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Michael F. Farrell, J.D. and Arthur E. Reed, MBA, MST, CPA,
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Paul Debole, J.D
William A. Grubbs, MBA, CPA
1
Financial Accounting
and
Reporting
by
Vincent W. Lambers, MBA, CPA
Donald T. Hanson, MBA, CPA
William A. Grubbs, MBA, CPA
Published by
Copyright © 2012 by LearnForce Partners, LLC.
All rights reserved. No part of this publication
may be reproduced in any form without the
written permission of the publisher.
ACKNOWLEDGMENTS
It would be impossible to write a CPA examination preparation book of any kind without the assistance of
the American Institute of Certified Public Accountants, and their various operating divisions, in granting
permission to use various materials. We respectfully acknowledge and thank those persons in the American
Institute who promptly answered our inquiries.
Those areas of the set for which we received permission to use copyrighted material from the American
Institute are:
CPA Examination Questions, Problems and Solutions
Opinions of the Accounting Principles Board and The Financial Accounting Standards Board
Statements on Auditing Standards
The Code of Professional Ethics and Interpretations Thereof
Vincent W. Lambers, CPA
Donald T. Hanson, CPA
William A. Grubbs, CPA
North Andover, Massachusetts
Chapter Subjects of
Volume 1—FINANCIAL ACCOUNTING AND REPORTING
Chapter One
PARTNERSHIPS
Chapter Two
STOCKHOLDERS' EQUITY AND INVESTMENTS IN STOCK
Chapter Three
INVENTORIES
Chapter Four
CONSOLIDATED FINANCIAL STATEMENTS
Chapter Five
EARNINGS PER SHARE, SEGMENT REPORTING
Chapter Six
PRICE LEVEL—FOREIGN EXCHANGE
Chapter Seven
ACCOUNTING THEORY
Chapter Eight
STATEMENT OF CASH FLOWS (ASC 230), FINANCIAL STATEMENT ANALYSIS
Chapter Nine
BONDS, ACCOUNTING FOR DEBT
Chapter Ten
REVENUE AND EXPENSE RECOGNITION, MISCELLANEOUS ITEMS
Chapter Eleven
OTHER ASSETS, LIABILITIES, AND DISCLOSURES
Chapter Twelve
REPORTING THE RESULTS OF OPERATIONS
Chapter Thirteen
ACCOUNTING FOR INCOME TAXES
Chapter Fourteen
ACCOUNTING FOR LEASES, PENSION AND POSTRETIREMENT PLANS
Chapter Fifteen
GOVERNMENTAL ACCOUNTING
Chapter Sixteen
NOT-FOR-PROFIT ACCOUNTING
Material from Uniform CPA Examination Questions and Unofficial
Answers, copyright 1977 through 2010 by the American Institute
of Certified Public Accountants, Inc., is reprinted (or adapted) with
permission.
Chapter One
Partnerships
DEFINED .......................................................................................................................................................... 1-1
AGREEMENTS ................................................................................................................................................ 1-1
DIVISION OF PROFITS .................................................................................................................................. 1-1
ADMISSION OF A PARTNER ........................................................................................................................ 1-1
PURCHASE OF AN INTEREST ...................................................................................................................... 1-1
Payment to an Existing Partner
Payment to More Than One Partner
INVESTMENT IN A PARTNERSHIP BY CONTRIBUTION TO THE
FIRM'S CAPITAL ............................................................................................................................................. 1-3
No Goodwill or Bonus
Goodwill Recognized to Old Partners
Bonus Allowed to Old Partners
Goodwill Allowed to New Partner
Bonus Allowed to New Partner
DIVISION OF PROFITS .................................................................................................................................. 1-4
Interest on Capital
Partners' Salaries
RETIREMENT OF A PARTNER ..................................................................................................................... 1-4
Goodwill Recorded
Implied Bonus or Goodwill
DISSOLUTION AND LIQUIDATION ............................................................................................................ 1-5
Causes of Dissolution
Liquidation
LIQUIDATION IN INSTALLMENTS ............................................................................................................. 1-6
CASH DISTRIBUTION PLANS ...................................................................................................................... 1-7
INCORPORATION OF A PARTNERSHIP ..................................................................................................... 1-9
BONUS COMPUTATIONS ............................................................................................................................. 1-9
IFRS…………………………………………………………………………………………………………….1-10
Chapter One
Partnerships
DEFINED
"Association of two or more persons to carry on, as co-owners, a business for profit."
AGREEMENTS
Can be expressed (oral or written contract) or implied (actions).
Should be in writing for protection of partners. The agreement governs the formation, operation, distribution of
income or loss, and dissolution of the partnership.
DIVISION OF PROFITS
• Profits can be shared in any way agreeable to the partners.
• If the agreement is silent, the law assumes that profits and losses will be shared equally.
• Amount of capital contributed has no effect on profit division unless specified in the agreement.
ADMISSION OF PARTNER
• Admission or withdrawal of a partner generally dissolves the partnership and brings into being a new
partnership.
