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2.10 Incorporation of an Unincorporated Business (1)

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INCORPORATION OF AN UNINCORPORATED BUSINESS
a) Purchase of an Unincorporated business
1. You may be required to prepare the Journal entries on purchase of the business.
2. The Balance sheet after the purchase of the business.
Example
Siriah Company Ltd purchased the business of Subit, a sole trader, on 1 December 2022. Subit’s Balance Sheet at
that date was:
Fixed assets
Land and Buildings
60,000
Plant and Machinery
35,000
Motor Vehicles
21,000
116,000
Current Assets
Stock
7,000
Debtors
4,000
Bank
5,000
16,000
132,000
Capital
130,000
Current liabilities
2,000
132,000
The assets were taken over at the following values:
Land and Buildings
Plant and Machinery
Motor Vehicles
Stock
Debtors
Creditors
80,000
28,000
16,000
5,000
3,000
2,000
Siriah Ltd did not take over Subit’s Bank account. Siriah paid Subit $150,000 made up of the following:
Cash $20,000 and 100,000 Ordinary shares of $1 each.
Required:
a) Prepare the journal entries in Siriah Company’s books to record the purchase of Subit’s business.
Note these two important points:
1. Goodwill = Purchase consideration less value of net assets acquired (where net assets = Total assets less
total liabilities = ($,000 – $2,000) = $130,000
= $150,000 – $130,000 = $20,000
2. The shares were valued at ($150,000 – $20,000) = $130,000. Since only 100,000 shares given at $1 =
$100,000 the remainder make up the Share Premium. ($130,000 - $100,000) = $30,000
Solution – Journal Entries
Date
Details
1 December
Land and Buildings
2022
Plant and Machinery
Motor Vehicle
Stock
Debtors
Goodwill
Creditors
Cash
Ordinary Share capital
Share Premium
Debit
80,000
28,000
16,000
5,000
3,000
20,000
152,000
Credit
2,000
20,000
100,000
30,000
152,000
b) Siriah company Balance Sheet at 1 December 2022 before it acquired the business of Subit was as follows:
Fixed assets
Land and Buildings
Plant and Machinery
Motor Vehicles
Current Assets
Stock
Debtors
Bank
200,000
75,000
40,000
315,000
21,000
16,000
32,000
69,000
384,000
Capital
Ordinary share
Retained profit
Current liabilities
300,000
77,000
377,000
7,000
384,000
Required:
Prepare Siriah’s company Balance Sheet immediately after the purchase of the business of Subit.
Solution - Balance sheet (Add the items taken over or the journal entries to Siriah’s Balance sheet)
Fixed assets
Land and Buildings (200,000 + 80,000)
Plant and Machinery (75,000 + 28,000)
Motor Vehicles (40,000 + 16,000)
280,000
103,000
56,000
439,000
Intangible asset
Goodwill
Total Fixed Assets
Current Assets
Stock (21,000 + 5,000)
Debtors ( 16,000 + 3,000)
Bank (32,000 – 20,000)
20,000
459,000
26,000
19,000
12,000
57,000
516,000
Capital
Ordinary share (300,000 + 100,000)
Share Premium
Retained profit
Current liabilities
400,000
30,000
77,000
507,000
9,000
516,000
INCORPORATION
b) Conversion of Unincorporated business (Sole trader/Partnership ) to an Incorporated business (Company)
Benefits of incorporation
1. Limited liability. Corporation is a separate legal entity. Owners not responsible for indebtedness. Cannot
lose their personal wealth only their Investment in the corporation. Creditors have recourse only to
corporate assets to satisfy their claims. They have no claim on the personal assets of the owners.
2. Ability to acquire capital. Greater amount of capital can be raised through share issue. Because of the
limited liability they offer more attractive to investors. Also Banks are more willing to lend money to
incorporated businesses. Can also issue bonds to raise capital.
3. Continuous Life. Since the corporation is a separate legal entity its continuance as a going concern is not
affected by the withdrawal, death etc of the owners as in a partnership or sole trader.
4. Transferable ownership (Public company). Ownership in a company is held in shares which can be easily
disposed of by simply selling these stocks in the stock exchange. It does not need approval as in a partnership
which will require the consent of each owner.
