accounting topics 8-11 2014

Study Guide 13-B.4 Accounting

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ACCOUNTING

Study Guide 13-B4

UNITS 8-11 (2014 VERSION 1)



CONTENTS:

CONTENTS:

UNITS 8-11

Chapter Unit Title Page

1 8 Conceptual Basis 3

2 9 Inventory 13

3 10 Partnerships 17

4 11 Companies 29



Chapter 1

Unit 8: Conceptual Basis

Contents 8.1 The New Zealand Framework

8.2 Accounting Assumptions

8.3 Qualitative Characteristics of Accounting Information

8.4 Statutory Compliance

8.5 Financial Reporting Standards

8.1 The New Zealand Framework

The NZ Framework sets out the concepts that underlie the preparation and presentation of financial statements by entities that are required to prepare general purpose financial statements that comply with generally accepted accounting practice in New Zealand. (NZ GAAP) The purpose of the New Zealand Framework is to give accountants principles to follow when preparing financial reports.

Key Concepts:

Accrual Basis: the effects of transactions and other events are recognised when they occur and are reported in the financial statements of the periods to which they relate.

Matching Costs with Income Concept: The profit is determined by matching the expenses incurred against the income earned in a reporting period.

Monetary Measurement Concept: All transactions, assets, liabilities, income, expenses, and equity are recorded in a common dollar unit such as the $NZ.

THE NEW ZEALAND FRAMEWORK

ELEMENTS:

Assets

Liabilities

Equity

Income

Expenses

FUNDAMENTAL

QUALITATIVE

CHARACTERISTICS

Relevance

Faithful representation

Recognition Measurement

Historical Cost Fair Value

Enhancing QCs

Comparability

Verifiability

Timeliness

Understandability

Present Value

Assumptions

Explicit: Going Concern

Implicit Periodicity



Elements:

THE NEW ZEALAND FRAMEWORK ELEMENTS

Assets

are resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. eg premises.

Liabilities

are present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. eg Loan.

Equity is the residual interest in the assets of the entity after deduction of its liabilities.

Income

is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. eg Sales, fees.

Expenses

are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity other than those relating to distributions to equity participants. eg. Wages.

ESSENTIAL CHARACTERISTICS OF ACCOUNTING ELEMENTS

Assets Past transaction

Present control (can use freely and deny others from its use)

Future economic benefit or service potential

Liabilities Past transaction

Present obligation to pay

Future outflow of resources embodying economic benefit

Equity Equity equals total assets less total liabilities

Residual interest, ranking after liabilities in claims to the assets of the business.

Income Increase in equity

Increase in assets or reduction in liabilities

Does not include contributions from the owner

Expenses Decrease in equity

Reductions in assets or increases in liabilities

Does not result from drawings

Before an asset can be recognised:

it must be probable that any future economic benefit associated with the asset will flow to the entity.

the asset must have a cost or other value which can be measured with reliability. Students should be aware that recognition criteria is essential for each element.



8.2 ACCOUNTING ASSUMPTIONS

(a) Explicit:

Going Concern: Financial reports are normally prepared on the assumption that the entity will continue

in its present operations into the foreseeable future. It is assumed that the entity does not plan to closed down. Assets are therefore valued at their worth to the business as a going concern, not at their liquidation value. They are recorded at their historical cost less accumulated depreciation, not at their market price.

If the entity is intending to close or change shape, the going concern assumption is no longer valid. Non-current assets would then be valued at current market value or the agreed value of the purchaser.

(b) Implicit: Periodicity: The life of the entity can be divided into equal time periods.

8.3 Key Concept:

(a) Accrual Basis: The effects of transactions and other events are recognised when they occur and are reported in the financial statements of the periods to which they relate.

(b) Monetary Measurement Concept: All transactions, assets, liabilities, income, expenses, and equity are recorded in a common dollar unit such as the $NZ.

8.4 QUALITATIVE CHARACTERISTICS:

Relevance Information which is capable of making a difference in the decisions made by users. To be relevant information must have predictive value and/or confirmatory value.

Materiality

Information disclosed is governed by relevance. Materiality becomes a guideline helping the accountant to determine if the nature or amount of an item requires separate disclosure. An item should be shown separately if its amount or nature is significant enough to change users’ decisions. Materiality is an entity-specific aspect of relevance based on nature or magnitude (or both) of the items to which the information relates in the context of an individual entity’s financial report.

Faithful

Representation

Information which a reader sees as matching the underlying transaction or event. For example, a source document shows that information is reliable because the information is faithfully

represented. The underlying characteristics of completeness,

neutrality and freedom from error help financial information to faithfully represent the event that has occurred.

Completeness Information in the financial statements must be complete within the bounds of materiality and cost and this information should be able to faithfully represent the business event.

Neutrality Information which has not been prepared in such a way as to influence a decision is likely to faithfully represent the business event.

Freedom from error

Accurate information is likely to faithfully represent the event.



8.5 Enhancing Qualitative Characteristics:

Comparability Information about a reporting entity is more useful if it can be compared with a similar information about other entities and with similar information about the same entity for another period or another date. Comparability enables users to identify and understand similarities in, and differences among items. Consistency is the means of achieving comparability.

Verifiability Verifiability means that different knowledgeable and independent observers could reach agreement.

Timeliness

Timeliness means that information is available to decision-makers in time to be capable of influencing their decisions.

Understandability

Classifying and presenting information clearly and concisely makes it understandable to a business user.

NZCETA Level 2 2006 Practice Exam

QUESTION 1: (a) Ashleigh is disturbed to see that Becky has included her personal motor vehicle in the

financial statements for her firm. State the accounting concept that has NOT been followed here.

(b) Define the accounting concept that you identified in question two (a) above.

(c) Ashleigh is also concerned that Becky has recorded her library of law books at their cost

price of $5000 Australian Dollars. She believes that this breaches the Monetary

Measurement Concept. Define the Monetary Measurement Concept for Becky.

(d) Define the going concern concept.

To help her decide whether Becky should expand her business, Ashleigh searches through the pile of paperwork on her desk and obtains a copy of the Balance Sheet for Becky’s existing business. Becky has tried to save some money by preparing the statements herself.



QUESTION Two

(a) Define depreciation

(b) Explain WHY interest expense is classified as a Finance Cost in the Income Statement.

According to the Summary of Significant Accounting Policies, business equipment is

depreciated using the Reducing Balance Method.

(c) Explain WHY the Reducing Balance method has been used to depreciate the business

equipment.

(d) Write a paragraph to explain to Becky why a loan from a bank to finance business

expansion is a liability. (Mid-Course January/April 2007)

Becky’s Financial Reports makes reference to depreciation. Becky is confused and decides she will ask Ashleigh about it.



QUESTION THREE

(a) Define Income

(b) Using the essential characteristics of an expense, explain WHY insurance is listed in the

Income Statement as an expense.

(c) Comprehensively explain how the inclusion of Accumulated Depreciation on Building

in the Balance Sheet follows the influence of Materiality.

(d) Write a paragraph in which you explain why bad debts is an expense and provide three

strategies a business can use to avoid bad debts. (Mid-Course Exam January/April 2010)

Becky sits in the bank manager’s office hoping to borrow enough money to finance her business expansion. The bank manager seems very interested in the financial statements.



(e) Explain, using the recognition criteria for a liability, WHY Bank Overdraft is reported in the Balance Sheet as a Liability.

8.6 Statutory Compliance The Accounting Standards Review Board (ASRB) is responsible for approving financial reporting standards under the Financial Reporting Act 1993. New Zealand entities required to comply with NZ GAAP under the Financial Reporting Act must apply International Financial Reporting Standards. Statutes that accountants must comply with in the preparation of financial statements include:

Companies Act 1993

Financial Reporting Act 1993

The Income Tax Act 2004

8.7 Financial Reporting Standards: The New Zealand Institute of Chartered Accountants (NZICA) is New Zealand’s professional accounting body. A major role of NZICA, is the development of accounting standards. Compliance with the New Zealand Equivalents to International Financial Reporting Standards NZIAS makes the financial statements of various reporting entities more comparable and understandable.

Final Accounting Exam January/April Intake 2010 Question: The sales figure in the Income Statement includes only credit sales. Fully explain how credit sales result in an increase in economic benefits.

The Recognition Criteria for Liability A liability shall be recognised when: (a) It is probable that the outflow of future economic benefits embodied in

the asset will eventuate; and (b) the liability possesses a cost or other value that can be measured with

reliability.



SUMMARY ACCOUNTING CONCEPTS AND TERMS TO LEARN

Asset Relevance Going Concern Materiality

Liability Understandability Periodicity Faithful Representation

Income Neutrality Accrual Basis Cost vs Benefit

Expense Comparability Depreciation Accounting entity

Equity Goodwill Auditor Accounting

Historical Cost Reducing Balance Units of Use Statutory

Verifiability Summary of Significant Accounting Policies Straight Line

Timeliness Monetary Unit Elements

Choose the appropriate terms from this list above to match the correct meaning given below and write your answer on the table on pages 10.

1 An item should be shown separately if its amount or nature is significant enough to change users’ decisions.

2 Depreciation is calculated as a fixed percentage of cost each year.

3 Financial reports are prepared on the assumption that as far as the owners are aware, the entity will continue in operation for the foreseeable future.

4 An independent chartered accountant who checks the accounts for accuracy in order to determine whether the reports show a true and fair view of profits and financial position.

