Chapter Three

Current Liabilities
CURRENT LIABILITIES
Three essential characteristics:

1) Present obligation.
2) Arises from past events.
3) Results in an outflow of resources (cash, goods, services).
A current liability is reported if one of two conditions exists:
1. Liability is expected to be settled within its normal operating cycle; or
2. Liability is expected to be settled within 12 months after the reporting date.
 The operating cycle is the period of time elapsing between the acquisition of goods
and services and the final cash realization resulting from sales and subsequent
collections.
 Typical Current Liabilities
1) Accounts payable
2) Notes payable
3) Current maturities of long-term debt
4) Short-term obligations expected to be refinanced
5) Dividends payable
6) Customer advances and deposits
7) Unearned revenues
8) Sales & value-added taxes payable
9) Income taxes payable
10) Employee-related liabilities
1. Accounts Payable (Trade Accounts Payable)
 Balances owed to others for goods, supplies, or services purchased on
open account.
 Time lag between the receipt of services or acquisition of title to
assets and the payment for them.
 Terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.) usually state
period of extended credit, commonly 30 to 60 days.
2. Notes Payable
 Written promises to pay a certain sum of money on a specified future
date.
 Arise from purchases, financing, or other transactions.
 Notes classified as short-term or long-term.
 Notes may be interest-bearing or zero-interest-bearing.
 Interest-Bearing Note Issued
Illustration: Castle National Bank agrees to lend €100,000 on March 1,
2015, to Landscape Co. if Landscape signs a €100,000, 6 percent, four-month
note. Landscape records the cash received on March 1 as follows:
Cash…………………..100,000
Notes Payable…………………..100,000
 If Landscape prepares financial statements semiannually, it makes the
following adjusting entry to recognize interest expense and interest payable
at June 30, 2015:

Interest Expense………………2,000
Interest Payable………………….2,000
 At maturity (July 1, 2016), Landscape records payment of the note and
accrued interest as follows.
Notes Payable………………..100,000
Interest Payable…………………2,000
Cash……………………………….102,000
 Zero-Interest-Bearing Note Issued
Illustration: On March 1, Landscape issues a €102,000, four-month,
zero-interest-bearing note to Castle National Bank. The present value of
the note is €100,000. Landscape records this transaction as follows.
Cash…………………………...100,000
Notes Payable………………….100,000
 If Landscape prepares financial statements semiannually, it makes the
following adjusting entry to recognize interest expense and the
increase in the note payable of €2,000 at June 30.
Interest Expense……………..2,000
Notes Payable……………….2,000
 At maturity (July 1), Landscape must pay the note, as follows.
Notes Payable…………..102,000
Cash……………………..102,000
Exercises: The following are selected 2015 transactions of
Darby Corporation.
 Sept. 1 - Purchased inventory from Orion Company on
account for $50,000. Darby records purchases gross and
uses a periodic inventory system.
 Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in
payment of account.
 Oct. 1 - Borrowed $75,000 from the Shore Bank by
signing a 12-month, zero-interest-bearing $81,000 note.

 Prepare journal entries for the selected transactions.

Sept. 1 - Purchased inventory from Orion Company on account for $50,000. Darby
records purchases gross and uses a periodic inventory system.
Sept. 1 Purchases…………………50,000
Accounts Payable…..……..50,000
Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in payment of account.
Oct. 1 Accounts Payable……………50,000
Notes Payable………………50,000

Dec. 31 Interest Expense………….1,000

Interest Payable……………1,000
Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a 12-month, zero-interest-
bearing $81,000 note.
Oct. 1 Cash……………………75,000
Notes Payable……………….75,000

