Partnership Firm Accounting Concepts and Final Accounts

Partnership Concepts and Final Accounts

1. CHAPTER 6
Partnerships
Accounting concepts and final accounts

2. Progression
Grade 10: Preparation of final accounts of sole traders
Grade 11: Preparation of final accounts of partnerships
and clubs
Grade 12: Preparation of final accounts of companies
______________________________________________

3. Introduction
Up until now in accounting, we have only dealt with:
Sole traders are businesses with only one owner.
In this chapter, we will discuss the accounting records of:
Partnerships are businesses with more than one owner.
The general day-to-day transactions of a partnership are exactly the same as those
of a sole trader.
So how do these businesses differ from each other?
_______________________________________________________________________________
One
owner
Sole traders the net profit generated by the business belongs to
Partnerships
More than
one owner
the net profit generated by the business belongs to
Sole traders
Partnerships

4. Differences between a sole trader and a partnership
The following table highlights the main differences between a sole trader and a partnership:
_____________________________________________________________________________
Sole trader Partnership
Capital account balance of each partner will only change if a
partner increases or decreases their capital.
Capital account balance will vary each year, as
the net profit is added and drawings deducted.
Drawings account of each partner is closed off to the Current
account of each partner at the end of the financial year.
Drawings account is closed off to the Capital
account at the end of the financial year.
Net profit is posted from the Profit and Loss account to the
Appropriation account, where it is shared among partners
according to the partnership agreement.
Net profit is posted from the Profit and Loss
account to the Capital account.
A Drawings account for each partner
A Current account for each partner
Only one Drawings account
A Capital account for each partnerOnly one Capital account
Minimum of two partnersOnly one owner

5. What is a partnership?
_____________________________________________________________________________
A partnership is usually formed when:
two or more people want to start a business together, and
they want to conduct business in a similar manner to a sole trader,
rather than forming a legal entity such as a Close Corporation or
company.
The partners contribute towards the partnership by providing:
Capital (usually cash, but can also be fixed assets)
Knowledge, skills and expertise
Professionals, such as doctors, lawyers or architects usually form partnerships.
In such partnerships:
each professional (partner) will offer their services independently
the partners share common costs (e.g. a receptionist, bookkeeper,
assistants and offices).
the partners will refer patients/clients to each other.

6. Partnership agreement
_____________________________________________________________________________
A partnership involves a legal agreement between two or more people.
This agreement can be verbal, but should preferably be in writing.
A written agreement between partners is known as a partnership agreement.
The partnership agreement will differ from one partnership to the next, but should at
least contain the following:
Contents of partnership agreement
•The names of the partnership and partners involved.
•The aim of the business, and the product or service provided.
•The amount of capital, work or labour, knowledge and/or skills or goodwill
each partner will contribute to the business.
•The specific job description for each partner.
•The extent to which the partners will be liable for debts or losses.
•The ratio according to which the net profit is shared among partners.
•Any other stipulations with regards to changes in capital, drawings, retirement
or withdrawal from the partnership.

7. Liability of partners
_____________________________________________________________________________
Since a partnership is not a legal entity, the partners are jointly and severally
liable for debts of the partnership.
This means that if a partnership become insolvent, the partners will have to use their
personal funds to settle any outstanding debts of the partnership.
A partnership thus has unlimited liability.
This means the liability of the partners is not limited to the amount of capital
invested in the partnership.
Ethical considerations relating to partnerships
Partners invest a lot of capital and time in the partnership, so it is very important that:
they have a trusting relationship.
they have, and adhere to, a partnership agreement.
they have the best interest of the partnership at heart.
A partner is not entitled to enrich himself at the cost of the partnership.
A partner can bind the business contractually, so communication between partners
is very important as all the partners need to know what their potential liabilities are.

8. Types of partnerships
___________________________________________________________________________
Type of partnerContribution
Physically works for the
partnership
Is known to
the public
Liability for debts
and/or losses
Active
partner
Sleeping
partner
Anonymous
partner
Commanditarian
partner
Limited
partner
Quasi-
partner
Liability is limited to
the amount invested
NoNo
Capital in the form of a loan
(interest varies according to
the net profit generated)
Liability is limited to
the amount invested
YesYesCapital
Liability is limited to
the amount invested
NoNoCapital
Fully liableNoNoCapital, labour or skills
Fully liableYesNo (often retired partner)Capital, labour or skills
Fully liableYesYesCapital, labour or skills

9. Advantages and disadvantages of a partnership
___________________________________________________________________________
Advantages
A partnership is relatively easy to form.
A bigger capital amount can be raised – more than one person contributing.
More talent – skills, expertise and knowledge of different people in various fields are combined.
Competition is limited.
Continuation of the business – a partner can be replaced or bought out by the other partners.
Disadvantages
Partners are jointly and severally liable for all debts or losses.
The death or retirement of a partner could cause problems.
The behaviour and attitude of one partner could have a negative impact on the entire partnership.
Each partner has the power to bind the business contractually.
Arguments could affect the trust relationship and smooth running of the business.

