 1, 20X3, and the name of the business was changed to the ABC Partnership.
For purposes of this illustration, assume that A remained in the partnership and, in
20X4, the partners agreed to a realignment of their profit and loss sharing
percentages to more closely conform with the efforts of each partner. The profit and
loss sharing percentages after realignment in 20X4 and the balances of each of the
three partners’ capital accounts on May 1, 20X5 are:
Partners
A B C
Profit and Loss Percentage 40% 40% 20%
Partnership Capital Accounts Br 34,000 Br 10,000 Br 16,000
The three partners also prepare personal net worth statements, including the
expected net capital and loan values of each partner’s investment in the ABC
Partnership, which show the following:
A B C
Personal assets Br 150,000
20
Br 12,000 Br 42,000
Personal liabilities (86,000) (16,000) (14,000)
Net worth (deficit) Br 64,000 Br (4,000) Br 28,000
This shows that partner A and C are personally solvent. B, on the other hand, is
personally insolvent.
If the partnership is insolvent, that is, partnership liabilities exceed partnership
assets the deficit must be made up by additional contributions from individual
partners.
The partnership creditors, however, are not required to wait for individual partners
to make additional contributions of capital. Because of the unlimited liability of
general partners for partnership obligations, the partnership’s creditors can make
claims against a general partner’s individual assets for the unpaid partnership
liabilities.
4.2 Statement of Partnership Liquidation

To guide and summarize the partnership liquidation process, a statement of liqui-
dation may be prepared. It is the basis of the journal entries made to record the
liquidation. It presents the effects of the liquidation on the balance sheet accounts of
the partnership. The statement shows the conversion of assets into cash, the alloca-
tion of any gains or losses to the partners, and the distribution of cash to creditors
and partners.
Liquidation could be lump sum of installment. A Lump sum liquidation of a

partnership is one in which all the assets are converted into cash within a very short
time, outside creditors are paid, and a single, lump-sum payment is made to the
partners for their capital interests. Realization of assets– is conversion of non-cash
assets into cash. Any losses on realization and expenses of liquidation are allocated
to the partners according to the profit and loss ratio. In installment liquidation, the
realization of assets may take a long period. In this section, we assume lump sum
liquidation.
To illustrate, a condensed trial balance of the ABC Partnership in which A, B, and C

are partners, on May 1, 20X5, the day the partners decide to liquidate the business, is
presented below.
ABC Partnership
Trial Balance
May 1, 20X5
Cash Br10,000
Non-cash Assets 90,000
Liabilities Br40,000
Loan Payable to Partner C 4,000
A, Capital (40%) 34,000
B, Capital (40%) 10,000
21
C, Capital (20%) 12,000
Total Br 100,000 Br 100,000
 The partnership liquidation schedule will be prepared and the journal

entries recorded under the following assumptions.
1. Non-cash assets of ABC partnership are sold for Br 80,000, The outside
creditors are paid Br 40,000 on May 20, and the remaining Br 50000 cash is
distributed to the partners on May 30, 20X5.
Cash Non- Liab. A, B, C,

cash Cap. Cap. Cap.
assets 40% 40% 20%
Pre-liquidation balance 10000 90000 40000 34000 10000 16000
Sale of Assets and loss
distribution 80000 (90000) (4000) (4000) (2000)
9000 0 40000 30000 6000 10000
L/Sum pyt to partners:
Partners’ capital (50,000) (30000) (6000) (14000)
 The following entries are recorded using the partnership liquidation schedule:

20X5
May Cash 80,000
15
A, Capital [4/10 x 10,000] 4,000
B, Capital [4/10 x 10,000] 4,000
C, Capital [2/10 x 10,000] 2,000
Non-cash assets 90,000
Liabilities 40,000
20
Cash 40,000
A, capital 30,000
30
B, Capital 6,000
C, capital 14,000
Cash 50,000
2. The three partner’s capital personal financial statements are as follows:
22
A B C
Personal assets Br 15000 Br 12000 Br 42000
Personal liabilities (86000) (16000) (14000)
Net worth (Deficit) Br 64000 Br (4000) Br 28000
 The non-cash assets of the partnership are sold for Br 35000 on May 15,
20X5 and Br 55000 loss is allocated to the partners’ capital accounts.
 The outside creditors are paid Br 40000 on May 20, 20X5.
 The remaining Br 5000 cash is distributed to the partners as a lump-sum
payment on May 20X5.
Cash Non- Liab. A, B, C,

cash Cap. Cap. Cap.
assets 40% 40% 20%
Pre-liquidation 10000 90000 40000 34000 10000 16000
Balance
Sale of Assets and 35000 (90000) (22000) (22000) (11000)
loss dist
45000 0 40000 12000 (12000) 5000
Pty to outside (40000) (40000)
creditors
5000 0 0 12000 (12000) 5000
Dist. of deficit (8000) 12000 (4000)
(40:20)
5000 0 0 4000 0 1000
L/Sum Pyt to 5000 0 0 (4000) 0 (1000)
partners:
Balance - - - - - -

20X5
The
May 15 Cash 35,000
following
A, Capital [4/10 x 55,000] 22,000
entries are
B, Capital [4/10 x 55,000] 22,000 recorded
C, Capital [2/10 x 55,000] 11,000 using the
Non-cash assets 90,000 partnership
liquidation
20 Liabilities 40,000 schedule:
Cash 40,000
30 A, capital [4/6 x 12,000] 8,000