5. They enjoy EOS. They can operate on large scale enjoying benefits of bulk purchasing discounts etc.
Disadvantages of incorporation
1. More legal requirements and regulations. Corporations are subject to more legal, reporting and financial
requirements than other forms of ownership. They must meet stringent requirements for recording and
reporting management decisions and actions. They must also hold annual general meetings and public
companies must publish their financial statements.
2. Double taxation. Because a corporation is a separate legal entity, it must pay corporate taxes on its net
income then stockholders must pay taxes on the dividends from these same profits at the income tax rate.
Thus, a corporation profit is taxed twice.
3. Over expansion can result in inefficiency. The can become to large and experience diseconomies of scale
such as lack of control and coordination.
4. Separation of ownership and control. Stockholders legally own the company, but they manage the company
indirectly through a board of directors they elect. The objective of the board may be different from the
shareholders.
5. Costly and time consuming to form. An attorney may be needed to handle the incorporation process. It also
requires a variety of fees that are not applicable to sole traders and partnership.
Characteristics of a Corporation
1. Separate legal existence. It is an entity separate and distinct from its owners. It acts under its own name
rather than in the name of the stockholders. It can buy, own and sell property. It may borrow money and
enter into legal contract in its own name. It can sue or be sued, and it pays its own taxes.
2. Limited liability of stockholders
3. Transferability of ownership rights
4. Continuous life
5. Managed by Board of Directors elected by shareholders. Shareholders do not manage the company.
EXAMPLE 1 IVY and FLORA (Conversion of Partnership to Company)
1. Journals to record incorporation of partnership will consist of:
I.
Journals to record changes in assets and liabilities with corresponding entries to the valuation adjustment
account.
II.
Journals to close valuation adjustment account and transfer balance to partners’ capital account in profit
sharing ratio.
III.
Journals to record distribution of shares among partners and closure of partnership business.
i.
Journals to record changes in assets and liabilities
Land and building
CR Valuation adjustment
50,000
50,000
DR Valuation adjustment
Equipment
10,000
Mortgage payable
CR Valuation Adjustment
5,000
DR Valuation Adjustment - Inventories
Inventories
20,000
Investments
CR Valuation adjustment – Investments
5,000
ii.
Journal entry for Valuation Adjustment [Gain]
Valuation adjustment (50,000 + 5,000 + 5,000 – 20,000 -10,000)
Capital Ivy
(½ x 30,000)
Capital Flora
(½ x 30,000)
iii.
Journal entry to record distribution of Shares
Capital Ivy
(200,000 + 15,000)
Capital Flora (155,000 + 15,000)
Common stock
Share Premium (Balancing figure)
10,000
5,000
20,000
5,000
30,000
15,000
15,000
215,000
170,000
250,000
135,000
The Valuation and Capital accounts shown below are not required unless specified in the question:
Valuation Adjustment Account
Assets Decrease
Equipment
Inventories
Capital: Ivy (1/2 x 30,000)
Flora (½ x 30,000)
Balance c/d
Ivy
215,000
215,000
10,000
20,000
15,000
15,000
Assets Increase
Land and building
Mortgage payable
Investments
30,000
60,000
60,000
Capital Adjustment Accounts of Partners
Flora
170,000
Balance b/d
Gain on Revaluation
170,000
2. Statement of Financial Position of Incorporated business
Classy Care Company
Statement of Financial Position
as at 1st January 2005
ASSETS
Non-Current Assets
Land and buildings
Equipment
Total non-current
Current Assets
Investments
Inventories
Accounts receivable
Cash
Total current assets
Total Assets
Equity and Liabilities
Equity
Ordinary Shares $5par value,200,000 authorised
share,50,000 issued and outstanding (50,000 x $5)
Share Premium ( balancing figure)
Total Equity
50,000
5,000
5,000
Ivy
200,000
15,000
215,000
Flora
155,000
15,000
170,000
Fair Values
150,000
140,000
290,000
10,000
80,000
50,000
20,000
160,000
450,000
250,000
135,000
385,000
Non-current liabilities
Mortgage payable
45,000
Current liabilities
Accounts payable
20,000
Total Equity and liabilities
450,000
Note that share issue (50,000 x $5 = $250,000) was not sufficient to cover balance of 385,000. It means that the shares
were issued at a premium.
