ACCOUNTING Financial and Organisational Decision Making

ACCOUNTINGFinancial and Organisational Decision Making Chapter 8 The principle applied: owners’ equity Slides written and designed by Tony Van Eekelen

Learning Objectives • In this chapter you will be introduced to : • the formation of a partnership • how to appropriate profits among partners • the report of appropriations for both a partnership and a company • the difference between the financial statements of a partnership and those of a sole trader • how to account for the admission of a new partner, and the dissolution and liquidation of a partnership

Learning Objectives • The meaning of “goodwill” • how to apply the basics of partnership liquidation to various situations, such as the selling of the partnership as a going concern. • The characteristics of a company • the advantages and disadvantages of companies when compared with partnerships

Learning Objectives • the incorporation of companies • the take-over of an existing business by a company • the issue of shares by instalments • how to account for income tax expense, payment of dividends and transfers to reserves

Formation of partnerships • A partnership is defined by the Partnership Act, as the relationship that “subsists between persons carrying on a business with a view to profit”

Formation of partnerships • Reasons for a partnership • basic motivation is mutual advantage • the pooling of capital and skills • being able to raise more capital • Formation is easy • maybe formed verbally • no need for partnership agreement but is advisable • Partnership Act covers distribution of profits

Partnership Agreement • An agreement should cover • name and addresses of partners • business name • purpose of business • profit/loss distribution • investment and withdrawal of funds • admission of new partners and • provisions for dissolution of the partnership

Formation Example • On 1 January X7, B Bart and A Arty decided to start a business as a partnership. Bart contributes the following: cash $2,000, equipment $5,600 and a motor vehicle of $12,400. Arty contributed $20,000 cash.

Formation entries Date Accounts Dr Cr. 1/1/X7 Cash 2,000 Equipment 5,600 Motor vehicle 12,400 Capital:Bart 20,000 (capital contribution) 1/1/X7 Cash 20,000 Capital: Arty 20,000 (capital contribution)

Appropriation of Profits • Profit and losses are distributes as per the agreement or as the Act states equally. • Ways of distributing the profits comes in many forms, such as • salaries • interest on advances • interest on capital

Appropriation of Profits • Note: all remuneration, whether salary, interest or shared profits is classified as a withdrawal and not a business expense.

Example • Bart and Arty share profits as follows: Bart Arty • Salaries $50,000 $30,000 • Interest on capital 5% p.a. 5% p.a. • Share of profits 60% 40% • At the end of the period, the relevant balances were: • capital $120,000 Cr $80,000 Cr • current $60,000 Dr $34,000 Dr • Profit and loss summary $210,000 Cr

Appropriation statement Appropriation Statement as at 30 June X7 Net Profit $210,000 Less Appropriations Salaries - Bart $50,000 - Arty $30,000 $80,000 Interest - Bart $6,000 -Arty $4,000 $10,000 $90,000 $120,000 Profit Share - Bart (60%) $72,000 - Arty (40%) $48,000 $120,000 $120,000

Admission of a new partner • In some cases an existing partnership may admit a new partner to the partnership. • This will effectively start a new partnership, and gives the partners the opportunity to revalue the existing assets to their fair market value.

Admission of a new partner • Goodwill can also be recognise at this point • the goodwill could be for • an establish reputation, • special skills • competent and loyal employees • can be difficult to value • Note: the revaluing of assets and the goodwill can be enter as the partnership is new

Dissolution of the partnership • A partnership may dissolve • if a partner retires, dies or is bankrupt • if the partnership is unable to continue to conduct business, or • if the partnership wishes to become a company

Dissolution of the partnership • How to dissolve: • The assets might be sold in the normal way and the liabilities paid from the proceeds • One of the partners might continue with the business alone, by buying the partnership assets and taking over the liabilities • The partnership business might be sold as a going concern to another party or to a company incorporated for that purpose

Dissolving a partnership • There are certain steps that need to be performed when dissolving a partnership. 1. Closing entries • Close all temporary accounts to the profit and loss summary account, then to the appropriation account and to the capital and current accounts. 2. Transfer of assets to realisation account • Close sold assets to the realisation account

Dissolving a partnership 3. Proceeds of realisation of assets • Enter the proceeds from sale of assets into the realisation account and cash account. 4. Expenses of realisation • Close any expenses incurred during the realisation process to the realisation account. 5. Apportion of loss on realisation between the partners. • Close any gain or loss from sale to the current accounts

Dissolving a partnership 6. Repayment of liabilities and partners’ advances • Pay the liabilities and any partner loans to the partnership 7. Transfer of current to capital accounts • Close current account to capital accounts 8. Repayment of capital • Repay the capital accounts from the cash.