Dec. 31 Interest Expense…………1,500

Notes Payable………1,500
3. Current Maturities of Long-Term Debt
 Portion of bonds, mortgage notes, and other long-term indebtedness
that matures within the next fiscal year.
 Exclude long-term debts maturing currently if they are to be:
1) Retired by assets accumulated that have not been shown as current
assets,
2) Refinanced, or retired from the proceeds of a new debt issue, or
3) Converted into ordinary shares.
4. Short-Term Obligations Expected to Be Refinanced
 Exclude from current liabilities if both of the following conditions are
met:
1. Must intend to refinance the obligation on a long-term basis.
2. Must have an unconditional right to defer settlement of the liability
for at least 12 months after the reporting date.
Exercise: The CFO for Yong Corporation is discussing with
the company’s chief executive officer issues related to the
company’s short-term obligations. Presently, both the current
ratio and the acid-test ratio for the company are quite low, and
the CEO is wondering if any of these short-term obligations
could be reclassified as long-term. The financial reporting date
is December 31, 2014. Two short-term obligations were
discussed, and the following action was taken by the CFO.
Instructions: Indicate how these transactions should be
reported at Dec. 31, 2014, on Yongs’ SoFP.
STO-A: Yong has a $50,000 short-term obligation due on March 1,
2015. The CFO discussed with its lender whether the payment could be
extended to March 1, 2017, provided Yong agrees to provide additional
collateral. An agreement is reached on February 1, 2015, to change the
loan terms to extend the obligation’s maturity to March 1, 2017. The
financial statements are authorized for issuance on April 1, 2015.
STO-B: Yong also has another short-term obligation of $120,000 due on
February 15, 2015. In its discussion with the lender, the lender agrees to
extend the maturity date to February 1, 2016. The agreement is signed on
December 18, 2014. The financial statements are authorized for issuance
on March 31, 2015.
 5. Dividends Payable
 Amount owed by a corporation to its stockholders as a result of
board of directors’ authorization.
 Generally paid within three months.
 Undeclared dividends on cumulative preference shares not
recognized as a liability.
 Dividends payable in the form of additional shares are not
recognized as a liability.
► Reported in equity.
6. Customer Advances and Deposits
 Returnable cash deposits received from customers and
employees.
May be classified as current or non-current liabilities.
ILLUSTRATION 13-2: Unearned and Earned Revenue Accounts
 7. Unearned Revenues
• Payment received before providing goods or performing
services.
Exercise: Sports Pro Magazine sold 12,000 annual
subscriptions on August 1, 2015, for €18 each. Prepare Sports
Pro’s August 1, 2015, journal entry and the December 31,
2015, annual adjusting entry.
Aug. 1 Cash……………………...216,000
Unearned Revenue………….….216,000
(12,000 x €18)
Dec. 31 Unearned Revenue…………….90,000
Subscription Revenue……………….90,000
(€216,000 x 5/12 = €90,000)
 8. Sales and Value-Added Taxes Payable
Consumption taxes are generally either
 a sales tax or
 a value-added tax (VAT).
 Purpose is to generate revenue for the government.
 The two systems use different methods to accomplish this objective.
Sales Taxes Payable
Illustration: Halo Supermarket sells loaves of bread to consumers
on a given day for €2,400. Assuming a sales tax rate of 10 percent, Halo
Supermarket makes the following entry to record the sale.
Cash 2,640
Sales Revenue 2,400
Sales Taxes Payable 240
Value-Added Taxes Payable
Illustration: The VAT is collected every time a
business purchases products from another business in
the product’s supply chain. To illustrate,

1. Hill Farms Wheat Company grows wheat and sells

it to Sunshine Baking for €1,000. Hill Farms Wheat
makes the following entry to record the sale,
assuming the VAT is 10 percent.

Cash 1,100
Sales Revenue 1,000
Value-Added Taxes Payable 100
2. Sunshine Baking makes loaves of bread from this wheat and sells it to Halo
Supermarket for €2,000. Sunshine Baking makes the following entry to
record the sale, assuming the VAT is 10 percent.
Cash 2,200
Sales Revenue 2,000
Value-Added Taxes Payable 200
Sunshine Baking then remits €100 to the government, not €200. The reason:
Sunshine Baking has already paid €100 to Hill Farms Wheat.
3. Halo Supermarket sells the loaves of bread to consumers for €2,400. Halo
Supermarket makes the following entry to record the sale, assuming the
VAT is 10 percent.
Cash 2,640
Sales Revenue 2,400
Value-Added Taxes Payable 240
Halo Supermarket then sends only €40 to the tax authority as it deducts the
€200 VAT already paid to Sunshine Baking.
 9. Income Tax Payable
Businesses must prepare an income tax return and
compute the income tax payable.
 Taxes payable are a current liability.
 Corporations must make periodic tax payments.
 Differences between taxable income and
accounting income sometimes occur.
 10. Employee-Related Liabilities
 Amounts owed to employees for salaries or wages are reported as a current
liability.
 Current liabilities may include:
Payroll deductions.
Compensated absences.
Bonuses.