10. Accounting concepts unique to partnerships
___________________________________________________________________________
The day-to-day transactions, source documents, journals and accounts of a
partnership are the same as for sole traders.
However, the accounts relating to owner’s equity and profit sharing are different.
We will examine the following accounts that are specifically used in partnerships:
Capital account (for each partner)
Drawings account (for each partner)
Salary account (for each partner)
Bonus to partner account (for each partner)
Interest on capital account
Appropriation account
Current account (for each partner)

11. Information: Partners A Abel and B Beck started a partnership, AB Bicycle Shop, in 2016.
A Abel contributed R100 000 and B Beck R180 000.
On 31 October 2019, the partners decided that they should have an equal contribution.
A Abel increased his capital by R50 000 while B Beck decreased his capital by R30 000.
Example: Capital accounts of a partnership
Capital accounts
In a partnership, each partner has their own separate Capital account.
The Capital accounts are only used to record the amount of capital contributed by each partner.
Net profit and drawings are closed off to another account called the Current account.
Dr Capital: A Abel B1 Cr
00100 000b/dBalance1
2019
Mar
0050 000CRJBank31Oct
00150 00031 c/dBalance

2019
Oct
00150 00000150 000
00150 000b/dBalance1
2019
Nov
Dr Capital: B Beck B2 Cr
00180 000b/dBalance1
2019
Mar0030 00031 CPJBank

2019
Oct
00180 00000180 000
00150 000b/dBalance1
2019
Nov
00150 000c/dBalance

12. Information: Partner A Abel works in the business every day, doing purchases, sales and
running the business. A Abel withdraws R12 000 on the last day of every month to meet
his living expenses. He also took trading stock with a cost price of R800 on 15 March 2019
and stationery to the value of R300 for personal use on 22 March 2019.
Example: Drawings accounts of a partnership
Drawings accounts
In a partnership, each partner has their own separate Drawings account.
The Drawings accounts are used to record all amounts withdrawn from the partnership by each partner.
Salaries paid to partners will also be posted to each partner’s Drawings account (not the Salaries account).
Dr Drawings: A Abel B3 Cr
0080015 GJTrading stock

2019
Mar
0030022 GJStationery
0012 00031 CPJBank
Entries in the Drawings account of A Abel for March 2019

13. Salary accounts of partners
The partnership agreement usually makes provision for the allocation of a salary to
partners in order to compensate partners for services rendered to the
partnership.
This allocation is in addition to the partner’s share in the profit.
As already mentioned, all amounts paid to partners during the financial year are
entered in the Drawings accounts of each of the partner.
Thus the Salary accounts of partners are merely convenience account.
This means they will only be opened and used at the end of the financial period,
when the profit sharing is calculated and entered in the books.
Since the salary earned by each partner forms part of the appropriation of profits:
Salary accounts of partners are not closed off to the Profit and Loss
account as operating expenses,
but are instead closed off to the Appropriation account.
At the end of the financial year, the full amount of partners’ salaries according to
the partnership agreement is entered in each partner’s individual Salary accounts,
whether the partner has actually drawn the money or not.
____________________________________________________________________________________
Salary accounts
of partners
Profit and Loss
account
Appropriation
account

14. Information:
Partner A Abel works in the business every day, doing purchases, sales and running the business.
The partnership agreement stipulates that he should be allocated a salary of R120 000 per annum
for services rendered to the business.
Partner B Beck is retired and does the business books on a monthly basis. As he is spending less
hours rendering a service to the partnership, he is allocated R48 000 per annum for services
rendered to the business.
Example: Salary accounts of partners
Entries in the Salary accounts of the partners
Dr Salary: A Abel N20 Cr
00120 000GJAppropriation account29
2020
Feb00120 00029 GJCurrent account: A Abel

2020
Feb
00120 00000120 000
Dr Salary: B Beck N21 Cr
0048 000GJAppropriation account29
2020
Feb0048 00029 GJCurrent account: B Beck

