Mbali proff

PRESENTATION
ON
GENERAL LEDGER
&
TRAIL BALANCE

Prepared by

HASHIBUL HASAN
h.hashibul@yahoo.com

General ledger

HASHIBUL HASAN
DEPARTMENT OF CSE
DAFFODIL INTERNATIONAL UNIVERSITY
DHAKA,BANGLADESH

Definition

The General Ledger contains all of the balance sheet

accounts of an accounting system. The balance sheet

DEPARTMENT OF CSE

DHAKA,BANGLADESH
HASHIBUL HASAN
accounts are the assets, liabilities, and fund balance
accounts of the school district. Values in General Ledger are
expressed as debits or credits.

The ledger page is actually a T-account in a more detailed format. It has the
account title and its corresponding account number on top. It also has two
sides, namely, the debit side and the credit side. Each T-account or ledger
account has the following columns.

 Date (debit side)- the date of the debit entry is entered in this
column.

 Explanation (debit side)- A brief explanation of the debit entry is
entered in this column.

DEPARTMENT OF CSE

DHAKA,BANGLADESH
HASHIBUL HASAN
 “F” or folio (debit side)- The journal page number from where the
debit entry was taken is entered in this column.
 Debit- The amount of the debit entry is entered in this column.
 Date (credit side) - the date of the credit entry is entered in this
column.
 Explanation (credit side) - A brief explanation of the credit entry
is entered in this column.
 “F” or folio (credit side)- The journal page number from where the
credit entry was taken is entered in this column.
 Credit - The amount of the credit entry is entered in this column

An example of a page from a ledger is as follows:-

Accounts receivable Account No: 2001
Date Explanation F Debit Date Explanation F Credit

2008 2008

DEPARTMENT OF CSE

DHAKA,BANGLADESH
HASHIBUL HASAN
Sept-29 Service on credit 1 50, 000.00 Sept. 30 Collection 1 20,000.00
10 Collection 1 30,000.00
50,000.00
Balance 0.0

The posting procedure
 Step 1- Locate the account title used by the journal entry in the general ledger.

 Step 2- Determine if the journal entry is a debit entry or a credit. If it is a debit entry, it should be
posted on the debit side of the located ledger account. If it is credit entry, it should be posted on the
credit side of the located ledger account.

 Step 3- Record the date of the journal entry in the date column. If the posting is to be done on a
fresh page, write the year on the first line. Then write the month and day of the journal entry on the
second line. For succeeding entries, only the day of the journal entry should be written. The month

should be written only if it is different from the month of the last entry made.

DEPARTMENT OF CSE

DHAKA,BANGLADESH
 Step 4- Write a brief explanation of the journal entry in the explanation column. It should be on the

HASHIBUL HASAN
same line as that of the date.

 Step 5- Write the amount of the journal entry in the amount column. It should be on the same line as
that of the date and explanation.

 Step 6- In the folio column, write the page number of the general journal page that contains the
posted journal entry. It should be on the same line as that of the date, the explanation, and the
amount.

 Step 7- In the folio column of the general journal, write the account number of the page number of
the ledger account in which the journal entry was posted. The account number of the page number
should be on the same line as of the journal entry.

 Step 8- Do not leave a blank line between entries in the general ledger.

Explain With A Example :-

HASHIBUL HASAN
DEPARTMENT OF CSE
DHAKA,BANGLADESH

Selected transaction for tina cordero company during its first month in business are presenter below :-

st. 1. Invested $10000 cash in the business
Sept. 5. Purchased equipment for $12000 paying $5000 in cash and the balance on account.
Sept.25. Paid $3000 cash on balance owed for equipment.
Sept.30. Withdrew $500 cash for personal use.
General Journal General Ledger >>Equipment
Date Account Title & Ref Debit Credit Date Explanation Re Debit Credit Balance
Description f
Sept-1 Cash 10,000 Sept.5 J1 12,000 12,000
Tina 10,000
Cordero,capital
General Ledger >>Account Payable