Payroll Deductions
Taxes: Social Security Taxes
Income Tax Withholding Summary of Payroll Liabilities
Profit-Sharing and Bonus Plans

Payments to certain or all employees in addition to

their regular salaries or wages.
 Bonuses paid are an operating expense.
 Unpaid bonuses should be reported as a current
liability.
End of Chapter 3
 Chapter Four
Accounting for the Payroll System in an Ethiopian Context
4.1. Meaning of Payroll
What is Payroll and Payroll Accounting?
• The term Payroll often refers to the document prepared to pay remuneration for the
service rendered in a given period of time.
• Payroll Accounting is an accounting that is concerned with preparation of payroll and
recording and reporting of remunerations.

4.2. The Importance of Payroll Accounting

• The payroll accounting of a firm has to be given emphasis for the following reasons
1. Employees are sensitive to payroll errors and irregularities, and maintaining
good employee moral requires that the payroll be paid on a timely, accurate basis.
2. Payroll expenditures are subject to various government regulations.
3. The payment for payroll and related taxes has significant effect on the net
income of most business enterprises.
• For the aforesaid reasons the need for accurate system of handling the payroll of a
business is unquestionable.
4.3. Definitions of Payroll Related Terms
1) Salary Vs. Wages
 Salary and wages are usually used interchangeably.
 However, the term wages is more correctly used to refer to
payments for manual labor that are paid based on the number of
hours worked or the number of units produced. So, they are
usually paid when a particular piece of work is completed or for a
period less than a month.
 On the other hand, compensations to employees on monthly or
annual basis are termed as salaries.
 It must be clear that when we say an employee, we refer to an
individual who works primarily to an organization and whose
activities are under the direction and supervision of the employer.
 Hence an employee is different from an independent contractor,
a self-employed individual who works on a fee basis to a firm.
2) The Pay Period
 It is the length of time covered by each payroll payment.
 Pay periods for wage workers are usually made on weekly or bi-weekly.
 On the other hand, salaried employees pay periods are monthly or semi-monthly.
3) The Pay Day
 The day, on which wages or salaries are paid to employees, usually the last day
of the pay period is known as the PAY DAY.
4) A Payroll Register (Sheet)
 It is the entire list of employees of a business along with each employee’s gross
earnings, deductions, and net pay for a particular payroll period.
 The basis for the preparation of the payroll register can be the attendance sheets,
punched (clock) cards or time cards.
5) Employee Earnings Record
 It is a summary of each employee's Earnings, Deductions, and Net Pay for each
payroll period and of cumulative gross earnings during the year.
 It is a separate record kept for each employee.
 The individual employees' earnings record helps the employer organization to
properly summaries and file tax returns.
6) Pay Check
 It is an instrument for paying salary if the firm makes payment via writing a
check in the name of each employee for the net pay or a check for the total pay.
7) Gross Earnings
 It is the total pay to an employee before deduction for the pay period.
8) Payroll Taxes
 They are taxes levied against the employer on the payroll of a firm.
 It is the portion of pension or social security contribution made by the employer.
 It is an additional payroll related expense to an employer.
9) Withholding Taxes
 These are taxes levied against the earnings of the employees of an
organization and withheld by the employer per the regulations of the
concerned government.
10) Payroll Deductions
 These are all the reductions from the gross earnings of an employee such as
withholding taxes, union dues, fines, credit association pays, etc.
11) Net Pay
 The gross earnings after subtracting all the deductions, it is sometimes
known as take home pay.
 In the above definitions of payroll related terms, the three are considered the
basic records of a payroll accounting system.
 These are: (1) A payroll sheet, (2) Individual employees' earnings records,
and (3) Pay checks.
 These records are generated from a payroll system that is operated either
 4.4. Possible Components of a Payroll Register
1) Employee Number
 Numbers assigned to employees for identification purpose when a relatively
large number of employees are included in the payroll register.
2) Name of Employees
 List of the name of employees.
3) Earnings
 Money earned by an employee(s) of a firm from various sources. It may
include:
A) The Basic Salary or Regular Earning
 A flat monthly salary of an employee that is paid for carrying out the
normal work of employment and subject to change when the employee is
promoted.
B) Allowances
 Money paid monthly to an employee for special reason, which may include:
i. Position Allowance
 Monthly sum paid to an employee for bearing a particular office responsibility, e.g.
HoD.
ii. House Allowance
 A monthly allowance given to cover housing costs of the individual employee when
the employment contract requires the employer to provide housing but fails to do so.
iii. Hardship Allowance
 A sum of money given to an employee to compensate for an inconvenient
circumstance caused by the employer.
 For instance, unexpected transfer to a different and distant work area or location.
 It is sometimes known as disturbance allowance.
iv. Desert Allowance
 A monthly allowance given to an employee because of assignment to a relatively hot
region.
v. Transportation (Fuel) Allowance
 A monthly allowance to an employee to cover cost of transportation up to the work
place if the employer has committed itself to provide transportation service.
 C) Overtime Earning
 Overtime work is the work performed by an employee beyond the regular working hours
or days.
 Overtime earning is the amount payable to an employee for overtime work done.
 In Ethiopia, in this respect, according to Article 33 of proclamation No. 64/1975, the
following is discussed about payment for overtime work.
 A worker shall be entitle to be paid at rate of one and one quarter( 1 & 1/2) times his
ordinary hourly rate for overtime work performed before 10 o’clock in the evening (10
p.m).
 A worker shall be paid at the rate of one and one half (1 & 3/4) times his ordinary hourly
rate for overtime work performed between 10 O’clock in the evening (10 p.m) and 6
O’clock in the morning (6 a.m).
 Overtime work performed on the weekly rest days shall be paid at a rate of two (2) times
the ordinary hourly rate of payment.
 A worker shall be paid at a rate of two and half (2 & 1/2) times the ordinary hourly rate for
overtime work performed on a public holiday.
 Hence, the gross earnings of an employee may, therefore, include the basic salary,
allowances and overtime earnings.
 You may find sometimes other form of earnings such as Bonus that is paid to employees
Exercise 1: Mr. X is an employee of a governmental organization. He
has a monthly basic salary of Birr 8,000. In a given month Mr. X has
worked 12 hours during weekly rest days. In addition Mr. X has also
worked 9 hours and 15 hours during the holidays and b/n 10 pm and 6
am respectively.
Required: Assuming a normal working hours of 160 per month
determine the OTE of Mr. X.
4) Deductions
 These are amounts to be subtracted from the earnings of employee because they
are required by the government (mandatory deductions) or permitted by the
employee himself (voluntary deductions).
 Mandatory deductions include employment income tax and pension
contribution.
 In our country, Ethiopia, some of the deductions against the earnings of
employees are:
A. Employee Income Tax
 In Ethiopia every citizen is required to pay something in the form of income tax
from his/her earning of employment.
 In this case, a progressive income tax system that charges higher rates for higher
earnings is applied on the gross earnings of each employee.
 The new tax system/rate that has become in effect beginning Hamle 1, 2008 E.C.
exempts the first Birr 600 of the earnings of an employee from income tax.
 The money on which a person does not have to pay income tax is an exemption.
 According to the new tax system/rate, employee income tax has to be computed
Schedule “A”

