Unit 1 Advanced Accounting

UNIT 1: SEGMENT REPORTING
Content
1.0 Aims and Objectives
1.1 Introduction
1.2 Objectives of Segment Reporting and Applicable Accounting Standards
1.3 Coverage of Segmental Reporting
1.3.1 Operation in Different Industries
1.3.1.1 Revenue Test
1.3.1.2 Operating Profit Test
1.3.1.3 Asset Test
1.3.2 Foreign Operations
1.3.3 Export Sales
1.3.4 Major Customer
1.4 The Position of Security and Exchange Commission (SEC) on Segment Reporting
1.5 Summary
1.6 Answers to Check Your Progress Exercises
1.7 Model Examination Questions
1.0 AIMS AND OBJECTIVES
After completing this unit, students should be able to:

 discuss the criteria used to identify an industry segment for the purpose of segment
reporting.
 identify reportable segments when the revenue test is applied.
 identify reportable segments when the operating profit test is applied.
 identify reportable segments when the identifiable asset test is applied.
 prepare the necessary disclosures for reportable segments
 prepare the necessary disclosures for foreign operations
 discuss the disclosures required when a firm has a major customer.
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1.1 INTRODUCTION
It is customary for many companies to diversify their operations into a variety of related and
unrelated industry areas. Financial analysts and other users of financial statements face
difficulty in analyzing and interpreting financial statements prepared for diversified companies.
The reason is that different industry segments can have differing growth potentials, capital
requirements, and profitability characteristics. Some segments operate in a stable industry, and
others in highly cyclical, or high demand industry.
In terms of capital requirements, the segment may operate in labor-intensive, modest capital
requirements, or high capital intensive industry. As a result, it is not sound to combine all
segments and evaluate the company’s growth potential and profitability. In order to make
meaningful analysis, the total company financial data should be disaggregated into segments.
1.2 OBJECTIVES OF SEGMENT REPORTING AND APPLICABLE ACCOUNTING

STANDARDS
According to FASB (statement No. 14), diversified companies should separately prepare
reporting for each segment. In the view of the FASB, financial information about business
segments will assist financial statement users in analyzing and understanding the financial
statements of the enterprise by permitting better assessment of the company’s past performance
and future prospects.
Generally, segment information is based on the totals of consolidated financial statements.

Thus, the principles governing consolidations are used for segment reporting. In segment
reporting, transactions between segments are not eliminated for purposes of segment
disclosures with the exception of inter segment loans, advances and related interest. These
items are generally excluded from segment assets and revenues.
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1.3 COVERAGE OF SEGMENTAL REPORTING
According to Financial Accounting Standard Board (statement No. 14), an enterprise may have
to disclose data for one or more of the following areas:
1. Operations in different industries
2. Domestic and foreign operations
3. Export sales
4. Major customer
Each of these is explained in subsequent sections.
1.3.1 Operations in different industries
A company may have segments in different industries. The company may not be required to
report its operations in different industries. In order to determine whether the company must
report its operations in different industries, several factors may be considered. The first factor is
to identify the industry segments in which it operates. The aim is to identify a reportable
segment. A reportable segment is a significant component of a company that provides related
products and services primarily to unaffiliated customers. Besides, in order to be reportable, a
segment has to meet one of the three tests  revenue test, operating profit test, and asset test.
1. 3.1.1 Revenue test

An industry segment is reportable if it meets the revenue test. The revenue test is met when an
industry segment’s revenue is 10% or more of the combined revenue of all industry segments.
Revenue includes inter segment sales and transfers. Interest is included in the revenue test if the
assets on which the interest is earned are included in that segment’s identifiable assets. The
interest includes interest on inter segment trade receivables, but does not include interest on
intersegment loans and advances.
To illustrate, assume that Amtex company has 4 segments; namely, A, B, C, and D. tTeir sales
are shown below:
Segments Total Eliminati Consol

FASB  Financial Accounting Standard Board
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A B C D on idated
Sales to unaffiliated outsiders - $40,000 20,000 50,000 1,000 125,000 - 125,00
Inter segments sales ---
10,000 10,000 20,000 - 40,000 (40,000) 0
Total sales
50,000 30,000 70,000 15,000 165,000 (40,000) 125,00

0
The benchmark for a 10% revenue test is $16500 (i.e. 10% of 165,000).
= 10% of total sales
Since the sales of segments A, B, and C are greater than the benchmark sales amount, they are
considered segments Segment D is not a reportable segment because its revenue is less than
10% of the total sales of all segments (i.e 15,000).
1.3.1.2 Operating profit test

Operating profit is defined as an industry segment’s revenue minus all operating expenses.
Operating profit includes expenses that relate to inter segment sales or transfers and expenses
allocated among segments on a reasonable basis. Operating profit should not include revenues
earned at the corporate level, general corporate expenses, interest expense (except for financial
segments), domestic and foreign income taxes, income or loss from equity, investors, gain or
loss on discontinued operations, extraordinary items, minority interest, and the cumulative
effect of an accounting change. Intersegment interest expenses and revenues of an industry
segment that is primarily financial in nature are included in determining the operating profit or
loss of the segment.
The operating profit test is met when an industry segment absolute amount of its operating
profit or loss is 10% or more of the greater, in absolute amount of (1) the combined operating
profits of all industry segments that do not incur operating loss, or (2) the combined operating
loss of all industry segments that did incur an operating loss.
To illustrate, assume that XYZ company has four segments; namely W, X, Y, & Z. Their
operating profits/losses are shown below:
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Segments Corporate Consolidat
W X Y Z Administration ed
Operating profit (Loss) Br(50,000) Br(10,000) Br. 90,000 Br. 70,000 – Br. 100,000
Equity investment income 15,000 - - - 25,000 ---------- 40,000
Corporate expenses _ _ _ _ (12,000) (12,000)
Interest (5,000) (5,000)
Totals Br (35,000) (10,000) 90,000 70,000 8,000 123,000
In order to determine the reportable segment using the operating profit test, the following steps
can be followed:
Step 1: Add the profits of all segments that reported a profit. In this case, segment Y and Z
reported a profit and their total operating profits are Br. 160,000 (i.e. 90,000 + 70,000
= Br. 160,00).
Step 2. Add the losses of all segments that reported a loss. In the forgoing example, segments
W and X have reported a loss. The total losses of both segments are Br. 60,000 (i.e
50,000 + 10,000 = 60,000).
Step 3. Determine the benchmark to identify reportable segment
Benchmark = 10% of total operating profit, or
= 10% of total operating losses, i.e.
= 10% x 160,000 = 16,000
= 10% x 60,000 = 6,000
Step 4. Identify the reportable segment
The greater of the benchmark determined in step 3 is Br. 16,000. Thus, a segment
whose operating profit is 10% or more is reportable. As a result, segment W, Y, and Z
are reportable because their operating profits or losses are greater than Br. 16,000.
1.3.1.3 Asset test

The asset test is met when an industry segment’s identifiable assets are 10% or more of the
combined identifiable assets of all industry segments. Identifiable assets include tangible and
intangible assets (including good will) used exclusively by an industry segment and an
allocated portion of assets used jointly by two or more industry segments. In the determination
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of segment’s identifiable assets, asset valuation allowances should be taken into account. Asset
valuation allowances include allowance for doubtful accounts, accumulated depreciation,
marketable securities valuation allowance, and inventories valuation allowances.
The identifiable assets of the segment should not include assets maintained for general
corporate purposes and inter segment loans, advances, or investments, except for those of a
financial segment.
To illustrate, suppose that the identifiable assets of XYZ company’s segments are shown below
(in thousands):
Segments Elimi Consolid

W X Y Z Corporate Total nations ated
Identifiable assets Br 40 50 300 90 – 480 - 480
Investments (inter segment) - - 20 – 60 80 – 80
Corporate _ _ _ _ 10 10 – 10
Loans (inter segment) 5 4 - - 8 17 (17) –
Totals 45 54 320 90 78 587 (17) 570
Besides, it is assumed that none of the segments is financial segment.
To identify reportable segment, the following steps can be followed:

Step 1. Compute the total identifiable assets of all segment
Total identifiable assets = 480,000
Step 2. Determine the benchmark
Benchmark = 10% of total identifiable assets
= 10% x 480,000
= 48,000
Step 3. Identify a reportable segment
A reportable segment is one whose identifiable assets are 10% or more of total identifiable
assets of all segments. Since their identifiable assets are grater than Br. 48,000, segments X, Y,
and Z are reportable segments.
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Evaluation of reportable segments
According to statement No. 14 of FASB, an industry segment is considered reportable if it
meets either revenue test, operating profit test, or asset test. However, the statement also
specified additional rules and criteria for a final determination of a reportable segment. These
rules and criteria include:
1. The segment should not be considered reportable when it meets only one of tests but is
not expected to meet the test in the future.
2. A segment that does not meet any of tests may be considered reportable if it has been
reportable in prior years and is expected to meet one or more of the tests in the future.
3. The combined reportable segments must represent a substantial portions (at least 75%)
of the total operations of the enterprise. For example, if the total revenue of reportable
segment is less than 75% of the total revenues of all industry segments, additional
segment must be identified as reportable segment.
4. If the number of reportable segments exceeds 10, it may be appropriate to combine the
most closely related industry segments in to broader reportable segments with a view of
reducing their numbers.
Check your progress 1.1

1. What is an industry segment?
2. What is reportable industry segment?
3. The following data is selected for the segments of Crown Company for the year ended
December 31, 2003:
Segments
J K L M N
Revenues 21,000 6500 32,000 3100 17,000
Operating profit (loss) 1,200 (300) 7500 200 6700
Identifiable assets 34000 3800 22,000 7200 5900
Required: Determine
a. Which, if any, of these segments would qualify as reportable segments?
b. Whether a substantial portion of crown company’s total operations is represented by
reportable segments.
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1.3.2 Foreign operations
According to FASB statement No. 14, multinational companies are required to disclose
domestic as well as significant foreign operations. Multinational companies are those
companies that establish their own plants in different countries over the world. Foreign
operations (for multinational companies) include those operations that are located outside a
“home country” and which produce revenue either:
- by unaffiliated customer sales
- by inter company sales
Foreign operations do not include the operation of unconsolidated subsidiaries and investees.
Multinational companies may group operations in individual foreign countries. The basis of
grouping may be:
- proximity
- economic affinity, or
- similarity in business environment
As indicated above, multinational companies are required to disclose only significant foreign
operations. Foreign operation is said to be significant if it meets either of the following two
tests:
1. Revenue test
Revenue from sales to unaffiliated customers is 10% or more of consolidated revenue. In this
case, if the revenue from sales to unaffiliated customers is 10% or more of consolidated
revenue, the operation should be reported separately.
Example
Intel Telecommunication Company has subsidiaries in three different African countries. The
sales results of domestic and foreign operations are shown below (in thousands)
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Domestic Kenya Uganda Togo Combined Elim Consoli
nations dated
Sales to unaffiliated
Customers 4000 1500 5000 700 11,200 – 11200
Inter area sales 500 – 200 – 700 (700) –
Total revenue 4500 1500 5200 700 11,900 (700) 11,200
Revenue test benchmark = 10% of consolidated revenues

= 10% x 11,200 = 1120
Domestic operations, Kenya operation, and Uganda operation are reportable operations because
their revenue from sales to unaffiliated customers is greater than 10% of consolidated revenue.
Togo’s operation is not reportable because its sales ($700) are less than 10% of consolidated
revenue.
2. Asset test
If asset test is followed, the operation’s identifiable assets should be 10% or more of
consolidated assets in order to be reportable.
Example
Intel Telecommunication Company has subsidiaries in three different African countries. The
assets of domestic and three foreign operations are shown below: (in thousands)
Domestic Kenya Uganda Togo Combined Eliminations Consolidated

Identifiable assets $20,000 5000 10,000 3000 38,000 – 38,000
Investments Affiliates 7000 – 2000 9,000 – 9000
General corporate assets 12,000 12,000 – 12,000
Inter area advances 4000 1000 - - 5,000 (5000) –
Total assets 43,000 6000 12000 3000 64,000 (5000) 59000
Assets test benchmark = 10% of consolidated assets

= 10% x 59000 = 5900
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On the basis of asset test, only domestic Kenya and Uganda operations are reportable because
their identifiable assets are greater than the asset test benchmark of $5900. Togo operation is
not separately reported.
Generally, for all separately reportable operations as well as for the combined areas, revenues,
profitability information, and identifiable assets must be disclosed.
Check your progress 2
1. What is meant by foreign operations?

2. What is multinational company?
3. Assume that more corporation has operations in South Africa and three African
countries. (In thousands)
Benin Ghana Cameron Domestic

Sales to unaffi
liated customers 4000 8000 5000 18,000
Inter area sales 2000 3000 – 6000
Identifiable assets 10,000 15,000 11,000 25,000
General corporate assets 16,000
Required
Identify an operation that requires separate disclosure under the following tests:
a. revenue test
b. asset test
1.3.3 Export sales
Are foreign operations and export sales the same? No. Foreign operations and export sales are
not the same although it is not easy to identify the boundary between them. In general, as
defined earlier, foreign operations are those operations that are located outside a “home
country” and which produce revenue from either sale to unaffiliated customers or to members
of a group of companies. On the other hand, export sales represent revenues generated aboard
from services provided by domestic offices. Export sales is said to occur if the company’s
domestic operations sell to unaffiliated foreign customers. Export sales should be disclosed in
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total and when appropriate by geographic area if such sales are at least 10% of the company’s
consolidated revenue.
1.3.4 Major customer
According to Statement of Financial Accounting Standard (SFAS No. 30), a major customer is
one that provides a firm with 10% or more of the company’s revenue. Major customer could be
business concerns, domestic government entity, or foreign government entity. According to the
statement, the company has to disclose sales to major customers.
1.4 THE POSITION OF SECURITY AND EXCHANGE COMMISSION (SEC) ON

SEGMENT REPORTING
With respect to segment reporting, Financial Accounting Standard Board and SEC agreed in
most cases except the following:
a. FASB requires segmental data only for those years for which a complete set of financial
statements is prepared, where as SEC requires segmental data for three years historical
period.
b. FASB requires the reporting of major customers if sales represent 10% or more of total
revenue, where as SEC requires identification of major customer or customers if the
loss of such a customer or customers would have a materially adverse effect on the
enterprise.
Check your progress 1–3
1. Export sales and foreign operations are one and the same. True/False.
2. Foreign operations generate revenue from aboard by providing service through
domestic offices. True/False.
3. Export sales are not disclosed if they represent 8% of the consolidated revenue of the
company.
4. A major customer may be:
a. Business concern
b. Domestic government entity e. a and b only
c. Foreign government entity
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d. All of the above
e. a and b only
5. If the sales from a customer is 12% of the company’s revenue, it should be disclosed.
True/False
6. Unlike SEC, FASB requires segmental data of three years historical data. True/False
7. There is no disagreement between SEC and FASB on the disclosure of major
customers.
1.5 SUMMARY
The users of financial statements are interested in segment reporting in order to analyze and
interpret the firm’s past performance and to make predictions regarding the firm’s future
prospects. Given certain guidelines, most firms (except closely held companies) are required to
report segment information.
All segments are not reportable. In order to determine the reportable segment, the firm’s profit
centers are the focus. There are three types of tests in identifying a reportable segment; namely,
revenue test, operating profit test, and asset test. If the revenue of the segment is 10% or more
of the combined revenue of all industry segments, it is reportable.
According to profit test, a segment is said to be reportable if its operating profit or loss is 10%
or more of the combined if its operating profit or loss of all segments. On the other hand, using
asset test, if the segment’s identifiable assets are 10% or more of the combined identifiable
assets of all segments, the segment is reportable.
A segment is said to be dominant if its revenues, operating profit, and assets comprise more
than 90% of the firm’s revenues, operating profits, and assets. In this case, only dominant
segment is reportable.
Firm’s operating on multinational basis are required to disclose their foreign operations and
export sales if they constitute 10% or more of the total revenues of the firm.
If a customer provides 10% or more revenue to the firm, it is called a major customer, and
should be disclosed.
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1.6 ANSWERS TO CHECK YOUR PROGRESS EXERCISES
1. A business segment is a component of a business enterprise whose activities

represent a separate major line of business or class of customer.
2. Reportable industry segment is a significant component of an enterprise that
provides related products and services primarily to unaffiliated customers
provided it meets either a revenue test, an operating profit test, or an asset test.
3. (a) Reportable segment using:
Revenue test: J, L, and N
Operating profit test: J, L, and N
Asset test: J and L
(b) The reportable segments represent a substantial portion of the enterprise’s
operations because:
- 75% of total revenue of the enterprise = 59700
- Total revenue of reportable segments = 70,000
Since total revenues of reportable segment exceed 75% of total revenue of the
enterprise, it is said to be reportable.
1. A Foreign operations are those operations that are located outside a “home country” and
which produce revenue from either sales to unaffiliated customers, or to members of a
group of companies.
2. Multinational company is a company, which operates on international basis in the form
of establishing a plant in other countries and/or export of service by domestic offices.
3. a. All operations are reportable separately
b. All operations are reportable separately
Check your progress 1. 3
1. False 3. True 5. True 7. False

2. False 4. D 6. False
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1.7 MODEL EXAMINATION QUESTIONS
1. In segment reporting, inter segmental transactions are not eliminated. True/False

2. Which of the following items are excluded from segment assets and revenues in
segment reporting?
a. Inter segment loans
b. Inter segment advances
c. Interest on inter segment loan
d. All of the above
e. a and b only
3. According to revenue test, a segment is said to be reportable if its revenue is less than
10% of the combined revenue of all industry segments. True/False
4. In revenue test, inter segment sales should be excluded from segment revenue.
True/False
5. When revenue test is used in identifying reportable segment, segment revenue does not
include:
a. Inter segment transfers
b. Inter segment sales
c. Interest on inter segment trade receivables
d. Interest on inter segment loans
e. a and d only
6. When operating profit test is used in identifying reportable segment, segment profit
includes all of the following except:
a. Expenses related to inter segment sales
b. Inter segment interest expenses
c. Expenses allocated among segments
d. Revenues of an industry segment
e. Revenues earned at corporate level
7. When operating profit test is employed in identifying reportable segment, segment
profit excludes all of the following except:
a. General corporate expense
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b. Inter segment interest expense
c. Corporate interest expense
d. Domestic and foreign income taxes
e. Gain or loss on discontinued operations
8. The asset test is said to be met when an industry segment’s identifiable assets are 10%
or more of the total assets of industry. True/False
9. Which of the following items is (are) not considered in the determination of the
segment’s identifiable assets?
a. Assets maintained for general corporate purpose
b. Goodwill identifiable with the segment
c. Allowance for doubtful account on segment receivables
d. Accumulated depreciation on segment’s fixed assets
e. All of the above except d.
10. Although a given segment does not currently meet any test but expected to meet one of
the test in the future, it would be a reportable segment. True/False
11. Which of the following is not the basis of grouping multinational companies?
a. similarity in business environment
b. proximity
c. economic affinity
d. all of the above
e. none of the above
12. Operations of unconsolidated subsidiaries should be excluded from foreign operations.
True/False
13. Which of the following test is not used in identifying foreign operations?
a. operating profit test c. revenue test
b. asset test d. expense test e. a and d
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UNIT 2: INTERIM FINANCIAL REPORTING
Content

2.1 Introduction
2.2 The Need for Interim Reports
2.3 Approaches to Interim Reporting
2.4 Standards for Interim Reporting of Revenues, Costs, and Expenses
2.5 Income Taxes in Interim Financial Statements
2.6 Reporting of Accounting Changes and Extra Ordinary and Other Non-Operating
Items
2.6.1 Reporting Extra Ordinary and Other Non Operating Items
2.6.2 Reporting Gains or Losses From Disposal of Business Segment
2.6.3 Reporting Accounting Changes iun Interim Periods
2.7 Disclosure of Summarized Interim Finanical Data
2.8 Summary
2.9 Answers To Check Your Progress Exercises
2.10 Glossary
After reading this unit, you will be able to:

 differentiate the underlying assumptions of the discrete period approach and the integral
approach when they are used for interim reporting.
 calculate the amount of an interim period inventory write down due to the application of
the lower of cost or market rule when inventory declines are either temporary or
permanent.
 apply the standard cost accounting to interim reports.
 apply the costs of the major repairs, property taxes, advertising, and quantity discounts
to interim reports.
 compute the income tax provision required for a firm’s interim financial statements.
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 discuss the required disclosures of accounting changes and extra ordinary items in
interim reports.
 enumerate the minimum disclosures required in interim reports when a few set of
interim financial statements is not presented.
2.1 INTRODUCTION
Stakeholders, like investors, creditors, suppliers, and others, need information about the
financial performance of the enterprise. These users cannot wait for the end of the year to do
so. They need financial information periodically, at the end of either a month, quarter, or
semiannually. This chapter deals with important issues like accounting principles and practices
used in the preparation of interim financial statements, and approaches to preparing interim
financial statements.
2.2 THE NEED FOR INTERIM REPORTS
Interim financial reports are defined as reports prepared for a period of less than a year. The
purpose of preparing interim financial reports is to meet the needs of decision makers. Decision
makers are interested in frequent and timely information about the firm’s financial position and
results of operations. Among decision makers lenders are the common users. They need to
closely monitor the progress of borrowers so that problems can be identified as early as
possible. Another reason for the interest in interim financial reports is to use such reports as a
basis for projecting annual results.
An interim financial report may include either a

a. Selected financial data
b. Complete set of financial statements
Although there is greater need for interim financial reports, there are problems associated in
their preparation. Some of them include the following:
1. It is difficult to make estimates and judgments as accurately as possible. When the
accounting period gets shorter, estimates and judgments cannot be accurately made.
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2. The treatment of seasonal expenses. i.e. expenses that relate to a full year’s activity but
that occur randomly during the year.
2.3 APPROACHES TO INTERIM REPORTING
This relates to the view accountants hold about interim period. Accountants hold two views
about interim period. There are:
1. Discrete period approach

It is the approach in which each interim period is treated as a distinct accounting period. Alike
annual financial results, the same principles and processes are used in determining interim net
income. Under this approach, any outlay such as for advertising, repairs and maintenance
would be expensed in the interim period in which the outlay occurs.
2. Integral period approach

It is an approach in which an interim period is considered as an integral part of the annual
period. Under this approach, accruals, deferrals, estimates, and allocations depend on overall
estimates of the relationship between estimated annual revenues and expenses. Expenses, such
as advertising and research and development costs will be deferred so that a proper allocation
between interim periods within one year can be achieved.
According to Accounting Principles Board (APB) opinion No. 28, interims financial
statements are based on integral period approach. APB opinion No. 28 also stressed that interim
financial statements should be based on the same accounting principles and practices that are
used in the preparation of annual financial statements.
2.4 STANDARDS FOR INTERIM REPORTING OF REVENUES, COSTS, AND

EXPENSES
1. Revenues
Revenues should be recognized as earned during the interim period on the same basis as
followed for the full year. Seasonal variations in revenue should be disclosed by issuing data
for the latest 12 months in addition to the interim data.

