Advanced Accounting I

CHAPTER ONE
ACCOUNTING FOR PARTNERSHIP AND JOINT VENTURES
Introduction
A partnership is the association of two or more persons to carry on bushiness as co
owners for profit. Partnerships are easy to form and their dissolution is too. Ease in their
formation and dissolution, and avoidance of double taxation makes partnership form of
businesses more preferable than corporations do in the present era.
A joint venture is a type of partnership that ends when the specific objective for which it
established is accomplished. Joint ventures are governed by partnership principles, but
differ from partnership in its limited objective and duration.
This chapter is about partnership and joint ventures. The first section introduces you
about Partnership Formation and Operation, Accounting for Formation and Operations of
a Partnership, Accounting for Partnership Dissolution and Liquidation. The second
section introduces you about Joint ventures.
After studying this chapter, you should be able to:

 Describe the characteristics of the partnership form of business organization.
 Explain the accounting entries for the formation of partnership.
 Choose between partnership and corporate form of business organization.
 Explain the different types of partnership.
 Identify partnership provisions in Ethiopia according to the commercial code of
Ethiopia.
 Identify partners’ owners' equity accounts.
 Understand valuation of investments by partners.
 Identify partners’ equity in assets and share in earnings (profits/losses).
 Distinguish the different methods of income sharing plans for partnership.
 Explain the financial statements presentations for a LLP.
 Understand the conditions and accounting for partnership dissolution.
 Describe the procedures for partnership dissolution by admission of a new
partner.
 Describe the procedures for partnership dissolution when a partner withdraws.
 Explain the conditions and accounting for partnership liquidation.
 Describe the division of loss and gains on liquidation to partners.
 Distribute cash or other assets to partners.
 Show settlement of partners' capital balances.
 Identify characteristics of joint ventures compared to partnerships.
 Differentiate between traditional and modern joint ventures.
 Describe about corporate joint ventures.
 Identify joint venture provision in Ethiopia.
 Understand accounting for joint venture.
1. PARTNERSHIP
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Course Material for Advanced Accounting-I
1.1.1 Partnership Formation and Operation
Definition: The Uniform Partnership Act (UPA) defines a partnership as “an association
of two or more persons to carry on business as co-owners for profit.” This definition
encompasses three distinct factors:
1. Association of two or more persons. The “persons” are usually individuals; however,
they could be corporations or other partnerships.
2. To carry on as co-owners. A partnership is an aggregation of partners’ individual
rights. This means that all partners are co-owners of partnerships property and are co-
owners of the profit or losses of the partnership.
3. Business for profit. A partnership may be formed to perform any legal business, trade,
profession or other service. However, the partnership must attempt to make a profit;
therefore, not-for-profit organizations, such as fraternal groups, may not be
partnerships.
1.1.1.1. Characteristics of Partnerships
A partnership form of business has a number of distinguishing characteristics identified

as follows:
Ease of Formation: Unlike incorporation (the formation of corporation) which requires
many legal requirements and procedures, the partnership form of business does not
involve any complicated legal formalities. There is no requirement to register a
partnership with a state. By an oral or written agreement which clarifies their relationship
a partnership can be created.
Limited Life: Partnerships have limited life. A partnership legally terminates as a
business each time there is a change in membership. This legal termination is
called“dissolution of partnership’’. A partnership may dissolve whenever a partner
withdraws from the partnership or when a new partner is admitted in to the partnership. A
partnership may also end involuntarily by death or incapacity of the partners. In general,
any change in the composition of the existing partners either by admission, withdrawal,
death or incapacity will dissolve the existing partnership and a new partnership is created.
Unlimited Liability: Even though a partnership can be either general or limited
partnership, there will always be a partner or some partners who will be always
personally responsible for debts of the firm and have the authority to act for the firm.
That is why laws for a limited partnership require at least one general partner in the
partnership. All partners in a general partnership have unlimited liability. In the event
the partnership fails and its assets are sufficient to pay its liabilities, the partnership
creditors may take recourse by obtaining liens or attachments against the personal assets
of any or all of the partners. Generally, creditors will take action against the partner with
the most liquid assets. This means that any individual partner may be required to pay the
partnership’s creditors from personal assets in an amount exceeding his or her capital
balance in the partnership. This unlimited liability of partners differs from the corporate
form of business, in which an investor’s ultimate loss is limited to the amount invested in
the corporation’s stock.
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Co-ownership of partnership assets and earnings: Once the assets are invested or
contributed by each individual partner in the partnership, these assets invested are then
jointly owned by all partners. Each partner is a co-owner of the partnership assets and
liabilities. Every member of the partnership also has an interest in the partnership
earnings.
Mutual Agency: Creditors view each partner as an agent of the partnership capable of
transacting business in the partnership’s name. Consequently, any partner can bind the
partnership when acting within the scope of the partnership activities. For example
partner A sings a lease in the partnership name even though the agreement specifies that
only partner B may sign leases. The partnership is still bound by the lease because the
other party to the lease can assume mutual agency of each partner. Each partner has the
authority to act for the partnership and to enter into contracts on its behalf. However, acts
beyond the normal scope of business operations, such as the obtaining of a bank loan by a
partner, generally do not bind the partnership, unless specific authority has been given to
the partner to enter into such transactions.
1.1.1.2. Choosing between Partnership and Corporate Form of Business
Organization
Partnership is an association of two or more individuals who agree to carry on business

together for the purpose of earning and sharing of profit. This form of business
organization allows two or more persons to combine capital, managerial talent, skill and
experience with minimum effort.
Corporation is a separate legal entity in which ownership is divided in to shares of stock.

A number of factors can be considered in choosing between partnership and corporate
form of business organization which can favor either of them. Some of them are the
following:
Ease of Formation: Partnerships are easy to form. This is one of the most common
motives for forming partnerships. Only an oral or written agreement is sufficient to create
a legally binding partnership. In contrast incorporation needs more complicated
procedures. It requires fulfilling different legal requirements such as filling of a formal
application form and completion of the various documents and forms.
Taxation: One of the most important factors that need to be considered in choosing a
partnership and a corporate form of business organization is the income tax status of the
enterprise and of its owners. Partnerships are not required to pay income tax but it is
required to file an annual information return showing its revenue and expenses. Only the
share of partners respective net income from the partnership is taxed based on the
individual partners’ income tax returns. On the contrary since a corporation is a separate
legal entity, it is subject to a corporate income tax. Hence there is double taxation in
corporate form of the organization. First corporate income tax as separate legal entity and
second when the net income is distributed to stockholders as dividends. Therefore, a
partnership is advantageous than a corporation with regard to taxation.
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Amount of Required Capital: Another factor influencing a choice between partnership
and corporation is amounts of capital raised. This factor is in favor of corporation, which
has the opportunity for obtaining larger amounts of capital where ownership is divided in
to shares of capital stock which could be easily transferable without disturbing the life of
the organization. But in partnership form of business organization, a partner can not
transfer his share to an outsider without the consent of the other partners. Hence, there is
restriction on transfer of shares.
Limited Liability: With regard to the factor limited liability a corporation is more
advantages than a partnership. This is because all stockholders in a corporation have
limited liability for unpaid debts of the corporation and corporations have full discretion
over the amount of profits they can distribute or retain. In contrast, with the exception of
limited liability partnership which provides limited liability to its members, other types of
partnership such as general partnership (where all partners have unlimited liability) and
limited partnership (where at least one general partner which has unlimited liability
should exist in the partnership and other limited partners have unlimited liability) have
unlimited liability.
In summary; ease of formation and avoidance of double taxation favors the choice of
partnership form of business organization over incorporation. Where as the large amount
of capital that can be raised in a corporation, the limited liability of stockholders and the
separation of management and ownership favors the formation of corporate form of
organization.
1.1.1.3. Types of Partnership
A partnership is a legal relationship formed by the agreement between two or more
individuals to carry on a business as co owners. A partnership may be organized on the
basis of either limited or unlimited liability. From the point of view of risk limited
liability is preferable. Limited liability means the debts of the business is limited only to
the amount of capital agreed to be contributed by partners in the business. Hence
creditors have no claim over the personal assets of the partners. Unlimited liability means
that even the partners’ personal assets will be liable to be attached for the payment of the
business debts. Based on this personal responsibility of individual partners for the unpaid
debs of the partnership; partnerships types are divided in to three as follows:
A. General Partnership (GP)
B. Limited Partnership (LP)
C. Limited Liability Partnership (LLP)
A. General Partnership (GP): is a partnership formed with only general partners. In
general partnership, each of the two or more partners will have unlimited liability hence
each partner bears personal responsibility for the liabilities of the partnership. A general
partner in the partnership takes part in the daily operations of the partnership.
B. Limited Partnership (LP): is a type of partnership with both general partners and
limited partners. In contrast to a general partner who is liable for all of the
partnership’s liabilities, a limited partner in the partnership is not liable for any
amount greater than his or her original investments in the partnership. Furthermore, a
limited partner takes no part in managing the partnership but he/she has a share of
ownership. Both limited partners and general partners receive a share in profits and
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losses of the partnership based on their income and loss-sharing ratio. The limited
partnership was a popular partnership form in the 1970s and 1980s, before the advent
of the limited liability partnership (LLP).
C. Limited Liability Partnership (LLP): A limited liability partnership provides
limited liability for all of its members, but can be treated as a partnership for federal
income tax purpose. The partners are still liable to up to the amount of their capital
accounts, but their personal assets are protected from the partnership creditors. It is
different from a general partnership or a limited partnership. An LLP differs from
general partnership because all partners in an LLP have limited liability and are
shielded from wrongful acts, errors, omissions, negligence, incompetence, or
malpractice committed by other partners or employees. Of course, any partner
involved in wrongful or negligence acts are still personally liable, but other partners
are protected from liability for those acts. An LLP combines the characteristics of
partnership and corporations. As in a corporation all partners in an LLP have limited
liabilities but typically can be treated as in a partnership for federal income tax
purpose. In LLP, all partners have the same general management responsibilities or
can have centralized management in one or more of the members. A limited liability
partnership must identify itself as such by adding the LLP letters behind the name of
the partnership in all correspondence or other means of identification of the firm.
Partnership Contract (Agreement)
Although a partnership may be formed based on an oral agreement or may be implied by
the actions of its members, good business practice requires that the partnership contract
be in writing. In this sense, the partnership agreement is merely a written expression of
what the partners have agreed to. One advantage of preparing the partnership contract is
that the process of reaching agreement on specific issues will develop a better
understanding among the partners on many issues that might be highly controversial if
not settled at the outset.
In addition to essential legal provisions, partnership agreement in most countries should
address the following:
1.Partnership’s exact name and designated place of business, partnership’s business
purpose, basis of accounting to be used, the nature of accounting, financial statements,
auditing requirements by independent public accountants, partnership’s accounting year
end and partnership’s duration.
2. Name and address of each partner.
3. The assets to be invested by each partner, the procedure for valuing non cash
investments, and the penalties for failure to invest and maintain the agreed amount of
capital.
4. The authority, rights and duties of each partner.
5. The plan for sharing net income or loss, including the frequency of income
measurement and the distribution of income or loss among the partners.
6. The amount of salaries and withdrawals, conditions for withdrawals and the penalties
if any for excess withdrawals.
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7. Insurance on the lives of partners, with the partnership or surviving partners named as
beneficiaries.
8. Provision for settlement of conflicts of interest, disputes and liquidation of the
partnership at the end of the term as specified in the partnership agreement or at the
death or retirement of a partner. Agreements such as, procedures for the valuation of
the partnership assets and methods of settlement with the estate of a deceased partner
are important in avoiding disputes.
However; in the initial partnership agreement; it may not be possible to cover all issues
that would be arising later. Hence, revision of the partnership contract is possible with the
help of attorneys and accountants and by the approval of all partners.
Disputes arising among partners that can not be resolved by reference to the partnership
contract may be settled by binding arbitration or in the courts.
1.1.1.4. Partnership Provision in Ethiopia
The Commercial Code of Ethiopia classifies partnership in three types as ordinary

partnership, general partnership and limited partnership. The definition of each is given in
the article as follows:
Art.227. Ordinary Partnership: A partnership is an ordinary partnership within the
meaning of this Title where it does not have characteristics which make it a business
organization covered by another Title of this Code.
Art.280. A General Partnership: consists of partners who are personally, jointly,

severally and fully liable as between themselves and to the partnership for the partnership
firm’s undertakings. Any provision to the contrary in the partnership agreement shall be
of no effect with regard to third parties.
Art.296. A Limited Partnership: comprises two types of partners: general partners in full
liable to personally, jointly and severally and limited partners who are only liable to the
extent of their contributions.
Art 300. The general partners in a limited partnership shall have the same rights and
obligations as partners in a general partnership and only they may be appointed as
managers.
Art. 301. Limited partners.

1. Action may be taken by a firm’s creditor to compel limited partners to subscribe
their contributions.
2. Limited partners need not repay dividends received by them in good faith after
approval of the firm’s balance sheet.
3. Limited partners may not act as managers even under a power of attorney. A
limited partner who contravenes this rule shall be fully, jointly and severally
liable for any liabilities arising out of his activities. Where appropriate, s/he may
be declared jointly and severally liable in respect of some or all the firm’s
undertakings.
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4. A limited partner shall not be deemed to act as manager when s/he:
(a) consults with other partners;
(b) deals with the firm;
(c) investigates managerial acts;
(d) give advice and counsel to the firm;
(e) gives permission to do acts outside the manager’s power.
5. Limited partners may be employed in the firm and bind themselves by contracts
of employment.
6. Limited partners may inspect the books of the firm and may call for the
accounts.
7. Unless and otherwise agreed, nothing affecting a limited partner shall be a
ground for dissolution.
As per Article 284 of the Ethiopian commercial code, the memorandum of association
to be drawn by partners shall contain the following:
1. The name, address and nationality of each partner,
2. The firm name,
3. The head office and branches, if any,
4. The business purpose of the firm,
5. The contributions of each partner, their values and the method of valuation,
6. The services required from contributing skills,
7. The share of each partner in the profits in the losses and the agreed procedure for
allocation,
8. The managers and agents of the firm,
9. The period of time for which the partnership has been established, and
10. Penalties for not meeting capital commitments.
1.1.2. Accounting for Formation and Operations of a Partnership
1.1.2.1. Partners’ Owners Equity Accounts

What makes the accounting for partnership different from accounting for corporation?
The most important difference between accounting for partnership and accounting for
corporation lies in the maintenance of owners’ equity (partner’s ledger) accounts and in
the sharing of profits and losses. That means, in a partnership, their will be as many
capital accounts as the number of partners. Instead of maintaining one capital of the
partnership, all partners in the partnership will have their own capital account
representing the ownership equity of individual partner.
Though it is possible to maintain partnership accounting records with only one ledger
account for each partner; three types of accounts can be maintained for each partner.
These consist of:
1. Capital accounts,
2. Drawing accounts, and
3. Accounts for loans to and from partners.
1. Capital Accounts: the original investments by each partner in the partnership is
recorded by debiting assets invested , crediting any liabilities assumed by the partnership
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and by crediting the partner’s capital accounts with the current fair value (agreed upon
values) of the net assets ( assets minus liabilities)invested.
Subsequent to this original investment, the partner’s equity will increase by:
a. Any additional investment made by each partner,
b. A share of partnership profit by their profit/loss sharing ratio, and
c. Any change in the ownership of the partnership.
Similarly, the partner’s equity will decrease by:
a. Withdrawal of cash or other assets by partners , and
b. Share of partnership losses in the profit/loss ratio.
2. Drawing (Personal Accounts): drawings (withdrawals of cash or other assets) by the

partners in anticipation of net income or drawings that are considered salary allowances
are recorded by debits to drawing accounts. But when the withdrawal is large and
considered as permanent reduction in the ownership equity of a partner, it is debited
directly to the partner’s capital account instead of drawing accounts.
Finally, at the end of each accounting period, the net income or net loss in the
partnership’s Income Summary ledger account is transferred (closed) to the individual
partners’ capital accounts in accordance with the partnership agreement for profit and
loss sharing. Similarly, the debit balance in the drawing ledger accounts are closed to the
partners’ capital account at the end of the accounting period.
3. Loans to and from partners: Sometimes with the intention of repaying, a partner may
receive cash from the partnership. On the opposite, a partner may make a cash payment
to the partnership with the intention of recollecting. The receipt of cash by the partner
from the partnership is considered as loan to a partner from the partnership and hence is
debited to Loans Receivable from Partners ledger account instead of debiting to
partner’s drawing account. On the other hand the payment of cash by the partner to the
partnership is considered as a loan which will be payable to the partner from the
partnership. Such a transaction is recorded by a credit to Loans Payable to Partners
ledger account. Loans Receivable from Partners, are treated as assets where as Loans
Payable to Partners are treated as liabilities on the balance sheet of the partnership.
1.1.2.2. Valuation of Investments by Partners

In the formation of partnership, partners often invest in firm cash or non-cash assets such
as land, building, machinery and furniture and so forth. Should these non-cash assets
invested by partners be recorded in partnership at current fair value, at cost or at some
other value? All investments by partners with the exception of cash should be recorded at
the agreed up on current fair value at the time of their investment and therefore the assets
are recognized in the accounting records at such values. This ensures the equitable
treatment of each partner from the beginning. Any gains or losses that will be arising later
as a result of disposal of such assets during the operation of the partnership, or at the time
of liquidation are then divided according to the plan for sharing profits/losses. Thus,
partnership gains or losses from disposal of non-cash assets invested by the partners will
be measured by the difference between the disposal price and the current fair value of the
assets invested by partners, adjusted only for depreciation.
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1.1.2.3. Partners’ Equity in Assets versus Share in Earnings (Profits/Losses)
The ownership equity of a partner in the net assets of the partnership must be clearly
differentiated from a partners share in earnings (profits or losses). Partners in the
partnership may agree on any type of income sharing plan (profit and loss sharing ratio),
regardless of the amount of their respective capital account balances. Thus to say that Mr.
B is one-fifth partner is a vague statement. Because Mr. B may have a one-fifth
ownership equity in the net assets of the partnership but may have a larger or smaller
share in the net income or losses of the partnership. On the other hand the statement may
be interpreted to mean that Mr. B can have one- fifth share in the net income or losses
even though his capital account represented much more or much less than one-fifth of the
total partners capital. However, if partners fail to specify a plan for sharing net income or
losses, the uniform partnership Act states that the partners are assumed to share net
income or loss equally.
1.1.2.4. Income Sharing Plans for Limited Liability Partnerships (LLPs)
The profits or losses of a partnership can be shared in many different ways. Hence,
partners should select among the numerous plans that is sensible, practical and equitable.
The possible alternative plans for sharing net income or loss among partners of a limited
liability partnership are summarized in the following categories:
1. Equally or in some other ratio,
2. In the ratio of partners’ capital account balance on a particular date, or in the ratio of
average capital account balances during the year.
3. Allowing interest on partners’ capital account balances; and dividing the remaining
net income or loss in a specified ratio.
4. Allowing salaries to partners’ and dividing the remaining net income or loss in a
specified ratio.
5. Allowing salaries and interest on capital to partners and dividing the remaining net
income or loss in a specified ratio.
6. Bonus to managing partner based on income.
The above differences in the alternative income sharing plans arise from two main
reasons. The first is due to differences in the amounts of capital invested by each partner,
and the second reason is differences in the amount and quality of managerial services
rendered by individual partners. The variations either in the amount and quality of
managerial service rendered or the amount of capital invested are important factors in the
success or failure of a limited liability partnership. Hence, provisions may be made for
salaries to partners, interest on their respective account balances, interest and salaries or
bonus for any managerial post as a preliminary step in the division of income or loss. Let
us see the different plans of net income or loss sharing with the help of examples.
Example: Assume X and Y Limited Liability Partnership had a net income of Birr
40,000 on December 31, 2005, the first year of operation. Partner X invested Birr 50,000
on January 1, 2005, and an additional investment of Birr 20,000 on April 1. Partner Y
invested Birr 80,000 on January 1, 2005 and an additional investment of Birr 24,000 on
April 1, 2005. Partner Y has also withdraw Birr 6,000 on July 1, 2005. The partnership
contract provides that each partner may withdraw Birr 600 cash on the last day of each
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month; both partners did so during 2005.The drawings are recorded by debits to the
partners’ drawing accounts and are not a factor in the division of net income or loss.
Required:
A) Prepare the necessary journal entries
B) Summarize the above transactions and events in the appropriate ledger accounts.
C) Record the division of the Birr 40,000 net income using the six profit/loss sharing
plans between partners X and Y.
Solution: A) Journal entries in general journal form:
General journal Page 1
Date Description P/ Debit Credit
R
Jan. 1 2005 Cash 130,000 00
X, capital 50,000 00
Y, Capital 80,000 00
(Initial investment by partners)
31 2005 X, Drawing 600 00
Y, Drawing 600 00
Payable to X and Y 1200 00
(Monthly withdrawal, recorded at
the end of every month.)
April 1 2005 Cash 24,000 00 24,00
Y, Capital 0 00
(Additional investment by Y)
1 2005
Cash 20,000 00
X, Capital 20,000 00
(Additional investment by X )
July 1 2005 Y, Capital 6,000 00
Cash 6,000 00
(Cash withdrawal by Y)
B) Ledger Accounts for X and Y
Account X, Capital
Balance
Date Item P/R Debit Credit Debit Credit
Jan. 1,2005 GJ(P1) 50,000 00 50,00 00
0
April 1, 2005 Add.invest. GJ(P1) 20,000 00 70,00 00
0
Account Y, Capital
Date Item P/R Debit Credit Balance
Debit Credit
Jan. 1,2005 GJ(P1) 80,0 00 80,000 00
00
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April 1,2005 Add.inves. GJ(P1) 24,0 00 104,000 00
00
July 1,2005 Withdrawal GJ(P1) 6000 00 6000 00 98,000 00
Account X, Drawing
Balance
Jan. 31,2005 Drawings GJ(P1) 600 00 600 00

Account Y, Drawing
Balance
Jan. 31,2005 Drawings GJ(P1) 600 00 600 00

Account Income Summary
Balance
Dec. 31,2005 GJ(P1) 40,000 00 40,000 00

As you have seen in the above journal and ledger account, the balance; X, Capital
account is Birr 70,000 and the balance of Y, Capital account is Birr 98,000 where as their
respective drawing accounts show Birr 600 each for X and Y during the first year.
Similarly, the income summary account has a credit balance of Birr 40,000 as of
December 31, 2005.
C) Division of the Birr 40,000 net income among the partners
i) Net income or loss shared equally or some other specified ratio
Division of net income equally becomes rational when equal weight is given to the
partners’ contribution and in situations where no specific agreement for sharing profits
and losses have been made. The net income in this situation will be divided equally to all
partners and will be transferred by a closing entry from the income summary account to
the individual partners’ capital account on December 31, 2005.Journal entries to close
income summary account:
Income summary 40,000
X, Capital 20,000
Y, capital 20,000
(To record division of net income between Partners X and Y for 2005)
Similarly, the drawing accounts should be closed to the partners’ capital accounts on
December 31, 2005 as follows:
X, Capital 600
Y, Capital 600
X, Drawing 600
Y, Drawing 600
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(To close drawing accounts)
Assume in the above example, X and Y LLP , has incurred a net loss of Birr 20,000
instead of the profit during its first year operation, and profits and losses are shared
equally. The journal entry to close the income summary account in this will be:
X, Capital 10,000
Y, Capital 10,000
Income Summary 20,000

(To record division net loss of Birr 20,000 between partners)
Sometimes a partnership agreement may provide a specified ratio for sharing net income
or net loss. One partner may be given a higher income /loss ratio than the other
considering the greater experience and personal contacts. For example, if the partnership
X and Y agreed to share profits in ratio of 1:4, then the net income of Birr 40,000 would
have been divided as (1/5 X 40,000; 4/5 X 40,000) Birr 8,000 and Birr 32,000 for
Partner X and Partner Y respectively. If a loss has been incurred and if no other ratios are
stated for sharing of losses, partner Y will be entitled to receive 4/5 of the net loss.
ii) Net income or loss shared in the ratio of capital account balance
When capital invested in the partnership has been considered as the most important
factor, considerable weight will be given to it, and the division of profits and losses
would be based on the partners’ capital balance. In this case, considerable care should
have to be taken in identifying whether the capital account balance stated in the
agreement is:
 the original capital investment; the capital account balance at the beginning of
each year;
 the balances of capital at the end of each year (before the distribution of net
income or loss); or
 the average capital account balance during each year.
Examples: Continuing the example for X and Y partnership, assume now that the
partnership agreement provides for sharing division net income and losses in the ratio of:
a) Original capital investment,
b) Capital balances at the end of the year, before withdrawals and distribution of profits
c) Average capital account balance.
Solution:
a) On the ratio of original capital investment
X: 40,000 x50, 000/130,000 = 15,385; X’s share of net income
Y: 40,000x80, 000/130,000 = 24,615; Y’s Share of net income
X, Capital 15,385
Y, Capital 24,615
(Journal entry to close income summary)

b) Capital balance at the end of each year before withdrawals and distribution of
profits
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X: 40,000*70,000/168,000 = 16,667; X’s share of net income
Y: 40,000* 98,000/168,000 =23,333; Y’s Share of net income
X, Capital 16,667
Y, Capital 23,333
C) Average capital balance; if there are material change in the capital accounts during
the year; the division of net income on the basis of original capital investment, yearly
beginning capital balances or yearly ending capital balances may become inequitable. As
a result the better way for sharing net income in such instances will be using the average
capital account balance since it reflects the actual capital available for use by the
partnership during the year.
X and Y LLP
Computation of Average Capital Account Balances
For the Year Ended December 31, 2005
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Partner Date Increase Capital Fraction of year Average capital
(Decrease) Account Unchanged Account
In capital Balance Balance
X Jan. 1. Br 50,000 Br.50, 000 ¼ 12, 500
Apr. 1. 20,000 70,000 ¾ 52,500
65,000
Y Jan. 1 80,000 80,000 ¼ 20,000
April.1 24,000 104,000 ¼ 26,000
July 1. (6,000) 98,000 ½ 49,000
95, 000
Total average account balance of X and Y Br.160, 000
Division of net income based on average capital:
X: 40,000*65,000/160,000 = 16,250; X’s share of net income
Y: 40,000* 95,000/160,000 = 23,750; Y’s Share of net income
X, Capital 16,250
Y, Capital 23,750
iii) Division of net income or loss on interest on partners’ capital account balances
with remaining net income or loss divided in specified ratio
When the amount of invested capital is not considered as the only factor that contributes
to the success of partnership, a certain portion of the net income or loss may be shared by
allowing partners interest on their respective capital balance and the remaining divided
equally on some other specified ratio. Here, it is important to identify whether the interest
is to be computed on capital account balances on specific date or on average capital
account balances during the year.
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Example 1: Refer to the foregoing example for X and Y partnership with net income of
Birr 40,000 and average capital account of Birr 65,000 and Birr 95,000 respectively for
the year 2005. Assume further that the partnership contract allows interest on partners’
average capital balance at 12%, with any remaining net income or loss to be divided
equally.
Required: Based on the above given data show the division of the Birr 40,000 net income
between partners X and Y.
Solution: Interests on average capital balances:
____________________________________________________________________
X Y Combined
Birr 65,000 X 0.12 = 7,800 - 7,800
Birr 95,000 X 0.12 = - 11,400 11,400
Sub total 19,200
Remainder (40,000 – 19,200)
=20, 800; divided equally 10,400 10,400 20,800
Totals 18, 200 21,800 40,000

X, Capital 18, 200
Y, Capital 21, 800
Example 2 : Assume that there was loss of Birr 10,000 , unless a specific provision in
the partnership contract during a loss year is given, the above interest on capital balance
must be enforced regardless of whether operations are profitable or unprofitable.
Therefore the division of the Birr 10,000 loss between partners X and Y is as follows:
___________________________________________________________________
X Y Combined
Birr 65,000 X 0.12 7,800 - 7,800
Birr 95,000 X 0.12 - 11,400 11, 400
Sub Total 19,200
Resulting deficiency (10,000 + 19,200)
= 29, 200; divided equally: (14,600) (14, 600) (29,200)
Total (6,800) (3,200) (10,000)
X, Capital 6,800
Y, Capital 3,200
Note: Interest on partners’ capital accounts is not an expense of the partnership and hence
has no effect on the measurement of net income or loss of the partnership. But interest on
loans from partners is recognized as an expense and is a factor in the measurement of net
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income or loss of the partnership. Similarly interest earned on loans to partners is
recognized as partnership revenue.
iv). Division of net income or loss based on salary allowance with remaining net
income /loss shared in the specified ratio
When a partnership agreement considers a difference in the skill and experience of
different partners as well as amount of time devoted in the partnership for rendering
service; net income or loss can be shared based on salary allowances. Here it is important
to clearly differentiate between salaries and drawings. Salaries and drawings are not the
same thing.
The term salary represents weekly or monthly cash payments for personal services that
are recognized as operating expenses by LLP. Drawing on the other hand are just
withdrawals of cash or other assets that reduce the partner’s equity and has no part in the
division of net income. Salaries in partnership accounting, are used a device for sharing
profits and losses and is also included in the measuring of net income or loss.
Example: Assume in the partnership X and Y; X has more experience and ability and
also devotes more time to the partnership. The partnership contract provides for an annual
salary of Birr 9,000 to X and Birr 6,000 to Y, with resultant net income or loss to be
divided equally. The salaries are paid monthly during the year. The net income of Birr
40,000 for 2005 is divided between X and Y as follows:
________________________________________________________________________
X Y Combined
Salaries Br. 9,000 6,000 15,000
Net income (40,000 - 15,000)
= 25,000; divided equally: 12,500 12,500 25,000
Totals 21,500 18,500 40,000
Monthly journal entries required for the foregoing transactions are:
a) Journal entries to record partners’ monthly salary expenses :
Partner’s Salary Expense (15,000/12) 1,250
X – Capital (9,000 /12) 750
Y – Capital (6,000/12) 500
b) Journal entry to record monthly drawings by partners:
X – Capital 750
Y – Capital 500
Cash 1250
End of year journal entry to close the income summary:
X, Capital 12, 500
Y, Capital 12, 500
v). Division of net income or loss based on salaries to partners and with interest on
capital accounts.
Many LLP divide net income or loss by allowing salaries to partners and also interest on
their capital account balance; any resultant net income or loss is divided equally or in
some other specified ratio. Such plans have the merits of recognizing and valuing
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differences in personal services rendered by different partners, and also differences in the
amounts of capital invested. This plan warrants an equitable plan for sharing net income
or loss.
Example: Assume the partnership agreement for X and Y LLP provides the following:
1. Annual salaries of Birr 9,000 and Birr 6,000 to X and Y respectively recognized
as operating expense of the partnership, with salaries to be paid monthly.
2. 20% interest on average capital account balances.
3. Remaining net income or loss divided equally.
Assuming income of Birr 40,000 for 2005, before annual salaries expense, the resulting
Birr 25,000 (40,000-15,000) is divided as follows:
________________________________________________________________________
X Y Combined
Interest on average capital account balances:
X= 65,000 X0.2 Br. 13,000 Br.13,000
Y= 95,000X 0.2 Br. 19,000 19,000
Sub total 32,000
Resulting deficiency (32,000-25,000)
Divided equally: (3,500) (3,500) (7,000)
Totals 9,500 15,500 25,000
Journal entries:
1. Partners’ salary expense 1,250
X- Capital 750
Y- Capital 500
(To record monthly partners’ salary expense)
2. X – Drawing 750
Y – Drawing 500
Cash 1250
(To record monthly withdrawal of partners’ salary)
3. Income summary 32,000
X – Capital 13,000
Y - Capital 19,000
(Journal entry to close the income summary)
vi). Bonus to Managing Partner Based on Income
Bonuses are sometimes used as a means of providing additional compensation to partners
who have provided services to the partnership. Bonuses are typically stated as a
percentage of income either before or after the bonus. The partnership contract should
state whether the basis of the bonus is net income without deduction of the bonus as an
operating expense or income after the bonus.
Example 1: Assume that X and Y, LLP contract provides for a bonus to partner X 20%
of the net income and that the remaining income divided equally; What is the share of
partner X and Y from the Birr 40,000 net income ?
________________________________________________________________________
X Y Combined
____________________________________________________________________ 16
Bonus to X: 40,000 X 0.2; 8,000 - 8,000
Remaining (32,000) divided equally; 16,000 16,000 32,000
Total 24,000 16,000 40,000
Example 2: The partnership contract provides for a bonus of 20% of income after the
bonus to Partner X and remaining income shared equally. What is the share on net
income between X and Y?
The bonus is computed as follows:

Bonus + income after bonus = Birr 40,000
Let Z be income after bonus;
0.2Z + Z = 40,000
1.2Z = 40,000
Z = 40,000/1.2; 33,333; this is income after bonus.
Bonus = 0.2 x 33,333 = 6,667 Birr and the resultant net income (40,000-6,667 = 33,333)
shared equally giving 16,666.5 Birr share to each partner. Thus; partner X will have a
total share of net income 23,333.5 (6,667 + 16, 666.5) and partner Y will have a share of
Birr 16,666.5 net income.
1.1.2.5. Financial Statements for an LLP
A partnership is a separate reporting entity for accounting purpose, and four financial
statements – income statement, statement of partners’ capital, balance sheet and
statement of cash flow are typically prepared for the partnership at the end of each
reporting period. Interim statements may also be prepared to meet the partners’
information needs.
Income Statement: The income statement of a partnership is supposed to show
explanations regarding the division of income or loss among the partners in accordance
with the given scheme in a separate section below the net income or loss, included in the
partnership’s income statement or in a note form to the financial statements. This
information is referred to as the division of net income or loss section of the income
statement.
Illustration:
Elsa and Baye LLP
Income Statement
For the year ended December 31, 2006
Net Sales Birr. 4,000,000
Cost of goods sold 2,800,000
Gross Profit on Sales 1,200,000
Partner’s salaries expense Birr 180,000
Other operating expenses 800,000 (980,000)
Net Income Birr 220,000
Division of Net Income:
Partner Elsa Birr 88,000
Partner Baye 132,000
Total Birr 220,000
____________________________________________________________________ 17
Statement of Partners Capital: Shows the changes in the partner’s capital accounts
each year separately to each partner as well as the combined partnership capital account
change during the year. This financial statement helps partners and other users to know
the changes in partners’ capital accounts each year.
Illustration:
Elsa and Baye LLP
Statement of Partner’s Capital
Elsa Baye Combined
Partners’ original investment Birr 500,000 Birr 900,000 Birr 1,400,000
Additional Investment (withdrawal) of capital 200,000 (60,000) 140,000
Balance before salaries, net income & drawing 700,000 840,000 1,540,000
Add: Salaries 120,000 60,000 180,000
Net Income 88,000 132,000 220,000
Subtotals 908,000 1,032,000 1,940,000
Less: Drawings (120,000) ( 60,000) (180,000)
Partners’ Capital end of the year Birr 788,000 972,000 1,760,000
Balance Sheet: Shows the financial position of the partnership at a specific date. That is
the total assets, liabilities and balance of each partner’s capital at the end of the
accounting period.
Elsa and Baye LLP
Balance Sheet
December 31, 2006
Assets Liabilities and Partners’ Capital
Cash Birr 160,000 Accounts Payable Birr 250,000
Accounts receivable 150,000 Long term debt 410,000
Inventories 500,000 Total Liabilities 660,000
Plant Assets (net) 1,610,000 Partners’ capital:
Elsa 788,000
Baye 972,000 1,760,000
Total Assets Birr 2,420,000 Total liabilities & Partners’ Capital Birr 2,420,000
Statement of cash flow: A statement of cash flow is prepared for a partnership as it is for
a corporation. This financial statement displays the net cash provided by operating
activities, net cash used in investing activities, and net cash provided or used in financing
activities of the partnership.(you can refer intermediate accounting textbook to further
understand how a statement of cash flow is prepared using the direct and indirect
method).
1.1.3. Accounting for Partnership Dissolution
Changes in the ownership of a partnership, results in when a new partner is admitted into
the existing partnership or when an existing partner withdraws from the partnership. Such
changes in the ownership of partnership do not interrupt the normal operation of the
partnership and have no significant change in the financial conditions of the partnership.
____________________________________________________________________ 18
However, from the legal point of view, any change in ownership by either admission or
withdrawal dissolves the existing partnership and a new partnership is created.
Moreover, retirement or death of a partner; bankruptcy of a partnership or partners; and
expiration of a time period of the partnership as stated in the partnership contract or
mutual agreement of the partners to end their association dissolves an existing
partnership.
Thus; dissolution may range from an insignificant business event that take into account
only minor changes in the ownership interest of the partners which do not affect the
operations of the business; to major business events such as decision by the partners to
terminate the partnership which affects the business and requires change in significant
accounting polices. Accountants are concerned with the economic substance of an event
rather than its legal form. Therefore, all circumstances of individual cases to determine
how a change in partners should be evaluated and recorded carefully.
Changes in the ownership of a partnership raise a number of accounting and management
issues; such as setting of terms for admission of a partner, the possible revaluation of
existing partnership assets, the development of new plan for the division of net income or
loss, and the determination of the amount to be paid to a retiring partner.
1.1.3.1. Dissolution by Admission of a New Partner

One of the changes in ownership interest of a partnership results due to admission of a
new partner into the partnership. When the new partner is admitted to a partnership, it is
appropriate to consider the fairness and adequacy of past accounting polices, and the need
for correction of errors in prior years’ accounting data as well as restate the carrying
amounts of assets and liabilities to the current fair value before a new partner is admitted.
There are two alternative ways of admitting a new partner into an existing partnership:
These are:
1. Admission through by an acquisition of all or part of the ownership interest of
one or more of the existing partners or,
2. Admission through an investment of assets by the new partner in to the
partnership,
1. Admission by purchasing an ownership interest from one or more of the existing

partners
Purchase of interest from one or more of partners by a new partner can be done by direct
payment to partners. If a new partner acquires an interest from on or more of the existing
partners, the transaction is recorded by:
Establishing a capital account for the new partner , and
Decreasing the capital account balances of the selling partners by the same
amount
The transfer of ownership from the existing partner(s) to the newly admitted partner is
merely a private transaction between partners. Therefore, no assets are received by the
____________________________________________________________________ 19
partnership and do not affect the partnership account. Hence, the partnership assets,
liabilities and owners equity remains unaffected.
Example: Dawit and Fikru are partners sharing net income and losses equally. Each has
capital account balance of Birr 80,000.With the consent of Dawit, a new partner Girma
purchases one –half of Fikru’s ownership interest by cash payment.
The journal entry to record the above transaction between partners B and C is:
Fikru – Capital 40,000
Girma - Capital (½ X 80,000) 40,000
(Journal entry to record the transfer of ½ of Fikru’s capital to Girma)
The cash paid by partner Girma to Partner Fikru may have a carrying amount:
Equal to the Ownership interest ( Birr 40,00),
More than the ownership interest (> Birr 40,000),
Less than the ownership interest ( < Birr 40,000) , or
Simply, a gift by an existing partner Fikru to the new partner Girma.
Whatever the above case may be, the journal entry that is required in the partnership’s
accounting records will be a debit to Fikru’s capital by Birr 40,000 and a resulting credit
to Girma’s capital by the amount. No change has occurred in the partnership assets,
liabilities and total partnership’s capital. The only change is an increase in Girma’s
capital and a decrease in Fikru’s capital by Birr 40,000 each.
To elaborate the above statement, let us further assume that Girma paid Birr 50,000 to
Fikru for one- half of Fikru’s Birr 80,000 equity in the partnership. The Birr 10,000
amount (50,000- 40,000) paid in excess of the ownership’s carrying value of Girma’s
capital is a personal transaction between Girma and Fikru, and brings no change in the
total assets of the partnership. The partnership has neither received nor distributed any
assets. Therefore, the partnership should not record the excess amount paid by Girma to
Fikru.
2. Admission by an investment: The other alternative way in which a new partner may
gain admission into the partnership is by investing assets. Unlike admission by
acquisition, admission by investment has an effect on the partnership’s assets, liabilities
and owners’ equity. There is an increase in total partnership assets and capital, and
therefore the transaction is recorded in the partnership accounting books. The new partner
may invest an amount equal to, greater than, or less than the carrying amount of the
ownership interest she /he acquires. The payment of the price more than the ownership
interest by the new partner leads to the recognition of either good will or bonus.
Example: Assume that Tamru and Habtamu, partners of Tamru and Habtamu LLP, share
net income or loss equally and that each has a capital account balance of Birr 50,000.
Tefera has a land that might be used for expansion of partnership. Tamru and Habtamu
agree to admit Tefera to their partnership by an investment of the land. The land has a
cost of Birr 60,000 but has a current fair value of Birr 100,000. Assume further that the
carrying amounts of the partnership assets before admission are approximately equal to
____________________________________________________________________ 20
current fair values. The net income or losses of the new firm are to be shared equally. The
admission of Tefera is recorded by the partnership as follows:
Land 100,000
Tefera, Capital 100,000
(To record admission of Tefera to the partnership)
Tefera has a capital account balance of Birr 100,000 and thus owns a 50% [Birr
100,000/Birr 50,000+ Birr 50,000+Birr 100,000] =0.50] interest in the net assets of the
firm. The fact that the three partners share net income or losses equally does not require
that their capital account balance be equal.
Bonus or Goodwill Allowed to Existing Partners
When a new (incoming) partner invests an amount greater than the carrying value of the
ownership interest he or she acquires, the existing partners may insist that a portion of the
investment by a new partner be allocated to them as a bonus or goodwill be recognized
and credited to the existing partners. This is true when the existing partnership is well
established, reputable and profitable. The new partner may agree to such terms because
of the benefits to be gained by becoming a member of a firm with high earning power.
Bonus to Existing Partners
Example: Assume that in the Meron and Helen LLP, the two partners share net income
and losses equally and have capital account balances of Birr 50,000 each. The carrying
amounts of the partnership net assets approximate current fair values. The partners agree
to admit Saba to a one-forth interest in capital and a one-forth share in net income or
losses for a cash investment of Birr 60,000.
The excess cash investment by Saba is recognized as bonus to Meron and Helen in the
profit and loss sharing ratio before Saba’s admission as shown in the journal entry below:
Cash 60,000
Meron, Capital 10,000
Helen, Capital 10,000
Saba, Capital (160,000x1/4) 40,000
(To record investment by Saba for a one-forth interest in capital, with bonus of Birr
20,000 divided equally between Meron and Helen).
The investment increases the partnership assets by Birr 60,000 and the partners’ capital
by Birr 10,000 for Meron and Helen and by Birr 40,000 for Saba.
Goodwill to Existing Partners
An alternative to bonus method is recognition of goodwill to existing partners. In the
foregoing example, Saba invested Birr 60,000 but received a capital account balance of
only Birr 40,000, representing a one forth interest in the net assets of the partnership.
Instead, Saba might prefer that the full amount invested i.e. Birr 60,000, be credited to
Saba’s capital account recognizing a one-forth interest if goodwill is recognized by the
partnership, with the offsetting credit divided equally between the two existing partners.
____________________________________________________________________ 21
Therefore, if the one- forth interest of Saba’s capital represent Birr 60,000, the total value
of the partnership will be: 1/4xY= 60,000; Y=4x60,000=Birr 240,000; where Y
represents the total value of the partnership. From this amount the combined capital of
Meron and Helen will be Birr 180,000 (240,000-60,000) or 3/4x240,000. However; we
know that the present book value of Meron and Helen capitals
is( 50,000+50,000=100,000). Hence the excess amount of Birr 80,000( 180,000-100,000)
will be recognized as goodwill to existing partners and shared between Meron and Helen
as follows:
Cash 60,000
Goodwill 80,000
Meron, Capital 40,000
Helen, Capital 40,000
Saba Capital 60,000
(To record investment by Saba for one-forth interest in capital, with credit offsetting
goodwill of Birr 80,000 divided equally between Meron and Helen).
In the preceding examples of bonus or good will allowed to the existing partners, it was
assumed that the carrying amounts of assets of the partnership approximated current fair
values. However, if assets such as land and buildings have been owned by the partnership
for many years, the carrying amounts and current fair values may be significantly
different. For example, assume the net assets of Meron and Helen Partnership carried at
Birr 100,000 were estimated to have a current fair value of Birr 140,000 at the time of
admission of Kibrom as a partner and Kibrom was required to receive a one-forth interest
in the partnership net assets for an investment of Birr 60,000.
The write up of the partnership’s identifiable net assets from Birr 100,000 to Birr 140,000
increases the capital account balance of existing partners. Hence, neither a bonus nor
goodwill recognition would be necessary to record the admission of Kibrom with a one-
forth interest in net assets for an investment of Birr 60,000. This is because the
investment by Kibrom equals one-forth of the total partnership capital of Birr 240,000
(50,000+50,000+140,000).
Bonus or Goodwill Allowed to New Partner
Sometimes a partnership admits a new partner because the incoming partner has
valuables skill, experience or the partnership is in need of cash. With the expectation of
valuable skill and experience of the new partner, the existing partnership may offer the
new partner equity, which is larger than the amount invested by the new partner.
Therefore, either bonus or goodwill will be recognized for the new partner.
Here, it is important to remember that the net assets of the partnership should be properly
valued before admission of a new partner in to the partnership.
Bonus to New Partner: When a partner is admitted for a cash investment of and is
credited with a capital account balance larger than the cash invested, the difference
should be recorded as a bonus to the new partner from the existing partners.
____________________________________________________________________ 22
Example: Assume partners Melkamu and Fasil who share net income and losses equally
have capital account balances of Birr 60,000 each. Molla is admitted in to the partnership
of Melkamu and Fasil with one- forth interest in the net assets and one- half share of net
income or losses for an investment of Birr 30,000. Their admission is based on a need for
more cash and on the assumption that Molla’s personal skills and business contacts will
be valuable to the partnership. Molla is entitled to receive Birr 37,500 which is a one-
forth interest in net assets (60,000 + 60,000 + 30,000 = 150,000 x ¼). The excess of
Molla’s capital account balance over the amount invested Birr 7,500 (37,500-30.000)
represent a bonus allowed to the new partner Molla. Partners Melkamu and Fasil share
net income and loss equally. Hence, the bonus allowed to Molla will be shared equally
based on their income or loss sharing ratio, and reduces the capital account balance of
each partner by Birr 3750. The following journal entry shows the above transaction.
Cash 30,000
Melkamu’s Capital (7,500x1/2) 3,750
Fasil’s Capital (7,500x ½) 3,750
Molla’s Capital 37,500
(To record admission of Molla, with bonus of Birr 7,500 from Melkamu and Fasil)
Goodwill to New Partner: Generally, goodwill is recognized as part of the investment of
a new partner only when the new partner invests in the partnership a business enterprise
of superior earning power, which is substantiated by objective evidence.
Example: Assume in the foregoing example, the new partner Molla is the owner of a
successful business (single proprietorship) that Molla invests his profitable business
instead of cash investment. The identifiable tangible and intangible net assets of the
business owned by Molla are worth Birr 30,000; but, because of superior earnings record,
a current fair value for the total net assets is agreed to Birr 40,000. Assume further that
Melkamu and Fasil has the same capital account balance of Birr 60,000 and give Molla a
one-forth interest and net income and losses.
The admission of Molla in the partnership is recorded as follows:
Identifiable tangible and intangible assets 30,000
Goodwill (40,000-30,000) 10,000
Molla Capital 40,000
(To record admission of Molla; goodwill is attributable to superior earnings of single
proprietorship invested by Molla).
The point to be stressed here is that generally goodwill is recognized as part of the
investment of a new partner only when the new partner invests in the partnership a
business enterprise of superior earning power.
1.1.3.2. Dissolution by Withdrawal (Retirement) of a Partner
Change in the ownership of a partnership also results when a partner retires or withdraws
from the partnership by different reasons. This retirement or withdrawal of partners from
the partnership dissolves the existing partnership as seen in the case of admission of a
new partner in the partnership. However, the retirement or withdrawal of the partner(s)
____________________________________________________________________ 23
from the existing partnership does not necessarily mean the end of the partnership life,
because the remaining partners may wish to continue operating the business.
The articles of co-partnership should specify the procedures to be followed by the
partnership to ensure that the agreement of the partners is carried out. The primary
accounting issue is the proper measurement of the retiring partner’s capital account. This
some times requires a determination of the partnership’s fair value when the partner
retires, including the computation of the partnership income since the end of the last
fiscal period. The retiring partner is still personally liable for any partnership debts
accumulated before the withdrawal of date but is not responsible for any partnership
debts incurred after the retirement date. Therefore, it is especially important to determine
all liabilities that exist on the retirement date. The retiring partner may simply sell the
interest to an out side party, with approval, or to one or more of the remaining partners.
As a means of settling the partner’s right of co-ownership, cash or other assets can be
distributed to the retiring partner from the partnership.
Generally, the existing partners may buy out the retiring partner either by making a direct
acquisition or by having the partnership acquire the retiring partner’s interest. If the
present partners directly acquire the retiring partner’s interest, the only entry on
partnership’s books is to record the reclassification of capital among the partners. If the
partnership acquires the retiring partner’s interest, the partnership must record the
reduction of total partnership capital and the corresponding reduction of assets paid to the
retiring partner.
The withdrawal (retirement) of an individual partner and the resulting distribution of
partnership property can be accounted for by either the bonus method or the goodwill
method as seen in the case of admission. If a bonus is recorded, the amount can be
attributed to either the withdrawing partner or remaining partners. Conversely, any
revaluation of partnership property as well as establishment of goodwill balance is
allocated among all partners in recognition of possible unrecorded gains.
Illustration: Assume that the partnership of Alem, Bereket and Chala who do business
for a number of years. Currently the partners have the following capital account balance
profit and loss sharing ratio:
Profit and Loss Ratio Capital balance

Alem 50% Birr 80,000
Bereket 30% 40,000
Chala 20% 20,000
Total 100% Birr 140,000
Chala decides to withdraw from the partnership where as Alem and Bereket plan to
continue operating the partnership. According to their original partnership agreement, the
final settlement distribution for Chala is computed based on the following specified
provisions:
1. To determine the estimated fair value of the partnership, an appraisal will be made by
an independent expert.
____________________________________________________________________ 24
2. Any partner who leaves the partnership is entitled to receive cash or other assets equal
to that partner’s current capital balance after recording an appropriate share of any
adjustment indicated by the previous valuation.
3. The allocation of unrecorded gains and losses is based on the normal profit and loss
ratio.
When Chala makes a decision to withdraw from the partnership, a valuation of the
partnership and its property is made. Based on the result the total fair market value of the
partnership is estimated at Birr 200,000, a figure Birr 60,000 in excess of the book value.
According to the valuation, Land owned by the partnership is currently worth Birr 40,000
more than its original cost. In addition, Birr 20,000 goodwill is attributed to the
partnership based on the value of the partnership. Therefore, Chala is entitled to receive
Birr 32,000 at the time of withdrawal; i.e. the original Birr 20,000 plus a 20% share of
Birr 60,000 increment. This can be accounted using the bonus and goodwill method as
follows:
Bonus Method: When the bonus method is applied (used) by the partnership to record
the above transaction, the additional Birr 12,000 paid to Chala, is simply recorded as a
decrease in the remaining partners’ capital account based on the their relative profit of
and loss ratio as shown in the following journal entry:
Chala, Capital (to remove account balance) 20,000
Alem, Capital (5/8 of excess distribution) 7,500
Bereket, Capital (3/8 of excess distribution) 4,500
Cash 32,000
(To record Chala’s withdrawal with Birr 12,000 excess distribution taken from remaining
partners).
Goodwill Method: Using the goodwill (revaluation) method, the goodwill as well as the
revaluation is recorded as an increase in the partners’ capital account and an additional
journal entry is needed to record the settlement of the withdrawing partner’s capital as
shown below:
Land 40,000
Goodwill 20,000
Alem, Capital (50%) 30,000
Bereket, Capital (30%) 18,000
Chala, Capital (20%) 12,000
(Recognition of land value and goodwill before Chala’s withdrawal)
Chala, Capital (to remove account balance) 32,000
Cash 32,000
(Cash distributed to Chala in settlement of partnership interest at the time of withdrawal)
1.1.4. Accounting for Partnership Liquidation
Any change in the ownership of a partnership by admission, withdrawal, death or

incapacity of the partnership or partners in the partnership will lead to dissolution of the
existing partnership and formation of a new one with revised agreement. However, the
dissolution of a partnership by any means does not necessarily mean stopping of the
____________________________________________________________________ 25
partnership operation and complete winding up of the partnership. This is because the
existing partners if agreed may continue operating the partnership.
When dissolution brings formal termination of business and leading to business winding
up, it is referred to as liquidation. In other words, the liquidation process of a partnership
is the complete winding up of partnership operation usually accomplished by selling of
non cash assets, paying of liabilities, and distributing any remaining cash to partners.
In general, the liquidation process of a partnership consists of the following steps:
1. Conversion of non cash assets in to cash through sale, referred as realization,
2. Realization of gain or loss on sale of non-cash assets,
3. Distribution of gain or loss on sale of non-cash assets among partners in
accordance with their profit and loss sharing ratio,
4. Payment of liabilities in accordance with legal priority, and
5. Distribution of the remaining cash in settlement of partner’s respective capital.
The conversion of non -cash assets in to cash can be done as a unit sale or sales based on
installment.
The following actions should be taken when a decision is made to liquidate a partnership:
Accounting records of the partnership should be adjusted and closed,
Determination of net income or loss of for the period,
Distribution of net income or loss to partners based on net income or loss sharing
ratio and transferring it to their respective capital balances.
The liquidation process usually starts with the realization (conversion) of non-cash assets
in to cash. This means that all non cash assets will be sold out and converted in to cash.
After realization, before any payment to partners, all outside creditors of the partnership
must be paid in full. If the cash obtained from the realization of non cash assets is
insufficient to pay liabilities in full, unpaid creditor may act to enforce collection from
the personal assets of any solvent partner whose actions caused the partnership
insolvency, regardless of whether that partner has a credit or a debit capital account
balance.
1.1.4.1. Division of Loss and Gains on Realization
The loss or gain from the realization of non cash assets should be divided among the
partners according to the profit and loss sharing ratio prevailing in the normal operations
of the partnership. When the net loss or gain from liquidation is divided among the
partners, the final balances of in the partner’s capital and loan accounts are supposed to
be equal to the cash available for distribution, after which cash payments are often made
in settlement of partners’ respective capital.
1.1. 4.2. Distribution of Cash or Other Assets to Partners
The uniform partnership Act lists orders for the distribution of cash by a liquidating
partnership as:
Payment of creditors in full,
Payment of loans to partners, and
Payment of partners’ capital account balance.
____________________________________________________________________ 26
The indicated priority of partners’ loans over partners’ capital appears to legal fiction
based on legal doctrine called right of offset.
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 a loan account receives any cash, the payment
is recorded as a debit to the loan account to the extent of the balance of that amount.
For example, if the partnership ABC has a Birr 4,000, loan payable to partner C, the loan
was originally recorded by the partnership with the following journal entry:
Cash 4,000
Loan payable to partner C 4,000
Loans payable to partners have higher priority in liquidation than partners’ capital
account balances, but lower priority than liabilities to outside creditors. However, the
legal right of offset allows a deficit in partner capital account to be offset by a loan
payable to that partner. For example, if partner C from the above example had a Birr
2,000 deficit in his capital account at the end of the liquidation process, Birr 2,000 of the
loan payable to him would be offset against the capital deficit as follows:
Loan payable to C 2,000
C –Capital 2,000
(Offset deficit in C’s capital account with loan payable)
Because of the right of offset, the total amount of cash received by a partner during
liquidation always will be the same as if loans to the partnership had been recorded in the
partner’s capital account balances. Furthermore, the existence of partners loan account
will not advance the time of payment to any partner during liquidation.
In the liquidation process of a partnership, non cash assets may be sold as unit (lump sum
liquidation) or the assets may sold in installments.
1. Lump Sum Liquidation: a lump sum liquidation of a partnership is one in which all
assets are converted in to cash, creditors are paid, with in a very short period of interests.
Payments to Partners of an LLP after All Non-cash Assets are Realized
Case 1: Equity of each partner is sufficient to absorb loss from realization
Example 1: The following illustration is used to present the lump sum liquidation of XYZ
partnership in which X, Y and Z are partners. The condensed balance sheet of the
partnership as of March 31, 2004, the day the partners decide to liquidate, is as follows:
XYZ Partnership
Balance Sheet
March 31, 2004
________________________________________________________________________
Cash Birr 10,000 Liabilities Birr 30,000
Non cash assets 80,000 Loan payable to Y 20,000
X, Capital 20,000
Y, Capital 10,000
____________________________________________________________________ 27
Z, Capital 10,000
Total Br. 90,000 Br. 90,000
The non-cash assets are sold for Birr 60,000 with a resulting loss of Birr 20,000. The
statement of realization and liquidation as well as the distribution of remaining cash is as
follows:
XYZ Partnership
Statement of Realization and Liquidation, April 1 through 15, 2004
Assets Partners’ Capital
X Y Z
Cash Other Liabilities Y loan (40%) (40%) (20%)
Balance before
liquidation 10,000 80,000 30,000 20,000 20,000 10,000 10,000
Realization of non
cash assets at loss of
20,000 60,000 (80,000) - - (8,000) (8000) (4000)
Balances 70,000 - - - 12,000 2,000 6,000
Payment to creditors (30,000) - (30,000) - - - -
Balances 40,000 - - 20,000 12,000 2,000 6,000
Payment to partners: - -
- Partners loan (20,000) - - (20,000)
- Partners’ -
Capital (20,000) (12000) (2000) (6000)
Balances -0- -0- -0- -0- -0- -0- -0-
The above statement of realization and liquidation covering the period April 1 through
15, 2004 shows:
 The division of loss on realization of birr 20,000,
 The payment of outside creditors, and
 The distribution of the remaining cash to partners
 There is no right offset since all partners have credit capital balance.
Let us assume now the non-cash (other assets) are sold for Birr 50,000 with a realization
of Birr 30,000 loss. The statement of realization and liquidation in this case has shown as
below:
____________________________________________________________________ 28
XYZ Partnership
Statement of Realization and Liquidation
April 1 through 15, 2004
Partners’ Capital
Assets
Description Liabilities Y loan X Y Z

Cash Other (40%) (40%) (20%)
Balance before
liquidation 10,000 80,000 30,000 20,000 20,000 10,000 10,000
Realization of none
cash assets at a loss
of 30,000 50,000 (80,000) - - (12000) (12000) (6000)
Balances 60,000 - - 8,000 (2,000) 4,000
Payment to -
creditors (30,000) - ( 30,000) - - - -
Balances 30,000 -0- -0- 20,000 8,000 (2,000) 4,000
Offset of Y’s - -
capital deficit - - ( 2,000) 2,000
against Y’s loans
Balances 30,000 - - 18,000 8,000 -0- 4,000
Payment to
partners: - - - - - -
-Partners loan (18,000) - - (18,000) - -
-Partners’ Capital (12,000 - - -0- ( 8,000) (4,000)
Balance -0- - - - -0- -0-
The above statement of realization and liquidation covering the period April 1 through
15, 2004 shows:
 The division of loss on realization of birr 30,000,
 The payment of outside creditors, and
 The offset of Y’s Capital deficit against Y’s loan
 The distribution of the remaining cash to partners
From the foregoing statement of realization and liquidation, Y’s loan account balance of
Birr 20,000 and capital account balance of Birr 10,000 might have been combined to
obtain equity of Birr 30,000 for Y. Such a procedure would be appropriate because the
legal priority of a partner’s loan has no significance in determining either the total
amount of cash paid to partners or the timing of cash payment to partners during
liquidation. Hence, the partner’s loan account has no special significance in the
____________________________________________________________________ 29
partnership liquidation. Partner X received cash of Birr 8,000 and partner Z received cash
Birr 4,000. Neither partner received cash until after partnership creditors had been paid in
full, because the only partnership asset is Birr 30,000 at this point.
The statement of realization and liquidation for XYZ partnership is the basis for the
following journal entries to record the liquidation process.
1. Cash 50,000
X- Capital 12,000
Y-Capital 12,000
Z-Capital 6,000
Non cash assets 80,000
(Realization of all non-cash assets of XYZ partnership and distribution of Birr 30,000
loss using profit and loss ratio)
2. Liabilities 30,000
Cash 30,000
(Payment of out side creditors)
3. Y’s Loan 2,000
Y’s Capital 2,000
(Offset of Y’s capital deficit 2000 against Y’s loan)
4. Y’s loan 18,000
X’s Capital 8,000
Z’s Capital 4,000
Cash 30,000
Case 2: Equity of One Partner is not sufficient to absorb that Partner’s Share of
Loss from Realization
A deficit in partners capital account balance can occur if the credit balance of that capital
account is too low to absorb his/her share of losses in realization. The loss on realization,
when distributed in the income-sharing ratio, results in a debit balance (deficit) in the
capital accounts of one or more of the partners. To fulfill an agreement to share a
specified percentage of partnership losses:
The partner must pay to the partnership sufficient cash to eliminate any capital
deficit.
If the partner is unable to pay, the partner’s capital deficit is distributed to the
other partners in their resulting profit and loss sharing ratio.
Illustration: The following balance sheet represents a partnership ABC, before
liquidation:
Cash Birr 10,000 Liabilities 40,000
Other assets 90,000 A, Capital 30,000
B, Capital 20,000
C, Capital 10,000
------------
Total 100,000 100,000
____________________________________________________________________ 30
Partners A, B and C share net income losses in the ratio of 20%, 30%, 50%. The other
assets with a carrying amount of Birr 90,000 are realized at Birr 60,000 cash resulting in
a loss of Birr 30,000. The statement of realization and liquidation for ABC partnership is
shown below:
ABC Partnership
July 1 through 15, 2005
Assets Partners’ capital
Cash Other Liabilities A (20%) B (30%) C (50%)
Balance before liquidation 10,000 90,000 40,000 30,000 20,000 10,000
Sale of other assets at loss
of Birr 30,000. 60,000 (90,000) (6,000) (9,000) (15,000)
Balance 70,000 -0- 40,000 24,000 11,000 (5,000)
Payment to creditors 40,000 (40,000)
Balances 30,000 -0- 24,000 11,000 (5,000)
Cash received from C 5,000 5,000
Balance 35,000 24,000 11,000 -0-
Payments to partners (35,000) (24,000) (11,000) -
In the above statement of realization and liquidation, the assumption is that partner C, is
able to pay the capital deficit of Birr 5,000 to the partnership. However, partner C may
not have the ability to pay the Birr 5,000 capital deficit to the partnership. In this case if
the cash available after payment to creditors is to be distributed to A and B without delay
to determine the collectivity of the Birr 5,000 claim against C, the statement of realization
and liquidation appears as follows:
ABC Partnership
July 1 through 15, 2005
Assets Liabilities Partners’ capital
Cash Other A (20%) B (30%) C (50%)
Sale of other assets at loss
of Birr 30,000. 60,000 (90,000) (6,000) (9,000) (15,000)
Balance 70,000 -0- 40,000 24,000 11,000 (5,000)
Payment to creditors (40,000) (40,000)
Balances 30,000 -0- 24,000 11,000 (5,000)
Payments to partners 30,000 (22,000) (8,000) -
Share of C’s deficit 2,000 3,000 (5,000)
The cash payments of Birr 22,000 to A and Birr 8,000 to B leave both partners with a
sufficient capital account credit balances to absorb their share of additional losses of C
which is unable to pay Birr 5,000 to the partnership. This capital deficit of Birr 5,000 will
be then shared between A and B as 2/5x5, 000 and 3/5 x5, 000 Birr 2,000 and 3,000
respectively.
____________________________________________________________________ 31
If the Birr 5,000 is latter collected from C, this amount is divided to A and B; Birr 2,000
to A and Birr 3,000 to B. Thus, the foregoing uncompleted statement of realization and
liquidation then may be completed as follows:
Balances from preceding Assets Liabili Partners’ capital