33
Employment Income Difference Tax Income tax Deductible
per Month (taxable Rate (taxable income (direct deduction)
income) * tax rate)
TB

1st 0 ---600 600 0 0 Exempt (0%)

2nd 600----1,650 1,050 10% 105 (600*10%)-0=60

3rd 1,650----3,200 1,550 15% 232.5 (1,650 *15%) - 105=142.5

5thth 5,250----7,800 2,550 25% 637.5 (5,250*25%)-105-232.5-
4 3,200----5,250 2,050 20% 410 (3,200*20%)- 105-
410=565
232.5=302.5
6th 7,800--10,900 3,100 30% 930 7,800*30%)- 105-232.5-
410-637.5=955
7th Above10,900 - 35% - 10,900*35%)- 105-232.5-
410-637.5- 930= 1,500
 Generally, taxable income from employment includes salaries, wages,
allowances, director’s fees and other personal emoluments, all payments in cash
and benefits in kind.
 However, there are some income items, which are exempted/free from taxation.
 Accordingly, Article 13 of the proclamation No. 286/2002 declares the following
categories of payments in cash or benefits in kind to be excluded from
computation of employment income tax.
 Income from employment received by casual employees. Casual employees are
workers who do not work for more than one month for the same employer in any
twelve-month period.
 Pension contribution, provident fund and all forms of retirement benefit
contributed by employers that does not exceed 15% of the monthly salary of
employees.
 Subject to reciprocity, income from employment of diplomatic and consular
representatives.
 Amounts paid by employer to cover the actual cost of Medical treatment of
employees.
 Allowance in lieu of means of transportation granted to employees under
contract of employment.
 However, the treatment of transportation allowance differs at Federal and City
administration level.
 For example, at federal level only transportation allowances up to 25% of the BS
of the employee or an amount that does not exceed Br. 800 is exempted from tax.
Any amount in excess of this is subject to tax.
 In Addis Ababa & Dire Dawa City administrations, the exempted amount of
transportation allowance is 15 % the Basic Salary of the employee or an amount
that does not exceed Br. 600 is exempted from tax.
 Hardship Allowance
 Amounts paid to employees in reimbursement of travelling expenses incurred on
duty.
 Allowances paid to members and secretaries of boards of public enterprises and
public bodies as well as members and secretaries of study groups set up by
federal and regional government.
 Income from persons employed for domestic duties (home servants)
Exercise 2

