Business Accounts – The Law Student Blog

Consolidated accounts

November 24, 2020March 23, 2021TheLawStudent

Companies with one or more subsidiaries are required to publish accounts for the group of companies as a whole as well as their own annual accounts (s.399 CA 2006). This is because (subject to certain exemptions) shareholders of the parent company should have access to some information regarding the subsidiary company. In principle, every subsidiary in the group also has a duty to prepare its own individual accounts, but exemptions are widely available so it is likely to be rare in practice for subsidiaries to do so (ss.394A and 479A CA 2006).

In this post, I discuss the concept of consolidated accounts at a high level, without considering the rules in any detail.

The consolidated Profit and Loss Account

In consolidated accounts, the Profit and Loss Account of the parent company and its subsidiaries are brought together (see the third column in the example below).

The Profit and Loss Account of the parent company (column 1 above) will include dividends paid to it by the subsidiary but not the subsidiary’s profits. Such dividends and any intra group trading that has taken place between the subsidiary and the parent company are excluded from the consolidated Profit and Loss Account (column 3 above).

There is one further factor to consider if the subsidiary is not wholly owned (i.e. if there is a third-party minority interest in the subsidiary). In this scenario, the entire profit for the parent company and its subsidiaries will be shown in the group accounts – then the minority interest’s share is deducted.

The consolidated Balance Sheet

The Balance Sheets of each company in the group will be amalgamated and the only issued share capital represented on the consolidated Balance Sheet (column 3) will be that of the parent company.

The Balance Sheet of the parent company will include the share capital of the subsidiary as a long-term investment, at cost. The subsidiary in this example has no subsidiary of its own and so shows no long term investment in its Balance Sheet (Column 2).

The assets of the subsidiary must however be added to the assets of the parent and represented in the consolidated Balance Sheet accordingly. After a subsidiary has been acquired, its profits are included in the consolidated Profit and Loss Account.

What if the subsidiary is not wholly owned? The total assets and liabilities of the companies in the group are shown, along with the minority interest’s share in those assets and liabilities as a deduction.

Company owned investments

November 23, 2020March 22, 2021TheLawStudent

Companies can own investments in exactly the same way as a natural person would, for example, a company may have subsidiaries or own a portfolio of shares in other companies. These are assets.

If investments are held for the long term, they should be shown in the Balance Sheet as a non-current asset.
If investments are held only for the short term, with the intention of selling them in the fairly near future, they should be shown in the Balance Sheet as a current asset.

Income from investments (i.e. dividends received by a company) is shown in the Profit and Loss Account.

‘Writing down’ investments

Investments are usually shown at cost (without impairment). If their value falls, however, they should be ‘written down’ to their new, lower value. This will involve the following adjustments to the accounts:

reduction in the value of the asset in the Balance Sheet by the amount of the decrease in value; and
reduction in value to be treated as an expense in the Profit and Loss Account (‘impairment of investments’).

These adjustments have the following effect:

the increase in the expenses reduces the profit for the year at the bottom of the Profit and Loss Account to the same extent; and
the reduction in size of the ‘Profit for the year’ figure which is carried across to the SoCiE causes a similar reduction in the size of Retained Earnings (profit and loss carried forward) in the Balance Sheet, thus maintaining the balance.

Bonus issue of shares

November 23, 2020March 22, 2021TheLawStudent

A ‘bonus issue’ of shares is also known as a ‘capitalisation issue’ or ‘scrip
issue’.

A company may decide to convert some of its reserves into share capital by issuing fully paid shares to existing shareholders on a pro rata basis for no consideration; in other words, shareholders do not have to pay for the bonus shares. ‘Pro rata’ means that the proportion of shares held by each shareholder pre- and post-bonus issue will not change, and therefore the proportions of voting rights will also remain the same.

Shares that are issued pro rata are often expressed by way of a ratio, i.e. x:y, where x is the amount of shares issued to the shareholder for every amount of shares (y) they currently hold.

This process does not raise any money for the company, but rather the company will use its reserves to fund the issue. A company may use its retained earnings or its share premium account to fund a bonus issue (s.610(3) CA 2006).

The assets and liabilities of the company are unchanged after the bonus issue.