2020
Feb
0048 0000048 000

15. Information: Besides managing the business, partner A Abel is a very good cyclist and
people come to the shop because he is known in the cycling community. He therefore
adds goodwill to the business.
The partnership agreement therefore stipulates that partner A Abel should be allocated a
bonus of 10% of the net profit of the business for the year. The net profit of AB Bicycle
Shop for the year ended 29 February 2020 amounted to R296 400.
Example: Bonus to partner accounts
Bonus to partner accounts
The partnership often makes provision for a bonus to the partner managing the business.
The bonus is usually a percentage of the net profit.
These calculations are also done at the end of the financial year, when the closing transfers are done.
Entries in the Bonus to partner account of A Abel
Dr Bonus to partner: A Abel N22 Cr
0029 640GJAppropriation account29
2020
Feb0029 64029 GJCurrent account: A Abel

2020
Feb
0029 6400029 640
Calculation: Bonus: A Abel = R296 400  10% = R29 640

16. Interest on capital account
To compensate a partner for investing more capital in the business than another partner, it is
custom to first calculate interest on capital before appropriating the remaining profit.
The interest rate will be stipulated in the partnership agreement.
This is also regarded as profit shared and will be done at the end of the financial period.
The Interest on Capital account is closed off to the Appropriation account and is indicated in
the partner’s Current account.
Information: According to the partnership agreement, the partners of AB Bicycle Shop are
entitled to 12% interest on the capital invested in the partnership.
Note that partner A Abel increased his capital by R50 000 and partner B Beck decreased his
capital by R30 000 on 31 October 2019.
Example: Interest on capital account
Entries in the Interest on Capital account
Dr Interest on Capital N23 Cr
0034 400GJAppropriation account29
2020
Feb0014 00029 GJCurrent account: A Abel

2020
Feb
0034 4000034 400
Calculations:
0020 400GJCurrent account: B Beck
Interest on capital (A Abel) = (R100 000  12% 
8
/
12
) + (R150 000  12% 
4
/
12
) = R8 000 + R6 000 = R14 000
Interest on capital (B Beck) = (R180 000  12% 
8
/
12
) + (R150 000  12% 
4
/
12
) = R14 400 + R6 000 = R20 400

17. Appropriation account
As in the case of a sole trader, the gross profit is calculated in the Trading
account and the net profit in the Profit and Loss account.
In the case of the partnership, however, the net profit is then closed off to a
third final account, the Appropriation account.
The Appropriation account is then used to distribute the profit between the
partners according to the partnership agreement.
The distribution of the net profit is done in two steps, namely the primary
distribution and the final distribution.
Primary distribution
Salaries of each partner
Interest on the capital of partners
Bonuses allocated to partners
Final (secondary) distribution
The remaining profit is distributed according to the ratio stipulated in the
partnership agreement.
____________________________________________________________________________________
Trading
account
Profit and Loss
account
Appropriation
account
Primary distribution
 Salaries of partners
 Interest on capital
 Bonuses
Final distribution
Share in remaining profit
Remaining profit = Net profit – Primary distribution
Net profit
Gross profit

18. Information: The net profit of AB Bicycle Shop for the year ended 29 February 2020, calculated in
the Profit and Loss account, is R296 400.
The partnership agreement stipulates the following:
• Partner A Abel earns a salary of R120 000 p.a. and partner B Beck earns a salary of R48 000 p.a.
• Partner A Abel receives a bonus of 10% of the net profit for the year.
• Partners earn interest of 12% p.a. on the capital invested.
• Remaining profits are to be shared equally between the partners.
Example: Appropriation account
Entries in the Appropriation account
Dr Appropriation account F3 Cr
00296 400GJProfit and Loss account29
2020
Feb00120 00029 GJSalary: A Abel

2020
Feb
00296 40000296 400
0048 000GJSalary: B Beck
0029 640GJBonus to partner
0034 400GJInterest on capital
0032 180GJCurrent account: A Abel
0032 180GJCurrent account: B Beck
Primary distribution:
Calculations:
Remaining profit = Net profit – Primary distributionFinal distribution:
Share in remaining profit = R64 360  2 = R32 180
R120 000 + 48 000 + 29 640 + 34 400 = R232 040
= R296 400 – R232 040 = R64 360

19. Current accounts
The balances of the Capital accounts need to be maintained at constant levels.
Therefore the distribution of the net profit can not be entered in the Capital accounts.
The distribution of the net profit is thus recorded in the Current accounts of each partner.
The distribution of net profit is posted to the credit side of the partner’s Current account.
The partners’ Drawings accounts are then closed off to the debit side of their Current accounts.
A credit balance in the Current account of a partner indicates that the partner has:
not withdrawn all of the profit allocated to him/her from the business (retained profits).
A debit balance in the Current account of a partner indicates that the partner has:
withdrawn more than his/her share of the profit (this decreases the partner’s owner’s equity).
Together, the Capital and Current accounts form the partner’s owner’s equity accounts.
____________________________________________________________________________________
Owner’s equity = Capital account balance + Current accounts balance

