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CHANGES IN PARTNERSHIP

CHANGES IN PARTNERSHIP. Changes in partnership’s structures. Typical events that requires special treatment and may change the partnership structures: Change in profit sharing ratio Admission of new partners Death or retirement of existing partner. CHANGE IN PROFIT SHARING RATIO. Due to:

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CHANGES IN PARTNERSHIP

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  1. CHANGES IN PARTNERSHIP

  2. Changes in partnership’s structures Typical events that requires special treatment and may change the partnership structures: Change in profit sharing ratio Admission of new partners Death or retirement of existing partner

  3. CHANGE IN PROFIT SHARING RATIO Due to: • Changes in capital contribution • Changes in partner’s skills and ability • A partner may now be doing much more for the business than in the past Adjustment need to be done: • Profits distribution must be made on monthly basis. • expenses distributed on monthly basis. • Distribute gross profits based on: • level of profit or • Monthly basis

  4. Partnership MSY Profits and loss account for the year ended 31 December 2001 RM RM Sales 50,000 (-) Cost of sales (20,000) 30,000 Less: sales and distribution expenses 8,000 administrative expenses 6,00014,000 16,000 Example Mazlan, Saiful dan Yassin are in partnership sharing profits and losses in the ratio of 2:2:1. Below are financial statements for the business at 31 December 2001 On 1 July 2001, they agreed to make the following changes in partnership agreement: Profits sharing ratio was changed to 3:2:1 Mazlan will received salary RM3,000 per year Sales up to 30 June 2001 amounted RM20,000 Shows a Profits and loss Appropriation Account for the year ended 31 Dec 2001

  5. 1.1.01 – 30.6.01 1.7.01 – 31.12.01 Sales 20,000 30,000 Less: cost of sales (8,000) (12,000) 12,000 18,000 Less: Sales exp. (3,200) (4,800) Admn. Exp. (3,000) (3,000) Net Profits 5,800 10,200 step 1: Partnership MSY Profits and loss account for the month ended 1.1.01 – 30.6.01 and 1.7.01 – 31.12.01

  6. 1.1.01 – 30.6.01 1.7.01 – 31.12.01 Net Profits 5,800 10,200 Less: Salary- Mazlan - 1,500 Profits to be shared 5,800 8,700 Profits sharing: Ratio (2:2:1) Ratio(3:2:1) Mazlan 2,320 4,350 Saiful 2,320 2,900 Yassin 1,160 1,450 5,800 8,700 Step 2: MSY Partnership Profit and loss Appropriation Account for the month ended 1.1.01 – 30.6.01 and 1.7.01 – 31.12.01

  7. ADMISSION AND RETIREMENTthis changes will lead to : Revaluation of Assets Revaluation of Goodwill Actions should be taken BEFORE accounting for changes (ie. Before admitting new partner or before a partner retire or before using the new ratio) to avoid inequitable state of affairsTO OLD PARTNER (some get more and some get less then they should)

  8. Revaluation of Assets Why do we revalue : Amount charged as depreciation every year can only be an approximation If no changes in composition of partnership, this basis of revaluing assets is satisfactory When changes occur, it becomes necessary to revalue the assets Assets revaluation: Comparing the book value of assets with market value of the assets.

  9. Accounting for revaluation Open Revaluation Account Revaluation a/c : Item to be recorded in revaluation account Increase and decrease in assets any expenses or revenue that are not yet recorded

  10. Revaluation a/c : in value in value (Dt Revaluation Cr Assets ) xxx (Dt Assets Cr Revaluation) Xxx Unrecorded expenses xxx unrecorded revenue Xxx Bal – Profit on Revaluation xxx Bal – Loss on revaluation xxx ( Dt Revaluation Cr Capital a/c) ( Dt Capital a/c Cr Revaluation )

  11. Partnership MSY Balance Sheet as at 31 December 2001 Premises at cost 6,500 Fixtures at cost 1,500 8,000 Stock 2,000 Debtors 1,200 Bank 8004,000 12,000 Capital : M 7,000 S 5,000 12,000 Example: Following is the balance sheet as at 31 Dec 2001 of M and S who shared profits and losses in the ratio M two third; S one-third. From 1 January 2002 the profit and losses sharing ratio are to be altered to M one-half; S one-half. The asset was revaluated on 1 July to be: Premises RM9,000 Fixtures RM1,100 Other assets remained at the same values.