Statement of realization and Cash Other ties A (20%) B (30%) C (50%)
liquidation - - - 2,000 3,000 (5,000)
Cash received from C 5,000 5,000
Payment to partners (5,000) ( 2,000) (3,000) -
However, if the Birr 5,000 receivable from partner C, is uncollectible, the statement of
Realization and liquidation would be completed with the write off C’s capital deficit and
the additional loss be absorbed by A and B as shown below:
Balances from preceding Assets Liabili Partners’ capital

Statement of realization Cash Other ties A (20%) B (30%) C (50%)
and liquidation - - - 2,000 3,000 (5,000)
Additional loss from C’s
uncollectible capital (5,000) ( 2,000) (3,000) 5,000
deficit
Case 3: Equities of Two Partners are not sufficient to absorb their Shares of Loss
from Realization
A partner unable to pay the partnership for a capital deficit causes additional losses to
other partners. A partner may have sufficient capital, or combination of capital and loan
accounts, to absorb any direct share of loss on realization of non cash assets, but not
sufficient equity to absorb additional actual or potential losses caused by inability of the
partnership to collect the deficit in another partner’s capital account. One capital deficit if
not collectible, may cause a second capital deficit that may or may not be collectible.
Illustration: Assume that P, Q, R and S partners of PQRS LLP share net income and loss
in the ratio of 10%, 20%, 30%, and 40% respectively, their balance sheet accounts are
shown below:
Other assets 100,000 P, Capital 39,000
Q, Capital 24,000
R, Capital 11,000
------------ S, Capital 6,000
Total 120,000 120,000
The other assets are sold for Birr 70,000.The statement of realization and liquidation
looks the following:
PQRS Partnership
____________________________________________________________________ 32
May 1, through 30, 2005
Assets Partners’ capital
Cash Other Liabiliti P Q R S
es (10%) (20%) (30%) (40%)
Balance before
liquidation 20,000 100,000 40,000 39,000 24,000 11,000 6,000
Sale of other assets at
loss of Birr 30,000. 70,000 (100,000) (3,000) (6,000) (9,000) (12,000)
Balance 90,000 -0- 40,000 36,000 18,000 2,000 (6,000)

Payment to creditors 40,000 (40,000)
Balances 50,000 -0- 36,000 18,000 2,000 (6,000)
Payments to partners 50,000 34,667 15,333 - -

Balances (35,000) 1,333 2,667 2,000 (6,000)
The capital deficit by partner S, if uncollectible is shared between partners P, Q and R in

the ratio of 10: 20; 30. This share of additional loss for the capital deficit, leads to another
capital deficit of partner R; because the capital balance of R is unable to absorb the
additional loss from partner S, who has a capital deficit as shown below:
PQRS Partnership
Computation of Cash Payments to Partners
_______________________________________________________________________
P Q R S
Capital balance before distribution of cash payments 36,000 18,000 2,000 (6,000)
Additional loss to P, Q&R if S’s deficit is uncollectible (1,000) (2,000) (3,000) 6,000
Balances 35,000 16,000 (1,000) - 0-
Additional loss to P&R if R’s deficit is uncollectible 333 667 1000 -
Amounts that may be paid to partners P&Q 34,667 15,333 - -
Partner R is not eligible to receive a cash payment. If this deficit in R’s capital account
proves uncollectible, the balances remaining in the capital accounts of P&Q after cash
payment to them totaling Birr 50,000 will be equal to the amounts (Birr 333 and Birr 667
respectively) needed to absorb the additional loss shifted from R’s capital account.
Case 4: Partnership is Insolvent but Partners are Solvent
If a limited liability partnership is insolvent, it is unable to pay all outside creditors and at
least one and perhaps all of the partners will have debit balances in their capital accounts.
In any event, the total of the capital account debit balances will exceed the total of the
credit balances. If the partner or partners with a capital deficit pay the required amount to
the partnership, it will have cash to pay its liabilities in full. However, the partnership
creditors may demand payment from any solvent partner whose actions caused the
partnership’s insolvency, regardless of whether the partner’s capital account has a debit
or a credit balance. In terms of relationships with creditors, the limited liability
____________________________________________________________________ 33
partnership is not a separate entity. A partner who makes payments to partnership
creditors receives a credit to his or her capital account.
Illustration: Assume an insolvent partnership of P, Q&R; whose partners are solvent
(have personal assets in excess of liabilities). The partners P, Q and R share net income
and losses equally have the following balance sheet just prior to liquidation on May 10,
2004:
PQR Partnership
Balance Sheet
May 10, 2004
Non cash assets 85,000 P, capital 18,000
Q, Capital 10,000
R, Capital 7,000
Total 100,000 Birr 100,000
On May 12, 2004, the other assets with a carrying amount of Birr 85,000 realized at Birr
40,000 cash, which causes a loss of Birr 45,000 to be divided equally among the partners.
The total cash of Birr 55,000(15,000+40,000) is paid to the partnership creditors, which
leaves unpaid liabilities of Birr 10,000(65,000-55,000). Partner P’s capital account has a
credit balance of Birr 3,000 after absorbing one third of the loss. Partners R and Q owe
the partnership Birr 5,000(15,000-10,000) and Birr 8,000(15,000-7,000), respectively.
Assume that on May 30, 2004 partners Q and R paid the amounts of their deficiencies,
the partnership will use this Birr 13,000 in paying the unpaid liabilities of Birr 10,000
leaving Birr 3,000 to be distributed to partner P. The statement of realization and
liquidation, which summarizes the above events, is presented below:
It should be noted that if a limited liability partnership is insolvent because of an adverse

award of damages in a lawsuit, and the partner or partners responsible for damages are
solvent, they alone of the partners must pay the amount of damages that the insolvent
limited liability partnership is unable to pay. However, if such partners are also insolvent,
both they and the limited liability partnership may have for liquidation. The partners of
the limited liability partnership are not responsible for the award of damages, unless they
too were insolvent apparently would not have to undertake bankruptcy proceedings.
PQR Partnership
May 11 through 30, 2004
Assets Partner’s Capital
Cash Other Liabilities P Q R
Balances before liquidation 15,000 85,000 65,000 18,000 10,000 7,000
Realization of other assets at 40,000 (85,000) (15,000) (15,000) (15,000)
____________________________________________________________________ 34
a loss of Birr 45,000. 55,000 65,000 3,000 (5,000) (8,000)
Balances (55,000) (55,000)
Payment to Creditors -0- 10,000 3,000 (5,000) (8,000)
Balances 13,000 5,000 8,000
Cash received from Q&R 13,000 10,000 3,000
Balances (10,000) (10,000)
Final payment to creditors 3,000 3,000
Balances (3,000) (3,000)
Payment to partner P
Case 5: General Partnership is Insolvent and Partners are Insolvent

In the foregoing illustration of an insolvent limited liability partnership, the partners were
solvent and therefore able to pay their capital deficits to the partnership. In this case, we
will consider an insolvent general partnership in which one or more of the partners are
insolvent. This situation raises a question as to the relative rights of two groups of
creditors:
Creditors of the partnership and;
Creditors of the partners
The relative rights of these two groups of creditors are governed by the provisions of the
Uniform Partnership Act relating to the marshaling of assets. The marshaling of assets
rules provide that, assets of the general partnership (including partners’ capital deficits)
are first available to creditors of partnership and that assets of the partners are first
available to their creditors. After the liabilities of the partnership have been paid in full,
the creditors of an individual partner have a claim against the assets (if any) of the
partnership to the extent of that partner’s equity in the partnership.
After the creditors of a partner have been paid in full from the assets of the partner, any
remaining assets of the partner are available to partnership creditors, regardless of
whether the partner’s capital account has a credit balance or a debit balance. Such claims
by creditors of the partnership are permitted only when these creditors are unable to
obtain payment from the partnership.
Illustration: To show the relative rights of creditors of an insolvent general partnership

and personal creditors of an insolvent partner, assume that R, S and T partnership,
general partnership whose partners share net income and losses equally, has partnership
balance sheet below prior to liquidation on November 30, 2002.
RST Partnership
Balance Sheet
November 30, 2002
________________________________________________________________________
Assets Liabilities & Partners’ Capital
Other assets 110,000 R, Capital 5000
S, Capital 15,000
____________________________________________________________________ 35
_______ T, Capital 30,000
Total Birr 110,000 Br. 110,000
Assume also that on November 30, 2002, the partners have the following assets and
liabilities other than their equities in the partnership and the other assets are realized at
Birr 40,000.
Personal Personal
Partners Assets Liabilities
R 100,000 25,000
S 50,000 50,000
T 5,000 60,000
RST Partnership
December 1 through 15, 2002
Assets Liabiliti Partner’s Capital
Cash Other es R S T
Balances before liquidation 10,000 100,000 60,000 5,000 15,000 30,000
Realization of other assets at (100,000)
a loss of Birr 60,000. 40,000 (20,000) (20,000) (20,000)
Balances 50,000 60,000 (15,000) (5,000) 10,000
Partial Payment to Creditors (50,000) (50,000)

Balances -0- 10,000 (15,000) (5,000) 10,000
The creditors of the partnership have received all the cash of the general partnership and
still have unpaid claims of Birr 10,000. They cannot collect from S or T because the
assets of these two partners are just sufficient to or are insufficient to pay their liabilities.
However, the partnership creditors may collect the Birr 10,000 in full from R, who is
solvent. By chance, R has a capital deficit of Birr 15,000, but this is not of concern to
creditors of the partnership, who may collect in full from any partner who has sufficient
assets, regardless of whether that partner’s capital account has a debit balance or a credit
balance.
The statement of realization and liquidation that continues from the foregoing statement
to show R’s payment of the final Birr 10,000 owed to partnership creditors. Because the
assumptions above R’s finances showed that R had Birr 100,000 of assets and only Birr
25,000 of liabilities, R is able to invest in the partnership the additional Birr 5,000 needed
to offset R’s capital deficit. This Birr 5,000 cash is paid to partner T, the only partner
with a capital account credit balance.
Continuation of statement of realization and liquidation for general partnership
Cash Other Liabiliti R S T
es
____________________________________________________________________ 36
Balances from above 10,000 (15,000) (5,000) 10,000
Payment by R to partnership
Creditors (10,000) 10,000
Balances (5,000) (5,000) 10,000
Cash invested by R 5,000 (5,000)
Balances 5,000 (5,000) 10,000
Payment to T (or T’s creditors) (5,000) (5,000)
Balances (5,000) 5,000
The continued statement of realization and liquidation now shows that S owes Birr 5,000
to the partnership, however S’s assets are of Birr 50,000 are exactly equal to S’s
liabilities of Birr 50,000. Under the Uniform Partnership Act., all the assets of S will go
to S’s creditors; therefore, the Birr 5,000 deficit in S’s capital account represents an
additional loss to be shared equally by R and T. To conclude the liquidation, R, who is
solvent, pays Birr 2,500 to the partnership, and the Birr 2,500 will be paid to T or to T ‘s
creditors, because T is insolvent. These payments are shown below to complete the
statement of realization and liquidation for R, S &T partnership.
Completion of statement liquidation and realization

Cash R S T
Other
Balances from above (5,000) 5,000
Write off S’s capital deficit as
uncollectible ( 2,500 5,000 (2,500)
Balances )
Cash invested by R 2,500
Balances (2,500)
Payment to T or T’s Creditors 2,500 2,500
2,500 2,500
(2,500) (2,500)
The results of the liquidation show that the partnership creditors received payment in full
because of the financial status of partner R. Because R was solvent, the creditors of R
also were paid in full. The creditors of S were paid in full, thereby exhausting S’s assets;
however, because S failed to pay the $ 5,000 capital deficit to the partnership, an
additional loss of Birr 5,000 was absorbed by R and T. The creditors of T received all of
T’s separate assets of Birr 5,000 and Birr 7,500 from the partnership, representing T’s
equity in the firm. However, T’s creditors were able to collect only Birr 12,500
(5,000+7,500=$ 12,500) on their total claims of Birr 60,000.
2. Installment Liquidations
Under the lump sum liquidation in the foregoing examples, all the partnership non-cash
assets were realized and the total loss from liquidation was divided among the partners
before any cash payments were made to them. However, an installment liquidation
typically requires several months has to complete and includes periodic, or installment
payments to the partners during the liquidation period. Most partnerships liquidation
____________________________________________________________________ 37
takes place over an extended period of time in order to obtain the largest possible amount
from the realization of assets.
Liquidation on installments is a process of realizing some assets, paying creditors, paying

the remaining available cash to partners, realizing additional assets and making additional
cash payments to partners. The liquidation continues until all non-cash assets have been
realized and all cash has been distributed to partnership creditors and partners.
Installment liquidations involve the distribution of cash to partners before complete
liquidation of the assets occur. Installment payments to partners are appropriate if
necessary safeguards are used to ensure that all partnership creditors are paid n full and
no partners are paid more than the amount to which they would be entitled after all
losses on realization of assets are known.
Guiding Principles for Installment Liquidations
In liquidation on installments, the liquidator will be authorizing cash payments to
partners before the loss on realization are entirely known. In such a case, the liquidator
may be personally liable to other partners for any loss caused by his improper distribution
of cash. For example, if payments are made to partners while later losses cause deficiency
in capital accounts, and the partners concerned can not return payment, the liquidator
may be personally liable. Consequently, the guiding principle for the liquidator to
authorize payment to a partner only if the partner has credit balance in the capital, or loan
and capital account combined, which exceeds the amount required to absorb his portion
of the maximum possible loss to be incurred on liquidation. This also includes losses that
have to be absorbed from inability of other partners to make good for any capital
deficiency that arises in their capital accounts.
Accordingly, the following practical guidelines are used to assist the liquidator in
determining the safe installment payments to the partners.
1. Distribute no cash to the partners until all liabilities and actual and potential
liquidation expenses have been paid or provided for by reserving the necessary
cash.
2. Anticipate the worst or most restrictive, possible case before determining the
amount of cash installment each partner receives:
(a) Assume that all remaining non cash assets will be written off as a loss;
that is, assume that nothing will be realized on non cash assets disposal.
(b) Assume that deficits created in the partners’ capital account will be
distributed to the remaining partners; that is, assume that deficits will not
be eliminated by additional partner capital contribution.
3. After the liquidator has assumed the worst possible cases the remaining credit
balances loan and capital accounts represent safe distributions of asset and cash
that may be distributed to partners in those amounts.
Cash Distribution Program
Instead of computing the maximum possible loss on unsold assets each time, and
determining the cash that can be safely distributed to partners; accountants
(liquidators) commonly prepare a cash distribution program at the beginning of the
liquidation process. A cash distribution program is a pro forma projection of the
____________________________________________________________________ 38
application of cash as it becomes available. It gives the partners an idea of the
installment cash payments each will receive as cash becomes available to the
partnership. If such a program is prepared, any amounts of cash received from the
realization of partnership assets may paid immediately to partnership creditors and
the partners as specified in the program.
The following steps (procedures) are used in preparing the cash distribution program:
Step 1: Determine the net capital account balance before liquidation representing the
equities of partners in the partnership. This comprises of the partner’s
account plus a loan to, or minus a loan from partnership.
Step 2: Divide the net capital account balance of each partner by the share of each
partner’s profit and loss sharing ratio. This figure gives the loss absorption
capacity of each partner by:
a) Identifying the partner who has largest loss absorption capacity and thus
who will be able to withstand losses long and will be first to receive cash,
b) Ranking partners in the order in which they will be entitled to receive cash
determining the amount of cash each partner should receive at different
stages of liquidation. The partner with the largest loss absorption capacity
will be able to withstand losses on realization and still remain with positive
capital balance, while the other partners with least loss absorption capacity
will be the first ones to be wiped out and appear with negative capital
balances, thus making them unable for cash payment first.
Step 3: To even out the loss absorption capacity of partners, reduce the highest loss
absorption capacity to the next highest loss absorption capacity. Thus the
excess of loss absorption capacity times the income sharing ratio determines
the amount of the first cash distribution to the partner with the highest loss
absorption capacity.
Step 4: Continue the process until the loss absorption capacity of all partners is
equalized.
Step 5: Multiply the equalized loss absorption capacity by the profit and loss sharing
ratios, and the result should be equal to the remaining capital balances. This
means that any additional cash on above those determined in step 2 and 3 will
be divided in the ratio of the profit and loss sharing as the capital amounts
themselves have been brought down to the profit and loss sharing ratios.
The amounts of cash that may be distributed safely to the partners each month ( or at any
other point in time ) may be determined by computing the impact on partners equities
( capital and loan account balances) of the maximum possible loss on non cash assets
remaining to be realized and the resultant potential impact on partners’ capital.
Illustration: Assume that partners P, R and S who share profits and losses in the ratio of
4:3:2, decided to liquidate the partnership and to distribute cash in installments. The
balance sheet for P, R and S partnership prior to liquidation on July 1, 2000, is as follows:
P, R & S Partnership
Balance Sheet
July 1, 2000
Assets Liabilities and Partner’s Capital
____________________________________________________________________ 39
Other assets 190,000 P, Capital 40,000
R, Capital 45,000
S, Capital 55,000
Total Birr 200,000 Birr 200,000
Other assets were realized in to cash as follows:

______________________________________________________________________
Carrying amount Cash received Loss on
Date of assets realized by Partnership realization
July 31, 2000 60,000 42,000 18,000
August 31, 2000 65,000 38,000 27,000
Sept. 31, 2000 65,000 47,000 18,000
Totals 190,000 127,000 63,000
P, R & S Partnership
Cash Distribution Program
Partner P Partner R Partner S
1. Net capital balance 40,000 45,000 55,000
2. Profit and loss sharing ratio 4 3 2
3. Loss absorption capacity (1/2) 10,000 15,000 27,500
4. Required reduction in highest loss
Absorption capacity to the next highest
loss absorption capacity (S to R) - - (12,500)
5. Capital per unit of profit or loss
Sharing ratio 10,000 15,000 15, 000
6 Required reduction in capital of
S & R to reduce their capital equal
to partner P’s balance - (5,000) (5,000)
7. Capital per unit of profit or loss sharing
ratio after payment of Birr 15,000 to R
and Birr 10,000 to S. 10,000 10,000 10,000
Note the following form the above cash distribution program:

 From Step 3 Partner S, has the highest loss absorption capacity (27,500).To
reduce this highest loss absorption capacity to the next highest loss absorption
capacity (partner R, 15,000) deduct 12,500 from 27,500 to balance the capital per
unit of profit and loss sharing ratio of partner S with the capital per unit of profit
and loss sharing ratio of partner R. Since Partner S has 2 units of profit sharing
ratio, it will receive 25,000 (12,500 X 2) cash after the creditors and before
partner R and P.
 The partner P is with the least loss absorption capacity, and deducts 5,000 to
reduce the capital per unit of profit and loss sharing ratio of partner S and R, to P.
Since partner S has 2 units of profit and loss sharing ratio, it is entitled to receive
Birr 10,000( 5000 X 2) cash and partner R is entitled to receive Birr 15,000 ( 5000
X 3) cash since it has 3 units of profit and loss sharing ratio before any amount is
distributed to partner P.
____________________________________________________________________ 40
 Since all partners’ capital per unit of profit and loss ratio is equalized, the
remaining cash may be distributed in profit and loss sharing ratio based on their
capital balance.
 Partner S receives a total cash balance of Birr 35,000 (25,000 + 10,000)
P, R&S Partnership
July 31 through Sept, 2000
Assets Partners’ Capital

Other P (4) R (3) S (2)
Description Cash assets Liabiliti
es
July 31, Installment
Realization of other assets at a
loss of Birr 18,000 42,000 (60,000 ) - (8,000) (6,000) (4,000)
Balances 52,000 130,000 60,000 32,000 (39,000) 51,000
Payment to creditors (52,000) - (52,000) - - -
-
Balances 0 130,000 8,000 32,000 39,000 51,000
August 31, Installment
Realization of other assets at a 38,000 (65,000) - (12,000) (9,000) (6,000)
loss of Birr 27,000
Balances 38,000 65,000 8,000 20,000 30,000 45,000
Payment to creditors (8,000) (8,000)
Balances 30,000 65,000 - 20,000 30,000 45,000
Payment to partners:
- First Birr to 25,000 to - 25,000
Partner S 2,000 3,000
- Second remaining 5000 (30,000) 28,000
to partners S & R ( 3: 2 )
Balances 0 65,000 0 20,000 28,000 17,000
Sept. 30, Installment
Realization of other assets at a
loss of Birr 18,000 47,000 (65,000) - (8,000) (6,000) (4,000)
Balances 47,000 0 - 12,000 22,000 13,000
Payment to partners (47,000) - - (12,000) (22,000) (13,000)
From the above statement of realization and liquidation, only Birr 52,000
(10,000+42,000) cash is available for distribution on July 31, 2000. The first claim is that
of partnership creditors, because their claims totals Birr 60,000, the entire Birr 52,000
available on July 31, 2000 is paid to creditors leaving unpaid balance of Birr 8,000
(60,000-52,000) and the partners receive nothing on that date.
____________________________________________________________________ 41
On August 31, 2000 Birr 38,000 cash is available for distribution; the first 8,000 Birr paid
to creditors for unpaid balances remaining, leaving 30,000 Birr cash distributed to the
partners based on the cash distribution program. The program requires partner S to
receive the first Birr 25,000 available for distribution to partners and S and R to share the
next 5,000 in the ratio of 3:2. Thus, on August 31, only Birr 5,000 cash (38,000-8,000-
25,000) is available for payment to S and R and they receive Birr 3,000 and Birr 2,000 to
respectively. Finally, on September 30, 2000; Birr 47,000 cash is available for
distribution to partners P, R & S based on the profit and loss sharing ratio as shown in the
cash distribution program below.
Journal Entries:
July 31, 2000: Cash 42,000
P, Capital 8,000
R, Capital 6,000
S, Capital 4,000
Other assets 60,000
(To record the realization of assets and division of Birr18, 000 losses among partners in
the 4: 3: 2 ratios)
July 31, 2000: Liabilities 52,000

Cash 52,000
(To record payment to creditors)
August 31, 2000: Cash 38,000
P, Capital 12,000
R, Capital 9,000
S, Capital 6,000
Other assets 65,000
(To record the realization of assets and division of Birr 27, 000 losses among partners in the 4: 3: 2 ratios)
Liabilities 8,000
R, Capital 2,000
S, Capital 28,000
Cash 38,000
(To record payment to creditors and first installment to partners R and S)
September 30, 2000: Cash 47,000
P, Capital 8,000
R, Capital 6,000
S, Capital 4,000
Other assets 65,000
(To record the realization of assets and division of Birr 18, 000 losses among partners in
the 4: 3: 2 ratios)
September 30, 2000: P, Capital 12,000
R, Capital 22,000
S, Capital 13,000
Cash 47,000
(To record final installment to complete the liquidation of the partnership)
1.1.4.4 Incorporation of a Limited Liability Partnership
____________________________________________________________________ 42
As a partnership continues to grow, the partners may decide to incorporate the business.
Partners will evaluate the possible advantages to be gained by incorporating a
partnership. Among such advantages are to have additional equity financing, to limit their
personal liability, to obtain selected tax advantages or to achieve sound business
purposes.
At the time of incorporation the partnership is terminated and to assure that each partner
receives an equitable portion of the capital stock issued by the new corporation, the assets
and liabilities of the partnership must be revalued and adjusted to current fair values
before being transferred to the corporation. The gain or loss on revaluation is allocated to
the partner’s capital accounts in the profit and loss sharing ratio. Any identifiable
intangible assets or goodwill developed by the partnership is included among the assets
transferred to the corporation.
Capital stock in the new corporation is then distributed in proportion to the partners’
capital accounts. The corporation may continue to use the partnership’s accounting
journals and ledgers to record its entries. In this case partners’ capital accounts are closed,
and the newly issued stock is recorded at the appropriate par value and any additional
paid in capital. If the corporation decides to open a new set of accounting records, the
partnership’s books are closed with the receipt of the new corporation’s stock for the
partnership’s assets and liabilities and the subsequent distribution of the stock to the
partners in proportion to their capital credits.
Illustration I: The trial balance of ABC partnership on May 1, 2005, is shown below.
The partners decide to incorporate the partnership. The new corporation is to be called
Endless Products Corporation. The new partnership will keep the partnership’s books.
ABC Partnership
Trial Balance
May 1, 2005
Dr. Cr.
Cash Birr 10,000
Noncash Assets 90,000
Liabilities Birr 40,000
A, Capital (40%) 34,000
B, Capital (40%) 10,000
C, Capital (20%) 12,000
Total Birr 100,000 Birr 100,000
Assume that the assets have a market value of Birr 80,000 when appraised. The Birr
10,000 loss to market value (90,000-80,000) is allocated to partners’ capital accounts
before the incorporation, as follows:
A, Capital 4,000
B, Capital 4,000
C, capital 2,000
____________________________________________________________________ 43
(Recognize loss on reduction of assts to market values)
Now all assets and liabilities are at their respective fair values. Assume that Endless
Products Corporation issues 460 shares Birr 10 par common stock in exchange for the
partners’ capital interests in the partnership. The entry to record the stock distribution is
as follows:
A, Capital 30,000
B, Capital 6,000
C, Capital 10,000
Common Stock 4,600
Paid in capital in excess of par 41,400
(Stock distributed to Prior Partners)
Alternatively if Endless Products Corporation decides to open a new set of books, entries
are made by the corporation to acquire the partnership assets and liabilities and by the
partnership to receive the stock and distribute it to the partners.
The entry on the corporation’s books is as follows:
Cash 10,000
Liabilities 40,000
Loan payable to C 4,000
Common stock 4,600
Paid in capital in excess of par 41,400
(Issuance of stock for partnerships assets and liabilities)
The partners make the following entry on the partnership’s books:
Investment in Endless Products Stock 46,000
Liabilities 40,000
Cash 10,000
(Receipt of stock in Endless Products for partnership’s net assets)
Note that the noncash assets were reduced their fair values. To distribute the stock to the
partners and close the partnership’s assets, the final entry is as follows:
A, Capital 30,000
B, Capital 6,000
C, Capital 10,000
Investment in Endless Products Stock 46,000
(Distribution of Endless Products Stock to partners)
1. 2. JOINT VENTURES
1.2.1. Characteristics of Joint Ventures
____________________________________________________________________ 44
A joint venture is a business entity owned, operated, and jointly controlled by a small
group of investors as a separate and specific business project organized for the mutual
benefit of the ownership group. A joint venture differs from a partnership in that it is
limited to carrying out a single project. Many joint ventures are short term associations of
two or more parties to fulfill a specific project such as the development of real state,
production of motion pictures, construction of buildings, dams, bridges; acquisition,
development and sale of real properties, joint oil or gas drilling effort, etc.
Reasons for forming a joint venture: reasons for formation of joint ventures include
internal reasons, completive goals and synergistic goals.
Internal reasons
Build on company's strengths
Spreading costs and risks
Improving access to financial resources
Economies of scale and advantages of size
Access to new technologies and customers
Access to innovative managerial practices
Competitive goals
Influencing structural evolution of the industry
Pre-empting competition
Defensive response to blurring industry boundaries
Creation of stronger competitive units
Speed to market
Improved agility
Strategic goals
Synergies
Transfer of technology/skills
Diversification
1.2.2. Traditional Versus Modern Joint
Traditional Joint Ventures: Historically joint ventures were used to finance the sale or
exchange of a cargo of merchandise in a foreign country. In an era when marine
transportation and foreign trade involved many hazards, individuals (venturers) with
different capabilities, seaman, and owners of vessel and persons of wealth band together
to undertake the voyage that involved a great risk to be born by any one individual. The
capital required in such transactions usually was larger than one person could provide,
and the risks were too high to be born alone.
In such traditional joint ventures, because of the risks involved and the relatively short
duration of the project, no net income was recognized until the venture was completed. It
is only at the end of the voyage the net income or loss is computed and divided among
the venturers and then their association ends. Therefore, traditional joint venturers did not
follow the accrual basis of accounting. Instead of the measurement of net income or loss
at regular intervals according to the accrual basis of accounting, the measurement and
____________________________________________________________________ 45
reporting of net income loss awaited the completion of the venture. The assumption of
continuity was also not appropriate.
1.2.3. Corporate Joint Ventures
Present day modern joint ventures are formed as corporate joint ventures. Corporate joint
venture refers to a corporation owned and operated by a small group of businesses (the
joint ventures) as a separate and specific business or project for the mutual benefit of the
members of the group. The government may also be a member of the group. The
corporate joint venture is usually formed for long-term projects such as the development
and sharing of technical knowledge among a small group of companies. The
incorporation of joint ventures formalizes the legal relationship between the ventures and
limits each investor’s liability to the amount of investment in the venture. The purposes
of corporate joint ventures frequently is to share risks and rewards in developing a new
market, product or technology; to combine complementary technological knowledge; or
to pool recourses in developing production or other facilities.
1. 2.4. Joint Venture Provisions in Ethiopia
Article 271 of the Commercial Code of Ethiopia, defines a joint venture as “an agreement
between partners on terms mutually agreed and is subject to the general principles of law
relating to partnership.” According to Article 272, the following are stated about joint
ventures:
A joint venture is not made known to third parties.
A joint venture agreement need not be in writing and is not subject to
registration and other forms of publication required in respect of other business
organizations.
A joint venture does not have legal personality.
Where a joint venture is made known to third parties, it shall be deemed, insofar
as such are concerned, to be an actual partnership.
Article 278 states grounds for joint venture dissolution:

(1) A joint venture may be dissolved on one of the following grounds:
the expiry of the term fixed by the memorandum of association, unless there is
provision for its extension;
the completion of the venture;
failure of the purpose or impossibility of performance;
a decision of all the partners for dissolution taken at any time;
a request for dissolution by one partner, where no fixed term has been specified;
dissolution by the court for good cause at the request of one partner;
the acquisition by one partner of all the shares;
death, bankruptcy or incapacity of a partner, unless otherwise lawfully agreed;
a decision of the manager, if such power is conferred upon him in the
memorandum of association.
(2) The provision of this Article shall apply not withstanding any provision to the
contrary in the memorandum of association.
____________________________________________________________________ 46
1.2.5. Accounting for Joint Ventures
1.2.5.1. Accounting for Corporate Joint Ventures
Accounting for corporate joint ventures is guided by APB 18; which states; ‘‘The Board
concludes that the equity method best enables investors in corporate joint ventures to
reflect the underlying nature of their investment in those ventures. Therefore, investors
should account for in common stock of corporate joint ventures by the equity method.’’
Corporate joint ventures uses the accrual basis of accounting and periodic financial
statements for the joint venture permit regular reporting of the share of net income or loss
allocable to each venture.
The accounting records of corporate joint ventures include the usual accounts for assets,
liabilities, stockholders equity, revenues and expenses. The stockholders equity account
of the joint venture, each venturer account is credited for cash or non-cash assets
contributed. The entire process should conform to the Generally Accepted Accounting
principles (GAAP) from the recording of transactions to the preparation of financial
statements.
1. 2.5.2. Accounting for Unincorporated Joint Venture
Accounting for unincorporated joint ventures that have undivided interests usually
follows the method of accounting used by partnerships. An undivided interest exists
when each investor-venturer owns a proportionate share of each asset and is
proportionately liable for its share of each liability. There are two methods of accounting
for an incorporated joint venture. These are;
1. Equity method
2. Proportionate share method
Equity Method: Assume that Company A and B invested Birr 500,000 for a 50% interest
in unincorporated joint venture on January 2, 2002. Condensed financial statements for
the joint venture of AB Company for 2002 were as follows:
AB Company (a Joint Venture)

Income statement
Revenues Birr 2,500,000
Less costs and expenses (1,500,000)
Net income Birr 1,000,000
Division of net income:
Company A (50% *1,000,000) 500,000
Company B (50% * 1,000,000) 500,000
Total Birr 1,000,000
AB Company (a joint Venture)

Statement of Venturers’ Capital
A B Total
____________________________________________________________________ 47
Investment Jan 2, 2002 Br. 500,000 Br. 500,000 Br. 1,000,000
Add: Net Income 500,000 500,000 1,000,000
Venturer’s Capital end of the year Br. 1,000,000 Br. 1,000,000 Br 2,000,000
AB Company (a Joint Venture)

