Final Accounts Preparation Flashcards
The Partnership Act of 1890 defines a partnership as….
The relation which subsists between partners carrying on a business in common with a view of profit
A partnership is usually made up of how many members?
Between 2 - 20 members with the exceptions being larger professional business such as solicitors or accountant which are usually formed as a limited liability partnership (LLP)
The accounting requirements of a partnership are either…
To follow the rules set out in the Partnership Act of 1890
Or - and more likely - for the partners to agree amongst themselves, by means of a partnership agreement
What type of financial statements does a partnership prepare?
The same as a sole trader so
Statement of Profit or Loss
Statement of Financial Position
With the addition of a Partnership Appropriation Account which immediately follows after the statement of profit or loss
What is the purpose of a Partnership Appropriation Account?
The purpose is to show how the profit or loss from the statement of profit or loss is shared amongst the partners.
A partnership agreement will usually cover the following 4 main points….
- Division of profits and losses between partners (which may be expressed as a ratio, fraction or percentage)
- Partner’s salaries/commission
- Whether interest is allowed on partner’s capital and at what rate
- If interest is to charged on partner’s drawings and at what rate
What are the two factors that a Partnership’s SoFP would be understated?
Faithful Representation
Goodwill
Why would faithful representation of a partnership accounts cause the SoFP to be understated?
If there is doubt over the value of an asset, they will usually be stated at the lower figure, but without bias
What is the definition of Goodwill?
The difference between the value of a business as a whole, and the net value of its separate assets and liabilities.
Goodwill has a value as an intangible non-current asset to the owners/owners of the going concern business.
Why would goodwill cause a partnership’s SoFP to be understated?
a going concern business will often have a value of goodwill due the various factors e.g trading relationships build up with long standing customers, the reputation of the business, location of the business or the skills of its employees. Without these factors the business would be find it difficult to continue to trade.
Why would a partnership need to look at the valuation of goodwill?
If the partnership is being sold, the goodwill will need to be valued most commonly by looking at the average profit of the business over a given number of years then multiplied by a an agreed figure. If there is an admission of a new partner or retirement of a partner.
What is premium for goodwill?
An amount charged to a new partner who joins an existing partnership.
What are the steps (in terms of goodwill) for the admission of a new partner?
- Agree a valuation for goodwill
- Old partners: Goodwill Created (DEBIT goodwill account with the amount of goodwill/CREDIT partners’ capital account (in the old profit sharing ratio) with the amount of goodwill)
- Old partners + new partner : goodwill written off (DEBIT partners’ capital accounts (in the new profit sharing ratio) / CREDIT goodwill account
This is too charge the new partner with a premium for goodwill
Why do we charge new partners a premium for goodwill?
This is because the new partner will start to share in the profits of the business immediately and will benefit from the goodwill already established by the existing partners.
The premium for goodwill is an additional amount paid by the new partner to compensate to the old partners for the part of profit taken up by them.
What are the steps (in terms of goodwill) for the retirement of a partner?
- Agree a valuation for goodwill
- Old partners : goodwill created (DEBIT goodwill account / CREDIT partner’s capital accounts (in the old profit sharing ratio)
- Remaining Partner’s : goodwill written off (DEBIT Partners’ capital accounts (in the new profit sharing ratio) / CREDIT goodwill account)
What happens (financially) when a partner retires from the business?
The amount of goodwill (which is due to the partner that was built up whilst they worked for the business) plus the balances in the retiring partners capital and current accounts is the paid to the partner from the business bank account (usually if there are insufficient fund to do so the retiring partner will keep some money in the business as a ‘loan’ which is then paid off over a period of time)
Why would there be a need to change the profit sharing ratios within a going concern partnership?
It might be necessary to change the ratios due to a number of factors which include a higher capital contribution in relation to the other partners or a partner takes a more active role within the business, the profit sharing ratios would then need to be adjusted accordingly (the same will also be true for the reverse i.e less capital contribution or a partner taking a step back in the day to day running of the business.)
What is the Cost of Sales calculation
Opening inventory
PLUS purchases
LESS purchases returns
LESS closing inventory
EQUAL cost of sales
What are the debit and credit entries on the SoPL for the cost of sales (if the cost of sales hadn’t already been calculated)
DEBIT
Opening Inventory
DEBIT
Purchases
CREDIT
Purchases Returns
CREDIT
Closing Inventory
If the Cost of Sales had already been calculated at the year end would it be showing as a debit or credit entry?
Debit
Is the closing inventory figure shown as a CREDIT or DEBIT balance on the SoFP
DEBIT - because it is shown as an asset on the SoFP
What is the definition of unlimited liability
Unlimited liability means that should a business become insolvent, the personal assets of the owner(s) may be used to pay the debts of the business
What is the definition of incorporated?
A business that has now formed into a legal corporation
What is the definition of a corporation?
A corporation is a legal entity that is separate and distinct from its owners