  12. Revaluation a/c : in value in value Fixtures 400 Premises 2,500 Gain in revaluation: capital a/c - M capital a/c - S 1,400 700 2,500 2,500

  13. Balance sheet after revaluation of asset Partnership MSY Balance Sheet as at 31 December 2001 Premises 9,000 Fixtures 1,100 10,100 Stock 2,000 Debtors 1,200 Bank 8004,000 14,100 Capital : M 8,400 S 5,70014,100

  14. Revaluation of goodwill Goodwill (MASB ED 28) What is? Difference between the value of the business as a whole and the sum of the values of the identifiable assets less the sum of its liabilities (value of net assets) Ability to earn profits in the future

  15. Value of business 50000 Assets 34000 Liabilities 12000 (Net assets) 22000 Goodwill 28000 Usually when the business is sold: purchased goodwill Badwill – negative goodwill Example:

  16. Factors that may bring about the existence of goodwill Personal characteristics of the owner (charm, relationship with customers, tact etc.) Quality of goods Location of premises The possession of near-monopoly rights Value of labour force, management skills Cost of the research and development that make it more efficient to run the business anything that could make customers/clients keep coming back to do business with us

  17. Goodwill should be valued before making changes in partnership structures (example admitting new partner) and should be recorded in old partners’ capital a/c. However, goodwill should be eliminated immediately after the changes in partnership structure (admitting the new partner.)

  18. Accounting for goodwill 2 methods: open goodwill a/c adjustment made without goodwill a/c

  19. Dr goodwill a/c Cr partners capital’ account (using the old profit sharing ratio) Method 1: GOODWILL ACCOUNT OPENED Steps to be taken: • Open a goodwill account • Shared goodwill using the old ratio • Entry to be made:

  20. Goodwill and change in ratio Change in ratio may be due to change in contribution of partners in terms of skills or efforts Reduce – ill health, old age, busy elsewhere Increase – increase in skills, education, time contributed

  21. Example ABY are in partnership sharing profits and losses in the ratio 3:2:1 respectively. From 1 Jan. 2003 they agreed to amend the profit sharing ratio to 1:2:3 and goodwill should be valued at the amount of RM12,000. Below is the balance sheet taken as at 31 Dec. 2002 before the changes was made. Balance Sheet as at 31 December 2002 Asset 100,000 100,000 Liability 30,000 Capital a/c; A 30,000 B 20,000 Y 20,000 70,000 100,000

  22. Dr goodwill a/c 12,000 Cr capital a/c- A 6,000 capital a/c- B 4,000 capital a/c -Y 2,000 A B Y A B Y Bal b/d 30,000 20,000 20,000 Bal. c/d 36,000 24,000 22,000 goodwill 6,000 4,000 2,000 36,000 24,000 22,000 36,000 24,000 22,000 Journal entry: Open goodwill account Capital account

  23. Balance Sheet as at 1 January 2003 Goodwill 12,000 Asset 100,000 112,000 Liability 30,000 Capital a/c; A 36,000 B 24,000 Y 22,000 82,000 112,000 • Usually goodwill account is not shown in Balance Sheet (BS) • After the changes in partnership structure, adjustment of goodwill is made by closing the account to partners’ capital account using the new ratio (method 2)

  24. Dr goodwill a/c Cr partners capital’ account (using the old profit sharing ratio) Dr partners capital’ account (using the old profit sharing ratio) Cr goodwill account Method 2: GOODWILL ACCOUNT NOT OPENED Steps to be taken: • Open a goodwill account • Shared goodwill using the old ratio • Entry to be made: • After changes in partnership structure: • Close goodwill account by debiting partners capital’ account (using the new profit sharing ratio)

  25. Dr goodwill a/c 12,000 Cr capital a/c- A 6,000 capital a/c- B 4,000 capital a/c -Y 2,000 Dr capital a/c- A 2,000 capital a/c- B 4,000 capital a/c -Y 6,000 Cr goodwill a/c 12,000 Journal entry: Open goodwill account • Close goodwill a/c • After changes in profit sharing ratio (new ratio 1:2:3)