C, capital [2/6 x 12,000] 4,000
B, Capital 12,000
23
A, capital 4,000
C, Capital 1,000
Cash 5,000
3. Non-cash assets are sold for Br 20,000, and Partner B is personally insolvent, A and C
are personally solvent.
Cash Non-cash Liab. A, B, C,
assets Cap. Cap. Cap.
40% 40% 20%
Pre-liquidation 10000 90000 40000 34000 10000 16000
Balance
Sale of Assets and 20000 (90000) (28000) (28000) (14000)
loss dist
30000 0 40000 6000 (18000) 2000
Dist. of deficit (40:20) (12000) 18000 (6000)
30000 0 40000 (6000) 0 (4000)
Contributed by A and 10000 6000 4000
C
40000 0 40000 0 0 0
Pyt to creditors (40000) (40000)
Post-liquidation 0 0 0 0 0 0
balance

20X5
May Cash 20,000
15
A, Capital [4/10 x 70,000] 28,000
B, Capital [4/10 x 70,000] 28,000
C, Capital [2/10 x 70,000] 14,000
Non-cash assets 90,000
A, capital [4/6 x 18,000] 12,000

B, capital [2/6 x 18,000] 6,000
B, Capital 18,000
Cash 10,000
A, Capital 6,000
C, Capital 4,000
24
Liabilities 40,000
Cash 40,000
ACCOUNTING FOR CORPORATIONS
1.1 Nature of a Corporation

A corporation is a legal entity—an artificial legal “person”— created on the
approval of the appropriate governmental authority. To form a corporation, the
incorporators (often at least three are required) must apply for a charter. The
incorporators prepare and file the articles of incorporation, which delineate the
basic structure of the corporation, including the purposes for which it is formed, the
amount of capital stock to be authorized, and the number of shares into which the
stock is to be divided. If the incorporators meet the requirements of the law, the
government issues a charter or certificate of incorporation. After the charter has
been granted, the incorporators (or the subscribers to the corporation’s capital stock)
hold an organization meeting to elect the first board of directors and adopt the
bylaws of corporations.
25
Because assets are essential to corporate operations, the corporation issues
certificates of capital stock to obtain the necessary funds. As owners of the corpo-
ration, stockholders, or shareholders, are entitled to a voice in the control and man-
agement of the company. Stockholders with voting stock may vote at the annual
meeting and participate in the election of the board of directors. The board of
directors is responsible for the overall management of the corporation. Normally the
board selects such corporate officers as a president, one or more vice-presidents, a
controller, and a treasurer. The officers implement the policies of the board of
directors and actively manage the day-to-day affairs of the corporation.
Creating a corporation is more costly than organizing a proprietorship or

partnership. The expenditures incurred to organize a corporation are charged to
Organization Costs, an intangible asset account. These costs include attorney’s fees,
fees paid to the government, and costs of promoting the enterprise. As we discussed
in Module One, organization costs typically are amortized.
1.2 Characteristics of Corporations

 Separate Legal Entity
A business with a corporate charter is empowered to conduct business affairs apart
from its owners. The corporation, as a legal entity, may acquire assets, incur debt,
enter into contracts, sue, and be sued—all in its own name. The owners, or
stockholders, of the corporation receive stock certificates as evidence of their
ownership interests; the stockholders, however, are separate and distinct from the
corporation. This characteristic contrasts with proprietorships and partnerships,
which are accounting entities but not legal entities apart from their owners. Owners
of proprietorships and partnerships can be held responsible separately and
collectively for unsatisfied obligations of the business.
 Limited Liability
The liability of shareholders with respect to company affairs is usually limited to
their investment in the corporation. Because of this limited liability, laws restrict
distributions to shareholders. To protect creditors, the government controls the
distribution of contributed capital. Distributions of retained earnings (undistributed
profits) are not legal unless the board of directors formally declares a dividend.
Because of the legal delineation of owner capital available for distribution,
corporations must maintain careful distinctions in the accounts to identify the
different elements of stockholders’ equity.
 Transferability of Ownership
Shares in a corporation may be routinely transferred without affecting the
company’s operations. The corporation merely notes such transfers of ownership in
the stockholder records (ledger). Although a corporation must have stockholder
records to notify shareholders of meetings and to pay dividends, the price at which
shares transfer between owners is not recognized in the corporation’s accounts.
26
 Continuity of Existence
Because routine transfers of ownership do not affect the affairs of a corporation the
corporation is said to have continuity of existence. In this respect, a corporation is
completely different from a partnership. In a partnership, any change in ownership
technically results in dissolution of the old partnership and formation of a new one.
In a partnership, the individual partners’ capital accounts indicate their relative

interests in the business. The stockholders’ equity section of a corporate balance
sheet does not present individual stockholder accounts. A shareholder, however, can
easily compute his or her interest in the corporation by calculating the proportion of
the total shares outstanding that his or her shares represent. For example, if only one
class of stock is outstanding and it totals 1,000 shares, an individual owning 200
shares has a 20% interest in the total stockholders’ equity of the corporation, which
includes all contributed capital and retained earnings. The dollar amount of this
interest, however, is a book amount, rarely coinciding with the market value. A
stockholder who liquidates his or her investment would sell it at a price negotiated
with a buyer or, if the stock is traded on a stock exchange, at the exchange’s quoted
market price.
 Capital-raising Capability
The limited liability of stockholders and the ease with which shares of stock may be
transferred from one investor to another are attractive features to potential
stockholders. These characteristics enhance the ability of the corporation to raise
large amounts of capital by issuing shares of stock. Because both large and small
investors may acquire ownership interests in a corporation, a wide spectrum of
potential investors exists.
 Taxation
As legal entities, corporations are subject to income taxes on their earnings, whether
distributed or not. In addition, shareholders must pay income taxes on earnings
received as dividends. Therefore, corporate income is subject to double taxation.
 Regulation and Supervision