APB – Accounting Principles Board
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2. Costs and expense
a. Direct costs and expenses

Costs and expenses may be classified into direct costs, and indirect costs. Direct costs and
expenses are those that can be associated with revenues, or directly associated with the products
or services provided. They are also called allocated product costs, and include all inventoriable
direct costs (i.e. materials, labor, and manufacturing overhead).
For interim periods, direct/allocated costs are treated in the same way as full year. However,
APB opinion No. 28 provided the following exceptions with respect to the determination of
cost of goods sold for interim financial statements.
a. Enterprises that use the gross profit method at interim dates to estimate cost of goods
sold should disclose their practice in the interim financial statements.
b. Enterprises using the LIFO method of inventory may dig into LIFO layers temporarily
during an interim period because LIFO is an annual concept.
c. Inventory losses resulting from market declines should not be deferred beyond the
interim period in which they occur. If losses are recovered in a subsequent interim
period, gains should be recognized to the extent of losses previously recognized. To
illustrate, assume that the costs and market value of inventory in the 1st quarter are Br.
10,000 and Br. 7000 respectively. Inventory loss to be reported in the 1 st quarter would
be Br. 3000 (i.e 10,000 – 7000 = 3000). If inventory value (market value) is Br. 14,000
in the 2nd quarter, gain is Br. 4000, but only Br. 3000 is recognized because loss was Br.
3000 in the 1st quarter.
Inventory losses due to temporary inventory market decline should not be recognized in interim
period. (Temporary inventory market decline is a market value decline in one interim period
with an expected market recovery in a subsequent interim period within the same fiscal year.
To illustrate, the application of the lower-of-cost or market rule to interim reporting, let’s
consider the following data. Grace Company accounts for its single merchandise item on the
FIFO basis by applying the lower-of-cost or market method. The company has 15000 units in
stock with a cost of Br. 60,000 or Br. 4 per unit. For simplicity of illustration, we assume that
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no purchases were made during the year (2003). Quarterly sales and end-of-quarter
replacement costs for inventory during the year were as follows:
Quarter Quarterly End of quarter

ended sales (units) Replacement cost/per unit
March 31 -----------------3000 --------------------------------.--Br. 5
June 30 -------------------2000 ---------------------------------------3
September 30 -----------3500 ---------------------------------------6
December 31 -----------2500 ----------------------------------------2
Assume that the replacement cost decline in the second was not considered to be temporarily.
Grace Company’s cost of goods sold for four quarters, including the second quarter is
computed as follows:
Cost of goods sold

Quarter ended Computation for quarter For quarter Cumulative
March 31 ------------------3000 x 4------------------------- 12,000 12,000
June 30 --------------------(2000 x 4) + (10,000 x 1)a -----18,000 30,000
September 30 -------------(3500 x 3) – (6500 x 1)b --------4,000 34,000
December 31 --------------(2500 x 4) + (4000 x 2)c ------18,000 52,000
a. 10,000 units remaining in inventory multiplied by Br. 1 write down to lower

replacement cost
b. 6500 units in inventory multiplied by Br. 1 write-up to original FIFO cost.
c. 4000 units remaining in inventory multiplied by Br. 2 write-down to lower replacement
cost.
The Br. 52,000 cumulative cost of goods sold for Grace Company for 2003 may be verified as
follows:
Alternative 1:
11000 units sold during 2003, at Br. 4.00 FIFO cost
per unit (4 x 11,000) -------------------------------------------------------------44,000
Add: write-down of 2003 ending inventory to
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replacement cost (4000 units x Br. 2.00) ------------------------------------------8,000
------------------------------------------8,000
Cost of goods sold for 2003 ---------------------------------------------------------------52,000
---------------------------------------------------------------52,000
Alternative 2
Cost of goods available for sale (15000 units x Br. 4) --------------------------------60,000
Less: Ending inventory, at lower of FIFO cost, or market
(4000 units x Br. 2) ------------------------------------------------------------------8,000
------------------------------------------------------------------8,000
Cost of goods sold for 2003 --------------------------------------------------------------52,000
--------------------------------------------------------------52,000
Therefore, if interim reports are prepared for the 2 nd quarter, cost of goods sold is reported at
Br. 18,000.
1. What are the reasons for preparing interim financial statements?

2. What does interim financial statements include?
3. Mention the problems associated with the preparation of interim financial statements?
4. What are the two approaches to preparing interim financial statements? Which one is
recommended by APB opinion No. 28. Differentiate between the two approaches?
5. What are the principles and practices of treating revenues in interim reports?
6. What principles and practices are followed in treating direct costs and expenses in
interim financial statements? Indirect costs and expenses?
7. What are the exceptions provided by APB opinion No. 28 with respect to the
determination of costs of goods sold for interim financial statements?
8. Pool Company uses FIFO basis by applying the lower-of-cost, or market method for its
single merchandise item, M7. On January 1, year 3, the company had an inventory of
20,000 units in stock with a cost of Br. 100,000. Assume that there were no purchases
during year 3. Quarterly unit sales as well as end of quarter market quotations for the
merchandise items were as follows:
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Sales for Quarter End of quarter
Quarter (units) market quote per unit
First ---------------------------------5000 Br. 7
Second -----------------------------7000 3
Third -------------------------------4000 6
Fourth -----------------------------3000 4
Assume that the replacement cost decline in the second was not considered to be temporary.
Required
a. Compute the cost of goods sold for four quarters.
b. What is the cost of goods sold that should be reported in the third quarter interim
financial statements?
c. What is the cumulative cost of goods sold for year 3?
d. Verify the cumulative cost of goods sold for the year.
Enterprise using standard cost accounting for the determination of inventory and cost of goods
sold should follow the same procedures for interim periods as would apply to the entire fiscal
year. The following guidelines may apply to variances.
(i) Planned or normal variances at the end of the interim period should be deferred at
the interim date because they are absorbed by the end of the fiscal year.
(ii) Unplanned or abnormal variances should be shown in the interim period during
which they occur.
b. Indirect costs
Indirect costs represent those costs and expenses other than product cost (direct, or
allocated costs). APB opinion No. 28 has indicated the following standards with respect to
costs and expenses other than product costs:
(i) They should be charged to income in interim period as incurred or be
allocated among interim period based on an estimate of time expired, benefit
received, or activity associated with the periods. The same procedures
should be used as annual reporting dates.
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(ii) Those costs and expenses that cannot be readily identified with the activities
or benefits of other interim periods should be charged to the interim period
in which incurred, and disclosures should be made.
(iii) Arbitrary assignment of the amount of indirect costs and expenses to an
interim period should not be made.
(iv) Gains and losses that arise in any interim period similar to those that would
not be deferred at year-end, should not be deferred to later interim periods
within the same fiscal year.
N.B
1. The above standards apply to such items as major repairs, quantity discounts, property
taxes, and advertising costs.
2. The above standards encourage enterprises to avoid year-end adjustments as much as
possible may making quarterly estimates of items, such as inventory shortages, bad
debt expense, and contract adjustments.
2.5 INCOME TAXES IN INTERIM FINANCIAL STATEMENTS
The determination of interim operating results requires the estimation of income tax provision
for the interim periods. According to APB opinion No. 28, the amount of income tax charged to
an interim period should be related to the expected annual income tax provision. To estimate
interim income tax, we need to determine the effective tax rate for the entire current fiscal
period at the end of each interim period. This effective tax rate is applied into interim income.
Interim income tax expense (or benefit) is computed as follows:
Year-to-date tax expense or benefit ----------------------------------------------------------- xxx

Less: cumulative amounts of tax reported in the
previous interim period ----------------------------------------------------------------- xxx
Interim income tax expense or benefit ------------------------------------------------------- xxx
The effect of permanent tax differences should be estimated in determining the estimated
effective annual tax rate. Permanent tax differences include:
- Percentage of depletion
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- Nontaxable income
- Non taxable expense
In determining the estimated effective annual tax rate, we need to exclude the tax effect of non-
ordinary items of income or loss because they are sold net of income tax effect. Non ordinary
item of income or expense include:
- Extra ordinary items
- Discontinued operations
- Cumulative effect of changes in accounting principles
Illustration
Suppose that Stars Company has pretax income of Br. 130,000 at the end of the first quarter.
Assume further that at the end of the first quarter, Stars estimated that effective annual tax rate
is 59%. What is income tax provision for the first quarter?
Tax provision for the 1st quarter is equal to pretax income times estimated effective income tax
rate. i.e.
Income tax provision = Pretax income x Estimated effective tax rate

= 130,000 x 59%
= 76,700
To illustrate further, Stars Company had a pretax income of Br. 180,000 for second quarter. Its
estimated combined effective tax rate is 55% at the end of the second year. Income tax
provision for the second quarter is the difference between year to date tax expense (or benefit)
and cumulative amounts of tax reported in the previous interim period. i.e
Cumulative pretax income year-to-date (130,000 + 180,000) -----------------310,000

Tax at estimated combined rate of 55% ------------------------------------------170,500
Less: Income tax accrued first-in the 1st quarter --------------------------------- 76,700
Income tax provision for the second quarter --------------------------------------93,800
--------------------------------------93,800
The above process is repeated for the third and fourth quarters. The effect of a change in the
estimated full year tax rate is included in the tax provision of the second quarter. As a result,
retroactive revision is not undertaken.
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Journal Entries
1. To record Stars’ 1st quarter income tax provision
Income taxes expense ------------------------76,700
Income taxes payable -------------------------76,700
2. To record Stars’ 2nd quarter income tax provision
Income taxes expense -------------------------93,800
Income taxes payable --------------------------93,800
Tax benefit arises when operating result for the quarter turned to be a loss and the realization of
tax benefit is assured reasonably. If income tax benefit resulting from operating loss is not
reasonably assured, it is not realized.
To illustrate, consider the following data for Stars Company in year 3.
Pretax income Estimated

Quarter Current Year to date tax rate for year
First -----------------Br. (40,000) Br. (40,000) 70%
Second -------------------30,000 (10,000) 70%
Third ---------------------70,000 60,000 70%
Fourth --------------------90,000 150,000 65%
Assume that tax benefits that arise from loss are not assured beyond a reasonable doubt.
Based on the above data, income tax provision for each quarter can be determined as follows:
Tax provision for quarter three:

Cumulative pretax income year to date ------------------------------------------------- 60,000
Tax at estimated combined rate (70% x 60,000) ---------------------------------------42,000
Less: Income tax accrued for the 1st and 2nd quarters -------------------------------------0
-------------------------------------0
Income tax provision for the 3rd quarter ------------------------------------------------ 42,000
Tax provision for 4th quarter:

Cumulative pretax income ---------------------------------------------------------------150,000
---------------------------------------------------------------150,000
Tax at estimated combined rate of 65% --------------------------------------------------97500
Less: Tax accrued for 1st, 2nd, & 3rd quarters -------------------------------------------42,000
-------------------------------------------42,000
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Income tax provision ---------------------------------------------------------------------- 55,500
The manner in which tax provisions (tax benefits) are determined differs if tax benefits arising
from loss are assured reasonably. To illustrate, consider the above data for Stars Company
assuming that the realization of tax benefits from the 1st quarter was assured reasonably. Then
tax benefits or expense for each quarter can be determined as follows:
First Quarter
Cumulative pretax income ------------------------------------------------------ (40,000)
Tax at estimated effective rate of 70% (40,000 x 0.70)---------------------- (28,000)
Quarter two
Cumulative pretax income ----------------------------------------------------- (10,000)
Tax at estimated combined rate of 70% (10,000 x 0.70)-------------------- (7000)
Less: Tax benefit accrued for 1st quarter ------------------------------------ (28,000)
Tax benefit in 2nd quarter ------------------------------------------------------- 21000
3rd quarter
Cumulative pretax income ------------------------------------------------------ 60,000
Tax at estimated combined rate of 70% (60,000 x 0.70)-------------------- 42,000
Less: Tax benefits accrued for 1st & 2nd quarters ----------------------------(7,000)
----------------------------(7,000)
Tax provision for 3rd quarter --------------------------------------------------- 49,000
4th quarter
Cumulative pretax income -------------------------------------------------------150,000
-------------------------------------------------------150,000
Tax at estimated combined rate of 65% (150,000 x 0.65)- --------------------97500
Less: Tax accrued for three quarters -------------------------------------------- 42,000
Income tax provision for 4th quarter ---------------------------------------------55,500
---------------------------------------------55,500
1. Assume that Moon Company prepares its interim financial statements quarterly. The
following data were extracted from its records during year 2.
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Quarterly pretax Estimated tax rate for
Quarter Income year
First Br. 180,000 60%
Second 160,000 70%
Third 220,000 50%
Fourth 290,000 40%
Required
a. Determine income tax provision for each quarter
b. Prepare the entry to record income tax provision for each quarter.
2. Assume that Moon Company prepares its interim financial statements quarterly. The
following data were extracted from its records during year 3.
Quarterly pretax Estimated tax

Quarter Income rate for year
First -------------------- Br. (95,000) 40%
Second ---------------------(40,000) 50%
Third -----------------------120,000 50%
Fourth ---------------------200,000 40%
Required
a. Assuming that the realization of tax benefits is not reasonably assured, determine tax
benefit or tax expense for each quarter.
b. Assuming that the realization of tax benefit is reasonably assured, determine tax benefit
or tax expense for each quarter.
2.6 REPORTING OF ACCOUNTING CHANGES AND EXTRA ORDINARY AND

OTHER NON OPERATING ITEMS
2.6.1 Reporting extra ordinary and other non operating items
Extra ordinary items are events or transactions that are distinguished by their unusual nature
and by the infrequency of their occurrence. Any loss arising from extra ordinary events are
27
shown in the income statement, net of income taxes. Extraordinary and unusual items are
reported in full as they occur so that their impact is immediately known i.e. they are shown in
the income statement in the interim period in which they occur.
2.6.2 Reporting gains or losses from disposal of business segment
Business segment is a component of a business enterprise whose activities represent a separate

major line of business or class of customer. Any gain or loss on the disposal of the segment is
reported separately in the income statement, net of the related income tax effects. In interim
reports, any gain or loss resulting from disposal of segment is reported in full in the interim
period it arises.
2.6.3 Reporting accounting changes in interim periods
Business enterprises are required to use accounting principles consistently so that the financial
performance of two periods can be compared. However, management of a business enterprise
may justify a change in accounting principles on grounds that it is preferable. There are three
types of accounting changes. These are changes in accounting principles, a change in
accounting estimates, and a change in reporting entity.
A change in accounting principles generally requires the inclusion of the cumulative effect of
change to a new principle in net income of the accounting period in which the change is made.
Change in accounting estimates affect only the current and future periods’ financial statements.
With regards to reporting accounting changes in interim period, there are two principal
provisions.
1. Accounting changes in the First interim period

If a change of accounting principles is made during the first interim period of an enterprise’s
fiscal year, the cumulative effect of the change on retained earnings at the beginning of that
fiscal year shall be include in net income of the first interim period.
2. Accounting changes in other than the first interim period of an enterprise.

If a change of accounting principle is made in other than the first interim period no cumulative
effect of the change shall be included in net income of the period of the change. Instead,
financial information for the pre-change interim periods of the fiscal year in which the change
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is made shall be stated by applying the newly adopted accounting principle to those prechance
interim periods. The cumulative effect of the change on retained earnings at the beginning of
that fiscal year shall be included in restated net income of the first interim period of the fiscal
year in which the change is made.
2.7 DISCLOSURE OF SUMMARIZED INTERIM FINANCIAL DATA
In order to be timely, interim financial reports may not be as detail as annual financial reports.
However they should contain at minimum the following information: for the current quarter,
the current year-to date, or the last 12 months to date.
1. Sales (or gross revenue),
2. Provision for income taxes
3. Extra ordinary items
4. Cumulative effect of change in accounting principles
5. Net income
6. Earning per share data
7. Seasonal revenue, costs, or expenses
8. Significant changes in estimates or provision for income taxes
9. Disposal of a business segment
10. Contingent items
11. Significant changes in financial position
Note that interim reports may not be prepared for the 4th quarter of the fiscal year. In such case,
annual financial reports should disclose the effects of the following for the fourth quarter:
- Disposal of a segment
- Extraordinary items
- Changes in accounting principles
- The aggregate effect of year-end adjustments that are material to the 4th quarter
results.
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2.8 SUMMARY
Annual financial statements normally do not provide decision makers with the timely data
needed to make decisions. Thus, external decision makers need financial data for shorter
intervals of time. Interim financial statements are provided to external users to meet their needs.
Interim financial statements may be prepared using the discrete period approach, and integral
period approach. The integral period approach is presently used for interim reporting purposes.
Revenues in interim reports are recognized on the same basis used for annual reports. Costs and
expenses that are associated with revenue are allocated to the products or service rendered.
Another costs and expenses are charged to the interim period based on time expired, benefits
received, or activities associated with the interim period.
The income tax provision for an interim period should use an effective annualized tax rate.
Extraordinary and other non-operating items should be recognized in the interim period in
which they occur.
2.9 ANSWERS TO CHECK YOUR PROGRESS EXERICSES
1. - To provide frequent and timely information to decision makers

- To project the annual financial results.
2. - Selected financial data
- Complete set of financial statements
3. - Difficulty to make estimates and judgments as accurately as possible.
- The treatment of seasonal expenses
4. Discrete period approach and integral period approach. APB opinion No. 28
recommends the integral period approach. Discrete period approach treats each period
as a distinct accounting period whereas integral period approach treats interim period as
an integral part of the annual period.
5. Revenues are recognized on the same basis as followed for the full year.
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6. Direct costs and expenses are recognized in the same way as full year. Indirect costs and
expenses are charged against income as incurred in the interim period.
7. a. If gross profit method is used to estimate the cost of goods sold, it has to be disclosed.
b. The interim cost of goods sold should include for replacement of inventory when
LIFO method is used.
c. Inventory losses resulting from market declines should not be deferred beyond the
interim period in which they occur.
8. a. Quarter 1 = Br. 25,000 Quarter 3 = Br. 4,000
Quarter 2 = Br. 51,000 Quarter 4 = Br. 16000
b. Br. 20,000
c. Br. 96,000
d. 19,0000 units sold during year 3 at Br. 5.00 ------------------------ 95,000
Add: write-down of year 3 ending inventory
to replacement cost (1000 x Br. 1) ----------------------------1,000
----------------------------1,000
Cost of goods sold for year 3 ---------------------------------------- 96,000

1. (a) 1st quarter =Br. 108,000 3rd quarter = Br. 42,000
2nd quarter = 130,000 4th quarter = Br. 60,000
1st 2nd 3rd 4th
(b) Income taxes expense 108,000 130,000 42,000 60,000
Income taxes payable 108,000 130,000 42,000 60,000
2. a) Quarter
One = 0
Two = 20,500
Three = 60,000
Four = 81,500
b) Quarter
One = (38,000)
Two = 29500
Three = 60,000
Four = 81,500
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2.10 GLOSSARY
1. Interim financial statements. Financial statements prepared for a period of less than a
year.
2. Discrete period approach. The approach in which each interim period is treated as a
distinct accounting period.
3. Integral period approach. The approach in which an interim period is considered as an
integral part of the annual period.
4. Temporary inventory market decline. A market value decline of inventory in one
interim period with an expected market recovery in a subsequent interim period within
the same fiscal year.
5. Extraordinary items. Events or transactions that are distinguished by their unusual
nature and by the infrequency of their occurrence.
6. Business segment. A component of a business enterprise whose activities represent a
separate major line of business or class of customer.
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UNIT 3: ACCOUNTING FOR ESTATES AND TRUSTS
Content

