Intermediate Accounting

COURSE NAME/CODE: INTERMEDIATE ACCOUNTING (BSAF011)

Lecture Notes by Professor Olwor Sunday Nicholas

PhD, JD, MBA, LLM, PGDPAM, BA

Course description;

This course will give students an in-depth study of accounting theory and practice for students who require more than introductory coverage both conceptual and application topics are studied .

Course objectives;

Objectives

1) To prepare accounts and Financial Statements of a business enterprise
2) To record transactions of a manufacturing concern and prepare its accounts
3) To record transactions in royalty, Hire purchase and branch Accounting
4) Prepare royalty accounts, Hire purchase and branch accounts
5) Prepare final accounts with adjustment

Course outline;

- Preparation of accounts
- Presentation of business, partnership and company Accounts
- Receipts and payments Accounts
- Income and expenditure Accounts
- Cash flow statements 10hrs

Manufacturing Accounts

- Introduction
- Elements of costs
- Product cost and period cost
- Stock in trade of a manufacturing firm
- Market value of goods manufactured
- Unrealized profit in stock
- Consignment Accounts
- Insurance Accounts, farm Accounts 14hrs
Departmental Accounts

Departmental Accounts

- Understanding departmentalization
- Preparing departmental accounts

Royalty Accounts

- Definition of royalty
- Royalty Accounts & their purpose 8hrs

Hire purchase Accounts

- Definition of hire purchase transactions
- Distinguishing hire purchase transaction from ordinary sales
- Accounting treatment for hire purchase transaction 8hrs

Branch Accounts

- Definition and types of branches
- Accounting entries for branch accounts
- Principle of markup
- Reconciling current accounts
- Final accounts for organizations with branches 10hrs

Accounting for lease obligations

- Definition of Lease Accounting
- Disclosure requirements
- Accounting entries for lease
- Accounting for sale and lease ball transactions.

10hrs

Total lecture hours 60

Mode of assessments

Course work test 1 20%

Course work test 2 20%

Final exam 60%

PARTNERSHIP ACCOUNTS

INTRODU (I ION

A partnership is an agreement between two or more people who enter into business with a view of earning profits. A partnership may be established formally by means of a partnership agreement/deed or a partnership may be presumed to exist from the actions of the individuals.

A partnership agreement/deed is a written agreement in which the partners among others set out the terms of the partnership. The partnership^ agreement specifies among others;

- The names of the partners
- Capital to be contributed by each partner
- Interest on capital (if any)
- Drawings to; be made by the partners
- Interest on drawings (if any) Salaries paid to active partners
- Nature and kind of business Contractual duties of the partners
- Valuation of goodwill in case of changes in the partnership
- Preparation and auditing of accounts
- Procedure of admission and retirement of partners
- Duration of the partnerships business.

Where no partnership agreement exists, the Partnership Act guides the partners.

Advantages of a Partnership

A partnership is regarded to be the second stage in the evolution of business the first stage being sole proprietorship. The main Advantages enjoyed by the partnership over sole trade include;

- It has access to more capital since up to 20 members may contribute capital towards the partnership business
- It can command a wide range of experience and skills from the partners. The risks are spread across a large number of people
- Easy formation of the partnership business
- The partnership will have a wider network of contacts.

Disadvantages of Partnership

On the other hand, partnerships suffer from the following disadvantages;

- Profits are spread between a number of people
- Dilution of control over the business
- There is a limitation on the number of partner such that the number cannot exceed 20 members
- Disputes may arise amongst the members on such ma
- Risks of implied authority, every partner is liable for the actions of another provided by the principal agency relationship that exists among them
- Unlike a limited company, partnerships always have limited resources and may not be able to undertake large-scale operations
- The members have unlimited liability. In the event of winding up of business and the proceeds from business assets cannot cover the obligations, partners are called upon to raise cash towards the de.bts from their own private source to cover the debts of the partnership.