Revenue reserves and dividends

November 21, 2020March 22, 2021TheLawStudent

Retained Earnings

‘Retained earnings’ is the reserve account for retained profits.

The retained earnings represent profits after tax earned by the company over its history and not distributed by way of dividend or appropriated to another reserve. It generally increases from year to year as most companies do not distribute all of their profits.

Statement of Changes in Equity

For company accounts, profit for the year is not carried over directly from the Profit and Loss Account to the bottom half of the Balance Sheet. Instead, it is carried over into a separate calculation, the Statement of Changes in Equity (the ‘SoCiE’).

Dividends

Dividends are paid or payable out of profits generated in the current or previous accounting periods. Any company can make a distribution (e.g. a dividend) provided that it has ‘profits available for the purpose’ (s.830(1) CA 2006). It is only after the financial statements have been completed that the profits generated in a given accounting period can finally be determined.

In ALCIE terminology, dividends are recorded in a capital account as they are transactions between the business and its owner(s). For this reason, dividends do not belong on a Profit and Loss account. When a company declares a dividend, this will show up in the SoCiE.

Ordinary Shares

There are two types of dividend that can be paid on ordinary shares; a final or an interim dividend. Both are calculated in exactly the same way, the only difference between the two being that:

the final dividend is declared after the year end and paid some time thereafter; and
the interim dividend is paid during, and in respect of, the current accounting period.

Final dividend

The size of the final dividend is declared by the company’s directors in the Directors’ Report, and approved by the company’s shareholders by ordinary resolution, typically passed at the Annual General Meeting (AGM) if the company has one.

If the directors have recommended a final dividend, but the shareholders have not yet approved it, the dividend is called a proposed dividend. A proposed dividend does not constitute a debt enforceable by the relevant shareholders until it is approved i.e. declared by an ordinary resolution of the shareholders. Therefore, any final dividend which is proposed but which has not been approved will not appear in the accounts of that accounting period.

Example:
A company with an accounting period of a year ending on 31 December 2020 wishes to pay a final dividend in respect of that accounting period. The directors of the company tell you that the final dividend will be approved by an ordinary resolution of the shareholders at a general meeting which is due to take place in March 2021. If the final dividend is declared by ordinary resolution at the general meeting, it will appear in the accounts for the period ending 31 December 2021.

A final dividend that has been approved by the shareholders is called a declared dividend. A declared dividend constitutes a debt of the company enforceable by the relevant shareholders. A declared dividend will be taken into account in the SoCiE, as a deduction in calculating the Retained Earnings (profit and loss carried forward) which will appear in the bottom half of the Balance Sheet.

If the declared dividend has not yet been paid to shareholders by the time the accounts for that year have been prepared, it will appear in the Balance Sheet at the end of the year in which it was declared (as part of ‘current liabilities’). It will also be taken into account in the SoCiE at that year-end.

A declared dividend which has been paid to shareholders before that year end will only be taken into account in the SoCiE.

Interim dividend

The articles of a company normally give the directors the power to decide to pay interim dividends. Interim dividends can therefore be paid without the need for an ordinary resolution of the shareholders. Any board resolution to pay an interim dividend may be rescinded before the interim dividend is paid, so an unpaid interim dividend is not a debt that the shareholders are legally entitled to sue upon.

For this reason, the accounting treatment of interim dividends is different to the treatment of final dividends. Interim dividends will only be reflected in a company’s accounts if they have actually been paid. When an interim dividend has been paid in any year the amount of the dividend will have been deducted from the assets, i.e. cash and cash equivalents, and will be shown as an item on the trial balance. A dividend is an allocation of profit and not an expense of the company so it will not be shown in the Profit and Loss Account. The interim dividend will be taken into account in the SoCiE (in this respect, interim dividends are treated the same as declared (and paid) dividends).

Any profits after tax not paid to shareholders as dividends are retained in the company.

Preference shares

Preference dividends are usually paid in two instalments each year. Because of the nature of preference shares, the amount of the dividend will already be known each year.