2021
(Conversion of Partnership to Company)
b) Journals to record formation of the partnership
Date 2016
January 1
Account title and explanation (Details)
Cash (20,000 + 10,000)
Computer Equipment
Accounts receivable
Specialised Software
Intangible Assets
Bank Loan
Joe Capital ( 20,000 + 10,000 + 2,500 + 10,000 – 5,000)
Bill Capital (10,000 + 5,000)
Being Assets, Liabilities and Owner’s Equity invested 0n 1st January 2016.
Debit
30,000
10,000
2,500
5,000
10,000
Credit
5,000
37,500
15,000
(c) Terms that may be found in a formal partnership agreement:
(1) Rate of interest on partners’ capitals, if any, to be allowed.
(a) the interest rate
(b) which capital balance to be used (beginning, ending or average)
When there is a difference in capital invested, it would probably be advisable, that there to be some sort of interest paid
on capital.
(2) Rate of interest on partners’ drawings, if any, to be charged.
Interest may be charged on drawings to prevent partners withdrawing to much cash so that funds can remain in the
business and be ploughed back for reinvestment and growth.
(3) Amounts of partners’ salaries, if any.
If partners are contributing a considerable amount of their time to the partnership a salary allocation would be
appropriate. The salary could be a flat amount based on estimated value of time spent, or it could be dependent upon
output or service provided ie piece rate system. Salary could also reflect skills of partners used in the business..
(4) Procedures to be carried out when a partner retires or dies eg the amount of goodwill to be paid, the terms of
repayment (cash payment or loan to the business, time of repayment), interest to be charged if the monies owed to the
partner is to remain as a loan.
(5) Procedures to be carried on liquidation or dissolution of the partnership.
(6) Procedures to be carried on admission of a new partner.
(7) Rate of interest on partners’ loans, if any, to firm. Loans is an expense of the firm, not an appropriation of profit
and should not be debited in the Appropriation account but the Profit and Loss account. It is however an item in the
current or capital account
di) Journals to record incorporation of partnership will consist of:
1. Journals to record changes in assets and liabilities
Valuation Adjustment
Accounts Receivable
1,500
1,500
Investments
Valuation Adjustment
5,000
Valuation Adjustment
Equipment
5,000
2. Journal entry for Valuation Adjustment (LOSS)
Capital Joe 3/5 x 1,500
Capital Bill 2/5 x 1,500
Valuation Adjustment [ 5,000 – 1,500 – 5,000]
5,000
5,000
900
600
1,500
3. Journal entry to record distribution of Shares evenly to Joe, Bill and Jill
Capital Joe 1/3 x 178,000
59,333.33
Capital Bill 1/3 x 178,000
59,333,33
Capital Jill 1/3 x 178,000
59,333,33
Common stock (30,000 x 5)
Share Premium (Balancing figure from the balance sheet)
If the question did not state that shares were to be distributed evenly to Joe, Bill and Jill:
Journal entry to record distribution of Shares
Capital Joe 95,000 - 900
94,100
Capital Bill 84,500 - 600
83,900
Common stock (30,000 x 5)
Share Premium (Balancing figure)
ii) Statement of Financial Position of Incorporated business
Advanced Marketing Inc.
Statement of Financial Position
as at 1st January 2021
ASSETS
Non-Current Assets
$
Equipment
Software
Total non-current assets
Fair Values
$
20,000
5,000
25,000
Current Assets
Investments
Accounts receivable
Cash
Total current assets
Total Assets
161,000
186,000
Equity and Liabilities
Equity
Ordinary Shares $5par value, 30,000 issued and
outstanding (30,000 x $5)
Share Premium (balancing figure)
Total Equity
Current liabilities
Accounts payable
Other accrued liabilities
Total Equity and liabilities
150,000
28,000
150,000
28,000
105,000
6,000
50,000
150,000
28,000
178,000
6,000
2,000
8,000
186,000
Note that share issue (30,000 x $5 = $150,000) was not sufficient to cover balance of 178,000. It means that the shares
were issued at a premium.