Balance Sheet
December 31, 2002
Assets Liabilities and Venturer’s Capital
Current assets 1,800,000 Liabilities 700,000
Other assets 2,700,000 Long term debt 1,800,000
Venturer’s Capital:
Company A 1,000,000
Company B 1,000,000 2,000,000
Totals 4,500,000 Total liabilities & Capital 4,500,000
Under the equity method of accounting, both Company A and Company B prepare the
following journal entries for the investment in AB Company.
January 2, 2002: Investment in AB Co. (Joint Venture) 500,000
Cash 500,000
(To record investment in joint venture by each partner)
December 31, 2002: Investment in AB Co. (Joint Venture) 500,000
Investment Income 500,000
(To record the share of AB Co. net income (1,000,000 x 0.5)
Under the proportionate share method of accounting; in addition to the two foregoing
formal entries, both A and B Co. prepare the following journal entry for their respective
shares of the assets, liabilities , revenues and expenses of AB Co.
December 31, 2002:
Current assets (1,800,000 x 0.5) 900,000
Other assets (2, 700,000 x 0.5) 1,350,000
Costs and expenses (1,500,000 x 0.5) 750,000
Investment income 500,000
Current liabilities (700,000x0.5) 350,000
Long-term debt (1,800,000 x 0.5) 900,000
Revenue (2,500,000x 0.5) 1,250,000
Investment in AB Co. 1,000,000
(To record proportionate share of joint venture’s assets, liabilities, revenues and expenses
1.3. Summary
According to the Uniform Partnership Act, a partnership is defined as an “association
of two or more persons to carry on as co-owners a business for profit. The primary
____________________________________________________________________ 48
advantage of the partnership form of entity is ease of formation. The agreement to form a
partnership may be as informal as a handshake or as formal as many paged agreement
typically termed as the articles of co-ownership. Each partner must agree to the formation
of agreement and, partners are strongly advised to have a formal written agreement to
avoid potential problems that may arise during the operation of the business.
Accounting for partnership recognizes the unique aspects of this form of business
organization. Profits must be distributed to partners in accordance with the partnership
agreement or, in the absence of agreement, equally. The partnership is a separate
accounting entity but not separate legal or tax entity. For financial accounting purpose
non cash capital investments are recorded at their fair values at the time of the
contribution to the partnership. Another accounting issue to be resolved in forming a
partnership is the allocation of annual net income. Although an equal division can be
used to allocate the profit or loss, partners frequently devise distinctive plans in an
attempt to be equitable. Such factors as time spent for the partnership, expertise, invested
capital should be considered in creating an allocation procedure.
A partnership is legally dissolved when a new partner is admitted to the partnership or

when an existing partner retires or dies. From the legal viewpoint, a new partnership is
formed after each change in membership. From the practical pint of view, however, the
business often continues to operate.
Dissolution of a partnership is a change in the relationship between the partners. The

dissolution of a partnership does not necessarily mean the partnership must stop doing
business, close its doors, and liquidate. Many partnerships go through dissolution without
any effect on their day-to-day operations. Termination, which is the cessation of normal
business functions, or liquidation, which is the disposal of assets, payment of liabilities,
and distribution of cash to partners, can be avoided by carefully preparing the articles of
co partnership to allow continuation of the business when a new partner is admitted or a
partner retires.
During partnership liquidation, accountants must be aware of the priority of claims

against partnership assets and against partner’s personal assets. The Uniform of
Partnership Act provides for the marshaling of assets and the right of offset. Marshaling
of assets establishes priorities the claims against assets; the right of offset means the loans
payable to partners or receivable fro partners may be offset against their capital accounts.
Liquidations can involve a single lump sum payment to partners. Most liquidation,
however, takes several months and involves installment payments to partners during the
liquidation process. Liquidations are facilitated by the preparation of the statement of
partnership realization and liquidation. A cash distribution plan provides for information
to partners about the installment payments they will receive as cash becomes available to
the partnership. The plan is prepared at the beginning of the liquidation process. The
actual cash distributions during the liquidation process are determined with the statement
of realization and liquidation. A joint venture is a business entity owned, operated, and
jointly controlled by a small group of investors as a separate and specific business project
____________________________________________________________________ 49
organized for the mutual benefit of the ownership group. A joint venture differs from a
partnership in that it is limited to carrying out a single project.
1.4 Review Questions
A. Try to answer the following questions
1. What are the different characteristics of partnership form of organization?
2. In the formation of a partnership, partners often invest non-monetary assets such
as land building and machinery as well as cash. Should non-monetary assets be
recognized by the partnership at current fair value, at cost, or at some other
amount?
3. In choosing a partnership and a corporation, what are the advantages of a
partnership over a corporation?
4. Explain how partners’ salaries should be displayed in the income statement of the
partnership.
5. List the items that should be included (stated) in the partnership contract.
6. What are the different methods by which net income or losses of a partnership
may be divided among the partners?
7. Differentiate between a limited liability partnership (LLP) and a limited
partnership.
8. Should the carrying amounts of a limited liability partnership’s assets be restated
to the current fair values when a partner retires or a new partner is admitted to the
partnership? Explain.
9. How do you differentiate between goodwill and bonus methods method when a
partner is admitted by acquiring an ownership interest less or greater than the
amount the invested?
10. Under what circumstances goodwill be allocated to a new partner entering a
partnership?
11. What steps are followed in the liquidation process of a partnership?
12. Explain the procedures to be followed in partnership liquidation when a debit
balance arises in the capital account of one of the partners.
13. L and M, partners of the liquidating L&M partnership, share net income and loss
equally. State the reasons for allocation of losses incurred in the realization of
assets equally or in the ratio of capital account balances.
14. Explain the basic principles to observe in the distribution of cash in installments
to partners when the liquidation of a partnership extends over several months.
15. During the installment liquidation of a partnership, it is appropriate to estimate the
loss from realization of non-cash assets. What journal entries, if any, should be
made to recognize in the partners’ capital accounts respective shares of loss that
may be incurred during the liquidation?
16. What is the right of offset? What is the purpose of this doctrine?
17. What is the purpose of marshaling of assets principle? What does this principle
specifically state?
18. Explain how joint ventures differ from partnership
19. What are corporate joint ventures?
20. Compare the equity method of accounting with the proportionate share method of
accounting for an investment in unincorporated joint venture.
____________________________________________________________________ 50
B. Select the best answer for each of the following multiple-choice questions:
1. The partnership contract of L and M provided for salaries of Br. 45,000 to L and Br.
35,000 to M, with any remaining income or loss divided equally. During the year
2000 pre-salaries income of L&M was Br. 100,000 and both L and M withdrew cash
from the partnership equal to 80% of their salary allowances. L’s equity in the
partnership during 2000 is:
A. Increased more than M’s equity
B. Decreased more than M’s equity
C. Increased the same amount as M’s equity
D. Decreased the same amount as M’s equity
2. When D retires from D, E & F partnership, he received cash in excess of his capital
account balance. Under the bonus method, the excess received by D:
A. Reduced the capital account balance of E and F.
B. Had no effect on the capital account balance of E & F.
C. Was recognized as good will of the partnership.
D. Was recognized as an operating expense of the partnership.
3. A large cash withdrawal by Partner D from C, D, E&F partnership which is viewed as
a permanent reduction of D’s ownership equity in the partnership is recorded with a
debit to:
A. Loan receivable from D
B. D, Capital
C. D, Drawing
D. Retained Earnings
4. The partnership contract for C&D partnership provides that “net income or losses are
to be distributed in the ratio of partners’ capital account balances.” The appropriate
interpretation of this provision is that net income or losses should be distributed in:
A. The ratio of beginning capital account balances
B. The ratio of average capital account balances
C. The ratio of ending capital account balances (before distribution of net income or
loss)
D. One of the foregoing methods should be specified by partners C&D.
5. Salaries for a limited liability partnership typically should be accounted for as:
A. A device for sharing net income
B. An operating expense of the partnership
C. Drawings by the partners from the partnership
D. reductions of the partners’ capital account balances
6. The income sharing provision of the contract that established E&F partnership
provided that E was to receive a bonus of 20% of income after deduction of the
bonus, the remaining income distributed 40% to E and 60% to F. If income before the
bonus of E&F partnership was Br. 240,000 for the year ended August 31,1999, the
capital accounts of E&F should be credited, respectively, in the amounts of :
A. Birr 120,000 and Birr 120,000 E. None of the above
B. Birr 124,800 and Birr 115,200
C. Birr 96,000 and Birr 144,000
D. Birr 163,500 and Birr 76,500
____________________________________________________________________ 51
7. The two partners of A&B LLP share net income and losses in the ratio of 7:3
respectively. On February 1,1999, their capital account balances were as follows:
A, Capital Birr 70,000
B, Capital 60,000
A and B agreed to admit partner C with a one third interest in the partnership capital and
net income or losses for an investment of Birr 50,000. The new partnership will begin
with the total capital of Birr 180,000. Immediately after C’s admission to the partnership
the capital account balances of A, B&C, respectively are:
A). Br. 60,000, Br. 60,000, Br. 60,000
B). Br. 63,000, Br. 57,000, Br. 60,000
C). Br. 63,333, Br.56, 667, Br. 60,000
D). Br. 70,000, Br. 60,000 Br. 50,000
8. In the liquidation of a limited liability partnership a loan payable to a partner:
A. Must be offset against the partner’s capital account balance before liquidation
commences
B. Will not advance the time of payment to the partner during the liquidation
C. Has the same priority as mounts payable to outside creditors of the partnership
D. Must be closed to that partner’s drawing account
____________________________________________________________________ 52
9. In the liquidation of a limited liability partnership, cash received by partner having a
loan receivable from the partnership is debited to the partner’s:
A. Loan account C. Drawing account
B. Capital account D. Retained Earning account
10. The marshaling of assets provisions of the Uniform Partnership Act provide that
unpaid creditors of an insolvent general partnership have first claim to the assets of:
A. The partnership
B. A solvent partner
C. An insolvent partner
D. Either a partnership or a solvent partner, as elected by the creditor
11. In the liquidation of a limited liability partnership in installments, the partner who
receives the first payment cash after all liabilities have been paid is the partner having
the largest:
A. Capital account balance
B. Income sharing percentage
C. Capital per unit of income sharing
D. Loan account balance
12. The proportionate share method of accounting is appropriate for:
A. Corporate joint ventures only
B. Unincorporated joint ventures only
C. Both for corporate joint ventures and unincorporated joint ventures
D. Neither for corporate joint ventures nor unincorporated joint ventures.
Exercises
EX.1. On January 2, 1999, C&D established C&D limited liability partnership, with C
investing Birr 80,000 and D investing Birr 70,000 on that date. The income sharing
provisions of the partnership contract were as follows:
a. Salaries of Birr 30,000 to each partner.
b. Interest at 6% per annum on the beginning capital account balance of each partner
c. Remaining income or loss divided equally
d. Pre salary income of C&D LLP for the month of January 1999 was Birr 20,000
e. Neither partner had a drawing for that month.
Required: Prepare journal entries for C&D LLP on January 31, 1999 to provide for
partners’ salaries and close the Income Summary ledger account. Show supporting
computations in the explanations for the entries:
EX.2. Partners A&B of A&B LLP have capital account balance of Birr 30,000 and
20,000 respectively, and they share net income and losses in the a 3:1 ratio. Prepare
journal entries to record the admission of C to A, B&C LLP under each of the following
conditions:
a) C invests Birr 30,000 for one-fourth interest in net assets; the total partnership capital
after C’s admission is to be Birr 80,000.
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b) C invests Birr 30,000, of which Birr 10,000 is a bonus to A&B. In conjunction with
the admission of C, the carrying amount of the inventories is increased by Birr 16,000.
C’s capital account is credited for Birr 20,000.
EX.3. On January 31, 1999, partners of L, M&N had the following loan and capital
account balances (after closing entries for January):
Loan receivable from L Birr 20,000 dr.
Loan payable to N 60,000 cr.
L, Capital 30,000dr
M, Capital 120,000cr
N, Capital 70,000cr
The partnerships income-sharing ratio was L, 50%; M, 20% and N, 30%. On January 31,
1999, O was admitted to the partnership for a 20% interest in total capital of the
partnership in exchange for an investment of Birr 40,000 cash. Prior to O’s admission,
the existing partners agreed to increase the carrying amounts of the partnership’s
inventories to current fair value, a Birr 60,000 increase.
Prepare journal entries on January 31, 1999, for L, M, and N& O LLP to record
a. The Birr 60,000 increase in the partnership’s inventories,
b. The admission of partner O for a Birr 40,000 cash investment.
EX.4. On June 30, 2004, the balance sheet of K, L and M LLP and the partners’
respective income sharing percentages were as shown below:
K, L& M LLP
Balance Sheet
June 30, 2004
Assets
Current assets Birr 185,000
Plant assets (net) 200,000
Total assets Birr 385,000
Liabilities and Partner’s Capital
Trade accounts payable Birr 85,000
Loan Payable to K 15,000
K, Capital (20%) 70,000
L, Capital (20%) 65,000
M, Capital (60%) 150,000
Total Liabilities and Partners’ Capital Birr 385,000
K decided to retire from the partnership on June 30, 2004, and by mutual agreement of
the partners, the plant assets were adjusted to their total current fair value of Birr 260,000.
The partnership paid Birr 92,000 cash for K’s equity in the Partnership, exclusive of the
loan, which was repaid in full. No goodwill was recognized in this transaction.
Required: Prepare Journal entries for K, L&M LLP on June 30, 2004 to record:
____________________________________________________________________ 54
a) the adjustment of plant assets to current fair value
b) K’s retirement from the partnership.
EX.5. After the realization of all non cash assets and the payment of all liabilities, the
balance sheet of the liquidating P,Q&R LLP on January 31, 2005, showed cash Br.
15,000; P, Capital, ( Br. 9,000); Q, Capital, Br. 8,000; and R, Capital Br. 16,000; where
the brackets indicate capital deficit. The Partners share net income and loss equally.
Required: Prepare journal entry for P,Q &R LLP on January 31, 2005, to show the
payment of cash in safe manner to the partners. Show computations in the explanation for
the journal entry.
EX.6. After the realization of the non cash assets of E,F&G LLP, which was being
liquidated, the capital account balance were E, Br. 33,000; F, Br. 40,000; and G,
Br.42,000.Cash of Br. 42,000 and other assets with a carrying amount of Br. 78,000 were
on hand. Creditor’s claims total Br.5, 000. The partners share net income and losses in
5:3:2 ratios.
Required: Prepare a working paper to compute the cash payments (totaling Br. 37,000)
that may be made to the partners.
EX.7. On November 10, 2004, M, N &O, partners of M, N& O LLP, had capital account
balances of Br.20, 000, Br. 25,000, and Br. 9,000, respectively, and share net income and
losses in a 4: 2:1 ratio.
Required: a) Prepare a cash distribution program for liquidation of M, N &O Partnership

in installments, assuming liabilities totaled Birr 20,000 on November 10,
2004.
c) How much cash was paid to all partners if M received Birr 4,000 on
Liquidation?
d) If M receives Birr 13,000 cash pursuant to liquidation, how much did O
receive?
e) If N received only Birr 11,000 as a result of liquidation, what was the loss
on partnership realization of assets? (No partner invested any additional
assets in the partnership.
Workout Problems
P1. The condensed balance sheet of G&H LLP on December 31, 2004, as follows:
G&H LLP
Balance Sheet
December 31, 2004
Assets Liabilities Partner’s Capital
Current assets Birr 100,000 Liabilities Birr 300,000
Plant assets 500,000 G’s Capital 200,000
H’s Capital 100,000
Total Birr 600,000 Total Br. 600,000
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G & H shared net income or losses 40% and 60%, respectively. On January 2, 2005,
partner I was admitted to G, H & I LLP by the investment of the net assets of her highly
profitable proprietorship. The partners agreed to the following current fair values of the
identifiable net assets of I’s proprietorship:
Current assets Birr 70,000
Plant assets 230,000
Total assets 300,000
Less liabilities 200,000
Net assets Birr 100,000
Partner I’s Capital account was credited for Birr 120,000. The partners agreed further that
the current fair values of the net assets G & H LLP were equal to their carrying amounts
and that the accounting records of the old partnership should be used for the new
partnership. The following partner remuneration plan was adopted for the new
partnership.
1. Salaries of Birr 10,000 to G, Birr 15,000 to H, and Birr 20,000 to I, to be
recognized as an expense of the partnership.
2. A bonus of 10% income after deduction of partner’s salaries and the bonus to I.
3. Remaining income or loss as follows: 30% to G, 40% to H, and 30% to I.
For the year ended December 31, 2005 G, H, & I LLP had income of Birr 78,000 before
partners’ salaries and the bonus to partner I.
Instructions: Prepare journal entries for G, H & I LLP to record the following:
a) The admission of partner I to the partnership on January 2, 2005.
b) The partners’ salaries, bonus, and division of net income for the year ended
December 31, 2005.
P2. R & S LLP was organized and begins operations on March 1, 2002. On that date R
invested Birr 150,000, and S invested land and building with current fair values of Birr
80,000 and Birr 100,000, respectively. S also invested Birr 60,000 in the partnership on
November 1, 2002, because of its shortage of cash. The partnership contract includes the
following remuneration plan:
_______________________________________________________________________
R S
Annual salary (recognized as operating expense) 18,000 24,000
Annual interest on average capital account balances 10% 10%
Remainder 60% 40%
The annual salary was to withdrawn by each partner in 12 monthly installments.

During the year ended February 28 , 2003, R & S had net sales of Birr 500,000, cost of
goods sold of Birr 280,000, and total operating expense of 100,000( including partners’
salaries expense but excluding interest on partners’ average capital account balances).
Each partner made monthly cash drawing in accordance with the partnership contract.
Instructions:
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a) Prepare a condensed income statement of R & S LLP for the year ended
February 28, 2003. Show the details of the divisions of net income.
b) Prepare a statement of partners’ capital for R & S LLP for the year ended
February 28, 2003.
N.B: please compare your answers for the exercises and problems with the answers given
at the end of this module.
CHAPTER TWO
PUBLIC ENTERPRISES
Introduction
A public enterprise as a form of business organization has attained a great deal of

significance in recent times. Nationalization really took off following the World Wars of
the first half of the twentieth century. Across Europe, because of the extreme demands on
industries and the economy, central planning was required to ensure the maximum degree
of efficient production obtained. Many public services, especially electricity, gas and
public transport were products of this era. Following the Second World War, many
countries also began to implement universal health care and expanded education under
the funding and guidance of the state.
Establishment of public enterprise in most countries of the world dated back as early as
post world- war period. It is only in some countries such as the UK that the
nationalization process began shortly after World War I when the state intervened in
commercial activities to take over mines and railways in situations where the existing
private owners were facing financial difficulty. During 20 th century, various governments
have taken active part in the industrial and commercial activities.
The term public enterprise denotes a form of business organization owned and managed
by the state government or any other public authority. So, it is an undertaking owned and
controlled by the local or state or central government. The whole or most of the
investment is made by the government. Public enterprises are established by the
____________________________________________________________________ 57
government with the intent that the cost of producing goods and services to the public be
financed or recovered primarily through user charges.
The United Nations definition of a public enterprise is ‘‘an incorporated or large

unincorporated enterprise in which public authorities hold a majority of the shares and/or
can exercise control over management decisions’’.
Although the objectives of establishing public enterprises differ from country to country,
there are common factors that necessitated their coming into existence. In some countries
governments would hold a belief that the scale and range of investment required for
sustainable economic development was beyond the reach of pure market forces. Hence,
activities supposed to have a significant contribution in building the economy of a
country but not undertaken by the sector due to involvement of a greater risk had to
undertaken by the government. The other motive was governments’ political commitment
to multiple non commercial objectives for enterprises such as employment generation,
income distribution and economic welfare that can be provided by the state only. In still
some other countries, ruling parties had a belief that their continued stay in power and
subsequent electoral success depended on socialist principles emphasizing the state’s
control of the ‘ commanding heights’ of the economy. In addition, the reluctance or
inability of the equality devastated business communities to commit recourses to capital
intensive sectors with long payback periods in the years immediately following World-
War II compelled governments to take over some commercial activities.
Chapter Objectives
 Define the term public enterprises.
 Explain the characteristics of public enterprises.
 Describe the benefits of public enterprises
 Understand Proclamation 25/1992 with regard to public enterprises in Ethiopia
 Understand and explain accounting for public enterprises.
2.1. Characteristics of Public Enterprises
The chief characteristics of public enterprises are:
 Autonomous or semi-autonomous organization: Public enterprise is an
autonomous or semi-autonomous organization because some enterprises work
under the direct control of the government and some organizations are established
under statutes and companies act. Though the public enterprise is subject to
supervision and control by the state, it is reasonable to say that public enterprises
must ensure their autonomy of normal day to day operations affording freedom
from government red tape, treasury control, and political dictation.
 Financial independence: Though investments in government undertaking are
done by the government, they become financially independent by arranging
finance for day-to-day operation. The autonomy concept will remain not real
unless accompanied by financial independence. To realize the expected outcome,
the public enterprises must rely on assured economic resources they can
command at once rather than on the annual ‘generosity of the legislature’.
 State control: The public enterprises are financed, owned and managed by the
government that may be a central or state government.
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 Rendering service: Public services is a term usually used to mean services
provided by government to its citizens, either directly (through the public sector)
or by financing private provision of services.The primary objective of the
establishment of public enterprises is to serve the public at large by supplying the
essential goods at a reasonable price and creating employment opportunities. A
public enterprise has a public purpose and other objectives than profits. It is
therefore not interested in maximizing profits, but should run efficiently and in
the process make profits or surpluses that are essential especially for the growth
of the economy.
 Useful to various sectors: The state enterprises serve all sectors of the people of
the company. They do not serve a particular section of the people in the
community.
 Monopoly enterprises: In some specific cases private sectors are not allowed and
as such the public enterprises enjoy monopoly in operation. The state enterprises
enjoy monopoly in railways, post and telegraph and energy production. Public
enterprises may then have monopolistic rights in that particular area line of
business activity, as it would be uneconomical and wasteful to permit competing
units in parallel lines of public undertaking. There is thus a strong case for
combination and amalgamation of similar activities and enforcing a monopolistic
operation by public enterprises.
 A direct channel for use of foreign money: Sometimes the government receives
foreign assistance from industrially advanced countries for the development of
industries. These advances received are spent through public enterprises.
 Public accountability: The state enterprises are liable to the general public for
their performances because they are responsible for the nation.
 Agent for implementing government plans: The public enterprises run as per
the whims of the government and as such, the economic policies and plans of the
government are implemented through public enterprises.
 No share and shareholders: The public enterprise has no share or shareholders
and the “profit motive” is replaced by “public service motive” but in financial
terms the nation or the state owns the equity of the public enterprise. The nation
is, the entrepreneur in the final analysis, and it stands in gain or loss from the
operation of publicly owned enterprises. It must be noted that the gain or loss may
be in various forms .i.e., lower prices, reduced level of taxation brought about by
efficiency, or higher prices and increased level of taxation caused by inefficiency.
Public service tend to be those considered so essential to modern life that for moral
reasons their universal provision should be guaranteed, and they may be associated with
fundamental human rights (such as the right to water). An example of a service which is
not generally considered an essential public service is hairdressing. The Volunteer Fire
Dept. and Ambulance Corporations are institutions with the mission of servicing the
community. A service is helping others with a specific need or want. Service ranges from
a doctor curing an illness, to a repair man, to even a food pantry. All of these services are
important in people's lives.
In modern, developed countries the term public services often includes:
Broadcasting Public transportation
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Social housing Police service
Telecommunications Education
Town planning Electricity
Waste management Fire service
Water services Gas
Public information and Health care
archiving, such as libraries Military
Social services
2.2. Benefits of Public Enterprises
Public enterprises are highly beneficial to the economy. In general, we can sub group the
benefits of public enterprises in to two as an economic and social benefit.
2.2.1. Economic Benefits of Public Enterprises
Public enterprises are so important in strengthening the economy of a particular nation by
providing the following benefits:
Public enterprises generate revenue in the form of divided, interest on loans,
taxes, etc. which are paid to the government.
Public enterprises maximize the social welfare and developmental opportunities
of the economy, since they exploit the natural and technological recourses of the
state.
Public enterprises help in reducing regional disparities through fair dispersal of
industries in taking in to account rural areas of the country in proper perspective.
Public enterprises provide infrastructural facilities that can help for the
development of the economy.
By exporting the foreign currency generating goods and services of the country
and by substituting imported products and services, public enterprises can save
foreign exchange.
2.2.2. Social Benefits of Public Enterprises
Public enterprises provide social benefits by promoting welfare of the society. The social
benefits of the society are summarized as follows:
Public enterprises provide job opportunity for the society and play its role in the
reduction of unemployment.
Public enterprises provide various welfare benefits such medical, transportation,
housing and other social benefits to employees.
Public enterprises provide goods and services at cheaper price to low income
groups.
Public enterprises play a social role by safeguarding the interest of consumers
by offering items of good quality with a reasonable price.
2.3. Public Enterprise in Ethiopia

Proclamation NO.25/1992: Definition of Terms
Art.2 (1) Public Enterprise: a wholly state owned public enterprise established pursuant
to Proc.No.25/1992 to carry on business for gain in manufacturing, distribution, service
rendering or other economic related activities.
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Art.2 (3) Total Assets: all immovable and movable property, receivables, cash and bank
balances of the enterprise including intangible assets, deferred charges and other debit
balances.
Art.2 (4) Net Total Assets: total assets less current liabilities, long term debts, deferred
income and other liabilities.
Art 2 (5) Capital: the original value of the net total assets assigned to the enterprise by
the state at the time of its establishment or any time thereafter.
Art.20 (1) the paid up capital shall not be less than 25% of the authorized capital at the
time of its establishment.
Art. 20 (2) the authorized capital of the enterprise shall be fully paid up with in 5 years
from the date of its establishment.
Art.2 (7) Net Profit: any excess of all revenue and other receipts over costs and operating
expenses properly attributable to the operations of the financial year including
depreciation, interest and taxes.
Art. 2(9): State Dividend: remaining balance after deduction of the transfers to the legal
reserve fund and other reserve fund from net profits.
Art. 29 (2) Legal reserve: 5% of net income of the financial year.
The following Articles in Proclamation No. 25/1992 states about accounting for Public
Enterprises:
Art. 27-28.
 Public enterprises follow generally accepted accounting principles
 The financial year used by public enterprises are determined by the supervisory
authority.
 Accounts should be closed at least once a year-with in three months following the
end of the financial year.
Art. 29.
 Legal reserve 5% of net profits until such reserve equals 20% of the capital of the
enterprise. The legal reserve is used to cover losses and enforceable expenses and
liabilities.
 Other reserve funds may established with the approval of the supervisory
authority.
2.4. Accounting for Public Enterprises
Accounting for the public enterprise must be based on clear understanding of the
underlying assumptions to be made on the characteristics of the public enterprise, and the
type or structural relationship established.
Entity accounting is accounting for a separate organization that has legal personality of
its own separate from its owners. The accounting equation assets equal liabilities plus
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capital could be applicable in its entirety to the public enterprise. The double entry
system of accounting together with the accrual basis of accounting is essential for more
adequate follow up of the enterprise business transactions. Most of the asset accounting
of public enterprises is the same as in private corporate entity accounting except for
variations in classification and valuation methods. Liabilities, which represent accruals to
and claims creditors, will be accounted for in similar manner as in private corporate
accounting entity except for classification.
Proclamation No. 25/1992 contains provisions for accounting for public enterprises in
Ethiopia, such as the formation, operation, privatization, amalgamation and division, as
well as dissolution and winding up of public enterprises.
2.4.1. Formation
Example: On January1, 2006, the Government of Ethiopia formed XYZ Enterprise with
Authorized Capital of Birr 50,000,000 in accordance with the requirements of Proc.No.
25/1992 with an investment of the following assets:
Cash Br. 15,000,000
Equipment (fair value) 700,000
Required: Pass the journal entry to record the above investment.