Example:
A company which has issued 200,000 non-redeemable non-cumulative 6% preference shares of £1 each pays an annual dividend of 6 pence on each preference share (subject to there being sufficient profits to do so). If part of that dividend has already been paid to preference shareholders as an interim dividend in any year, that part will not appear on the top half of the company’s Balance Sheet for the relevant year. However, it will appear as a deduction in the SoCiE to calculate the Retained Earnings in the bottom half of the Balance Sheet. The remainder of the preference dividend is declared by the shareholders, and though paid after the year end, will appear in the SoCiE to calculate retained earnings and be shown as a Current liability in the top half of the Balance Sheet.

Legal treatment of dividends for ordinary shares

It is important to understand the differences between the legal and accounting treatment of dividends, based on the type of dividend and its status. These are summarised in the table below

	Legal treatment	Accounting treatment
Final dividend – proposed	Not a legal debt, cannot be enforced by shareholders.	Dividend does not appear in the company accounts.
Final dividend – declared, but not paid	Legal debt enforceable by shareholders.	Dividend will be taken into account in the SoCiE at the end of the accounting period in which it is declared. In the unlikely event that the dividend has been declared but not paid as at the date of the Balance Sheet, it will also appear in the Balance Sheet as part of ‘Current liabilities’.
Final dividend – declared and paid	Legal debt enforceable by shareholders.	The assets of the company will have been reduced by the amount of the dividend and the dividend will feature as an item in the trial balance. The dividend will be taken into account in the SoCiE at the end of the accounting period in which it is declared and will impact on the Retained Earnings (profit and loss carried forward) in the Balance Sheet.
Interim dividend – declared and paid	The interim dividend becomes a legal debt once it has been paid to the shareholders.	The assets of the company will have been reduced by the amount of the dividend and the dividend will feature as an item in the trial balance. The dividend will be taken into account in the SoCiE at the end of the accounting period in which it is paid and will impact on the Retained Earnings (profit and loss carried forward) in the Balance Sheet.

Share capital and reserves

November 21, 2020March 22, 2021TheLawStudent

Called up share capital

The share capital account tells the reader the aggregate amount that has been ‘called up’ (i.e. the amount of the nominal value of its shares that the company has required its shareholders to pay) on each class of issued shares, not including any premium. This called up value may, or may not, be the same as the aggregate of the nominal value of the issued shares, for example, if they are not fully paid. It is relatively rare to encounter shares which are not fully paid up.

Example:
A newly-incorporated company has issued 300,000 ordinary shares of £1, and has called up 75p per share. The value of the called up share capital in the company’s Balance Sheet will therefore be £225,000.

Reserves

Reserves can be described as the capital of the company in excess of the called up value of the issued share capital. Reserves can be split into two categories:

capital reserves (e.g. share premium account, revaluation reserve, capital redemption reserve), which I will discuss below; and
revenue reserves (e.g. retained earnings), which I will discuss in a future post.

Broadly speaking, assets representing the capital reserves cannot be distributed by way of dividend or other payment to shareholders. However, revenue reserves are distributable reserves and therefore, assets representing such reserves can be distributed to shareholders in the form of dividends.

Share premium account

The share premium account represents the difference between the nominal value of the shares and the amount that the shareholders actually paid for the shares i.e. the subscription price (if greater). N.B. The market price of the shares, once they have been issued, has no bearing at all on the company’s accounts and so, if their market price goes up or down, the share premium account will remain unaltered.

The share premium account is a capital reserve. Assets representing it therefore cannot be distributed to shareholders, except in exceptional circumstances such as a bonus issue or on a buyback of shares.

Revaluation reserve

A revaluation reserve is created when a company’s directors, as a matter of accounting policy, wish to show more up to date values of non-current assets in the accounts. For example, the value of its real property portfolio may have increased, and so the company re-values the assets in question to their current value.

The increase in the value of the asset in the Balance Sheet causes the figure for Net Assets to rise correspondingly i.e. in simple terms, the top half of the Balance Sheet has increased. It is therefore necessary to make a corresponding change to the bottom half of the Balance Sheet. This is achieved by creating or increasing an existing revaluation reserve by the same value.

The revaluation reserve represents a notional profit to the company from the rise in value of the asset. This profit is, however, unrealised until the asset is sold, and as such it is a capital reserve and is not distributable as a dividend until the company sells the asset and realises the profit (s.830(2) CA 2006).