Corporations are subject to greater degrees of regulation and supervision than are
proprietorships and partnerships. The laws limit the powers a corporation may
exercise, identify reports that must be filed, and define the rights and liabilities of
stockholders. Furthermore, corporations whose stock is listed and traded on
organized security exchanges are subject to the various reporting and disclosure
requirements of these exchanges.
1.3 Nature and Types of Stock in a Corporation

The corporate charter may specify a face value, or par value, for each share of a
27
stock of any class. Par values are typically set at amounts well below the stock’s
market value at date of issue. Par value today, therefore, has no economic
significance. However, par value may have legal implications. In some countries,
par value may represent the minimum amount that must be paid-in per share of
stock. If stock is issued at a discount (that is, at less than par value), the stockholder
may have a liability for the discount if creditors claims remain unsatisfied after the
liquidation of the company. Issuing stock at a discount is a rare event, because
boards of directors have generally established par values below market values at
time of issue.
Par value may also be used in some laws to define the legal capital of a corporation.
The legal capital is the minimum amount of contributed capital that must remain in
the corporation as a margin of protection for creditors. A distribution of assets to
stockholders would not be allowed if it reduced stockholders’ equity below the
amount of legal capital. Given the role that par value may play in defining legal
capital, accountants carefully segregate and record the par value of stock
transactions in an appropriate capital stock account.
The laws of most countries permit the issuance of stock without a par value—that is,
no-par stock. The company’s board of directors usually sets a stated value for the
no-par stock. In such cases, the stated value will determine the corporation’s legal
capital. Again, the stated value figure is usually set well below market value at time
of issue, but in contrast to par value, the stated value is not printed on the stock
certificate. For accounting purposes, stated value amounts are treated in a fashion
similar to par value amounts. In the absence of a stated value, the entire proceeds
from the issuance of no-par stock will likely establish the legal capital of the
corporation.
1.4 Classification of Stock

The amounts and kinds of stock that a corporation may issue are enumerated in the
company’s charter. Providing for several classes of stock permits the company to
raise capital from different types of investors. The charter also specifies the
corporation’s authorized stock —the maximum number of shares of each class of
stock that may be issued. A corporation that wishes to issue more shares than its
authorized number must first amend its charter. Shares that have been sold and
issued to stockholders constitute the issued stock of the corporation. The corporation
may repurchase some of this stock. Shares actually held by stockholders are called
outstanding stock, whereas those reacquired by the corporation (and not retired) are
treasury stock. The stocks that are issues and held by the corporation are referred to
as outstanding stock.
1.4.1 Common Stock

When only one class of stock is issued, it is called common stock. Common
shareholders compose the basic ownership class. They have rights to vote, to share
28
in earnings, to participate in additional issues of stock, and—in the case of
liquidation—to share in assets after prior claims on the corporation have been
settled. We now consider each of these rights.
As the owners of a corporation, the common shareholders elect the board of

directors and vote on other matters requiring the approval of owners. Common
shareholders are entitled to one vote for each share of stock they own. Owners who
do not attend the annual stockholders’ meetings may vote by proxy (this may be the
case for most stockholders in large corporations).
A common stockholder has the right to a proportionate share of the earnings of the
corporation that are distributed as dividends. All earnings belong to the corporation,
however, until the board of directors formally declares a dividend.
Each shareholder of a corporation has a preemptive right to maintain his or her

proportionate interest in the corporation. If the company issues additional shares of
stock, current owners of that type of stock receive the first opportunity to acquire,
on a pro-rata basis, the new shares. In certain situations, management may request
shareholders to waive their preemptive rights. For example, the corporation may
wish to issue additional stock to acquire another company. Further, stockholders of
firms incorporated in some states do not receive preemptive rights.
A liquidating corporation converts its assets to a form suitable for distribution,

usually cash, which it then distributes to parties having claims on the corporate
assets. Any assets remaining after all claims have been satisfied belong to the
residual ownership interest in the corporation—the common stockholders. These
owners are entitled to the final distribution of the balance of the assets.
1.4.2 Preferred Stock

Preferred stock is a class of stock with various characteristics that distinguish it from
common stock. Preferred stock has one or more preferences over common stock,
usually with reference to (1) dividends and (2) assets when the corporation
liquidates. To determine the features of a particular issue, we must examine the
stock contract. The majority of preferred issues, however, have certain typical
features, which we discuss below.
 Dividend Preference
When the board of directors declares a distribution of earnings, preferred
stockholders are entitled to a certain annual amount of dividends before common
stockholders receive any distribution. The amount is usually specified in the
preferred stock contract as a percentage of the par value of the stock or in dollars per
share if the stock does not have a par value. Thus, if the preferred stock has a Br 100
par value and a 6% dividend rate, the preferred shareholders receive Br 6 per share
in dividends. However, the amount is owed to the stockholders only if declared.
29
Preferred dividends are usually cumulative—that is, regular dividends to the
preferred stockholders omitted in past years must be paid in addition to the dividend
of the current year before any distribution is made to common shareholders. For
example, a dividend may not be declared in an unprofitable year. If the Br 6
preferred stock dividend mentioned above is one year in arrears and a dividend is
declared in the current year, preferred shareholders would receive Br 12 per share
before common shareholders received anything.
If a preferred stock is non-cumulative, omitted dividends do not carry forward.

