ACCOUNTANCY FORM 6 – PARTNERSHIP ACCOUNTING

SECOND METHOD; PROFIT ANALYSIS BASIS

In this method profit is apportioned by using analyzed profit and loss. This requires the use of separated column in the profit and loss account for the period in question.

a) Gross Profit

Is apportioned between the period on basis of turn over.

b) Fixed charges

Fixed charges are apportioned on the basis of time.

c) Variable charges

Variable charges are apportioned on the basis of turnover.

d) Other charges

Other charges with special information given are apportioned according to that given information.

EXERCISE

X and Y are carrying on a business in partnership sharing profit and losses in the ratio of 3:2 but during the year ended Dec 31^st 2007 two other member were admitted namely W and Z on July 1^st and sept 30^th 2007 respectively. Net sale during the year amounted to shs. 250,000, selling and nglish-swahili/distribution” target=”_blank”>distribution on expenses amount to shs. 12,000.

However the firms sales break down were;          Tshs.

January 1^st to march 31st                                     62,500

April 1^st to June 30^th                                            93,750

July 1^st to sept 30^th                                            31,250

Oct 1^st to Dec 31^st                                               62,500

The firm normally fixes the Gross profit at 25% above the cost

Their profits and losses sharing ratios were;

X and Y and W was 2; 2; 1

X, Y, W and Z was 4; 3; 2; 1

Prepare;

a) The profit and loss account for the year ended 31^st Dec 2007

b) An appropriation account for the year ended Dec 2007.

SOLUTION;

W_1; GROSS PROFIT AMOUNT

If the gross profit is 25% above the cost

Thus

Sales are at 25%

G.P = x 250,000; from where r = rate

                                                         = 50,000

W₂; First 6 month’s G.P; (sales; – 62500 + 93750 = 156250)

6 months G.P = Gross profit x sales for the period

                          =   x 156,250 = 31250.

W_3; Gross profit from July 1^st – 30^th sept (sales = 31250)

     3 months G.P = x 31250     

                               = 6250

W₄ = Gross profit from October^1st– Dec 31^st (sales = 62500)

Lost 3 month’s G.P  

                        = 12,500

W_5; Administrative expenses 12,000

a) X 12,000 = 6000

b) X 12000 = 3000

c) X 12,000 = 3000

Selling and nglish-swahili/distribution” target=”_blank”>distribution expenses 25,000

a)  For 6 month’s sales = 156250

6 month’s selling and nglish-swahili/distribution” target=”_blank”>distribution exp.

Total expenses  x sale for the period

   Total sales

25,000   x 156,250

250,000

         = 15,625

b)   For next 3 months sales = 31,250

   3 months selling and nglish-swahili/distribution” target=”_blank”>distribution exp. = 25,000 x 31250

                                                                     250,000

                                                                   = 3125

c) For the last 3 month’s sales = 62,500

Last 3 month’s selling and nglish-swahili/distribution” target=”_blank”>distribution exp. =

25,000 x 62,500   = 6250

250,000

 DR     PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31^ST DEC 2007            CR

PROFIT AND LOSS APPROPRIATION A/C FOR THE PERIOD ENDED 30/6/07

PROFIT AND LOSS APPROPRIATION FOR THE PERIOD ENDED 31^ST DEC.2007

PROFIT AND LOSS APPROPRIATION A/C FOR THE PERIOD ENDED 31^ST DEC.2007

ADMISSION OF PARTNERS

• When additional capital or managerial stalls or both are required in the course of expansion it is quite usual to take new partner or partners into partnership firm.
  
• The new partner usually invests additional capital to the firm.
  
• Admission of a new partner raises the following thins.
  

 

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1. Treatment of Goodwill
   
2. Revaluation of Assets and liabilities
   
3. Re-arrangement of old partners capital balances after admission
   
4. Re-arrangement of old partners profit sharing rations
   

 

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GOODWILL

• Goodwill simply means the good name or the reputation of the business
  
• Attraction of more customers depends on Goodwill and helps in earning more profit in future
  
• Goodwill is an asset
  
• New partner gets benefit of the extra asset and old ones lose their shares
  
• In other words when a new partner get some shares in the profit of the firm he acquire the same rights in the existing Assets of the firm and in the extra Asset (Goodwill).
  
• If that’s the case automatically incoming partner, he has to compensate the old partners either:
  

  By paying in cash for his share of Goodwill
  

  By allowing the old partners capital account to be raised rate-ably
  

 

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Method of Valuing Goodwill/Methods of calculating Goodwill

• The Goodwill of any business whether sole trader, Firm or company is generally determined by sharing.
  
• But it depends upon the following factors;
  

 

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1. Present earning capacity of the business.
   