Any subsequent reduction in a re-valued asset’s value can be set off against the revaluation reserve.

Capital redemption reserve

A capital redemption reserve can only be created as a consequence of a transaction between the company and its shareholders under detailed provisions of the Companies Act 2006 such as, for example, a buyback of shares out of a company’s capital. Such transactions are relatively unusual and do not form part of the course of everyday business for any company.

Company financial statements

November 20, 2020March 22, 2021TheLawStudent

Company Profit and Loss Account

There are a number of slight differences in the format (and words used) of the accounts of companies compared to those used in relation to sole traders and partnerships. The Profit and Loss Account may also be referred to as ‘the Statement of Profit and Loss’ or ‘the Income Statement’).

Instead of using the words ‘income’ or ‘sales’ to denote cash generated by the business, the word ‘revenue’ is commonly used in company accounts.
Companies may show the expenses as a single line in the accounts or may split the expenses into categories.
An entry for finance costs relates to interest payable by the company on funds borrowed and is included as an expense. This can be contrasted with a figure for interest receivable. This would be interest generated on money lent by the company and would be an income entry included in turnover in the top part of the Profit and Loss Account.
An entry for taxation will be included, which will usually include taxation payable on company profits and does not include other employment or consumption taxes.
The Profit for the year figure will be carried over to the Statement of Changes in Equity in the Balance Sheet.

Company Balance Sheet

number of differences in the Balance Sheet of a company compared with that of a sole trader or partnership can be observed.Note:

An ‘Impairment of Receivables’ entry is the provision for doubtful debts, and this information would normally be shown in a supporting note, with only the updated ‘Receivables’ figure shown in the Balance Sheet.
What was previously referred to as ‘current liabilities’ and ‘long term liabilities’, are referred to in company accounts as ‘Current Liabilities’ (such as overdrafts repayable on demand, trade payables, accruals and dividends declared but not yet paid) and ‘Non-current Liabilities’ (such as bank loans repayable in more than one year) respectively.
In terms of the bottom portion of the Balance Sheet, there is no reference to capital contributions or drawings. Instead, the bottom portion of the Balance Sheet shows what is referred to as ‘Total Equity’ or ‘Equity and Reserves’ (these terms are interchangeable). As with all Balance Sheets, the Net Assets should always balance with the bottom portion of the Balance Sheet. This is because Net Assets represent the manner in which the Equity is being used by the company as at the date of the Balance Sheet.
An item labelled ‘Retained Earnings (profit and loss carried forward)’ may appear on the Balance Sheet and should not be confused with the Profit for the Year shown on the Profit and Loss Account. The figure comes from a ‘Statement of Change in Equity’. This is because the correct figure for retained profit needs to be calculated before the balance sheet can be completed: it will include the profit from the current accounting year, together with all retained profits from previous years, net of dividends.
The company Balance Sheet may also include reference to other ‘reserves’, known as ‘capital reserves’. These commonly include the Share Premium Account and Revaluation Reserve.

Differences between company and sole trader/partnership accounts

November 19, 2020March 19, 2021TheLawStudent

There are a number of differences in the content of financial statements for companies: terminology used, tax, dividends and the content of the financial statements. I will briefly mention the differences here and then we will look at some of them in more depth in later posts.

Terminology

As we move from considering unincorporated entities (sole traders and partnerships) to companies, the accounting terminology differs to bring company accounts in line with accounting standards.

Tax in company accounts

So far, tax has not played a part in any of the accounting statements that we considered for sole traders and partnerships. This is because partnerships and businesses run by sole traders do not have separate legal personality, and therefore do not pay tax. The partners or the sole trader pay tax by reference to their own personal tax computations.

Companies however do have a separate legal personality, and as such, they must pay tax on their own account. In practice, therefore, the Profit and Loss Account of a company includes a statement of the tax the company should pay on its profits. This is corporation tax and will ultimately affect the profitability of the company.

Dividends

The owners of companies are shareholders and the shareholders’ return on their investment is the dividend that they may receive.