Because investors normally consider the non-cumulative feature unattractive, non-
cumulative preferred stock is rarely issued.
Dividends in arrears (that is, omitted in past years) on cumulative preferred stock
are not an accounting liability and do not appear in the liability section of the
balance sheet. They do not become an obligation of the corporation until the board
of directors formally declares such dividends. Any arrearages are typically disclosed
to investors in a footnote to the balance sheet.
 Asset Distribution Preference

Preferred stockholders normally have a preference over common stockholders as to
the receipt of assets when a corporation liquidates. As the corporation goes out of
business, the claims of creditors are settled first. Then, preferred stockholders have
the right to receive assets equal to the par value of their stock or a larger stated
liquidation value per share before any assets are distributed to common
stockholders. The preferred stockholders’ preference to assets in liquidation also
includes any dividends in arrears.
Preferred stocks may also be classified into participating and non-participating.

Participating preferred stock refers to preferred stock that has a right to a stated
dividend and, after common stock has been paid a dividend, can participate in any
excess dividends. Nonparticipating preferred stock does not have this right.
Accounting for Corporations
2.1 Issuance of Stocks
Capital stock may be issued at par, above par, or below par. Par value is not an
indicator of market value – it is strictly a legal matter. When stock is issued above or
below par, the excess or deficiency is recorded in a premium account called Paid-
in Capital in Excess of Par, or, if no balance exists in this account, in a discount
account. Stock can be issued for cash, plant assets, legal services, or on account.
Treasury stocks are those shares that are re-acquired and held by the corporation.
The number of shares currently owned by stockholders; that is, the number of shares
30
authorized minus the total number of un-issued shares and minus the number of
treasury shares.
 To illustrate, assume that the corporate charter of XYZ Company specifies

"authorized capital stock, 100,000 shares, par value Br1 per share.
Further, assume that to date, XYZ Corporation has sold and issued 30,000
shares of its capital stock. The stocks can be summarized as follows:
Authorized shares 100,000
Issued shares 30,000
Un-issued shares 70,000
If the corporation has repurchased 1,000 shares to date, the authorized shares,
treasury stocks, un-issued stocks, and outstanding stocks will be as follows:
Authorized shares 100,000
Treasury stock (1,000)
Un-issued shares (70,000)
Outstanding shares 29,000 shares
The stockholders’ equity accounts of a corporation represent the two primary
sources of stockholders' equity:
1. Contributed capital from the sale of stock, which is the
amount invested by stockholders through the purchase of shares of stock from
the corporation. Contributed capital has two distinct components: (a) par or
stated value derived from the sale of capital stock and (b) additional contributed
capital in excess of par or stated value. This is often called additional paid-in
capital.
2. Retained earnings generated by the profit-making

activities of the company. This is the cumulative amount of net income earned
since the organization of the corporation less the cumulative amount of dividends
paid by the corporation since organization.
Most companies generate a significant part of their stockholders' equity from
retained earnings rather than from capital raised through the sale of stock.
2.1.1 Sale and Issuance of Capital Stock

Most sales of stock to the public are cash transactions. To illustrate accounting for
an initial sale of stock, assume that on January 1, 20x5, M Company sold 100,000
shares of its Br 0.10 par value stock for Br 22 per share. The company records the
following journal entry:

20X5
Jan. 1 Cash (100,000x Br 22) 2,200,000
Common stock (100,000 x Br0.10) 10,000
Paid In Capital in Excess of par 2,190,000
31
Some corporations do not specify a par value for their stock. In these cases,
depending on the law, common stock is recorded under one of the following
two approaches:
1. The corporation must specify in its bylaws a stated value per share as
legal capital. This stated value is used as a substitute for par value, and the
sale of common stock is recorded in a manner similar to the previous
journal entry.
20X5
Jan. 1 Cash (100,000x Br 22) 2,200,000
Common stock (100,000 x Br0.10) 10,000
Paid In Capital in excess of stated value 2,190,000
Please note that in the stocks issued are proffered stocks, the
Preferred stock account would be credited for Br 10,000 and
the Paid in Capital in Excess of Par: Preferred stock account
would be credited for Br 2,190,000.
2. The corporation must record the total proceeds received from each sale
of no-par stock as legal capital. In this case, the total proceeds are
recorded in the Common Stock account and there is no account called
Capital in Excess of Par.

20X5
Jan. 1 Cash (100,000 x Br 22) 2,200,000
Common stock 2,200,00
(100,000 x Br 22) 0
2.1.2 Capital Stock Sold and Issued for Non-cash Assets and/or Services
One feature common to all start-up companies is a shortage of cash. Because these
companies often cannot afford to pay cash for needed assets and services, they
32
sometimes issue stock to people who can supply these assets and services. Indeed,
many executives will join start-up companies for very low salaries because they also
earn shares of stock.
When a company issues stock to acquire assets or services, the acquired items are
recorded at the market value of the stock issued at the date of the transaction in
accordance with the cost principle. If the market value of the stock issued cannot be
determined, the market value of the consideration received should be used. .
To illustrate, assume that during its early years of operations, M Company was
unable to pay cash for needed legal services. The company issued 10,000 shares of
stock to a law firm when the stock was selling for Br 15 per share. At that time, the
company recorded the following journal entry:

20X5
Jan. 1 Legal Fees 150,000
Common stock (100,000 x Br 0.10) 1,000
Paid-in Capital in Excess of Par 149,000
Notice that the value of the legal services received is assumed to be the same as the
value of the stock that was issued. This assumption is reasonable because two
independent parties usually keep negotiating a deal until the value of what is given
up equals the value of what is received.
2.1.3 Capital Stock Sold and Issued through Subscription
The stocks could also be issued with the arrangement that the subscribers sign a
contract to effect payment for a specified number of shares in installment and the
shares would be issued to the subscribers upon the final payment.
To illustrate, assume that on Feb 1 20x5, M Company signed a stock subscription

agreement to issue 10,000 shares of common stock at Br 10 per share. A Br 20,000
down payment was collected. The remainder of the subscription price is due in two
equal installments on March 1, 20x5 and April 1, 20x5.
On February 1, 20x5, the transaction will be recorded as follows:
20X5
Feb. 1 Stock Subscription Receivable 80,000
Cash 20,000
Common stock Subscribed (10,000x Br0.10) 1,000
Paid-in Capital in Excess of Par 199,000
33
Stock Subscription Receivable Account is a current asset account to be reported on
the balance sheet. The common stock subscribed account is a temporary capital
account to be closed to the common stock account when the subscriptions are fully
collected. The temporary capital account is used to show that the subscribers do not
have the rights of shareholders, as they did not finalize the transaction of buying the
shares.
When the first installment is collected on March 1, 20x5, the following entry
would be recorded:

20X5
Mar. Cash [80,000/2] 40,000
1
Stock subscriptions Receivable 40,000
On April 1, 20x5, the final installment is collected and the shares are issued to
the subscribers. On this date the following entry is prepared:.

20X5
Apr. Cash [80,000/2] 40,000
1
Stock Subscriptions Receivable 40,000
Common Stock Subscribed 10,000

1
Common Stock 10,000
The first entry shows collection of the receivables. And the second entry closes the
temporary capital account of- Common Stock Subscribed since all the amounts due
from the subscribers are collected.
2.2 Treasury Stock
Capital stock that is reacquired by a corporation is termed treasury stock. Treasury

stock has no voting, dividend, or other stockholder rights. Stock can be reacquired
for various reasons, such as to have shares available for distribution to employees
under bonus plans, and to support the market price of the stock by stimulating
trading in it.
If treasury stock is resold, no gain or loss is recognized on the exchange because the
corporation’s primary objective is not to make profit by trading in its own stock. In
34
addition, the treasury stocks are not assets, rather they are deductions from
stockholders equity.
The recording of the purchase of treasury stock is based on the cost of the shares
that were purchased. Assume that On April 1, 20x5, M Company bought 100,000
shares of its stock in the open market when it was selling for Br 22 per share. Using
the cost method, the company records the following journal entry:

20X5
Apr. 1 Treasury stock (100,000 x Br220) 2,200,000
Cash 2,200,000
Intuitively, many students expect the Treasury Stock account to be reported as an

asset. This is not the case because a company cannot create an asset by investing in
itself. The Treasury Stock account is actually a contra equity account, which means
that it is reported as a subtraction from the total stockholders' equity. This makes
sense because treasury stock is stock that is no longer outstanding, and therefore,
should not be included as part of stockholders' equity.
If M Company eventually sells its treasury stock; it will not report an accounting
profit or loss on the transaction even if it sells the stock for more or less than it paid.
GAAP do not permit a corporation to report income or losses from investments in
its own stock because transactions with the owners are not considered to be normal
profit- making activities. Based on the previous example, assume that on April 15,
M Company sold 10,000 shares of treasury stock for Br30 per share. Remember that
the company had purchased the stock for Br22 per share. M Company records the
following entry:

20X5
Apr. 15 Cash (10,000 x Br 30) 300,000
Treasury Stock 220,000
Paid in capital from sale of treasury sock 80,000
If treasury stock were sold at a price below its purchase price (i.e., an a ‘loss’), the
Paid in Capital from Treasury Stock Transactions account would be debited for the
amount of the loss. Retained Earnings would be debited for some or the entire
amount of the ‘losses’ only if there were an insufficient credit balance in the Paid in
Capital from Treasury Stock Transactions account.
35
In some cases a corporation may receive some of its stocks through donation. The
Donated Capital account is credited for the market value of the shares at the date of
acquisition. For example, assume that on March 1, 20x5, M Company received 100
shares form stockholders in donation. If the market price per share is Br 100, the
following entry would be prepared:
Neither the Date Accounts Debit Credit
purchase 20X5
nor sale of Mar. 1 Treasury Stock 100,000
treasury Donated Capital [1,000 x Br 100] 100,000
stock
affects the number of shares of stock that are issued or un-issued. Treasury stock
affects only the number of shares of outstanding stock; the basic difference between
treasury stock and un-issued stock is that treasury stock has been sold at least once.
Therefore, the stockholders equity section could be presented as follows:
Paid in Capital:
Common stock Br xxxxx
Capital in excess of par xxxxx xxxxx
Donated Capital xxxxx
Retained earnings xxxxx
Less: Treasury stock xxxxx
Total stockholders' equity Br xxxxx
Retained Earnings, Dividends and Stock Splits
3.1 Restrictions on Retained Earnings

As the result of several types of business transactions, restrictions to retained
earnings limit a company's ability to pay dividends. A typical example occurs when
a business borrows money and banks include a loan covenant that limits the amount
a corporation can pay by placing a restriction on its retained earnings
The full-disclosure principle requires restrictions on retained earnings to be reported

in the financial statements or in a separate note to the financial statements. Users are
particularly interested in information concerning these restrictions because of the
impact they have on the company's dividend policy.
Most companies report restrictions on retained earnings in a note to financial

statements. An example of such a note on the annual report follows:
Under the most restrictive covenants of long-term debt agreements, Br1.2 million restricted
as to the payment of dividends and/or common share repurchase
This type of note describes other restrictions that were imposed as a result of debt
covenants. These restrictions often include a limit on borrowing and required
minimum balances of cash or working capital. If debt covenants were violated, the
creditor can demand immediate payment of debt. For this reason, users want to
review these restrictions to be sure that companies are not close to violating loan
36
agreements.
Another alternative is to record a journal entry, which shows the existence of the
restrictions. Under this alternative there are two retained earnings accounts:
appropriated [restricted] and Un-appropriated [Un-restricted]. For example, the
following entry could be prepared for the restriction mentioned above.

