FUNDAMENTALS OF ACCOUNTING - CHAPTER 8

Illustration 1 The Balance Sheet of Seed, Plant and Flower as at 31st December, 2009 was as under : Liabilities Rs. Assets Rs. Sundry Creditors 20,000 Fixed Assets 40,000 General Reserve 5,000 Sundry Debtors 10,000 Capital : Bills Receivable 4,000 Seed 25,000 Stock 16,000 Plant 15,000 Cash at Bank 10,000 Flower 15,000 55,000 80,000 80,000 The profit sharing ratio was: Seed 5/10, Plant 3/10 and Flower 2/10. On 1st May, 2009 Plant died. It was agreed that: (a) Goodwill should be valued at 3 years purchase of the average profits for 4 years. The profits were : 2005 Rs. 10,000 2007 Rs. 12,000 2006 Rs. 13,000 2008 Rs. 15,000 (b) The deceased partner to be given share of profits upto the date of death on the basis of the previous year. (c) Fixed Assets were to be depreciated by 10%. A bill for Rs. 1,000 was found to be worthless. These are not to affect goodwill. (d) A sum of Rs. 7,750 was to be paid immediately, the balance was to remain as a loan with the firm at 9% p.a. as interest. Seed and Flower agreed to share profits and losses in future in the ratio of 3 : 2. Give necessary journal entries. FUNDAMENTALS OF ACCOUNTING 8.101 Copyright -The Institute of Chartered Accountants of India DEATH OF PARTNER Solution Journal Entries 2009 Dr. Cr. Rs. Rs. May 1 General Reserve Account Dr. 5,000 To Seed's Capital Account 2,500 To Plant's Capital Account 1,500 To Flower's Capital Account 1,000 (General Reserve transferred to Capital Account on the death of Plant) Seed's Capital Account Dr. 3,750 Flower's Capital Account Dr. 7,500 To Plant's Capital Acco0unt 11,250 (Adjustment for goodwill on the death of Plant on the basis of gaining ratio) (Value = 3 × (10,000 + 13,000 + 12,000 + 15,000)/4) Revaluation Account Dr. 5,000 To Fixed Assets Account 4,000 To Bills Receivable Account 1,000 (Depreciation of fixed assets @ 10% and writing off of one bill for Rs. 1,000 on Plant's death) Seed's Capital Account Dr. 2,500 Plant's Capital Account Dr. 1,500 Flower's Capital Account Dr. 1,000 To Revaluation Account 5,000 (Loss on Revaluation transferred to capital accounts) Profit and Loss Suspense Account Dr. 1,500 To Plant's Capital Account 1,500 (Plant's share of four month's profit based on the year 2008) Plant's Capital Account Dr. 27,750 To Plant's Executor's Account 27,750 (Amount standing to the credit of Plant's Capital Account transferred to the credit of his Executor's Account) Plant's Executor's Account Dr. 7,750 To Bank Account 7,750 (Amount paid to Plant's Executors) 8.102 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Illustration 2 The following was the Balance Sheet of Om & Co. in which X, Y, Z were partners sharing profits and losses in the ratio of 1:2:2 as on 31.3.2009. Mr. Z died on 31st December, 2009. His account has to be settled under the following terms. Balance Sheet of Om & Co. as on 31.3.2009 Liabilities Rs. Rs. Assets Rs. Sundry creditors 20,000 Goodwill 30,000 Bank loan 50,000 Building 1,20,000 General reserve 30,000 Computers 80,000 Capital accounts: Stock 20,000 X 40,000 Sundry debtors 20,000 Y 80,000 Cash at bank 20,000 Z 80,000 2,00,000 Investments 10,000 3,00,000 3,00,000 Goodwill is to be calculated at the rate of two years purchase on the basis of average of three years' profits and losses. The profits and losses for the three years were detailed as below: Year ending on profit/loss 31.3.2009 30,000 31.3.2008 20,000 31.3.2007 (10,000) Loss Profit for the period from 1.4.2009 to 31.12.2009 shall be ascertained proportionately on the basis of average