Like drawings that a sole trader takes from his business, a dividend is an appropriation of profits (after tax). It is not an expense of the business. In practice, dividends will usually appear in a financial statement called the ‘statement of equity’ (or ‘statement of changes in equity’) because they are transactions between the company and its shareholders. Dividends are also sometimes included in an addition to the Balance Sheet called the Statement of Changes in Equity (SoCiE). This shows profits brought forward and added to current year profits subject to any deductions for dividends. The resulting ‘Retained Earnings’ will appear on the bottom half of the Balance Sheet, showing the total profits carried forward to the next accounting period.

Capital accounts: the bottom half of the balance sheet

Company accounts follow a format which differs from those of sole traders and partnerships. The main difference relates to the bottom half of the Balance Sheet and this is due to the fact that the capital of a company consists of share capital, reserves and retained earnings.

Company accounts

November 19, 2020March 17, 2021TheLawStudent

Introduction to company accounts

My previous posts on business accounts have discussed the format of the Profit and Loss Account and Balance Sheet for sole traders and partnerships, together with the necessity of making year-end adjustments such as accruals, prepayments, depreciation and bad and doubtful debts to the trial balance before producing the financial statements. These same principles also apply to companies, however there are some differences to the Profit and Loss Account and Balance Sheet of a company, which I will cover over the next few posts.

Regulation of company accounts

There are three main sources of regulation of UK company accounts:

The Companies Acts 1985, 1989 and 2006 (‘CA’);
Accounting standards; and
The FCA Listing Rules, Prospectus Rules and Disclosure and Transparency Rules (for companies whose securities are offered to the public in the UK or admitted to trading by the London Stock Exchange).

Companies prepare accounts because they are obliged to do so by statute. The accounts also have to take on a particular appearance and format and must also present a true and fair view of the profits, assets and liabilities of the company (s.396(2) CA 2006). This is because the accounts need to provide the reader, whether they are a shareholder, potential investor or an individual investigating an allegation of fraud, with certain key information. Unless that information is presented in a particular way, and consistently each year, then the story that the accounts actually tell may not be true or fair.

A company is free to choose its own accounting reference period, subject to provisions of the Companies Act 2006. Under s.391(4) CA 2006, a company’s accounting reference date (ARD) (the date on which the accounts are ‘ruled off’) is the last day of the month in which the anniversary of its incorporation falls. A company is, however, able to change its ARD to a date of its choice provided the provisions of s.392 CA 2006 are complied with. Under s.442(2)(a) CA 2006, a private company must file its accounts at Companies House within nine months after the end of the relevant accounting reference period and under s.442(2)(b) CA 2006, a public company must file its accounts at Companies House within six months after the end of the same period.

The main accounting requirements of the Companies Act 2006 are contained in Part XV and deal with matters such as:

the duty to keep accounting records (s.386 CA 2006);
accounting reference periods and accounting reference date (s.391-392 CA 2006);
the duty to prepare annual company accounts (s.396 CA 2006);
for parent companies, the duty to prepare group accounts (ss.399, 403 and 404 CA 2006). In principle, every subsidiary in a group remains subject to the duty to prepare its own individual accounts – but in practice many subsidiaries will qualify for an exemption from this;
the duty to prepare a directors’ report (ss.415- 419A CA 2006);
the duty to prepare an auditors’ report (ss.475, 495- 497A CA 2006);
the duty to provide every member with a copy of the accounts (s.423 CA 2006);
the duty for public companies to lay the accounts before a general meeting (ss.437-38 CA 2006); and
the duty to deliver copies of the accounts to the registrar (ss.441, 444- 447 CA 2006).

Accounting standards are issued as Financial Reporting Standards (‘FRSs’) by the Financial Reporting Council (www.frc.org.uk). They were formerly issued as Statements of Standard Accounting Practice (‘SSAPs’), some of which are still in force. Accounting standards apply to all companies.

As a consequence of the Companies Acts, FRSs and SSAPs, company accounts tend to conform to a given format, with a large number of supplementary notes (i.e. footnotes giving extra detail).

Some of the legal and regulatory requirements are relaxed in relation to ‘small’ or ‘medium-sized’ companies, as defined by statute (ss.382, 465 CA 2006). In addition, ‘micro-entities’ (very small companies) are exempt from certain financial reporting requirements, including in relation to s.396(2A) CA 2006.