Companies • Characteristics of a company: • limited liability of shareholders • shareholders are liable for any unpaid portion of the issue price of their shares. • Perpetual succession and transferability of shares • companies continue indefinitely and ownership is easily transferred via units known as shares

Companies • Characteristics of a company: • Raising additional finance • may issue more share and debenture to raise funds • Ownership and management • controlled by shareholders and can elect directors to run organisation on their behalf • Tax savings advantages • In some cases certain company structures have tax advantages

Contracts with resource providers • Debt • involves a credit relationship • Public companies can issue debenture or unsecured notes • Debentures are issued securities which are secured be a claim over the assets. Interest is paid to the holder at interval and at maturity the face value to repaid. • Unsecured notes are similar to debentures but are not secured against assets.

Contracts with resource providers • Equity • consists of share capital, retained profits and reserves. • Share capital maybe divided into different share classes; ie different voting rights… • Hybrids • some instruments have the characteristics of both debt and equity eg preference shares • The appropriate mix • the appropriate mix of debt and equity depends upon two factors financial and business risk (chapter 11)

Company share issues • In the past, company shares would have a par value, however, this has now been removed. This has also removed the concept of a premium which was when a company issued shares at a value greater than there par value. • Recording of share issues using the Australasian method has become less appropriate. • Transferring ownership • The Issuer Sponsored Holding statement has replace share certificates. This systems is a part of the CHESS system

Company formation • The steps to form a company from an accounting perspective are: • promoters buy initial shares at registration • any formation costs are paid to promoters and solicitors • any existing assets & liabilities that are taken over, can be revalued at their fair market value • any difference between the consideration and the value of the assets is known as goodwill

Appropriation of profits • Unlike a sole trader and a partnership, a company does not have to distribute its profits. Any unappropriated profits can be used by the company as a source of funds for future expansion. • Thus in the owners’ equity section of a company a new account exist called retained profits.

Example of appropriation • The balance in the profit and loss summary before tax is $200,000. • A company pays taxation as it is a separate legal entity. • The taxation payable is $86,000. • A final dividend of $20,000 is allowed for. • Transfer $30,000 to the general reserve.

Example Accounts Dr Cr. Income tax expense $86,000 Taxation Payable $86,000 (Adjustment for taxation) Profit and loss Summary $114,000 Retained Profits $114,000 (Transfer of net profit) Retained profits $50,000 General reserve $20,000 Final Dividend payable $30,000 (appropriation of profits)

Future aspects of share issues • Reserves created form retained profits such as the general reserve is known as a revenue reserves. • Dividends can be paid from these reserves. • The dividends may come in the form of cash or a bonus share issued. • A bonus share issue is where the shareholders receive free shares based upon the existing holdings.

Issuing shares by instalments • Shares can be issued where the payment is by instalment. • The payments can be three stages: • Application • an amount due with the application for shares • Allotment • A payment due when the shares are formally allotted to applicants • Calls • Amounts due when they are called for by the company

Journal entries for instalment payments • Issue of Prospectus • No journal entries as no transaction has taken place. • Receipt of Application • Any application moneys received must be placed in a trust account. Account Dr Cr Cash trust xxxx Application xxxx

Journal entries for instalment payments • Allotment of shares • Shares are allotted and the application money is transferred from the trust account to the company cash account Account Dr Cr Application xxxx Paid-up capital xxxx Cash at Bank xxxx Cash trust xxxx

Journal entries for instalment payments • Call on shares and receipt of call Account Dr Cr Call No 1 xxxx Paid-up capital xxxx (call of $0.40 made on shares) Cash at Bank xxxx Call No 1 xxxx (call monies received in full)

ACCOUNTING Financial and Organisational Decision Making