 Ato Kassahun the employee of government owned organizations

has worked 8 hours, 6 hours and 10 hours during the holidays, after
mid night working days and week end days respectively in a given
month. For the year 2009 he has earned a regular monthly salary of
Birr 3,500 as a result of working 160 regular hours. Then determine

a) Over time earning (OTE) of Ato Kassahun

b) Gross earning (GE)

c) EIT based on the new income tax system

B. Pension Contribution
• Permanent employees of an organization, employees who are governed by the existing
regulations of the Ethiopian public servants, are expected to pay or contribute certain
percentage (7%) of their basic (monthly) salary to the government pension trust fund.
• This amount should be withheld by the employer from the basic salary of each
employee on every payroll and later be paid to the respective government body.
• On the other hand, the employer is also expected to contribute towards the same fund
11% of the basic salary of every permanent employee of it. It is this total amount that
we called earlier as payroll taxes expense to the employer organization
• Consequently, the total contribution to the pension trust fund of the Ethiopian
government is equal to 18% of the total basic salary of all permanent employees of an
organization (i.e. 7% comes from the employees and the 11% comes from the
employer).
• This enables a permanent employee of an organization to be entitled to the pension pay
given that the employee has satisfied the minimum requirements to enjoy this benefit
when retired.
• Non-governmental organizations are also using this kind scheme to benefit their
employees with some modifications.
• This is made in some NGO'S by keeping a fund known as Provident Fund.
• Both the employees and the employer contribute towards this fund monthly.
• Ultimately, when an employee is retired or drawn out of work a lump sum amount is
Exercise 3
 W/ro Kidist Mamo is a permanent employee of a government
owned organization. The employer contributes Birr 550 for
pension on behalf of W/ro Kidist Mamo for the month of
Ginbot 2011. Then determine,
 The monthly basic salary of W/ro Kidist Mamo.
 The amount of pension contribution to be withheld from W/ro
Kidist in the month Ginbot 2007 to pension trust fund.
C. Other Deductions (Voluntary Deductions)
 Apart from the above two kinds of deductions from employees
earnings, employees may individually authorize additional deductions
such as deductions to pay health or life insurance premiums; to repay
loans from the employer or credit association; to pay for donations to
charitable organizations; etc.
 Each of the major other deductions may be put in special column in
the payroll register.
Ultimately, the sum of the employees’ income tax, pension
contributions and other deductions gives the total deductions from the
gross earnings of an employee.
The column “Total Deductions” shows the total amount to be
deducted from the earnings of employees.
5) The Net Pay
 This amount is held in one column of the payroll register representing the
excess of gross earnings over the total deductions of an employee.
 The column 'Net Pay' total tells the excess of grand total earnings over
grand total deductions made from the earnings of employees.
 It is the grand total take-home pay.