5 The excess of the price paid for a business above the fair value of total net assets.

6 The financial affairs of the business are kept separate and distinct from the financial affairs of the owner.

7 Users must be able to compare the financial statements of an entity through time and compare the financial statements of different entities.

8 Method of depreciation used when the economic life of the asset is dependent on the amount of use made of it.

9 Assets are recorded at their price at the time of acquisition, ie their original purchase price.

10 The life of the entity can be divided into equal time periods.

11 The cost of providing additional information should not exceed the benefit to the user.

12 Required by law, eg Companies Act 1993

13 The systematic allocation of the cost of an asset less its residual value over its useful life.

14 The effects of transactions and other events are recognised when they occur and are reported in the financial statements of the periods to which they relate.

15 A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

16 Are used to group the economic activities of a business entity.

17 Information which is capable of making a difference in the decisions made by users. To be relevant information must have predictive value and/or confirmatory value.



18 The statement of the principles followed by a business when preparing financial statements.

19 Depreciation is calculated as a percentage of the carrying amount each year.

20 Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Eg. wages.

21 All transactions, assets, liabilities, incomes and expenses are recorded in a common dollar unit such as the $NZ.

22 The residual interest in the entity’s assets after the deduction of its liabilities.

23 The process of identifying, measuring, recording and communicating financial information in order to permit informed decisions to be made by the users of the information.

24 Information of which a user can easily comprehend its meaning.

25 A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

26 Information which a reader sees as matching the underlying transaction or event.

27 Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. Eg Sales, Fees

28 Financial information meets this characteristic of accounting if different knowledgeable and independent observers could reach agreement on the value of an item recorded in the financial reports.

29 Information is available to decision-makers in time to be capable of influencing their decisions.

30 Information which has not been prepared in such a way as to influence a decision is likely to faithfully represent the business event.

ANSWERS:

1 11 21

2 12 22

3 13 23

4 14 24

5 15 25

6 16 26

7 17 27

8 18 28

9 19 29

10 20 30



Constraints on financial reporting are materiality and cost versus benefit.

Question: Final Accounting Exam January/April Intake 2010

The Statement of Significant Accounting policies states there have been no changes in accounting policies. Explain how stating whether or not there have been any changes meets

the characteristic of comparability.

QUALITATIVE CHARACTERISTICS

Relevance

Faithful

Representation

Materiality Enhancing

Characteristics

Comparability

Verifiability

Timeliness

Understandability

Underlying

Characteristics

Completeness

Neutrality

Freedom from error



THE CONCEPTUAL BASIS OF ACCOUNTING

Explicit Implicit Measurement

Assumption Assumption

1. Historical Cost

Going Concern Periodicity 2. Fair Value

3. Present Value

Qualitative Characteristics Elements

1. Fundamental 1. Assets

2. Enhancing 2. Liabilities

3. Equity

4. Income

5. Expense

Objective Provide information about

the reporting entity that

is decision useful

to present and

potential capital

providers.

FIRST LEVEL

SECOND LEVEL

THIRD LEVEL



Unit 9: Inventory

9.1 Periodic Inventory System: The periodic inventory system records purchases as an expense and relies on calculating the inventory at the end of the period to calculate cost of goods sold.

Exercise: 9.11 On 1 January 20X0 I. Revise started business with the following assets and liabilities Cash at Bank $2,000 Accounts Receivable $3,000 Inventories $4,000 Office Equipment $10,000 Accumulated Depreciation on Office Equipment $1,000 Accounts Payable $1,500 Transactions were: Jan 5 Bought goods on credit $8,000 Invoice 309 Jan 10 A customer who owed $100 paid $90 in full settlement. Receipt No 1 Jan 15 Paid a creditor $55 and received a $5 discount. Cheque No 1 Jan 20 Returned goods to a supplier $100. Credit Note 81. Jan 25 Sold goods on credit for $20,000 Invoice 1-29 Jan 26 Paid wages $1,500 Paid Rent $2,000. Jan 30 A customer returned damaged goods $75 Credit Note 1 REQUIRED:

Prepare Journal entries to record the above transactions

Post to the Ledger

Take out a Trial Balance on 31 January 20X0.

A stock take shows that the Closing Inventory is $7,000.

Prepare an Income Statement for the month ended 31 January 20X0.

Prepare a Balance Sheet as at 31 January 20X0.

Exercise: 9.12 2010

May 1 Start business with inventory $500

2 Buy goods using an overdraft $400

3 Sell goods for Cash – Cost Price $80, Selling Price $150

4 Buy goods on credit $2,000

5 Sell goods on credit – Cost Price $200, Selling Price $400

6 Sell goods for cash Cost Price $1,000, Selling Price $2,000

Required: Periodic Inventory System.

a. Record the transactions in Ex 9.12 in the General Ledger and take out a trial balance. b. The inventory balance on 6 May is $1,620. Prepare an Income Statement for the

week ended 6 May 2010. c. Prepare a Balance Sheet as at 6 May 2010.

9.2 Perpetual Inventory System: The perpetual inventory inventory system maintains a continuous record of both inventory and cost of goods sold. It provides for better control of inventory because when it is combined with a physical stocktake, shortages caused by lost, stolen or spoiled goods can be detected. Complete Exercise 9.12 using the Perpetual Inventory System.



Exercise: 9.2.1 Financial Statements using Perpetual Inventory:

Ivor Perpetual

Adjusted Trial Balance

As at 30 June 20X0

$NZ $NZ Sales Revenue 227 210 Advertising 2 000 Salesperson's salary 24 000 Office salary 17 250 Cost of Goods Sold 119 300 Office rent 4 800 Inventory 28 500 Accounts Receivable 13 500 Allowance for doubtful debts 1 000 Delivery vehicles 48 000 Accumulated depreciation of delivery vehicles 22 400 Capital 68 590 Prepayments 400 Accrued Expenses 250 Depreciation on Delivery Vehicles 6 400 Doubtful Debts 300 Bank 5,000 Drawings 50,000

Required. a. Prepare an Income Statement for the year ended 30 June 20XO. b. Prepare a Balance Sheet as at 30 June 20XO.

9.2.1 Comparison of periodic and perpetual inventory systems: Complete the table below:

Periodic Perpetual

Provides a continuous record of inventories?

Stocktake necessary?

Detects shortages or theft?

Easy to calculate regular profitability of the business?

The name of the expense account?

Provides control over inventories?

NZ IAS 2 Inventories, states that Inventories shall be measured at the lower of cost and net realisable value. If inventories are overstated, profits will be: …………………………………… If inventories are understated, profits will be: …………………………………….



8.8 Examination questions:

a. Final Exam 2009 January/April Conceptual Basis Question: In the accounts of Educational Toys Ltd which has a balance day of 30 June 20X0 the inventory is valued at its net realisable value of $148,000 instead of its historical cost of $150,000. Explain the conflict between historical cost and relevance in relation to the reporting of inventory at $148,000.

b. Final Exam 2010 January/April Conceptual Basis Question: Some plants that are in an unhealthy condition on 30 September 2010 are included in the inventory asset at their net realisable value of $3,000 rather than at their cost of $5,000.

Explain the conflict between historical cost and faithful representation in relation to the reporting of these plants at $3,000.

(2 marks)



Mid Course Accounting Exam 2010 July/September Intake: This question deals with the Financial Reporting requirements of Lala, a sole proprietor who operates a book shop trading as Lala Adams Books. You are provided with the following Trial Balance on 30 June 2010.

LALA ADAMS BOOKS

TRIAL BALANCE

AS AT 30 JUNE 2010

Accounts Receivable 22,000

Advertising Expense 3,000

Cost of Goods Sold 111,000

Drawings 30,000

Electricity Expense 1,800

Insurance Expense 1,000

Interest on Overdraft Expense 750

Inventory 25,000

Delivery Van (cost) 17,000

Machinery (cost) 15,800

Office Expenses 3,600

Postage and Stationery Expense 1,200

Salaries (office) Expense 15,000

Telephone Expense 800

Van Expenses 2,200

Commission received 9,700

Wages (Sales) Expense 28,500

Accounts Payable 5,750

Bank 4,500

Capital 33,600

Sales Revenue 220,000

Allowance for Doubtful Debts 400

Accumulated Depreciation on Machinery 1,300

Accumulated Depreciation on Van 3,400

Additional information: 1. Insurance prepaid on balance day $200. 2. Interest due on overdraft $250. 3. Commission received in advance $450. 4. Allowance for doubtful debts to be 2% of accounts receivable 5. Depreciate the Van and Machinery at 20% p.a. on cost. 6. $200 of stationery has not been used on balance day.



Required: (a) Adjust the Trial Balance by crossing out the original number and writing the adjusted figure to the left or right as

appropriate, to record the adjustments required at reporting date.

(b) Complete a classified Income Statement for Lala Adams Books for the year

ended 30 June 2010 below after adjusting the Trial Balance.

(c) Complete the Notes to the Balance Sheet for Lala Adams Books as at 30 June 2010. (d) Complete a Balance Sheet as at 30 June 2010.

Chapter 3

Unit 10: Partnerships

FORMS OF BUSINESS ORGANISATION:

1. SOLE TRADER: Definition: A sole trader is an unincorporated entity with one owner. Advantages: - low start up costs - owner in direct control - all profits to owner Disadvantages: - unlimited liability - lack of continuity of business - difficulty in raising capital - management responsibility and time commitment

Can you explain what unlimited liability means?