2. Results of the operations of a few previous years.
   
3. The future prospectors of the business.
   
4. Efficiency of management and employers.
   
5. Efficiency of advertising machinery and possession of trade marks.
   

 

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WHEN VALUATION NEEDED

(a)   On admission of a new partner.

(b)   On retirement of a new partner.

(c)   When changing profit sharing ratios.

(d)   On sale of the business.

(e)   During Amalgamation.

(f)    On dissolution.

METHOD OF VALUATION OF GOODWILL

We are having four methods of valuation of Goodwill

1. Purchases of Past profit methods
   
2. Purchase of super profits methods
   
3.  Inferred or Implied Goodwill method
   
4. Valuation by bargaining (Arbitrary methods).
   

 

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– The value of goodwill is decided by direct bargaining between the buyer and seller.

– For Examination purposes such an amount is usually mentioned.   

(a)   Purchase of Past Profit Method

In this method Goodwill is valued at an agreed number of years (2-3 years) of an average profits of a given number of past years) illustration.

Goodwill is valued at two years purchased of the average profits of four years.

• It means average of four years profit multiply by two
  

 

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Goodwill =  x  no. years of purchase

                       = x 2= 100,000/=  

                         Goodwill = 100,000

B.   Purchase of super profit method

Super profit is the difference (Excess) between average annual earning (actual) of the business and the expected or normal return on capital invested.  If the average annual profit of the business is Shs.5000,000/= and the normal earning capacity is 6%, if the capital invested is shs.300,000. Find super profits.

Super Profit = Average profit (Actual) – Normal return of capital invested.

= 50000 – x 800,000

= 50000 – 48,000

= 2000

Then super profit is taken as a base in compilation of Goodwill.

The goodwill be valued at a certain years of purchase of that super profit

3 years purchase: 2000 x 3 = 6,000

C.   Inferred or implied goodwill method        

When a prospective buyer of a business agrees to pay more than the value of the business taken over, the difference between the purchase price and actual value of the business is known as inferred or implied goodwill.                                    

Example

If the Assets worth 1,000,000 Tshs along with the liabilities of Tshs.30, 000 Tshs are taken over by a buyer for Shs.1, 000,000 then the goodwill is;

Goodwill = Purchase Price – Value of the business

= 1,000,000 = [1,000,000 – 30,000]

= 1,000,000 – 970,000

:. Goodwill 30,000

D.   Valuation by bargaining (arbitrary valuation)

–        The value of goodwill is decided by direct bargaining between the buyer and seller.  

–        For examination purposes such an amount is usually mentioned.

ACCOUNTING TREATMENT OF GOODWILL ON ADMISSION

There are two methods in which goodwill can be accounted in the books on admission

(a)   When the goodwill is not appeared in the books

(b)   When the goodwill is already appearing in the books (in the balance sheet)

(c)     When goodwill is not appearing in the books

(d)   When new partner pays cash for goodwill, it is always equal to his share in the total goodwill.

MODE OF PAYMENT

(i)   Cash paid to all partners outside the business or paid privately

(ii)   Cash paid through the firm or business, such cash may be

(a)   Raised in the business as additional working capital

(b)   written drawn by old partners either full or partial

(iii)   Goodwill raised in the books

• When the new partner cannot pay in cash for his share in goodwill and partners capital accounts will be raised rate-ably by raising or bringing in goodwill in the books.
  
• In this case goodwill must be recorded at it is full value ways.
  

  (i)     Goodwill raised and retained in the books at full value
  

  (ii)   Goodwill raised and written off either fully or partly
  

  (iii)   Goodwill raised without opening goodwill account in the books
  

 

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b) When the goodwill is already appearing in the Books

• When goodwill appears in the books (Appeared in the Balance sheet) it means it has been already recorded and credit given told partners
  
• Therefore new partner need not to contribute for goodwill
  
• If new partner brings in cash for goodwill in this case should treated as additional capital and the goodwill should cancelled out.
  

 

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ACCOUNTING ENTRIES FOR GOODWILL

1. When no goodwill appears in the balance sheet

     – When incoming pays money for goodwill privately

       In this there is no Entry.

2. When incoming partners brings in cash and is retained in the business

Debit: Cash a/c                                   (with cash) brought

Credit: Goodwill a/c    

Debit; Goodwill     a/c                            (Old profit)

Credit; old partner’s capital a/c         (sharing ratio)

Example I

A and B are partners carrying on a Business, their profit sharing ratio is 3:2. They decide to admit C in the firm. Their new profit sharing ratio is 2:2:1 for A, B and C respectively C pays shs.10, 000/= as goodwill. These money were left into the business.