• New articles of partnership should be drawn up.
• A new partner can purchase an interest or invest in the partnership.
Care should be taken to distinguish between a purchase of an interest and the investment in a partnership. The
difference is critical to the proper procedure to follow in partnership problems.
1. Purchase of interest. Example: A purchases interest of X in XYZ partnership or part of interest of XYZ in
XYZ partnership. The amount A paid for his interest is outside the partnership and not recorded in the books.
2. Investment. Example: A invests $10,000 in XYZ partnership, thereby increasing the capital of the partnership.
PURCHASE OF AN INTEREST
1. Payment to an existing partner
No cash transaction is to be entered on the books in the purchase of an interest. X, Y, and Z have capitals of
$10,000, $15,000 and $20,000 respectively. Z sells half of his capital interest to P for the sum of $12,000.
Entry: Z, Capital $10,000
P, Capital $10,000
Transaction is between Z and P as to amount and Z has merely transferred one-half of his interest to P.
2. Payment to more than one partner
Purchase at book value: P purchases a one-fourth interest for $11,250.
Entry: X, Capital $2,500 (25% × $10,000)
Y, Capital $3,750 (25% × $15,000)
Z, Capital $5,000 (25% × $20,000)
P, Capital $11,250
Purchase at more than book value: Where purchase is at more than book value, goodwill may or may not be
recognized.
1-1
Example: P pays $15,000 for a one-fourth interest and XYZ share profits on a 4:3:3 basis.
a. Goodwill not recognized. Transfer of capital same as above. The existing partners will divide the $15,000 cash
on some agreed basis or as follows:
X(40) Y(30) Z(30) Total
For Capital $2,500 $3,750 $5,000 $11,250
Amount in Excess of Capital
in P&L Ratio 1,500 1,125 1,125 3,750
$4,000 $4,875 $6,125 $15,000
b. Goodwill recognized. If P is willing to pay $15,000 for a one-fourth interest, the implied value of the
partnership is $60,000 ($15,000 × 4). Goodwill must be placed on the books prior to the admission of P to bring
total capital to $60,000.
Goodwill $15,000 ($60,000 – $45,000 XYZ total capital)
X, Capital $6,000 ($15,000 × 40%)
Y, Capital 4,500 ($15,000 × 30%)
Z, Capital 4,500 ($15,000 × 30%)
To recognize goodwill and increase total capital to $60,000.
(1) X, Capital $4,000
(2) Y, Capital 4,875
(3) Z, Capital 6,125
P, Capital $15,000
(1) $16,000 × 1/4 (2) $19,500 × 1/4 (3) $24,500 × 1/4
To record transfer of capital to P.
Purchase at less than book value: P pays $10,000 for a one-fourth interest.
a. No adjustment of the old partner's capital account. The same journal entry as in #2 above will be recorded
since P will receive $11,250 in capital for $10,000. The existing partners will divide the $10,000 cash on some
agreed basis or as follows:
X(40) Y(30) Z(30) Total
Capital $2,500 $3,750 $5,000 $11,250
Loss: $11,250 – 10,000 in P&L ratio (500) (375) (375) (1,250)
Division of Cash $2,000 $3,375 $4,625 $10,000
b. Adjustment of old partner's capital account: In this situation the partners are giving recognition to the loss in
value of their interest. Total capital is reduced to $40,000 implied value ($10,000 × 4), with the resulting asset
write-down of $5,000.
X(40) Y(30) Z(30) P Total
Original Capitals $10,000 $15,000 $20,000 $45,000
Asset write-down
$45,000 – $40,000 in P&L ratio (2,000) (1,500) (1,500) (5,000)
8,000 13,500 18,500 40,000
Capital transfers (2,000) (3,375) (4,625) 10,000 --
$ 6,000 $10,125 $13,875 $10,000 $40,000
1-2
INVESTMENT IN A PARTNERSHIP BY CONTRIBUTION
TO THE FIRM'S CAPITAL
Asset values may be adjusted before admission of any new partner(s). An investment may result in the following:
• Recognition of either goodwill or bonus to the old partners.
Goodwill is placed on the books before admission of a new partner.
Bonus--part of the capital contributed is credited to the account of the old partners.
• Recognition to the incoming partner in the form of either goodwill or bonus.
1. No goodwill or bonus.
A and B have capitals of $10,000 and $20,000 respectively, share profits and losses equally, and C is to be admitted
to the firm by making a contribution to the firm's capital. C is to invest $10,000.
Entry: Cash $10,000
C, Capital $10,000
Note that C's profit sharing ratio is not determined by the amount of capital contributed, but must result from
agreement with the original partners.
2. Goodwill recognized to old partners
C is to invest $12,000 for a one-fourth interest. Analysis: Implied value is $48,000 (4 × $12,000). C's contribution
plus A and B's capital equals $42,000; therefore, $6,000 in goodwill must be added to total capital.