5 Equipment 12,000
Cash 5,000 Date Explanation Ref Debit Credit Balance
DEPARTMENT OF CSE

DHAKA,BANGLADESH
HASHIBUL HASAN

Account Payable 7,000
Sept.5 J1 7,000 7,000
25 Account Payable 3,000
25 J1 3,000 4,000
Cash 3,000
30 Drawings 500 General Ledger >>Tina Cordero,capital
Cash 500
Date Explanation Ref Debit Credit Balance
General Ledger>>cash Sept.1 J1 10,000 10,000

Date Explanation Ref Debit Credit Balance

Sept.1 J1 10,000 10,000 General Ledge >>Tina Cordero,drawing
5 J1 5,000 5,000
25 J1 3,000 2,000 Date Explanation Ref Debit Credit Balance
30 J1 500 1,500
Sept.30 J1 500 500

TRAIL BALANCE

HASHIBUL HASAN
DEPARTMENT OF CSE
DHAKA,BANGLADESH

Trial Balance
Trial Balance Calculation
 A basic rule of double-entry accounting Account Debits Credits
is that for every credit there must be
an equal debit amount. From this Account 1 xxxx.xx
concept, one can say that the sum of Account 2 xxxx.xx

all debits must equal the sum of all
credits in the accounting system. If Account 3 xxxx.xx

DEPARTMENT OF CSE

DHAKA,BANGLADESH
debits do not equal credits, then an

HASHIBUL HASAN
.
error has been made. The trial
balance is a tool for detecting such .
errors. .
Account 4 xxxx.xx
 The trial balance is calculated by
summing the balances of all the ledger Account 5 xxxx.xx
accounts. The account balances are Account 6 xxxx.xx
used because the balance
summarizes the net effect of all of the .
debits and credits in an account. To .
calculate the trial balance, construct a .
table in the following format :

Total xxxx.xx xxxx.xx

Steps to Prepare the Trial Balance

 For each ledger account — Cash, Accounts Payable, etc. — total
your credits and debits.

 If the credit total is larger, subtract the debit total from the credit total to

get your ledger account total which goes in the credit column of the trial

DEPARTMENT OF CSE

DHAKA,BANGLADESH
balance

HASHIBUL HASAN
 If the debit total is larger, subtract the credit total from the debit total to
get your ledger account total which goes in the debit column of the trial
balance
 Put the ledger account total in the credit or debit column of your trial
balance (as identified above).

 When you have debit or credit totals for each ledger account, add all
of your credit totals to get a credit grand total.

 Add all of your debit totals to get a debit grand total. This is your trial
balance.

Unbalanced Trial Balance

If you have an unbalanced trial balance, then you have an error
somewhere in the accounting process. Examples of problems that can
unbalance a trial balance include:

DEPARTMENT OF CSE

DHAKA,BANGLADESH
 Adding the debits and credits for the trial balance incorrectly;

HASHIBUL HASAN
 Forgetting to include a ledger account balance on the trial balance;
 Putting the ledger account balances in the wrong debit/credit
column in the trial balance;
 Writing the wrong ledger account balances in the trial balance
columns;
 Miscalculating the ledger account totals;
 Posting a journal entry incorrectly to the general ledger, whether
using the wrong number or getting your debits/credits mixed up;
 Making an error in your journal entry, whether using the wrong
number or forgetting part of a compound journal entry.

Balanced Trial Balance

 If all of your journal entries were posted properly (and error-free) in the
general ledger, your debit grand total and credit grand total should balance,
and you can move on in the accounting cycle. If the debit and credit grand
totals do not balance, then you have an error to find somewhere in your

transaction posting process (journal to general ledger to trial balance).