Required;   Draw journal entries to record the goodwill

       JOURNAL ENTRIES

III. When incoming partner pays ash for Goodwill and that money is withdrawn by old partners

Debit; Cash a/c                        (with Cash brought)

     Credit; Goodwill   a/c                

Debit; Goodwill     a/c

     Credit; old partner’s capital   a/c

Debit; old partner’s capital a/c

       Credit, Cash   a/c

(With old profit sharing ratio).

Example 2

X and Y are equal partners carrying on business as accountants and auditors they decided to admit W with share of profit to the business. W paid Shs.30,000 as goodwill in the business in cash. But old partners decided withdraw all the money paid for business.

Required

-Draw up Journal entries to receive the above.

                                    JOURNAL ENTRIES

IV   When Incoming Partner does not Bring Cash

• When new partner does not bring cash for goodwill the goodwill accounts is raised in the books of account is raised in the books of accounts and it is allowed to remain in the books.
  
• It is agreed to estimate the value of Goodwill for that particular business. However an adjustment is made in the old partners capital accounts in proportion to less suffered by old partners
  

 

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ENTRIES

1. ADJUSTMENTS                                                    
   

 

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Dr: New partner’s capital a/c                                  

              Cr: Old partner’s capital a/c                                                                  

           Dr: Goodwill a/c                                                      

               Cr: old partner’s capital a/c (With old profit sharing ratio).

Example

M and N are partners with PSR 3:2. They decided to admit O as a new partner to the business; they agreed new profit sharing ratio is 4:3:3 for m, N and O respectively. But it was further agreed that unrecorded goodwill of Shs 105,000.00 is to be raised in the Books of the firm.

Required; Show journal entries to show 

(a)   Loss suffered by M and N

(b)   Goodwill shared by M and N

Determine the proportion of loss suffered on admitting O

Determine O share of Goodwill

O share = Amount of Goodwill x sacrificed Ratio

= 105000 x () = 31,500

REVALUATION OF ASSETS AND LIABILITIES

When a new partner is admitted is very important to revalue all assets depending on market value rather than in their cost or written down value.

Open revaluation account

II. Revaluation Account results   (Transfer)

In case of Profit on revaluation

Debit; revaluation   a/c

       Credit; Capital       a/c

In case of loss on revaluation

   Debit; capital       a/c

       Credit; Revaluation   a/c

Exercise

                              

                                          BALANCE SHEET AS AT 31/12/1997

On First January 1998, they admit John to bring in 10,000 as capital, the profit and loss sharing ratio is 3:1:1 respectively, old profit and loss sharing ratio 3.2.

The Asset to be revealed.

Freehold = 27,000

Motor cars = 4,000

Office Equipment = 2500

Stock = 3750

Unrecorded liabilities = 500

Creditors’ overcast by 200

Required;

-Journal Entries

                         
  JOURNAL ENTRIES AS AT 1^ST JANUARY, 1998

EXERCISE

Ofwang and Onyango are in partnership sharing Profit and loss equally. They decided to admit Othorong’ong’o on agreement that goodwill will value at Shs.600, 000/= is to be introduced in the books. Othorong’ong’o was required to produce capital equal to that of onyango after he has been credited with his share of goodwill. The new sharing is to be 4:3:3 respectively. The balance sheet before admission of Othorong’ong’o was as follows;

Required

1. Journal Entries for Admission of Othorong’o
   
2. Immediate balance sheet after admission of Othorong’ong’o
   

 

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Solution

                                     JOURNAL ENTRIES

OJWANG, ONYANGO AND OTHORONG’ONG’O STATEMENT OF FINANCIALPOSITION AS AT DATE.

Exercises (NECTA 2002)

1. Polpot and Golberg are in partnership with capitals of Shs 20,000,000 and shs.12, 000,000 respectively. The partnership agreement provided that profits shall be shared and after giving Goldberg a salary of shs 2,240,000 and giving both partner interest on capital at 8 percent annum.

The Net profit for the year was Shs.10, 320,000, Shs.40, 000 is to be written off the Goodwill Account.

Required,

– Write up the Appropriation Account for the years.  

              DR               Profit and Loss Appropriation A/C           CR  

1. Queen and Malkia are in partnership with capital of Tshs.10,000,000 and Tshs 6,000,000 respectively. The partnership agreement provides that profit and losses shall be shared and after giving Malkia a salary of Tshs 1,120,000 and giving both partners interest on capital at 8 percent per annum.
   

   The results for the year show a net loss of Tshs. 1,824,000, sh. 200,000 is to be written off the goodwill a/c.
   

   Required;–
   

 

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• Write up Appropriation account for the year.
  

 

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DR         PROFIT AND LOSS APPROPRIATION ACCOUNT   CR