profits and losses of the preceding three years. During the year ending on 31.3.2009 a car costing Rs. 40,000 was purchased on 1.4.2004 and debited to traveling expenses account on which depreciation is to be calculated at 20% p.a. This asset is to be brought into account at the depreciated value. Other values of assets were agreed as follows: Stock at Rs. 16,000, building at Rs. 1,40,000, computers at Rs. 50,000; investments at Rs. 6,000. Sundry debtors were considered good. You are required to: (i) Calculate goodwill and Z's share in the profits of the firm for the period 1.4.2009 to 31.12.2009. (ii) Prepare revaluation account assuming that other items of assets and liabilities remained the same. FUNDAMENTALS OF ACCOUNTING 8.103 Copyright -The Institute of Chartered Accountants of India DEATH OF PARTNER Solution (i) Calculation of goodwill and Z's share of profit: (a) Adjusted profit for the year ended 31.3.09: Rs. Rs. Profit (Given) 30,000 Add: Cost of car wrongly written off 40,000 Less: Depreciation for the year 2008-09 8,000 32,000 (20% on Rs. 40,000) 62,000 (b) Average of last three year's profits and losses Year ended on Profit/(loss) Rs. 31.3.2007 (10,000) 31.3.2008 20,000 31.3.2009 62,000 72,000 Average profit (72,000/3) 24,000 (c) Goodwill at 2 years' purchase Rs. 24,000 x 2 = Rs. 48,000 (d) Z's share of profits from the period 1.4.2009 to 31.12.2009 Rs. 24,000 x 9/12 x 2/5 = Rs. 7,200 (ii) Revaluation Account Dr. Cr. Rs. Rs. To Stock account 4,000 By Building account 20,000 To Computers account 30,000 By Loss transferred to To Investments account 4,000 X 3,600 Y 7,200 Z 7,200 18,000 38,000 38,000 8.104 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Illustration 3 On the basis of illustration 2, prepare partners' capital accounts and balance sheet of the firm Om & Co. as on 31.12.2009. Solution Partners' Capital Accounts Dr. Cr. X Y Z X Y Z Rs. Rs. Rs. Rs. Rs. Rs. To Revaluation A/c 3,600 7,200 7,200 By Balance b/d 40,000 80,000 80,000 To Z's Executor's A/c 1,12,000 By General reserve 6,000 12,000 12,000 To Goodwill A/c 6,000 12,000 12,000 By X and Y – – 19,200 To Z 6,400 12,800 – By Car A/c 6,400 12,800 12,800 To Balance c/d 36,400 72,800 By Profit and Loss suspense A/c – – 7,200 52,400 1,04,800 1,31,200 52,400 1,04,800 1,31,200 Balance Sheet of Om & Co. as 31.12.2009 Liabilities Rs. Assets Rs. Sundry creditors 20,000 Building 1,40,000 Bank loan 50,000 Car 32,000 Capital accounts: Stock 16,000 X 36,400 Computers 50,000 Y 72,800 Investments 6,000 Z's Executor's account 1,12,000 Sundry debtors 20,000 Cash at bank 20,000 Profit and Loss suspense Account 7,200 2,91,200 2,91,200 Goodwill calculated at the time of death of partner Z (See W.N.c of solution 2) Rs. 48,000 Partner Old Share New Share Gain Sacrifice 1 1 2 X – 5 3 15 2 2 4 Y – 5 3 15 2 2 Z – – 5 5 FUNDAMENTALS OF ACCOUNTING 8.105 Copyright -The Institute of Chartered Accountants of India DEATH OF PARTNER Adjusting entry : X's Capital Account Dr. 6,400 Y's Capital Account Dr. 12,800 To Z's Capital Account 19,200 (Adjustment for goodwill on the death of Z on the basis of gaining ratio) Illustration 4 The partnership agreement of a firm consisting of three partners - A, B and C (who share profits in proportion of ½, ¼ and ¼ and whose fixed capitals are Rs. 10,000; Rs. 6,000 and Rs. 4,000 respectively) provides as follows: (a) That partners be allowed interest at 10 per cent per annum on their fixed capitals, but no interest be allowed on undrawn profits or charged on drawings. (b) That upon the death of a partner, the goodwill of the firm be