Journal Entry: Cash 15,000,000
Equipment (fair Value) 700,000
State Capital 15,700,000
2.4.2. Operation
The trial balance of XYZ Enterprise on December 31, 2006 is shown below:
XYZ Enterprise
Trial Balance
December 31, 2006
Cash Birr 10,050,000
Accounts Receivable 2,600,000
Property Plant and Equipment 2,200,000
Accumulated Depreciation Birr. 50,000
Accounts Payable 150,000
Notes Payable 200,000
Sales 5,000,000
Operating Expenses 2,950,000
Purchases 3, 300,000 ______
Total Br. 21,100,000 Br. 21,100,000
Additional Information:
 Ending inventory is Br. 1,600,000.
 The board of directors decided to establish other reserves of Br. 100,000 from the net
income of the year.
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 Profit tax rate is 35%.
Required:
a) Prepare the income statement for XYZ for the year ended December 31, 2006.
b) Prepare journal entries to record the transfer of net income to legal reserve and
other reserves, and to recognize the state dividend payable.
c) Prepare the balance sheet of XYZ Enterprise on December 31, 2006.
Solutions: a) Income statement

XYZ Enterprise
Income Statement
Sales Birr 5,000,000
Cost of Goods Sold 1,700,000
Gross Profit 3,300,000
Operating Expenses (2,950,000)
Income before tax 350,000
Income tax expenses (35%) (122,500)
Net Income Birr 227,500
b) Journal Entries
Legal Reserve (5%x227, 500) 11,375
Retained Earnings 100,000
State Divided Payable 116,125
Income tax expense 122,500

Income tax payable 122,500
c) Balance Sheet
XYZ Enterprise
Balance Sheet
December 31, 2006
Assets
Cash Birr. 10,050,000
Accounts Receivable 2, 600,000
Inventory 1,600,000
Property, Plant and Equipment 2,200,000
Less: Accumulated Depreciation (50,000) 2,150,000
Total assets Birr 16,400,000
Liabilities and Capital
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Notes payable 200,000
State Dividend Payable 116,125
Legal Reserve 11,375
Other Reserves 100,000
Total Liabilities and Capital Birr 16,400,000
2.4.3. Privatization
Privatization means the sale of public utilities to private concerns. It is the contract
operation of a public utility or service by a private entity. It most often occurs in solid
waste management, water/wastewater treatment, fleet maintenance, road/bridge building
and maintenance, and municipal management.
The term privatization has been applied to three different methods of increasing the
activity of the private sector in providing public services: 1) private sector choice,
financing, and production of a service;2) public-sector choice and financing with private
sector production of the service selected; 3) and deregulation of private firms providing
services. In the first case, the entire responsibility for a service is transferred from the
public sector to the private sector, and individual consumers select and purchase the
amount of services they desire from private providers. For example, solid-waste
collection is provided by private firms in some communities.
The second version of privatization refers to joint activity of the public and private
sectors in providing services. In this case, consumers select and pay for the quantity and
type of service desired through government, which then contracts with private firms to
produce the desired amount and category of service. Although the government provides
for the service, a private firm carries out the actual execution of it. The government
determines the service level and pays the amount specified in the contract, but leaves
decisions about production decisions to the private firm.
The third form of privatization means that government reduces or eliminates the
regulatory restrictions imposed on private firms providing specific services.
Advantages and Disadvantages of Privatization
The merits and drawbacks of privatization have been subjects of considerable debate
among business-people, city leaders, and public employees alike. Indeed, each element of
privatization from its apparent cost-saving properties to its possible negative impact on
minority workers provokes strong reaction. Following are some privatization issues that
communities, public providers, and private providers all need to consider:
____________________________________________________________________ 64
Costs and Productivity: Proponents of privatization argue that whereas government
producers have no incentive to hold down production costs, private producers who
contract with the government to provide the service have more at stake, thus encouraging
them to perform at a higher level for lower cost. The lower the cost incurred by the firm
in satisfying the contract, the greater profit it makes. On the other hand, the absence of
competition and profit incentives in the public sector is not likely to result in cost
minimization. Of course, small- and mid-sized companies also need to make sure that
they do not sacrifice an acceptable profit margin in their zeal to secure a contract.
Private firms have more flexibility than governmental units to use part-timers to meet
peak periods of activity, to fire unsatisfactory workers, and to allocate workers across a
variety of tasks. Moreover, critics of municipal governments argue that they are less
likely to reward individual initiatives or punish aberrant behavior when compared with
their private sector counterparts.
Service: Expected quality of service varies from community to community, depending on

a wide range of factors such as historical service levels, local taxation, and possible
changes in service requirements. Moreover, Public Works observed that good service is
sometimes defined differently by citizens, public service providers, and private service
providers. "Response time and public confidence need to be taken into account when
judging the pros and cons of private/public," stated Public Works. "Stability may be a
concern in the eyes of the public; a government agency cannot walk away at the end of a
contract period."
Operating Philosophies: Proponents of privatization state that, private firms may be
more likely to experiment with different and creative approaches to service provision,
whereas government tends to stick with the current approach since changes often create
political difficulties for elected officials. In addition, private firms may use retained
earnings to finance research or to purchase new capital equipment that lowers unit
production costs. On the other hand, government may not be able or willing to allocate
tax revenues to these purposes as easily, given the many competing demands on the
government's budget.
Regulatory Realities: In some cases, local, state, and federal regulations may determine
whether a service can even be handed over to a private provider. Moreover, "the ultimate
responsibility (in the eyes of the public, if not the courts) rests with the public agency that
assigns operating rights to a private concern," stated Public Works. "The local
government will still be held responsible for the cost and quality of the service under
contract."
Competition: Supporters of privatization often cite the competitive environment that is
nourished by the practice as a key to its success. Private owners have a strong incentive
to operate efficiently, they argue, while this incentive is lacking under public ownership.
If private firms spend more money and employ more people to do the same amount of
work, competition will lead to lower margins, lost customers, and decreased profits. The
disciplining effect of competition does not occur in the public sector. Still, even
advocates of privatization agree that private ownership produces the public benefits of
____________________________________________________________________ 65
lower costs and high quality only in the presence of a competitive environment.
Privatization cannot be expected to produce these same benefits if competition is absent.
Monitoring and Enforcement: Critics of privatization of government services contend
that problems sometimes arise in various aspects of the process, including the bidding
process, the precise specification of the contract, and the monitoring and enforcement of
the contract. For example, some observers have raised concerns that potential suppliers
may initially offer a price to the government that is less than actual production costs to
induce the government to transfer the service to the private sector or to win the contract.
Subsequently, the contractor would then demand a higher price after the government has
dismantled its own production system.
Employment: Privatization is understandably viewed as an alarming trend by public
employee groups. In some cases, privatization results in layoffs of public sector
employees, although governments often reassign them to other government jobs, place
them with private contractors, or offer them early retirement programs. These
possibilities have been particularly upsetting to public employee unions, which have been
at the forefront of efforts to block privatization.
The Ethiopian Privatization Agency (EPA)
The Ethiopian Privatization Agency (EPA) was established in February of 1994 by
Proclamations No. 87/1994 and 146/1998. Since then, EPA has become the lead agency
in carrying out the process of privatization of public enterprises. In addition to the powers
and duties mentioned, EPA has the power to investigate and decide on claims of
ownership in respect of property taken in violation of the relevant proclamations, in
accordance with Proclamation No.110/1995 and its amendment proclamation
No.193/2000. The Agency is accountable to the Ministry of Trade and Industry and
administered by a Board of Directors and managed by a General Manager.
The objectives of the Ethiopian Privatization Agency are:
 To generate revenue required for financing development activities undertaken by
the Government;
 To change the role and participation of the Government in the economy to enable it
to exert more effort on activities requiring its attention; and
 To promote the country's economic development through encouraging the
expansion of the private sector.
According to Proclamation No. 146, issued in December 1998, EPA is mandated with
clearly defined tasks and duties to:
 Implement the privatization program in accordance with the provisions of the
proclamation;
 Determine the privatization sequence or define a plan for all enterprises included
in the privatization program;
 Determine bid evaluation criteria for the selection of investors participating in
privatization;
 Prepare the necessary documents to be used in the privatization process;
____________________________________________________________________ 66
 Design ways and means of encouraging domestic investors to participate in the
privatization of enterprises;
 Take the necessary measures to publicize the privatization program and its
implementation;
 Through post-privatization monitoring, ensure compliance of investors
obligations, and undertake impact assessment of the privatization process in
general;
 Establish close relations with relevant institutions in the implementation of the
privatization program with a view to coordinating their actions;
 Own property, enter into contracts, sue and be sued in its own name; and
 Carry out other activities necessary for the fulfillment of its objectives.
In addition to the powers and duties mentioned above, EPA has the power to investigate
and decide on claims of ownership in respect of property taken over in violation of the
relevant proclamations. Regarding restitution, the EPA has the mandate to:
 Register claims of title presented to it in respect of property taken in violation of

the relevant proclamations;
 Investigate on the basis of the relevant proclamations the claims and conditions of
title submitted to it; to obtain any governmental or private office, organization or
establishment as well as from any private person any evidence it deems necessary
for such investigation; to hear the testimony of witness and require the production
before it of any written evidence;
 Give appropriate decisions on claims in respect of any property taken in violation
of the relevant proclamations upon examination of the evidence therefore; and to
take the measures necessary for the implementation of same;
 Delegate its powers and duties with detailed implementation guidelines, as it
deems it necessary, to the appropriate regional and central government organs;
 Submit to the appropriate government organ proposals regarding claims of title
where it finds that they require, beyond examination of evidence, policy or legal
determination;
 Issue an order for the purpose of restraining the transfer, to third parties, of any
property on which a restitution claim has been lodged, as well as the carrying out
of any activity that may result in substantial alteration on such property until
decision is made on the claim;
Alternatives Offered For Workers
1. For workers in retail shops, in small and middle standard hotels, restaurants
 To be transferred to the private owner together with the enterprise;
 To be included in the Safety Net Program designed by the Government and
workers' representatives;
 To take a payment in accordance with the law for the service one has given and
resign from job;
2. For workers who work in enterprises whose total value sale is up to 75%:
 To be transferred to the private owner together with the enterprise;
 To buy a certain amount of share from the 25% value of the enterprises which is
held as a reserve for workers, management and board members;
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 To take a payment in accordance with the law for the service one has given and
resign from job;
EPA started to implement its program first by privatizing small retail trade outlets and
hotels as well as small-scale manufacturing and agro-processing enterprises. The reason
was to gain first hand experience, which could be used in later privatization of medium
and large-scale enterprises whose privatization process could be more complex. The
privatization program steadily gathered momentum and a number of tenders and notices
were issued inviting prospective investors to participate in bids for enterprises floated for
privatization.
As a matter of policy, bids for retail trade outlets, stores, small hotels and restaurants as
well as small-scale manufacturing enterprises and dairy farms were floated for domestic
investors alone. The privatization modality selected was the sale of 100% ownership
interest.
For other enterprises, the Agency invited prospective investors, both local and foreign, to
participate in either joint expansion or improvement program with the government or in
the acquisition of full ownership of the enterprises. To date, 200 units and whole
enterprises have been privatized and transferred to domestic and foreign investors.
Among these, 44 of them have been sold to 1454 workers who are organized under the
Safety Net program. Over the coming two years, the plan is to privatize 113 public
enterprises. The necessary preparations are under way for the privatization of 81
enterprises with the help of foreign consultants and for 32 others on which preparatory
work has carried out by the in-house staff.
Since Ethiopia embarked on the road to liberalization and a market economy in the 1991,
the privatization of state-owned enterprise has become an important element of the
nationwide reform program. All the activities undertaken by the Ethiopian Privatization
Agency are therefore part and parcel of the reform measures. They are well integrated
into a larger political, social, and economic framework of Ethiopia within the historical
context. The Ethiopian privatization program which steadily gained momentum since its
inception in 1994 has evolved and changed in certain perspectives, but still works along
the main objectives of the Ethiopian Economic Policy launched in the year 1991. It is still
designed to support the Ethiopian economy on its long way to sustainable development
and growth.
The Privatization and Public Enterprises Supervisory Agency of Ethiopia (PPESA) has
sold 15 public enterprises and share companies for over 63 million birr last fiscal year
2001 E.C. Of the 30 private enterprises and share companies put up for tender in nine
months of the budget year, 15 were sold for 63,730,018 birr, according to a document
obtained from the agency. The agency has been employing strategies such as bidding,
renting, contract management and joint venture to privatize the enterprises, it added.
Among the enterprises privatized include Kombolcha Tannery Share Company, Gulele
Garment Share Company, Nazareth Garment Share Company, Mojjo Tannery Share
Company, Meher Fiber Products Factory, Kuriftu Ranch, and Ethiopia-Gambella Hotel,
according to the agency.
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Quara- Ghion Hotel, Senkelle Lime Factory, Kotebe Metal Factory, Akaki Garment
Share Company, Addis Garment Share Company and Addis Caramel Factory were also
sold in the budget year. The agency also said Awassa, Arba Minch and Bahir Dar textile
share companies were rented to Chinese and Turkish companies. A British company took
over the Ethiopian Tannery Share Company under a five-year contractual management as
of 2005, it further stated. The Dire Dawa Cement Factory and East African Group PLC as
well as Repi Soap Factory and Lina PLC are being run under joint ventures, PPESA
concluded.
Example: the following information is given for XYZ Company, a public enterprise,
which is privatized on December 31, 2006.
XYZ Enterprise
Balance Sheet
December 31, 2006
Assets Cost Market Value
Cash Birr 10,050,000 -
Accounts Receivable 2,600,000 Br.2, 000, 000
Inventory 1,600,000 2, 000, 000
Property, Plant and Equipment (net) 2,150,000 3, 000, 000
Total assets Birr 16,400,000
Liabilities and Capital
Other Reserves 100,000
Total Liabilities and Capital Birr 16,400,000
An individual investor X has paid Br. 20,000,000 to acquire the XYZ Company.
Required: Journalize the transaction.
Case 1: Continuing with the books of XYZ.
Inventory Br. 400,000
Property, Plant and Equipment 850,000
Good will (note) 3,538,625
Other Reserve 100,000
Account Receivable 600,000
X Capital 20,000,000
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Note: Goodwill determination
Cost Br. 20,000,000
Less: Net Assets
Other Reserve 100,000
Revaluation Surplus (note) 650,000 (16,461,375)
Goodwill Br. 3,538,625
Note: Revaluation surplus determination
Account Receivable (600,000)
Inventory 400,000
Plant, Property& Equipment 850,000
Net Surplus Br. 650,000
Note: Net assets determination

Total Assets (10,050,000+2,000,000+2,000,000+3,000,000) Br. 17,050,000
Less: Liabilities (150,000+122,500+200,000+116,625) (588,625)
Net Assets Br.16, 461,325
Case 2: New Book

Cash Br. 10,050,000
Accounts Receivable 2,000,000
Inventory 2,000,000
Property, Plant and Equipment (net) 3,000,000
Goodwill 3,538,625
X Capital 20,000,000
2.4.4. Amalgamations and Division
Regarding the amalgamation and division of public enterprises, the Proclamation

No.25/1992, from Article 35-38 has its say.
Article 35-38
 No decision to amalgamate or divide if the enterprises resulting from
amalgamation or division are unable to meet the obligations towards the creditors.
 The rights and obligations of the enterprise are transferred to the new enterprises.
Amalgamation
 Enterprise A + Enterprise B = Enterprise C
 Enterprise A + Enterprise B = Enterprise A or Enterprise A
 Goodwill/negative goodwill is recorded.
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Division
 Enterprise A = Enterprise A and Enterprise B
2.4.5. Dissolution and Winding Up
The Proclamation No.25/1992, from Article 39-45 has discussed regarding the
dissolution and winding up process of public enterprises.
Article 39-45
 Sale of asset
 Payment of creditors (if the assets of the enterprise are not sufficient to pay the
debts, & if the authorized capital is not fully paid up, the liquidator can ask for
full payment of the authorized capital).
 Payment of the remaining assets to the government.
2.5. Summary
The term public enterprise denotes a form of business organization owned and managed
by the state government or any other public authority. So it is an undertaking owned and
controlled by the local or state or central government. Although the objectives of
establishing public enterprises differ from country to country, there are common factors
that necessitated their coming into existence. In some countries, governments would hold
a belief that the scale and range of investment required for sustainable economic
development was beyond the reach of pure market forces. Hence, activities supposed to
have a significant contribution in building the economy of a country but not undertaken
by the sector due to involvement of a greater risk had to undertaken by the government.
The other motive was governments’ political commitment to multiple non-commercial
objectives for enterprises such as employment generation, income distribution and
economic welfare that can be provided by the state only. Proclamation No. 25/1992
contains provisions for accounting for public enterprises in Ethiopia, such as the
formation, operation, privatization, amalgamation and division, as well as dissolution and
winding up of public enterprises.
2.6. Review Questions
Try to answer the following questions

1. What is public enterprise?
2. Briefly discuss the characteristics of public enterprises.
3. What are the social and economic benefits of public enterprises?
4. Discuss the provisions of public enterprises in Ethiopia in relation to definitions,
formation, operation, privatization, amalgamation & division, dissolution and
winding up processes.
5. Discuss the role of the Ethiopian Privatization Agency in the process of
transferring public enterprises in to private hand.
CHAPTER 3
AGENCY AND PRINCIPAL, HEAD OFFICE AND BRANCH
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Introduction
As a business enterprise grows, it may establish one or more branches to market its
products over a large territory. Frequently the development of these areas cannot be
adequately accomplished by salespersons traveling from the head office. The use of
catalogs with mail orders or shipments on consignment may increase sales but may still
fail to accomplish the desired results. The establishment of sales headquarters in several
districts may be the means of achieving marketing objectives. Selling activities are
conducted from sales offices at different locations under the direction of the home office.
Customers deal, not with the headquarters of the business, but with an outlying sales unit.
Contact with the organization is more easily and quickly made. The desired goods or
services are more readily available.
Chapter Objectives

 Describe the characteristics of agency, principal, head office and branch.
 Distinguish agency and branch.
 Describe accounting for sales agency.
 Describe accounting for branches.
 Identify the reciprocal ledger accounts and their use.
 Explain the alternative methods of billing merchandise to branches.
 Prepare combined financial statements for home office and branch.
 Describe transactions between branches.
3.1. Characteristics of Principal and Agency and Branch
The tem branch is used to describe a business unit located at some distance from the
home office. This unit carries merchandises, makes sales, approves customers’ credit, and
makes collections from its customers. A branch may obtain merchandises solely from the
home office, or a portion may be purchased from outside suppliers. The cash receipts
often are deposited in a bank account belonging to the home office; the branch expenses
then are paid from an imprest cash fund or a bank account provided by the home office.
As the imprest cash fund is depleted, the branch submits a list of cash payments
supported by vouchers and receives a check or a transfer from the home office to
replenish the fund. The use of an imprest cash fund gives the home office considerable
control over the cash transactions of the branch. However, it is common practice for a
large branch to maintain its own bank accounts.
A sales agency, sometimes referred to simply as ‘agency’ on the other hand; is an
organization that sells goods on behalf of another organization. The sales agent keeps
merchandises without assuming risk of non salability.
3.2. Distinguishing Agency and Branch

The difference between a sales agent and a branch mainly lies on the degree of autonomy
given from the headquarters. A branch usually has more autonomy and a greater range of
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services than a sales agent does. However, the extent of autonomy and responsibility of a
branch varies, even among different branches of the same business enterprise. A branch
typically stocks merchandises and fills customers’ orders. In some companies the
branches perform their own credit function, while other companies' credit is handled by
the home office. The degree of decision making in branches usually greater than in sales
agencies but differs considerably from company to company. Some branch managers
may be permitted few choices, while other branch managers may operate with relative
independence from the home office.
The sales agency is not an autonomous operation but acts on behalf of the home office.
The agency may display and demonstrate sample merchandise, take orders, and arrange
for delivery. The orders typically are filled by the home office because a sales agency
usually does not stock inventory. Merchandise selection, advertising, granting of credit,
collection of accounts, and other aspects of operating the business usually are conducted
by the home office. There is typically little management decision making in a sales
agency; decisions are made at the home office and the agency conducts routine
operations.
Article 44 of the Commercial Code of Ethiopia, defines a commercial agent as follows:

1. A commercial agent is a person or business organization, not bound to a trader by
contract of employment and carrying out independent activities, who is entrusted
by a trader with representing him/her permanently in a specified area and dealing
or making agreements in the name and on behalf of the trader.
2. Unless otherwise provided in the agency agreement, contracts entered into by a
commercial agent shall become effective without conformation by the trader.
3. A commercial agent normally acts as agent and may act as a broker. He is a
trader.
Article 46: Duties of commercial agent:
1. A commercial agent shall safeguard the principal’s interests with the care due by a
good trader.
2. He shall:
a) carry out all instructions of the principal;
b) inform the principal of all contacts negotiated or entered into by him;
c) send to the principal periodical reports on his activities and all such
information as may be required on the state of affairs with in the area where
he acts.
Article 47: Prohibition from carrying on private trade:
(1) A commercial agent may carry on any private trade which is not similar to the trade
carried on by the principal. The agency agreement may be cancelled and damages may be
due where the agent carries on trade similar to the trade carried on by the principal.
(2) Unless otherwise provided in the agency agreement, a commercial agent may not act
in the area specified in the agreement on behalf of traders other than the principal.
(3) In no case may a commercial agent act, in the area specified in the agency agreement,
on behalf of traders who carry on a trade similar to the trade carried on by the
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principal. The agency agreement may be cancelled and damages may be due where
the agent disagrees this prohibition.
3.3. Accounting for Sales Agency
The typical agency does not require a complete set of books. Customarily, summaries of
the working fund receipts and disbursements and records of sales to customers are
sufficient. Summaries of working fund disbursements accompanied by supporting
evidences in the form of paid vouchers are sent to the home office. A sales agency that
does not carry an inventory of merchandise, maintain receivables, or make collections has
no need for a complete set of accounting records. All that is needed is a record of sales to
customers and a summary of cash payments supported by vouchers.
When the home office has more than one sales agency and wants to measure the
profitability of each sales agency, it will establish a separate revenue and expense general
ledger in the name of the agency. The cost of goods sold by each agency should also be
recorded. For example, Sales: Bhair Dar Agency; Rent Expense: Bahir Dar Agency; Cost
of goods sold: Bahir Dar Agency etc. If there is no desire to summarize agency
operations separately, the home office may record transactions of the agency in the
revenue and expense accounts used for its own transactions. After these accounts are
closed, the income summary account reports the results for combined operations.
When the perpetual inventory system is used, shipments of the goods sold to customers
of Bahir Dar Agency are debited to Cost of goods sold: Bahir Dar Agency and credited to
Inventories. When the periodic inventory system is used, shipments of goods sold by an
agency may be recorded by a debit to Cost of Good Sold: Bahir Dar Agency and a credit
to Shipments to Agencies at the end of the accounting period. Where as, a memorandum
record is maintained during the period listing the cost of goods sold shipped to fill sales
orders received from agencies. At the end of the period Shipments to agencies ledger
account if offset against the total of the beginning inventories and purchase to measure
the cost of goods available for sale for the home office in its own operations.
An imprest cash fund generally is maintained at the sales agency for the payment of the
operating expense. In adopting such imprest fund system for the agency working fund,
the home office writes a check to the agency for the fund. Establishing of the fund is
recorded on the home office books by a debit Agency Working Fund account and a credit
to Cash. Whenever the fund runs low, the agency will request fund replenishment at the
end of each fiscal period. The request is normally accompanied by an itemized and
authenticated statement of disbursements and the paid vouchers. Upon sending the
agency a check in replenishment of, the home office, debits expense accounts or other
accounts for which disbursement from the fund were reported and credits Cash.
Office furniture or other assets located at a sales agency may be carried in a separate
ledger account by the home office or control over such assets may be achieved by use of
a subsidiary ledger with a complete record of each asset showing cost, location, and any
other relevant information.
3.4. Accounting for Branches

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The accounting system of one business enterprise with branches may provide for
complete set of accounting records at each branch; policies of another such enterprise
may keep all accounting records in the home office. For example, in some business firms
such as branches of drug and grocery chain stores submit daily reports and business
documents to the home office, which enters all transactions by branches in computerized
accounting records kept in a central location. The home office may not even conduct
operations of its own; it may serve as an accounting and control center for the branches.
On the other hand, a branch may maintain a complete set of accounting records
consisting of journals, ledgers, and a chart of accounts similar to those of an independent
business enterprise. Financial statements are prepared by the branch accountant and
forwarded to the home office. The number and type of ledger accounts, the internal
control structure, the form and content of the financial statements, and the accounting
polices generally are prescribed by the home office. Branch accounting systems may
provide for the maintenance of branch records at the home office, at both branch and
home office or at branch.
When the home office keeps the complete records summarizing branch activities, branch
transactions may be recorded in the home office journals and legers or in a separate set of
records. Data to be recorded are supplied by the branch in the form of either original
documents evidencing branch transactions or memorandum records summarizing branch
transactions supported by original vouchers.
A system where by both the branch and the home office maintains detailed records of
branch transactions is sometimes adopted. In such a case, the branch may maintain the
books of original entry for all transactions in duplicate. Copies of the books of original
entry are sent to the home office, where data are posted to branch accounts maintained
separately or included in the home office general ledger. At the end of the period the
home office adjusts and closes the branch accounts and determines the branch earnings.
When the branch accounting records are maintained at the branch; the branch keeps the
books of original entry and posts to ledger accounts. Financial statements are prepared
the branch periodically and are submitted to the home office and verified by the
company’s internal auditors.
This chapter focuses on a branch operation that maintains a complete set of accounting
records. Transactions recorded by a branch should include all controllable expenses and
revenues for which the branch manager is responsible. If the branch manager has
responsibility over all branch assets, liabilities, revenues and expenses, the branch
accounting records should reflect this responsibility. Expenses such as depreciation are
not subject to control by branch manager; therefore, both the branch plant assets and the
related depreciation ledger accounts generally are maintained by the home office.
3.5. Reciprocal Ledger Accounts and their Reconciliation
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The accounting records maintained by a branch include a Home Office ledger account
that is credited for all merchandises, cash, or other assets provided by the home office; it
is debited for all cash, merchandise, or other assets sent by the branch to the home office
or other branches. The Home Office account is a quasi ownership equity account that
shows the net investment by the home office in the branch. At the end of an accounting
period when the branch closes its accounting records, the income summary account is
closed to the Home Office account; a net loss decreases this balance.
In the home office accounting records, a reciprocal ledger account with a title such as
Investment in Branch is maintained. This non current asset account is debited for cash,
merchandise, and services provided to the branch by the home office, and for net income
reported by the branch. It is credited for cash or other assets received from the branch,
and for net losses reported by the branch. Thus the Investment in Branch reflects the
equity method of accounting. A separate investment account generally is maintained by
the home office for each branch. If there is only one branch, the account title is likely to
be Investment in Branch; if there are numerous branches, each account title includes a
name or number to identify each branch.
Expenses Incurred by Home Office and Allocated to Branches

Some businesses follow a policy of notifying each branch of expenses incurred by the
home office on the branch’s behalf. Plant assets located at a branch generally are carried
in the home office accounting records. If a plant asset is acquired by the home office for
the branch, the journal entry for the acquisition is a debit to an appropriate asset account
such as Equipment: Branch and credit to Cash or an appropriate liability account. If the
branch acquires a plant asset, it debits the Home Office ledger account and credits cash or
an appropriate liability account. The home office debits an asset account such as
Equipment: Branch and credits Investment in Branch.
The home office also usually acquires insurance, pays property and other taxes, and
arranges for advertising that benefits all branches. Clearly, such expenses as depreciation,
property taxes, insurance, and advertising must be considered in determining the
profitability of a branch. A policy decision must be made as to whether these expenses
data are to be retained at the home office or are to be reported to the branches so that the
income statement prepared for each branch will give a complete picture of its operations.
An expense incurred by the home office and allocated to the a branch is recorded by the
home office by a debit to Investment in Branch and a credit to an appropriate expense
ledger account; the branch debits an expense account and credits Home Office.
If the home office does not make sales, but functions as only as an accounting and control
center, most or all of its expenses may be allocated to the branches. To facilitate,
comparison of the operating results of the various branches, the home office may charge
each branch interest on the capital invested in the branch. Such interest expense
recognized by the branches would be offset by interest revenue recognized by the home
office and would not be displayed in the combined income statement of the business
enterprise as a whole.
3.6. Alternative Methods of Billing Merchandise Shipments to Branches
____________________________________________________________________ 76
The shipment of merchandise to home office does not constitute a sale because
ownership of the merchandise does not change. Three alternative methods are available
to the home office for billing merchandises shipped to its branches. The shipments may
be billed at:
1. at home office cost,
2. at a percentage above home office cost
3. at the branches retail selling price.
1 Billing of merchandise at home office cost: this is the simplest procedure and most
widely used. It avoids complication of unrealized gross profit in inventories and
permits the financial statements of branches to give a meaningful picture of
operations. However, billings of merchandises at home office cost attributes all gross
profit of the enterprise to the branches, even though some of the merchandises may be
manufactured by the home office. Under these circumstances, home office cost may
not be the most realistic basis for billing of shipments to branches.
2. Billing of merchandise at a percentage above home office cost: this method may
be intended to allocate a reasonable gross profit to the home office. When
merchandise is billed to a branch at a price above home office cost, the net income
reported by the branch is understated and the ending inventories are overstated for
the enterprise as a whole. Adjustments must be made by the home office to eliminate
the excess of billed prices over cost (intercompany profits) in the preparation of
combined financial statements for the home office and the branch. These factors must
be recognized by the home office and given effect up on its accounting records in
summarizing branch operations. For example, assume that merchandises costing at
Birr 12,000 are shipped by a home office to branch, and the branch is billed for the
merchandise at 10% above cost or Birr 13,200.The shipment may recorded as
follows:
Transaction Home Office Books Branch Books

Transfer of merchandise at Branch 13,200 Shipments
Home office cost Br. Shipments From Home
12,000 and billing to to Branch............12,000 Office..........13,200
branch at Br. 13,200 Unrealized Home Office.....13,200
Intercompany
Profits ...................1200
The branch records the goods at their billed price. The home office book debits the
Branch account at the billed price and credits Shipments to Branch for the actual cost of
the merchandise; and Unrealized Intercompany profit is credited for the difference
____________________________________________________________________ 77
between the billed price and the actual cost of the merchandise shipped. Branch and
home office accounts are then reciprocal. Merchandise shipments reported at cost of
merchandise can be subtracted from the sum of the beginning inventory and the
purchases in arriving at the cost of merchandise available for home office sales. The
balance intercompany profit account is properly recognized as an offset against the
branch account in arriving at the actual investment in branch.
As the branch sells the goods acquired from the home office and recognizes profit for the
difference between the billed price and the sales price, the difference between the cost
and the billed price, reported by the home office in the unrealized profit account, is
properly recognized as earned. At the time of shipment, the home office defers
recognition of such earnings until the end of the fiscal period. At this time, the unrealized
profit account is reduced to a balance equal to the unrealized profit actually present in the
branch inventory, and the amount of the reduction is added to the income reported by the
branch. For example, referring to the preceding illustration, unrealized profit of Birr
1,200 is recorded on the books of the home office upon the shipment of merchandise,
cost Birr 12,000, at a billed price of Birr 13,200.
At the end of the period the branch reports an inventory of Birr 11,000. The actual cost of
the branch inventory is Birr 10,000 (11,000/1.10).The unrealized profit balance of Birr
1,200 is excessive and should be reduced to Birr 1,000 (11,000-10,000). The branch
recognizes cost of goods sold at Birr 2,200(13,200- 11,000). The actual cost of the goods
sold by the branch is Birr 2000, (2200/1.10). Therefore the earnings reported by the
branch are understated and should be increased by Birr 200.
Assume that the branch books report net income of birr 6000, journal entries to
summarize branch and home office books are as follows:
Transaction Home Office Books Branch Books

1) To close branch earnings to 2) Branch 6,000 1) Income
home office account on branch Branch summary 6,000
books income 6,000 Home
2)To recognize branch earnings office 6,000
on home office books
To bring unrealized profit Unrealized inter-
account to required balance and Company profit 200
to correct branch earnings Branch
Income 200
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To close branch earnings into Branch
income summary account Income 6,200
Income
Summary 6,200
The balance of unrealized intercompany profit is now Birr 1,000 and reports the
overstatement in the branch investment balance at the end of the period. The credit of 200
to the branch income account on the home office books corrects the branch earnings for
the overstatement of the branch cost of goods sold.
3. Billing of merchandise at the branches retail-selling price: Billing shipments to a
branch at branch retail selling prices may be based on a desire to strengthen internal
control over inventories and to conceal information concerning branch earnings from
branch officials. The inventories ledger account of the branch shows the merchandise
received and sold at retail selling prices. Consequently, the account will show the
ending inventories that should be on hand at retail prices. The home office record of
shipments to a branch, when considered along with sales reported by the branch,
provides a perpetual inventory stated at selling prices. If the physical inventories
taken periodically at the branch do not agree with the amounts thus computed, an
error or theft may be indicated and should be investigated promptly.
Illustrative Journal Entries for Operations of a Branch
To illustrate accounting for the operations of a branch, assume that on September 1, Abay
Company establishes its branch in Gondar. Abay Company bills merchandise to Gondar
Branch at home office cost and that Gondar branch maintains complete accounting
records and prepares financial statements. Both home office and branch use the perpetual
inventory system Equipment used at branch is carried in the home office accounting.
Certain expenses such as advertising and insurance, incurred by the home office on
behalf of the branch, are billed to the branch. Transactions and events during the first
year (2005) of operations of Gondar Branch are summarized as follows:
1. Cash of Birr 2,000 was forwarded by the home office to Gondar Branch.
2. Merchandise with a home office cost of Birr 80,000 was shipped by the home
office to Gondar branch.
3. Equipment was acquired by Gondar branch for Birr 1,000, to be carried in the
home office accounting records. (Other plant assets for Gondar Branch generally
are acquired by the home office.
4. Credit sales by Gondar branch amounted to Birr 100,000; the branches cost of
merchandises sold were Birr 55,000.
5. Collections of trade accounts receivable by Gondar branch amounted to Birr
72,000.
6. Payments for operating expenses by Gondar branch totals Birr 20,000.
7. Cash of Birr 47,500 was remitted by Gondar branch to the home office.
8. Operating expenses incurred by the home office and charged to Gondar branch
totaled Birr 5,000.
Required: 1. Record the above transactions and events by the home office and by branch
2. Prepare reciprocal ledger accounts
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3. Record the adjusting and closing entries by the home office and the closing
entries by the branch.
1. Home Office Accounting Records Gondar Branch Accounting Records

1. Investment in 1. Cash 2,000
Gondar Branch 2,000 Home Office 2,000
Cash 2,000
2. Investment in
Gondar Branch 80,000 2. Merchandise
Merchandise Inventories 80,000
Inventories 80,000 Home office 80,000
3. Equipment
Gondar Branch 1,000 3. Home office 1, 000
Investment in Cash 1,000
Gondar Branch 1,000
4. None 4. Trade A/ Receivable 100,000
Sales 100,000
Cost of Goods Sold 55,000
Merchandise
Inventories 55,000
5. None 5. Cash 72,000
Trade A/ R 72,000
6. None 6. Operating Expenses 20,000
Cash 20,000
7. Cash 47,500 7. Home Office 47,500
Gondar Branch 47,500
8. Investment in 8. Operating Expense 5,000
Operating
Expenses 5,000
Note: If the branch obtains merchandises from outsides as well as from the home office,
the merchandise acquired from the home office may be recorded in a separate
merchandise inventories from home office ledger account.
In the home office accounting records, the Investment in Gondar ledger account has a
debit balance of Birr 38,500 before the accounting records are closed and the branch net
income of Birr 20,000 ( 100,000-55,000-20,000-5000= 20,000) is transferred to the
Investment in Gondar Branch ledger account) as shown below in the table.
In the accounting records of Gondar Branch, the Home Office ledger account has a credit
balance of Birr 38,500 (before the accounting records are closed and the net income of
Birr 20,000 is transferred to the Home Office account) as shown below in the table.
2. Reciprocal Ledger Accounts in the Home Office Records
Investment in Gondar Branch Account
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Date Explanation Debit Credit Balance (Dr.)
2005 Cash sent to branch 2,000 2,000
Merchandise billed to branch at home office cost 80,000 82,000
Equipment acquired by branch carried in home
Office accounting records 1,000 81,000()
Cash received from branch 47,500 33,500
Operating expenses billed to branch 5,000 38,500
Reciprocal Ledger Accounts in Gondar Branch Records
Home Office Account

Date Explanation Debit Credit Balance (Cr.)
2005 Cash received from home office 2,000 2,000
Merchandise received from home office 80,000 82,000
Equipment acquired by branch 1,000 81,000
Cash sent to home office 47,500 33,500
Operating expenses billed home office 5,000 38,500
Therefore, the reciprocal ledger account in accounting records of Home Office prior to
adjusting and closing entry; and reciprocal ledger accounts in accounting records of
Gondar Branch prior to closing entry are as shown above.
3) Home office Adjusting and closing entries and Branch closing entries
Home Office Accounting Records Gondar Branch Accounting Records
Adjusting and Closing entries Closing Entries
________________________________________________________________________
1. None 1. Sales 100,000
Cost of goods sold 55,000
Operating Expenses 25,000
2. Investment in 2. Income
Gondar Branch 20,000 Summary 20,000
Income Gondar Branch 20,000 Home Office 20,000
3. Income Gondar
Branch 20,000 3. None
Income
Summary 20,000
3.7. Combined Financial Statements for Home Office and Branch
____________________________________________________________________ 81
 A balance sheet for distribution to creditors, stockholders, and government agencies
must show the financial position of a business enterprise having branches as a single
entity.
____________________________________________________________________ 82
 The starting point in the preparation of a combined balance sheet would be the
adjusted trial balance of the home office and of the branch.
 The reciprocal ledger accounts are eliminated because they have no significant when
the branch and home office report as a single entity.
 The assets and liabilities of the branch are substituted for the Investment in Branch
ledger account included in the home office trial balance. Similar accounts are
combined to produce a single total amount for cash, trade accounts receivable, and
other assets and liabilities of the enterprise as a whole in the combined financial
statement.
 The balance of the Home office account is against the balance of the Investment in
Branch account; also any receivables and payables between the home office and the
branch (or between branches) are eliminated.
 The operating results of the enterprise are shown by an income statement in which the
revenue and expenses of the branches are combined with corresponding revenue and
expense for the home office. Any intracompany profits or losses are eliminated.
Working Paper for Combined Financial Statements
A working paper for combined financial statements has three purposes.

