Category: Accounting

Adjustment for Goodwill

Since the new partner gets a share in the profits of the rum, he should compensate the old partners for sharing the earning of the firm on account of the reputation or goodwill earned by the partnership firm so fan The problem of goodwill on admission of a new partner can be dealt in two different ways:

1. When the goodwill account already appears in the books.

2. When the goodwill account is not appearing in the books at the time of admission of a partner.

If the goodwill account is already appearing in the books. There can be three situations:

The goodwill account is appearing at a proper value. In such an event no adjustment will be required for goodwill.

A and B are sharing profits in the ratio 3 : 2. They admit a new partner C with 1/5 share in the profits. At the time of admission of C, goodwill is appearing in the firm’s books at Ps 10,000 and it is agreed by all partners (including C) that it is properly valued. Should C pay anything for goodwill?

Solution: 

Since goodwill is already appearing in the books, it shows that the old partners have already got credit to their capital accounts with the value of goodwill. Moreover, it is properly valued and hence C will not be required to pay anything for goodwill nor any further adjustment will be required.

(ii) The goodwill account is to be revalued. In such an event entry will be made only with the difference. The amount of over or under-valued goodwill is debited or credited to the old partners in the old ratio and credited or debited to goodwill account.

JOINT VENTURE AND PARTNERSHIP

According to the Indian Partnership Act. “Partnership is the relations between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.” Thus, both in joint venture and partnership there is some business activ,ity whose profit (or loss) is agreed to be shared by two or more than two persons. As a matter of fact in law, a joint venture is treated as a partnership. Of course, a partnership covers or is meant to cover a long period whereas ajoint venture is only for a limited purpose sought to be achieved in a short period. On account of this reason, joint venture is also sometimes termed as a temporary partnership’ or ‘partnership for a specific venture’ or ‘particular partnership’.

Joint Venture and Consignment

The following are the points of distinction between joint venture and consignment:

(1) .Relalionslnp: In case of a consignment transaction, the relationship between the consignor and the consignee is that of a principal and an agent. While in case of joint venture, the relationship amongst various venturers is that of partners, i.e., mutual agency. Each venturer is a principal as well as an agent for the other venturer.

(II) Sharing of profits: In case of consignment, the consignee gets only a commission on the goods sold by him on behalf of the consignor while in case of joint venture each venturer gets a share in the profits of the venture,

(iii) Transfer of risk: tn case of consignment, till the goods are sold the risk continues to be of consignor while ajoint venture is a temporary partnership hence the risk continues of all venturers.

METHODS OF VALUATION OF INVENTORIES

According to International Accounting Standard: 2 (lAS: 2), the inventories should be valued at the lower of “historical cost” and “net realisable value”.

Historical Cost

Historical cost of inventories is the aggregate of costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

Thus Historical cost includes not only the price paid for acquisition of inventories but also all costs incurred for bringing and making them fit for jise in production or for sale e.g. transportation costs, duties paid, insurance-in-transit, manufacturing expenses,wages paid or manufacturing expenses incurred for converting raw materials into finished products etc. Selling expenses such an advertisement expenses r storage costs should not be included.

A major objective of accounting for inventories is the proper determination of income thmugh the process of matching appropriate costs against revenues. It requires assigning of proper costs to inventory as well as goods sold.

However, it should be noted that assigning of such costs need not conform to the physical flow of goods.

The various methods for assigning historical costs to inventory and goods sold are being explained below.

I. Proforma invoice. It is a statement prepared by the consignor stating quantity, quality and price of goods. It is sent with goods despatched to consignee.

A proforma invoice is different from Invoice.

Invoice implies that a sale has taken place. It is a statement describing the goods despatched to the buyer and showing the total amount due by him to the seller. A proforma invoice is simply a statement of information in the form of invoice to apprise the party, who has not bought the goods but shall be having their possession, or dealing with them, of certain essential particulars of the goods. Such an invoice is sent by the intending seller to his agent or the intending buyer before the sale actually takes place. It does not show that the person to whom it is sent is indebted to the sender.

2. Account sales. It is a periodical statement rendered by the Consignee to the Consignor containing details of goods received, sales made, expenses incurred, commission charged, remittances made and balance due by him to the consignor. The following is a specimen of an Account Sales.

ACCOUNTING PROBLEMS

The accounting problems on admission of a new partner can be put as follows:

(i) Adjustment in the profit sharing ratio.

(ii) Adjustment for goodwill.

(iii) Adjustment for revaluation of assets and liabilities.

(iv) Adjustment for reserves and other accumulated profits.

(v) Adjustment for capital.

Each of the above problems are being discussed in the following pages.

Adjustment in the Profit Sharing Ratio

A newly admitted partner will be entitled to share the profits or bear the losses with the other partners. Hence the profit sharing ratio of the partners will change. There can be two situations.

The new partner may be given a certain proportion of the total profit or required to bear a certain proportion of the total loss and the old partners continue to share the balance of profit or bear the balance of loss in the old ratio in between themselves.

Accounting Problems 

The accounting problems in the event of retirement of a partner can be put as follows:

(i) Adjustment for Goodwill,

(ii) Revaluation of assets  and liabilities.

(iii) Adjustment regarding Reserves and other undistributed profits.

(iv) Adjustments regarding profit sharing ratios.

(v) Payment to the retiring partner.

1. Goodwill. The retiring partner will be entitled to his share of goodwill in the (inn. The problem of goodwill can be dealt in the following two different ways:

(a) Where goodwill account is already appearing in the books:

In such a case if goodwill is properly valued, no further adjustment will be needed. The amount has already been credited to all the partners including the retiring partner.

(b) Where goodwill account is not appearing in lire book. 

Steps for preparing statement of affairs. The following steps may be taken for preparing the Statement of Affairs.