20. Information: Current accounts balances on 1 March 2019:
• Current account: A Abel R890 (cr)
• Current account: B Beck R1 667 (cr)
Example: Current accounts
Dr Current account: A Abel B5 Cr
00890b/dBalance1
2019
Mar00197 10029 GJDrawings: A Abel

2020
Feb
00197 10000197 100
00120 000GJSalary: A Abel29
2020
Feb
0029 640GJBonus to partner
0014 000GJInterest on capital
0032 180GJAppropriation account
00390c/dBalance
003901 b/dBalance

2020
Mar
Dr Current account: B Beck B6 Cr
001 667b/dBalance1
2019
Mar0084 90029 GJDrawings: B Beck

2020
Feb
00102 247 00102 247
0048 000GJSalary: B Beck29
2020
Feb
0020 400GJInterest on capital
0032 180GJAppropriation account
0017 347c/dBalance
0017 347b/dBalance1
2020
Mar
Owner’s equity: A Abel = Capital account balance + Current account balance = R150 000 – R390 = R149 610
Owner’s equity: B Beck = Capital account balance + Current account balance = R150 000 + R17 347 = R167 347

21. Generally accepted accounting practice (GAAP)
GAAP principleDescription Example
Entity rule
Historical cost
concept
Going concern
concept
Matching
concept
Prudence
concept
Concept of
materiality
The following table shows a summary and example of each concept of the GAAP principles:
Interest on overdraft must be shown in a specific account,
while consumables costs can be included in the Sundry
Expenses account.
Material items must be shown in the
financial statements, but the immaterial
items need not be highlighted.
If the business expects to make a profit of R100 000 on
the sale of part of the building, it will not be entered in the
books until the transfer of the land has been concluded.
Financial results are reflected in a
conservative manner.
The telephone account for February 2015 has to be taken
into account in the financial year ending 28 February
2015, even if the account will only being paid in March.
Income and expenses must be
accounted for in the correct time period
(the one in which they were incurred).
Unused stationery printed in the name of the business is
recorded as a current asset at the end the financial period.
However, if the business will be closing down in the next
financial period, this stationery will have no value.
The financial statements of a business
are prepared with the assumption that
the business will continue operating in
the foreseeable future.
Land and buildings purchased for R500 000 will be
entered at that amount in the books, even if the business
can received a lot more for it after a couple of years.
Assets should be entered at its historical
cost; that is, the amount that was
originally paid for them.
The business has its own bank account and the partners
each have their own bank accounts.
The financial affairs of the partners
should be kept separate from those of the
business – they are two separate entities.

22. The accounting cycle
SOURCE DOCUMENTS
Receipt, cash register roll, deposit slip,
cheque counterfoil, duplicate and original invoice,
petty cash voucher, debit note, credit note
SUBSIDIARY JOURNALS
CJR, CPJ, DJ, CJ, PCJ, DAJ, CAJ, GJ
POSTING TO LEDGERS
General Ledger, Debtors Ledger, Creditors Ledger
PRE-ADJUSTMENT TRIAL BALANCE
YEAR-END ADJUSTMENTS
POST-ADJUSTMENT TRIAL BALANCE
CLOSING TRANSFERS & FINAL ACCOUNTS
Trading account, Profit and Loss account, Appropriation account
POST-CLOSING TRIAL BALANCE
FINANCIAL STATEMENTS
Income Statement, Balance Sheet, Notes to financial statements
The accounting cycle in a partnership is as follows:

23. Revision of adjustments dealt with in Grade 10
___________________________________________________________________________
We will briefly revise the following adjustments that were covered in Grade 10:
Depreciation
Prepaid expenses
Accrued expenses
Accrued income
Income received in advance
Trading stock deficit
Consumable stores on hand

24. Depreciation
Depreciation was covered extensively in the previous chapter on fixed assets.
You should now be able to calculate depreciation using the:
Straight-line (fixed amount) method
Diminishing balance method
You should also now be able to record depreciation in the:
Fixed assets register
General Journal
General Ledger
Recording the transaction:
Effect on the accounting equation:
Journal Account debited Account credited
Assets Owner’s equity Liabilities
EffectReason EffectReason EffectReason
Accumulated depreciation on equipmentDepreciationGeneral Journal
Accumulated depreciation on vehicleDepreciationGeneral Journal
Depreciation is an imputed expense –– Carrying value of asset decreased