Unlimited Liability: If the accounting entity for a partnership or sole trader becomes insolvent and the business assets are insufficient to settle liabilities, the owners will be personally liable for any amounts remaining unpaid.



2. PARTNERSHIP:

Definition: A partnership is a type of business ownership defined in the Partnership Act (1908) as the ‘relationship which exists between persons carrying on a business in common with a view to profit’. Three sources of authority which govern partnerships:

a. The Partnership Act (1908) is often the guiding principle. It outlines the rights, rules and the arrangement of the business.

b. A Partnership Agreement sets out the rights, duties and responsibilities of each partner and how the profits will be shared among them. Partners have the option of drafting their own Partnership Agreement.

c. Case Law. A court will examine the facts of a case and make a judgement. If similar situations have arisen in the past, the decision will be based on previous judgements.

Some major clauses from the Act and Aagreement PARTNERSHIP ACT 1908 PARTNERSHIP AGREEMENT

- Equal share of profits - No salaries for partners - Interest is paid only on

advances (loans). - New partners can join on

approval from all existing partners.

- Business ends on death of each partner.

- All the rules and arrangement for the business is discussed and approved by the partners themselves.

ADVANTAGES AND DISADVANTAGES OF PARTNERSHIPS

Advantages: - More capital and skills

Compared with a sole trader

- More flexibility - Not expensive to form Compared with a company - no special tax liability

Disadvantages:

- profit shared - unlimited liability - limited life

Special Accounts for partnerships: Contributed Capital, Current Capital, Drawings, Salary, Interest on Contributed Capital and Current Capital.



Formation of a Partnership There are 3 main ways to start a partnership:

1. Contribution of cash by partners:

General Journal GJ1

20X0

Mar 31 Bank 100,000

Contributed Capital A 60,000

Contributed Capital B 40,000

For capital contribution by partners as per Partnership Agreement.

Model 1 Dr Hurt and Dr Payne decide to commence business as Painfree on 1 April 20X0. Their partnership agreement states that they will contribute $100,000 each in cash as their initial capitals. They purchase the assets and liabilities (except cash at bank of Dr Surgeon for $180,000 cash. Dr Surgeon’s Balance Sheet as at the date of purchase reads as follows:

$NZ

Bank 15,000


Inventories of Drugs 75,000

Fixtures and Fittings 55,000


Capital 175,000

Required:

Prepare General Journal entries to record the formation of the new partnership and settlement of the purchase of the business from Dr Surgeon.

Prepare a Balance Sheet as at 1 April 20X0.

Exercise 10.1 On 1 May 20X0 Chris Cross and Jo King decided to form a partnership and trade as Fun and Games. They agreed to contribute $150,000 each as capital and signed an agreement with Candy Kane to purchase her business for $275,000. Candy Kane’s Balance Sheet read as follows:

Bank 10,000


Inventories 150,000

Equipment 120,000


Capital 260,000

Terms of the Agreement:

All assets and liabilities were taken over except the Bank Account.

All assets were taken over at their carrying amount.

Required:

Prepare General Journal entries to record the formation of the new partnership and settlement of the purchase of the business from Candy Kane.

Prepare a Balance Sheet as at 1 April 20X0.



2. Amalgamation of two businesses: The new owners must agree on the revaluation of assets. Current Assets

All current assets are revalued at agreed value.

Accounts receivable needs to be adjusted for Allowance for Doubtful Debts if the

agreed and existing values are different. The original Accounts Receivable amount must be debited in the journal.

Bank and Bank overdraft are combined. Non Current Assets

All property, plant and equipment is recorded at carrying amount or agreed values. That means the carrying amount or agreed value becomes the new historical cost.

Goodwill may have to be calculated and recorded.

Often a potential owner will have to contribute more than the value of the net assets. This is due to a number of benefits that the new partner will get by becoming one of the owners. These benefits could be in the form of

- good customer base - location - excellent business results - good employees

Liabilities

Recorded at agreed value

Equity

The partners should establish their equity sharing ratio. Additional cash may be required to be contributed by one partner in order to adjust their net assets to equal their required share of equity.

e.g. Balance Sheet Extract:

Equity Note

Contributed Capital 4 $120,000

Notes to the Balance Sheet:

4. Equity Contributed Capital

Partner A 90,000

Partner B 30,000

Total $120,000

For example: The equity sharing ratio is 75% for Partner A and 25% for Partner B. If the Capital of Partner A equals $90,000 Partner B’s Capital must equal $90,000/0.75 x 0.25 = $30,000

Goodwill is the excess of the price paid for a business above the fair value of total net assets.



Model 2 Art Major and Commerce Major decide to amalgamate their businesses on 1 April 20X0 and form a partnership trading as Academics. At the date of amalgamation their Balance Sheets read as follows. In brackets are the valuations at which it was agreed the assets be taken over:

Art Major’s Balance Sheet as at 1 April 20X0

$NZ $NZ

Bank 40,000 (40,000)

Accounts Receivable 200,000 (195,000)

Inventories 220,000 (220,000)

Equipment 250,000 (300,000)

Goodwill (50,000)


Capital 560,000

Commerce Major’s Balance Sheet as at 1 April 20X0

$NZ $NZ


Inventories 155,000 (220,000)

Equipment 280,000 (300,000)

Goodwill (40,000)

Bank Overdraft 8,000


Capital 450,000

In addition Commerce Major is to contribute sufficient cash to make his capital equal to Art Major’s capital. Required:

General Journal entries to record the formation of the Partnership.

Balance Sheet at the commencement of the Partnership.

Explain why Commerce Major and Art Major have formed a Partnership rather than remain as two sole traders.



Exercise 10.2 Gail Storm and Dusty Rhodes decide to amalgamate their businesses on 1 January 20X0 and form a partnership trading as Weather Patterns. At the date of amalgamation their Balance Sheets read as follows. In brackets are the valuations at which it was agreed the assets be taken over:

Gail Storm’s Balance Sheet as at 1 January 20X0

$NZ $NZ


Inventories 12,500 (15,000)

Equipment 12,750 (13,000)

Goodwill (6,000)



Capital 15,500

Dusty Rhode’s Balance Sheet as at 1 January 20X0

$NZ $NZ

Bank 1,150 (1,150)

Accounts Receivable 12,600 11,500

Inventories 13,750 (15,500)

Equipment 13,000 (15,000)

Goodwill (7,200)


Capital 27,500

Required:



Explain why Goodwill is sometimes recorded when a partnership is formed.



3. A business operating as a sole trader decides to form a partnership:

Model 3

Crisp Bacon’s Balance Sheet as at 1 January 20X0

Assets $NZ $NZ


Less Allowance for Doubtful Debts 250 9,750

Inventories 3,000

Equipment 10,000

Less Accumulated Depreciation 2,000 8,000

Goodwill 1,500

$22,250

Liabilities

Bank Overdraft 500


Capital 16,750

$22,250

The Partnership is to take over the assets and liabilities at their carrying amounts with the exception of Equipment which is to be revalued at $18,500. Crisp Bacon’s manager, A. Hogg, is to introduce sufficient cash to make his capital 50% of Bacon’s.

Exercise 10.3 Hazel Nutt decides to form a partnership on 1 January 20X0 with her manager Kandi Apple and trade as Delicacies. Hazel Nutt’s assets and liabilities at the date Kandi Apple enters the business as a partner are as follows: Bank $5,000, Accounts Receivable $45,000, Inventories $31,200, Equipment $44,000, Goodwill $8,000, Allowance for Doubtful Debts $800, Accumulated Depreciation $10,000, Accounts Payable $19,000. The Partnership is take over all the assets and liabilities but Accounts Receivable are revalued at $43,000 and Equipment at $35,200. Kandi Apple is to contribute sufficient cash to make her capital 20% of the total capital fo the partnership. Required:



Crisp Bacon decides to form a partnership with his manager and trade as Meat Treats. The Balance Sheet of Crisp Bacon at the date of forming the partnership reads as follows:



10.4 Further Exercises on Partnership Formation:

Exercise 10.4.1 B. Allen and Sue Wong both contribute $50,000 to form a partnership on 21 March 20X0 called Express Pizza. Required:

a. Prepare General Journal entries to record the formation of the partnership. b. Prepare the Balance Sheet as at 21 March 20X0.

Exercise 10.4.2 Zandor and Chip agreed to open a business together. Zandor is to give $20,000 for two thirds of the partnership and Chip to pay $10,000 for the other third. Prepare the general journal entry for these transactions.

Exercise 10.4.3 Hine and Sharie wish to work together fixing cables. Hine has a van and equipment at agreed values of $14,000 and $4,000 respectively. Sharie is to pay cash to make her capital up to a third of the total capital. The date to open the “Optix” partnership is 15 June 20X0. Required:

a. Prepare General Journal entries to record the formation of the partnership. b. Prepare the Balance Sheet as at 15 June 20X0.

Exercise 10.4.4 Peter has asked Yang to join him in an accounting business. Peter is to provide equipment he purchased at $6,000, furniture valued at $12,000, accounts receivable at an agreed value of $2,000 and his premises valued at $52,000. Yang is to contribute cash to make his contribution up to 40% of the business. Commencement date of the new business is 24 August 20X0. Required:

a. Prepare General Journal entries to record the formation of the partnership. b. Prepare the Balance Sheet as at 24 August 20X0.