Partnerships

November 18, 2020March 16, 2021TheLawStudent

In my previous articles on the subject of business accounts, I have focused on the accounts of sole traders. However, as you will be aware, these are not the only type of business entity that you may come into contact with in your role as a solicitor. I will now briefly move on to looking at the accounts of partnerships before we conclude with the accounts of companies.

Generally, the accounts of a partnership are very similar to those of a sole trader, having the same year-end adjustments. The main differences between the two is seen in the bottom half of the Balance Sheet (which you will recall denotes the capital held in the business). The reason for this is that in a partnership, the business will be owned by at least two different people. Therefore, to correctly show the capital of a partnership on the Balance Sheet, it is necessary to make an intermediate step in the preparation of the accounts. This is the preparation of a profit appropriation statement.

In short, the profit appropriation statement records the division of the profits of the business for the relevant accounting period between the partners.

Separate accounts for each partner

Within a partnership, each partner will have his or her own accounts, and commonly there are two accounts for each partner:

a Capital account, which represents the partner’s original investment in the partnership, together with any subsequent investments. This is long-term capital which cannot be withdrawn in normal circumstances.
a Current account, representing the capital that can be withdrawn at the partner’s discretion. This account records the partner’s share of the ongoing business profits. It will also show any drawings that the partner has taken out over the year.

Applying the ALCIE classification, both of these accounts are capital accounts.

Drawings are withdrawals of profits by the partners during the year, to pay themselves, in much the same way as sole traders pay themselves. The drawings are usually based on an estimate of the partner’s share of expected profits for the year. If a partner draws too much then they could be liable to make a balancing payment back to the partnership depending on the terms of the partnership agreement.

Appropriation of profits

Once the Profit and Loss account has been drawn up and the profit for the business as a whole has been calculated, the profit which the partnership has made needs to be divided amongst the partners. This is done as follows: firstly, sums are allocated to individual partners corresponding to any ‘interest’ on their capital or ‘salaries’ due to them under the partnership agreement. Then the residual profit will be distributed to the partners according to an agreed profit share ratio.

Notional interest on capital

The notional interest is a a payment representing interest on the capital in the partner’s long-term capital account. This will be calculated using a rate of interest that is specified in the partnership agreement. It is important to note that although it is labelled ‘interest’, it should not be treated as an expense item in the Profit and Loss Account. It is notional interest, i.e. it is really an appropriation of profit to a particular director under a different name.

Notional salary

One or more of the partners might receive a notional salary, which again will be in the partnership agreement and is also really an appropriation of profits. Generally, for partners, any salary paid to them:

must be treated as an appropriation of profit, not an expense in the Profit and Loss Account (which is how the salaries of any employees the partnership has would be represented); and
will be treated as drawings.

Residual profits

The residual profits are the profits for the period remaining after each partner has appropriated any amount(s), to which they are entitled as notional interest and/or notional salary. The residual profits are divided amongst the partners according to an agreed ratio, which will again be specified in the partnership agreement.

Profit appropriation statement

A profit appropriation statement is a practical way to work out the distribution of the profits and must be completed before the Balance Sheet can be drawn up. To complete a profit appropriation statement it is necessary to:

give each partner his/her appropriation of profit for notional salary and notional interest.
calculate how much profit is left over (the residual profit).
share this residual profit between the partners according to the profit-sharing ratio.

Example profit appropriation statement

Brown Design is a partnership of architects. The trial balance of the firm at 31 December 2020 included the following items:

	Debit £	Credit £
Brown Capital account Current account Drawings	22,000	75,000 25,000
Smith Capital account Current account Drawings	30,000	82,000 35,000
Jones Capital account Current account Drawings	35,000	50,000 40,000

For the year ended 31 December Year 2, the partnership made a profit of £135,000 and the profits are shared as follows:

Brown is given a notional salary of £21,000 and Smith is given a notional salary of £26,000.
Each partner is paid interest on (long-term) capital of 5% p.a.
The partners share the residual profits in the ratio 5:3:2 to Brown: Smith: Jones.