Characteristics of partnership:

From the above analysis, it can be concluded that partnerships are characterized with;

- Existence of a business with a major objective of making profits
- There must be two or more persons who have mutually agreed to carry on business
- There is always a contractual relationship between members. Only people who have contractual capacity can be partners
- The main objective of the partnership is the profit motive and there must be an agreement to share the profits and losses made using the agreed profit and loss sharing ratios
- The partnership members have unlimited liability that is in the event of the partnership winding up, the partners will be called upon to contribute to the debts incurred (if any) from their own resources.

TYPES OF PARTNERS

Sleeping/ dormant partners:

A sleeping partner is a partner who does not actively participate in the partnership activities. Though he/she doesn't participate in the day to day running of the business he has a right to books of accounts and sharing of profits or losses in the agreed ratios.

Nominal partner:

Is a person whose name is used as if he/she was a member of the firm, but who in reality is not a partner. He is liable to the third parties who give credit to the firm on the strength of his being a partner.

Minor partner:

A minor partner can be admitted to the benefits of the existing partnership with the consent of all the partners. A minor is not personally liable for the debts of the firm but he/she shares in the partnership profits and benefits.

Sub partners:

A partner who gets share of profits of the firm through one of the partners. He/She is not liable against the firm and is not liable to the third parties for the firm's debts.

Partners in profits only:

Is a partner who shares profits only but doesn't share losses. He does not take part hi the management of the business but is liable to third parties who deal with the partnership on that basis.

FINANCIAL STATEMENTS FOR PARTNERSHIPS

The income statement prepared by partnership is similar to that parepared by other businesses except the appropriations account. That is , the trading and profit and loss accounts are the same as those of other business enterprise. However, in addition to the trading, profit and loss account, an appropriation account is prepared as shown in this format

Structure of the income statement

Sales xxx

Less cost of sales

Opening Inventory xxx

Add: Purchase xxx

Goods available for sale xxx

Less : closing Inventory xxx

Cost of sales xxx

Gross profit xxx

Add other incomes xxx

Gross Income xxx

Less expenses total xxx

Profit for the year xxx

Add interest on drawing xxx

Xxx

Less: Interest on capital

A xxx

B xxx

C xxx

Partners salaries-C xxx xxx

Profits to be shared xxx

Share of profits

A XXX

B XXX

C XXX

Note:

- Interest on a loan is a business expense and treated as business expenses in the profit and loss account
- If a partnership gives out a loan in return for interest, the interest received is treated as a miscellaneous income
- If a partner extends a loan to the partnership, interest charges on the loan business expense and charged against the profits.

The balance sheet prepared by partnership is also similar to that of other businesses except the owner’s equity (capital) component as shown below.

Structure of the Balance Sheet

Non Current Asset cost acc. Depn. NBV

Plant xxx xxx xxx

Equipment xxx xxx xxx

Xxx xxx xxx

Current Assets

Inventory xxx

Accounts Receivable xxx

Bank xxx xxx

Total Assets xxx

Current Libilities

Capital Account

X xxx

Y xxx

Z xxx

Current A/cs

X xxx

Y (xxx)

Z xxx xxx

Non- current liabilities

Loan xxx

Current Liabilities xxx

Total Capital and Liabilities xxx

Note:

The negative balance in the current account implies a debit balance whereas a positive balance implies a credit balance.

PARTNERSHIP CAPITAL ACCOUNTS

The capital accounts of partnerships are maintained in a columnar form following either the fixed capital balance method or the fluctuating capital balance method.

Under the fixed capital balance method, the capital account records the partner’s capital contribution only and a current account is opened to record the individual partner’s dealings with partnership

For the fluctuating capital balance method, the capital account record both the individual partner’s dealings with the partnership and their capital contributions. A current account is not maintained.

The two methods can be illustrated as follows;

Fixed capital balance method

CAPITAL ACCOUNT

illustration not visible in this excerpt

Fluctuating capital balance method

CAPITAL ACCOUNTS

illustration not visible in this excerpt

The fixed balance method is preferred since it allows proper and independent monitoring of the capital contribution of the partners and their dealings with the partnership.