Exercise 10.4.5 Complete the table: The first one is done as an example

New

Partner’s

Investment

New

Partner’s

Share

Total Equity

of the new

business

Existing

owner’s new

capital

Agreed

value of net

assets

Goodwill

$10,000 Third $30,000 $20,000 $17,000 $3,000

$60,000 Half $42,000

$160,000 Fifth $639,500

$20,000 Two Thirds $7,300

$40,000 20% $132,000



Exercise 10.4.6 January Mid Course 2011 On 1 April 20X1 Arataki and Henare agree to form a partnership to expand Arataki’s profitable sole proprietor Maori hangi business to include the sale of Rewena bread. They agree to call their new business Poti Tara.

Arataki’s hangi business has the following assets, liabilities, and equity on 31 March 20X1.

Arataki’s Maori Hangi Trial Balance as at 31 March 20X1

$NZ $NZ

Bank 8,400

Accounts Receivable 850

Allowance for Doubtful Debts 45

Cooking Supplies 1,300

Cooking Equipment (cost) 35,000

Accumulated Depreciation on Cooking Equipment 6,300

Shop Fittings (cost) 12,000

Accumulated Depreciation on Shop Fittings 2,400

Buildings (cost) 250,000


GST Payable 3,650

Mortgage (6.5% due 20X8) 180,000

Capital 113,455

The following are the terms of agreement between Arataki and Henare.

Arataki’s bank account in her sole proprietor’s business is not to be taken through to the partnership.

Arataki will personally pay the GST owing.

All other assets and liabilities are to be taken over at carrying amount except for the following: Accounts Receivable is to be revalued at $800. Cooking Equipment has an agreed value of $30,000. Buildings have an agreed value of $300,000.

Arataki’s contribution to the partnership has an agreed value of $180,000.

Henare will invest a Motor Vehicle valued at $25,000 and sufficient cash to make his capital contribution 25% of the total capital of the partnership.

REQUIRED: 1. General Journal entries for the formation of the partnership between Arataki and Henare. 2. Prepare a Balance Sheet for Poti Tara as at 30 June 20X0. 3. A major disadvantage of forming a partnership is unlimited liability.

Explain the meaning of unlimited liability to Arataki and Henare.



Exercise 10.4.7 a. Hopeful is the owner of a small factory which manufactures toothbrushes. He has

asked his manager Tryer to form a partnership with him. The partnership will take over Hopeful’s Toothbrush factory for an agreed value of $200,000 and will trade as Toothbrush Partners. The following information relates to the agreement between Hopeful and Tryer. The assets will be revalued as follows:

Premises $80,000, Plant and machinery $35,600, Motor Vehicles $24,020, Inventories $70,000. Accounts Receivable are to be decreased by 5%.

Hopeful will be personally responsible for paying the overdraft of his business.

Tryer is to bring in sufficient cash to make his capital 20% of the total capital of the partnership.

Hopeful’s Assets and liabilities as at 31 July 20X0 are shown below:

$NZ $NZ $NZ

Liabilities



Loan from N. Smith 32,400 $78,600

Assets


Inventories 77,440

Motor Vehicles (cost) 38,560


Fixtures 21,800


Plant and Machinery 48,400


Premises 90,400

Less Accumulated Depreciation 24,000 66,400 $258,600

REQUIRED: 1. General Journal entries for the formation of the partnership between Hopeful and Tryer on

31 July 20X0. 2. Prepare a Balance Sheet for Toothbrush Partners as at 31 July 20X0.

b. State two reasons why it is important for Hopeful and Tryer to go to a lawyer and prepare a Partnership Agreement.



Exercise 10.4.8 Mid Course Accounting Exam January/April 2009

Ignore GST for this question.

Forrest Chen and Wright Zhu form a partnership trading as Interior Arts on 1 April 20X0. Their Partnership Agreement states that Forrest who has been trading as a sole trader will contribute his business for an agreed valuation of $150,000. Details of Forrest’s assets and liabilities and agreed valuations are set out below:

Carrying amount in Forrest’s ledger

Agreed valuation

$NZ $NZ

Bank 5,600 5,600

Accounts Receivable 31,800 29,400

Inventories 90,000 80,000

Plant and Equipment 60,000 55,000

Accounts Payable 30,000 30,000

Wright agrees to bring in inventories to a value of $70,000 and sufficient cash to make his share 40% of the total capital. (a) Prepare the General Journal entry to record Forrest’s contribution of the assets and liabilities to the partnership. A narration is not required.



(b) Prepare the General Journal entry to record Wright’s contribution to the partnership. A narration is not required.

INTERIOR ARTS

GENERAL JOURNAL GJ2

(c) Prepare the bank ledger account for the new partnership after the General Journal has

been posted on 1 April 20X0.

Bank 110

(d) Distinguish between the terms Accounting Entity and Legal Entity by defining what each term means. Explain why it is important for Forrest and Wright to understand the significance of these two concepts when they form their partnership.



Chapter 4

Unit 11: Companies

Contents 11.1 Definition/registration and Certificate of Incorporation

11.2 Issue of shares and Debentures

11.3 Tax Payable

11.4 Profit Distribution for companies

11.5 Statement of Changes in equity

11.6 Fully worked examples

11.7 Terms to learn

11.1 Definition Major factors of this definition include:

a. Has to be registered under the Companies Act 1993. This requires applying to the Registrar of Companies for a name reservation, sending in a company application form along with the prescribed fee.

b. Enjoying perpetual succession. This means the company continues regardless of the owners’ dealings. Owners may die or retire or may transfer their ownership in the company, ie. Buying and selling shares in a company. All of these events do not change the financial structure of the company. This helps to make the ownership more appealing to investors.

c. One or more owners. This means a company can be as small in size as a sole trader or have an unlimited amount of owners. Where there are many owners they may not all take part in the management of the business. Therefore financial statements become an important part of the accountability of the managers to the owners. The Companies Act 1993 requires certain disclosures to aid accountability.

A Company must have: A registered name One or more shares One or more shareholders Can be the One or more eligible directors same person A registered office An address for service

The Companies Act 1993 states that a company is a type of business organisation that is registered under the Companies Act 1993, which enjoys perpetual succession with one or more owners.



Comparison of Business Ownership:

Feature Sole Trader Partnership Company Owner

Life

Liability

Legal Status

Equity

Operating

document

Law

Cash distributions

Number of Owners

Managers

Proprietor Limited Unlimited Not a separate entity Capital None No Specific Document Drawings 1 Owner

Partners Limited Unlimited Not a separate entity Contributed Capital Current Capital Advances Partnership agreement Partnership Act 1908 Drawings 2+ Partners

Shareholders Perpetual Succession Limited Separate legal entity Contributed Equity Retained Earnings Asset Revaluation Surplus

Constitution Companies Act 1993 Financial Reporting Act 1993 Dividends 1+ Board of Directors

Companies’ essential differences stem from the fact that the owners are not always the managers of the business. In this regard the owners:

Are not personally liable for business debts

Do not receive dividends unless proposed by the directors

Are able to sell their shares in the company without disruption to the company.

Advantages and Disadvantages of the company structure Advantages Disadvantages

Limited Liability

Easier to raise funds through share

issue

Has perpetual succession

Professional managers rather than all

owners having to have an input

Can sell debentures

Expensive set up costs

Reporting requirements

Double taxation, company profits and

dividends paid to shareholders

Shareholders may, on liquidation, have to pay back any unpaid amount on shares purchased.



Shares A share is a portion of the ownership of the company. It has no set value other than the fair value of the company divided by the amount of shares held in the business. The smaller the number of shares, the higher the value of each share. The number of shares held by each owner decides the rights that each shareholder has to dividends and voting in the company. A shareholder owning over half the shares of the company will have the majority of voting rights and will therefore control the company. A share in a company confers on the holder:

The right to one vote on a poll at a meeting of the company on any resolution, including any resolution to:

Appoint or remove a director; Adopt a constitution; Alter a company’s constitution; Approve a major transaction; Approve an amalgamation of the company; Put the company into liquidation.

The right to an equal share in dividends authorised by the board

The right to an equal share in the distribution of the surplus assets of the company. Subject to the constitution of the company, different classes of shares may be issued. Shares can include those which:

are redeemable,

have - no voting rights - special voting rights - limited voting rights - conditional voting rights

confer preferential rights to distributions of capital or income. Where a company has more than one type of share the shares must be disclosed separately according to the Companies Act 1993. In this course only ordinary shares fully paid up are covered.

Rights of Shareholders The types of shares and their rights are outlined in each company’s constitution. Shareholders have many rights enforced through the disclosure requirements of the Companies Act 1993. As the shareholders do not take part in the management, they have been given the right to closely observe and ensure directors are fulfilling the obligations for which they were appointed. The shareholder’s rights include:

The ability to obtain information and ensure the company and its directors comply with obligations

The Annual reports must carry details of the total remuneration packages paid to directors.

Knowledge of the number of employees paid over $100,000 in $10,000 brackets must be included in the reports.

The ability to take action on behalf of the company where the directors are unwilling. The legal fees resulting from this action is paid by the company, not the shareholder.



Require the company to buy back their shares if they disagree with certain events.

A company is unable to undertake certain activities, such as a big expansion project, without approval from a special resolution of the shareholders. (75% approval required).