3.1 Introduction
3.2 Legal Aspects of Estate Administration
3.3 The classifications of legacies
3.4 Accounting aspects of state administration
3.5 Accounting and reporting for estates
3.5.1 Accounts Relating to Principal
3.5.2 Accounts Relating to Income
3.5.3 Reporting For Estates
3.6 Legal and accounting aspects of trusts.
3.7 Summary
3.8 Answers To Check Your Progress Exercises
3.9 Model Examination Questions
After successfully completing this unit, you will be able to:

- discuss the objective of estate planning
- explain the terminology and the legal steps of estate administration
- understand the accounting aspects of estate administration and the distinction between
principal and income
- prepare a charge and discharge statement
- summarize the legal and accounting aspects of trusts.
3.1 INTRODUCTION
Estate accounting is concerned with accounting for the administration and distribution of the
decedent’s property. In effect, this unit explores the legal and accounting aspects of estate
administration and trust.
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3.2 LEGAL ASPECTS OF ESTATE ADMINISTRATION
According to Oxford current English dictionary, estate refers to person’s assets and liabilities at
death. The estates of deceased persons (decedents), or missing person should be administered
distributed, and accounted by certain laws. The deceased person may or may not leave his will
about the estates.
If a person died with a valid will, he/she is considered to have died testate. This person is called
testator.
The disposition of such person’s real and personal property is governed by the will of the
testator.
On the other hand, a person may not leave his will in part/wholly about the real and personal
proprieties. He/she is considered to have died (in testate). In this case, the distribution of such
person is governed by the provisions of certain laws (laws of intestacy).
The administration of estate involves marshaling the estate’s assets, paying the debts of the
decedent, and the distribution of the remaining in accordance with the testator’s wishes or the
laws of intestacy. If the deceased left the will, the validity of the will should be validated. The
process by which the validity of a will is established is called probating the will. Once a will
has been admitted to probate, the court will proceed to appoint a personal representative of the
deceased whose function is to administer the estate. This person is called an executor
(executrix). An executor is a male fiduciary named in the will be the decedent to administer the
estate. An executrix is a female fiduciary named in the will of the decedent to administer the
estate.
If the decreased dies intestate, the court will appoint a personal representative who can
administer the estate. This person is called an administrator (adiminstiratrix). An administrator
is a male fiduciary appointed by a court to administer the estate of an in testate decedent. An
administratrix is a female fiduciary appointed by a court to administer the estate of an intestate
decedent. The appointed person is issued letters of administration as evidence of that
individual’s authority to act as a fiduciary to administer the estate of the intestate decedent.
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Once appointed, the personal representative will take the possession and control of the
decedent’s property. If it is a business enterprise, the representative may continue to operate a
business for some time (no longer than four months in USA) with the specified period (three
months in USA), the personal representative must submit to the court an inventory of property
owned by the decedent on the date of death. He/she also submits a list of any leins that exist
against the property. If additional assets of the decedent are discovered after the filing of the
inventory with the court, supplementary inventory reports must be filed with the court.
Claims against the estate

Once appointed, the representative must give public notice in a newspaper of general
circulation at sometime interval. The purpose of the notice is to request that those who have
claims against the estate present them within the specified time, or be forever barred from
asserting such claims.
Some allowances and exemptions precede all claims against estate. These are described as
follows:
1. Homestead allowance
It refers to an allowance of certain amount ($500 in USA) to a surviving spouse or surviving
minor children of the decedent. This allowance is additional to any other share of the estate that
passes to the spouse or children by the will.
2. Family allowance
It refers to a reasonable cash allowance (not to exceed $6000 for the 1st 12 months after death in
USA) to the decedent’s surviving spouse and dependent children. Except homestead allowance,
family allowance has priority over all claims against the estate.
3. Exempt property
It is a decedent’s household furnishings, automobile and other personal effects up to a value of
certain amount ($3500 in USA) and not available to creditors of the estate to the surviving
spouse and children.
After the above allowances are excluded, the representative pays in the claims in the following
order:
35
1. The expense of administering the estate
2. The funeral expense as well as the hospital and medical expense of the decedent’s
last illness.
3. Debts and taxes that have preference under federal or state laws.
4. All remaining claims
The settlement of an estate

Once the claims against the estate have been established and paid, the personal representative
has the duty to distribute the remaining assets of the estate to persons entitled to it.
Distribution of Intestate
When a person has died intestate, his/her estate will be distributed in accordance with the
applicable law. This is generally distributed to a spouse or blood relative. Real property is
distributed to heirs under the laws of the state where the property is located (in USA). Personal
property is distributed to next of kin under the laws of the state in which the decedent was
domiciled.
Distribution of Testate
If a person dies testate, the distribution of the decedent’s property is mostly governed by the
terms of the will. In such a situation, the gift of real property is called a devise. The recipient
(beneficiary) is called a devisee. Testamentary gifts of personal property are called bequests or
legacies. The recipient (beneficiary) is called legatee.
3.3 THE CLASSIFICATION OF LEGACIES
As defined above, legacy refers to the testamentary gifts of personal property. There are various
types of legacies. They are described below:
a. A specific legacy
It is a gift of personal property specifically identified in the will such as a specific piece of
Jewelry.
36
b. A demonstrative legacy
It is a testamentary gift payable out of a source specified in the will such as a specific amount
of money to be paid out of a specific bank account or the proceeds from a specific insurance
policy.
c. A general legacy
It is a gift of an indicated amount of money or quantity of something without designation as to
source.
d. Residual legacy
It is a testamentary gift of property remaining in an estate after all debts have been satisfied and
all other legacies have been distributed, or otherwise provided for.
3.4 ACCOUNTING ASPECTS OF ESTATE ADMINISTRATION
Facilitating the reporting by the personal representative, called fiduciary to the court is the
major purpose of estate accounting. The reporting involves two aspects. There are:
1. Accountability
Accountability emphasizes that the personal representative is responsible for the assets of the
deceased and for their administration and disposition. In this case, estate accounting reflects the
assets for which the fiduciary is charged with responsibility and the distributions and payments
to creditors and beneficiaries. The fiduciary is credited with the distributions and payments to
creditors and beneficiaries.
2. The distinction between principal and income

The distinction between principal and income is the basic to estate accounting. Principal, also
called corpus, is defined as the property set aside by the owner (or the person legally entitled to
do so) so that it is held in trust for eventual delivery to remainderman. Remainderman is a
person named to receive the principal of an estate at the conclusion of the income beneficiary’s
interest. Principal consists of the net assets of the estate on the date of death.
Net Assets = Gross Assets – Liabilities

Principal includes
37
- Proceeds of insurance on property forming part of the principal
- Stock dividends and liquidating corporate distributions
- Rents or other types of revenues which already accrued at the date of death of the
testator
- All proceeds from the sale or redemption of bonds
- Cash dividends declared prior to a decedent’s death.
Charges against estate principal include:

- All expenses incurred in connection with the settlement of an estate. These include
funeral expenses, debts, estate taxes, interest on taxes, penalties on taxes, and family
allowances.
- Part of court costs and accountant’s fees, attorneys’ fees, personal representatives
fees, and trustees’ fees. The remaining part of these costs should be charged against
income.
- Costs incurred in preparing principal property for sale or rent.
- Cost of investing and reinvesting principal assets
- Major repairs to principal assets
- Income taxes on receipts or gains allocable to principal
- Rental expenses payable at the date of death of the decedent.
Income
Income is defined as the return in money, or property derived from the use of principal. Income
represents the earnings on the net assets of the estate. Income includes
- Rent
- Interest
- Cash dividend
- Receipts from business and farming operations
- Any revenue earned during the administration of a decedent’s estate.
Income may be charged with the following items:

- Ordinary expenses incurred in the management and preservation of estate or trust
property. This includes regularly recurring taxes assessed on the principal
- Water charges
38
- Insurance premiums
- Interest
- Ordinary repairs
- Depletion and depreciation depending on the expressed intention of the testator with
respect to the preservation of the principal of the estate
- Expenditures required to preserve the normal operating efficiency of depreciable
assets.
Depending on the testator’s will, the income of the estate (or a portion of it) accrues for the
benefit of one party for a stipulated period of time. The party who is entitled for the income of
the estate is called income beneficiary for a limited period of time after which the principal is
to be distributed to another party, called remainderman. Remainderman was defined earlier. To
illustrate the difference between income beneficiary and remainderman, assume that Ato
Bulcha has a business enterprise called Bulcha Company. W/ro Biftu is the spouse of Ato
Bulcha. Ato Bulcha has also three children. Assume further that Ato Bulcha has died on May
10,2004, at which time the net asset of his business is Br. 200,000. Before his death, he
expressed that income from his business is to be used by his spouse, and after her death the Br.
200,000 would be used by his children.
From the above description, the Br. 200,000 represents the principal. W/ro Biftu is called
income beneficiary, Ato Bulcha’s children are called remaindermen.
3.5 ACCOUNTING AND REPORTING FOR ESTATES
As indicated earlier, the major focus of estate accounting is on the accountability for estate
assets and for their proper administration and distribution. Therefore, regarding fiduciaries, the
fundamental accounting equation is shown below:
Assets = Accountability
The accounts are primarily designed to maintain the distinction between principal (capital, or
corpus), and income.
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3.5.1 Accounts relating to principal
The following accounts are used in relation to principal
1. Individual asset accounts

The accounting for an estate begins when the fiduciary files an inventory of the decedent’s
property with the court. At that time each asset account is debited at the asset’s fair market
value. For example, if the decedent has cash of Br. 10,000 and inventory with a market value of
Br. 15000 on the date of death, cash account is debited for Br. 10,000, and inventory account is
debited for Br. 15,000.
2. Estate principal account

Estate principal account is credited when asset accounts are debited. In the above example,
estate capital account is credited for Br. 25,000 (i.e 10,000 Br. 15,000 – 25,000) if the decedent
had no liability. Estate principal account is the basic equity of the estate.
3. Assets Subsequently Discovered account

Assets Subsequently Discovered account is used to record assets that were not inventoried of
the date of death of the estate. This account is credited when the market value of the asset
discovered is debited to an appropriate asset account.
4. Gain (loss) on realization

This account is used to record any gain or loss upon the disposal of the deceased person’s
assets. Loss on realization account is debited if loss arises on disposal of assets. On the other
hand, if the disposal of assets results in gain, gain on realization account is credited.
5. Debts of Decedent Paid account

This account is used by the personal representative to indicate reduction of accountability for
estate assets in the form of payment of debts and legacies. Legacy refers to a testamentary gift
of personal property.
3.5.2 Accounts relating to income
The following accounts may be used in relation to income:

1. Estate Income account
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Estate Income account is used to record income collections.
2. Expense accounts
They are used to record expenses allocable against the interests of income beneficiaries.
3. Distributions to Income Beneficiaries accounts

It is used to record the distribution of income to income beneficiary.
3.5.3 Reporting for estates
The personal representative is required to prepare reports for estates and submits to the court.
He/she is required to prepare two types of reports. There are:
1. Charge and discharge statement - principal
2. Charge and discharge statement – income
Illustration for Estate Accounting

Assume that Ato Tadege died testate on April 5, 2003. His estate consisted of the following as
prepared by the executor on April 27, 2003.
Cash in bank Br. 90,000
Household Effects 20,000
Investment in Dashen bank stock 50,000
Investment in government bonds 60,000
Dividend declared on April 2, 2003
On Dashen Bank stock 5,000
Accrued interest on government bonds 8,000
According to the terms of the will, Ato Kassa Tadege is appointed to be executor. This will also
provided that general legacies of Br. 7000 (in cash) be paid to Meskerm (Decedent’s grand
daughter), and the decedent’s household effects to go to Ato Kassa Tadege. After payments of
debts and proper charges and distribution of legacies, the remainder of the estate property will
be distributed to Ato Kassa Tadege.
The following transactions and events occurred relating to the estate.

1. Public notice was given that creditors of the estate should make a presentment of their
claims.
41
2. Paid funeral expense Br. 3000
3. Collected interest on government bonds, Br. 8,000
4. Collected dividend on Dashen Bank stock, Br. 5000
5. Discovered rare coin collection and sold it for Br. 12000 cash.
6. Interest earned subsequent to date of death on cash in bank account Br. 2000.
7. Paid debts of the decedent Br. 6000
8. Paid attorney’s fees, Br. 2000, and other administration expenses of Br. 5000 of which
Br. 1000 relate to income.
9. Sold Dashen Bank stock for Br. 48000.
10. Paid cash legacies provided for in the will
11. Deliver the household effects to Ato Kassa Tadege
12. Interest accrued on government bonds, Br. 1500
13. Distributed remaining assets to residuary beneficiaries
Instructions
a. Prepare journal entries of the fiduciary
b. Prepare charge and discharge statement of Ato Kassa Tadege as to principal and
income as of Dec. 31, 2003.
c. Prepare closing entries reflecting the distribution of remaining assets to residual
beneficiaries and closing the fiduciary books.
Solution
a. Journal entries
April 27, 2003 (To record inventory of Ato Tadege’s estate)

Cash – principal 90,000
Household effects 20,000
Dividend receivable 5,000
Interest receivable 8,000
Estate principal 233,000
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1. No entry is needed
2. Funeral and administration expense 3000
Cash – principal 3000
To record funeral expense paid
3. Cash – principal 8000
Interest receivable 8000
To record interest collected on government bonds
Dividend receivable 5000
To record dividend collected on Dashen bank stock
Assets subsequently discovered 12000
To record the value of coins discovered
6. Cash – Income 2000
Estate income 2000
To record interest earned on bank account
7. Debts of decedent paid 6000
Cash-principal 6000
To record the payment of decedent’s debts
8. Funeral and administration expense 6000
Expenses-income 1000
Cash – principal 6000
Cash – income 1000
To record the payment of attorney’s fees and administration expense
9. Cash – principal 48,000
Loss on realization 2,000
To record the disposal of Dashen bank stock
10. Legacy – Meskerem 7000
Cash-principal 7000
To record the payment of legacy
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11. Legacy – Kassa 20,000
To record the delivery of household effect as per will
12. Interest receivable 1500
Estate income 1500
To record accrued interest on government bonds
b. Charge and discharge statement – principal
Estate of Ato Tadege, Deceased

Kassa Tadege, Executor
Charge and Discharge statement
April 27 to December 31,2003
I charge myself with:

Assets per original inventory $ 233,000
Assets subsequently discovered 12,000
Total 245, 000
I credit myself with:

Loss on realization of assets 2000
Funeral and administration expenses 9000
Debts of decedent paid 6000
Legacies paid/distributed
Mesekerm (cash) 7000
Kassu (household effects) 20,000 44,000
Balance as to principal $201,000
Which consists of:
Cash 141,000
$ 201,000
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Cash – principal
Bal. 90,000 3000 (2)
(3) 8000 6000 (7)
(4) 5000 6000 (8)
(5) 12,000 7000 (10)
(9) 48,000
Bal. 141,000
Charge and discharge statement – income

Estate of Ato Tadege, Deceased
Kassa Tadege, Executor
April 27 to December 31, 2003

Income collected/Accrued@ $ 3500
Expenses chargeable to income 1000
Balance as to income $ 2500
Which consists of:
Cash $ 1000
Interest receivable (government bonds) 1500
$ 2500
Estate income cash – income expense – income
2000 (6) (6) 2000 1000 (8) (8) 1000
1500 (12) Ba. 1000
Bal. 3500
Interest – receivable
(12) 1500
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c. Closing entries reflecting the distribution of estate assets.
13. Legacy – Kassa 201,000
To close the distribution of residual assets to residuary beneficiary
14. Estate principal 233,000
Loss on realization 2000
Debts of decedent paid 6000
Legacy – Meskerem 7000
Legacy – Kassa 221,000
Funeral & administration expenses 9000
To close open accounts as to estate principal
15. Distribution to Kassa 2500
Cash – income 1000
Interest receivable 1500
To record the distribution of remaining cash and interest receivable to income beneficiary.
16. Estate income 3500
Expense – income 1000
Distribution to income beneficiary – Kassa 2500
To close open accounts as to income.
Check your progress
1. Mention accounts that are related to principal in estate accounting.

2. Mention accounts that are related to income in estate accounting.
3. What is the fundamental accounting equation for the representative in estate
accounting?
4. What is the major focus of estate accounting?
5. Suppose that the personal representative has discovered undeposited cash after he has
filed the decedent’s property with a court? What account is used to record the
undeposited cash?
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6. When the representative paid cash to decedent’s creditor’s, what account should be used
to record?
7. What are the two major reports in estate accounting?
8. Ato Tulu died testate on January 13, 2004. His estate consists of the following:
Cash 40,000
Personal effects 20,000
Investment in AIB stock 90,000
House 100,000
The personal representative is Ato Wadajo
According to the terms of the will, personal effects were to be transferred to Ato Tulu’s
Son-in-law (Chala) and the title to the house transferred to Tulu’s wife (Ayantu). All
remaining assets were to be set up in trust for Ayantu. The following transactions occurred
as listed below:
1. Discovered undeposited cash amounting, $ 15,000
2. Paid debts of decedent, $ 25,000
3. Dividends declared and collected on AIB common stock, $ 8000.
4. Sold half of the common stock for $ 48,000.
5. Paid funereal and administrative expense, of $ 19,000, of which $ 3000 should be
charged against income.
6. Distributed legacies according to the terms of the will.
Required: prepare
a. Journal entries to record the transactions
b. Prepare a charge and discharge statement
c. Prepare journal entries to transfer to trust
d. Prepare the journal entries to close the books
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3.6 LEGAL AND ACCOUNTING ASPECTS OF TRUSTS
Estate administration Vs Trust administration

Estate administration is generally a short-term process that aims at the expeditious distribution
of estate assets. On the other hand, trust administration consists of the prudent management of
funds over longer period of time.
A trust may be created by a living grantor who transfer property for the benefit of another
person (beneficiary) to a trustee. The trustee is responsible to hold assets for the beneficiary.
The income from a trust is ordinarily distributed periodically to an income beneficiary. The
principal of the trust ultimately goes to a remainderman. The income beneficiary and the
remainderman may be the same person.
The trust may be testate or instate. When a trust is created by a will, it is called a testamentary
trust.
Trust accounting
The accounting procedures for a trust are very similar to those of an estate. With respect to
reporting, the trustee is required to fill an accounting with the court concerning events of the
previous period, specifying the accounting period, and giving the names and addresses of the
living beneficiaries. The trustee must give a statement of unpaid claims and reasons for non-
payment within the reporting period. Besides, the trustee must render final accounting covering
the period since the last intermediate accounting at the termination of the trust. He/she must
also prepare the plan for the distribution of trust assets still on hand. To conclude, the function
of the trustee is the administration of the trust, preservation of the assets, the discharging of
liabilities, and the equitable distribution of principal and income to those entitled to them in
accordance with applicable laws and the intent of legal requirements.
3.7 SUMMARY
The planning for and the administration of estates and trusts involves accounting skills, and
knowledge of tax and other specialized areas of law. The focus of estate and trust accounting is
not on compliance with generally accepted accounting principles, rather on specialized
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bookkeeping practices and accounting statements that aim at carrying out the intent of the law
and the intent of those who leave estates or create trusts.
A decedent died with testate leaves a will directing the distribution and administration of
his/her property. Whether the decedent had died testate or intestate, the administration of the
estate is normally under the jurisdiction of a court handling probate matters. The court issues
lesser of testamentary if the decedent died testate, and letters of administration if the decedent
died intestate.
Claims against estate are in the order of allowances and exemptions (homestead allowance,
family allowance, and exempt property) and followed by creditors.
If the estate is sufficient to liquidate all of the debts of the decedents with some estate property
remaining, the fiduciary may proceed with the distribution of the estate’s real property and its
personal property. The gift of real property is called a devise and the recipient is a devisee. A
gift of personal property is called a bequest or legacy and the recipient is a legatee. A legacy
may be any of the following:
1. Specific legacy – legacy specifically identified
2. Demonstrative legacy – a sum of money payable out of a particular bank account
3. General legacy – sum of money without naming the source of the funds
4. Residual legacy – balance in the estate after paying all debts and other legacies.
The fiduciary has to classify the estate assets in to principal and income because income
beneficiary is different from principal beneficiary. Accounts used in principal accounting and
income accounting are different. Ultimately two separate statements are prepared by the
fiduciary – charge and discharge statement – principal, and charge and discharge statement –
income.
Finally, the administration of trusts is similar to that of estates – the administrator of a trust is
called a trustee and the recipient of a trust’s benefits is a beneficiary.
1. Individual assets account, estate principal, assets subsequently discovered, gain (loss)
on realization, and debts of decedent paid.
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2. Estate income, expense, and distribution to income beneficiary
3. Assets = Accountability
4. On the accountability for estate assets, their proper administration and distribution.
5. Assets subsequently discovered
6. Charge and discharge statement – principal, and charge and discharge statement –
income
7. Debts of decedent paid.
8. a) Journal entries
Cash 40,000
House 100,000
1. Assets subsequently discovered 15,000
2. Debts of decedent paid 25,000
3. Cash – income 8000
Estate income 8000
4. Cash – principal 48,000
Gain on realization 3,000
5. Funeral & administrative expenses 16,000
Expenses – income 3000
Cash – income 3,000
6. Legacy – Tulu 20,000
Legacy – Ayantu 100,000
House 100,000
b. Charge and discharge statement
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Estate of Ato Tulu, Decedent
Ato Wadajo, personal representative
Charge and discharge statement (principal)