Once this information has been obtained, the Profit Appropriation Statement can be drawn up as follows:

Partner	Notional salary £	Notional interest £	Share of residual profit £	Total share of profit £
Brown	21,000	3,750	38,825	63,575
Smith	26,000	4,100	23,295	53,395
Jones		2,500	15,530	18,030
	47,000	10,350	77,650	135,000

Calculations:
Notional Interest = 5% of £75,000 for Brown, 5% of £82,000 for Smith and 5% of £50,000 for Jones.
Residual profit = £110,000 minus notional salaries (£47,000) and notional interest (£10,350).
Residual profit = £77,650, divided 5/10 to Brown, 3/10 to Smith and 3/10 to Jones.

Partnership Balance Sheet

The top half of a partnership Balance Sheet is similar to that of a sole trader, but the bottom half, which shows capital, follows a different format:

the Balance Sheet shows the capital position for each partner separately;
the Balance Sheet shows each partner’s capital account and current account; and
the balance of each partner’s current account is adjusted by adding that partner’s total share of profit (as calculated in the profit appropriation table) and subtracting that partner’s drawings.

The example below shows the bottom half of the balance sheet for Brown Design based on the information given previously.

			£	£	£
Brown:	Capital account			75,000
	Current account	At start of year	25,000
		Share of profit	63,575
		Drawings	(22,000)
		At end of year		66,575
Brown: total capital					141,575

Smith:	Capital account			82,000
	Current account	At start of year	35,000
		Share of profit	53,395
		Drawings	(30,000)
		At end of year		58,395
Smith: total capital					140,395

Jones:	Capital account			50,000
	Current account	At start of year	40,000
		Share of profit	18,030
		Drawings	(35,000)
		At end of year		23,030
Jones: total capital					73,030

Total partnership capital:					355,000

The total partnership capital would equal the Net Assets from the top half of the Balance Sheet.

Year-end adjustments for bad and doubtful debts

November 17, 2020March 14, 2021TheLawStudent

In my two previous posts, I discussed bad debts and doubtful debts as separate considerations for year-end adjustments. In practice though, when it comes to preparing financial statements for a company, both adjustments would be made in one combined calculation. When adjusting for ‘bad and doubtful debts’, it is important that the receivables figures are adjusted first, This means that you must deduct any bad debts written off at the year-end first. This is necessary because any general provision for doubtful debts is calculated by applying a percentage to the balance of the receivables asset account. You will only know the correct balance on this account after you have adjusted for any bad debts written off at the year-end.

Adjustment for bad debts

When you are given a preliminary trial balance:

the receivables asset account will show the balance on the account before taking into account the bad debt written off at the end of the year.
there may be a bad debt expense account, if the business has already written off bad debts during the course of the year and the receivables asset account (as it appears in the trial balance) will already have been reduced to take account of them.

To make the year-end adjustment for bad debts, you have to:

Deduct the amount of the bad debt from the receivables asset balance in the trial balance. The remainder constitutes the up-to-date figure for receivables and will appear on the balance sheet.
EITHER (if the trial balance already has a bad debts expense account) add the bad debt to the balance of the expense account OR (if the trial balance does not have a bad debts account) create a new expense account and show the bad debt as its balance.

Adjustment for doubtful debts

When you are given a preliminary trial balance:

the ‘Provision for Doubtful Debts’ account in the trial balance will show the provision for doubtful debts at the end of last year/start of the current year, so the actual figure shown on the trial balance is out-of-date and should not appear at all in the current year’s financial statements.
there will be no ‘Bad and Doubtful Debts’ expense account for the year shown on the trial balance. There may however be a ‘Bad Debts’ expense account, depending on whether or not bad debts have already been written off during the year.

To make the year-end adjustment for doubtful debts, you should:

calculate the current year end’s provision for doubtful debts figure (the ‘new provision figure’) in accordance with the method decided by the business itself. Eventually this figure will be shown on the balance sheet.
EITHER (where the new Provision for Doubtful Debts is more than the provision shown in the trial balance) add the amount by which the provision has increased to the (new or renamed) bad and doubtful debts expense account for the year OR (where the new Provision is less than the provision shown in the trial balance) subtract the amount by which the provision has decreased from the (new or renamed) bad and doubtful debts expense account for the year. The new provision figure is then shown in the ‘provision for doubtful debts’ liability account.