20X5
Sept 1 Retained Earnings: Un-appropriated 1,200,000
Retained Earnings: Appropriated 1,200,,000
When the loan is fully paid, the restriction is no more relevant and another
entry is prepared:
20X5
Dec. 1 Retained Earnings: Appropriated 1,200,000
Retained Earnings: Un-appropriated 1,200,000
If there were restricted retained earnings, the stockholders’ equity section of the
balance sheet would appear as follows:
Paid in Capital:
Common stock Br xxxxx
Capital in excess of par xxxxx xxxxx
Donated Capital xxxxx
Retained earnings: Appropriated xxxxx
Retained earnings: Un-ppropriated xxxxx
Less: Treasury stock xxxxx
Total stockholders' equity Br xxxxx
3.2 Dividends
The earnings of a corporation that are not retained in the business for growth and
expansion are distributed to the stockholders by means of dividends. Dividends are
paid only when formally declared by the board of directors of a corporation. A cash
dividend results in a decrease in assets (cash) and a commensurate decrease in
stockholders' equity (retained earnings). In contrast, a stock dividend does not
change assets, liabilities, or total stockholder's equity. A stock dividend results in a
transfer of retained earnings to the permanent or contributed capital of the
corporation by the amount of the stock dividend. Therefore, a stock dividend affects
only certain account balances within stockholders' equity. There are three important
dates in relation to dividends:
 Declaration date this is the date on which the board of directors officially
37
approves the dividend. As soon as it makes the declaration, it creates a
dividend liability, to be recorded in a journal entry.
 Date of record This date follows the declaration date. It is the date on which
the corporation prepares the list of current stockholders based on its
stockholder records. The dividend is payable only to those names listed on
the record date. No journal entry is made on this date.
 Date of payment this is the date on which the cash is disbursed to pay the
dividend liability. It follows the date of record as specified in the dividend
announcement.
3.2.1 Cash Dividend
Investors who purchase preferred stock give up certain advantages that are
available to investors in common stock. Generally, preferred stockholders do not
have the right to vote at the annual meeting, nor do they share in increased earnings
if the company becomes more profitable. To compensate these investors, preferred
stock offers some advantages not available to common stockholders. Perhaps, the
most important advantage is dividend preference. You will frequently encounter the
following dividend preferences:
1. Current dividend preference.
2. Cumulative dividend preference.
Preferred stock always carries a current dividend preference. It requires that the cur-
rent preferred dividend be paid before any dividends are paid on the common stock.
When the current dividend preference has been met and no other preference is
operative, dividends can be paid to the common stockholders.
Declared dividends must be allocated between the preferred and common stock.
First, the preferences of the preferred stock must be met, and then the remainder of
the total dividend can be allocated to the common stock.
Cumulative preferred stock has a cumulative dividend preference that states if all or
a part of the specified current dividend is not paid in full, the unpaid amount
becomes dividends in arrears. The amount of any cumulative preferred dividends in
arrears must be paid before any common dividends can be paid. Of course, if the
preferred stock is non-cumulative, dividends never can be in arrears. Therefore, the
preferred stockholders lose permanently any dividends passed (i.e., not declared).
Because preferred stockholders are not willing to accept this unfavorable feature,
preferred stock is usually cumulative.
Dividends are never an actual liability until the board of directors declares them.
Dividends in arrears are not reported on the balance sheet, but are disclosed in the
notes to the statements. The allocation of dividends between cumulative preferred
stock and common stock should be strict in accordance with the stock contract. But,
generally, we follow the steps below:
Step 1: Allocate dividends in arrears to the preferred stock
Step 2: Allocate current year dividend to the preferred stock
Step 3: If the preferred stocks are participating, allocate matching dividends to
38
common stock. This is dividend comparable to the current year dividend of
the preferred stock. For example, if the current year dividend to common
stock is 5 % of par, the common stock will also be entitled to 5% of their
stock’s par value. If the current year dividend to the preferred stock is Br 2
per share, the comparable dividend will also be Br 2 per share to the common
stock
 If the preferred stocks are non-participating, the entire remaining amount after
step 2 will be given to common stock.
Step 4: If there is a balance after step 3, it is allocated to both preferred and common
stock.
To illustrate, assume the following:

Preferred stock outstanding, 6%, par Br 20; 2,000 shares Br 40,000
Common stock outstanding, par Br10; 5,000 shares 50,000
 Assume that the dividends are in arrears for one year, and preferred stocks are
cumulative and participating.
If the amount of cash dividend declared is Br 50,000 it will be allocated as

follows:
Preferred Common Total

Par Value Br 40,000 Br 50,000 Br 90,000
Total Dividend Br 50,000
1. Dividends in arrears [0.06x 50,000] 3,000 (3,000)
Remaining amount 47,000
2. Current year dividend
to preferred 3,000 (3,000)
3. Matching dividend to common stock
[0.05 x 50,000] 2,500 (2,500)
4. To both classes of shares:
[41,500/90,000=0.46]
[0.46 x 40,000; 0.46 x 50,000] 18,444 23,056 (41,500)
Total 24,444 25556 50,000
Notice that all the four steps are applied in this example because there were
dividends in arrears and the preferred stocks were cumulative and participating.
On the date of declaration of the dividends, say December 31, 20x5, the following
entry is prepared
39
20X5
Dec. Dividends 50,000
31
Dividend Payable: Preferred 24,444
Dividend Payable: Common 25,556
The dividends account would be closed as follows:

20X5
Dec. Retained Earnings 50,000
31
Dividends 50,000
  If the dividends are paid out on January 1, 20x6, the following entry
would be prepared:

20X6
Jan 1 Retained Earnings 50,000
Dividend Payable: Preferred 24,444
Dividend Payable: Common 25,556
 If we assume that the preferred stocks are non-cumulative non-participating,

the dividends would be allocated as follows:
Preferred Common Total
Par Value Br 40,000 Br 50,000 Br 90,000
Total Dividend Br 50,000
1. Current year dividend
to preferred 3,000 (3,000)
2. All the remaining amounts to common
Stock _____ 47,000 (47,000)
Total 3,000 47,000 50,000
3.2.2 Stock Dividends

Corporations issue stock dividends instead of cash dividends. A stock dividend is a
distribution of additional shares of a corporation's own capital stock on a pro rata
basis to its stockholders at no cost. Stock dividends usually consist of common stock
issued to the holders of common stock. Pro rata basis means that each stockholder
receives additional shares equal to the percentage of shares already held. A
stockholder with 10 percent of the outstanding shares receives 10 percent of any
additional shares issued as a stock dividend.
40
The value of a stock dividend is the subject of much debate. In reality, a stock div-
idend has no economic value, as such. All stockholders receive a pro rata
distribution of shares; which means that each owns exactly the same portion of the
company both before and after the stock dividend. The value of an investment is
determined by the percentage of the company that is owned, not the number of
shares that are held. If you get change for a dollar, you do not have more wealth
because you hold four quarters instead of only one dollar. Similarly, if you own 10
percent of a company, you do not have more wealth simply because the company
declares a stock dividend and gives you (and all other stockholders) more shares of
stock. At this point, you may still wonder why having extra shares of stock does not
make an investor wealthier. The reason is simple: The stock market reacts
immediately when a stock dividend is issued, and the stock price falls
proportionally.
If the stock price was Br 60 before a stock dividend, normally (in the absence of
events affecting the company) the price falls to Br 30 if the number of shares is
doubled. Thus, an investor could own 100 shares worth Br 6,000 before the stock
dividend (100 x Br 60) and 200 shares worth Br 6,000 after the stock divi dend (200
x Br30).
To illustrate, assume that M Company, issues a 100 percent stock dividend February
25 20x6 to shareholders of record on February 2. M Company has 1,149,819,000
shares outstanding. The market value of the shares was Br 0.10.
Stock dividends are classified as either large or small. A large stock dividend
involves the distribution of additional shares that are more than 25 percent of the
currently outstanding shares. A small stock dividend involves additional shares that
are less than 25 percent of the outstanding shares. Because the M Company stock
dividend was equal to 100 percent of the outstanding shares, it should be classified
as a large dividend. The company makes the following entry to record a large stock
dividend:
20X6
Feb 6 Retained Earnings (0.10 x 1,149,819,000) 114,981,900
Common Stock 114,981,900
Notice that this journal entry moves an amount from Retained Earnings to the
permanent contributed capital of the company. The stock dividend did not
change total stockholders' equity-it changed only the balances of some of the
accounts that constitute stockholders' equity. This process of transferring an
amount from Retained Earnings to Contributed Capital often is called
capitalizing earnings because it reduces the amount of retained earnings
available for future dividends.
41
The amount transferred from Retained Earnings to Contributed Capital was based
on the par value of the shares issued as a stock dividend. Par value is used when the
stock dividend is classified as large. In those cases, when a stock dividend is small
(i.e., less than 25 percent), the amount transferred should be the total market value
of the shares issued.
3.3 Stock Splits
Stock splits occur when management wishes to reduce the market price of stock so
that more investors can afford it. When stock is split, the par or stated value of the
stock is reduced as well as the market value. However, the amounts in the paid-in
capital accounts are not affected. Consequently, no journal entry – other than a
memorandum entry – is needed to record the split. A stock split affects only the
par value of the stock and the number of shares outstanding; the individual equity
account balances are not changed.
Stock splits are not dividends. They are similar to a stock dividend, but are quite
different in terms of their impact on the stockholders' equity accounts. In a stock
split, the total number of authorized shares is increased by a specified amount, such
as a 2-for-1 split. In this instance, each share held is called in, and two new shares
are issued in its place. Typically, a stock split is accomplished by reducing the
par or stated value per share of all authorized shares so that the total par value of all
authorized shares is unchanged. If M Company executes a 2-for-1 stock split, it
reduces the par value of its stock from Br 0.10 to Br 0.05 and it doubles the number
of shares outstanding. In contrast to a stock dividend, a stock split does not result in
a transfer of retained earnings to contributed capital. No transfer is needed because
the reduction in the par value per share compensates for the increase in the number
of shares.
In both a stock dividend and a stock split, the stockholder receives more shares of
stock, but does not disburse any additional assets to acquire the additional shares, A
stock dividend requires a journal entry; a stock split does not require one. A stock
split is disclosed in the notes to the financial statements.
The comparative effects of a stock dividend versus a stock split may be summarized as
follows:
Stockholders' Equity
After a
Before 100% Two-for-One
Stock dividend Stock Split
Contributed capital
Number of shares outstanding 30,000 60,000 60,000
Par value per share Br 10 Br 10 Br 5
42
Total par value outstanding 300,000 600,000 300,000
Retained earnings 650,000 350,000 650,000
Total stockholders' equity 950,000 950,000 950,000
3.4 The Statement of Stockholders’ Equity
The statement of stockholders’ equity is prepared periodically to summarize the
changes that have occurred in the stockholders’ equity of the corporation. In some
cases, the statement of retained earnings is prepared instead of the statement of
Stockholders’ equity.
This represents a fairly typical statement of changes in retained earnings. Under rare
circumstances, you may see a statement that includes an adjustment to the beginning
balance of retained earnings. This adjustment is called a prior period adjustment,
which is a correction of an accounting error that occurred in the financial statements
of a prior period.
3.5 Equity Per Share