Assets per original inventory 250,000
Gain on realization 3000
Total 268,000
Funeral and administrative expenses 16,000
Debts of decedent paid 25,000
Legacies paid/distributed:
Tulu (effects) 20,000
Ayantu (House) 100,000 161,000
Balance as to principal 107,000
Which consists of
Cash 47,000
Investment in AIB common stock 45,000
3.9 MODEL EXAMINATION QUESTIONS
1. The administration of estate involves:

a. Marshalling an estate’s assets
b. Paying the debts of the decedent
c. The distribution of estate asset to creditors
d. The distribution of estate asset to the beneficiaries
e. All of the above
2. A male fiduciary appointed by a court to administer the estate of an interstate decedent
is:
a. Executor d. trustee
b. Bequest e. b and c
c. Administrator
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3. A principal account that is used to record assets of an estate not inventoried as of the
date of death but discovered at a later date is:
a. Debts of decedents paid
b. Income
c. Estate principal
d. Assets subsequently discovered
e. None of the above
4. A decedent is:
a. A devisee c. deceased person e. legatee
b. Executor d. remainderman
5. The testamentary gift of real estate is:
a. Decedent c. legacy e. a and c
b. Devise d. remainderman
6. A testamentary gift of an amount of money without designation is:
a. Specific legacy d. residual legacy
b. Demonstrative legacy e. bequest
c. General legacy
7. A testamentary gift payable out of a source specified in the will is:
a. General legacy d. specific legacy
b. Demonstrative legacy e. none
c. Residual legacy
8. The recipient of a testamentary gift of a personal property is:
a. Advisee c. grantor e. decedent
b. Legatee d. trustee
9. The recipient of a testamentary gift of real property is:
a. Grantor c. advisee d. decedent
b. Trustee e. legatee
10. A person named to receive the principal of an estate at the conclusion of the income
beneficiaries interest is:
a. Legatee c. personal representative
b. Trustee d. remainderman e. income beneficiary
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11. The status of a person who dies leaving a valid will is:
a. Decedent c. intestate e. legatee
b. Testate d. devisee
12. Which of the following account is not related to income in estate accounting?
a. Estate income c. distribution to income beneficiaries
b. Expense accounts d. debts of decedent paid
e. c and d
13. In estate accounting, income includes:
a. Interest on principal after death of decedent
b. Cash dividends before death
c. Rent income on the building of the decedent after death
d. Proceed from disposal of decedent’s investment
e. a and c
14. Creditors of the decedent have prior claim against the estate. True / False
15. If the decedent died intestate, the estate should be taken by the government. True/False
Exercise
1. Ato Jagama died on August 24, 2004. The will named Sarecho as the executor of the
estate. The executor prepares the following trial balance on December 5, 2004.
Serecho
Executor of the will of Jagama
Trial balance
December 5, 2004
Dr. Cr.
Cash – income 2,400
Art collection 42,000
Bond holdings 90,000
Gold bullion 7,500
Assets discovered 12,200
Liabilities paid 16,400
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Funeral & administrative exp. 4,500
Estate principal balance 215,500
Interest revenue 6,600
Expenses changeable to income 4,200
Total $ 234,300 $ 234,300
The estate principal balance of $ 215,500 represents the inventory of assets as of August
24,2004
Required
Prepare a charge and discharge statement for the estate of Jagama.
2. Ato Arega died on April 2, 2004. The will named Ato Belay as the executor of the estate,
which consisted of the following.
Cash 80,000
Condominium apartment 92,000
Treasury Bills 10,000
Automobile 6,000
Investment in common stock 52,000
The will instructed the executor to transfer household effects and the automobile to his son
Tulu; to pay taxes, liabilities, & administrative expenses of the estate; and to transfer the
remaining assets to a trust for the benefit of his son. Income from the estate and the trust is to
be paid to the son (Tulu).
Transactions of the executor during the period of April 2 September 3,2004 are shown below:
1. Paid administrative expenses for the estate, Br. 6500
2. Paid debts of decedent, Br. 13,600
3. Sold half of the common stock for Br. 32,500
4. Received Br. 600 interest payment on Tresury Bills.
5. Received dividends on the remaining stock, Br. 2800
6. Transferred household effects and automobile to the son, Tulu.
7. Paid expenses chargeable to income, Br. 960
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8. Distributed the income of the estate to Tulu.
9. Paid estate taxes, Br. 34,300.
Required.
Required. Prepare:
a. Journal entries on the books of the executor to record the transactions including
the opening entry and to close the accounting records for the estate on
September 2, 2004.
b. A charge and discharge statement prior to the transfer of estate assets to the
trust.
c. The journal entry to establish the accounting records for the trust.
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UNIT 4: BANKRUPTCY LIQUIDATION AND REORGANIZATION
Content
4.1 Introduction
4.2 Insolvency Vs Bankruptcy
4.3 Bankruptcy Liquidation
4.3.1 Debtors’ Petition
4.3.2 Creditors’ Petition
4.3.3 Unsecured Creditors with Priority
4.3.4 Property Claimed as Exempt
4.3.5 Role of Court In Liquidation
4.3.6 Role of Creditors
4.3.7 Role of Trustee
4.3.8 Discharge of Debtor
4.3.9 Role of Accountant in Bankruptcy Liquidation
4.4 Bankruptcy Reorganization
4.4.1 Appoint of Trustee or Examiner
4.4.2 Plan of Reorganization
4.4.3 Accounting for a Reorganization
4.4.4 Disclosure of Reorganization
4.5 Summary
After completing this unit successfully, students should be able to: -

- differentiate between bankruptcy liquidation and bankruptcy reorganization
- understand accounting for bankruptcy liquidation
- understand accounting for bankruptcy reorganization
- understand the roles of accountants, court, creditors and trustee in bankruptcy
liquidation.
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4.1 INTRODUCTION
Changes in business environment are common. If they are not properly managed, they may
cause business failures. More specifically, the causes of business failures include poor
management, excessive debt, and inadequate accounting. These result in the inability of firms
to pay their liabilities when they become due. This would bring about bankruptcy.
This chapter is concerned with bankruptcy liquidation and reorganization.
4.2 INSOLVENCY VS BANKRUPTCY
The term insolvent and bankrupt are often used interchangeably. Such usage is technically
incorrect. Insolvent refers to the financial condition of a person or business enterprise whereby
the sum of debts is greater than all of the fair value of its property. On the other hand, bankrupt
refers to a legal state.
4.3 BANKRUPTCY LIQUIDATION
Bankruptcy liquidation refers to the process that involves the realization (sale) of the assets of
an individual or a business enterprise and the distribution of the cash proceeds to the creditors
of the individual or enterprise. There are four classes of creditors in bankruptcy liquidation.
There are:
a. Fully secured creditors.
creditors. They are entitled to obtain satisfaction of all or part of
their claims from the assets pledged as collateral.
b. Partially secured creditors.
creditors.
c. Unsecured creditors with priority.
priority. The claims of these creditors are satisfied
in full from proceeds of realization of the debtor’s noncollateralized assets.
d. Unsecured creditors without priority.
priority. This class of creditors receive cash
from proceeds available from the realization of the debtor’s assets.
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4.3.1 Debtor’s petition (voluntary petition)
According to bankruptcy code, any person may file a petition in a court for voluntary
liquidation. The debtor’s bankruptcy petition must be accompanied by supporting exhibits of
the debts and property of the petitioner. The debts are classified into three. There are:
i. Creditors having priority
ii. Creditors holding security
iii. Creditors having unsecured claims without priority
The property of the debtor is reported into three categories
i. Real property
ii. Personal property
iii. Property claimed as exempt
N.B
i. Valuation of property are at market or current fair value
ii. A statement of financial affairs also accompanies the debtor’s bankruptcy petition.
4.3.2 Creditors’ petition (Involuntary petition)
If the debtor owes unpaid amounts to 12 or more unsecured creditors who are not employees,
relatives, stockholders, or other insiders, three or more of the creditors who have unsecured
claims totaling $10,000 or more may file in a federal bankruptcy court a creditors’ petition for
bankruptcy. The creditors’ petition is also called involuntary petition. If the number of
unsecured creditors is less than 10, one or more creditors having unsecured claims of $10,000
or more may file the petition. The petition of the creditors for bankruptcy may claim anyone of
the following:
i. The debtor is not paying debts as they come due
ii. The debtor is not paying debts within 120 days prior to the date of the petition
4.3.3 Unsecured creditors with priority

Unsecured creditors may be classified into unsecured creditors with priority and unsecured
creditors without priority. If adequate cash is not available for all unsecured creditors, the
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available cash needs to be paid in full to the unsecured creditors with priority. Debts which are
found in this category include:
- Administrative costs
- Claims arising in the course of the debtors business or financial affairs after the
commencement of a creditors’ bankruptcy proceeding but before the appointment of a
trustee or order for relief.
- Claims for wages, salaries, and commissions (including vacation, severance, and sick
leave pay not in excess of $4000 per claimant) earned within 90 days before the date
of filing petition for bankruptcy or cessation of the debtor’s business.
- Claims for contributions to employee benefit plans arising within 180 days before the
date of filing the petition for bankruptcy cessation of the debtor’s business.
- Claims by producers of grain against a grain storage facility or by fisherman against a
fish storage or processing facility not in excess of $4000 per claimant
- Claims for cash deposited for goods/ services for the personal, family, or household
use of the depositor, not in excess of $1800 per claimant.
- Claims for alimony, maintenance, or support of a spouse, former spouse or child of
the debtor, under a separation agreement, divorce decree, or court order.
- Claims or government entities for various taxes or duties, subject to varying time
limitations.
Note that settlement of the above debts would be in the order specified.
4.3.4 Property claimed as exempt
Certain property of a bankruptcy petitioner is not included in the debtors’ estate. These include:
- Residential property exemptions provided by homestead laws.
- Exemptions for life insurance policies payable on death to the spouse or a relative of
the debtor.
4.3.5 Role of court in liquidation

All aspects of the bankruptcy proceedings are dealt with by the Federal Bankruptcy Court
(USA) with respect to a debtor’s and creditor’s petition for bankruptcy liquidation. The roles of
the court include:
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i. Dismiss the debtor’s or creditor’s bankruptcy petition or to grant an order for relief.
An order for relief is given for the filling of a debtor’s petition in bankruptcy. The
court also gives order for relief in a creditor’s petition after a hearing at which the
debtor may attempt to refuse the creditors’ allegations that the debtor was not pay
debtors as they came due. Thus, the creditors’ petition may be dismissed or order for
relief be given by the court.
Any suits that are pending against a debtor for whom a debtor’s or creditors’ bankruptcy
petition is filed are stayed until order for relief or dismissal of the petition after order for relief,
such suits are further stayed until the question of the debtor’s discharge is determined by the
court.
ii. The court appoints an interim trustee to serve permanently or until the trustee is
elected by the creditors. This is done after the court granted the order for relief.
iii. The court calls a meeting of the creditors after the order for relief within 10 to 30
days.
4.3.6 Role of creditors
As indicated above, within a period of 10 to 30 days after order for relief, the court calls a
meeting of the creditors. One of the responsibility of the creditors is to appoint a trustee to
manage the debtor’s estate. A majority vote is required for actions by creditors in appointing
the trustee.
4.3.7 Role of the Trustee
The trustee may be appointed by the court or elected by the creditors. The trustee is required to
assume the custody of the non-exempt property of the debtor. The principal duties of the trustee
are:
i. Continue to operate the debtor’s business (if directed by court)
ii. Realize the free assets of the debtor’s estate
iii. Pay cash to unsecured creditors
iv. Keep accounting records to enable the filing of a final report with the court
v. Invalidate a preference
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Preference is defined as the transfer of cash or property to an “outsider” creditor for an existing
debt made while the debtor was insolvent and within 90 days of filing of the bankruptcy
petition. This is the case if the transfer caused the creditor to receive more cash or property than
would be received in the bankruptcy liquidation. In this case, the trustee may recover from the
creditor the cash or property constituting the reference and include it in the debtor’s estate.
4.3.8 Discharge of Debtor
Discharge refers to the release of the debtor from all unliquidated debts. It is the court that
determines the debtor’s discharge. The role of the trustee is to liquidate the debtor’s property
and pay the necessary claims.
After all properties have been liquidated, all secured and priority creditor claims have been
paid, and all remaining cash has been paid to unsecured, nonprority creditors.
Discharge of the debtor does not include:
1. taxes payable by the debtor
2. debts resulting from the debtor’s obtaining money or property under false
representations, or willful conversion of the property of others.
3. debts not scheduled by the debtor in support of the bankruptcy petition.
4. debts arising from embezzlement or other fraudulent acts by the debtor acting in
a fiduciary capacity.
5. amounts payable for alimony, maintenance, or child support
6. debts for willful and malicious injuries to the persons or property of others
7. Debts for fines, penalties, or forfeitures payable to government entities, other
than for tax penalties
8. Debts for educational loans made, insured or guaranteed by governmental
entities, or by nonprofit universities or colleges.
Note that a debtor will not be discharge if:

! The debtor for commits any crimes, misstatements, or other malicious acts that are in
connection with the court proceedings.
!! The current bankruptcy petition was fined within six years of a previous bankruptcy
discharge to the same debtor.
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4.3.9 Role of Accountant in Bankruptcy Liquidation
The role of the accountant in liquidation proceedings is concerned with proper reporting of the
financial condition of the debtor and adequate accounting and reporting for the trustee for the
debtor. There are
1. The statement of affairs.

The statement of Affairs is prepared to present the financial condition of the debtor enterprise.
The statement is prepared on the assumption of quitting concern. This is due to the fact that a
business enterprise that enters bankruptcy liquidation proceedings is a quitting concern and not
a going concern. As a result, the balance sheet is not appropriate for an enterprise in
liquidation. Thus, Statement of Affairs is the financial statement designed for a business
enterprise entering liquidation.
The purpose of the Statement of Affairs is to display the assets and liabilities of the debtor
enterprise from the point of liquidation. The assets of the debtor enterprise are valued at current
fair values and the carrying values are presented on a memorandum basis. Besides, assets and
liabilities are classified according to the rankings and priorities. They are not prevented
according to the current classification used in the traditional balance sheet.
2. Statement of Realization and liquidation

Liquidation involves realization of the assets of the debtor’s estate. Statement of Realization
and liquidation is based on the assumed activities of the trustee for the estate of the bankrupt
firm. This statement is accompanied by the statement of cash receipts and cash payments.
1. The term insolvent and bankruptcy are technically used inter changeably. (True / False)
2. If the sum of debts exceeds the fair value of all of its property, the firm is said to be
(Insolvent / Bankrupt)
3. Bankruptcy liquidation involves:
a). Realization of bankrupt firm’s assets
b) Distribution of cash proceeds to the creditors
c) Permit the firm to alive
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d) A and B.
4. Which class of creditors are entitled to obtain satisfaction of all or part of their claims
from
a) Partially secured creditors
b) Fully secured creditors
c) Unsecured creditors with out priority
d) Unsecured creditors with priority
5. The class of creditors who are entitled to receive cash from proceeds available from the
realization of the debtor’s assets are:
a) Unsecured creditors with out priority
b) Unsecured creditors with priority
c) Fully secured creditors
d) Partially secured creditors
6. The class of creditors who are satisfied in full from proceeds of realization of the
debtors non collateralized assets are:
a) Unsecured creditors with out priority
b) Unsecured creditors with priority
c) Partially secured creditors
d) Fully secured creditors
7. In voluntary petition, petition is filed by:
a) Creditors c) family of debtor
b) Debtors d) government
8. In bankruptcy liquidation, the property of the debtor is classified into:
a) Personal property c) property claimed as exempt
b) Real property d) all of the above
9. In involuntary petition, petition is filed by:
a) Debtors c) government
b) Creditors d) spouse of the debtor
10. If adequate cash is not available for all unsecured creditors, the available cash needs to
be paid in full to the unsecured creditor without priority. (True/False)
11. In bankruptcy liquidation, which of the following is not property claimed as exempt?
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a) Residential property c) business policies
b) Life insurance policies d) a and b
12. Which of the following is the role of court in liquidation?
a) Appoint the trustee
b) Call the meetings of the creditors
c) Dismiss the debtor’s or creditor’s petition for bankruptcy
d) Grant an order for relief
e) All of the above
13. The major role of the creditors in bankruptcy liquidation is to appoint a trustee who will
manage the estate of the debtor. (True/False)
14. Which of the following is not the duty of the trustee in bankruptcy liquidation
a) Keep accounting records
b) Pay cash to unsecured creditors
c) Operate the debtor’s business
d) All of the above are the duties of the trustee
15. The release of the debtors from all unliquidated debts is referred to as:
a) Recharge c) discharge
b) Discredit d) uncharge
16. The debtor’s discharge is determined by:
a) The creditor c) the trustee
b) The debtor d) the court e) all of the above
17. Which of the following is the role of accountant in bankruptcy liquidation?
a) Adequate accounting and reporting for the trustee
b) Prepare statement of affairs
c) Prepare statement of realization and liquidation
d) Reporting of the financial condition of the creditor
e) All except d
18. In bankruptcy liquidation, the statement of affairs is:
a) Prepared to present the financial condition of the debtor enterprise
b) Prepared on the assumption of going concern
c) Designed for a business enterprise entering liquidation
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d) Used to display the assets and liabilities of the debtor enterprise
from the point of liquidation
e) All except b
19. The statement of realization and liquidation is based on the assumed activities of the
court for the estate of the bankrupt firm. (True/False)
4.4 BANKRUPTCY REORGANIZATION
When a business becomes insolvent, it does not have enough cash to meet its interest and
principal payments. Then the decision must be made whether to dissolve the firm through
liquidation or to permit it to reorganize and thus stay alive. The decision to force a firm to
liquidate versus permit it to reorganize depends on whether the value of the reorganized firm is
likely to be greater than the value of the firm’s assets if they are sold off piecemeal. The issue
of liquidation was discussed earlier.
In a reorganization, a committee of unsecured creditors is appointed by the court to negotiate

with the management on the terms of a potential reorganization., the reorganization may call
for a restructuring of the firm’s debt. The restructuring of debts involve:
1. Reduce interests rate
2. Lengthen the term to maturity
3. Exchange some debts for equity
The purpose of restructuring is to reduce the financial charges to a level that the firm’s cash
flows can support.
In addition to committee, the court may appoint trustee to oversee the reorganization.
4.4.1 Appointment of trustee or examiner
The management or owners of the business enterprises may continue to operate the enterprise
as debtor in possession. Alternatively, the court may appoint a trustee to manage the enterprise.
The purposes of appointing the trustee are

1. To reduce fraud, dishonesty, incompetence or gross management by current
owners or managers
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2. To protect the interest of the creditors or stockholders of the enterprise.
Where the reorganization involves the trustee, examiner may be appointed to investigate
possible fraud or mismanagement by the current managers or owners of the enterprise.
The powers and duties of the trustee include:

1. Prepare and file a list of creditors in court. The list includes class of creditors and their
claims and lest of stockholder of each class.
2. Investigate the acts, conduct, property, liabilities, and business operations on the
enterprise. The trustee indicates the desirability of continuing operations.
3. Report to the bankruptcy judge any facts ascertained as to fraud against or
mismanagement of the debtor enterprise.
4.4.2 Plan of reorganization
The management or trustee is required to submit the plan of the organization to the bankruptcy
court. The same plan may also be given to the creditors and stockholders of the enterprise. The
purpose of submitting the plan of reorganization is for confirmation by the bankrutpcy court.
Before the plan of reorganization is confirmed by the court, the plan must be accepted by the
following parties:
1. Majority of the creditors, whose claims must account for two thirds of the total
liabilities.
2. Stockholder owning at least two thirds of the outstanding capital stuck of each
class.
If one or more classes of stockholders or creditors has accepted a plan, the bankruptcy court
may conform if the plan is fair and equitable to the nonacceptors. If the plan of reorganization
is confirmed by the bankruptcy court, it becomes binding on the debtor enterprise, on all
creditors and owners of the enterprise, and on any other enterprise issuing securities or
acquiring property user the plan.
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4.4.3 Accounting for a Reorganization
Accounting for reorganization involves journal entries for the following adjustments:
a) Carrying amounts of assets
b) Reduction of par or sated value of capital stock
c) Extensions of due dates and revisions of interest rates of notes payable
d) Exchanges of debt securities for equity securities (debt securities include notes
payable, bond, etc. Equity securities primarily include common stock and preferred
stock).
e) The elimination of a retained earnings deficit.
The reorganized enterprise is essentially a new enterprise whose assets and liabilities should be
valued at current fair values and whose shareholders’ equity consists only of paid in capital.
To illustrate accounting for reorganization, suppose Topcon Company has the following assets.
Liabilities, owners equity before bankruptcy petition by the debtors.
Topcon Company
Balance sheet
December 31,2003.
Assets:
Current Assets: Br. 95,000
Faded assets 180,000
Total cossets 275,000
Liabilities and stockholders’ Equity:
Liabilities:
Current liabilities:
Notes payable (due December 31,2004) 40,000
Notes payable (due September 30,2004) 50,000
Trade Accounts payable 20,000
Salaries and wages payable 10,000
Employee Income taxes payable 25,000
Total current liabilities 145,000
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Bonds payable 100,000
Total liabilities 245,000
Stockholders’ Equity:
Common stock, Br.100 par, 600 shares authorized issued
and outstanding 60,000
Deficit (30,000)
Total liabilities and stockholders’ equity 275,000
Stockholders and all unsecured creditors have approved the plan of reorganization and the
bankruptcy court has conformed it.
The plan of reorganization is described below