The Basic Double Entry records under partnership

In the preparation of the partner's capital and current accounts, the following double entry procedure should be followed;

1. When additional capital is brought into the business

Dr. Bank/Cash/Asset Account Cr. Individual Partner's capital Account

2. When the partners are entitled to interest on capital

Dr. Interest on capital account/Income statement. Cr. Individual Partner's current

Account

3. In case of drawings

Dr. Individual partner Current account

Cr. Bank/Cash Account

4. When partners are charged interest on drawings

Dr. Individual partners current account

Cr. Interest on drawings Account/income statement

5. When partners are entitled to partnership salaries

Dr. Partner’s Salary Account/ Income statement

Cr.Individual Partners Current Account

6. Share of profits made during the year

Dr. Income statement

Cr. Individual Partners Current Account

7. Share of losses Made/ incurred during the year

Dr. Partner’s current account

Cr, Income Statement

Example

Paul and John are in partnership sharing profits and losses in the ratios of 6:4 The following is their trial balance for the year ended 30th June 2007

Paul and John Trial balance for the year ended 30th June 2007

Dr. Cr.

Office equipment cost 13,000

Motor Vehicle cost 18,400

Provision for depreciation

Motor Vehicle 7,360

Office equipment 3,900

Inventory 30.6.2001 49,940

Accounts receivable 41,920

Accounts payable 32,550

Cash at Bank 1,230

Cash at Hand 280

Sales 180,740

Purchases 143,260

Salaries 16,834

Office expenses 2,740

Discounts Allowed 1,126

Current a/c

Paul 2,758

John 2422

Capital A/c4

Paul 54,000

Additional information:

- Closing inventory was valued at shs. 54,
- Office expenses owing was shs
- Provide for depreciation on motor vehicle 20% on cost and office equipment 1 at cost
- Interest on capital is charged at 10%
- Charge interest on drawings Paul shs.360 and John shs. 420

Required

Prepare the final set of Accounts including

a) the Income statement
b) Balance sheet
c) Draw up the capital and current accounts of the partners

PAUL AND JOHN INCOME STATEMENT FOR THE YEAR ENDED 30th June 2007

Sales 180,740

Less cost of sales

Inventory 49,940

Purchases 143,260

193,200

Less closing Inventory 54,680 138,520

Gross profit 42,220

Less operating expenses Salaries 16,834

Office expenses 2,740

Discounts Allowed 1,126

Accrued office expenses 220

Depreciation

Motor vehicles 3,680

Equipment 1,300

25,900

Net Profit 16,320

Add interest on drawings

Paul 360

John 420 780

17,100

Less interest on Capital

Paul 5,400

John 2.400 7,800

Profits to be shared 9,300

CURRENT ACCOUNTS

illustration not visible in this excerpt

PAUL AND JOHN BALANCE SHEET AS AT 30th June 2001

Non Current Assets Cost Accum. Dep. NBV

Motor vehicles 18,400 111,040 7,360

Office equipment 13,000 5,200 7,800

31,400 16,240 15,160

Current assets

Inventory 54,680

Accounts Receivables 41,920

Cash at Bank 1,230

Cash at Hand 280 98,110

Total assets 113,270

Capital and Liabilities

Capital Account

Paul 54,000

John 24,000

78,000

Current Account

Paul 2,378

John 122

Liabilities

Accounts Payables 32,550

Accrued expenses 220 32,770

Total Capital and Liabilities 113,270

COMPANY ACCOUNTS

Introduction

A company represents the third stage in the evolution of business organizations the first two being Sole proprietorship and partnership firms.

It is an association of persons formed for economic gains of its members who contribute money\s worth to a common stock (ordinary shares). It has a right to act as a natural being granted by law.

Essentials Characteristics of a Company

- Voluntary Association- cannot compel a person to become a member nor give up its membership
- Independent legal entity-a company is a legal entity quite distinct and separate from its members. Can own property, enter into contracts, open bank accounts, sue and be sued by its members as well as outsiders
- Perpetual existence- a company has a perpetual succession. The existence of a company can be terminated only by law. Thus members can come and go but the company may go on forever
- Common seal- the directors of the company act as its agents and all acts of the company are authorized by its common seal. The common seal is the official signature of the company
- Limited liability- the liability of the members of a company is generally limited to the extent of the unpaid value of the shares held by them
- Transferability of shares- the shares of a public company are freely transferable. However in the case of private companies they are transferable subject to the restrictions put by the companies Articles of Association.