One of the major decisions to be authorised by the shareholders includes the distribution of profits to shareholders. These distributions must pass a solvency test before they can be allowed.

Director’s duties The separation of ownership and management in the company structure has placed much power in the director’s hands. A director, in the definition of the Companies Act 1993, includes all appointed directors plus those who take on the power or duties normally associated with a director. The directors are able to bind the company into agreements without consent from the shareholders. Directors are accountable to the shareholders and must present information with which the shareholder can make investment decisions for the quality and ethical behaviour of their work. These are referred to in the Companies Act 1993 as their duties. Directors can become personally liable to pay for damages for any breach of duty. “These duties include:

Duty of Care: They should exercise care, diligence and skill of a reasonable director. They should base their decisions on reports, data and financial statements prepared for them which they accept in good faith and are not known to be inaccurate.

Duty to act in good faith and for the benefit of the company.

Duty to exercise power for a proper purpose.

Duty not to misuse confidential information.

Duty not to trade while insolvent: directors must not allow the company to continue trading if this may “create substantial risk of serious loss” to creditors.

Duty to disclose the interests in the Interests Register: This includes any dealing in shares; a civil liability is created for insider trading.”

(Companies Act 1993)

The major effects on larger companies of these duties have been to: a) Increase the directors fees b) Increase insurance costs, as companies are able to indemnify their directors against

such a personal loss.



Exercises: 11.1 Name the three important aspects to being a company as defined in the Companies

Act 1993. 11.2 List the six minimum requirements to be registered as a company. 11.3 Explain a separate advantage of the company structure for:

a) A small bookshop b) A large exporting business c) A forestry investment business d) A road making firm e) An investor with $10,000

11.4 Explain the disadvantages of the company structure for:

a) Directors b) Accounts Payable c) A small bookshop d) A forestry investment business

Accounting Entity: All business firms regardless of their ownership form are accounting entities. This means that the financial affairs of the business are kept separate and distinct from the financial affairs of the owners.

Legal Entity: A legal entity is an individual or organization which is legally permitted to enter into a contract and be sued if it fails to meet its contractual obligations. A Limited Liability company is both a legal entity and an accounting entity whereas a sole trader and a partnership are accounting entities only.

Statutory Requirements: A company must keep:

- the company’s Constitution (if it has one) - minutes of all shareholders’ meetings and resolutions

- an interests register - minutes of all directors’ meetings and resolutions - full names and addresses of current directors - copies of written communications to shareholders - annual reports - financial statements - accounting records



How to Register: Step 1.

Name registration An application is sent to the Companies Registrar to register the company name. It cannot be: Similar to another name Using government or royal words Offensive.

Step 2.

Application for incorporation Within 20 days of the name registration being issued, the directors must file to the registrar of companies an application form with the following information: Company constitution, if any Notice of name reservation Name and consent of director/s stating their eligibility Name and consent of initial shareholder/s Address of the registered offices Address of company

Step 3.

Certificate of Incorporation issued Once the certificate is issued the entity is a company under law and becomes a separate legal entity.

Registrar

of

Companies

1. Name reservation application

C

o

m

p

a

n

y

3. Separate legal entity. Limited liability status.

Notice of Name reservation

Certificate of Incorporation

2. Company constitution

Notice of name reservation

Name & Consent of Directors

Name & consent of shareholders

Address of registered office

Address of Company

Prescribed fee



Company Constitution: A company’s constitution is similar to a partnership agreement. It: States the name and objectives of the company sets out the rights, liabilities and duties of the directors and shareholders defines how meetings are run defines types of shares sets out how shares are issued how directors are elected. A company need not have a constitution. A constitution enables the company to take advantage of certain provisions of the Act. This includes share buy backs and indemnifying directors against anything except negligence.

Ownership of a Company

A company’s equity is divided into equal amounts called shares. These shares are issued to one or more owners. Shares may be issued at any time to any person during the life of the business within the Act and the constitution of the company. The value of each share is set at a fair value. This is the price someone is willing to pay at the time of purchase. The price will vary during the life of the business. The company has the right to accept or reject any person(s) as a shareholder from the company. The initial share issue is included with the incorporation of the company. The names of the initial shareholders and their consent to be shareholders will be recorded in the share register and filed with the application for incorporation to go to the Companies Registrar. The shareholder is liable to pay the value of the shares to the company either in cash, other assets or a cancellation of a debt from the company. The payment is recorded as the equity

of the business and is called Contributed Equity. This is similar to the Contributed Capital account of a partnership.

Student Activity:

For each of the following situations identify and explain the form of ownership:

1. Adam Jackson decides to open a corner dairy by investing in one share of $100,000. Adam is the only director of the business.

2. Bill and Ted each invest $45,000 to start a mobile phone shop. 3. Jackie Chan decides to give up his job and offer a data entry business from home. He

invests $8,000 to buy a new computer. 4. A group of ten teachers decide to form a business offering tuition to students. Each of

them invests $2,000 for a one tenth share in the business. The business is called Tutorials Ltd.



BUSINESS ENTITIES: Complete the tables from the words in the table at the bottom of this page.

SOLE TRADERS

Advantages Disadvantages

PARTNERSHIPS


Some advantages or disadvantages are used twice. These are indicated by the number 2.

Low start up costs 2 Easy to form 2

Owner in direct control Share decision making

All profits to the owner Additional sources of finance

Unlimited liability 2 More flexibility

Lack of continuity 2 Additional skills

Difficulty in raising capital 2 Limited outside regulation 2

Solely responsible for the business

Divided authority



COMPANIES


Limited liability

Transferability of ownership

Easy to raise finance

Regulatory requirements

Double taxation

Slow start-up

Higher set up costs

Perpetual succession

Professional managers

Can sell debentures



11.2 Issue of shares and debentures: When starting a new company shares can be issued:

a) in exchange for cash and/or other assets b) in exchange for the purchase of a business as a going concern c) for repayment of a debt

1. Shares issued to start a company by a small group of investors: Similar to owner invested cash to start the business. Debit Bank XX Credit Contributed Equity XX (Cash contribution for the issue of xx number of shares at $x each)

Example:

Jim started a company by investing in 40,000 shares at $5 each.

G and J started a business with $20,000 each for $1 shares.

G and S invested $25,000 each to form a new company.

2. Share issue in exchange for a business: Rules:

- Assets and Liabilities recorded at agreed values. - Accounts Receivable to be adjusted with Allowance for Doubtful Debts. - Non Current Assets recorded at agreed values. Do not record any Accumulated

Depreciation. - Goodwill is usually calculated.

Generally

Debit Bank XX Accounts Receivable XX Non Current Assets XX Goodwill XX Credit Allowance for Doubtful Debts XX Liabilities XX Vendor XX (Being assets and liabilities taken over

as per agreement dated …………………….) Debit Vendor XX Credit Contributed Equity XX (Issue of shares in consideration of assets and liabilities)



3. Prospectus issued to the public:

Steps: a. Money received from the public who are interested in becoming shareholders.

Debit Bank XX Credit Application XX

b. Issue of shares

Debit Application XX Credit Contributed Equity XX

c. Payment for the prospectus and legal fees associated with share issue Debit Contributed Equity XX Credit Bank XX

4. Accounting for oversubscription: If applications are received for more shares than the number offered in the prospectus, the directors must decide on how the shares will be allotted. The directors can only issue the

number of shares offered in the prospectus. Usually the shares are issued on a pro rata basis. This means that all applicants will receive shares in proportion to the number applied for. For example, if 100,000 shares of $1 were offered and 200,000 shares were applied for, each shareholder will get only 50% of the number of shares for which they applied. After the shares are issued, the excess money must be refunded to the shareholders. Illustration: Final Exam January/April Intake 2010: Otakau Ltd was registered on 1 July 20X0 with initial shareholders paying $45,000 for 30,000 shares in the company. On 2 July, 100,000 shares were offered to the public at a fair value of $1.50 per share. By 31 July, 105,000 shares had been applied for and on 1 August the directors resolved to issue the shares to the applicants on a pro-rata basis and refund surplus application money. Plant and equipment costing $180,000 was purchased with 75% in cash and the remainder financed by a five year loan from the bank at an interest rate of 7.5% p.a. due 1 August 20X5. REQUIRED:

Complete General Journal entries without narrations to record the information provided above for Otakau Ltd from 1 July to 1 August 20X0. Your teacher will go over this problem with you. Complete a correct answer on page 47 and use it as a model when you are studying.



OTAKAU LTD

GENERAL JOURNAL

GJ1

20X0

Jul 1

Cash contribution for the issue of 30,000

shares of $1.50 each.

31

Being receipt of monies for 105,000 shares

at $1.50 each

Aug 1

Being allotment of 100,000 shares of $1.50

each as per Directors’ resolution No 21 in

Minute Book.

Being refund for shares oversubscribed.

Being receipt of money for a five year loan.

For purchase of Plant and Equipment.