1. Deposit Br 40,000 with escrow agent, to cover liabilities with priority and costs of
reorganization proceedings (Br. 7000). Salaries and wages and employee income taxes
payable are liabilities with priorities.
2. Amend articles of incorporation to provide for 10,000 shares of authorized common
stock of Br.1 par. The new common stock is to be exchanged on a share for share basis
for the 600 shares of outstanding Br.100 par common stock.
3. Extend due date of unsecured notes payable to suppliers totaling Br. 50,000 for three
years until December 31,2007. Increase the interest rate on te notes from the stated rate
of 10% to 12%.
4. Exchange 2000 shares of new Br.1 par common stock (at current fair value of Br.20 a
share) for unsecured notes payable to suppliers totaling Br. 40,000.
5. Pay suppliers 60 cents per dollar of trade accounts payable owed.
The journal entries to record the reorganization are shown below:

1) (a) To record deposit of cash with escrow agent
Cash with escrow Agent 40,000
Cash 40,000
(b) To record escrow agent’s payment of liabilities with priority
Salaries and wages payable 10,000
Employee income taxes payable 25,000
Cash with Escrow Agent 35,000
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(c) To record payment for cost of bankruptcy proceedings
Costs of Bankruptcy proceedings 7000
Cash with escrow agent 7000
(2) To record issuance of 600 shares of Br. 1 common stock in exchange for 600 shares of Br.
100 par common stock
Common stock, Br. 100 par 60,000
Common stock, Br. 1 par 600
Paid in capital in excess of par 59400
(3) To record extension of due dates on Notes Payable
10% Notes Payable to suppliers, due date Dec. 31, 2004 50,000
12% Notes Payable to suppliers, due date Dec. 31, 2007 50,000
(4) To record exchange of 2000 shares of Br. 1 par common stock for Notes Payable
Notes payable to suppliers 40,000
Common stock, Br. 1 par 2000
Paid in capital in excess of par 38,000
(5) To record payment of Br. 0.60 per Birr of Accounts payable to suppliers
Trade accounts payable 20,000
Cash (20,000 x 0.60) 12000
Gain from discharge of indebtedness in Bankruptcy 8000
Assuming that fresh start reporting is appropriate for the company under consideration after the
plan of organization has been carried out. The following journal entry is made to eliminate
retained earnings deficit.
Paid in capital in excess of par 29000

Gain from discharge of indebtedness in Bankruptcy 8000
Costs of Bankruptcy proceedings 7000
Retained earnings 30,000
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4.4.4 Disclosure of reorganization
Notes to the financial statements are used to present the complex issues that are involved in
bankruptcy reorganization. The disclosure should include for the period in which the plan of
reorganization was carried out.
Check your progress 4-2

1. A bankrupt firm is reorganized if its value is likely to be greater than the value of the firm’s
assets when sold off piecemeal. (True/False)
2. The reorganization of bankrupt firm may involve:
a) Lengthening the term to maturity
b) Exchanging some debts for equity
c) Reducing interest rates
d) All of the above
e) b and c
3. In bankruptcy reorganization, the former management, by no means, can continue to operate
the enterprise. (True/False)
4. The court may appoint the trustee in reorganization
a) To reduce fraud and dishonesty
b) To protect the interest of the creditors
c) To protect the interest of shareholders of the enterprise
d) a and b
e) All of the above
5. The duties and responsibilities of the trustee in reorganization are:
a) Investigate the acts of business operations of bankruptcy firm
b) Report any facts related to fraud to debtors
c) Prepare and file a list of creditors in court
d) Evaluate the desirability of continuing the operation of bankruptcy firm
e) All except b
6. Which of the following party is not concerned with the plan of reorganization?
a) Majority of the creditors
b) Stockholders owning at least one-third of capital
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c) Court
d) a and c
e) All of the above
7. A plan of reorganization which is confirmed by the bankruptcy court becomes binding on the
a) Debtor enterprise d) party issuing securities
b) All creditors e) all of the above
c) Stockholders
8. In bankruptcy reorganization, the deposit of cash with escrow agent is debited to:
a) Accounts receivable
b) Paid-in capital in excess of par
c) Cash with escrow agent
d) Cash
e) Cost of bankruptcy proceedings
9. Consider the following transactions for BCD company plan of reorganization.
a) Amended articles of incorporation to provide for 100,000 shares of authorized common
stock, Br. 5 par, to be exchanged on a share-for share basis for 50,000 shares of
outstanding no-par, no stated value common stock with a carrying amount of Br.
600,000.
b) Exchange 10,000 shares of the new Br. 5 par common stock for trade accounts payable
totaling Br. 70,000.
c) Paid 80 cents per Birr for full settlement of other trade accounts payable totaling Br.
60,000.
Required: Prepare journal entries for BCD Company for the foregoing transactions.
4.5 SUMMARY
The failed business may be liquidated or reorganized. In the case of bankruptcy liquidation
non-cash assets are sold and the claims of the various parties be satisfied, usually beginning
with creditors. The quest for liquidation may be initiated b y the debtors or creditors. The court,
creditors, trustee and accountants are among the major parties involved in liquidation.
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On the other hand, a firm in failure state may be reorganized if the value of the reorganized
firm is likely to be greater than the value of the firm’s assets if they are sold off piecemeal.
1. False 8. D 15. C
2. Insolvent 9. B 16. D
3. D 10. False 17. E
4. B 11. D 18. E
5. A 12. E 19. False
6. A 13. True
7. B 14. D

1. True 6. B
2. D 7. E
3. False 8. C
4. E
5. E
9.
a) Common stock, Br. 5 par 250,000
Paid-in capital in excess of par 350,000
Common stock 600,000
b) Trade accounts payable 70,000
Common stock, B r.5 par 50,000
Paid-in capital in excess of par 20,000
c) Trade accounts payable 60,000
Cash (60,000 x 0.80) 48000
Gain from exchange of indebtedness in bankruptcy 12000
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UNIT 5: PARTNERSHIP ORGANIZATION AND OPERATION
Content
5.1 Introduction
5.2 Definition and Characteristics
5.3 Advantages and Disadvantages of Partnership
5.4 The Partnership agreement
5.5 Partnership Formation
5.6 Division of Net Income or Net Loss
5.7 Financial Statements for Partnership
5.8 Partnership Dissolution
5.8.1 Admission of a New Partner
5.8.1.1 Admission of a Partner by Purchasing The Existing Partner’s Interest
5.8.1.2 Admission by Investment of Assets In a Partnership
5.8.2 Withdrawal of a Partner
5.8.2.1 Withdrawing by Selling to One or More of The Remaining Partners
5.8.2.2 Payment From Partnership Assets to The Withdrawing Partner
5.8.3 Death of a Partner
5.9 Summary
After studying this unit, you should be able to:

 Identify the characteristics of partnership form of business organization.
 Describe the advantages and disadvantages of partnerships.
 Explain the accounting entries for the formation of a partnership.
 Identify the basis for dividing net income or net loss.
 Describe the form and content of partnership financial statements.
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 Describe the effects of the entries when partnership is dissolved – admission,
withdrawal, death etc.
 Describe and illustrate the liquidation of partnerships.
5.1 INTRODUCTION
Partnership is another form of organization, in addition to sole proprietorship and corporation.

Partnerships are common in retail establishments and in small scale manufacturing companies.
Similarly, if you enter a profession such as accounting, law, or medicine, you may find it
desirable to form a partnership with other professionals in your field. In this chapter, we will
discuss the essential features of partnerships, and explain the major issues in accounting for
partnerships.
5.2 DEFINITION AND CHARACTERISTICS OF A PARTNERSHIP
Definition of a partnership
Partnership is an association of two or more persons to carry, as co-owners, a business for

profit. In a partnership, there are at least two persons. The assets of the partnership are owned
jointly by the owners. The owners in a partnership are called partners. The partners share the
profit or loss of the partnership depending on their agreement.
Characteristics of a Partnership
Partnerships have several characteristics that have accounting implications. The principal
characteristics of the partnership form of business organization are described below:
a. Limited Life
A partnership has limited life. Its continuance as a going concern rests in the partnership
contract. A partnership may be ended voluntarily at any time through the acceptance of a new
partner into the firm or the withdrawal of the partner. A partnership may be ended in
voluntarily by the death or incapacity of a partner. In short, any change in the member of
partners, regardless of the cause, affects the dissolution of the partnership. Dissolution thus
refers to changes in ownership in the partnership. Dissolution does not necessarily mean that
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the business ends. If the remaining partners agree, operations can continue without interruption
by forming a new partnership.
b. Unlimited Liability
Each partner is personally and individually liable for all partnership liabilities. The claims of
the creditors attach first to partnership assets and then to personal assets of any partner,
regardless of that partner’s equity in the company.
c. Voluntary Association of Individuals

A partnership is a voluntary association of two or more individuals based on a legally binding
contract. The contract may be written, oral, or implied. A partnership may be divided into two;
namely, general partnership and limited partnership. General partnership is a partnership in
which each partner is individually liable to creditors for the debts incurred by the partnership.
In a general partnership, individual partner should contribute from his/her personal assets if the
partnership becomes insolvent (unable to pay its debt). On the other hand, limited partnership is
a partnership in which the liability of some partners is limited to the amount of capital
investment. The remaining partners are general partners (partners who have unlimited liability).
However, a limited partnership must have at least one general partner who has unlimited
liability.
d. Mutual Agency
Mutual agency means that each partner acts on behalf of the partnership when engaging in
partnership business. The act of any partner is binding on all other partners, even when partners
act beyond the scope of their authority, as long as the act appears to be appropriate for the
partnership. Because of mutual agency, an individual should be extremely cautious in selecting
partners.
e. Nontaxable entity
The income of a partnership is not taxed as a separate entity. However, a partnership is required
to file an information tax return showing partnership net income and each partner’s share of net
income. Each partners’ share is taxable at personal tax rates, regardless of the amount of net
income withdrawn from the business during the year.
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f. Co-ownership of Property
Partnership assets are co-owned by the partners. Once assets have been invested in the
partnership, they are owned jointly by all the partners. Moreover, if the partnership is
terminated, the assets do not legally revert to the original contributor. Each partner has a claim
on total assets equal to the balance in his/her respective capital account. This claim does not
attach to specific assets that an individual partner may have contributed to the firm.
1. A partnership may have only one partner. Do you agree?

2. The owner in a partnership is called --------------------.
3. List the principal characteristics of a partnership.
4. What are the two types of partnerships?
5.3 ADVANTAGES AND DISADVANTAGES OF A PARTNERSHIP
The advantages of a partnership include:

o A partnership is relatively easy and inexpensive to establish. It is relatively free
from government regulations and restrictions. (case of formation).
o A partnership enables to bring more capital, more skills, and more experience as
compared to sole proprietorship.
o The combined income taxes paid by the individual partners may be lower than
the income taxes that would be paid by a corporation.
o Decisions can be made quickly on substantial matters affecting the firm,
whereas in a corporation, formal meetings with the board of directors are often
needed. (i.e. ease of decision making)
Even though partnership has many advantages, it is not without limitations. Thus, the main
disadvantages (limitations) of a partnership include:
 Partnership has limited life.
 Partnership has unlimited liabilities.
 One partner can bind a partnership to contracts (i.e. mutual agency).
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 Raising large amount of capital is more difficult for a partnership than for a
corporation.
Deciding Between Limited Liability Partnership (LLP) and corporation
1. Income status of the enterprise and of its owners.

owners. An LLP pays no income tax but is
required to file an annual information return showing its revenue and expenses, the
amount of its net income and division of the net income among the partners. A
corporation is a separate legal entity subject to a corporate income the amount of net
income distributed to shareholders in the form of dividend is taxable income to
shareholder.
2. Opportunity for obtaining large amount of capital.
capital. Corporations have better
opportunity than partnership in terms of raising larger amount of capital.
5.4 THE PARTNERSHIP AGREEMENT
A partnership is created by a contract expressing the voluntary agreement of two or more

individuals. Partnership may be formed in written, oral, or implied. If the partnership is formed
in writing, the contract is called partnership agreement, or articles of co-partnership. The
articles of co-partnership include such basic information as:
 The principal and location of the firm.

 The purpose of the business.
 Date of establishment.
 Names and capital contributions of partners.
 Rights and duties of partners.
 Basis for sharing net income or net loss.
 Provision for the withdrawal of assets.
 Procedures for submitting disputes to arbitration.
 Procedures for the withdrawal or addition of a partner.
 Rights and duties of surviving partners in the event of a partner’s death.
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5.5 PARTNERSHIP FORMATION
Most of the day-to-day accounting for a partnership is the same as the accounting for any other
form of business organization. For example, the chart of accounts, with the exception of
drawing and capital accounts for each partner, does not differ from the chart of accounts of a
similar business conducted by a single owner. Transactions that are peculiar (unique) to
partnership organizations are:
 Formation of a partnership
 Income distribution
 Dissolution
 Liquidation
This topic deals with how to record the initial investments of each partner in the accounting
records of the partnership. The investment of each partner is separately recorded in a
partnership. Those assets, which are contributed by the partner, are debited to the proper asset
accounts. These assets should be recorded at their fair market value at the date of their transfer
to the partnership. All partners must agree to the values assigned to assets. Similarly, if
liabilities are assumed by the partnership, the appropriate liability accounts are credited. Then,
the difference between the assets and liabilities (net amount) should be credited to partner’s
capital account.
To illustrate, assume that Lemma and Kassa established a partnership, called LK partnership on
October 10,2003. Lemma contributed cash of Br. 50,000, and Kassa contributed equipment,
which was purchased 4 years ago for Br. 70,000. The partners agreed that the market value of
this equipment is Br. 40,000. The entry to record the investment of each partner is shown
below:
To record Lemma’s investment:

Cash……………………………………… 50,000
Lemma, capital…………………………….. 50,000
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To record Kassa’s investment
Equipment……………………………….. 40,000
Kassa, capital………………………………. 40,000
Note that the original cost of the equipment (Br. 70,000) is no more relevant for the partnership
because the equipment should be recorded at its current market value.
After each partner’s investment is recorded properly, the capital of the partnership can be
determined. For the example under question, total capital of the partnership is computed as
follows:
Lemma, capital……………………………. 50,000
Kassa, capital……………………………… 40,000
Total capital………………………. 90,000
A balance sheet can also be prepared for the partnership after recording the partner’s
investments. Notes the following balance sheet for the partnership being described:
LK Partnership
Balance Sheet
October 10,2003
Assets Liabilities and Capital
Capital
Cash 50,000 Lemma, capital 50,000
Equipment 40,000 Kassa, capital 40,000
Total Assets 90,000 Total liab. &capital 90,000
At this time, LK partnership has no liability. No partner’s liability was transferred to the
partnership.
Example
Assume that Mamo and Worku agree to combine their sole proprietorships to start a partnership
named MW partnership. On November 2, 2003 their investments in the partnership are as
follows:
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Items Book Value Market Value
Mamo Worku Mamo Worku
Cash Br. 7,000 8,000 Br. 7,000 Br. 8,000
Office Equipment 6,000 5,000
Accumulated Depreciation (2,000)
Accounts Receivable 3,000 3,000
Allowance for Doubtful (800) (1,100)
Accounts
Total Br. 11,000 Br. 10,200 Br. 12,000 Br. 9,900
Besides the partnership agreed to assume the liabilities (accounts payable) of former sole
proprietorship, owned by Mamo, amounted to Br. 4,000.
Required
a. Prepare the entry to record the partner’s investments
b. Prepare the balance sheet for the new partnership on November 2, 2003.
Solution
a) Investment of Mamo:
Mamo:
Cash………………………………………… 7,000
Office equipment……………………………. 5,000
Accounts payable……………………………… 4,000
Mamo, capital…………………………………. 8,000
Investment of Worku:
Worku:
Cash…………………………………………….. 8,000
Accounts Receivable…………………………….. 3,000
Allowance for Doubtful Accounts………………………. 1,100
Worku, capital…………………………………………… 9,900
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b) Balance Sheet
MW Partnership
Balance Sheet
November 2,2003
Assets
Cash (7,000 + 8,000) Br. 15,000
Accounts Receivable 3,000
Less: Allowance for Doubtful 1,100 1,900
Accounts
Office equipment 5,000
Total assets 21,900
Liabilities and Capital
Accounts payable 4,000
Capital:
Mamo, capital 8,000
Worku, capital 9,900
Total capital 17,900
Total liabilities and capital 21,900
Note that both the original cost and the accumulated depreciation of the equipment are not
recorded by the partnership. The equipment is recorded at its market value (i.e. Br. 5,000).
Since the equipment has not been used by the partnership, there can be no accumulated
depreciation. In contrast, the gross claims on customers ((Br. 3,000) are carried forward to the
partnership, and the allowance for doubtful accounts is adjusted to Br. 1,100 instead of Br. 800.
The difference between Br. 3,000 and its related allowance for doubtful account is equal cash
net realizable value. i.e. the net amount that is expected to be received from customers on
accounts receivable of Br. 3,000.
After the partnership has been formed, the accounting for its transactions is similar to
accounting for transactions of any other type of business organization. The steps described in
the accounting cycle are equally applicable to a partnership. i.e.
 Journalize transactions
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 Posting to accounts in the ledger
 Trail balance Preparation
 Worksheet Preparation
 Preparation of financial statements
 Journalizing and posting adjusting entries
 Journalizing and posting closing entries
 Post-closing trial balance preparation.
Ledger Accounts for partners

In accounting for partnership, there are three types of accounts for partners. There are
1. Capital Accounts
2. Drawing or Personal Accounts
3. Accounts for loans to and from partners
To explain Accounts for loans to and from partners, a partner may receive cash from the
partnership with the intention of repaying it. Such transaction is recorded in partnership
accounts as follows:
Loans Receivable from partners ***

Cash ***
On the other hand, a partner may make a cash payment to the partnership that is considered a
loan rather than an increase in the partner’s capital account balance. Such transaction is
recorded as follows:
Cash ***
Loans payable to partners ***
Loans Receivable from Partners is an asset while Loans Payable to Partners is a liability.
Check your progress
1. How should a partner’s initial investment of non-cash assets be valued?