1. to combine ledger account balances for like revenue, expenses, assets and
liabilities,
2. to eliminate the reciprocal accounts,
3. to eliminate any intracompany profits or losses
Note that any eliminations or offsetting of balances is done only in the working paper. No
entry is to be made in the accounting of either Home Office or Branch because its only
purpose is to facilitate the preparation of combined financial statements.
Illustration: The following working paper provides the information for combined
financial statements. The adjusted trial balance for the home office is assumed figures.
The adjusted trial balance for the Gondar branch is based on the foregoing transactions
and events.
Abay Company
Working Paper for Combined Financial Statements of Home Office and Branch
(Perpetual Inventory System: Billing above Cost)
Adjusted Trial Balance
Home Office Branch Elimination Combined
Explanation
Dr(Cr) Dr(Cr) Dr(Cr) Dr(Cr)
Income Statement
Sales (280,000) (100,000) - (380,000)
Cost of goods sold 80,000 68,750 (a) (13,750) 135,000
Operating Expenses 65,000 25,000 - 90,000
Net Income 135,000 6,250 (b) 13,750 155,000
____________________________________________________________________ 83
Totals - 0- -0- -0-
Statement of Retained
Earnings _
Retained earning Jan 1, 2005 (50,000) (6,250) (b) (13,750) (50,000)
Net Income(From I/s) (135,000) _ - (155,000)
Dividend Declared 75,000 _ - 75,000
Retained Earning Dec. 31,2005 _ - - 130,000
Balance Sheet -0-
Cash 27,500 5,500 - 33,000
Accounts Receivable 56,000 28,000 - 84,000
Merchandise Inventories 43,000 31,250 (a) (6,250) 68,000
Investment in Gondar branch 58,500 (c) (58,500) -
Allowance for Overvaluation of
Inventories: Gondar Branch (20,000) - (a) 20,000 -
Equipment 75,000 - - 75,000
Accumulated depreciation Eqt. (5000) - - (5,000)
Accounts Payable (25,000) - - (25,000)
Home Office - (58,500) (c) 58,500 -
Common stock, Birr 100 par (100,000) _ - (100,000)
Retained earning (From S R/E ) (165,000)
-0- -0- -0- -0-
Note:
(a) To reduce ending inventories and cost of goods sold of branch to cost, and to
eliminate unadjusted balance of Allowance of Overvaluation of Inventories: Gondar
Branch.
(b) To increase income of home office by portion of merchandise markup that was
realized by branch sales.
(c) To eliminate reciprocal ledger accounts.
Combined Financial Statements: the combined financial statements are the same as the
preceding combined financial statements when the merchandises are shipped at home
office cost; because the amount in the combined column of the working paper are the
same as the working paper prepared on page 89.
Income: Gondar branch
Home Office Adjusting and Closing Entries and Branch Closing Entries
Home Office Accounting Records Adjusting and Closing Entries
Investment in Gondar Branch 6,250
Income: Gondar Branch 6,250
(To record net income reported by Gondar Branch)
Allowance for Overvaluation of Inventories: Gondar Branch 13,750

Realized Gross Profit: Gondar Branch sales 13,750
(To reduce allowance to amount by which ending inventories of Branch exceed cost)
____________________________________________________________________ 84
Realized Gross profit: Gondar Branch 13,750
Income: Gondar branch 6,250
(To close branch net income and realized gross profit to income summary ledger
account)
After the foregoing journal entries have been posted, the ledger accounts in the home
office general ledger used to record branch operations are as follows:
Investment in Gondar Branch
Date Explanation Debit Credit Balance (Dr.)
2005 Cash sent to branch 2,000 2,000
Merchandise billed to branch at markup
of 25% above home office cost ,or 25%
of Billed price 100,000 102,000
Equipment acquired by branch carried 1,00
on home office accounting records 0 101,000
Operating expenses billed to branch 5,000 47,500 58,500
Net income for 2005 reported by branch 6,250 64,750
Allowance for Overvaluation of Inventories: Gondar Branch

Date Explanation Debit Credit Balance(Cr.)
2005 Markup on merchandise shipped to 20,0
branch during 2005 ( 25% of cost) 00 20,000
Realization of 25% markup on
merchandise sold by branch during 13,750 6,250
2005
Realized Gross Profit: Gondar Branch Sales

2005 Realization of 25% markup on
merchandise sold by branch during 13,750 13,750
2005 13,750 -0-
Closing entry
Income: Gondar Branch

Date Explanation Debit Credit Balance (Cr.)
2005 Net income for 2005 reported by 6,250 6,250
branch 6,250 - -0-
Closing entry
In the separate balance sheet for the home office, the Birr 6,250 credit balance of the
Allowance of Overvaluation of Inventories: Gondar Branch ledger account is deducted
from the Birr 64,750 debit balance of Investment in Gondar Branch account, thus
reducing the carrying amount of the investment account to a cost basis with respect to
____________________________________________________________________ 85
shipments of merchandise to the branch. In the separate income statement for the home
office, the Birr 13,750 realized gross profit on Gondar Branch sales may be displayed
following gross margin on sales Birr 200.000 (280,000-80,000)=Birr 200,000).
Gondar Branch Accounting Records Closing Entries
Sales 100,000
Operating expenses 25,000
(To close revenue and expense ledger accounts)
Home Office 6,250
(To close the net income in the income summary account to the Home Office account)
After the closing entries have been posted by the branch, the following Home Office
ledger account in the accounting records of Gondar: Branch has a credit balance of Birr
64,750, the same as the debit balance of the Investment in Gondar; Branch account in the
accounting records of the home office:
Home Office
2005 Cash received from home office - 2,000 2,000
Merchandise received from home office - 100,000 102,000
Equipment acquired 1,000 - 101,000
Cash received from branch 47,500 - 53,500
Operating expenses billed by home - 5,000 58,500
office - 6,250 64,750
Net income for 2005 reported by branch
Treatment of Beginning Inventories Priced Above Cost

If the a home office and branch use the periodic inventory system, the home office debits
Investment in Branch for the billed price of the merchandise shipped, credits Shipments to
Branch for the home office cost of the merchandises shipped, and credits any excess of
the billed price over cost to Allowance to Overvaluation of Inventories : Branch. The
branch debits Shipments from Home Office and credits Home Office at billed price. At the
end of the accounting period, the home office reduces (debits) Allowance for
Overvaluation of Inventories: Branch for the amount of Overvaluation applicable to the
branch’s cost of goods sold and credits the amount of the reduction to the Realized Gross
Profit: Branch ledger account.
Illustration: Referring to the Abay Company, assume that both the home office and
Gondar Branch adopted the periodic inventory system and the beginning inventories are
carried at an amount above home office cost by Gondar Branch for the second year of
operations(2006).
____________________________________________________________________ 86
The beginning inventories for 2006 were carried by Gondar Branch at 31,250, or 125% of
the cost of Birr 25,000 (25,000X1.25=31,250). Assume that during 2006 the office
shipped merchandise to Gondar Branch that cost Birr 60,000 and was billed at Birr
75,000, and that Gondar branch sold for Birr 112,250 the merchandise that was billed at
Birr 66,250. The journal entries to record shipments and sales under the periodic
inventory system are illustrated below:
Home Office Accounting Records Gondar Branch Accounting Records

1. Investment in 1. Shipments from
Shipments to Home Office 75,000
Gondar Branch 60,000
Allowance for Overvaluation
of inventories: Gondar Branch 15,000
2. None 2.Cash (or Trade A/R) 112,250
Sales 112,250
The flow of merchandise for Gondar branch during 2006 is summarized as follows:
Abay Company
Flow of Merchandise for Gondar Branch, during 2006
Billed Home Markup (25% of cost;
Price Office Cost or 20% of Billed price)
Beginning inventories Br. 31,250 Br. 25,000 Br. 6,250

Add: Shipments form home office 75,000 60,000 15,000
Available for sale 106,250 85,000 21, 250
Less: ending inventories (40,000) (32,000) (8,000)
Cost of goods sold 66,250 53,000 13,250
The following four home office ledger accounts show the end of period adjusting and
closing entries of the branch on December 31, 2006:
Investment in Gondar Branch
Date Explanation Debit Credit Balance(Dr.)
2006 Balance, Dec. 31,2005 - - 64,750
of Billed price 75,000 - 139,750
Cash received from branch - 109,750 30,000
Operating expenses billed to branch 4,000 - 34,000
Net income for 2006 reported by branch 22,000 - 56,000
Allowance for Overvaluation of Inventories: Gondar Branch
____________________________________________________________________ 87
2006 Balance, Dec.31,2005 - - 6,250
Markup on merchandise shipped to branch
during 2006 ( 25% of cost) - 15,000 21,250
Realization of 25% markup on
merchandise sold by branch during 2006 13,250 - 8,000
Realized Gross Profit: Gondar Branch sales

2006 Realization of 25% markup on -
merchandise sold by branch during 2006 - 13,250 13,250
Closing entry 13,250 - -0-
Income: Gondar Branch

2006 Net income for 2005 reported by branch - 8,000 8,000
Closing entry 8,000 - -0-
The Home Office account in the branch ledger shows the following activity and closing
entry on December 31, 2006:
Home Office
2006 Balance Dec. 31, 2005 64,750
Operating expenses billed by home office 4,000 34,000
Net income for 2005 reported by branch 22,000 56,000
____________________________________________________________________ 88
Abay Company
Working Paper for Combined Financial Statements of Home Office and Branch
(Periodic Inventory System: Billing above Cost)
Adjusted Trial Balance
Home Office Branch Elimination Combined
Explanation
Dr(Cr) Dr(Cr) Dr(Cr) Dr(Cr)
Income Statement
Sales (400,000) (112,250) (512,250)
Inventories, Dec.31, 2005 50,000 31,250 (b) (6,250) 75,000
Purchases 300,000 300,000
Shipments to Gondar Branch (60,000) (a) 60,000
Shipments from home office 75,000 (a) (75,000)
Inventories, Dec, 2005 (50,000) (40,000) (c) 8,000 (82,000)
Operating expenses 100,000 24,000 124,000
Net Income 60,000 22,000 (d) 13,250 95,250
Totals - 0- -0- -0-
Statement of Retained Earnings
Retained earning Jan 1, 2006 (130,000) - - (130,000)
Net Income(From I/s) (60,000) (22,000) (d) (13,250) (95,250)
Dividend Declared 75,000 _ - 75,000
Retained Earning Dec. 31,2005 -0- -0- 150,250
____________________________________________________________________ 89
Balance Sheet -0-
Cash 30,500 5,000 35,500
Accounts Receivable 70,000 25,000 - 95,000
Inventories, Dec,2006 50,000 40,000 (c) (8,000) 82,000
Allowance for Overvaluation of 21,250 - (a)(15,000) -
Inventories: Gondar Branch (b) (6,250) -
Investment in Gondar branch 34,000 - (e)(34,000) -
Equipment 137,700 - - 137,750
Accumulated depreciation Eqpt. (60,000) - - (60,000)
Accounts Payable (40,000) - - (40,000)
Home Office - (34,000) - (e) 34,000 -
Common stock, Birr 100 par (100,000) - - (100,000)
Retained earning (From S R/E ) - - - (150,250)
Balance -0- -0- -0- -0-
Note:
a) To eliminate reciprocal ledger accounts for merchandise shipments
b) To reduce beginning inventories of branch to cost
c) To reduce ending inventories of branch to cost
d) To increase income of home office by portion of merchandise markup that
was realized by branch sales.
e) To eliminate reciprocal ledger account balances.
Reconciliation of Reciprocal Ledger Accounts
At the end of an accounting period, the balance of Investment in Branch ledger account in
the accounting records of the home office may not agree with the balance of Home office
account in the accounting records of the branch because certain transaction may have
been recorded by one office but not by the other. The lack of agreement between the
reciprocal ledger accounts balances causes no difficulty during an accounting period, but
at the end of each period the reciprocal account balances must be brought into agreement
before combined financial statements are prepared.
Illustration: Assume that the home office and branch accounting records of Omedad
Company on December 31, 2004 contain the following data:
Investment in Lee Branch (in the accounting records of Home Office)
2004
Nov.30 Balance - - 30,750
Dec.10 Cash received from branch 10,000 20,750
27 Collection of branch trade A/receivable 1,000 19,750
29 Merchandise Shipped to branch 5,000 - 24,750
Home office (in the accounting records of Lee Branch)

Date Explanation Debit Credit Balance
____________________________________________________________________ 90
2004
Nov.30 Balance - - 30,750
Dec. 7 Cash sent to home office 10,000 - 20,750
28 Acquired equipment 3,000 - 17,750
30 Collection of home trade accounts - 3,000 20,750
receivable
Comparison of the two reciprocal ledger accounts discloses four reconciling items;
described as follows:
1. On Dec.29, 2004, the home office shift merchandises costing Birr 5,000 to the branch.
The home office debits its reciprocal ledger accounts with the branch on the date
merchandise is shipped , but the branch credits its reciprocal account with the home
office when the merchandise is received a few days later.
Home office debit investment in branch but the branch did not credit the Home office
account. The required journal entry on Dec.31, 2002, in the branch accounting records
assuming use of the perpetual accounting system is as follows:
Inventories in transit 5,000
Home office 5,000
(To record shipment of merchandise in transit from home office)
2. On Dec. 27, 2004, trade accounts receivables of the branch were collected by the home
office. The collection was recorded by the home office by a debit to Cash and a credit to
Investment in Lee Branch. No journal entry was recorded by Lee Branch; therefore, the
following journal entry is required in the accounting records of Lee Branch on
December 31, 2004
Home office 1,000
Trade Accounts Receivable 1,000
(To record the collection of accounts receivable by home office)
3. On Dec.28, 2004 the branch acquired equipment for Birr 3,000. Because the equipment
used by the branch is carried in the accounting records of the home office, the journal
entry made by the branch was a debit to Home Office and a credit to Cash. No journal
entry was made by the home office; therefore, the following journal entry is required on
Dec. 31, 2004, in the accounting records of the home office:
Equipment: Lee Branch 3,000
Investment in Lee Branch 3,000
(To record Equipment acquired by Branch)
4. On Dec.30, 2004; trade accounts receivables of the home office were collected by Lee
Branch. The collection was recorded by Lee Branch by a debit to Cash and a credit to
Home Office. No journal entry was made by the home office; therefore, the following
journal entry is required in the accounting records of the home office on December 31,
2004.
Investment in Lee Branch 2,000
Trade Accounts Receivable 2,000
(To record collection of accounts receivable by Lee Branch)
____________________________________________________________________ 91
The effect of the foregoing end of period journal entries is to update the reciprocal ledger
accounts, as shown by the following reconciliation:
Omedad Company – Home Office and Lee Branch
Reconciliation of Reciprocal Ledger Accounts
December 31, 2004
Investment in Lee Branch Home Office Account
(in the home office accounting records) (in branch accounting records)
Balances before adjustment Birr 24,750 dr Birr 20,750 cr
Add (1) Merchandise shipped to
Branch by home office - 5,000
(4) Home Office trade accounts
Receivable collected by branch 2,000 -
Less (2) Branch trade accounts receivable
Collected by home office - (1,000)
(3) Equipment acquired by branch (2,000)
Adjusted balances Birr24, 750 Birr 24,750
3.8. Transactions between Branches
Efficient operations may require on occasion require that merchandise or other assets be
transferred from one branch to another. Generally, a branch does not carry a reciprocal
ledger account with another branch but records the transfer in the home office ledger
account. The branch which transfers the merchandises to another branch debits Home
Office and credits Inventories (assuming that the perpetual inventory system is used). On
the receipt of the merchandise, the other branch debits Inventories and credits Home
Office. The home office records the transfer between branches by a debit to Investment in
Branch (transferor) and credits Investment in Branch (transferee).
The transfer of merchandise from one branch to another do not justify increasing the
carrying amounts of inventories by freight costs incurred because of the indirect routing.
The amount of freight costs properly included in inventories at a branch is limited to the
cost of shipping the merchandise directly from the home office to its present location.
Excess fright costs are recognized as of the home office; the assumption here is that the
home office makes the decisions directing all shipments. If branch managers are give the
authority to order transfers of merchandises between branches, the excess freight costs
are recognized as expenses attributable to the branches whose managers authorized the
transfers.
Illustration: Assume the home office shipped merchandises costing Birr 1,000 to branch
A and paid freight costs of Birr 300. Subsequently, the home office instructed branch A
to transfer this merchandise to branch B. Freight costs of Birr 200 were paid by branch A
to carry out this order. If the merchandises had been shipped directly from home office to
branch B, the freight costs would have been Birr 400. The journal entries to record these
events, assuming perpetual inventory system are as follows:
In the Accounting Records of Home Office
____________________________________________________________________ 92
Investment in Branch A 1,300
Inventories 1,000
Cash 300
(To record shipment of merchandise and payment of freight costs)
Investment in Branch B 1,400
Excess Freight Expense –Interbranch Transfers 100
Investment in Branch A 1,500
(To record transfer of merchandise from branch A to Branch B under the instruction of
home office. The excess freight expense of Birr 100(300 +200-400 =100).
In the Accounting Records of Branch A

Inventories 1,000
Freight in or (inventories) 300
Home Office 1,300
(To record receipt of merchandise from home office with freight cost paid in advance by
home office)
Home office 1,500
Inventories 1,000
Freight in (or Inventories) 300
Cash 200
(To record transfer of merchandise to Branch B under the instruction of home office and
payment of freight costs of Birr 200).
In the Accounting records of Branch B
Inventories 1,000
Freight in (or inventories) 400
Home Office 1,400
(To record receipt of merchandise from home Branch A transferred under instruction of
home office and normal freight costs billed by home office)
3.9 Accounting for Foreign Branches and Foreign Currency Translations
Many companies, large and small depend on international markets for supplies of goods
and for sales of their products and services. Multinational companies (a company
operating in many countries) often transact in a variety of currencies as a result of their
export and import activities.
When a multinational company prepares its consolidated or combined financial

statements that include the operating results, financial position, and cash flows of foreign
subsidiaries or branches, it must translate the amounts in the financial statements of the
foreign entities from the entities’ functional currency to its reporting currency. In
addition, if the foreign entity’s accounting records are maintained in a local currency (of
the foreign country) that is not the entity’s functional currency, the foreign entity’s
account balances must be remeasured to the functional currency from the local currency.
Therefore, the translation of the financial statements of a foreign business entity in to the
____________________________________________________________________ 93
functional currencies and restatement is necessary before the statements can be combined
or consolidated.
Accountants preparing financial statements must consider both the differences in

accounting principles and differences in currencies used to measure the foreign entity’s
operations.
Functional Currency: FASB 52 provides specific guidelines for translating foreign

currency financial statements. The FASB defined the functional currency of a foreign
entity as follows:
An entity’s functional currency is the currency of the primary economic environment

which the entity operates; normally, that is the currency of the environment in which an
entity primarily generates and expends cash.
For an entity with operations that are relatively self contained and integrated with in
particular country, the functional currency generally would be the currency of that
country. However, a foreign entity’s functional currency might not be the currency of the
country which the entity is located. For example, the parent’s currency generally would
be the functional currency for operations that are a direct and integral component or
extension of the parent company’s operations.
To assists in the determination of the functional currency of a foreign entity, the FASB
provided the following guidelines:
The following six economic indicators (factors) must be assessed individually or
collectively in determining an entity’s functional currency.
a. Cash flow indicators
(1) Foreign Currency – Cash flows related to the foreign entity’s individuals
assets and liabilities are primarily in the foreign currency and do not directly
influence the parent company’s cash flows.
(2) Parent’s Company – Cash flows related to the foreign entity’s individual
assets and liabilities directly influence the parent’s cash flows on a current
basis and are readily available for remittance to the parent company.
b. Sales price indicators
(1) Foreign Currency- Sales prices for the foreign entity’s products are not
primarily responsive on a short term basis to changes in exchanges rates but
are determined more by local competition or local government regulation.
(2) - Sales prices for the foreign entity’s products are primarily responsive on a
short term basis to changes in exchanges rates; for example, sales price are
determined more by worldwide competition or by international prices.
c. Sales market indicators
(1) Foreign Currency- There is an active local sales market for the foreign entity’s
products, although there also might be significant amounts of exports.
(2) Parent’s Company- The sales market is mostly in the parent’s country or sales
contracts are denominated in the parent’s currency.
____________________________________________________________________ 94
d. Expense indicators
(1) Foreign Currency-Labor, materials, and other costs for the foreign entity’s
products or services are primarily local costs, even though there also might be
imports from other countries.
(2) Parent’s Company- Labor, materials, and other costs for the foreign entity’s
products or services, on continuing basis, are primarily costs for components
obtained from the country in which the parent company is located.
e. Financing indicators
(1) Foreign Currency-Financing is primarily dominated in foreign currency, and
funds generated by the foreign entity’s operations are sufficient to service
existing and normally expected debt obligations.
(2) Parent’s Company- Financing is primarily from the parent or funds generated
by the foreign entity’s operations are not sufficient to service existing and
normally expected debt obligations without the infusion of additional funds
from the parent company. Infusion of additional funds from the parent
company for expansion is not a factor, provided funds generated by the
foreign entity’s expanded operations are expected to be sufficient to service
that additional financing.
f. Intercompany transactions and arrangements indicators
(1) Foreign Currency- There is a low volume of intercompany transactions and
there is not an extensive interrelationship between the operations of the
foreign entity and the parent company. However, the foreign entity’s
operations may rely on the parent’s or affiliates competitive advantages, such
as parents and trade marks.
(2) Parent’s Company- There is a high volume of intercompany transactions and
there is an extensive interrelationship between the operations of the foreign
entity and the parent company. Additionally, the parent’s currency generally
would be the functional currency if the foreign entity is a device or shell
corporation for holding investments, obligations, intangible assets, etc.,that
could readily be carried on the parent’s or an affiliate’s books.
The foregoing guidelines indicate the importance of determining the appropriate

functional currency for a foreign entity. The functional currency of the foreign entity
underlies the application of the monetary principle for the entity.
Alternative Methods for Translating Foreign Entities’ Financial Statements
If the exchange rate for the functional currency of a foreign subsidiary or branch
remained constant instead of fluctuating, translation of the foreign entity’s financial
statements to the parent company’s reporting currency would be simple. All financial
statement amounts would be translated to parent company’s reporting currency at the
constant exchange rate. However, exchange rates fluctuate frequently. Thus, accountants
charged with translating amounts in a foreign entity’s financial statements to parent
company’s reporting currency face a problem similar to the involving inventory valuation
during a period of purchase price fluctuations: which exchange rate or rates should be
used to translate the foreign entity’s financial statements? A number of answers were
proposed for this question before the issuance of FASB Statement No. 52, “Foreign
____________________________________________________________________ 95
Currency Translation.” The several methods of for foreign currency translation may be
grouped into three basic classes as follows:
1. Current/ Non current Method
2. Monetary/Non Monetary Method
3. Current Rate
4. Temporal(Same to the Monetary/Non Monetary Method)
The above methods of foreign currency translation differ principally in translation
techniques for balance sheet amounts as discussed below.
1.Current/ Non Current Method: In Current/ non current method of translation, current
assets and current liabilities are translated at the exchange rate in effect on the balance
sheet date of the foreign entity (the current rate). All other assets and liabilities, and the
elements of owners’ equity, are translated at the historical rates in effect at the time the
assets, liabilities, and equities first were recognized in the foreign entity’s accounting
records. In the income statement, depreciation expense and amortization expense are
translated at historical rates applicable to the related assets, while all other revenue and
expenses are translated at an average exchange rate for the accounting period.
The current/non-current method of translating foreign investees’ financial statements was
allowed by the AICPA fro many years. This method supposedly best reflected the
liquidity aspects of the foreign entity’s financial position by showing the current parent
company’s reporting currency equivalents of its working capital components. Today, the
current/non-current method has few supporters. The principal theoretical objection to the
current /non-current method is that, with respect to inventories, it represents a departure
from historical cost. Inventories are translated at the current rate, rather than at historical
rates in effect when the inventories were acquired, if the current/non-current method of
translating foreign currency accounts is applied.
2. Monetary/Nonmonetary Method: The monetary/non-monetary method of translating
foreign currencies focuses on the characteristics of assets and liabilities of the foreign
entity, rather than on their balance sheet classifications. This method is found on the same
monetary/non-monetary aspects of assets and liabilities that are employed in historical-
cost constant-purchasing power accounting. Monetary assets and liabilities those
representing claims or obligations expressed in a fixed monetary amount are translated at
the current exchange rate. All other assets, liabilities and owners’ equity amounts are
translated at appropriate historical rates. In the income statement, average exchange rates
are applied to all revenue and expense except depreciation expense, amortization expense
and cost of goods sold, which are translated at appropriate historical rates.
Supporters of the monetary/non-monetary method point out that this method emphasized
its intention of the historical-cost principle in the foreign entity’s financial statements are
consolidated or combined with those of the multinational enterprise; consistent
accounting principles are applied in the consolidated or combined financial statements.
The monetary/non-monetary method essentially was sanctioned by the FASB prior to the
issuance of FASB Statement No.52.
____________________________________________________________________ 96
3. Current Rate Method: Critics of the monetary/non-monetary method point out this
method emphasize the parent company aspects of a foreign entity’s financial position and
operating results. By reflecting the foreign entity’s changes in assets and liabilities, an
operating results, as though they were made in the parent company’s reporting currency,
monetary/non-monetary method misstates the actual financial position and operating
results of the foreign entity.
Critics of the monetary/non-monetary method of foreign currency translation generally
have supported the current rate method. Under the current rate method, all balance sheet
amounts other than owners’ equity are translated at the current exchange rate. Owners’
equity amounts are translated at historical rates.
To emphasize the functional currency aspects of the foreign entity’s operations, all
revenue and expenses may be translated at the current rate on the respective transaction
dates, if practical. Otherwise, an average exchange rate is used for all revenue and
expenses.
Standards for Translation Established by the Financial Accounting Standards
Board (FASB)
FASB Statement No.52 adopted the current rate method, as described in the preceding
section of this chapter, for translating a foreign entity’s financial statements from the
entity’s functional currency to the reporting currency of the parent company, which for an
Ethiopian enterprise is the Ethiopian Birr. If a foreign entity’s accounting records are
maintained in a currency other than its functional currency, account balances must be
remeasured to the functional currency before the foreign entity’s financial statements
may be translated. Remeasurement essentially is accomplished by the monetary method
of translation described above. Remeasurements, if required, must precede translation.
Measurement of a Foreign Entity’s Accounts
The FASB provide guidelines for remeasurement:
The remeasurement process should produce the same result as if the entity’s books of
record had been initially recorded in the functional currency. To accomplish that
result, it is necessary to use historical exchange rates between the functional
currency the remeasurement process for certain accounts (the current rate will be
used for all others)…it is also necessary to recognize currently in income,……gains
and losses from remeasurement of monetary assets and liabilities that are not
denominated in the functional currency.
The following list includes the nonmonetary balance sheet items and related revenue and
expense amount that should be remeasured using historical rates to produce the same
result in terms of the functional currency that would have occurred if those items had
been recorded initially in the functional currency. (All other items are remeasured using
the current rate.)
 Marketable securities carried at cost:
- Equity securities
- Debt securities not intended to be held until maturity
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 Inventories carried at cost
 Short-term prepayments such as insurance, advertising, and rent
 Plant assets and accumulated depreciation of plant assets
 Patents, trademarks, license, formulas, goodwill, other intangible assets, and
accumulated amortization of intangible assets
 Deferred charges and credits
 Deferred revenues
 Common stock
 Preferred stock carried at issuance price
 Examples of revenue and expenses related nonmonetary items:

- Cost of goods sold
- Depreciation of plant assets
 Amortization of intangible assets such as goodwill, patents, license, etc.
 Amortization of deferred charges or credits
The appropriate historical or current exchange rate generally is the rate applicable to
conversion of the foreign currency for dividend remittances. Accordingly, an Ethiopian
multinational enterprise having foreign branches, investees or subsidiaries typically uses
the buying spot rate on the balance sheet date or applicable historical date to remeasure
the foreign currency financial statements.
Illustrative Journal Entries for Operations of a Branch
To illustrate the remeasurement of a foreign entity’s account balances to the entity’s
functional currency from another currency, assume that Awash Supplies Company has a
branch in America (called Branch X) with merchandise shipments by the home office
(Awash Supplies Company) to Branch X in excess of home office cost. Assume further
that both the home office and branch X use the perpetual inventory system. Since the
branch is located in America the functional currency of branch X is the Ethiopian Birr
although the branch maintains its accounting records in dollar($), the local currency.
Transactions and events during the first year (2007) of operations Awash Supplies
Company (home office) and X Branch are summarized below. Following each
transaction is the exchange rate for the dollar on the date of transaction or event.
1. Cash of Birr 36,150 was sent by the home office to X Branch. (1$ =12.050 Birr)
1. Merchandise with a cost of Birr 60,000 was shipped by the home office to X Branch
at a billed price of Birr 90,000(1$ = 12.050 Birr)
2. Equipment was acquired by X Branch at $ 500, to be carried in the home office
accounting records. (1$ = 12.039Birr).
3. Sales by X branch on credit amounted to $ 42,500(1$ = 12.043Birr). Cost of goods
sold was $ 4,500(1$=12.043).
4. Collections of trade accounts receivable by X Branch amounted to
$22,000(1$=12.040)
5. Payments for operating expenses by X Branch totaled $6,000 (1$=12.045 Birr).
6. Cash of $ 8,000 was remitted by X Branch to the home office (1$=12.045 Birr).
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7. Operating expenses incurred by the home office and charged to X Branch totaled Birr
3,000(1$ =12.048 Birr).
The exchange rate on December 31, 2007 was 1$=12.043. The foregoing transactions or
events are recorded by the home office and by X Branch with the following journal
entries.
1. Home Office Accounting Records X Branch Accounting Records