6. Signature
Unless some other document is used, the payroll sheet may be designed
to allow a column for signature of the employees after collection of the net
pay.
In general, a payroll register should at least show the earnings,
deductions and the net pays along with the names of employees.
 4.5. Major Procedures Involved in Accounting for Payroll
1) Gathering the necessary data.
• All the relevant information about every employee should be gathered. This
activity requires reviewing various documents and to do some arithmetic work.
2) Including the names of employees along with the gathered data such as
earnings, deductions and NP’s in the appropriate columns of the payroll register.
3) Totaling and proving the payroll register.
• It must be proved that the grand total earnings equal the sum of the grand totals
of deductions and net pays in the register.
4)The accuracy/authenticity of the information summarized in the payroll should
be verified by a different person from the one who compiles it.
5) The payroll is approved by the authorized personnel.
6) Paying the payroll either in cash (this may be after cashing a check issued for
the total net pay of the payroll) or issuing a check for every individual employee
for the net amount payable to each employee.
7) Recording the payment of the payroll and WHT liabilities.
8) Recording the payroll taxes expense of the employer.
9) Paying and recording withholding and payroll tax liabilities to the concerned
authority, in our case to ERCA, on time.
 4.6. Demonstration Problem
 Ethio Relief Agency pays the salary of its employees according to the Ethiopian
Calendar month. The forth coming data relates to the month of Nehassie 2008.
S. Name of Basic All. OT Hrs Duration of BS Per
No. Employee Salary Worked OT Work Hour
01 Senait Bahiru 9,600 100 10 6 AM to 10 PM 60
02 Petros Challa 1,600 __ 8 10 PM to 6 AM 10
03 Abdu Mohammed 6,000 __ 6 Weekly Rest 37.5
Days
04 Leilla Jemal 4,000 50 __ __ 25
05 Kirkos Wolde 12,000 500 10 Public Holidays 75
Additional Information:
 Note that management of the agency usually expects an employee to work
40 hours in a week and during Nehassie 2008 all employees have worked as
they have been expected.
 Besides, all workers of this agency are permanent employees except Petros
Chala and the monthly allowance of Kirkos Wolde is not taxable; Abdu
Mohammed agreed to have Birr 200 be deducted from his earning and paid
to the Credit Association of the Agency as a monthly saving.
Instructions: Based on the above information:
A. Compute of earnings, deductions and net Pays.
B. Prepare a Payroll Register (or Sheet) for the agency for the month of
Nehassie 2008.
C. Record the payment of salary as of Nehassie 2008 using Check No.
41 as a source document.
D. Record the payroll tax expense for the month of Nehassie 2008 .
Memorandum No.006
E. Record the payment of the claim of the Credit Association of the
agency that arose from Nehassie’s payroll assuming that the
payment was made on Meskerem 1, 2008.
F. Record the payments of withholding taxes and payroll taxes of the
month of Nehassie, 2008 assuming that they have been paid on
Meskerem 5, 2008 via Check No. 50
 Solutions
A. Computation of Earnings, Deductions and Net Pays.
C. Record the payment of salary as of Nehassie 2008 using Check
No. 41 as a source document.
D. Record the payroll tax expense for the month of Nehassie 2008 .
Memorandum No.006
E. Record the payment of the claim of the Credit Association of the
agency that arose from Nehassie’s payroll assuming that the payment
was made on Meskerem 1, 2008.