2. What are the transactions that are unique to partnership form of organization?
3. Suppose that Bacha and Chaltu decide to organize the partnership called BC
partnership. Bacha invests Br. 20,000 cash, and Chaltu contributes Br. 15,000 and
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equipment having a book value of Br. 4,000. Prepare the entry to record the investment of
each partner, assuming that the equipment has a fair market value of Br. 4,500.
5.6 DIVISION OF NET INCOME OR NET LOSS
The partnership agreement should specify the basis for sharing net income or net loss. If the
partnership agreement failed to specify the basis of sharing net income or net loss, partnership
net income or net loss is shared equally. In other words, if the partnership agreement is silent as
to the manner in which net income or net loss is shared, the amount of net income or net loss is
shared equally. The same basis of division is usually applied to both net income and net loss.
The following are typical schemes (plans) that may be used to share net income or net loss.
1. A fixed ratio, expressed as a proportion (6:4, a percentage 60% and 40%) or a fraction
(2/3 and 1/3).
1/3).
Example
Suppose that TR partnership has net income of Br. 30,000 for 2002. The partners Tesfa, and
Rahel, agreed to share net income using a proportion of 6:4.
Required
a. Compute the share of net income for each partner.
b. Prepare the entry to record the share of net income.
Solution
a. Share of Net Income
Tesfa = 30,00 X 6/10 = Br. 18,000
Rahel = 30,000 X 4/10 = Br. 12,000
b. After the net income is shared between the partners, the share of each partner should be
recorded in the capital account of each partner. This is done to increase the balance of the
partner’s capital account. This entry is in essence, a closing entry and it is made as follows:
Income summary……………………………………………. 30,000

Tesfa, capital………………………………………………… 18,000
Rahel, capital………………………………………………… 12,000
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The capital account of each partner is credited for the share of net income. If the amount is net
loss, the partner’s capital account is debited for the share. Income summary account is debited
because share of partnership net income is closed after revenues and expenses are closed.
That is, the following closing entries are made before net income or net loss is closed. These
are:-
i. Debit each revenue account for its balance and credit income summary for total
revenues.
ii. Debit income summary for total expenses and credit each expense account for its
balance.
After entry No.( I) and entry No.( ii) are posted, income summary account may have debit or
credit balance.
It will have credit balance if total revenues are greater than total expenses. Income summary
account will have debit balance if total expenses are greater than total revenues. A debit
balance in income summary account represents net loss.
Therefore, closing the share of net income/net loss by the partners is done after revenues and
expenses are closed to income summary account.
2.. A ratio based on capital balances at the beginning of the period.

period.
Partners may agree to share income or loss on the ratio of their beginning capital balance.
To illustrate, suppose that R and S have beginning capital balances of Br. 45,000 and Br.
55,000 respectively. The net income of the partnership is Br. 20,000 for year 2002. Partners
agreed to share income on the basis of capital balances at the beginning of 2002.
Based on the above data, the share of net income for each partner can be computed.
a. Partners share income as follows:
R = 45,000 X 20,000 = Br. 9,000
100,000
S = 55,000 X 20,000 = Br. 11,000
100,000
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The denominator 45,000/100,000 is obtained by adding beginning capital balances of all
partners. In the example above, the denominator (Br. 100,000) is the sum of R capital and S
capital. The numerator represents the beginning capital balance of the partner for whom we are
computing the share of net income.
The entry to record the share of net income is shown below:

Income summary………………………………………………. 20,000
S. Capital………………………………………………………………. 9,000
R. Capital……………………………………………………………… 11,000
3. Salaries to partners and the remainder on some basis

As a means of recognizing differences in ability and amount of time devoted to the business,
articles of partnership often provide for the division of a portion of net income to the partners in
the form of salary allowance. The articles may also provide for withdrawals of cash by the
partners in lieu (instead of) salary payments. Therefore, a clear distinction must be made
between the division of net income (which is credited to the capital account) and payments to
the partners (which are debited to the drawing accounts)
Example
Assume that the articles of partnership of Hanna and Sosina provide for monthly salary
allowances of Br. 500 and Br. 600 respectively. The net income for the year is Br. 60,000. The
remaining net income is divided equally.
Required
a. Compute the share of net income for each partner.
b. Prepare the entry to close the share of net income.
Solution
a. Annual Salary:
Hanna = 500 X 12 = Br. 6,000
Sosina = 600 X 12 = Br. 7,200
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Division of Net Income:
Tota
Hanna Sosina l
Salary allowance 6,000 7,2000 13,200
Remaining Income 23,400 23,400 46,800
Net Income 29,400 30,600 60,000
b. Closing entry:
Income summary…………………………………………………. 60,000
Hanna, capital……………………………………………………. 29,400
Sosina, capital…………………………………………….……….. 30,600
4. Interest on partner’s capital and the remainder on some basis.
This scheme is used by the partners when one partner contributed large portion of capital than
the other. In order to recognize differences in capital investments, interest may be allowed on
capital as a means of dividing net income or net loss.
To illustrate, assume that Haile and Getachew have beginning capital balances of Br. 40,000
and Br. 70,000 respectively. The partnership agreement states that the partners are allowed
interest at 10% on beginning capital balances. The remaining net income is to be shared
equally. Assume further that the company generated net income of Br. 18,000 in the year.
The division of income is shown below:

Interest allowances:
Haile = 40,000 X 10% X 1= 4,000
Getachew = 70,000 X 10% X 1 = 7,000
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Division of net income:
Hai
le Getachew Total
Interest allowance 4,000 7,000 11,000
Remaining income 3,500 3,500 7,000
Net income 7,500 10,500 18,000
Closing entry for income division is presented below::

Income summary………………………………………………….. 18,000
Haile, capital…………………………………………………………..7,500
Getachew, capital…………………………………………………….10,500
5. Salaries to partners, interest on partners’ capital, and the remainder on some basis.
Partners may agree that the most equitable plan of income sharing is to allow salaries based on
the services rendered and also to allow interest on the capital investments. The remainder is
then shared in an arbitrary ratio.
Example
Assume that Serkalem and Ayantu are partners in the SA partnership. The partnership
agreement provides for:
- Annual salary allowances of Br. 5,000 to Serkalem and Br. 9,000 to Ayantu.
- Interest allowances of 10% on capital balances at the beginning of the year.
- The remainder equally.
Capital balances on January 1 were Serkalem, Br. 24,000, and Ayantu, Br. 20,000. In 2002,
partnership net income is Br. 25,000.
Required
a. Compute the division of net income
b. Prepare the entry to record the division of net income.
Solution
a. Interest allowances:
Serkalem = 24,000 X 10% = 2,400
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Ayantu = 20,000 X 10% = 2,000

Serkale Ayan Tota
m tu l
Interest 2,400 2,000 4,400
Allowance
Salary Allowance 5,000 9,000 14,000
Remaining 3,300 3,300 6,600
Income
Net Income 10,700 14,300 25,000
b. Closing entry:
Income summary…………………………………. 25,000
Serkalem, capital…………………………………………………10,700
Ayantu, capital……………………………………………………14,300
Sometimes the sum of interest allowance and salary allowance may exceed the amount of net
income. For example, consider the above example and assume that net income is Br. 15,000
instead of Br. 25,000. The net income will be shared as follows:
Division of Net Income

Serkal Ayant Tot
em u al
Total allowances 7,400 11,000 18,400
Excess of allowances over (1,700) (1,700) (3,400)
income
Net Income 5,700 9,300 15,000
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6. Equally
If each of the partner is to contribute equal services and amounts of capital, an equal sharing in
partnership net income would be equitable. That is, partners may agree to share income or loss
equally.
Example
Suppose that Sara and Tsige have capital balance of Br. 50,000 each in the partnership of
SATE partnership. Sara and Tsige have the same qualifications and contribute equal service to
the company. The net income for the year is B r. 3,000. Compute the division of net income if
they agreed to share income equally.
equally
Solution
Division of net income:
Sara = 3000/2= 1,500
Tsige = 3000/2 = 1,500
6. Income Sharing based on bonus to managing partner

A specified percentage of income may be provided to the managing partner in the form of
bonus. The partnership contract should state clearly whether the percentage is applied to net
income before deducting bonus, or net income after bonus.
To illustrate, assume that A is a managing director in AB partnership which is owned by A and

B . Net income for the year is Br. 40000. The partnership agreement states that net income is to
be shared based on bonus and the remaining equally. The director is allowed 20% bonus.
If the percentage is applied to income after tax, the amount of bonus to A and income sharing is
shown below:
Bonus = 40,000 ╳ 20% = 8000
A B Total
Bonus 8,000 ___ 8,000

Remaining income 16,000 16,000 32,000
Net income 24,000 16,000 40,000
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On the other hand, if the percentage is applied to net income before bonus, the amount of bonus
is shown below:
Bonus + NI after bonus= Income before bonus

Let X = Net Income After bonus
0.20 ╳ + ╳ = 40,000
1.20 ╳ = 40,000
╳ = 33,333
Bonus = 0.20 ╳ = 0.20 ╳ 33,333 = 6667
A B Total
Bonus 6667 __ 6667

Remaining income 16,666,50 16,666,50 33,333
Net income 23,333,50 16,666,50 40,000

1. Suppose that in a partnership of Sara and Mitiku, both partners have equal amount of capital
investments. However, Sara gives more time and service to the partnership than Mitiku. Which
income division scheme do you suggest to the partners?
2. A partnership of Tsefaye and Adane generated a net loss of Br. 20,000 in 2002. The
partnership agreement states that income is to be divided on the basis of 60% to Tesfaye and
40% to Adane.
Required
a. Compute the amount of net loss to be divided between the partners.
b. Prepare the entry to record the division of net loss.
3. On January 1, 2002, the capital balances of Nigat and Solomon are Br. 200,000 and Br.
300,000 respectively in NS partnership. During 2002, the company reported net income of Br.
60,000.
60,000
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Assumptions
a. Partners agreed to share income 2/3 to Nigat and 1/3 to Solomon.
b. Partners agreed to share income on the basis of beginning capital balances.
c. The articles of partnership provides for monthly salary allowances of Br. 1,000 to Nigat
and Br.800 to Solomon, and the remainder to be divided equally.
d. The articles of partnership provide interest allowance of 10% of beginning capital
balance, and the remainder to be divided 30% to Nigat and 70% to Solomon.
e.The
e.The articles of partnership provide yearly salary allowance of Br. 15,000 to Nigat, and Br.
12,000 to Solomon; interest of 10% on beginning capital balance, and the remainder
equally.
f. The partners agreed to share income or loss equally.
Required
Compute the division of income/loss to each partner under each of the above assumptions:
Withdrawals in A Partnership
Withdrawal refers to the taking out of cash or other assets by the partner from the partnership.
In a partnership, withdrawal may be made in lieu (instead) of salary allowances, and/or for
personal purposes. Regardless of the purpose for which the asset is withdrawn, the partner’s
drawing account is debited and the asset withdrawn is credited.
Example
Assume that DB partnership is owned and operated by Demeke and Bekele. During the month,
Bekele withdrew cash of Br. 3,000 from the partnership. Prepare the entry to record the
withdrawal.
Solution
The withdrawal is debited to Bekele’s drawing account, and credited to cash, i.e.
Bekele, Drawing…………………………………….. 3,000

Cash………………………………………………………. 3,000
Bekele, drawing account is a temporary capital account. As a result, it is closed to Bekele,

capital at the end of the period. The closing entry is presented below:
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Bekele, Capital………………………………………. 3,000
Bekele, Drawing………………………………………… 3,000
Withdrawal decreases the balance of capital. Thus, Bekele’s capital is decreased by Br. 3,000
during the month.
5.7 FINANCIAL STATEMENTS FOR A PARTNERSHIP
The financial statements of a partnership are similar to those of a sole proprietorship. There are
three financial statements for a partnership. These are income statement, capital statement (or
statement of owner’s equity) and balance sheet.
The income statement of partnership similar with that of sole proprietorship except that the
income statement of the partnership discloses the details of the division of net income. The
following is the partial income statement of H and G partnership in which Haile and Getachew
have capital balances of Br. 40,000 and Br. 70,000 respectively. The net income of the
partnership for the year ended December 31, 2002 was Br. 18,000. The partnership agreement
provided interest allowance of 10% on beginning capital balances and the remaining income to
be shared equally.
H and G partnership
Partial Income Statement
For the year ended December 31,2002
Net Income………………………………………………………………………Br. 18,000

Getach
Haile ew Total
Interest allowance Br. 4,000 Br. 7,000 Br. 11,000
Remaining Income 3,500 3,500 7,000
Net Income Br. 7,500 Br. 10,500 Br. 18,000
Therefore, the bottom part of income statement for a partnership includes the manner in which
income or loss was divided.
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The capital statement of the partnership is different from sole proprietorship in the sense that
there are more than two owners in a partnership. Capital statement shows or explains the
changes in each partner’s capital account and in total partnership capital during the year.
Changes in capital results from three causes; namely, additional investments, drawing, and net
income/net loss.
To exemplify, assume the data given for H and G partnership and consider the following
additional information:
H Getach
aile ew
Additional Investment Br. 15,000 Br. 16,000
Drawings 8,000 7,500
The capital statement of H and G partnership is shown below:
H and G partnership
Capital Statement
For the year ended December 31, 2002
Hail
e Getachew Total
Capital, January 1 40,000 70,000 110,000
Add: Additional Investment 15,000 16,000 31,000
Net Income 7,500 10,500 18,000
Sub total 62,500 96,500 159,000
Less: Drawings 8,000 7,500 15,500
Capital, December 31 54,500 89,000 143,500
The sources of information for the preparation of capital statement are income statement,
partner’s capital account, and drawing accounts.
The balance sheet for a partnership is the same as that of a sole proprietorship except in the
owner’s equity section. In a partnership, the capital balances of each partner are shown in the
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balance sheet. The owner’s equity section for H and G partnership is shown in the following
partial balance sheet.
H and G partnership
Partial Balance Sheet
December 31,2002
Total Liabilities (assumed amount) Br. 75,000

Owner’s equity (capital)
Haile, capital Br. 54,500
Getachew, capital 89,000
Total owner’s equity 143,500
Total liabilities and owner’s equity Br. 21,500
In the ABC Company, beginning capital balances on January 1,2003 are Abebe Br. 20,000,
Bekele Br. 60,000 and Chala Br. 35,000. During the year, drawings were Abebe Br. 8,000,
Bekele Br. 12,000, and Chala Br. 10,000. Net income was Br. 40,000. The partners share
income in the ratio of 3:4:3.
Required
a. Compute the division of net income.
b. Prepare capital statement for the year.
c. Prepare the owner’s equity section of the balance sheet at December 31, 2003.
5.8 PARTNERSHIP DISSOLUTION
Partnership type of organization is characterized by limited life. Any change in the members
(ownership) results in the dissolution of the partnership. Factors that result in partnership
dissolution are admission of new partner, withdrawal of the existing partner, death, or
bankruptcy. The winding up of the affairs of the business does not necessarily follow
dissolution of a partnership. When a partnership is dissolved, a new partnership may be formed
and the new article of partnership should be prepared.
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The following section describes accounting for the dissolution of a partnership.
5.8.1 Admission of a new partner
An additional person may be admitted to a partnership enterprise only with the consent of all
the current partners. The admission of a new partner results in the legal dissolution of the
existing partnership, and the beginning of a new partnership. However, from an economic
standpoint, the admission of a new partner (or partners) may be of minor significance in the
continuity of the business.
A new partner may be admitted to a partnership in one of the following two ways. These are:-
a. Purchasing the interest of one or more existing partners.
b. Investing assets in the partnership.
5.8.1.1 Admission of a partner by purchasing the existing partner’s interest

The capital interest of the incoming partner is obtained from one or more of the current
partners. The admission of a partner by purchase of an interest in the firm is a personal
transaction between one or more of the existing partners and the new partner. Each party is
acting as an individual separate from the partnership entity. The price paid is negotiated and
determined by the individuals involved. In a purchase of an interest, the partnership is not a
participant in the transaction. No cash is distributed from the partnership. The amount of the
purchase price passes directly from the new partners to partners who are giving up part or all of
their ownership claims. Upon purchase of an interest, the new partner acquired each selling
partner’s capital interest, and income-sharing ratio is decided then.
Note that the selling partner does not have to obtain the approval of the other partners to sell his
or her interest. However, some partnership acts may state that the purchaser does not become a
partner until he/she is accepted into the firm by the continuing partners.
Accounting for the purchase of an interest is straightforward. The only entry needed in the
records of the partnership is the transfer of the proper amounts of owner’s equity from the
capital account of the selling partner to the capital account of the incoming (new) partner. That
is, the capital account is debited for the ownership sold, and the capital account of the incoming
partner is credited for the ownership obtained.
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Note that the amount of cash paid to the selling partner may be greater, less than or equal to the
ownership obtained. Regardless of the amount of payment, the capital accounts of the partners
are recorded at the ownership received.
When a new partner is admitted to a partnership by purchasing ownership interest, the total
assets and total capital of the partnership are not changed.
Example
Assume that Kassa and Tollera agreed to sell one third of their interest to Assefa. At the time of
admission of Assefa, each partner has a Br. 48,000 capital balance. Assume that Assefa paid
Br. 18,000 each to the selling partners for 1/3 interest acquired.
Required
a. Prepare the entry to record the admission of Assefa.
b. Compute the total capital of the partnership after admission.
Solution
a. Kassa, Captial (48,000 – 16,000) …………………………. 16,000
Tollera, Capital (48,000 X1/3)………………………………16,000
Assefa, capital (48,000 X 1/3 X 2)………………………………..32,000
b. Total Capital
Assefa, Capital…………………………………32,000
Kassa, Capital (48,000 – 16,000)………………32,000
Tolera, cpatial (48,000 – 16,000)………………32,000
16,000)………………32,000
Total capital……………………………………96,000
capital……………………………………96,000
Note that the total capital of the partnership before the admission (48,000 + 48,000 = Br.
96,000) is the same as after the admission of Assefa (Br. 96,000). Assefa’s ownership interest
is one-third of the selling partner capital balance (Br. 16,000) regardless of the amount of cash
he paid. In the foregoing example, Assefa paid Br. 18,000 to get ownership interest of Br.
16,000. The entry is the same whether the amount Assefa paid to the selling partner is equal to,
greater than, or less than Br. 16,000. This implies that the amount paid by the buyer has no
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effect on the entry when the new partner is admitted to a partnership by purchasing the
ownership interest from one or more of the existing partners.
5.8.1.2 Admission by investment of assets in a partnership

Instead of buying an interest from the current partners, the incoming partner may contribute (or
invest) assets to the partnership. The admission of a new partner by an investment of assets is a
transaction between the new partner and the partnership. In this case, the transaction increases
both the assets and capital of the partnership. The investment by the new partner may be cash,
equipment, furniture, automobile, or other asset. The market value of the asset contributed to
the partnership is debited to the appropriate asset account and credited to capital account of the
new partner.
Example
Assume that Demere and Adugna are partners with capital balances of Br. 40,000 and Br.
55,000 respectively. On December 1, 2003, they agreed to admit Bulcha for cash investment of
Br. 30,000, for which he is to receive ownership equity of Br. 30,000.
Required
1. Compute total capital of the partnership before Bulcha’s admission.
2. Prepare the entry to record Bulcha’s admission.
3. Determine total capital of the partnership after admission.
Solution
1. Total capital before Bulcha’s admission:
Demere, capital…………………………………. Br. 40,000
Adugna, capital…………………………………. 55,000
Total capital…………………………… Br. 95,000
2. Entry to record Bulcha’s admission is:
Cash……………………………………….30,000
Bulcha, capital……………………………. 30,000
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3. Total partnership capital after Bulcha’s admission:
Demere, capital……………………………………. Br. 40,000
Adugna, capital……………………………………. 55,000
Bulcha, capital…………………………………….. 30,000
Total capital……………………………… Br. 125,000
Note that Bulcha’s cash investment of Br. 30,000 increases the total capital of the partnership
by Br. 30,000 (i.e. 125,000 – 95,000 = 30,000). Total assets of the partnership are also
increased by Br. 30,000. Due to this transaction, the capital balances of the existing partners are
not affected.
At the time of admitting new partner by investing assets, the partnership assets should be stated
in terms of their current market values. If the partnership assets are not fairly stated at their
current market value, the capital accounts of the old partners should be adjusted accordingly.
The net increases or decreases in assets of old partnership due to revaluation should be
allocated to old partners capital accounts according to their income-sharing ratio. It is only then
that the investment of new partner should be recorded.
Example
Assume that Adanech and Tigist are partners with capital balances of Br. 70,000 and Br.
50,000 respectively. On December 1,2003, they agreed to admit Kidist for cash contribution of
Br. 40,000, for which she is to receive an ownership equity of Br. 40,000. Assume that the
balance of equipment account had been Br. 90,000 before Kidist’s admission and its current
market value is Br. 110,000. Adanech and Tigist share income equally.
Required
a. Determine total capital of the partnership before revaluation.
b. Prepare the entry to record the revaluation of equipment.
c. Compute the capital balance of each partner after revaluation, but before Kidist’s
admission.
d. Prepare the entry to record the admission of Kidist.
e. Determine the partnership’s total capital after the admission of Kidist.
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Solution
a. Total capital before revaluation
Adanech, capital…………………………………………………….. Br. 70,000
Tigist, capital………………………………………………………..
50,000
Total capital………………………………………………. Br. 120,000
b. The entry to record asset revaluation:

Increase in equipment value = 110,000 – 90,000 = 20,000
Share of increase in value of equipment between old partners.
Adanech = 20,000/2 = 10,000
Tigist = 20,000/2 = 10,000
Entry
Equipment ……………………………………………………..20,000
Adanech, capital………………………………………….. 10,000
Tigist, capital……………………………………………… 10,000
If a number of assets are revalued, the adjustments may be debited to a temporary account
called Asset Revaluation. After all adjusting entries are made, the account is closed to the
capital accounts. For the ongoing example, if assets revaluation account is used, the adjusting
entry and closing entry are made as follows:
Adjusting entry
Equipment………………………………………………….20,000
Asset Revaluation………………………………………… 20,000
Closing Entry
Asset Revaluation………………………………………….20,000
Adanech, capital………………………………………… 10,000
Tigist, capital……………………………………………. 10,000
If the current market value of the asset is less than its book value, adjusting entry debits old
partners capital accounts and credits the asset account (if asset revaluation is not used).
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c. Old partners capital balance after revaluation:
Adanech, capital (70,000 + 10,000)…………………….. Br. 80,000
Tigist, capital (50,000 + 10,000)……………………….. 60,000
Total capital……………………………………………. Br. 140,000
d. The entry to record Kidist’s admission:

Cash……………………………………… 40,000
Kidist, capital…………………………………. 40,000
e. Total capital after admission:

Adanech, capital……………………………………….. Br. 80,000
Tigist, capital………………………………………….. 60,000
Kidist, capital………………………………………….. 40,000
Total capital………………………………….. Br. 180,000
Note that the partnership capital is increased by Br. 60,000. Also note that Kidist;s interest in
the partnership is 22% (i.e. 40,000/180,000 = 22%). This does not mean that Kidist will share
22% of the income of the partnership. It may or may not be equal to the 22% capital interest.
Since the new partnership agreement will be written, a new income-sharing ratio will be agreed
upon.
In the case of admission by the investment, further complications occur when the new partner’s
investment differs from the capital equity acquired. When those amounts are not the same, the
difference is considered the bonus either to (1) the existing (old) partners or (2) the new
partner.
Bonus to old partners