25. Prepaid expenses and Accrued expenses
A prepaid expense is an expense that has been paid in the current financial year, but
the expense relates to the next financial year.
An accrued expense is an expense that relates to the current financial year, but will
only be paid in the next financial year.
Adjustment entries are made at the end of the financial year to ensure that prepaid
and accrued expenses are accounted for in the correct financial period.
These entries are then reversed in the next financial year.
Recording the transactions:
Effect on the accounting equation:
Journal Account debited Account credited
Assets Owner’s equity Liabilities
EffectReason EffectReason EffectReason
Expense account adjustedPrepaid expenses
General Journal Accrued expensesExpense account adjusted
General Journal
Create liability: Accrued expenses+– Expense increased
Expense decreased++ Create asset: Prepaid expenses
Matching

26. Accrued income and Income received in advance
Accrued income is income that has been earned in the current financial year, but will
only be received in the next financial year.
Income received in advance is income that has been received during the current
financial year, but the income relates to the next financial year.
Adjustment entries are made at the end of the financial year to ensure that accrued
income and income received in advance are accounted for in the correct financial
period.
These entries are then reversed in the next financial year.
Recording the transactions:
Effect on the accounting equation:
Journal Account debited Account credited
Assets Owner’s equity Liabilities
EffectReason EffectReason EffectReason
Income account adjustedAccrued income
General Journal Income received in advanceIncome account adjusted
General Journal
Create liability: Income received in advance+– Income decreased
Income increased++ Create asset: Accrued income
Matching

27. Trading stock deficit and Consumable stores on hand
Trading stock deficit is the difference between the book value of stock in the
Trading Stock account and the physical value of stock in the business.
The physical value is determined by doing a stock take.
Consumable stores on hand is the difference between the value of consumable
item (e.g. stationery) in the books and the physical value counted during a stock
take.
Recording the transactions:
Effect on the accounting equation:
Journal Account debited Account credited
Assets Owner’s equity Liabilities
EffectReason EffectReason EffectReason
Trading stockTrading stock deficit
General Journal Expense account adjustedConsumable stores on hand
General Journal
Expense decreased++ Create asset: Consumable stores on hand
Trading stock deficit is a loss/expense–– Value of trading stock decreased

28. Additional end-of-year adjustments: Provision for bad debts
As you learnt in grade 10, most businesses incur bad debts (debts written off as irrecoverable).
It thus follows that the full amount owed by debtors at the end of the financial year will not
normally be collected from debtors.
Normally some of these debts will be written off as bad debts in the following financial year.
These expected bad debts must be provided for at the end of the financial year, in order to:
ensure that the debtors amount in the Balance Sheet is as accurate as possible.
account for these bad debts (expense) during the current financial period.
The percentage of debtors that are expected to be written off as bad debts depends on the
business and is usually based on previous years’ trends.
The Provision for Bad Debts account is created in the business’s first financial year.
The balance of the Provision for Bad Debts account is then adjusted in subsequent financial years.
This adjustment is calculated so that the balance always remains at a constant percentage (e.g. 5%)
of outstanding debtors in the current financial year.
Provision for bad debts is a negative asset, because it decreases the value of an asset (debtors).
The contra-account for Provision for Bad Debts is Provision for Bad Debts Adjustment.
The Provision for Bad Debts Adjustment account can be an income or an expense account,
depending on whether the provision for bad debts had to be decreased or increased.
This adjustment is recorded in the General Journal.
____________________________________________________________________________________
Matching
Prudence

29. Information: Cunningham Traders’ Cunningham Traders started trading on 1 March 2016,
and their first financial year therefore ended on 28 February 2017.
Entry in the General Journal:
General Journal of Cunningham Traders – February 2017
GJ12
DayDetails Fol. Debit Credit
Example: Provision for bad debts – creating an account
800 00N21Provision for Bad Debts Adjustment28
B9Provision for Bad Debts 800 00
Calculation: Provision for bad debts = R16 000  5% = R800
Extract from Pre-adjustment Trial Balance of Cunningham Traders as at 28 February 2017
Balance Sheet accounts Fol. Debit Credit
Debtors control B8 16 00000
Adjustment on 28 February 2017:
Provision for bad debts must be adjusted to 5% of outstanding debtors on 28 February 2017.
(Create the account to make provision for
bad debts on 5% of debtors)