5 Issue of shares by Sharebroker:

Example: ABC LTD gets a sharebroker to issue 100,000 shares at $2.40 fully paid on application. The sharebroker charges a 5% brokerage fee. Prospectus and legal fees associated with the share issue are paid by the company totalling $8,000. Indirect administration costs are paid by the company totalling $1,000. The final entries required relating to this share issue are: Dr Bank 228,000 Cr Contributed Equity 228,000 (Money received for the issue of 100,000 shares) Dr Contributed Equity 8,000 Cr Bank 8,000 (Payment of prospectus and legal fees associated with share issue) Dr Administration Expenses 1,000 Cr Bank 1,000 (Payment of indirect costs associated with share issue)

Repurchase of Shares The Companies Act 1993 allows a company to repurchase shares from existing shareholders if it is written in its constitution. The benefits for a company are to:

Improve the earnings per share;

To buy out a participant; or

To buy out a problem shareholder

Reduce the chance for a takeover of the company A solvency test needs to be made before the buy back is allowed.



Questions on Share Issue and Refunds

Model 1: Example Ltd was formed on 1 April 20X0. A prospectus was issued offering 500,000 shares of $1 to the public. The share issue was fully subscribed and the shares issued on 1 May. Legal costs amounted to $1,000 and property, plant and equipment of $100,000 was purchased for cash on which a mortgage of $50,000 was raised. REQUIRED:

Journal entries

Post to the ledger and prepare a Trial Balance as at 1 May 20X0.

Balance Sheet as at 1 May 20X0. Exercise 11.5 The City Company Ltd was formed on 30 June 20X0. A prospectus was issued offering 2,000,000 shares of $1 to the public. The shares were issued on 15 July. Legal costs amounted to $2,500 and property, plant and equipment was purchased for $1,000,000 cash on which a mortgage of $500,000 was raised. REQUIRED:

Journal entries

Post to the ledger accounts and prepare a Trial Balance as at 15 July 20X0.

Balance Sheet as at 15 July 20X0.

Model 2: Z Ltd was formed on 1 April. It offered 50,000 shares of $1 and received all application money by 1 May. It issued shares on 15 May. Legal costs of $1,000 were paid. Property, plant and equipment was purchased on credit for $20,000 with a deposit of 20% being paid. REQUIRED:

Journal entries

Post to the ledger accounts and prepare a Trial Balance as at 15 May 20X0.

Balance Sheet as at 15 May 20X0. Exercise 11.6 The Patana Company Ltd was formed on 30 June 20X0. Applications were received for 7,500,000 shares of 50 cents each by 31 July. The shares were allotted on 1 August. Legal fees amounted to $5,000. Property, plant and equipment was purchased from Hebe Ltd for $1,000,000. A deposit of 10% was paid. REQUIRED:

Journal entries

Post to the ledger accounts and prepare a Trial Balance as at 1 August 20X0.

Balance Sheet as at 1 August 20X0.



Exercise 11.7 The following is a summary of the Trial Balance of the Goliath Trading Company Ltd as at 31 March 20X0. $NZ $NZ

Bank 80,000

Property, Plant and Equipment 700,000


Contributed Equity 400,000

Mortgage 400,000

$800,000 $800,000

The Directors resolve to issue 50,000 additional shares of $2 payable in full on application. All the shareholders applied and paid for their shares by 1 May when the shares were allotted. REQUIRED:

Journal entries


Balance Sheet as at 1 May 20X0.

OVERSUBSCRIPTION

(When a company receives applications for more shares than it wishes to allot.) Exercise 11.8 Mailata Ltd offers 100,000 shares to the public at $1 and receives 140,000 applications by 1 May 20X0 when the directors decide to allot 100,000 shares on a pro rata basis REQUIRED:

Journal entries


Balance Sheet as at 1 May 20X0. Exercise 11.9 Duong Ltd offers 200,000 $2 shares to existing shareholders pro rata. Applications are received for 310,000 shares by 30 June 20X0. Directors resolve to issue shares on 1 July. REQUIRED:

Journal entries

Post to the ledger accounts and prepare a Trial Balance as at 1 July 20X0.

Balance Sheet as at 1 July 20X0.

Exercise 11.10 Westside Couriers is trying to expand. The business needs $100,000. On 3 November 20X0 the company issued a prospectus offering 20,000 shares of $5 each. When applications closed on November, $150,000 had been received. Directors resolved to issue shares on 30 November. Excess application moneys would be refunded on a pro rata basis. REQUIRED:

Journal entries

Jeffries applied for 6,000 shares. How many shares did he receive? How much did he initially pay and how much is his refund?



Exercise 11.11 Bucket Plumbers decided to expand their operations and need another $200,000 which they expect to receive through issuing shares of $10 each. By 15 October applications had been received for 30,000 shares and the applications were subsequently closed. After looking through the applications they decided to refund 10,000 shares and issue the remaining on a pro rata basis. REQUIRED:

Joan applied for 1000 shares. How many would she receive from the share issue?

Prepare the journal entries

Prepare the Ledger accounts Exercise 11.12 Tutorials Limited is expanding and needs $10,000. Its plans to sell shares at a fair value of $1 each. Share application starts on 1 January and close on 15 January. In this period $15,000 was received by the company from prospective shareholders. On 31 January the company decided to allocate the shares. Because the shares were oversubscribed the company needed to refund the excess application money. The share issue incurred legal expenses of $250 that were paid. REQUIRED: General Journal entries. Exercise 11.13 (Final Examination 2008) On 1 January 2008 Avery Ltd was registered as a company with five shareholders, each owning 100 shares issued at $10, fully paid. On 1 June 2010, Avery Ltd approaches Broking Direct Ltd, a local sharebroker, to make a public share issue. Avery Ltd paid Broking Direct Ltd $3,500 for the prospectus on 30 June 2010. (a) Complete the General Journal entry to record the payment for the prospectus charged

directly to contributed equity. General Journal GJ188

Payment for prospectus charged directly to contributed equity.

On 1 July 2010, Broking Direct Ltd issued the prospectus offering 10,000 shares, at a fair value of $20 per share, payable in full on application. By 1 September, the issue was fully subscribed. Broking Direct Ltd charges a brokerage fee of 5% of the value of the shares issued. On 5 September 2010, Broking Direct Ltd paid the net amount owing for the issue to Avery Ltd.

(b) Complete the General Journal entry to record the receipt of monies for the issue of 10,000 shares of $20 each on 5 September 2010.

General Journal GJ188

Receipt of monies for issue of 10,000 shares of $20 each net of 5% brokerage fee.



OVERSUBSCRIPTION AND PURCHASE OF A BUSINESS:

Exercise 11.14

A group of investors decide to form a company called Shan Wen Ting Ltd which will operate in the chemicals industry. They pay cash for 50,000 shares of $1 each on 1 July 20X0. On 15 July 20X0 a prospectus is issued offering 375,000 shares to the public at $1 each payable in full on application. Applications closed on 28 August when the issue was oversubscribed by 20%. The directors met on 31 August and agreed to allot 5 shares for every 6 applied for. Excess application money was refunded to the public. During August, the company’s Managing Director signs an agreement to take over Chemical Products from its owner Lee Sak Kim. The Resource below shows the Balance Sheet for Chemical Products as well as the agreement which was signed on 31 August.

RESOURCE:

Required: 1. Prepare the General Journal entries to record the above transactions. Date and

narrations are required. 2. Prepare a Trial Balance as at 31 August 20X0. 3. Prepare the Balance Sheet for Shan Wen Ting Ltd as at 31 August 20X0.

CHEMICAL PRODUCTS

BALANCE SHEET (Extract)

31 AUGUST 20X0

Assets

Bank 1,500


Inventories 3,000

Plant and Equipment 20,000

Less Accumulated Depreciation 5,000 15,000 20,700

Less Liabilities


Loan 3,700 5,700

Total Net Assets $15,000

AGREEMENT FOR SALE AND PURCHASE

1 The Vendor, Ms Lee Sak Kim, is to be paid $25,000 cash plus the allotment of 10,000 fully paid shares of $1 each on 31 August 20X0.

2 Shan Wen Ting Ltd will take over all assets and liabilities of Chemical Products except for the loan.

3 The Assets and Liabilities will be valued at their carrying amounts except for the following revaluations: Accounts Receivable $1,050 and Plant and Equipment $13,000.



BONUS ISSUES A bonus issue is an issue of shares to existing shareholders for which no payment is required. The issue is made from a reserve account such as Retained Earnings or an Asset Revaluation Surplus. Example: The directors decide to issue 1 bonus share of $1 for every five held out of retained earnings.

Equity

Contributed Equity (100,000 fully paid shares) 100,000

Retained Earnings 25,000

TOTAL EQUITY 125,000

Journal entry to record the bonus issue: General Journal

Mar 31 Retained Earnings 20,000


For bonus issue from retained earnings.

Equity



TOTAL EQUITY 125,000

Shareholders can sell the bonus shares if they wish. Exercise 11.15 During the year Capital Properties Limited decided to issue two shares for every five held out of Retained Earnings at a share price of $20 each. Their current Equity shows:



a) Prepare General Journal entries for the transaction b) Calculate the number of shares held in the company after distribution of bonus shares. c) Prepare the new Equity section of the Balance Sheet

Revaluation Surplus The following journal entry is recorded when a non current asset is revalued upwards to record its fair value instead of its historical cost.

Debit Asset Credit Asset revaluation surplus

The revaluation surplus forms part of the equity of the company.



Exercise 11.16

Share Issue An extract from the Balance Sheet for Saddleback Ltd as at 31 March 20X0 is shown below. On that date, to help financial expansion, the directors offered 200,000 shares at a fair value of $2.00 each to the public, payable in full on application. On the same date as shares were to be issued, existing shareholders were to be given a bonus issue of one for three, fully paid, from the Land Revaluation Surplus, at a fair value of $1.20 per share. The issue was heavily oversubscribed and by 30 April 20X0 $480,000 was received on application. On 10 May the directors decided to allot 200,000 shares and to refund the application monies in full to the unsuccessful applicants.