The existing partners may be unwilling to admit a new partner without receiving a bonus for
both personal and business reasons. In an established firm, existing partners may insist on a
bonus as compensation for the personal scarifies they have made for the company over the
years. Two accounting related factors underline the business reason. These are:
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1. Total capital of the partnership equals the book value of the recorded assets of the
partnership. At the time the new partner is admitted, the fair market values of assets
such as land and building may be higher than their book values.
2. When the partnership has been profitable, goodwill exist.
In such cases, the new partner is usually willing to pay the bonus to become a partner. A bonus
to old partners results when the new partner’s capital credit (acquired ownership interest) on the
date of admittance is less than her/his investment in the firm. The bonus results in an increase
in the capital balances of the old partners. The bonus is allocated to them on the basis of
income sharing ratio before the admission of the new partner.
The procedures for determining the ownership of the new partner and the bonus to the old
partners are described below:
Step 1: Determine the total capital of the new partnership by adding the new partner’s
investment to the total capital of the old partnership.
Step 2: Determine the new partner’s ownership interest by multiplying the total capital of the
new partnership by the new partner’s ownership interest percentage.
Step 3: Determine the amount of bonus
New partner’s investment………………………………………………….. xxx
Less: new partner’s ownership interest…………………………………… xxx
Amount of Bonus…………………………………………………………. xxx
Step 4: Allocate the bonus to the old partners on the basis of their income-sharing ratio.
Example
Assume that Hawi and Melat have capital balances of Br. 100,000 and Br. 120,000 respectively
in HAME partnership. Naol acquires a 25% ownership (capital) interest by making cash
investment of Br. 90,000 in the partnership. According to partnership agreement, Hawi and
Melat share income as follows: Hawi, 60%, and Melat, 40%.
Required
1. Compute:
a. The total capital of the new partnership.
b. The ownership interest of Naol.
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c. The amount of bonus to old partners.
d. The share of bonus by old partners.
2. Prepare the entry to record the admission of Naol.
Solution
1) (a). Total capital of new partnership before bonus:
Hawi, capital………………………………………. Br. 100,000
Melat, capital……………………………………… 120,000
Naol’s investment………………………………… 90,000
Total ……………………………………. Br. 310,000
(b). Naol’s ownership interest = 310,000 X 25% = Br. 77,500
( c). Bonus = Naol’s investment – Naol’s capital (ownership interest)
= 90,000 – 77,500
= 12,500
(d). Share of bonus:
Hawi = 12,500 X 60% = Br. 7,500
Melat = 12,500 X 40% = 5,000
2) The entry to record the admission of Naol:

Cash………………………………………………… 90,000
Hawi, capital……………………………………….. 7,500
Melat, capital……………………………………….. 5,000
Naol, capital…………………………………………. 77,500
Some organizations refer to record the amount of bonus as goodwill. If this procedure is
followed, the required entries are made as follows:
(1) To record goodwill:
Goodwill………………………………………………….. 12,500
Hawi, capital…………………………………………………. 7,500
Melat, capital………………………………………………… 5,000
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(2) To record Naol’s admission:
Cash …………………………………………………………90,000
Naol, capital………………………………………………… 90,000
Bonus to new partner

If a partnership admits a new partner who is expected to improve the fortunes of the firm, old
partners may agree to give a bonus to new partner. In other words, the new partner possesses
resources or special attributes that are desired by the partnership. A bonus to a new partner
results when the new partner’s ownership equity is greater than his/her investment of assets in
the firm. For example, when bank interest rates are high, the new partner may be able to supply
cash that is urgently needed for expansion or to meet maturing debt. Alternatively, the new
partner may be a recognized expert or authority in a relevant field. For example, an engineering
firm may be willing to give known engineers a bonus to join the firm.
Similarly, the partner of a sporting goods store may offer a bonus to a spots celebrity in order to
add the athlet’s name to the partnership name.
Example
Assume that Helen invests Br. 60,000 in cash for a 30% ownership interest in the Hanna and
Hawi partnership, in which the capital balances of Hanna and Hawi are Br.90,000 and Br.
120,000 respectively. The old partners share income equally.
Required
a. Compute Helen’s capital
b. Prepare the entry to record the admission of Helen.
Solution
a. Helen’s capital:
Total capital of new partnership = 90,000 + 120,000 + 60,000 = 270,000
Helen’s equity = 270,000 x 30% = 81,000
b. Bonus to Helen = 81,000 – 60,000 = Br. 21,000

Allocation of Bonus:
Hanna = 21,000/2 = 10,500
Hawi = 21,000/2 = 10,500
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Entry
Cash………………………………………………………………..…. 60,000
Hanna, capital………………………………………………………… 10,500
Hawi, capital…………………………………………………………. 10,500
Helen, capital……………………………………………………..….. 81,000
1. Assume that Hanna, Hawi, and Helen share income on a 5:3:2 basis. They have capital
balances of Br. 32,000 Br. 24,000, and Br. 21,000 respectively. When Tigist is admitted to the
partnership.
Required:
Prepare the entry to record the admission of Tigist under each of the following independent
assumptions:
a. Purchased one half of Hana’s equity for Br. 18,000.
b. Purchased one-half of Hawi’s equity for Br. 10,000.
c. Purchased one-half o Helen’s equity for Br. 9,000.
2. Assume that Gelena and Lemmesa share income on a 6:4 basis. They have capital balances
of Br. 90,000 and Br. 70,000 respectively, when Bacha is admitted to the partnership.
Required: prepared the entry to record the admission of Bacha under each of the following
independent assumptions:
a) Investment of Br. 80,000 cash for a one-fourth ownership interest with
bonuses to the existing partners.
b) Investment of Br. 40,000 cash for a one-fourth ownership interest with
a bonus to the new partner.
5.8.2 Withdrawal of a partner
A partner may withdraw from a partnership voluntarily by selling his/her equity in the firm, or
involuntarily by reaching mandatory retirement age or dying. Like the admission of a partner,
the withdrawal of a partner legally dissolves the partnership. The legal effects may be
recognized in accounting for a withdrawal by dissolving the firm. However, it is customary to
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record only the economic effects. The partnership agreement should specify the terms of the
withdrawal.
The withdrawal of a partner may be accomplished in two ways. These are:-

1. Selling to one or more of the remaining partners.
2. Payment from partnership assets.
Each of these ways of withdrawal will be explained in the following section.
5.8.2.1 Withdrawing by selling to one or more of the remaining partners

In this type of withdrawal, the withdrawing partner sells his/her ownership equity to one or
more of the existing partners. Payment is made to the withdrawing partner from the personal
assets of the buying partners, and not from partnership assets. The withdrawal of a partner
when payment is made from partner’s personal assets is the direct opposite of admitting a new
partner who purchases a partner’s interest. This transaction is a personal transaction between
the partners. Partnership assets are not involved in the withdrawal of the partner. As a result,
the total assets and total capital of the partnership are not changed. A change occurs only in
individual partner’s capital account. The required accounting entry debits the equity of the
withdrawing partners, and the capital account(s) of the buying partner(s). The amount received
by the withdrawing partner does not affect the entry. Whether the amount of cash received by
the withdrawing partner is equal to, less than, or greater than his/her ownership equity, the
entry is the same. The entry required to record the withdrawal is made after all assets are
revalued to reflect their current market value.
Example
Assume that Tsige, Kebede, and Tulu have capital balances of Br. 50,000, Br. 60,000, and Br.
45,000 respectively. Assume further that Kebede decides to withdraw from the partnership, and
Tsige and Tulu agree to buy Kebede’s ownership equity. Each of them agreed to pay Kebede
Br. 35,000 in exchange for one-half of Kebede’s ownership interest of Br. 60,000.
Required
a. Compute the total capital before Kebede’s withdrawal
b. Prepare the entry to record Kebede’s withdrawal
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c. Determine the capital balance of each partner and total capital after Kebede’s
withdrawal.
Solution
a. Total capital before withdrawal:
Tsige, capital…………………………………………. Br. 50,000
Kebede, capital……………………………………….. 60,000
Tulu, capital………………………………………….. 45,000
Total capital………………………………………….. Br. 155,000
b. The entry to record the withdrawal:

Kebede, capital……………………………………… 60,000
Tsige, capital………………………………. 30,000
Tulu, capital……………………………….. 30,000
c. Capital balance of each partner and total capital after withdrawal:

Tsige, capital (50,000 + 30,000) ……………………. Br. 80,000
Tulu, capital (45,000 + 30,000)……………………… 75,000
Total capital…………………………………………. Br. 155,000
Note that the total capital of the partnership remains the same at Br. 155,000. Note also that the
Br. 70,000 paid to Kebede is not recorded. Similarly, Tsige capital is credited only for Br.
30,000, not the Br. 35,000 she paid. Tsige and Tulu will sign new articles of partnership.
partnership
5.8.2.2 Payment from Partnership assets to the Withdrawing partner

Using partnership assets to pay for a withdrawing partner’s equity is the reverse of admitting a
new partner through investment of assets in the partnership. Payment from partnership assets is
a transaction that involves the partnership. Thus, both total assets and total capital of the
partnership are decreased. The withdrawing partner will be settled with the amount equal to
his/her capital balance. This capital balance is determined by revaluing the current market value
of the assets. This is the case when the fair market values of the assets at the time of the
partner’s withdrawal are different from the recorded value of these assets. Any difference
between the current market value and book value of the assets should be divided between
(among) the partners’ capital accounts and adjusting entry is made accordingly.
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Example
Assume that Tigist, Tesfa, and Meseret have capital balances of Br. 20,000 Br. 18,000, and Br.
26,000 respectively at the time Tigist decided to withdraw. At the same time, merchandise
inventory with a book value of Br. 5,000 has market value of Br. 7,000. The partnership has
paid Tigist’s interests after adjusting for the difference in merchandise inventory value. The
partners share income on 5:3:2 basis.
Required
1. Prepare adjusting entry to revalue merchandise inventory.
2. Compute each partner’s capital balance.
3. Prepare the entry to record the withdrawal of Tigist.
Solution
1. Merchandise inventory………………………………………….. 2,000
Tigist, capital (2000 X 5/10)………………………………………… 1,000
Tesfa, capital (2000 X 3/10)…………………………………………. 600
Meseret, capital (2000 X 2/10)………………………………………. 400
2. Partners’ capital balances:

Tigist, capital (20,000 + 1,000)………………………21,000
Tesfa, capital (18,000 + 600)………………………18,600
Meseret, capital (18,000 + 400)…………………… 18,400
Total capital…………………………….. 58000
3. The entry to record Tigist’s withdrawal:

Tigist, capital……………………………………. 21,000
Cash………………………………………………… 21,000
After Tigist’s withdrawal, total capital of the partnership is equal to Br. 45,000 (i.e. 18,600 +
26,400 = 45,000)
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1. Lemma, Amare, and Getu have capital balances of Br. 32,000, Br. 38,000 and Br.
36,000 respectively, and their income sharing ratios are 5:2:3. Amare withdraws from
the partnership under each of the following independent assumptions:
a. Lemma and Getu agree to purchase Amare’s equity by paying Br. 20,000 each
from their personal assets. Each purchaser received 50% of Amare’s equity.
b. Lemma agrees to purchase all of Amare’s equity by paying B r. 42,000 cash
from his personal assets.
c. Getu agrees to purchase all of Amare’s equity by paying Br. 36,000 cash from
his personal assets.
Required
Prepare the entry to record the withdrawal of Amare under each of the above independent
assumption.
2. Assume that Solomon has a capital balance of Br. 45,000 ion S-K-L partnership. He decided
to withdraw from the partnership. The partnership agreed to settle Solomon’s ownership equity
from its assets.
Required
Prepare the entry to record the withdrawal of Solomon.
5.8.3 Death of a Partner
The death of a partner dissolves a partnership. When a partner dies it is necessary to determine
the partner’s at the date of death. This is done by:
1. Determining the net income or net loss for the fractional part of a year.
2. Closing the accounts.
3. Preparing financial statements.
Then the balance in the capital account of the deceased partner is transferred to a liability
account with the deceased’s estate. The surviving partners may continue the business or the
affairs may be wound up. The ownership equity is paid to the deceased person’s heir (s).
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Example
Assume that XYZ partnership has three partners; namely X,Y & Z. Their capital balances on
January 1, 2003, the beginning of the fiscal period, are X Br. 12,000, Y Br. 15,000 and 2 Br.
19,000. Partner Y has died on August 30, 2003. Net income for the period between January 1
and August 30,2003 is Br. 8,000. The partners agreed to share income on 4:4:2. Y’s legal heir
is W.
Required
1. Compute the share of net income on August 30.
2. Prepare the entry to record the division of net income.
3. Determine each partner’s capital balance.
4. If W decides to take the ownership equity of Y from the partnership, prepare the entry
to record the payment to W.
5. If W decides to join the partnership in place of Y, prepare the entry to record the
admission of W.
Solution
1. Division of Net Income:
X = 8,000 X 4/10 = 3,200
Y = 8,000 X 4/10 = 3,200
Z = 8,000 X 2/10 = 1,600
2. Entry to record the division of net income:

Income summary……………………………………8,000
summary……………………………………8,000
X, capital………………………………………… 3,200
Y, capital………………………………………… 3,200
Z, capital………………………………………… 1,600
3. Partner’s capital balances:

X, capital = 12,000 + 3,200 = 15,200
Y, capital = 15,000 + 3,200 = 18,200
Z, capital = 19,000 + 1,600 = 20,600
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4. Y, capital …………………………………… 18,200
Cash……………………………………………….. 18,200
5. Y, capital…………………………………….. 18,200
W, Capital………………………………………… 18,200
5.9 SUMMARY
A partnership form of organization is owned and operated by two or more persons for the
purpose of profit. It is characterized by limited life, unlimited liabilities, mutual agency, non
taxability and so on.
Partnership agreement may be in writing, orally, or impliedly. It is generally believed that

partnership agreement should be in writing to avoid minimize potential conflict between the
partners.
There are four unique (peculiar) transactions for partnership, namely, partnership formation,
division of net income, or net loss, partnership dissolution, and partnership liquidation, the first
three are dealt with in this chapter, and partnership liquidation will be addressed in unit six.
The possible means of sharing net income or net loss of the partnership are equally, based on
some fixed rations, based the services of the partners, based the partners’ capital investments of
the partnership liquidation may result due to admission of new partner, withdrawal of partner,
death of partner etc.
A new partner may be admitted to a partnership either by purchasing ownership interest from
one or more of the existing partners, or by investing assets into the partnership. On the other
hand, withdrawal of a partner may take either by selling the ownership interest to one or more
of the remaining partners, or by obtaining payment from the partnership.
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5.10 ANSWER TO CHECK YOUR PROGRESS EXERCISES

1. I do not agree. A partnership should have at least two partners.
2. Partner.
3. Limited life, Association of individuals, unlimited liabilities, mutual agency, nontaxable
entity, and co-ownership of property.
4. General partnership and limited partnership

1. At fair market value
2. Partnership formation, income distribution, dissolution, and liquidation
3. Bacha’s Investment
Cash……………………………………………………….20,000
Bacha, capital…………………………………………….20,000
Chaltu’s Investment
Cash………………………………………………………15,000
Equipment………………………………………………….4,500
Chaltu, capital…………………………………………..19,500

1. The one that considers salary allowance
2.
a. Share of net loss:
loss:
Tesfaye = 20,000 X 60%= 12,000 ?????
Adane = 20,000 X 40% = 8,000
b. Tesfaye, capital……………………………………..12,000
Adane, capital……………………………………… 8,000
Income summary…………………………………..20,000
3.
a) Nigat = 2/3 X 60,000 = 40,000
Solomon = 1/3 x 60,000 = 20,000
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b) Nigat = 200,000/500,000 X 60,000 = 24,000
Solomon = 300,000/500,000 X 60,000 = 36,000
c) Salary allowances:
Nigat = 1,000 X 12 = 12,000
Solomon = 800 X 12 = 9,600
Niga Solom Tot
t on al
Salary allowance 12000 9600 21600
Remaining income 19200 19200 38400
Net income 31200 28800 60000
d) Interest allowances:
Nigat = 200,000 X 10% = 20,000
Solomon = 300,000 X 10% = 30,000
Total ………………… 50,000
Remaining income = 60,000 – 50,000 = 10,000
Nigat = 10,000 X 30% = 3,000
Solomon = 10,000 X 70% = 7,000
Division of income to:
Nigat = 20,000 + 3,000 = 23,000
Solomon = 3,000 + 7,000 = 37,000
e)
Nig Solom Tota
at on l
Total 35,000 42,000 77,000
Excess of allowances
over
Income (8,500) (8,500) (17,000)
Net income 26,500 33,500 60,000
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f.. Division of income
Nigat = 60,000/2 = 30,000
Solomon = 60,000 X ½ = 30,000

(a) Division of net income:
Abebe = 40,000 X 3/10 =12,000
Bekele = 40,000 X 4/10 = 16,000
Chala = 40,000 X 3/10 = 12,000
(b)
ABC Company
Capital Statement
For the year ended December 31, 2003
Abe Bekel Chal
be e a Total
Capital, January 1 20,000 60,000 35,000 115,000
Add: Net income 12,000 16,000 12,000 40,000
Sub total 32,000 76,000 47,000 155,000
Ded: Drawings 8,000 12,000 10,000 30,000
Capital, December 31 24,000 64,000 37,000 125,000
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ABC Company
Balance Sheet (partial)
December 31,2003
Owner’s Equity:
Abebe, capital 24,000
Bekele, capital 64,000
Chala, capital 37,000
Total capital 125,000

1. a) Hanna, capital (32,000 X ½ ) ……………………..16,000
Tigist, capital……………………………………..………..16,000
b) Hawi, capital (24,000 X ½) ………………………….12,000

Tigist, capital…………………………………….………..12,000
c) Helen, capital (21,000 X ½) ………………………….10,500

Tigist, capital…………………………………….………..10,500
2. a) Bonus to existing partners:

Total capital (90,000 + 70,000 + 80,000)………..………240,000
Bacha’s equity = 240,000/4 = 60,000
Bonus = 80,000 – 60,000 = 20,000
Share of bonus by the existing partners:
Gelana = 20,000 X 6/10 = 12,000
Lemessa = 20,000 X 4/10 = 8,000
Entry
Cash………………………………………………….80,000
Bacha, capital…………………………………………….60,000
Gelana, capital……………………………………………12,000
Lemmessa, capital……………………………………….. 8,000
b) Bonus to Bacha:
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Total capital = 90,000 + 70,000 + 40,000 = 200,000
Bacha’s equity = 200,000 X ¼ = 50,000
Bonus to Bacha = 50,000 – 40,000 = 10,000
Entry
Cash…………………………………………………40,000
Gelana, capital (10,000 X 6/10)…………………….. 6,000
Lemmessa, capital (10,000 X 4/10)…………………. 4,000
Bacha, capital……………………………………………50,000
1. a) Amare, capital………………………………….38,000
Lemma, capital…………………………………………19,000
Getu, capital……………………………………………19,000
b) Amare, capital…………………………………..38,000
Lemma, capital…………………………………………38,000
c) Amare, capital…………………………………..38,000
Getu, capital……………………………………………38,000
2. Solomon, capital………………………………….45,000
Cash……………………………………………………45,000
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UNIT 6: LIQUIDATION OF A PARTNERSHIP
Content

6.1 Introduction
6.2 The Partnership Liquidation Process
6.3 Illustration on Partnership Liquidation
6.4 Partnership Liquidation When Loan Payable Exists
6.5 Summary
After completing this unit, the student should be able to:

- discuss the liquidation process in a partnership
- how to prepare statement of partnership liquidation
- describe accounting for transactions in partnership liquidation
6.1 INTRODUCTION
Liquidation refers to the process of winding-up the operation of the business. Liquidation may
result form the sale of the business by mutual agreement of the partners, from the death of a
partner, or from bankruptcy. In contrast to the dissolution of a partnership, liquidation ends
both the legal and economic life of the entity. The liquidation of a partnership terminates the
business.
6.2 THE PARTNERSHIP LIQUIDATION PROCESS
The liquidation process involves four steps. These are:

1. Adjust and close accounts and prepare trial balance. When the ordinary business
activities are discontinued, as the partnership goes out of the business, the accounts
should be adjusted and closed according to the customary procedures of the periodic
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summary. Then a post closing trial balance is prepared that contains only assets,
liabilities, and owner’s equity.
2. Sale of the non-cash assets and allocation of gain/loss on realization

Once the operation of the business is terminated, the non-cash assets should be
converted to cash through sale. The sale of non-cash assets for cash is called realization.
The non-cash assets may be sold in a single transaction, or on piecemeal basis. When
assets are sold on piecemeal basis, the liquidation process may extend over a
considerable period of time.
If the cash proceed from sale is greater than book value, the difference is gain on
realization. After recording the sale of the non-cash assts, gain or loss on realization is
allocated between/among partners according to their income sharing ratios.
ratios
3. Payment of partnership Liabilities

After the non-cash assets are sold, the available cash is used to pay the partnership creditors
before any cash is distributed to partners. The accounting entry debits liabilities (or liability
account) and credit cash.
4. Distribute the remaining cash to partners