Equity per share (EPS) is the ratio of stockholder's equity to the related number of
shares of stock outstanding. If there is only one class of shares (common stock),
equity per share is computed as follows:
EPS= Total stockholder's equity
No. of shares outstanding
If there are both common and preferred shares, we have allocate the total equity
should be the preferred and common stock. The equity to preferred stock is the
liquidation value. The liquidation value is the amount that the preferred stockholders
can claim if the corporation is liquidated. The equity to preferred stock includes the
dividends in arrears. If the equity to the preferred stock is determined, the common
equity is computed by deducting equity to common stock from the total equity.
Then, EPS would be computed as follows:
Preferred EPS = Equity allocated to preferred stock
No. of outstanding o/s shares of preferred stock
Common EPS = Equity allocated to common stock
No. of outstanding shares of common stock
The Retained Earnings account is a stockholders’ equity account with a normal

credit balance. As a result of net losses, however, a debit balance in Retained
Earnings may occur. Such a balance is called a deficit. The deficit reduces the total
stockholders’ equity of the corporation.
 To illustrate, assume that the following balances appear on the balance

sheet of ABC Company:
Common stock, Br 10 par Br 600,000
Paid in Capital excess of par 120,000
Deficit 75, 000
43
Total stockholders’ equity is Br 645,000 (Br 600,000 + Br 120,000 – Br 75,000) and
the number of share is 60,000 (Br 600,000/Br 10). The business has only common
stock and hence, the EPS is
 To illustrate, assume the following data:
Preferred, 11% stock, Br 50 par Br2,500,000
Premium on preferred stock 275,000
Common stock, Br25 par 3,750,000
Deficit 1,240,000
Assume also that Preferred stock has prior claim to assets on liquidation to the
extent of 110% of par.
 To compute EPS, let us first split the total equity into the two classes
of shares:
Total Equity:
Preferred, 11% stock, Br 50 par Br2,500,000
Premium on preferred stock 275,000
Common stock, Br25 par 3,750,000
Deficit (1,240,000) Br 5,285,000
Less: Equity to preferred stock (110% x 2,500,000) 2,750,000

Equity to Common Stock Br 2,535,000
Therefore,
Preferred EPS = Br 2,750,000 = Br 55.00 per share
2,500,000/Br 50
Common EPS = Br 2,535,000 = Br 16.90

3,750,000/Br 25
44

Accounting For A Partnership

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ACCOUNTING FOR A PARTNERSHIP

1.1 The Nature of a Partnership

1.2 Characteristics of a Partnership

2.1 Partnership Accounting: General

Loans to or from partners should be separately classified in a balance sheet, as there

2.2 Accounts Maintained

Drawing Accounts – Partners generally make withdrawals of assets from the

The journal entry to record the initial capital contribution by Mr A would be

Date Accounts Debit Credit

  Mr B’s contribution of Br 10,000 is recorded as follows:

Date Accounts Debit Credit

2.4 Withdrawal of Assets by Partners

Date Accounts Debit Credit

Distributing partnership income based on interest on capital balances recognizes the

Date Debit Credit Balance

Case 1: If A and B share profits or losses in the ratio of 60 percent to A and 40

The distribution of the Br. 10,000 profit would be calculated as follows:

Therefore, the closing entry would be:

Closing Date Accounts Debit Credit

Case 4: The agreement provides that a bonus of 10 percent of income in excess of

 In alternative 1, where bonus is a percentage of income before subtracting the

Bonus = X%(NI — MIN)

Where X% = the bonus percentage

 In alternative 1, we compute bonus as follows:

 The distribution of net income based on Alternative 2 is calculated as follows:

Occasionally, a person may be admitted as a partner without any specific

On January 1, 20X3, A and B invited C to become a partner in their business. C

Date Accounts Debit Credit

Date Accounts Debit Credit

 The increase of Br 6000 may also be due to the existence of unrecorded

Date Accounts Debit Credit

3.1.2 Admission with Investment in the Partnership

To illustrate, assume that the January 1, 20X3, capital of the AB

C’s proportionate BV = (Br. 30,000 + Br. 10,000) x 0.25 = Br. 10,000

Date Accounts Debit Credit

Date Accounts Debit Credit

Date Accounts Debit Credit

d. C, invested Br 11000 for a one-fourth interest in the partnership the

C’s proportionate BV = (Br. 30,000 + 8,000) 0.25 = Br. 9,500

Step 1: Estimate total resulting capital:

C’s proportionate BV = (Br 30,000 + Br 8,000) x 0.25 = Br 9,500

3.2 Retirement of a Partner

Case 1: The entire amount of goodwill is placed on the books

Date Accounts Debit Credit

Date Accounts Debit Credit

Frequently the partnership is not in a position to liquidate in one cash distribution

Date Accounts Debit Credit

Case 2: Retiring Partner’s Share of Goodwill Placed on Books

Date Accounts Debit Credit

Case 3: The capital balances of remaining partners to be adjusted in lieu of

Date Accounts Debit Credit

4.2 Statement of Partnership Liquidation

Liquidation could be lump sum of installment. A Lump sum liquidation of a

To illustrate, a condensed trial balance of the ABC Partnership in which A, B, and C

 The partnership liquidation schedule will be prepared and the journal

Cash Non- Liab. A, B, C,

Date Accounts Debit Credit

2. The three partner’s capital personal financial statements are as follows:

Cash Non- Liab. A, B, C,