(i) In most cases in single entry system, a cash book is maintained. In case, this has been done, the cash and the bank balances can be taken from the cash book. In the absence of a proper cash book, cash balance may have to be found out by preparing a receipts and payments account on the basis of information collected from the proprietor of the business and the statement of accounts which might have been received or sent by the proprietor from/to his debtors and creditors. Information regarding other business expenses can be collected from the salaries register of his employees, petty cash book if any maintained by him, etc., and the actual cash balance available with the business. The balance at the bank can be verified from the bank pass book or Statement of Account from the Bank.

(ii) A list of sundry debtors and creditors should be prepared. This may not be difficult because in mostcases, a record of personal accounts is maintained under the single entry system.

(iii) The value of the fixed assets like building, plant, furniture. etc., should be ascertained from vouchers or other documents available with the business. A reasonable charge for depreciation should also be made and the assets should be shown in the Statement of Affairs after charging depreciation.

(iv) A physical verification of the stock should be taken and the value of the stock in hand should be ascertaIned on the basis of the different invoices received from suppliers from time to time in respect of the goods purchased.

(v) The amount of outstanding expenses and the accrued income should also be determined. Last year’s figures about these items may be of considerable help in this respect.

(iv) The excess of assets over liabilities should be found out and this will denote the net worth or the capital of the business on the date on which the Statement of Affairs has been prepared.

Pricing of Goods Sent on Consigmnent 

Goods can be consigned to the consigneç either (1) at cost or (ii) at invoice price.

At cost. In case of this method the goods are charged to the consignment at cost price to the consignor. The proforma invoice is also prepared at this price. For example if the goods costing Rs 10,000 are purchased by A and 80 per cent of such goods are sent by him on consignment to Bombay, proforma invoice will show the value of goods as Rs 8,000 and the Consignment to Bombay account will also be charged with this price. The consignee may be given the direction regarding the price at which he should sell the goods (see illustration 1.2.).

At invoice price, In case of this method the goods are charged to the,consignment at a price higher than cost The proforma invoice also shows the value of goods at such higher price. The excess of invoice price over the actual cost, represents the profit which the consignor intends to make on the goods consigned. For example, if in the above case the goods are consigned at a profit of 25 per cent on cost (or 20 per cent on invoice price), the consignment account will be charged with Rs 10,000 (i.e., Ps 8,000 + Rs 2,000) for the value of goods sent on consignment However, in order to find out the profit, at the end of the accounting period, the consignment account will be given credit with the excess price so charged. In this case, the credit to the consignment account will be of Rs 2,000. Thus, in fact, consignment account has been charged only with the cost (i.e., Ps 10,000— Ps 2,000) of the goods sent on consignment as has been done in the first case. Suitable adjustment for profit clement included in the stock with the consignee has also to be made

The system suffers from several disadvantages:

(i) Arithmetical accuracy cannot be checked. In case of Double Entry System

Book-keeping Trial Balance is prepared to check the arithmetical accuracy of the books of accounts. This is possible because every transaction is recorded at two places. In case of Single Entry System, this is not done. Hence, Trial Balance cannot be prepared and the

-arithmetical accuracy of the books of accounts cannot be checked. This increases the possibility of more frauds and misappropriations as compared to the Double Entry System of Book-keeping.

(ii) True profits cannot be known. In the absence of complete information for sales, purchases and other expenses, it is notpossible to draw the Profit and Loss Account. Hence, the true profit or loss made or suffered by the business cannot be known.

(iii) Financial position of the business cannot be judged. In the absence of true figure of profit and correct information about the assets and liabilities of the busiiless, the Balance Sheet cannot be drawn up to give a correct picture of the financial position of the business on a particular date.

(iv) Makes planning and decision-making difficult. The system does not provide accurate figures about the performance of the business and its financial position. For example, separate figure of gross profit, net profit and sales are not available. Thus, the ratio of gross profit to sales or net profit to sales cannot be found out. Similarly in the absence of any information about the cost of goods sold, the proportion of differeut elements of cost of sales cannot be found out. In the absence of such information, it becomes difficult for the proprietor of the business to know the reasons of his improving or deteriorating profitability and financial position. Thus, he is not in a position to compare, plan and take sound decision for the prosperity of the business. Moreover, it may be difficult for him to find the real value of his business in the event of his deciding to sell the business.

When assets and liabilities have to appear in the books at the revised values.

In such a case a Profit and Loss Adjustment Account or Revaluation Account is opened in the books. The following entries are to be passed.

(i) For increase in the value of an asset or decrease in the value of a liability: 

Asset/Liability A/c  Dr.

To P. & L. AdjustnientA/c

(ii) For decrease in the value of an asset or increase in the value of a liability. 

P. & L. Adjustment A/c Dr.

To Asset/Liability A/c

(iii) The profit on revaluation will be transferred to old partners’ capital accounts in the old profit sharing ratio. 

P. & L. Adjustment A/c  Dr.

To Old Partners Capital A/cs. (Individually)

In the event of loss, the entry will be reversed.

When assets and liabilities have to appear at old values in the books 

A Memorandum Profit and Loss Adjustment Account will be opened in the books. The increase in the value of assets or decrease in the value of liabilities will be credited to this account. The decrease in the value of assets or increase in the value of liabilities will be debited to this account. However only two entries will be passed:

(i) For credited in the profit on revaluation to old partners’ accounts: 

Memorandum P. & L. Adjustment A/c Dr.

To Old Partners’ Capital Accounts (in old ratio)

In case of loss the entry will be reversed.

(ii) For writing off the profit on revaluation to all partners’ capital accounts (including the new partner): 

Partners’ Capital Accounts (in the new ratio) Dr.

To Memorandum P& L. Adjustments A/c

In case of loss the entry will be reversed.