EXAMPLE 2 WILMA, MACKIE and O’HARA
(a) Journals to record incorporation of partnership
i. Journals to record changes in assets and liabilities
Land and building
Valuation adjustment
30,075
30,075
Valuation adjustment
Equipment
12,600
Mortgage payable
Valuation Adjustment
6,000
Valuation Adjustment
Inventories
7,700
Investments
Valuation adjustment
875
II. Journal entry to record Valuation Adjustment (Gain)
Valuation adjustment (30,075 + 6,000 + 875 – 12,600 – 7,700)
Capital Wilma (3/6 X 16,650)
Capital Mackie (2/6 X 16,650)
Capital O’Hara (1/6 x 16,650)
III. Journal entry to record distribution of Shares
Capital Wilma 192,780 + 8,325
Capital Mackie 80,325 + 5,550
Capital O’Hara 48,195 + 2775
Common stock 50,000 x $4
Share Premium (Balancing figure)
12,600
6,000
7,700
875
16,650
8,325
5,550
2,775
201,105
85,875
50,970
200,000
137,950
Note that the Valuation Adjustment account and Capital accounts of partners were not required.
(b) Statement of Financial Position of Incorporated business
Valpark Inc.
Statement of Financial Position
as at 1st January 2011
ASSETS
Non-Current Assets
Land and buildings
Equipment
Total non-current
Current Assets
Investments
Inventories
Interest Receivable
Accounts receivable
Cash
Total current assets
Total Assets
Equity and Liabilities
Equity
Ordinary Shares $4 par value,100,000 authorised
share,50,000 issued and outstanding
Share Premium ( balancing figure)
Total Equity
$
3,850
157,325
1,050
72,625
23,975
258,825
514,300
200,000
137,950
337,950
Non-current liabilities
Mortgage payable
Current liabilities
Accounts payable
Interest Payable
Other accrued liabilities
Total Equity and liabilities
$
91,500
163,975
255,475
90,250
28,700
11,025
46,375
86,100
514,300
EXAMPLE 3 OSCAR and WILLIAM
(a) Journal entry to record distribution of Shares to partners
Capital Oscar (40,000 + 23,000) x $1.50
94,500
Capital William (14,000 + 23,000) x$1.50
55,500
Common stock in Oxley ltd (100,000 x $1.50)
150,000
To record the distribution of shares to partners
Workings for amount of shares each partner receives:
Details
(Capital + Current) / $1.50 = (36,000 + 24,000)/ $1.50
(Capital - Current) / $1.50 = (27,000 - 6,000)/ $1.50
Balance to be share equally (100,000 – 54,000)/2
Total number of shares for each partner
Oscar
40,000
23,000
63,000
William
14,000
23,000
37,000
(b) Realisation Account
Assets at book value
Premises
Fixtures
Inventory
Accounts Receivable
Bank
Gain on realization:
Capital Oscar (69,000 x ½)
Capital William (69,000 x ½)
Current account
Ordinary Shares in Oxley Ltd
36,000
15,000
12,000
18,000
9,000
Liabilities & Purchase consideration
Accounts Payable
9,000
Purchase Consideration
150, 000
34,500
34,500
159,000
Capital Accounts of Partners
Oscar
William
-06,000 Balance b/d
94,500
55,500
Gain on Realisation
______
_______
Current account
94,500
61,500
_______
159,000
Oscar
36,000
34,500
24,000
94,500
William
27,000
34,500
-061,500
(c) Statement of Financial Position of Incorporated business
Oxley Limited
Statement of Financial Position
as at 31st March 2006
ASSETS
Non-Current Assets
Premises
Fixtures (45,000 + 15,000)
Motor Vehicles
Total non-current
Intangible asset - Goodwill
Current Assets
Inventories (60,000 + 12,000)
Accounts receivable (54,000 + 18,000)
Bank
(21,000 + 9,000)
Total current assets
Total Assets
Equity and Liabilities
Equity
Ordinary Shares $1par value,400,000 authorised share,
310,000 issued and outstanding [210,000 + (100,000 x $1)]
Share Premium [10,000 + (100,000 x $0.50)]
Retained earnings
Total Equity
Current liabilities
Accounts payable (30,000 + 9,000)
Total Equity and liabilities
36,000
60,000
75,000
171,000
69,000
72,000
72,000
30,000
174,000
414,000
310,000
60,000
5,000
100,000 x $0.50
375,000
39,000
_______
414,000
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