Entries: Goodwill $6,000
A, Capital $3,000
B, Capital 3,000
Cash 12,000
C, Capital $12,000
3. Bonus allowed to old partners
C is to invest $18,000; capital of A and B plus C's contribution equals $48,000. Since C is contributing $18,000 but
is to receive only a one-fourth interest of $12,000 (1/4 × $48,000), a bonus of $6,000 is given to A and B.
Entry: Cash $18,000
A, Capital $ 3,000
B, Capital 3,000
C, Capital 12,000
Note that in bonus situations total capital equals the old capital plus the partner's contribution.
4. Goodwill allowed to new partner
C is to invest $9,000 of miscellaneous business assets and agreed total capital is to be $40,000.
Entry: Goodwill $1,000 ($40,000 – $30,000 – $9,000)
Misc. Assets 9,000
C, Capital $10,000 (1/4 × 40,000)
5. Bonus allowed to new partner
C is to invest $9,000; a bonus is allowed to C.
Entry: Cash $9,000
A, Capital 375
B, Capital 375
C, Capital $9,750 (1/4 × 39,000)
1-3
DIVISION OF PROFITS
Division of profits is governed by the partnership agreement. Profits may be divided:
1. Equally
2. On some other fractional basis
3. In capital ratio
4. On average capital ratio
5. By allowing interest on capitals and dividing remainder, and
6. By allowing salaries to the partners and dividing remaining profit.
If the agreement makes no provision for the division of profit and losses, the law assumes they will be shared
equally.
1. Interest on Capital
• Partner cannot claim interest on capital unless provided for in the partnership agreement.
• Interest on capital should not be included in income statement as an expense.
• Interest paid on partners' loans may be treated as a financial expense.
2. Partners' Salaries: Treated as a division of profits. Allocation of partners' "salaries" may exceed partnership
income and create a loss to be allocated to all partners according to the partnership agreement.
Method of Distribution
• Allocate salaries, interest first
• Distribute remaining profit (loss) per agreement
Example: A, B, and C agreed to the following distribution of profit:
A B C
Annual salary $10,000 $ 8,000 0
Interest on average capital 0 4% 10%
Remainder 40% 40% 20%
Average capital $50,000 $50,000 $200,000
Profit distribution under three different assumptions:
A B C Total
Interest allocation --0-- $ 2,000 $20,000 $22,000
Salary allowance $10,000 8,000 -0-- 18,000
$10,000 $10,000 $20,000 $40,000
1. Assume $50,000 profit
Remainder ($50,000 – $40,000) 4,000 4,000 2,000 10,000
2. Assume $20,000 profit
Remainder ($20,000 – $40,000) (8,000) (8,000) (4,000) (20,000)
3. Assume $10,000 loss
Remainder (– $10,000 – $40,000) (20,000) (20,000) (10,000) (50,000)
RETIREMENT OF A PARTNER
Adjustment of asset values may be required to determine the fair equity of a retiring partner. This may be necessary
to:
a. Correct improper operating charges of prior periods (bad debts, accruals, depreciation and recognition of
inventories).
b. Give recognition to the existence of goodwill.
c. Give recognition to changes in market values.
1-4
Problem: C is to retire from A, B, C partnership. A goodwill value of $6,000 has been agreed upon.
1. Goodwill recorded on the books for (1) all partners or (2) only the retiring partner.
(1) Goodwill $6,000
A, Capital $2,000
B, Capital 2,000
C, Capital 2,000
(2) Goodwill $2,000
C, Capital $2,000
2. Implied bonus or goodwill
Assume that A, B and C have capitals of $10,000 each and share profits equally. C is to retire and is to be paid
$12,000 from partnership assets. The $2,000 excess of the payment to C over his capital may be recorded as a bonus
or as goodwill.
Bonus A, Capital $ 1,000
B, Capital 1,000
C, Capital 10,000
Cash $12,000
Goodwill: Goodwill $ 2,000
C, Capital $ 2,000
C, Capital 12,000
Cash 12,000
DISSOLUTION AND LIQUIDATION
1. Causes of Dissolution
Dissolution occurs when the existing partnership arrangement is altered for some reason. Liquidation may follow
dissolution but often outsiders would be unaware of the end of one partnership and the start of another.
2. Liquidation—Terminating the Affairs of a Business
A. Procedure:
(1) Realization of assets—convert assets into cash
(2) Division of loss or gain on realization, by charges or credits to partner's capital
(3) Payment of the liabilities
(4) Payment of the partner's interest
B. Order of distribution in liquidation
(1) Outside creditors
(a) Priority claims such as artisans, government, liquidation expenses.
(b) Secured creditors to the extent covered by proceeds from sale of pledged assets. Excess claim treated as
unsecured credit.
(c) Unsecured credit to the extent covered by proceeds from sale of unpledged (or free) assets.
(2) Partners for loan accounts (right of "offset" reserved, however)
(3) Partners' capital
As a practical matter partners' loans and capital are considered as one. Any known gain or loss should be distributed
before any payments are made to partners.
1-5