30. Example: Provision for bad debts – creating an account (continued)
Posting to the General Ledger:
General Ledger of Cunningham Traders
Balance Sheet accounts
Dr Provision for Bad Debts Adjustment N21 Cr
Nominal accounts
0080028 GJ12Provision for bad debts

2017
Feb
Dr Provision for Bad Debts B9 Cr
00800GJ12
Provision for bad debts
adjustment28
2017
Feb
Assets Owner’s equity Liabilities
EffectReason EffectReason EffectReason
The effect on the accounting equation:
Provision for bad debts
adjustment is an expense
– 800Negative asset: Provision for
bad debts increased
– 800

31. Information: The financial year of Cunningham Traders ends on 28 February. The business
has already been trading for two years.
Entry in the General Journal:
General Journal of Cunningham Traders – February 2018
GJ12
DayDetails Fol. Debit Credit
Example: Provision for bad debts adjustment as an expense
60 00N21Provision for Bad Debts Adjustment28
B9Provision for Bad Debts 60 00
Calculation: Provision for bad debts = R17 200  5% = R860
Extract from Pre-adjustment Trial Balance of Cunningham Traders as at 28 February 2018
Balance Sheet accounts Fol. Debit Credit
Debtors control B8 17 20000
Provision for bad debts B9 80000
Adjustment on 28 February 2018:
Provision for bad debts must be adjusted to 5% of outstanding debtors on 28 February
2018.
(Adjust provision for bad debts to 5% of debtors)
Provision for bad debts adjustment = R860 – R800 = R60

32. Example: Provision for bad debts adjustment as an expense (continued)
Posting to the General Ledger:
General Ledger of Cunningham Traders
Balance Sheet accounts
Dr Provision for Bad Debts Adjustment N21 Cr
Nominal accounts
006028 GJ12Provision for bad debts

2018
Feb
Dr Provision for Bad Debts B9 Cr
00800b/dBalance1
2017
Mar
Assets Owner’s equity Liabilities
EffectReason EffectReason EffectReason
The effect on the accounting equation:
Provision for bad debts
adjustment is an expense
– 60Negative asset: Provision for
bad debts increased
– 60
0060GJ12
Provision for bad debts
adjustment28
2018
Feb
00860
0060GJ12Profit and Loss account28
2018
Feb
00600060

33. Information: The financial year of Cunningham Traders ends on 28 February. The business
has already been trading for three years.
Entry in the General Journal:
General Journal of Cunningham Traders – February 2019
GJ12
DayDetails Fol. Debit Credit
Example: Provision for bad debts adjustment as income
145 00B9Provision for Bad Debts28
N21Provision for Bad Debts Adjustment 145 00
Calculation: Provision for bad debts = R14 300  5% = R715
Extract from Pre-adjustment Trial Balance of Cunningham Traders as at 28 February 2019
Balance Sheet accounts Fol. Debit Credit
Debtors control B8 14 30000
Provision for bad debts B9 86000
Adjustment on 28 February 2019:
Provision for bad debts must be adjusted to 5% of outstanding debtors on 28 February
2019.
(Adjust provision for bad debts to 5% of debtors)
Provision for bad debts adjustment = R715 – R860 = – R145

34. Example: Provision for bad debts adjustment as income (continued)
Posting to the General Ledger:
General Ledger of Cunningham Traders
Balance Sheet accounts
Dr Provision for Bad Debts Adjustment N21 Cr
Nominal accounts
0014528 GJ12Profit and Loss account

2019
Feb
Dr Provision for Bad Debts B9 Cr
00860b/dBalance1
2018
Mar
Assets Owner’s equity Liabilities
EffectReason EffectReason EffectReason
The effect on the accounting equation:
Provision for bad debts
adjustment is income
+ 145Negative asset: Provision for
bad debts decreased
+ 145
00145GJ12Provision for bad debts28
2019
Feb
0014500145
0014528 GJ12
Provision for bad debts
adjustment

2019
Feb
00715c/dBalance
0086000860
00715b/dBalance1
2019
Mar

35. Additional end-of-year adjustments: Interest capitalised
What is interest?
Interest can be:
the cost of borrowed money (interest on loan) or
the earnings on an investment (interest on fixed deposit).
There are different ways to calculate interest.
Simple interest
Simple interest is calculated on the original amount only.
Accumulated interest is not used in this calculation.
The formula for simple interest is:
Compound interest
Compound interest is calculated on the total of the principal (original) amount plus interest
accumulated during past periods.
So we say interest is earned on interest (interest is compounded).
The formula for compound interest is:
____________________________________________________________________________________
A = P(1 + i.n)
Where:
A = the final amount, including the interest
P = the principal amount (the original amount
borrowed/invested)
i = the interest rate for one period
n = number of periods
A = P(1 + i