  26. A B Y A B Y Goodwill (ii) 2,000 4,000 6,000 Bal b/d 30,000 20,000 20,000 Bal. c/d 34,000 20,000 16,000 Goodwill (i) 6,000 4,000 2,000 36,000 24,000 22,000 36,000 24,000 22,000 Capital account

  27. Balance Sheet as at 1 January 2003 Asset 100,000 100,000 Liability 30,000 Capital a/c; A 34,000 B 20,000 Y 16,000 70,000 100,000 Balance sheet after closing the goodwill account **note that the goodwill account is no longer in balance sheet after the changes

  28. Before After gain / loss Action required A (3/6) 6,000 1/6 2,000 loss 4,000 Credit Capital a/c - A B (2/6) 4,000 2/6 4,000 - - - Y (1/6) 2,000 3/6 6,000 Gain 4,000 Debit Capital a/c-Y Method 2 can be summarized using the table below: Schedule A: before and after adjustment of goodwill

  29. A B Y A B Y goodwill 4,000 Bal b/d 30,000 20,000 20,000 Bal. c/d 34,000 20,000 16,000 goodwill 4,000 34,000 20,000 20,000 34,000 20,000 20,000 Balance Sheet as at 31 December 2002 Asset 100,000 100,000 Liability 30,000 Capital a/c; A 30,000 B 20,000 Y 20,00070,000 100,000 Balance Sheet as at 1 January 2003 Asset 100,000 100,000 Liability 30,000 Capital a/c; A 34,000 B 20,000 Y 16,00070,000 100,000 Capital account After Before

  30. ADMISSION OF NEW PARTNER Procedures to be taken: Revaluation of Assets Revaluation of goodwill

  31. You sre required to prepare: • Revaluation account • Related assets account being revaluated • Partners’ capital account Example: Jati and Cengal are partners sharing profit with ratio 2:1 respectively. In Jan 2003 Meranti is admitted as a new partners. They agreed to make the following adjustment: • The three partners will share profits and losses one-third each. • Revaluation of asset: • Land RM 90,000 • Furnitures RM 11,000 • Other assets remained at the same value • Total goodwill is valued at RM30,000 • Below is balance sheet as at 31 Dec 2002

  32. Jati dan Cengal Partnership Balance Sheet as at 31 December 2002 Fixed asset Capital a/c Land 65,000 Jati 70,000 Furniture 15,000 Cengal 50,000 Current assets Stock 20,000 Debtors 12,000 Bank 8,000 120,000120,000

  33. Answer

  34. Goodwill and admission of new partner New partner will pay cash (premium) in addition to capital) for the share of future goodwill and recompense the old partners for giving the rights to the new partner. 3 ways of paying for that premium: Payment made privately to old partners - no entries needed Cash paid into the business but will then paid out immediately Cash paid into the business and retained for the use of the business.

  35. Example; Siti and Dayang are partners sharing profits and losses equally. The agreed to accept Ziana as a new partners. Ziana is required to brought in RM 50,000 as capital and paid premium RM30,000. Shows the relevant journal entry: Situation a: • Payment made privately to old partners - no entries needed to record the premium Debit Cash/Bank RM50,000 Credit Capital a/c- Ziana RM50,000

  36. Situation b • Cash paid into the business but will then paid out immediately Debit Cash/bank RM80,000 Credit capital a/c – Siti RM15,000 Dayang RM15,000 Ziana RM50,000 (payment made to business) Debit capital a/c– Siti RM15,000 - Dayang RM15,000 Credit Cash/bank RM30,000 (Payment of premium made to old partners)

  37. Debit Cash/bank RM80,000 Credit capital a/c – Siti RM15,000 Dayang RM15,000 Ziana RM50,000 (payment made to business) Situation c • Cash paid into the business and retained for the use of the business.