After all debt claims are settled, the remaining cash will be distributed to the partners according
to their capital balances. Note that the remaining cash is not distributed to the partners on the
basis of their income-sharing ratio.
Each of the above step must be performed in sequence because creditors must be paid before
partners receive any cash distributions. Each step also must be recorded by an accounting entry.
6.3 ILLUSTRATION ON LIQUIDATION
The following section illustrates the liquidation process
Example
Assume that HM partnership is liquidated when its ledger shows the following assets, liabilities
and owners’ equity accounts:
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Assets Liabilities & Owner’s equity
Cash Br. 6,000 Accounts payable Br. 15,000
Accounts receivable 13,000 Hanna, capital 38,000
Inventory 20,000 Meseret, capital 21,000
Equipment 45,000 Total Br. 74,000
Accumulated depreciation (10,000)
(equipment ) Br. 74,000
Total
Accounts have been adjusted and closed
Hanna and Meseret share income on a 6:4 basis. Assume further that all non-cash assets are
sold in a single transaction. All non-cash assets are sold for Br. 80,000. The liquidation process
started on November 3 and ended on Nov.26, 2003.
Required
a. Prepare statement of partnership liquidation.
b. Prepare the entry to record transactions in the liquidation process.
Solution
a. Statement of partnership liquidation
The statement of partnership liquidation is organized around the basic accounting equation. It is
prepared to show the liquidation process and to determine the distribution of cash to partners.
The statement of partnership liquidation for HM partnership is shown below:
Items Cash + Non cash = Liabilities + Hanna + Meseret

Assets Capital Capital
Balances before realization 6000 + 68000 = 15000 + 38000 + 21000
Sale of non-cash assets and allocation of gain 80000 + (68000) = - 7200 + 4800
New balances 86000 + - 0 - = 15000 + 45200 + 25800
Pay liabilities (15000) + - 0 - = (15000) - -
New balances 71000 + -0- = -0- + 45200 + 25800
Cash distribution to partners (71000) + - = - (45200) + (25800)
Final balances -0- -0- -0-
-0- -0- -0-
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Note that Gain on realization is Br. 12,000 (i.e. 80,000 – 68,000 = 12,000). The amount of gain
is divided between the two partners based on their income sharing ratio of 6:4 i.e. allocation of
gain to:
Hanna = 12,000 x 6/10 = 7,200
Meseret = 12,000 X 4/10 = 4,800
The amount of gain increases the partners’ capital accounts. Cash distribution to partners is
based on the partners’ capital balances. For example, after the liabilities have been paid, the
remaining cash is Br. 71,000. At this time, Hanna has a balance of Br. 45,200 and Meseret has
Br. 25,800. Since the sum of the capital balances of the partners is equal to the remaining cash
of Br. 71,000, the Br. 71,000 can be distributed to partners according to their capital balances
i.e. Br. 45,200 is distributed to Hanna and Br. 25,800 is distributed to Meseret.
b. The following entries can be made to record the foregoing events:

1) To record the realization of non-cash assets
Cash……………………………………………………… 80,000
Accumulated Depreciation – Equipment……………….. 10,000
Accounts Receivable …………………………………. 13,000
Inventory……………………………………………….. 20,000
Equipment……………………………………………… 45,000
Gain on realization………………………………….….. 12,000
2) To record the allocation of gain to the partners’ capital accounts

Gain on Realization……………………………………. 12,000
Hanna, capital………………………………………….. 7,200
Meseret, capital………………………………………… 4,800
3) To record the payment of liabilities
Accounts payable…………………………………….. 15,000
Cash……………………………………………………… 15,000
4) To record the distribution of the remaining cash to partners
Hanna, capital……………………………………………. 45,200
Meseret, capital………………………………………….. 25,800
Cash……………………………………………… 71,000
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There is slight difference in the statement of partnership liquidation and journal entries if the
realization of non-cash assets results in a loss. For example, assume that the non-cash assets are
sold for Br. 50,000. In this case, loss on realization is equal to Br. 18,000 (i.e. 68,000 – 50,000
= 18,000). The statement of partnership liquidation is prepared as follows:
HM Partnership
Statement of Partnership Liquidation
For the period from November 3 and November 26,2003
Items Cash + Non-cash + Liabilities + Hanna + Meseret

Balance before realization 6000 + 68000 = 15000 38000 21000
Sale of non-cash assets and allocation of loss 50000 + (68000) = - (10800) (7200)
New balances 56000 + -0- = 15000 27200 13800
Pay liabilities (15000) + - = (15000) - -
New balances 41000 + -0- = -0- 27200 13800
Cash distribution to partners (41000) + - = - (27200) (13800)
Final balances -0- + -0- = -0- -0- -0-
From the above statement, although non-cash assets are sold at loss of Br. 18,000, the capital
accounts of the partners are able to bear the share of the loss. After the division of loss (Br.
18,000) between partners, their capital balances are positive. Similarly, after the liabilities of
Br. 15,000 are paid, the remaining cash balance of Br. 41,000 is distributed to partners
according to their capital balances (Hanna, Br. 27200; and Meseret Br. 13,800). This leaves the
partners capital balances zero.
The accounting entries required to record the above transactions are presented below:
(1) To record the realization of non-cash assets
Cash……………………………………………………………….. 50,000
Loss on Realization………………………………………………..18,000
Accumulated depreciation – Equipment…………………………..10,000

Accounts Receivable………………………………………………..…13,000
Receivable………………………………………………..…13,000
Inventory……………………………………………………………….20,000
Equipment……………………………………………………………...45,000
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2. To record the allocation of loss to partners
Hanna, capital…………………………………………..10,800
Meseret, capital………………………………………… 7,200
Loss on Realization…………………………………………18,000
3. To record the payment of liabilities
Accounts payable………………………………………..15,000
Cash………………………………………………………..15,000
4. To record the distribution of cash to partners
Hanna, capital……………………………………….27,200
Meseret, capital……………………………………..13,800
Cash…………………………………………………..41,000
In the above case, although the realization of non-cash assets results in a loss, the capital
accounts of the partners were able to bear the loss. That is, each partner’s capital account shows
a positive balance after the division of loss (Hanna, Br. 27200; and Meseret, capital, Br.
13800). There is a case in which one or more partner’s capital accounts are unable to bear the
loss due to realization of non-cash assets. In other words, the allocation of loss on realization
may result in debit (negative) capital balance for one or more partners.
For example, assume that the non-cash assets were sold for Br. 10,000 instead of Br. 80,000.
This results in a Br. 58,000 (i.e. 68,000 – 10,000 = 8,000) loss on realization. This loss is
allocated as follows:
Hanna = 58,000 X 60% = 34,800
Meseret = 58,000 X 40% = 23,200
It is readily apparent that the part of the loss allocated to Meseret Br. 23,200 exceeds the Br.
21,000 balance in Meseret’s capital account. This results in capital deficiency of Br. 3,000 (i.e.
23,200 – 21,000 = 2,200). This deficiency of Meseret (Br. 2,200) is a potential deficiency to
Hanna and must be tentatively absorbed by Hanna. The capital balance remaining represents
Meseret’s claim on the partnership cash. The computations may be summarized in the
following manner:
121
Hanna Meseret
Capital Capital Total
Balances before realization 38,000 21,000 59,000
Division of loss on realization (34,800) (23,200) (58,000)
Balances after realization 3,200 (2,200) 1,000
Allocation of potential additional deficiency (2,200) 2,200 -
Claim to partnership cash 1,000 - 1,000
HM partnership
For the period from November 3 and November 26,2003
Items Cash + Non-Cash = Liabilities + Hanna + Meseret
Assets capital capital
Balances before realization 6000 + 68000 =15000 + 38000 + 21000
Sales of non-cash assets and
allocation of loss 10000 + (68000) = - + (34800) + (23,200)
New balances 16000 + -0- 15000 + 3200 + (2200)
Pay liabilities (15000) + - (15000) + - + -
New balances 1000 + -0- -0- + 3200 + (2200)
Cash distribution to partners (1000) + - - + (1000) -
New balances -0- -0- -0- + 2200 + (2200)
Accounting Entries
1) To record the realization of non-cash assets
Cash………………………………………………………… 10,000
Loss on realization………………………………………….. 58,000
Accumulated depreciation – equipment ……………………. 10,000
Equipment………………………………………………..… 45,000
Accounts receivable…………………………………… 13,000
Inventory……………………………………………….. 20,000
2) To record the allocation of loss to partners:
Hanna, capital……………………………………………………34,800
Meseret, capital………………………………………………….23,200
Loss on realization…………………………………………………58,000
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3) To record the payment of liabilities
Accounts payable……………………………………………….15,000
Cash……………………………………………………………….15,000
4) To record the distribution of cash to partners

Hanna, capital…………………………………………………..1,000
Cash……………………………………………………………….1,000
A partnership has unlimited liability in the sense that deficient partner is obliged to contribute
from his/her personal assets. A deficient partner is a partner whose capital balance is debit
(negative). The deficient partner may not have personal asset. In this case, partners with
positive capital will bear the deficiency.
For the foregoing example, let’s consider the following assumptions:

Assumption A:
A: Meseret pays the entire amount of the Br. 2,200 deficiency to the partnership.
Assumption B:
B: Meseret pays Br. 1,500 of the deficiency to the partnership, and the remainder
is considered to be uncollectible.
Assumption C:
C: Meseret is unable to pay any part of the Br. 2,200 deficiency.
The various steps in the final settlements and the entries for the partnership under three
different assumptions as to the final settlement are illustrated below:
Assumption A: Meseret pays the entire amount of Br. 2200 deficiency to the partnership
The receipt of Br. 2200 paid by Meseret to the partnership, and the distribution of the Br. 2200
to the partner (Hanna) are illustrated in the following partnership statement.
HM Partnership
For period November 3-26,2003
assets capital capital
New balances -0- + -0- = -0- + 2200 + (2200)
Receipt of deficiency 2200 + - - - 2200
New balances 2200 + -0- -0- +2200 + -0-
Distribution of cash to Hanna (2200) - - (2200) -
Final balances -0- -0- -0- -0- -0-
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The entries to record the final settlement are as follows:
5) To record the receipt of deficiency
Cash……………………………………………………….. 2200
Meseret, capital…………………………………………….. 2200
6) To distribute cash to Hanna
Hanna, capital………………………………………………..2200
Cash………………………………………………………..2200
Assumption B: Meseret pays Br. 1500 of the deficiency to the partnership, and the
remainder is considered to be uncollectible.
The receipt of Br. 1500 paid by Meseret to the partnership, the allocation of the Br. 700 loss,
and the payment of the Br. 1500 to Hanna are indicated in the following statement of
partnership liquidation.
HM partnership
Statement of partnership Liquidation
For period November 3-26,2003
assets capital capital
New balances - + -0- = -0- + 2200 + (2200)
Receipt of deficiency -1500 + - - - 1500
New balances 1500 + -0- = -0- +2200 + (700)
Allocation of Loss - - - (700) + 700
New balances 1500 +-0- = -0- 1500 + -0-
Distribution of cash to Hanna (1500) - - (1500) -
Final balances -0- -0- -0- -0- -0-
Note that the Br. 700 loss was borne by Hanna. The entries to record the final settlement are as
follows:
(5) To record the receipt of part of deficiency
Cash…………………………………………………………… 1500
Meseret, capital…………………………………………………..1500
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(6) To record the allocation of loss to Hanna
Hanna, capital………………………………………………………...700
Meseret, capital……………………………………………………700
(7) To record the distribution of cash to Hanna

Hanna, capital……………………………………………………….1500
capital……………………………………………………….
Cash……………………………………………………………….1500
Assumption C: Meseret is unable to pay any part of the Br. 2200 deficiency.
deficiency.
The allocation of Br. 2200 loss to Hanna is indicated in the following statement of partnership
liquidation.
New balances -0- + -0- = -0- + 2200 + (2200)
Division of loss - + - - (2200) 2200
Final balances -0- -0- -0- -0- -0-
The entry required to record the final step in the liquidation is shown below:
(5) To record the allocation of loss to Hanna
Hanna, capital……………………………………………………..2200
Meseret, capital………………………………………………….2200
Note that Assumption A, B, and C are independent in the sense that all do not occur at the same
time. Either assumption A, B, or C occurs at a time.
1. Bale Company at December 31 has cash Br. 20,000, non cash assets Br. 100,000,
liabilities Br. 55,000, and the following capital balances: Bayisa Br. 40,000 and Lemma
Br. 25,000. The firm is liquidated and Br. 110,000 in cash is received for the non-cash
assets. Bayisa and Lemma share income at 55% and 45% respectively. The liquidation
process took 15 days (November 16-30, 2003).
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Required
a. Prepare the statement of partnership liquidation.
b. Prepare the entry to record:
i. The sale of non-cash assets
ii. The allocation of gain or loss to the partner
iii. Payment of creditors
iv. Distribution of cash to the partners.
2. Prior to the distribution of cash to the partners, the accounts of MEL Company show the
following balances. Cash Br. 30,000, M capital Br. 18,000 (Cr.), E capital (Cr.) Br. 16,000, and
L capital (Dr.) Br. 4,000. The income sharing ratios are 5:3:2 respectively.
Required
a) Prepare the entry to record:
i. L’s payment of Br. 4000 in cash to the partnership
ii. The distribution of cash to partners with credit balances
b) Prepare the entry to record:
i) The absorption of L’s capital deficiency by the other partners
ii) The distribution of cash to the partners with credit balances
6.4 PARTNERSHIP LIQUIDATION WHEN LOAN PAYABLE EXISTS
The right of offset may be applied in partnership liquidation. The right of offset states that if a
partner’s capital account has a debit balance, any credit balance in that partner’s loan account
must be offset against the deficit in the capital account. However, if a partner with loan account
receives any cash, the payment is recorded by a debit to the loan account to the extent of the
balance of that account.
Assume that A, B and C who share net income or losses in 4: 4:2 ratio, decide to liquidate the
partnership. The balance sheet on December 31,2004, just prior to liquidation, is shown below:
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ABC Partnership
Balance sheet
December 31, 2004
Assets Liabilities and capital

Cash 20,000 Liabilities 10,000
Other assets 85,000 Loan payable to B 30,000
A, Capital 32,000
B, Capital 15,000
_______ C, Capital 35,000
Total 105,000 Total 105,000
Assume that the non cash assets are sold for Br. 60,000. The liquidation process took place
from January 1 to April 1,2005.
Loss on realization = 85,000 – 60,000 = 25,000
Statement of Realization and liquidation is prepared as follows:
ABC Partnership
Statement of Realization and liquidation
January 1 through April 1,2005
Other
Cash Assets Liab. Loan A B C
Balances before realization 20,000 85,000 10,000 20,000 32,000 8,000 35,000
Realization of other Assets 60,000 (85,000)
(85,000) --- ---- (10,000)
(10,000) (10,000) (5,000)
Balances 80,000 ---- 10,000 20,000 22,000 2,000 30,000
Payment to creditors (10,000) --- (10,000)
(10,000) --- --- -- -- ___
Balances 70,000 --- -- 20,000 22,000 (2,000) 30,000
Offset B’ Capital deficit
Against B’s loan -- --- --- (2000) ---- 2000 ---__
Balances 70,000 --- --- 18,000 22,000 --- 30,000
Payment to partners (70,000) --- --- (18,000)
(18,000) (22,000)
(22,000) --- (30,000)
Balances --- --- -- --- --- -- ---
127
6.5 SUMMARY
Partnership dissolution may be followed by liquidation. Liquidation involves termination of the

operation of the partnership. When a partnership is liquidated accounts should be adjusted and
closed; non-cash assets are converted to cash; all creditors are paid; and the remaining cash
should b e distributed to the partners.
The sale of non-cash assets (realization) may result in gain or loss. Any gain or loss arising
from realization is divided between/among partners according to their income sharing
agreement. Gain on realization increase’s the partners’ capital accounts while loss on
realization reduces the accounts.
After all creditors are paid the remaining cash is distributed to the partners according to their
capital balances.

1. a) Gain on realization = 110,000 – 100,000 = 10,000
Division of gain:
Bayisa = 10,000 X 55% = 5,500
Lemma = 10,000 X 45% = 4,500
128
Bale Company
For period November 16-30, 2003
Items + Non cash = Liabilities + Bayisa + Lemma
Cash assets capital capital
Balances before realization 20000 + 100000 = 55000 + 40000 + 25000
Sale of non-cash assets & division of gain 110000 + (100000) = - + 5500 +4500
New balances 130000 + -0- = 55000 + 45500 + 29500
Pay liabilities (55000) - (55000) - + -
New balances 75000 +-0- = -0- 45500 + 29500
Distribution of cash to partners (75000) - - (45500) + (29500)
Final balances -0- -0- -0- -0- -0-
b. (i) Cash…………………………………………………………….. 110,000

Non cash Assets ……………………………………….…………….………..100,000
Gain on Realization………………………………………………….……….. 10,000
(ii) Gain on realization…………………………………………………10,000
Bayisa, capital………………………………………………………..….5,500
Lemma, capital……………………………………………………..……4,500
(iii) Liabilities………………………………………………………….55,000
Cash……………………………………………………………55,000
(iv) Bayisa, capital…………………………………………………………45,500
Lemma, capital ……………………………………………………….29,500
Cash…………………………………………………………….………75,000
2. a. (i) Cash…………………………………………………………..4,000
L, capital………………………………………………………………4,000
(ii) M, capital…………………………………………………………18,000
E, capital………………………………………………………… 16,000
Cash…………………………………………………………………..34,000
Cash………………………………………………………………
b. (i) M, capital (4,000 x 5/8) ………………………………………2,500
E, capital (4,000 X 3/8)……………………………………….1,500
L, capital…………………………………..…….………………4,000
(ii) M, capital (18,000 – 2,500)……………………………………….15,500
129
E, capital (16,000 – 1,500)………………………………………...14,500
Cash………………………………………………………………..30,000
6.7 REFERENCES
1. Larsen, E. John (2000), Modern Advanced Accounting,

Accounting, 8th ed. McGraw-Hill, Boston.
2. Hoyle, J.B., et.al (2001), Advanced Accounting,
Accounting, 6th edition IRWIN, New York
3. Engler and Bernstein (1998), Advanced Accounting,
Accounting, 2nd edition, McGraw-Hill Company,
Boston.
4. S.KR. Paul (1996), Advanced Accounting,
Accounting, New Central Book Agency (P) LTD, Calcutta.
130

Unit 1 Advanced Accounting

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Unit 1 Advanced Accounting

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UNIT 1: SEGMENT REPORTING

1.0 AIMS AND OBJECTIVES

After completing this unit, students should be able to:

1.2 OBJECTIVES OF SEGMENT REPORTING AND APPLICABLE ACCOUNTING

Generally, segment information is based on the totals of consolidated financial statements.

1.3.1 Operations in different industries

1. 3.1.1 Revenue test

Segments Total Eliminati Consol

50,000 30,000 70,000 15,000 165,000 (40,000) 125,00

1.3.1.2 Operating profit test

1.3.1.3 Asset test

Segments Elimi Consolid

Besides, it is assumed that none of the segments is financial segment.

To identify reportable segment, the following steps can be followed:

Check your progress 1.1

Revenue test benchmark = 10% of consolidated revenues

Domestic Kenya Uganda Togo Combined Eliminations Consolidated

Assets test benchmark = 10% of consolidated assets

Check your progress 2

1. What is meant by foreign operations?

Benin Ghana Cameron Domestic

1.3.3 Export sales

1.3.4 Major customer

1.4 THE POSITION OF SECURITY AND EXCHANGE COMMISSION (SEC) ON

Check your progress 1–3

Check your progress 1.1

1. A business segment is a component of a business enterprise whose activities

Check your progress 1.2

Check your progress 1. 3

1. False 3. True 5. True 7. False

1. In segment reporting, inter segmental transactions are not eliminated. True/False

2.0 Aims and Objectives

2.0 AIMS AND OBJECTIVES

After reading this unit, you will be able to:

2.2 THE NEED FOR INTERIM REPORTS

An interim financial report may include either a

2.3 APPROACHES TO INTERIM REPORTING

1. Discrete period approach

2. Integral period approach

2.4 STANDARDS FOR INTERIM REPORTING OF REVENUES, COSTS, AND

a. Direct costs and expenses

Quarter Quarterly End of quarter

Cost of goods sold

a. 10,000 units remaining in inventory multiplied by Br. 1 write down to lower

Check your progress 2.1

1. What are the reasons for preparing interim financial statements?

2.5 INCOME TAXES IN INTERIM FINANCIAL STATEMENTS

Year-to-date tax expense or benefit ----------------------------------------------------------- xxx

Income tax provision = Pretax income x Estimated effective tax rate

Cumulative pretax income year-to-date (130,000 + 180,000) -----------------310,000

To illustrate, consider the following data for Stars Company in year 3.

Pretax income Estimated

Tax provision for quarter three:

Tax provision for 4th quarter:

Check your progress 2.2

Quarterly pretax Estimated tax

2.6 REPORTING OF ACCOUNTING CHANGES AND EXTRA ORDINARY AND

2.6.1 Reporting extra ordinary and other non operating items

2.6.2 Reporting gains or losses from disposal of business segment

Business segment is a component of a business enterprise whose activities represent a separate

2.6.3 Reporting accounting changes in interim periods

1. Accounting changes in the First interim period