)n

36. Information:
R3 000 is invested in a fixed deposit account at a bank for four years. The interest is 12%
p.a.
Example: Interest capitalised
Calculations:
Required:
Show the value of the investment at the end of the four years if:
 Simple interest is used
 Compound interest is calculated on a annual basis.
Simple interest Compound interest
Simple interest Compound interest
By using the formula for each it is much faster:
End of year 4: R4 214,78 + (0,12)(R4 214,78) = R4 720,56 (to the nearest cent)
End of year 3: R3 763,20 + (0,12)(R3 763,20) = R4 214,78 (to the nearest cent)
End of year 2: R3 360 + (0,12)(R3 360) = R3 763,20
End of year 1: R3 000 + (0,12)(R3 000) = R3 360
At the end of each year, the interest raised previously is added to the principal
(original) amount, and 12% interest is then calculated on the total amount.
End of year 4: R4 080 + (0,12)(R3 000) = R4 440
End of year 3: R3 720 + (0,12)(R3 000) = R4 080
End of year 2: R3 360 + (0,12)(R3 000) = R3 720
End of year 1: R3 000 + (0,12)(R3 000) = R3 360
The interest is 12% on R3 000 each year for 4 years. The
interest received is the same every year.
A = P(1 + i )nA = P(1 + i.n)= R3 000 [1 + (0,12)(4)]= R4 440 = R3 000(1 + 0,12)4= R4 720,56

37. Information:
On 1 March 2015, Joanne’s Boutique invested R3 000 in a fixed deposit account at AB Bank for four
years. Interest must be capitalised and calculated at 12% compound interest per annum.
At the end of Year 1, 29 February 2016, the business received the following statement from the bank:
Example: Interest capitalised (continued)
Balance of fixed deposit on 1 March 2015 R3 00000
Interest earned for the year R36000
Balance of fixed deposit on 29 February 2016 R3 36000
Entry in the General Journal:
General Journal of Joanne’s Boutique for February 2016 GJ12
DayDetails Fol. Debit Credit
360 00Fixed deposit: AB Bank 29
Interest on fixed deposit 360 00
(Adjustment for interest on fixed deposit capitalised)
Entry in the Cash Payments Journal:
Cash Payments Journal of Joanne’s Boutique for March 2015
CPJ1
Doc
no.
Day Details Fol. Bank
Sundry accounts
Amount Details
003 000003 000AB Bank1BS Fixed deposit: AB Bank

38. Example: Interest capitalised (continued)
Posting to the General Ledger:
General Ledger of Joanne’s Boutique
Balance Sheet accounts
Dr Interest on Fixed Deposit Cr
Nominal accounts
0036029 GJ12Profit and Loss account

2016
Feb
Dr Fixed Deposit: AB Bank Cr
Assets Owner’s equity Liabilities
EffectReason EffectReason EffectReason
The effect on the accounting equation:
Interest on fixed deposit is income+ 360
Cash in bank decreases– 3 000
00360GJ12Fixed deposit: AB Bank29
2016
Feb
0036000360
003 0001 CPJ1Bank

2015
Mar
0036029 GJ12Interest on fixed deposit
2016
Feb
003 360
Fixed deposit increases+ 3 000
Fixed deposit increases + 360

39. Information:
At the end of Year 2, 28 February 2017, Joanne’s Boutique received the following
statement from the bank:
Example: Interest capitalised (continued)
Balance of fixed deposit on 1 March 2016 R3 36000
Interest earned for the year R40320
Balance of fixed deposit on 28 February 2017 R3 76320
Entry in the General Journal:
General Journal of Joanne’s Boutique for February 2017 GJ12
DayDetails Fol. Debit Credit
403 20Fixed deposit: AB Bank 29
Interest on fixed deposit 403 20
(Adjustment for interest on fixed deposit capitalised)

40. Example: Interest capitalised (continued)
Posting to the General Ledger:
General Ledger of Joanne’s Boutique
Balance Sheet accounts
Dr Interest on Fixed Deposit Cr
Nominal accounts
2040328 GJ12Profit and Loss account

2017
Feb
Dr Fixed Deposit: AB Bank Cr
Assets Owner’s equity Liabilities
EffectReason EffectReason EffectReason
The effect on the accounting equation:
Interest on fixed deposit is income+ 403,20
20403GJ12Fixed deposit: AB Bank28
2017
Feb
2040320403
003 3601 b/dBalance