valued at two years' purchase of the average net profits (after charging interest on capital) for the three years to 31st December preceding the death of a partner. (c) That an insurance policy of Rs. 10,000 each to be taken in individual names of each partner, the premium is to be charged against the profit of the firm. (d) Upon the death of a partner, he is to be credited with his share of the profits, interest on capitals etc. calculated upon 31st December following his death. (e) That the share of the partnership policy and goodwill be credited to a deceased partner as on 31st December following his death. (f) That the partnership books be closed annually on 31st December. A died on 30th September 2009, the amount standing to the credit of his current account on 31st December, 2008 was Rs. 450 and from that date to the date of death he had withdrawn Rs. 3,000 from the business. An unrecorded liability of Rs. 2,000 was discovered on 30th September, 2009. It was decided to record it and be immediately paid off. The trading result of the firm (before charging interest on capital) had been as follows: 2006 Profit Rs. 9,640; 2007 Profit Rs. 6,720; 2008 Loss Rs. 640; 2009 Profit Rs. 3,670. Assuming the surrender value of the policy to be 20 percent of the sum assured, you are required to prepare an account showing the amount due to A's legal representative as on 31st December, 2009. 8.106 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Solution A's Capital Account 2009 Rs. 2009 Rs. Sep. 30 To Current A/c 2,550 Jan. 1 By Balance b/d 10,000 (3,000 - 450) Dec. 31 By Profit and Loss A/c : Dec. 31 To Profit and Loss Adjt. 1,000 Interest on Capital 1,000 (Unrecorded Liability) Share of Profit 835 To Balance Transferred to B & C (Goodwill) 3,240 A's Executor's A/c 18,525 Insurance Policies A/c 7,000 22,075 22,075 Working Notes : (i) Valuation of Goodwill YearProfit before Interest Interest Profit after on fixed capital interest Rs. Rs. Rs. 2006 9,640 2,000 7,640 2007 6,720 2,000 4,720 2008 (-) 640 2,000 (-) 2,640 15,720 6,000 9,720 Rs. Average 3,240 Goodwill at two years purchase of average net profits 6,480 Share of A in the goodwill 3,240 (ii) Profit on Separate Life Policy : A's policy 10,000 B and C's policy @ 20% 4,000 14,000 Share of A (1/2) 7,000 (iii) Share in profit for 2009 : Profit for the year 3,670 Less : Interest on capitals 2,000 1,670 A's share in profit (1/2) 835 (iv) As unrecorded liability of Rs. 2,000 has been charged to Capital Accounts through Profit and Loss Adjustment Account, no further adjustment in current year's profit is required. FUNDAMENTALS OF ACCOUNTING 8.107 Copyright -The Institute of Chartered Accountants of India DEATH OF PARTNER (v) Profits for 2006, 2007 and 2008 have not been adjusted (for valuing goodwill) for unrecorded liability for want of precise information. Illustration 5 The following is the Balance Sheet of M/s. ABC Bros as at 31st December, 2008. Balance Sheet as at 31st December, 2008 Liabilities Rs. Assets Rs. Capital A 4,100 Machinery 5,000 B 4,100 Furniture 2,800 C 4,500 Fixture General Reserve 1,500 Cash 2,100 Creditors 2,350 Stock 1,500 Debtors 4,500 Less: Provision for DD 300 950 4,200 16,550 16,550 C died on 3rd January, 2009 and the following agreement was to be put into effect. (a) Assets were to be revalued : Machinery to Rs. 5,850; Furniture to Rs. 2,300; Stock to Rs. 750. (b) Goodwill was valued at Rs. 3,000 and was to be credited with his share, without using a Goodwill Account (c) Rs. 1,000 was to be paid away to the executors of the dead partner