(Ethiopian Birr) (Dollar)
1. Investment in 1. Cash 3,000
X Branch 36,150 Home Office 3,000
Cash 36,150
2. Investment in
X Branch 90,375
Inventories 60,000 2. Inventories 7,500
Allowance for Overvaluation Home Office 7,500
Inventories: X Branch 30,375
3. Equipment
X Branch 6,020 3. Home office 500
Investment in Cash 500
X Branch 6,020
4. None 4. Trade A/ Receivable 42,500

Sales 42,500
Inventories 4,500
5. None 5. Cash 22,000
Trade A/ R 22,000
6. None Operating Expenses 6,000
Cash 6,000
7. Cash 96,360 7. Home Office 8,000
X Branch 96,360
8. Investment in 8.Operating Expense 500
X Branch 6,024 Home Office 500
Operating
Expenses 6,024
Home Office Reciprocal Ledger Account with Branch (in Birr): in the home office
accounting records, the Investment in X Branch ledger account (in Birr, before the
accounts are closed is as follows:
Investment in X Branch
Date Explanation Debit Credit Balance(dr)
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2007 Cash sent to branch Br.36,150 Br. 36,150
Merchandise billed to branch 90,375 126525
Equipment acquired by branch carried in home
office accounting records 6,020 120,506
Operating expenses billed to branch 6,024 30,170
Branch Reciprocal Ledger Account with Home Office (in dollar).In X Branch accounting
records, the Home office ledger account (in dollars, before the accounts are closed) is as
follows:
Home Office
Date Explanation Debit Credit Balance(Cr)
2007 Cash received from home office $3,000 3,000
Equipment acquired by branch $ 500 10,000
Operating expenses billed home office 500 2,500
Following is X Branch trial balance (in dollar) on December, 2007
Awash Supplies Company

X Branch Trial Balance
December, 2007
Debit Credit
Cash $ 10,500
Trade accounts receivable 20,500
Inventories 3,000
Home Office 2,500
Sales 42,500
Cost of goods sold 4,500
Operating Expenses 6,500 ______
$45,000 $45,000
Remeasurement of Branch Trial Balance
Remeasurement of X Branch trial balance on December 31, 2007 is shown below.
Awash Supplies Company
Remeasurement of X Branch Trial Balance to Ethiopian Birr
December 31, 2007
Balance ($) Exchange Balance
Dr (Cr) rate Birr Dr (Cr) _______
Cash $ 10,500 12.043 Br. 126,452
Trade accounts receivable 20,500 12.043 Br. 246,882
Inventories 3,000 12.050 Br. 36,150
Home Office (2,500) (30,170)
Sales (42,500) 12.0465 Br. (511,976)
Cost of goods sold 4,500 12.050 Br. 54,225
Operating Expenses 6,500 12.0465 Br. 78,302
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Sub totals $0 (135)
Foreign currency transaction loss 135
_____ _____
Totals $0 Br.0
In a review of the remeasurement of the American branch trial balance, the following
four features should be noted:
1. Monetary assets are remeasured at the current rate; the single nonmonetary assets-
inventories-is remeasured at the appropriate historical rate.
2. To achieve the same result as remeasurement of the home office ledger account
transactions at appropriate historical rates, the balance of the home office’s
investment in branch X accounts ( in Birr) is substituted for the branches’ home
office account ( in Dollar). All equity ledger accounts regardless of legal form of
the investee are remeasured at historical rates.
3. A simple average of beginning of year and end of year exchange rates is used to
remeaure revenue and expense accounts other than cost of goods sold, which is
remeasured at the appropriate historical rates. In practice, a quarterly, monthly or
even daily weighted average might be computed.
4. A balancing amount labeled transaction gain, which is not a ledger account, is
used to reconcile the total debits ant total credits of the branch’s remeasured trial
balance. This transaction gain is included in the measurement of the branch’s net
income for year1, because it results from the branch’s transactions having been
recorded in American Dollars, the branch’s local currency.
3.10 Summary
A branch is a unit of a business enterprise located some distance from the home office. A
branch generally caries a stock of merchandise obtained from home office, makes sales,
approves customers’ credit, and makes on collections on trade accounts receivable. The
merchandise of a branch may be obtained exclusively from the home office or a portion
may be purchased from outside suppliers. The cash receipts of the branch may be
deposited in a bank account of the home office; branch expenses are then paid from an
imprest cash fund provided by the home office. The imprest cash fund is replenished
periodically by the home office. Alternatively, a branch may maintain its own bank
account.
The accounting records for branches may be centralized in the home office or may be
decentralized so that each branch maintains a complete set of accounting records. If the
accounting records are centralized in the home office, each branch prepares daily reports
and documents that are used as sources for journal entries in the accounting records of the
home office. If a branch maintains its own accounting records, some transactions or
events relating to the branch may be recorded by the home office. Periodic financial
statements are provided by the branch to the home office so that combined statements
may be prepared.
The accounting records of the branch a Home Office ledger account that is credited for
assets and services provided by the home office, and for branch net income. The Home
Office account is debited for any assets and services provided by the branch to the home
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office or to other branches, and for branch net losses. The Home office account is thus an
ownership equity type account representing the net investment of the home office in the
branch. A home office maintains a reciprocal ledger account, Investment in Branch,
which is debited for assets and other services provided to a branch, and for net income of
branch; it is credited for the assets and services received from the branch, and for the
branch net losses.
Merchandises shipped by the home office to branches may be billed t home office cost, at
home office cost plus markup, or at retail selling price. The shipment of merchandise to a
branch is not a sale. Billing at home office cost attributes the entire gross profit on
merchandises sold by a branch to the branch. When the merchandise is billed at a price
above home office cost (or a retail-selling price), the valuation assigned to the branch
inventory at the end of the accounting period must be reduced to cost when combined
financial statements are prepared.
If the merchandise is billed to the branch a price above home office cost and the
perpetual inventory system is used, the home office debits Investment in Branch for the
billed price of the merchandise, credits inventories for the cost of merchandise, and
credits Allowance for Overvaluation of Inventories: Branch for the excess of the billed
price over cost. The branch debits Inventories and credits Home Office at billed prices of
merchandise; sales by the branch are debited to cost of goods sold and credited to
Inventories at billed prices.
A separate income statement and balance sheet for each branch may be prepared for use
by the enterprise management. A combined balance sheet for home office and branch
shows the financial position of the business enterprise as a single entity. In the working
paper for combined financial statements, the assts and liabilities of the branch are
substituted for the Investment in Branch ledger account included in the adjusted trial
balance of the home office. This is accompanied by elimination of the balances of the
Home Office and Investment in Branch reciprocal ledger accounts.
If the home office and branch use a periodic inventory system, the home office debits
Investment in Branch for the billed price of the merchandise shipped, credits Shipments
to Branch for the home office cost of the merchandise shipped, credits any excess of
billed price over cost to allowance for Overvaluation of Inventories: Branch. The branch
debits Shipments from Home Office and credits Home Office at billed price. At the end
of the accounting period, the home office reduces(debits) Allowance for Over valuation
of Inventories: Branch for the amount of overvaluation applicable to the branch’s cost of
goods sold and credits the amount of the reduction to the Realized Gross Profit: Branch
Sales ledger account. At the end of the period, the balance of Investment in Branch
account may not agree with the balance of the Home Office account. In such cases, the
reciprocal ledger account must be reconciled and brought up to date before combined
financial statements are prepared.
If the home office operates more than one branch, certain transactions, such as
merchandise shipments, may take place between branches. Such inter branch transactions
usually are cleared through the Home Office ledger account. The transfer of merchandise
from one branch to another does not justify increasing the carrying amount of inventories
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by the additional freight costs incurred because of the indirect routing. Excess freight
costs incurred because of such transfers are recognized as an operating expense of the
home office because the home office makes the decision to transfer the merchandise.
3.11 Review Questions
Answer the following questions.

1. What is a branch? What makes a branch different from the sales agency?
2. Explain the use of reciprocal ledger accounts in the home office and branch
accounting systems in conjunction with the periodic inventory system.
3. Explain the use of and journal entries for a home office’s Allowance for
Overvaluation of Inventories: Branch ledger account.
3.12 Self check Exercises

A. Select the best answer for each of the following multiple-choice questions:
1. A branch journal entry debiting Home Office and crediting cash may be prepared
for:
A. The branches transmittal of cash to the home office only
B. The branch’s acquisition for cash of plant assets to be carried in the home
office accounting records only.
C. Either A or B.
D. Neither A nor B.
2. Which of the following generally is not a method of billing merchandise shipments
by home office to a branch?
A. Billing at cost
B. Billing at a percentage above cost
C. Billing at a percentage below cost
D. Billing at retail selling prices.
3. A home office’s Allowance for Overvaluation of Inventories: Branch ledger
account, which has a credit balance is:
A. An asset Valuation account D. An expense account
B. A revenue account E. An equity account
C. A liability account
4. A branch uses Shipments from Home Office ledger account under the:
A. Periodic inventory system
B. Both in the periodic and perpetual system
C. Perpetual inventory system
D. Neither in the periodic nor perpetual system
5. If a home office bills merchandise shipments to the branch at a markup of 20% on
cost, the mark up on billed price is:
A. 50/3% C. 20%
B. 25% D. none
6. For a home office that uses a periodic inventory system of accounting for shipments
of merchandise to branch, the credit balance of the Shipments to Branch ledger
account is displayed in the home offices separate:
A. Income statement as an offset to Investment in branch

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B. Balance sheet as an offset to Investment in Branch
C. Balance sheet as an offset to Inventories
D. Income statement as revenue
7. If the home office maintains in its general ledger accounts for a branch’s plant
assets, the branch debits its acquisition of office equipment to:
A. Home Office D. Office equipment carried
B. Payable to home office by home office
C. Office Equipment
8. The appropriate journal entry for the home office to recognize the branch’s
expenditure of Birr 1,000 for equipment to be carried in the home office accounting
records is:
A. Equipment 1,000
Investment in Branch 1,000
B. Home Office 1,000
Equipment 1,000
C. Investment in Branch 1,000
Cash 1,000
D. Equipment: Branch 1,000
9. The appropriate journal entry in the accounting records of the home office to record
a Birr 10,000 cash remittance in transit from the branch at the end of an accounting
period is:
A. Cash 10,000 C. Cash 10,000
Cash in Transit 10,000 Home office 10,000
B. Cash in Transit 10,000 D. Cash in Transit 10,000
Investment in Branch 10,000 Cash 10,000
B. Try the following exercises

1. Consider the following transactions.
a) Rehoboth Corporation, located in Addis Ababa, establishes a branch called
Yedidya in Axum, Tigray by transferring cash of br. 20,000, office equipment
br. 5,000 and Store equipment br. 30,000.
b) The home office shipped merchandise at a billed price of br. 90,000 (50% above
home office cost).
c) Branch acquired equipment to be carried at home office for br. 1500.
d) Branch sales on account amounted br. 80,000 which costs br 65,000.
e) Branch collections on account amount br. 63,000.
f) Branch payment for operating expenses amount br. 7,000.
g) Branch transfer of cash to home office amount br 35,000.
h) Home office allocation of operating expenses to branch amount br. 1,500.
i) Branch transferred the operating result to home office and closed its temporary
accounts.
j) Home office made adjusting and closing entries.
Required:
A. Prepare journal entries for Rehoboth Corporation and Yedidya Branch to
record the above transactions. Both use the perpetual inventory system.
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B. Compute the balance of reciprocal ledge accounts.
2. The following information is available for Electra Corporation’s home office (Addis
Ababa) and its Dessie Branch at December 2009:
1. Balance on December 31, 2009:
Home Office account (Branch Books)………………………Br.452, 300
Investment in Branch: Dessie account (Home office Books)…..492,000
2. Dessie branch sent a check for Br.12, 000 cash to the home office on Dec.31
which is not received by the home office until January 2.
3. The home office shipped merchandise costing Br.20, 000 to its Dessie
branch on Dec.27, 2009 at a transfer price of Br.25, 000. The merchandise
was not received by Dessie branch until January 3, 2010.
4. Advertising expense of Br. 8,500 was allocated by the home office to Dessie
branch. The expenses were recorded at Br.5, 800 by the branch.
Required: a) Reconcile the reciprocal ledger accounts.
b) Prepare adjusting and correcting entries on December 31, 2009.
3. The home office of ABC Industries ships merchandise at its Br.200, 000 costs from
Addis Ababa to Gondar branch, and that it pays Br.2, 500 freight charges on the
merchandise. A few days later, the Bahir Dar branch experiences a merchandise shortage
and the merchandise is transferred from Gondar to Bahir Dar at Br.800 freight cost paid
by the Gondar branch .The cost of shipping the merchandise right from Addis Ababa to
Bahir Dar would have been Br.2,100.
Required: Journalize the necessary entries required to record the above events on the
books of: a) ABC Industries (Home office)
b) Gondar Branch
c) Bahir Dar Branch
N.B: please compare your answers for the exercises with the answers given at the end of
this module.
CHAPTER FOUR
INSTALLMENT SALES
Introduction
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Business enterprises always want to achieve the highest possible sales in order to
maximize their profit. Attaining maximum sales by following a strict cash sales policy
does not help them to meet their objective. Hence, instead of sticking to the cash sales
they design various sales mechanisms that allow them to maximize profit. Among the
mechanisms is allowing credit sales where customers are given time to pay after some
time for the goods purchased. Though giving such credit sales to customers, who do not
have the capacity to pay cash immediately at the time of sale, helps the seller to increase
sales volume, it has the risk of uncollectability. This risk mainly arise because of the fact
that customers are allowed an extended period of time over which they have to settle their
account. When the credit sales give the customers an extended period where in collection
of cash is made is called installment sales. If installment sales transactions represent a
significant part of total sales, full disclosure of installment sales and any expenses
allocable to installment sales is desirable.
Chapter Objectives
 Explain the characteristics of installment sales.
 Identify the methods of recognition of profit on installment sales.
 Describe the accounting for installment sales.
 Describe the accounting for defaults and reposition.
4.1. Characteristics of Installment Sales
The term installment sale describes any type of sale for which payment is required in
periodic installment over an extended period. In installment sales, customers make initial
payment at the time of purchasing goods and pay the balance on periodic installments.
An installment sale helps the seller to increase sales by giving the customers an extended
period of time for making payments, but increases the risk of uncollectability. Use of
installment sales is justified in situations where receivables are collected over an
extended period of time and there is no reasonable basis for estimating the degree of
collectability. The method is used extensively in tax accounting and has relevance
because of the increased emphasis on cash flows. The installment sale method allows the
taxpayer to defer the inclusion of income until the payments is made in cash or a cash
equivalent.
To protect themselves against this grater risk of uncollectability, sellers of real or
personal property on installment basis generally select a form of contract called security
agreement that enables them to repossess the property if the purchaser fails to make
payments. The sellers’ right to protect their security for the uncollectible balance of sales
contract and to repossess the item sold varies by type of industry, the form of contract,
and the law relating to repossessions. For example, for a service type enterprise,
repossessions obviously are not available as a safeguard against the failure to collect. The
concept of installment sales was first developed for sales of real estate and high priced
durable goods, and later it has spread through other types of sales such as sales of
merchandise.
4.2. Methods of Recognition of Profit on Installment Sales
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Recognizing of revenue from installment sales is some difficult than revenue recognition
from cash sales. The difficulty arises in matching the revenues with expenses. The
question here is whether to recognize the gross profit from installment sale are
recognized in full in the accounting period in which the sale made or spread over the term
of the installment contract. Normally according to the generally accepted accounting
principles for recognizing revenues under the accrual basis of accounting, revenues are
recognized in the period in which a sale is made. However, in installment sales, because
of the uncertainty involved in collecting the accounts to be received over an extended
period of time may suggest the postponement of revenue recognition until the probability
of collection can be reasonably estimated.
There are two general approaches in recognizing gross profit on installment sales:
1. The gross profit may be recognized in the period in which the sales were made
2. The gross profit may be recognized in the period in which cash is collected on the
installment sales contract.
4.2.1. Gross Profit Recognized in the Period of Sale
In this approach the installment sales is recognized in the period in which the sales were
made which is similar to that employed for regular sales. Gross profit may be recognized
at the time of sale, the point at which goods are exchanged for legally enforceable claims
against customers.
4.2.2. Gross profit Recognized in the Period in which Cash is Collected
In this approach the gross profit is recognized related to the periods in which the
installment receivables are collected rather than to the periods in which sales was made.
Thus the inflow of cash rather than the time become the criterion for revenue recognition.
The following procedures can be applied in recognizing gross profit related to the periods
in which cash is collected. However; the installment sales plan that is employed must be
considered carefully in making a choice as to the procedures that will measure net income
most satisfactorily.
1. Collections regarded as first recovery of cost. This is the most conservative
approach under which collections on installment sales are first regarded as
recover of costs. After the recovery of the cost, all further collections are regarded
as profit. This method is more acceptable only when there is doubt as to any
recoverable value associated with the balance of the installment receivables or the
goods subject to repossessions.
2. Collections regarded as first the realization of profit. Under this approach
collections are first regarded as representing the realization of profit on the
contract. After recognition of the full profit on the transaction, all further
collections are regarded as a recovery of cost. This procedure lacks sufficient
conservatism under most circumstances in view of the probability that the defaults
and repossessions over the life of contracts will impair the original profit margin.
3. Collections regarded as both return of cost and realization of profit. In this
procedure, each collection on installment receivable is regarded as representing
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both a return of cost and a realization of gross profit in the ratio in which these
two factors are found in the original sales price. The gross profit on installment
sales in this method is spread over the full life of the installment contract.
Continuing expenses on an installment contract are matched against the gross
profit that is recognized in successive periods; the possible failure to realize the
full amount of the gross profit in the event of default by the buyer is anticipated.
When gross profit is recognized in proportion to collections on installment receivables it
is called installment method.
4.3. Accounting for Installment Sales
The installment sales method is one of several approaches used to recognize revenue.
Methods such as the cost recovery method and the cash method are two of several other
methods used to recognize revenue. Revenue recognition is deferred when collection of
sales price is not reasonably assured and no reliable estimates can be made. The
installment method places emphasis on collection of cash, rather than the period of sale,
as installment sales lead to income realization in the period of collection. This does not
mean that revenue is considered unrealized until the entire sales price has been collected
but rather the revenue realization is proportionate to collection. This is due to the fact that
the ultimate profit is more uncertain in installment sales than in ordinary sales because
collection is more doubtful.
Under the installment sales of accounting, the gross profit (sales less cost of goods sold)
on installment sales are deferred to those periods in which cash is collected. Operating
expenses such as selling and administrative expenses are treated as expenses in the period
they are incurred. Thus the installment method of accounting normally implies the
deferral of gross profit but the recognition of selling and administrative expenses in the
period of their incurrence. The deferred gross profit on installment sales is generally
treated as unearned revenue and classified as current liability.
The following procedures apply under the installment sales method:

1. During the year, record both sales and cost of sales in the regular way using
separate installment sales accounts and compute the rate of gross profit on
installment sales transactions.
2. At the end of the year, apply the rate of gross profit to the cash collections of the
current year’s installment sales to arrive at the realized gross profit.
3. The gross profit not realized should be deferred to future years.
In any years in which collections from prior years’ installment sales are received, the
gross profit rate of each year’s sales must be applied against cash collections of accounts
resulting from the year’s sales to arrive at the realized gross profit.
Example One: To illustrate the installment sales method of accounting, assume the
following data for X Enterprise.
2003 2004 2005
Installment sales Birr 200,000 Birr 250,000 Birr 240,000
Cost of installment sales (150,000) (190,000) (168,000)
Gross Profit 50,000 60,000 72,000
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Gross profit rate 25% 24% 30%
Cash received in:
From 2003 sales 60,000 100,000 40,000
From 2004 sales -0- 100,000 125,000
From 2005 sales -0- -0- 80,000
Required: Determine the realized and deferred gross profit and pass the necessary journal
entries at the end of each year.
Solution
1) To record installment sales
2003 2004 2005
Installment A/ Receivable 200,000 250,000 240,000
Installment Sales 200,000 250,000 240,000
2) To record cash collections on installment receivables

Cash 60,000 200,000 245,000
Installment A/ Receivable (2003) 60,000 100,000 40,000
Installment A/Receivable (2004) - 100,000 125,000
Installment A/Receivable (2005) - - 80,000
3) To Record cost of goods sold
Cost of installment sales 150,000 190,000 168,000
Inventories 150,000 190,000 168,000
4) To close installment sales and cost of installment sales
Installment Sales 200,000 250,000 240,000
Cost of installment sales 150,000 190,000 168,000
Deferred Gross Profit 50,000 60,000 72,000
5) To record realized gross profit

Deferred Gross Profit (2003) 15,000 25,000 10,000
Deferred Gross Profit (2004) - 24,000 30,000
Deferred Gross Profit (2005) - - 24,000
Realized Gross Profit 15,000 49,000 64, 000
The realized gross profit above is computed by applying the gross profit rate on the cash
collections of each year. i.e. 25 %( 60,000); 25% (100,000); 25% (40,000) for the year
2003. For the year 2004, 24 %( 100,000); and 24 %( 125,000) and 30 %( 80,000) for the
year 2005.
6) To close the realized gross profit to income summary
Realized Gross Profit 15,000 49,000 64,000

Income Summary 15,000 49,000 64,000
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The deferred gross profits at the end of each year are as follows:
For the year 2003, Birr 35,000 (50,000-15,000) = 35,000
For the year 2004, Birr 46,000 (60,000+35,000-49,000) = 46,000
For the year 2005, Birr 54,000 (72,000+46,000-64,000) = 54,000
Example Two: Alpha PLC sold a piece of land for Br. 110,000 and the acquisition cost
was Br. 40,000. Commission and expenses pertaining to the sale were Br.10, 000. The net
account receivable was Br.100, 000 of which 40% is considered as return in an
investment in land and 60% was considered as deferred gross profit. All collections from
the buyer were regarded as consisting of 40% cost balance and 60% as realized gain.
The contract of sale called for a down payment of Br.20, 000 and promissory note with
payments every six month in the amount of Br. 7,500 plus interest at the annual rate of
8% on the unpaid balance for six years. One half of the down payment was considered as
deductions towards expenses and commissions. The land was sold on November 1, 2000
and the accounting period ends on December 31 of each year.
Required: Prepare journal entries for the first three years of installment collection.
Solution
Year One
November 1 / Cash 10,000
2000 Notes Receivable 90,000
Land 40,000
Deferred Gross Profit 60,000
December 31/ Deferred Gross Profit 6,000 [10,000x60%= 6,000]
2000 Realized Gross Profit 6,000
December 31/ Interest Receivable 1,200 [90,000x8%x2/12= 1,200]
2000 Interest Revenue 1,200
Year Two
May 1, 2001 Cash 11,100
Notes Receivable 7,500
Interest Receivable 1,200
Interest Revenue 2,400 [90,000x8%x4/12= 2,400]
Nov. 1, 2001 Cash 10,800
Interest Revenue 3,300 [82,500x8%x 6/12= 3,300]
Dec.31, 2001 Deferred Gross Profit 9,000 [15,000x60%= 9,000]

Realized Gross Profit 9,000
Dec.31, 2001 Interest Receivable 1,000 [75,000x8%x2/12= 1,000]
Interest Revenue 1,000
Year Three
May 1, 2002/ Cash 10,500
____________________________________________________________________ 110
Interest Revenue 2,000 [75,000x8%x4/12= 2,000]
Nov. 1, 2002 Cash 10,200
Interest Revenue 2,700 [67,500x8%x 6/12= 2,700]
Dec.31, 2002 Deferred Gross Profit 9,000 [15,000x60%= 9000]
Dec.31, 2002 Interest Receivable 800 [60,000x8%x2/12= 800]
Interest Revenue 800
4.4. Defaults and Repossessions
Since customers in installment sales are given an extended period of time in making
payments, the seller involves a grater risk for the collectivity of installment sales
receivable. To protect themselves against this grater risk of uncollectability, sellers of real
or personal property on installment basis generally select a form of contract called
security agreement that enables them to repossess the property if the purchaser fails to
make payments.
The accounting for defaults and repossessions, on an installment contract recognizes and
repossessions of the article sold needs an entry on the book of the seller. The seller
reports the merchandise reacquired; written off the related installment receivable account
that is not collectible; and also removes the related applicable deferred gross profit from
the ledger.
Repossessed merchandise should be recorded in the repossessed merchandise inventory

account at its fair value. The objective is to put any asset reacquired on the books at its
fair value or, when fair value is not ascertainable, at the best possible approximation of
fair value.
Illustration: Assume the following data:
Total installment sales for the year 2000 Birr 80,000

Gross profit rate on installment sales in the year 2000 30%
In 2001, a customer defaults on a contract for Birr 500 that had originated in the year
2000. A total of Birr 230 had been collected on the contract in 2000 prior to the default.
The merchandise sold is repossessed and its fair value to the company is Birr 150,
allowing for reconditioning costs and a normal gross profit on resale. The journal entry to
record the default and repossessions is as follows:
Merchandise –Repossessions 150

Deferred gross profit-2000 (30%x270) 81
Loss on repossessions (270-(150+81) 39
Installment contract receivable (500-230) 270
____________________________________________________________________ 111
Writing off the installment sales receivable balance of Birr 270 is accompanied by
removal of deferred gross profit of Birr 81(30% of Birr 270). The repossessed
merchandise is at its fair value of Birr 150. A loss of Birr 39 is recognized on the
repossession, representing the difference between the installment contract balances
canceled Birr 270, the deferred gross profit Birr 81 and the value assigned to repossessed
merchandise [270-(150+81)=39].
If the repossessed merchandise in the above given example is recorded at a value above
the Birr 270, the difference between the balance in the installment contract receivable
account and the deferred gross profit account, will be a gain. However, the conservatism
principle suggests no gain would be recognized at the time of repossession and
recognition of the gain should wait the sale of the repossessed goods. Any gain or loss on
defaults and repossessions is reported on the income statement as an addition or
subtraction from the realized profit on installment sales.
Assume that the merchandise from the preceding example has a value Birr 200 the
journal entry to record the defaults and repositions is as fallows:
Merchandise – Repossessions 200

Deferred gross profit (30% of 270) 81
Installment contract receivable (500-230) 270
Gain on repossessions 11
4.5. Summary
Business enterprises always want to achieve the highest possible sales in order to
maximize their profit. Attaining maximum sales by following a strict cash sales policy
does not help them to meet their objective. Hence, instead of sticking to the cash sales
they design various sales mechanisms that allow them to maximize profit. Among the
mechanisms is allowing credit sales where customers are given time to pay after some
time for the goods purchased. When the credit sales give the customers an extended
period where in collection of cash is made is called installment sales.
The term installment sale describes any type of sale for which payment is required in
periodic installment over an extended period. In installment sales, customers make initial
payment at the time of purchasing goods and pay the balance on periodic installments.
Installment sales can be accounted for either by the point of sale method or the
installment method. Under the point of sale method, the entire gross profit on the
installment sales is realized in the year in which the sale has been carried out. Under the
installment method, profit is realized only to the extent of cash collected in a particular
period.
4.6. Review Questions
Answer the following questions

1. What is an installment sale?
2. What are the methods of profit recognition on installment sales?
3. What is meant by default and repossession?
4. Explain the following:
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a). Installment contract sales
b). Repossession of merchandise inventories sold under installment sales method.
4.7. Self Check Exercises
1. On August 31, 2000, the Alemgena Co. sold merchandise inventory to the
Yirgalem Co. for Br.500, 000.Terms of the sale called for a down payment of Br.
100,000 and four annual installments of Br. 100,000 due on each August 31,
beginning August 31, 2001. Each installment also will include interest of 9 % on
the unpaid balance. The book value of the merchandise inventory on Alemgena’s
book on the date of sale was Br. 300,000.The Company uses the perpetual
inventory system and its fiscal year end on December 31.
Required:
a) Compute the amount gross profit to be recognized in each of the five years
of the installment sale using the installment sales method.
b) Prepare necessary journal entries (including adjustments) for the first 3
years.
2. The ABX Corporation, which began business in 2000, appropriately uses the
installment sales method of accounting for its installment sales. The following
data were obtained for sales made during 2000 and 2001.
2000 2001
Installment Sales Br. 360,000 Br. 350,000
Cost of Installment Sales (216,000) (145,000)
Gross Profit 144,000 205,000
Rate of Gross Profit 40% 59%
Cash collection on installment sales during:

2000 150,000 100,000
2001 - 120,000
Required:
b). How much gross profit should be recognized in 2000 and 2001?
b). What should be the balance in the deferred gross profit account at the end of
2000 and 2001?
c). Prepare summary journal entries for 2000 and 2001 to account for the installment
sales and cash collections. The company uses the perpetual inventory system.
this module.
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CHAPTER FIVE
CONSIGNMENT SALES
Introduction
The increasing size of the market is making more complexity and difficulty for the
businessman to come in direct contact with the customers living at far off distance.
Generally, this situation forced businessman to enter into an agreement with a reliable
local trader who can sell goods on his behalf and in his risk for agreed amount of
commission. Such a dispatch of goods from one person to another person at a different
place for the purpose of warehousing and ultimate sale is termed as consignment sales.
Sellers seeking new and expanded wholesale and retail markets for goods can use
consignment sales to economic advantage in many cases.
Chapter Objectives
 Describe what consignment sales is?
 Distinguishing between sales on consignment and regular sales.
 Describe the accounting for consignor and consignee.
5.1. What is Consignment?
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Instead of making direct sales, individuals and businesses often place goods with others
who make sales for them. These types of transactions are commonly called consignment
sales. Consignment is the act of consigning, which is placing a person or thing in the
hand of another, but retaining ownership until the goods are sold or person is transferred.
This may be done for shipping, or for sale in a store (i.e. a consignment shop). Also
commonly used in the drug dealing trade. Therefore, consignment is the transfer of goods
by their owner to another party who is to act as a sales agent, where legal title to the
goods retained by the owner until their sale. The party who owns the goods is known as
the consignor; the party who makes the sell of the goods on the owner’s behalf is known
as the consignee.
5.2. Distinguishing between Sales on Consignment and Regular Sales
A proper distinction between a sale and consignment should be made though both
involve the shipment of merchandise. This is particularly important in the determination
of inventories and cost of merchandise sold and for the proper measurement of income.
When the merchandises are shipped on consignment, ownership (title) of the merchandise
does not pass to the consignee until the merchandises are sold but remains on the hands
of the consignor. Therefore, the consignor includes the merchandises as part of inventory
at the end of the fiscal period. Moreover, unlike regular sales the consigner recognizes no
revenue at the time when the merchandises are shipped (transferred) to the consignee.
In general, the following distinctions can be made between regular and consignment
sales:
1. In consignment, the legal ownership of the goods (merchandises) remains with

the consignor and the property in the goods does not pass to the consignee.
Consigned goods are included in the inventory of the consignor, but excluded
from the consignee’s inventory. However, in regular sales the ownership of goods
passes directly from the seller to the buyer.
2. In consignment, the risk attaching to the goods does not pass to the consignee.
The loss or damage to goods is to be born by the consignor, provided that the
consignee has taken responsible care of the goods and the loss or damage is due to
his negligence. However, in regular sales the risk attaching to the goods passes
along with ownership to the buyer.
3. In consignment, the relationship between the consignor and consignee is that of
principal and agent guided by laws that govern relationship of principal and agent.
On the other hand, the relationship between the seller and the buyer in regular
sales is that of creditor and debtor. The person to whom the goods are sold is the
debtor.
4. A consignment good is returnable if it can not be sold in consignment sales;
where as in regular sales the goods sold are not returnable except for some special
reasons such as damage or wrong quality of goods.
5. Revenue from consignment sales is recognized when the goods are transferred to
third party (sold) by the consignee; where as revenue form regular sales is
recognized when the seller transfers ownership and goods to the seller.
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5.3 Advantages of Consignment Sales
Advantages of consignment sales to the consignor
Consignment sale has the following advantages for the consignor:
It provides the manufacturer with the opportunity to have the merchandise
exposed to the buying market, instead of having it stored and isolated in a
warehouse while waiting for an order from a buyer. The dealer (consignee)
incurring neither the liability nor the risk involved with the purchase of the goods
is generally willing to accept goods on a consignment basis.
The consignor avoids the risk of inherent in selling on credit to dealers of
questionable financial strength.
The consignor, who still owns the consigned goods, can control the selling price
of the consigned goods. This may be difficult or impossible when the goods are
actually sold to the dealer.
The consignor, particularly for the sale of grain and livestock, may obtain selling
specialists. The compensation for such services is frequently a commission, which
may be a percentage of sales price or a fixed amount for each unit of the goods
sold.
Advantages of consignment sales to consignee
The consignee may favor the acquisition of goods on consignment for the following
reasons:
The consignee avoids the risk of ownership due to lack of inability to sale,
obsolescence, and decline in market value.
The consignee requires less capital investment as there is no payment for receipt
or possession of consigned goods.
5. 4 Rights and Responsibilities of the Consignee
In the transfer of goods on consignment, a written contract should be prepared expressing

the nature of the relationship. The contract covers such matters as:
credit terms to be granted by the consignee to customers;
expenses of the consignee to be reimbursed by the consignor;
commissions or profits to be allowed to the consignee;
care and handling of consignment inventories and proceeds from consignment
sales;
remittances and settlements by the consignee ; and
reports to be submitted by the consignee.
The rights and duties of the consignee are established and defined by the laws of bailment
and of agency, as modified by the Uniform Commercial Code. The following rights and
duties are among the most important once:
Consignee’s rights
1. The consignee is entitled to reimbursement for necessary expenditures on
consigned goods and to compensation for sales. Necessary expenditures depends
____________________________________________________________________ 116
upon the nature of the consigned goods and ordinarily include freight, insurance,
taxes, storage, handling charges, repairs under warranties, and such other charges
as are by custom born by the consignor.
2. Granting of normal credit terms, sometimes followed by guaranteeing collection
as Del creder agent, with additional compensation for assuming such risk.
3. The consignor has the right to offer the customary warranties on goods that are
sold, and the consignor is bound by the terms of such warranties.
Consignee’s duties (responsibilities)
1. The consignee must protect the consigned goods with due care. In addition the
consignee should exercise due care in granting and collecting receivables; such as
selling goods at specified price, granting normal credit terms, making normal
warranty, exert reasonable effort to collect the sales price.
2. The consignee should render timely periodic reporting of sales and collections
called account sales to the consignor which contains the information about;
Consignment goods recorded and sold,
Sales price,
Expenses incurred by consignee and chargeable to consignor,
Advances made by consignee,
Amounts owed due (payable) to consignor or due from (receivable) consignor and
remittances.
3. If the consignee has merchandises other than consigned goods, the consignee must
keep the goods of the consignor apart from other merchandises. In addition, the
consignment account receivable should not be combined with the consignee’s
own receivable.
5.5. Accounting for Consigned Goods
5.5.1. Accounting for Consignee
When the profits from consignment sales are to be separately determined, the consignee
maintained an account called consignment -In for each consignment. This account is
debited for all expenses to be absorbed by the consignor and is credited for the full
proceeds from consignment sales. The commission or profit on consignment sales is
transferred from the consignment -In account to a separate revenue account, and the
resulting balance in the consignment -In account reports the amount that is owed to the
consignor in settlement.
Consignee’s Records: The consignee records the following entries:
1. Transfer of goods to the consignee: the consignee records the receipt of goods on
consignment by a memorandum in the journal or in a separate book maintained
for such purpose. Supplementary records showing all details with respect to goods
received on consignment should be kept. This may be maintained in a subsidiary
ledger account.
2. Expenses of consignor identified with the consignment: The consignee is not
affected by transactions of the consignor.
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3. Expenses of the consignee identified with the consignment: consignee records
expenses that are to be absorbed by consignor by debiting consignment –In and
crediting appropriate asset or liability accounts. When an expense account that is
to absorbed entirely or in part by the consignor is originally debited on the
consignee’s book, Consignment-In is debited and the expense account is credited
for the amount chargeable to the consignor.
4. Sales by the consignee: When the merchandises shipped to the consignee are sold
to customer; the consignee records consignment sales by debiting the appropriate
asset account and crediting Consignment-In account.
5. Commission or profit accruing to the consignee: The consignee records the
commission or profit on consignment sales by debiting Consignment-In and
crediting appropriate revenue account. After the commission or profit is recorded,
the credit balances in Consignment-In recorded shows the amount that is owed to
the consignor in final settlement. Since no part of the consignee’s expenses has
been assigned to consignment commissions or profits, the consignment revenue
account must be regarded as gross profit balance.
6. Remittance and account sales rendered by the consignee: remittance of cash to
the consignor is recorded by the consignee by debiting Consignment- In and
crediting Cash. If the consignee makes the full amount cash to consignor, the
entry to record the payment closes the Consignment-In account. Some times the
consignee is required to make advance cash payments to the consignor up on
receiving the goods on consignment. Such advances may be recorded by debiting
an asset account, Advances to consignor, and a credit to Cash. The advances are
recognized as reductions in the amount owed to the consignor when settlement is
made. When remittance is made by the consignee for the difference between the
amount owed on consignment sales and the amount originally advanced, the
account reporting the liability to the consignor is debited, the advances account is
credited and cash is credited.
5.5.2. Accounting for Consignor
When the profits from consignment sales are to be separately determined, the consignor
maintains a Consignment-Out account for each consignment. Consignment-Out account
is debited for the cost of merchandise shipped to the consignee and for all other expenses
related to the consignment; it is credited for sales made by the consignee. Profit or loss
from consignment sales is ultimately transferred from the Consignment-Out account to
the income summary account in which new results from all activities are summarized.
Consignor’s Records: In general the consignor makes the following entries for the given
transactions:
1. Transfer of goods to the consignee: The transfer of goods from the consignor to
the consignee is recorded by the consignor as a debit to Consignment- Out and
credit to Merchandise Shipments on consignment if periodic inventory system is
used or Inventory account if perpetual inventory systems are used. In the
determination of the cost of goods available for regular sales, Merchandise
Shipments on Consignment is treated as a deduction from the sum of the
beginning inventory and purchases.
____________________________________________________________________ 118
2. Expenses of consignor identified with the consignment: The consignor records
expenses that are related to the consignment by debiting Consignment-Out and
crediting cash or liability accounts. When an expense account was originally
debited for an expense that is related to the consignment, Consignment-Out is
debited and the expense account is credited for the amount identified with the
consignment.
3. Expenses of the consignee identified with the consignment sales by the
consignee- commission charge by the consignee: the consignor makes no entries
for transactions of the consignee until a statement is received from consignee.
4. Remittance and account sales rendered by the consignee: When the consignor
receives an account sale, cash is debited for the cash remittance, Consignment Out
is debited for the total expense charged to the consignor’s account by the
consignee, and Consignment Out is credited for the gross sales reported by the
consignee. It is also possible to debit Cash and credit Consignment- Out for the
net proceeds from consignment sales and the balance of Consignment-Out would
be the same in both cases.
When the consignor needs advance cash receipts on consignment shipments, the advance
cash receipt may be recorded by debiting cash and crediting a liability account, Advances
from consignee. At the time of settlement a debit will be made to cash and advances
account; and a credit will be made to the Consignment-Out account recognizing revenues
and expenses reported by the consignee.
The consignment account shows the net result from consignment transactions, when all
of the consigned goods have been sold. A credit balance in Consignment-Out shows that
consignment revenue has exceeded consignment expenses, resulting in a profit; a debit
balance indicates that the consignment expenses have exceeded consignment revenue
resulting in a loss. The balance of profit or revenue is then transferred to an income
summary account by a closing entry.
Illustration: The following transactions are carried out by S Company (consignor) and F
Company (consignee).
1. S company shipped consignments to F Company 10 sets of refrigerators, which

cost Birr 5,000 each.
2. Authorized selling price was Birr 8,000 each.
3. Cost of packing the merchandise for shipment Birr 600. All costs incurred in the
packing department are charged to the packing expense.
4. Freight charges paid by consignee amounted to Birr 2700.
5. Consignee was entitled for sales commission of 20%.
6. All refrigerators sets were sold by the consignee at Birr 8000 each.
7. After deducting the commission of 20% and freight charges of Birr 2,700; F
Company sent a check for Birr 61,300 and the account sales to S Company.
Required: a) Prepare journal entries in both S and F Company books.

b) Prepare Consignment Out and Consignment In accounts.
____________________________________________________________________ 119
c) Prepare sales account
Assume the following two Situations:
I. All the 10 sets of refrigerators are sold –Complete sales
II. Only 4 sets of refrigerators are sold - Partial sales of sets
Situation Case I- When all the 10 sets are sold
a) Journal entries in S&F books
Transaction Consignor Book Consignee Book

1 Shipment of merchandise Consignment –Out 50,000 Memorandum Entry
at Birr 5,000 each on Inventory 50,000 Received 10 sets of
consignment. Consigned refrigerators to be sold for
merchandise is transferred Birr 8,000 each at a
to a separate inventory commission of 20% each
account- Consignment – and at a cost of Birr 5,000
Out. each.
2 Expense of Birr 600 Consignment-Out 600
allocated to consigned Packing Expense 600 No entry
merchandise (which was
previously recorded in
packing expense)
3 Consignment records of No entry Consignment- In 270
fright charges S company
Cash 270
4 Consignment sales of Birr Cash 61, 300
80,000 by consignee and Consignment-Out 2,700 Cash 80,000
payment of sales proceeds Commission-Exp 16,000 Consignment-In
recorded after deducting Consignment S- Company 80,000
payment and commission. Sales 80,000
5 Commission revenue Consignment In
recorded by the consignee S Company 16,000
Commission
Revenue 16,000
6 Cost of consignment sales Cost of consignment
recorded by the consignor Sales 53,300
Consignment-Out 53,300
7 Payment by the consignee Consignment-In
to the consignor through S Company 61,300
check Cash 61,300
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b) Consignment-Out and consignment-In accounts
Summary of Consignment -Out account (S Company)
Date Details Debit Credit Balance (Dr)
Inventory 50,000 - 50,000
Packing Expense 600 50,600
Fright 2,700 53,300
Cost of sales - 53,300 -
Presentation on the income statement:

Consignment Sales Birr 80,000
Less: Cost of consignment sales 53,300
Commission Expense 16,000 69,300
Gross profit on Consignment Sales Birr 10,700
Summary of Consignment- In account (F Company)

Date Details Debit Credit Balance (Cr)
Cash Freight 2,700 - 2,700
Commission 16,000 - 18,700
Cash Sales - 80,000 61,300
Payment to Consignor 61,300 - -0-
C) Preparing Sales Account by F Company (Consignee)

F Truck Company
Account Sales
Sales for Account January 17, 2008
S Company
Sales of 10 refrigerators @ Birr 8,000 each Birr 80,000
Less: Charges: Freight 2,700
Commission 16,000 (18,700)
Balance check enclosed Birr 61,300
Consigned refrigerator set on hand None (0)
Case II: Partial Sales of Consigned Goods
c) Journal entries in S&F books

Transaction Consignor Book Consignee Book
1 Shipment of merchandise at Memorandum Entry
Birr 5,000 each on Consignment –Out 20,000 Received 10 sets of
consignment Consigned Inventory 20,000 refrigerators to be sold for
merchandise is transferred to ( 4X5,000 each) Birr 8,000 each at a
a separate inventory account- commission of 20% each
Consignment –Out. and at a cost of Birr 5,000
each.
2 Expense of Birr 600 Consignment-Out 600
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allocated to consigned Packing Expense 600 No entry
merchandise (which was
previously recorded in
packing expense)
3 Consignment records of No entry Consignment- In 270
fright charges S company
Cash 270
4 Consignment sales of Birr Cash 10, 000
32,000 by consignee and A/ Receivable 12,900 Cash 19,100
payment Birr 10,000 Consignment-Out 2,700 A/ Receivable 12,900
received after charging by Commission
consignee: fright Birr 2,700, Expense 6,400 Consignment-In
commission (20%) 6,400. Consignment S- Company 32,000
Sales 32,000
5 Commission revenue Consignment In
recorded by the consignee S Company 6,400
Commission
Revenue 6,400
6 Cost of consignment sales Cost of consignment
recorded by the consignor Sales 21,320
[ 4( 5000+600/10+2700/10)] Consignment
= 21,120 -Out 21,320
7 Payment by the consignee to Consignment-In
the consignor through check S Company 10,000
Cash 10,000
b) Consignment-Out and consignment-In accounts

Summary of Consignment -Out account (S Company)
Date Details Debit Credit Balance (Dr)
Inventory 50,000 - 50,000
Packing Expense 600 50,600
Freight 2,700 53,300
Cost of sales - 21,320 31,980
Presentation on the Balance Sheet

Assets
Current Assets
Inventory on Consignment Birr 31,980
Summary of Consignment- In account (F Company)

Date Details Debit Credit Balance (Cr)
Cash Freight 2,700 - (2,700)
Commission 6,400 - (9,100)
Cash Sales - 32,000 22,900
Payment to Consignor 10,000 - 12,900
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c) Preparing Sales Account by F Company (Consignee)
F Truck Company
Account Sales
Sales for Account January 17, 2008
S Company
Sales of 4 sets refrigerators @ Birr 8,000 each Birr 32,000

Less: Charges: Freight 2,700
Commission 6,400 (9,100)
Balance payable to consignor 22,900
Balance check enclosed (10,000)
Balance due to consignor Birr 12,900
Consigned refrigerator set on hand Six (6)
5.6 Summary
Sellers seeking new and expanded wholesale and retail markets for goods can use
consignment sales to economic advantage in many cases. Selling goods on consignment
is described as a situation whereby goods are shipped to a dealer who pays you, the
consignor, only for the merchandise which sells. The dealer, referred to as the consignee,
has the right to return to you the merchandise which does not sell and without obligation.
Even with obvious disadvantages, there may be times when you may decide that
consignment selling can serve your purpose. It can be used as a marketing tool which
creates no obligation on the part of the dealer in the event they do not sell. As a result,
such practice can provide an attractive incentive for the dealer, at least to stock your
merchandise. The dealer has no risk and you have your merchandise before the buying
public. Examples of goods which very often are sold on consignment include light bulbs,
eggs, poultry, magazines, newspapers, Christmas decorations, garden seeds, batteries for
flashlights, and potted plants such as those found in supermarkets.
5. 7 Review Questions
Answer the following questions.

1. What is consignment?
2. What are the advantages of consignment sale?
3. What is the difference between normal sale and consignment sale?
4. Discuss accounting for consignment sales for consignor and consignee.
5. What are the rights and responsibilities/duties of the consignee?
____________________________________________________________________ 123
5.8 Self Check Exercises
1. The following transactions are related to Garad Trading (consignor) and Solar
Music Shop (consignee).
Jan.1. Shipment of 10 radio sets on consignment; cost to consignor Br.150 each.
Jan.1. Freight costs of consignor identified with the consignment, Br.60.The
expenses were previously recorded in freight account.
Jan.15. Freight costs paid by consignee, Br.25.
Jan.31. Sale of 10 units for Br.3000.
Jan. 31. Received account sales: 10 units sold for Br.3000, commission of 20% and
freight cost of Br.25 was deducted and the balance remitted.
Jan.31. Adjustment to record the cost of sales.
Required:
a) Prepare journal entries for the following transactions on the books consignor
and consignee.
b) Prepare consignment out and consignment in account.
2. Consider the information given in 1. Assume that from the consigned goods,
only 5 radio sets were sold and consignment sales of Br. 1500 were reported by
consignee with payment of Br.800 received after deducting freight of Br.25 and
commission of 20%.
Required: a) Prepare journal entries for consignor and consignee.

b) Prepare consignment out and consignment in accounts.
c) Prepare account sales.
this module.
SOLUTION FOR SELF CHECK EXERCISES
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CHAPTER ONE
Answers to multiple choice questions
1b)
1. A 7. B
2. A 8. A
3. B 9. A
4. D 10. A
5. B 11. C
6. A 12. B
Answers to exercises
Ex.1.1 C&D LLP

Income sharing schedule
For the month ended January 31, 1999
C D Total
Salaries (30,000/12) Br. 2,500 Br. 2,500 Br. 5,000
Interest (6%x80, 000x1/12; 6%x70, 000 x 1/12); 400 350 750
Remaining divided equally (20,000-5750=14250) 7125 7,125 14,250
Total Br. 10,025 Br. 9,975 Br. 20,000
Journal Entries: Partner’s Salaries Expense 5,000

C, Capital 2,500
D, Capital 2,500

C, Capital 10,025
D, Capital 9,975
Ex.1.2. a) Cash 30,000

A, Capital (3/4x 10,000) 7,500
B, capital (1/4x 10,000) 2,500
C, Capital (1/4x 80,000) 20,000
b) Cash 30,000
Assets 16,000
A, Capital (26,000x3/4) 19,500
B, Capital (26,000x1/4) 6,500
C, Capital 20,000
Ex.1.3. a) Inventories 60,000

L, Capital (60000x.5) 30,000
____________________________________________________________________ 125
M, Capital (60,000x.2) 12,000
N, Capital (60,000x.3) 18,000
b) Total partnership capital= Birr 260,000 as shown below
L, Capital (30,000) + 30,000+ (20,000 receivable) = 20,000 Dr.
M, Capital 120,000+12,000 =132,000Cr
N, Capital 70,000+ 60,000+18,000= 148,000 Cr
Total partnership capital= 20,000Dr. + 132,000Dr. +148,000 Cr. = Birr 260,000Cr
Capital interest of new partner O= 20%x260, 000= 52,000
Journal entry: Cash 40,000
L, Capital (12,000x.5) 6,000
M, Capital (12,000x.2) 2,400
N, Capital (12,000x.3) 3,600
O, Capital 52,000
Ex.1.4. a) Revaluation of assets (260,000-200,000) 60,000
K, Capital (60,000x20%) 12,000
L, Capital (60,000x20%) 12,000
M, Capital (60,000x60%) 36,000
b) K, Capital 92,000
Loan Payable to K 15,000
Cash 107,000
Ex.1.5. Cash P Q R
Balance 15,000 (9,000) 8,000 16,000
Division of loss - 9,000 (4,500) (4,500)
Balance 15,000 0 3,500 11,500
Division of cash (15,000) - (3,500) (11,500)
Journal Entry: Q, Capital 4,500

R, Capital 4,500
P, Capital 9,000
Q, Capital 3,500
R, Capital 11,500
Cash 15,000
Ex.1.6. Cash Non Cash assets Liabilities E F G

Balance 42,000 78,000 5,000 33,000 40,000 42,000
Payment of liabilities (5,000) - (5,000) - - -
Balance 37,000 78,000 0 33,000 40,000 42,000
CHAPTER THREE
Answers to multiple choice questions

1b) 1. C 6. A
____________________________________________________________________ 126
2. C 7. A
3. A 8. D
4. A 9. B
5. B
1a) Journal entries for Rehoboth Corporation and Yedidya Branch
Investment in Yedidya Branch Home Office Accounts
(Home Office Record) (Yedidya Branch Record)
a). Investment in Branch 55,000 b). Cash 20,000
Cash 20,000 Office Equipment 5,000
Office equipment 5,000 Store Equipment 30,000
Store equipment 30,000 Home Office 55,000
b). Investment in Branch 90,000 b).Merchandise Inventory 90,000
Merch. Inventory 60,000 Home Office 90,000
Allowance for Over-
valuation of Inventory 30,000
c). Equipment 1,500 c). Home Office 1,500
d). No entry d).A/Receivable 80,000
Sales 85,000
Merchandise Inventory 53,333
e). No entry e). Cash 63,000
A/Receivable 63,000
f). No entry f). Operating Expenses 7,000
Cash 7,000
g). Cash 35,000 g). Home Office 35,000
h). Investment in Branch 1,500 h). Operating Expenses 1,500
Operating Expenses 1,500 Home Office 1,500
i). Investment in Branch 18,167 i). Sales 80,000

Income Yed. Branch 18,167 Cost of Goods Sold 53,333
Operating Expenses 8,500
Incomes Summary 18,167

Home Office 18,167
j).Allowance for Overvaluation
of Inventory 26,667
Realized Gross Profit 26,667 j). No entry
Income Yed. Branch 18,167
____________________________________________________________________ 127
b) Balance of Reciprocal Ledger Accounts
Investment in Yedidya Branch (Rehoboth Corporation Records)
2006 Cash and equipment shipment 55,000 - 55,000
of the cost 90,000 145,000
Equipment purchased by branch - 1,500 143,500
Cash received from branch - 35,000 108,500
Operating expenses billed to branch 1,500 - 110,000
Net income for 2006 reported by branch 18,167 - 128,167
Home Office (Yedidya Branch Records)

2006 Cash and equipment shipment - 55,000 55,000
Merchandise billed to branch at markup of
33% above home office cost ,or 50% of the 90,000 145,000
cost
Equipment purchased by branch 1,500 - 143,500
Cash sent to home office 35,000 - 108,500
Operating expenses billed by home office - 1,500 110,000
Net income for 2005 reported by branch - 18,167 128,167
2a). Electra Corporation and Dessie Branch

Reconciliation of Reciprocal Leger Accounts
December 31, 2009
Investment in Dessie Branch Home Office
(Home Office Book) (Branch Book)
1. Balance before Adjustments Br.492, 000 Br. 452,300
Add :( 3) Shipments in transit to Dessie Branch - 25,000
(4) Error in recording adv. Expense - 2,700
Less: (2) Cash in transit to Home Office (12,000) -
Adjusted Balance Br. 480,000 Br. 480,000
b). Adjusting and Correcting Entries on December 31, 2009

Home Office: (2) Cash in Transit 12,000
Branch Book: (3) Shipment from HO: in transit 25,000
Home Office 25,000
Branch Book: (4) Advertising Expense 2,700
Home Office 2,700
3a).Journal Entries for ABC Industries (Home Office)
____________________________________________________________________ 128
Shipment to Gondar Branch 200,000
Cash 2,500
Investment in Bahir Dar Branch 202,100

Excess Freight Expense 1,200
Shipment to Gondar Branch 200,000
Shipment to Bahir Dar Branch 200,000
3b). Journal Entries Gondar Branch

Shipment from Home Office 200,000
Freight 2,500
Home Office 202,500
Home Office 203,300
Freight 2,500
Cash 8, 00
3c). Journal Entries Bahir Dar Branch
Freight 2,100
Home Office 202,100
CHAPTER FOUR
1a) Gross profit to be recognized under each year:
Sales Br. 500,000
(-) Cost of Sales (300,000)
Gross Profit 200,000
Gross Profit Rate 40%
Cash Collections Gross Profit
August 1, 2000= down payment of Br. 100,000x40% = Br.40, 000
August 1, 2001= 1st installment of Br. 100,000x40% = Br.40, 000
August 1, 2002= 2nd installment of Br. 100,000x40% = Br.40, 000
August 1, 2003= 3rd installment of Br. 100,000x40% = Br.40, 000
August 1, 2004= 4th installment of Br. 100,000x40% = Br.40, 000
Total Br.200,000
1b) Journal entries for the first three years:
Year One
August 1, 2000 Cash 100,000
Cost of Sales 300,000
Sales 500,000
Inventories 300,000
Or Cash 100,000
Inventories 300,000
____________________________________________________________________ 129
Deferred Gross Profit 200,000
December 31/ Deferred Gross Profit 40,000
December 31/ Interest Receivable 15,000
2000 Interest Revenue 15,000 [400,000x5/12x9%=15,000]
Year Two
August 1, 2001 Cash 136,000

Interest Revenue 21,000 [400,000x7/12x9%=21,000]


Year Three
August 31, 2002 Cash 127,000

Interest Revenue 15,750 [300,000x7/12x9%=15,750]


2a). Gross Profit to be recognized in 2000 and 2001:

Year Cash Collections Gross Profit Rate Gross Profit
2000 Br. 150,000 40% Br. 60,000
2001 100,000 40% 40,000

120,000 59% 70,800
2b) Balance of Deferred Gross Profit:
Year Deferred Gross Profit Realized Gross Profit Balance

2000 Br. 144,000 Br. 60,000 Br.84, 000
2001 289,000 110,800 178, 200
2c) Journal Entries
____________________________________________________________________ 130
2000 2001
To record installment sales
Installment A/ Receivable 360,000 350,000
Installment Sales 360,000 350,000
To record cash collections on installment receivables
Cash 150,000 220,000

Installment A/ Receivable (2000) 150,000 100,000
Installment A/Receivable (2001) - 120,000
To record cost of goods sold
Cost of installment sales 216,000 145,000

Inventories 216,000 145,000
To close installment sales and cost of installment sales
Installment Sales 360,000 350,000

Cost of installment sales 216,000 145,000
Deferred Gross Profit 144,000 205,000
To record realized gross profit
Deferred Gross Profit (2000) 60,000 40,000

Deferred Gross Profit (2001) - 70,800
Realized Gross Profit 60,000 110,800
CHAPTER FIVE
1a) Journal Entries for Consignor and Consignee

Garad Trading (Consignor) Solar Music Shop (Consignee)
Jan.1 Consignment Out 1,500 Memorandum entry
Inventory 1,500
Jan.1 Consignment Out 60 Memorandum entry
Freight Out 60
Jan.15 Non entry Consignment in 25
Cash 25
Jan.31 Non entry Cash (A/R) 3,000

Commission Revenue 600
Consignment in 2,400
____________________________________________________________________ 131
Jan.31 Cash 2,375 Consignment in 2,375
Commission Expense 600 Cash 2,375
Consignment Out 25
Consignment Sales 3,000
Jan.31 Cost of Consignment Sales 1,585 Non entry

Consignment Out 1,585
[1,500+60+25=1,585)
1b) Consignment Out and Consignment In Accounts
Consignment Out (Garad Trading)

Date Debit Credit Balance (Dr)
Jan.1-31 1,500 - 1,500
85 1,585
- 1,585 -0-
Consignment In (Solar Music Shop)

Date Debit Credit Balance (Cr)
Jan.1-31 25 - (25)
- 2,400 2,375
2,375 - -0-
2a) Journal Entries for Consignor and Consignee

Garad Trading (Consignor) Solar Music Shop (Consignee)
Jan.1 Consignment Out 1,500 Memorandum entry
Inventory 1,500
Jan.1 Consignment Out 60 Memorandum entry
Freight Out 60
Jan.15 Non entry Consignment in 25
Cash 25
Jan.31 No entry Cash 1,125
A/R 375
Consignment in 1,500
Jan.31 Cash 800 Consignment in 1,100
A/R 375 Commission Revenue 300
Consignment Out 25 Cash 800
Commission Exp. 300
Consignment Sales 1,500
____________________________________________________________________ 132
Jan.31 Cost of Consignment Sales 792.5 Non entry
Consignment Out 792.5
[1,500+60+25=1,585/2=792.5)
2b) Consignment Out and Consignment in Accounts
Consignment out (Garad Trading)
Date Debit Credit Balance (Dr)
Jan.1-31 1,500 - 1,500
85 1,585
- 792.5 792.5
Consignment In (Solar Music Shop)
Date Debit Credit Balance (Cr)
Jan.1-31 25 - (25)
- 1,500 1,475
1,100 - 375
2c) Sales for Account
Solar Music Shop
Account Sales
Sales for Account January 31…
Garad Trading
Sales of 5 radio sets @ Birr 300 each Birr 1,500
Less: Charges: Freight 25
Commission 300 (325)
Balance payable to consignor 1,175
Balance check enclosed (800)
Balance due to consignor Birr 375
Consigned radio set on hand Five (5)
REFERENCES
1. Modern Advanced Accounting, 9th Edition, Larson E. John and Mosich, A.N.,
McGraw Hill USA, 2003.
2. Advanced Accounting: Concepts and Practice, 8th Edition, Pahler, Arnold J., and
Mori, Joseph E, South Western Publishing, 2003.
3. Advanced Financial Accounting, 6th Edition, E.Baker, C.Lembke and C.King,
McGraw Hill USA.
4. Commercial Code of Ethiopia
5. http://www.inventoryops.com/ConsignmentInventory.htm, April 15th, 2010
6. http://domin.dom.edu/faculty/pollraym/acct420/partnerships.doc, May 2nd, 2010
____________________________________________________________________ 133

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Advanced Accounting I

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CHAPTER ONE

ACCOUNTING FOR PARTNERSHIP AND JOINT VENTURES

After studying this chapter, you should be able to:

A partnership form of business has a number of distinguishing characteristics identified

Partnership is an association of two or more individuals who agree to carry on business

Corporation is a separate legal entity in which ownership is divided in to shares of stock.

The Commercial Code of Ethiopia classifies partnership in three types as ordinary

Art.280. A General Partnership: consists of partners who are personally, jointly,

Art. 301. Limited partners.

1.1.2.1. Partners’ Owners Equity Accounts

2. Drawing (Personal Accounts): drawings (withdrawals of cash or other assets) by the

1.1.2.2. Valuation of Investments by Partners

Jan. 31,2005 Drawings GJ(P1) 600 00 600 00

Jan. 31,2005 Drawings GJ(P1) 600 00 600 00

Dec. 31,2005 GJ(P1) 40,000 00 40,000 00

Income Summary 20,000

(Journal entry to close income summary)

Income summary 40,000

The bonus is computed as follows:

1.1.3.1. Dissolution by Admission of a New Partner

1. Admission by purchasing an ownership interest from one or more of the existing

1.1.3.2. Dissolution by Withdrawal (Retirement) of a Partner

Profit and Loss Ratio Capital balance

1.1.4. Accounting for Partnership Liquidation

Any change in the ownership of a partnership by admission, withdrawal, death or

Description Liabilities Y loan X Y Z

Balances from preceding Assets Liabili Partners’ capital

Balances from preceding Assets Liabili Partners’ capital

Balance 90,000 -0- 40,000 36,000 18,000 2,000 (6,000)

Payments to partners 50,000 34,667 15,333 - -

The capital deficit by partner S, if uncollectible is shared between partners P, Q and R in

It should be noted that if a limited liability partnership is insolvent because of an adverse

Case 5: General Partnership is Insolvent and Partners are Insolvent

Illustration: To show the relative rights of creditors of an insolvent general partnership

Partial Payment to Creditors (50,000) (50,000)

Assets Partner’s Capital

Liquidation on installments is a process of realizing some assets, paying creditors, paying

Other assets were realized in to cash as follows:

Note the following form the above cash distribution program:

Assets Partners’ Capital

July 31, 2000: Liabilities 52,000

1.2.1. Characteristics of Joint Ventures

Article 278 states grounds for joint venture dissolution:

1.2.5.1. Accounting for Corporate Joint Ventures

AB Company (a Joint Venture)

AB Company (a joint Venture)

AB Company (a Joint Venture)

A partnership is legally dissolved when a new partner is admitted to the partnership or

Dissolution of a partnership is a change in the relationship between the partners. The

During partnership liquidation, accountants must be aware of the priority of claims

Required: a) Prepare a cash distribution program for liquidation of M, N &O Partnership

The annual salary was to withdrawn by each partner in 12 monthly installments.

A public enterprise as a form of business organization has attained a great deal of

The United Nations definition of a public enterprise is ‘‘an incorporated or large

2.3. Public Enterprise in Ethiopia

Required: Pass the journal entry to record the above investment.

Solutions: a) Income statement

Income tax expense 122,500

Service: Expected quality of service varies from community to community, depending on

 Register claims of title presented to it in respect of property taken in violation of

Note: Net assets determination

Case 2: New Book

2.4.4. Amalgamations and Division

Regarding the amalgamation and division of public enterprises, the Proclamation