2016
Mar
2040328 GJ12Interest on fixed deposit
2017
Feb
203 763
Fixed deposit increases + 403,20

41. Interest on loan capitalised
The same principles apply when interest on a loan is capitalised.
Lending institutions usually capitalise interest on loans.
This means the interest is charged directly to the Loan account.
Interest on Loan will be debited and the Loan account will be credited.
This transaction will be recorded in the General Journal.
The procedure with regards to loans and interest capitalised will be as follows:
____________________________________________________________________________________
An instalment of R1 000 will be paid to AB Bank
monthly. The instalment includes capital repayments
as well as interest which is calculated by the bank.
The entry is made in the CPJ:
Debit: Loan: AB Bank
Credit: Bank
The interest on loan is recorded in
the General Journal:
Debit: Interest on loan
Credit: Loan: AB Bank
At the end of the financial year the business needs to
know what the finance cost (interest) was with
regards to the loan.
AB Bank would have sent them a loan statement
periodically, reflecting this information.
An application is made
for a loan of R100 000.
AB Bank processes the
application.
The loan is approved by AB Bank
and paid to the business.
The entry is made in the CRJ:
Debit: Bank
Credit: Loan: AB Bank

42. Closing transfer process of a partnership (trading business)
at the end of the financial year:
Debtors Allowances
Cost of Sales Trading account
Profit and Loss account All IncomeAll Expenses
NET PROFIT
Appropriation accountCurrent account: Partner A
Sales
GROSS PROFIT
Final accounts and closing transfers
Drawings account: Partner A
Current account: Partner B
Drawings account: Partner B
Note:
 After the closing transfers have been done, a post-closing Trial Balance is drawn up.
 The post-closing Trial Balance contains only Balance Sheet accounts, since all nominal accounts have already
been
closed off.

43. At the beginning of a new financial year, reversals are made for adjustments relating to:
Accrued Expenses
Prepaid Expenses
Accrued Income
Income Received in Advance
Consumable stores on hand
The reversal entry is the exact opposite of the original entry and thus reverses the
effect of the original entry.
In other words:
the account that was originally debited must now be credited; and
the account that was originally credited will now be debited.
Reversals are done for two reasons:
to cancel these “temporary accounts” (Accrued Expenses, Prepaid Expenses, etc)
that were created at the end of the previous financial year.
to restore the amounts to the various income and expense accounts that were
previously adjusted.
All reversals of adjustments are done on the first day of the new financial year and are
recorded in the General Journal.
Reversal of adjustments (revision)
____________________________________________________________________________________
Matching

44. Information: At the end of the accounting period on 29 February 2016, the following balances appeared in
the financial records of HC Traders.
Reversal entries in the General Journal:
General Journal of HC Traders – March 2016 GJ1
DayDetails Fol. Debit Credit
Example: Reversal of adjustments
360 00N13Stationery1
B20Consumable stores on hand 360 00
Extract from Post-adjustment Trial Balance of HC Traders as at 29 February 2016
Balance Sheet accounts Fol. Debit Credit
Consumable stores on hand B20 36000
Income received in advance B21 1 25000
Required: Record the reversals for these adjustment on 1 March 2016.
(Reversal of adjustment)
 Consumable stores on hand relates to stationery that was not used in the previous financial period.
 Income received in advance is rent income (for March 2016) received during the previous financial period.
1 250 00B21Income received in advance
N14Rent income 1 250 00
(Reversal of adjustment)

45. Example: Reversal of adjustments (continued)
Posting to the General Ledger:
General Ledger of HC Traders
Balance Sheet accounts
Nominal accounts
Dr Rent Income N14 Cr
001 250GJ1Income received in advance (R)1
2016
Mar
Dr Consumable Stores on Hand B20 Cr
Dr Stationery N13 Cr
003601 GJConsumable stores on hand (R)

2016
Mar
0036029 b/dBalance

2016
Feb
0036000360
00360GJ1Stationery (R)1
2016
Mar
Dr Income Received in Advance B21 Cr
001 250b/dBalance29
2016
Feb
001 250001 250
001 2501 GJ1Rent income (R)

2016
Mar

46. Solutions to activities
________________________________________________________________________
Activity 6.1
Activity 6.2
Activity 6.3
Activity 6.4
Activity 6.5
Activity 6.6
Activity 6.7
Activity 6.8
Activity 6.9
Activity 6.10
Activity 6.11
Activity 6.12
Activity 6.13
Activity 6.14
Activity 6.15
Activity 6.16
Activity 6.17
Informal assessment 6.1
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