F. Record the payments of withholding taxes and payroll taxes of the

month of Nehassie, 2008 assuming that they have been paid on
Meskerem 5, 2008 via Check No. 50
Cont’d
The End of Chapter
4
 Chapter Five
Accounting For Partnership
5.1. Definition
• A partnership is a voluntary association of two or more people to pursue a business for a profit as a
co-owner.
• Partnerships are common especially in small retail and service business.
5.2. Characteristics of partnership
• Limited Life
• Mutual Agency
• Co-ownership of partnership property
• Unlimited Liability
Advantages and Disadvantages of Partnerships
Advantages
• Easy and inexpensive to organize
• Requiring only an agreement between two or more persons
• Able to bring more capital, more managerial skills, and more experiences than would a sole
proprietorship
• Non-taxable entity
Disadvantages
• Limited life
• Unlimited liability
 Accounting for Partnership
1. Recording Initial Investments
 A separate entry is made for the investments of each partner in a partnership.
 Assets contributed by a partner are debited to the proper asset accounts.
 If liabilities are assumed by the partnership, the appropriate liability accounts are
credited.
 The partner’s capital account is credited for the net amount.
Illustration: A, B, and C formed a partnership; A contributed $50,000 in cash and
inventory with a fair market value of $100,000 in the partnership; B contributed
equipment with a fair market value of $180,000 and a building with a fair market
value of $150,000 in the partnership; C contributed $100,000 in cash and equipment
with a fair market value of $90,000 and in addition to this ‘C’ transferred a liability of
$30,000 to the partnership. The entry to record the assets contributed and the liabilities
transferred by ‘A’, ‘B’, and ‘C’.
Cash--------------------$150,000
Inventory----------------100,000
Equipment--------------270,000
Building-----------------150,000
Accounts Payable---------------------------30,000
A, Capital-----------------------------------150,000
B, Capital-----------------------------------330,000
 2. Division of Net income or Net loss
 The partners may, however, make any agreement they wish in regard to the
division of net income and net loss.
A. Income Division Recognizing Services of Partners
 As a means of recognizing differences in ability and amount of time devoted to the
business, articles of partnership often provide for the division of a portion of net
income to the partners in the form of a salary allowances.
Illustration: Assume that the articles of partnership of Abebe and Emebet provide for
monthly salary allowances of Birr 2,500 and Birr 2,000 respectively, with the
balances of the net income to be divided equally, and that the net income for the year
is Birr 75,000.
 B. Income Division Recognizing Services of Partners and Investment
• Partners may agree the most equitable plan of income sharing is to allow salaries
based on the services rendered and also to allow interest on the capital investments.
• The remainder is then shared in an arbitrary ratio.
Illustration: Assume that Abebe and Emebet (1) are allowed monthly salaries of Birr
2,500 and Birr 2,000 respectively; (2) are allowed interest at 12% on capital balances
at January 1 of the current fiscal year, which amounted to Birr 80,000 and Birr 60,000
respectively; and (3) divide the remainder of net income equally.
 C. Income Division-Allowances Exceed Net Income
• If the net income is less than the total of the special allowances, the
“remaining balance” will be a negative figure that must be divided
among the partners as though it were a net loss.
 3. Partnership Dissolution
 Any change in the personnel of the ownership results in the
dissolution of the partnership.
 Thus, admission of a new partner dissolves the old firm.
 Similarly, death, bankruptcy, or withdrawal of a partner causes
dissolution.
A. Admission of a Partner
 An additional person may be admitted to a partnership enterprise only
with the consent of the current partners.
 An additional person may be admitted to a partnership through:
1.Purchase of an interest from one or more of the current partners.
2. Contribution of assets to the partnership.
Admission by purchase of an interest from one or more of the current partners
Example: assume that partners Tom and Nathan have capital balances of $50,000
each. On June 1, each sells one fifth of his respective equity to Joe for $10,000 in
cash. The exchange of cash is not a partnership transaction and thus is not recorded by
the partnership. The only entry required in the partnership accounts is as follows
Tom, Capital-----------------------10,000
Nathan, Capital-------------------10,000
Joe, Capital------------------------20,000
Admission by Contribution of Assets
 Instead of buying an interest from the current partners, the incoming partner may
contribute assets to the partnership.
 In this case both the assets and the owner’s equity of the firm are increased.
Illustration: - Assume that Donald and Gerald are partners with capital accounts of
$35,000 and $25,000 respectively. On June 1, Sharon invests $20,000 cash in the
business, for which she is to receive ownership equity of $20,000.
• The entry to record this transaction is as follows:
Cash------------------------20,000
Sharon, Capital--------------- 20,000
B. Withdrawal of a Partner
 When a partner retires or for some reason wishes to withdraw from
the firm, one or more of the remaining partners may purchase the
withdrawing partner’s interest and the business may be continued
without apparent interruption.
 The only entry required by the partnership is a debit to the capital
account of the partner withdrawing and a credit to the capital account
of the partner or partner’s acquiring the interest.
Illustration 1: Alan is to retire/withdraw from the partnership of
Theodor, Alan, and Smith. The capital balances of the partners are as
follows: Alan, $ 200,000; Theodor, $100,000; and Smith, $ 100,000.
Alan has sold his interest to Theodor for $200,000.
 Hence, the only entry required by the partnership to record the
withdrawal of Alan is follows:
Alan, Capital---------------200,000
Theodor, Capital-----------------200,000
Illustration 2: Alan is to retire/withdraw from the partnership of Alan, Theodor, and Smith. The
capital balances of the partners are as follows: Alan, $ 200,000; Theodor, $100,000; and Smith, $
100,000. Their net income/net loss sharing ratio is 2:1:1 respectively. At the time of the valuation
of assets at their market prices, the partners agreed that the merchandise inventory should be
increased by $10,500 and the allowance for doubtful accounts should be increased by $2,100.
Required: - Present entries to record;
1) The adjustment of the assets
2) The withdrawal of Alan from the partnership if:
a) Alan receives the full amount in cash
b) Alan agreed to accept an interest bearing note of $150,000 in partial settlement of his
ownership equity and the remainder of his claim to receive in cash.
Solution:
1. Merchandise inventory--------------10,500
Alan, Capi--------------------------------4,200
Theodor, Capital-------------------------2,100
Smith, Capital----------------------------2,100
Allowance for doubtful accounts-----2,100
2. (a) Alan, Capital--------204,200
Cash------------------204,200
(b) Alan, Capital----------204,200
Notes payable----------150,000
Cash----------------------54,200
 Liquidation of Partnership
• Liquidation is refers to the process of a wind-up of a business firm.
• When a partnership goes out of business, it usually sells the assets.
• The sale of non cash assets is called realization.
• During the process of realization, any gain or loss resulted from the sale of non cash
assets is shared among the partners based on their income sharing agreement.
• As cash is realized, it is applied first to the payment of the claims of creditors.
• After all liabilities have been paid, the remaining cash is distributed to the partners
based on their ownership equities as indicated by their capital accounts.
Illustration: The partnership of Dawit, Alemu, and Almaz share income in a ratio of
5:3:2, after discontinuing the ordinary business operations of their partnership and
closing the accounts, the following summary of the general ledger is prepared:
Cash-------------------------------------$11,000
Non cash assets-------------------------64,000
Liabilities---------------------------------------------$9,000
Dawit, Capital----------------------------------------22,000
Alemu, Capital----------------------------------------22,000