EXTRACT

SADDLEBACK LIMITED

BALANCE SHEET

AS AT 31 MARCH 20X0

Contributed Equity (300,000 shares) 300,000


Land Revaluation Surplus 160,000

REQUIRED: Record the transactions in the General Journal of Saddleback Limited. Narrations are not required. Exercise 11.17

Share Issue An extract from the Balance Sheet for Kiwi Ltd as at 31 March 20X0 is shown below. On that date, to help financial expansion, the directors offered 100,000 shares at a fair value of $1.50 to both the public and existing shareholders, payable in full upon application. On the same date as shares were to be issued, existing shareholders were to be given a bonus issue of one for two, fully paid, from the building revaluation surplus, at a fair value of $1.00 per share. Applications were received by 30 April 20X0 for 126,000 shares. Existing shareholders had applied for 80,000 shares, and on 10 May these were allotted in full. The remaining shares were allocated on a pro-rata basis and excess application money refunded.

EXTRACT: KIWI LIMITED

BALANCE SHEET

AS AT 31 MARCH 20X0



Building Revaluation Surplus 150,000

REQUIRED: Record the transactions in the General Journal of Kiwi Limited. Narrations are not required.



Exercise 11.18 Vitali Company Ltd is a registered company. An extract from its Balance Sheet as at 30 June 20X0 is shown below. VITALI COMPANY LTD BALANCE SHEET AS AT 30 JUNE 20X0



Land Revaluation Surplus 200,000

On 1 July 2010 Vitali Company Ltd issued a prospectus inviting the public to apply for 150,000 shares at a fair value of $2.50 per share.

The total amount was payable on application.

Applications for 200,000 shares had been received by 15 July.

On 30 July the directors met and allotted shares on a pro-rata basis. Excess application monies were refunded to applicants.

On the same day that the shares were allotted, a bonus issue of one share for every two held was given to existing shareholders from the Land Revaluation Surplus at a fair value of $1 per share.

REQUIRED: Prepare General Journal entries to show the transactions which occurred during July.

DEBENTURE ISSUE: A debenture is a non current liability. It is a loan of a fixed amount for a fixed term at a fixed interest rate. It may be issued by limited liability company or an incorporated society. Example: On 1 June 20X0, the Company issued 100 debentures of $1,000 interest rate 10% repayable on 1 June 20X5.

MANU INDUSTRIES GENERAL JOURNAL GJ59

20X0

Jun 1 Bank 100,000

Debentures (10% p.a. due 1.06.X5) 1,000

For the issue of 100 debentures of $1,000 each.

Debentures can be repaid by the issue of shares. Example: Manu Industries Ltd has a debenture with a carrying value of $60,000 and a present cash value of $55,000 which is converted to equity on 1 June 20X0. The General Journal entry is:

MANU INDUSTRIES GENERAL JOURNAL GJ59

20X0

Jun 1 Debentures 60,000


Income 5,000

Conversion of a debenture to equity.



CONVERSION OF DEBT TO EQUITY FINANCE - Exercises

Prepare General Journal entries for the following exercises: Ex 11.19 ZAK Ltd issued 40,000 shares at a fair value of $2.50 on 30 July 20X0 to repay debentures with a carrying value of $105,000 and a present cash value of $100,000. Ex 11.20 DON Ltd converted debentures with a carrying value of $30,000 and a present cash value of $28,000 by the issue of 14,000 fully paid $2 shares on 30 July 20X0. Ex 11.21 Fuqian Ltd has a debenture with a carrying value of $60,000 and a present cash value of $58,000 which is converted to equity on 30 July 20X0 by the issue of fully paid shares.

11.3 Tax Payable A profit earned by a company can either be held by the company, for future use, (RETAINED EARNINGS), or paid out to shareholders. All of a company’s profit after tax is recorded in retained earnings before it is paid out.

Provisional Tax: o A company pays tax on its profits as it is a separate legal entity. o The current company tax rate is 28%. o Companies are required to pay provisional tax. During the year companies pay

provisional tax based on the profit from the previous year. o Provisional tax is payable in three instalments (if the end of the reporting period is 31

March). 28 August 20X1 15 January 20X2 7 May 20X2

o At the end of the year the company will calculate the income tax on profits earned. o The difference between what has been paid in provisional tax and what must be paid

is called terminal tax. o Terminal tax is due to be paid on 7 February 20X3 o The date of payment is very important. Overdue payments incur penalty interest.

Step 1 – first instalment of provisional tax:

GENERAL JOURNAL

20X1 Aug 28 Provisional Tax Paid 30,000

Bank 30,000

(Provisional tax paid)



Step 2 - second instalment of provisional tax:

GENERAL JOURNAL

20X2 Jan 15 Provisional Tax Paid 30,000

Bank 30,000

(Provisional tax paid)

Step 3 – Balance day adjustment for Provisional tax owing: General Journal entry requried to record the third instalment of provisonal tax instalment due on 7 May 20X2.

GENERAL JOURNAL

20X2 Mar 31 Provisional Tax Paid 30,000

Tax Payable 30,000

(Provisional tax owing)

Step 4 – Close Provisional Tax Paid Account

GENERAL JOURNAL

20X2 Mar 31 Tax Payable 90,000

Provisional Tax Paid 90,000

(for closing journal entry)

Step 5 – Record Income tax expense on Actual Income for the year:

20X2 Mar 31 Income Tax Expense 100,000

Tax Payable 100,000

(to record income tax expense )

Step 6 – To close Income tax expense to Income Summary

20X2 Mar 31 Income Summary 100,000

Income Tax Expense 100,000

(to record income tax expense )

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GENERAL LEDGER

Provisional Tax Paid 791

20X1

Aug 28 Bank 30,000 30,000 Dr

20X2

Jan 15 Bank 30,000 60,000 Dr

Mar 31 Tax Payable 30,000 90,000 Dr

Tax Payable 90,000 0

Tax Payable 306

20X2

Mar 31 Provisional Tax Paid 30,000 30,000 Cr

Provisional Tax Paid 90,000 60,000 Dr

Income Tax Expense 100,000 40,000 Cr

Explanation: Tax payable $40,000 is a Current Liability which must be paid in the next reporting period. $30,000 provision tax due to be paid 7 May 20X2 $10,000 terminal tax due to be paid 7 Februay 20X3. Exercise 11.22 Crafty Containers Limited estimated their net operating surplus to be $72,000 for the year

ending 31 March 20X0. The tax rate is 28%. a) Prepare the cash payment journal entries necessary to meet their tax obligations. b) Crafty’s actual profit was better than expected at $80,000.

i) Prepare the necessary general journal entries at balance day to close off the accounts.

ii) Prepare an extract in the Income Statement, from the profit before tax to show the profit after tax.

If companies make a profit then that profit can be given to shareholders. That decision will be made by the Board of Directors

Profit before tax

Less Income tax

Profit after tax



Exercise 11.23 Final Examination January/April Intake 2013

PART A: COMPANIES Ignore GST for this question (10 marks) Waiata CD Ltd, was formed on 1 July 20X0 with five shareholders each owning 30,000 shares at $3 a share. It has been successfully trading over the past three years and had the following account information on 1 July 20X2.

$NZ

Contributed Equity (150,000 shares fully paid) 450,000 Cr

Retained Earnings 112,500 Cr

Tax Payable 4,500 Dr

The following transactions occurred during the year ended 30 June 20X3:

On 31 July 2012, directors proposed a final dividend for 20X2 of 15 cents per share. This was paid to shareholders on 1 September 20X2.

An interim dividend of 10 cents per share was paid to shareholders on 1 January 20X3.

On 1 February 2013, Waiata CD Ltd re-purchased 30,000 shares for a fair value of $4 each.

Three Provisional Tax Payments of $28,000 each were made on 28 August 20X2, 15 January 20X3 and 28 May 20X3. Profit before tax for the year ended 30 June 20X3 was $320,000 and the New Zealand company tax rate is 28% p.a. for the 20X3 tax year.

(a) Show the General Ledger account for the interim dividend for 2013, including the closing entry.

Dates are required.

Waiata CD Ltd GENERAL LEDGER Interim Dividend (20X3) 540

(b) Explain the two components of the solvency test which the directors of Waiata CD Ltd must

sign off before paying any dividends.



(c) Complete the General Journal entry indicated by the narrations in the General Journal below:

Waiata CD Ltd GENERAL JOURNAL GJ911

20X3

Feb 1

(For the re-purchase 30,000 shares for a fair

value of $4 each).

(1.5 marks)

(d) Complete the Provision Tax Paid account and the Tax Payable account for the year ended 30 June 20X3.

Waiata CD Ltd GENERAL LEDGER Provisional Tax Paid 790

Tax Payable 360

(e) Use all of the relevant information in the question to prepare the Retained Earnings Account

for the year ended 30 June 20X3.

Waiata CD Ltd GENERAL LEDGER Retained Earnings 520



11.4 Profit Distribution for Companies

Dividends are a distribution of profits to shareholders of a company. Before any distribution of dividends can be paid, there are two conditions that must be met: 1. A majority approval from shareholders (75% is required). 2. The registered company must pass the solvency test.