Advantages of companies

- There is limited liability
- Large capital base because of big membership and their contributions
- Professional management- owners trust the running of the business to managers who are professionals in different fields
- Higher chances of acquiring more funds from loans and debentures because companies can afford collateral security
- They have a legal framework- operate in accordance with the law-Companies Act
- There is continuity of business and perpetual succession of the business
- Shares are freely transferable, more especially in public limited companies.

3.3 Disadvantages of Companies

- Compliance with the companies Act
- Having to comply with all Accounting Standards during the preparation of Financial Statement
- Formation and annual registration costs.

Types of Companies

1. Statutory companies- a company formed by the Act passed either by the central or state legislature. Such companies are governed by their respective Acts and are not required to have ant Articles of Association (AOA) and Memorandum of Association (MO A)

2. Government Companies- a company of which no less than 51% of the paid up capital is held by the central government.

3. Foreign companies- a company which is incorporated outside the country but with a place of business in the country.

4. Registered companies —Companies formed by registration under the companies Act. The working of such companies is regulated by the provisions of the Companies Act, AOA and MOA. Such companies may be limited by share or limited by guarantee or unlimited companies.

- Companies limited by guarantee- a guarantee company in which the liability of its members is limited by the memorandum to such amounts as the members may undertake by memorandum to contribute to meet the deficiency of the assets of the company in the event of its being wound up.

- Unlimited - a company not having any limit on the liability of its members.

5. Private company- a private company is one which by its AOA,

-Restricts the number of members to fifty excluding the past and the present employees of the company who are members of the company.

-Prohibits any invitation of the public to subscribe to its shares or debentures.

-Required to add the words "private limited" at the end of its name.

6 Public company- a company whose AOA does not contain a requisite restrictions to make it a private company. A public company needs a minimum of seven (7) persons for its registration.

Formation of a company

The procedure for the formation of a company, from the time of the idea of . forming a company is first conceive until the company is actually formed and commences business may be divided into three stages;

- Promotion
- Incorporation
- Commencement of business

Promotion

This is the stage of conceiving the idea and its working up. The person involved in this task is termed a promoter.

Incorporation

This is the stage which brings the company into existence. It involves;

- Ascertainment of the availability of the proposed name of the company.
- Application for a license
- Securities and exchange board / committee approval to draft prospectus (this applies where the company proposes to raise capital by issue of shares or debentures to the general public)
- Preparation of the Memorandum of Association. This defines the company's constitution and objectives, lays down the fundamental conditions upon which the company is allowed to be formed. The MOA must have the following clauses.

- Name clause
- Object clause
- Liability clause
- Capital Clause
- Association clause

-Preparation of the Articles of Association-AOA are regulations and by­laws governing the internal affairs of the company. A public limited company may either have its own articles or. may accept to use schedule 1 of the companies Act. In case the company does not file its own articles it is presumed that is has adopted Table A for its articles.

-Preparation of the prospectus- a document inviting deposits from the public or offers from the public to subscribe to the shares or debentures of the company. The prospectus contains information about;

- The objectives of the company
- Past history and future prospects
- Managerial personnel
- Amount of minimum subscription

Fixation of underwriter, brokers, solicitors and auditors.

In addition to the above preliminary steps the promoters will have to take the following steps to get the company incorporated

- Filling the necessary documents
- Payment of the necessary fees
- Obtaining of the certificate of incorporation
- The promoters should file the following documents with the required fees to the registrar of companies
- Memorandum of Association (MOA)
- Articles of Association (AO A)
- A list of persons who have consented to become directors of the company
- A written consent by the directors to act as directors and written undertaking to take up and pay for the shares
- Notice of address of the registered office.

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