Almaz, Capital----------------------------------------22,000
  Based on these facts, accounting for the Liquidation of the
partnership will be illustrated using three different selling
prices for the non cash assets.
1. Gain on Realization
 Dawit, Alemu, and Almaz sell all non cash assets for $72,000,
 realizing a gain of $8,000 ($72,000 - $64,000).
 The gain is divided among the capital accounts of the partners in
the income sharing ratio of 5:3:2.
 The liabilities are paid, and the remaining cash is distributed to
the partners according to the balances in their capital accounts.
Required:
a) Prepare the partnership liquidation statement
b) Pass the necessary entries
The entries to record the several steps in the liquidation procedure are as follows:
1. To record the sale of non cash assets
Cash---------------------72,000
Non cash assets------------------64,000
Loss & gain on realization------8,000
2. To record the division of gain
Loss & gain on realization-------8,000
Dawit, Capital----------------- 4,000
Alemu, Capital------------------2,400
Almaz, Capital------------------1,600
3. To record the payment of liabilities
Liabilities------------------------------9,000
Cash----------------------------------9,000
4. To record the distribution of cash to partners
Dawit, Capital--------------------26,000
Alemu, Capital-------------------24,400
Almaz, Capital--------------------23,600
Cash-------------------------74,000
2. Loss on Realization; No Capital Deficiencies
 Assume that the foregoing example, Dawit, Alemu, and Almaz
dispose all of non cash assets for $44,000, incurring a loss of $20,000
($64,000 - $44,000).
 The various steps in the statement of partnership liquidation are
presented hereunder:
The entries to record the several steps in the liquidation procedure are as follows:
1. To record the sale of non cash assets
Cash----------------------------------44,000
Loss & gain on realization--------20,000
Non cash assets--------------------------64,000
2. To record the division of loss
Dawit, Capital--------------------------10,000
Alemu, Capital---------------------------6,000
Almaz, Capital---------------------------4,000
Loss & gain on realization--------------------20,000
3.To record the payment of liabilities
Liabilities------------------------9,000
Cash-----------------------------9,000
4. To record the distribution of cash to partners
Dawit, Capital---------------------12,000
Alemu, Capital--------------------16,000
Almaz, Capital---------------------18,000
Cash------------------------46,000
3. Loss on Realization; Capital Deficiency
 Assume that the foregoing example, Dawit, Alemu, and Almaz
dispose all of non cash assets for $10,000, incurring a loss of $54,000
($64,000 - $10,000).
 The various steps in the statement of partnership liquidation are
presented hereunder:
The entries to record the liquidation to this point are as follows:
1.To record the sale of non cash assets
Cash---------------------------------------10,000
Loss & gain on realization-------------54,000
Non cash assets----------------64,000
2.To record the division of loss
Dawit, Capital---------------------27,000
Alemu, Capital---------------------16,200
Almaz, Capital----------------------10,800
Loss & gain on realization-----------54,000
3. To record the payment of liabilities
Liabilities---------------------9,000
Cash----------------------------9,000
4. To record the distribution of cash to partners
Alemu, Capital----------------------2,800
Almaz, Capital----------------------9,200
Cash--------------------------12,000
End of Chapter 5