SOLVENCY TEST

There are two parts to the solvency test that need to be met before a distribution of profits can be made to shareholders.

1. Liquidity test:

The company must be able to pay its debts in the normal course of business before and after the dividend is paid. (This also applies to a share repurchase).

Cash flow forecasts must be used

Capital assets are not to be used to meet trading debts.

2. Balance Sheet Test

Directors must ensure that the assets are greater than liabilities after the dividends have been paid. (This also applies to a share repurchase).

Liabilities are to include contingent liabilities (those that will be owed subject to certain events happening).

If found at a later stage that the solvency test was not met after the distributions were made, the shareholders are liable to repay the dividends. In situations where this is not possible, the directors are personally liable for the difference.

DIVIDENDS Types of Dividends

1. Interim Dividend – paid during the year on projected profits of the current year. 2. Final Dividends – are proposed and declared after balance day. This will be disclosed

as note in the Financial Statements and is paid in the next accounting period. Recording of Interim Dividend Debit Interim Dividend XX Credit Bank XX (Payment of Interim Dividend)



Recording of Final Dividend Debit Final Dividend 20X0 XX Credit Bank XX (Final Dividend paid) Close off the accounts Debit Retained Earnings XX Credit Final Dividend XX Credit Interim Dividend XX (Close off Dividends accounts) Exercise 11.26

1. Act Taxis limited had issued capital of 200,000 shares. A 12 cents final dividend from the previous year was paid on 15 May with an 8 cents interim dividend paid on 30 October. Prepare journal entries to show the payments and also close the dividends accounts to retained earnings

2. Power Limited directors announced a dividend of $5 to its shareholders on 5 April. At

the Annual General Meeting on the 15 April it was approved and paid. On 12

November $2 Interim dividends were paid. There are 2000 shares issued. Prepare journal entries to show the payment of dividends and closing to the retained earnings account.

3. Give two reasons why the shareholders may reject the proposal for a final dividend.

Exercise 11.25

Part A XYZ Limited has been in operation for a few years now. The expected profits for the financial year ending 31 March 20X5 were $500,000. Based on this information the company made regular tax payments to the tax department. At the end of the financial year the actual reported profit was $520,000. Calculate

a. Provisional Tax payment b. Final Tax Payment c. Record in the journal

Part B The Board of Directors then decided to issue dividends. Due to good profits and excellent progress results currently they decided to pay an interim dividend of $2.50 per share. The total number of shares was 20,000 shares at $1. Calculate

a. Interim Dividend b. Record in journal



11.5 Statement of Changes in Equity

This statement shows the changes which have occurred to components of equity over the year. Components of equity include

- Contributed equity – increases when there is new share issue. - Retained earnings – increases with profit after tax and decreases with dividends

- land revaluation surplus/buildings revaluation surplus – increases if a particular non current asset is revalued upwards

Name of Business

Statement of Changes in Equity

For the year ended 31 March 20X0

Contributed

Equity

Asset

Revaluation

Surplus

Retained

Earnings

Total

$NZ 000 $NZ 000 $NZ 000 $NZ 000

Balance at 31 March 20XX

Changes in equity for 20X1

Gain on revaluations

Net income recognized directly in

equity

Profit for the year

Total recognized income and

expenses

Proceeds from share issue

Distributions

Balances at 31 March 20X1

NZIAS – Presentation of Financial Statements

Statement of Changes in Equity: The following items must be shown separately: a. Total recognised income and expenses including:

The profit or loss for the period

Increases/decreases in revaluation reserves

Currency translation differences b. Contributions by owners c. Distributions to the owners



FINAL EXAM JULY/SEPTEMBER INTAKE 2008-2009

COMPANY ACCOUNTING The following information was extracted from the trial balance of Plumbing Ltd as at 01 April 20X8. Contributed Equity (500,000 shares) $1,000,000 Cr Retained Earnings 200,000 Cr Asset Revaluation Surplus 100,000 Cr During the year ended 31 March 20X9 the following transactions occurred: 20X8 Jun 20 The directors issued 5,000 shares to the public at $3.00 each. Sep 30 The Company paid interim dividend $10,000 and final dividends of $12,000. 20X9 Mar 31 The business recorded a after tax profit of $168,000. It was further decided to revalue Land by $50,000.

Required: Complete the Statement of Changes in Equity using the information above for this company for the year ended 31 March 20X9.

Plumbing Ltd Statement of Changes in Equity for the year ended 31 March 20X9

Notes

Contributed

Equity

Asset

Revaluation

Surplus

Retained

Earnings

Total

Balance at 31 March 20X8

Changes in equity

for 20X9

Profit for the year

Balance at 31 March

20X9

(6 marks)



11.6 Fully Worked Examples

Exercise 11.27

Company Final Accounts

WILSON LTD

TRIAL BALANCE

as at 31 March 20X1

$NZ $NZ

Inventories 7,280


Wages Expense 10,740



Bank 9,980


Furniture 8,000

Plant 27,000

Term Deposit 3,760

Interim Dividend 3,000



Loan 2,440



$132,780 $132,780

REQUIRED:

Prepare an Income Statement for the year ended

31 March 20X1. Apply a taxation rate of 28%.

Prepare Interim Dividend Account and Retained

Earnings Account.

Prepare a Balance Sheet as at 31 March 20X1.



Exercise 11.28

MILLER LTD

TRIAL BALANCE

as at 31 March 20X1

$NZ $NZ

Bank 4,700

Office Equipment 9,000

Plant 40,000


Goodwill 24,000

Inventories 18,680

Cost of Goods sold 130,400


Rent Expense 7,600





Commission Income 1,460



Loan 2,920

$326,400 $326,400

REQUIRED:



Prepare Interim Dividend Account and Retained

Earnings Account.

Prepare a Balance Sheet as at 31 March 20X1.



Exercise 11.29

SIGNED LTD

ADJUSTED TRIAL BALANCE

AS AT 31 DECEMBER 20X1

$NZ $NZ

Cash 32,000


Inventories 111,000

Prepayments 8,000


General Expenses 123,000

Interest Expense 14,000


Term Deposit 9,000

Equipment 399,000


Accrued Expenses 31,000

Debentures 198,000





$1,414,000 $1,414,000

REQUIRED:


31 December 20X1. Apply a taxation rate of 28%.

Prepare Interim Dividend Account and Retained Earnings Account.

Prepare a Balance Sheet as at 31 December 20X1.



Exercise 11.30

REPAIR LTD

TRIAL BALANCE

as at 31 March 20X1

$NZ $NZ

Inventories 8,960

Purchases Expense 46,320



Insurance Expense 3,760

Bank 9,980


Furniture 8,000

Plant 30,000

Term Deposit 6,540




Loan 2,440



$147,780 $147,780

Inventories 31.03.X1 $7,280

Balance Day Adjustments

Advertising due but unpaid $500

Insurance paid in advance $450

1 Prepare General Journal entries for the balance day adjustments.

2 Adjust the trial balance

3 Prepare an Income Statement for the year ended


4 Prepare Interim Dividend Account and Retained Earnings Account

5 Prepare a Balance Sheet as at 31 March 20X1



11.7 Terms to learn:

Unlimited liability If a partnership or a sole trader becomes insolvent the owners are personally liable for the debts of the business.

Limited liability If a registered company becomes insolvent the shareholders are not personally liable for the debts of the company because the company is a separate legal entity. However, directors can be held personally liable for business debts.

Constitution A company constitution sets out the rights, liabilities and duties of the directors and shareholders. The constitution enables the company to take advantage of certain provisions of the Companies Act 1993, eg for the company to buy back shares.

Partnership Agreement

A Partnership Agreement sets out the rights, liabilities and duties of each partner. It enables the partners to change the restrictions laid out in the Partnership Act 1908.

Minutes Minutes record the decisions made at a meeting.

Debentures A debenture is a non current liability. It is a loan of a fixed amount for a fixed term at a fixed interest rate. It may be issued by limited liability companies and incorporated societies.

Dividends Dividends are a distribution of profits to shareholders of a company.

Interim Dividend An interim dividend is paid during the year.

Final Dividend A final dividend is declared at the end of the year.

Contingent Liabilities A potential obligation exists as a result of a past event. The liability cannot be recorded with certainty as it depends on the outcome of a future event. It should be disclosed in the notes to the Balance Sheet. Eg Amount which may be owed for a lawsuit, also a guarantee agreement for a loan.

Prospectus An invitation to the public to buy shares in a company.

Auditor An independent chartered accountant who checks the accounts for accuracy in order to determine whether the reports show a true and fair view of profits and financial position.

Summary of Significant Accounting Policies

The statement informs the user that the financial statements follow accepted accounting concepts and practices.

Statutory Requirements

Legal requirements, eg the Companies Act 1993 gives Statutory requirements for companies.

Retained Earnings The profits of a business that have not been paid out to the owners.



Bonus issue An issue of shares to existing shareholders for which no payment is required. The issue is made from a reserve accounts such as Retained Earnings or an Asset Revaluation Surplus.

Pro rata Proportionately. When shares are issued pro rata, it means they are issued in proportion to the number applied for. For example they may be issued 4 for every 5 applied for. The applicant will receive 80% of the shares they requested and be refunded the remaining 20%.

Acknowledgements:

Wilson, Mark Accounting Alive

accounting topics 8-11 2014

Documents

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