on 5th January, 2009. You are required to show: (i) The Journal Entry for Goodwill adjustment. (ii) The Revaluation Account and Capital Accounts of the partners. (iii) Which account would be debited and which account credited if the provision for doubtful debts in the Balance Sheet was to be found unnecessary to maintain at the death of C. Solution (i) Journal Entry in the books of the firm Dr. Cr. Date Particulars Rs. Rs. Jan 3 A’s Capital A/c Dr. 500 2009 B’s Capital A/c Dr. 500 To C’s Capital A/c 1,000 (Being the required adjustment for goodwill through the partner's capital accounts) 8.108 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India (ii) Revaluation Account Dr. Cr. Particulars Rs. Particulars Rs. To Furniture A/c (Rs. 2,800 - 2,300) 500 By Machinery A/c (Rs. 5,850 - 5,000) 850 To Stock A/c (Rs. 950 - 750) 200 To Partners' Capital A/cs 150 (A - Rs. 50, B - Rs. 50, C - Rs 50) 850 850 Partners Capital Accounts Particulars A B C Particulars A B C To C (Goodwill) 500 500 – By Balance b/d 4,100 4,100 4,500 To Cash A/c – – 1,000 By General Reserve A/c 500 500 500 To Executors A/c – – 5,050 By Revaluation A/c (Profit) 50 50 50 To Balance C/d 4,150 4,150 – By A (Goodwill) – – 500 By B (Goodwill) – – 500 4,650 4,650 6,050 4,650 4,650 6,050 (iii) Provision for Doubtful Debts Account is a credit balance. To close, this account is to be debited. It becomes a gain for the partners. Therefore, either Partners' Capital Accounts (including C) or Revaluation Account is to be credited. Working Note : Statement showing the Required Adjustment for Goodwill Particulars A B C Right of goodwill before death 1/3 1/3 1/3 Right of goodwill after death 1/2 1/2 – Gain / (Sacrifice) (+) 1/6 (+) 1/6 (-) 1/3 Profit sharing ratio is equal before or after the death of C because nothing has been mentioned in respect of profit-sharing ratio. Illustration 6 B and N were partners. The partnership deed provides inter alia: (i) That the accounts be balanced on 31st December each year. (ii) That the profits be divided as follows: B : One-half; N : One-third; and carried to Reserve Account : One-sixth FUNDAMENTALS OF ACCOUNTING 8.109 Copyright -The Institute of Chartered Accountants of India DEATH OF PARTNER (iii) That in the event of death of a partner, his executor will be entitled to the following: (a) the capital to his credit at the date of death; (b) his proportion of profit to date of death based on the average profits of the last three completed years; (c) his share of goodwill based on three years' purchases of the average profits for the three preceding completed years. Trial Balance on 31st December, 2008 Particulars Dr. (Rs) Cr. (Rs) B's Capital 90,000 N's Capital 60,000 Reserve 30,000 Bills receivable 50,000 Investments 40,000 Cash 1,10,000 Creditors 20,000 Total 2,00,000 2,00,000 The profits for the three years were 2006 : Rs. 42,000; 2007 : Rs. 39,000 and 2008 : Rs. 45,000. N died on 1st May, 2009. Show the calculation of N (i) Share of Profits; (ii) Share of Goodwill; (iii) Draw up N's Executors Account as would appear in the firms' ledger transferring the amount to the Loan Account. Solution (i) Ascertainment of N's Share of Profit (ii) Ascertainment of Value of Goodwill 2006 42,000 2006 42,000 2007 39,000 2007 39,000 2008 45,000 2008 45,000 Total Profit 1,26,000 Total Profit for 3 years 1,26,000 Average Profit 42,000 Average Profit 42,000 4 months' Profit 14,000 Goodwill - 3 years Purchase of Average Profit 1,26,000 N's Share in Profit (2/5th* of Rs.14,000) 5,600 N's Share of goodwill (2/5 of Rs. 1,26,000) 50,400 * Profit sharing ratio between B and N = 1/2; 1/3; = 3 : 2, Therefore N's share of Profit = 2/5 8.110 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India N’s Executors Account Date Particulars Rs. Date Particulars Rs. 2009 2009 May 1, - To N's Loan A/c 1,28,000 Jan. 1 By Capital A/c 60,000 May 1 By Reserves (2/5th of Rs. 30,000) 12,000 May 1 By B’s Capital A/c (Share of goodwill) 50,400 May 1 By P/L Suspense A/c (Share of Profit) 5,600 1,28,000 1,28,000 SELF EXAMINATION QUESTIONS Pick up the correct answer from the given choices: 1. On the death of a partner, his executor is paid the share of profits of the dying partner for the relevant period. This payment is recorded in Profit & Loss ……… Account. (a) Adjustment. (b) Appropriation. (c) Suspense. (d) Reserve. 2. Revaluation account is prepared at the time of (a) Admission of a partner (b) Retirement of a partner (c) Death of a partner (d) All of the above 3. In the absence of proper agreement, representative of the deceased partner is entitled to the Dead partner’s share in (a) Profits till date, goodwill, joint life policy, share in revalued assets and liabilities. (b) Capital, goodwill, joint life policy, interest on capital, share in revalued assets and liabilities. (c) Capital, profits till date, goodwill, interest on capital, share in revalued assets and liabilities. (d) Capital, profits till date, goodwill, joint life policy, share in revalued assets and liabilities. 4. As per Section 37 of the Indian Partnership Act, 1932, the executors would be entitled at their choice to the interest calculated from the date of death till the date of payment on the final amount due to the dead partner at …… percent per annum. (a) 7. (b) 4. (c) 6. (d) 12. 5. A, B and C are the partners sharing profits and losses in the ratio 2:1:1. Firm has a joint FUNDAMENTALS OF ACCOUNTING 8.111 Copyright -The Institute of Chartered Accountants of India DEATH OF PARTNER life policy of Rs. 1,20,000 and in the balance sheet it is appearing at the surrender value i.e. Rs. 20,000. On the death of A, how this JLP will be shared among the partners. (a) Rs. 50,000: Rs. 25,000: Rs. 25,000. (b) Rs. 60,000: Rs. 30,000: Rs. 30,000. (c) Rs. 40,000: Rs. 35,000: Rs. 25,000. (d) Whole of Rs. 1,20,000 will be paid to A. 6. R, J and D are the partners sharing profits in the ratio 7:5:4. D died on 30th June 2006. It was decided to value the goodwill on the basis of three year’s purchase of last five years average profits. If the profits are Rs. 29,600; Rs. 28,700; Rs. 28,900; Rs. 24,000 and Rs. 26,800. What will be D’s share of goodwill? (a) Rs. 20,700. (b) Rs. 27,600. (c) Rs. 82,800. (d) Rs. 27,000. 7. R, J and D are the partners sharing profits in the ratio 7:5:4. D died on 30th June 2006 and profits for the accounting year 2005-2006 were Rs. 24,000. How much share in profits for the period 1st April 2006 to 30th June 2006 will be credited to D’s Account. (a) Rs. 6,000. (b) Rs. 1,500. (c) Nil. (d) Rs. 2,000. 8. If three partners A, B & C are sharing profits as 5:3:2, then on the death of a partner A, how much B & C will pay to A’s executer on account of goodwill. Goodwill is to be calculated on the basis of 2 years purchase of last 3 years average profits. Profits for last three years are: Rs. 3,29,000; Rs. 3,46,000 and Rs. 4,05,000. (a) Rs. 2,16,000 & Rs. 1,42,000. (b) Rs. 2,44,000 & Rs. 2,16,000. (c) Rs. 3,60,000 & Rs. 3,60,000. (d) Rs. 2,16,000 & Rs. 1,44,000. ANSWERS 1. (c) 2. (d) 3. (d) 4. (c) 5. (a) 6. (a) 7. (b) 8. (d) 8.112 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India