  38. Exercise: admission of new partner

  39. RETIREMENT OF PARTNER

  40. Retirement due to: • death • Illnes • Retiring partner has interest in the firm that need to be accounted for • Share of profits • Revaluation of assets • Goodwill • Steps to be taken: • Revaluation of assets • Revaluation of goodwill • Recognition of unrecorded liability • Current a/c and all retiring or dead partner’s associated a/cs will be credited to Capital a/c. • Method of payment to retiring partner

  41. Putera, Muda and Azan Balance sheet as at 31 December 2002 Asset:capital a/c land 300,000 Putera 150,000 equipment 250,000 Muda 180,000 furniture 150,000 Azan 120,000 Stock 50,000 Bank 10,000 Current a/c Putera 55,000 Liabiliti Muda 75,000 Creditors (150,000) Azan 30,000 610,000610,000 Example Putera, Muda and Azan are partners, sharing profits and losses in ratio 3:2:1. On 1 January 2003, due to certain reasons Muda wants to retire from the partnership. Balance sheet as at 31 Dec 2002 are as follow:

  42. It was agreed before retirement that the business assets being revaluated: RM land 450,000 equipment 300,000 furniture 80,000 Stock 60,000 goodwill 90,000 After Muda’s retirement, Putera and Azan will share profits and losses equally. Required to prepare: Ledger a/c to shows the retirement of Muda if: a. goodwill account was opened b. goodwill account was not opened 2. Balance sheet after retirement but before payment was made to retiring partner under method (a) and (b)

  43. Answer Open revaluation a/c Opened goodwill a/c Open capital and current a/c Closed current a/c of retiring partners to capital a/c

  44. revaluation a/c furniture 70,000 land 150,000 Equipment 50,000 Stock 10,000 Gain from Revaluation: Putera 70,000 Muda 46,667 Azan 23,333140,000 210,000210,000

  45. a) Goodwill account was opened Goodwill a/c Capital a/c: Baki h/b 90,000 Putera 45,000 Muda 30,000 Azan 15,000 90,000 90,000

  46. Putera Muda Azan Putera Muda Azan Bal c/d 265,000 331,677 158,300 Bal b/d 150,000 180,000 120,000 Goodwill 45,000 30,000 15,000 Gain from revaluation 70,000 46,667 23,333 Current a/c - 75,000 - 265,000 331,667 158,833 265,000 331,667 158,833 Putera Muda Azan Putera Muda Azan Capital a/c - 75,000 - Bal b/d 55,000 75,000 30,000 Bal.c/d 55,000 - 30,000 55,000 75,000 30,000 55,000 75,000 30,000 Capital a/c Current a/c

  47. Putera, Muda and Azan Balance sheet as at 31 December 2002 Asset:Capital a/c Land 450,000 Putera 265,000 Equipment 300,000 Muda 331,667 Furniture 80,000 Azan 158,333 Goodwill 90,000 Current assets: Stock 60,000 Bank 10,000 Current a/c Putera 55,000 Liability Azan 30,000 Creditors (150,000) 840,000840,000

  48. b) Goodwill account was not opened Goodwill a/c Capital a/c: Capital a/c Putera 45,000 Putera 45,000 Muda 30,000 Muda 45,000 Azan 15,000 90,000 90,000

  49. Putera Muda Azan Putera Muda Azan Goodwill 45,000 - 45,000 Bal b/d 150,000 180,000 120,000 Bal c/d 220,000 331,677 113,333 Goodwill 45,000 30,000 15,000 Gain from revaluation 70,000 46,667 23,333 Current a/c - 75,000 - 265,000 331,667 158,833 265,000 331,667 158,833 Putera Muda Azan Putera Muda Azan Capital a/c - 75,000 - Bal b/d 55,000 75,000 30,000 Bal.c/d 55,000 - 30,000 55,000 75,000 30,000 55,000 75,000 30,000 Capital a/c Current a/c

  50. Putera, Muda and Azan Balance sheet as at 31 December 2002 Asset:Capital a/c Land 450,000 Putera 220,000 Equipment 300,000 Muda 331,667 Furniture 80,000 Azan 113,333 Current assets: Stock 60,000 Bank 10,000 Current a/c Putera 55,000 Liability Azan 30,000 Creditors (150,000) 750,000750,000

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