DEPARTMENT OF CSE

DHAKA,BANGLADESH
HASHIBUL HASAN
 It's possible to have a posting error even if the debits and credits do
balance, but that will get found and solved later in the accounting cycle.
Examples of problems that would not show up in the trial balance include:

* Putting the credit amount in the debit column and the debit amount in the credit
column for a particular transaction;
* Recording a transaction in an incorrect account;
* Forgetting to record a journal entry as a general ledger transaction;
* Neglecting to make a journal entry at all.

LIMITATIONS OF A TRIAL BALANCE
 A trial balance does not prove that all transactions have been
recorded or that the ledger is correct.
 Numerous errors may exist even though the trial balance columns
agree.
 The trial balance may balance even when:

* a transaction is not journalized,

DEPARTMENT OF CSE

DHAKA,BANGLADESH
HASHIBUL HASAN
* a correct journal entry is not posted,
* a journal entry is posted twice,
* incorrect accounts are used in journalizing or posting,
* offsetting errors are made in recording the amount of the

transaction.

Accounting Principles, 7th Edition
Weygandt • Kieso • Kimmel

Chapter 2

The Recording
Process

Prepared by Naomi Karolinski
Monroe Community College
and
Marianne Bradford
Bryant College
John Wiley & Sons, Inc. © 2005

CHAPTER 2
THE RECORDING
PROCESS
After studying this chapter, you should be able to:

1 Explain what an account is and how it
helps in the recording process
2 Define debits and credits and explain
how they are used to record business
transactions
3 Identify the basic steps in the recording
process
4 Explain what a journal is and how it
helps in the recording process

CHAPTER 2
THE RECORDING
After studying PROCESS
this chapter, you should be able to:

5 Explain what a ledger is and how it helps
in the recording process
6 Explain what posting is and how it helps
in the recording process
7 Prepare a trial balance and explain its
purpose

THE ACCOUNT
STUDY OBJECTIVE 1

 An account is an individual
accounting record of increases
and decreases in a specific asset,
liability, or owner’s equity item.
 There are separate accounts for
the items we used in transactions
such as cash, salaries expense,
accounts payable, etc.

BASIC FORM OF ACCOUNT
STUDY OBJECTIVE 2

 The simplest form an account consists of
1 the title of the account
2 a left or debit side
3 a right or credit side
 The alignment of these parts resembles the
letter T = T account
Title of Account
Left or debit side Right or credit
side
Debit balance Credit balance

DEBITS AND CREDITS

 Debit indicates left and Credit indicates right
 Recording $s on the left side of an account is
debiting the account
 Recording $s on the right side is crediting the
account
 If the total of debit amounts is bigger than credits,
the account has a debit balance
 If the total of credit amounts is bigger than debits,
the account has a credit balance

TABULAR SUMMARY
COMPARED TO ACCOUNT
FORM

DEBITING AN ACCOUNT

Cash
Debits Credits
15,000

Example: The owner makes an initial
investment of $15,000 to start
the business. Cash is debited
as the owner’s Capital is
credited.

CREDITING AN ACCOUNT

Cash
Debits Credits
7,000

Example: Monthly rent of $7,000 is paid.
Cash is credited as Rent
Expense is debited.

DEBITING / CREDITING AN
ACCOUNT
Cash
Debits Credits
15,000 7,000
8,000

Example: Cash is debited for $15,000 and
credited for $7,000, leaving a
debit balance of $8,000.

DOUBLE-ENTRY SYSTEM

equal debits and credits made
accounts for each transaction
total debits always equal the total
credits
accounting equation always stays
in balance

Assets Liabilities Equity

DEBIT AND CREDIT EFFECTS
— ASSETS AND LIABILITIES

Debits Credits
Increase assets Decrease assets
Decrease liabilities Increase liabilities

NORMAL BALANCE

everyaccount has a
designated normal balance.
It is either a debit or credit.

accountsrarely have an
abnormal balance.

NORMAL BALANCES —
ASSETS AND LIABILITIES
Assets
Increase Decrease

Normal

Liabilities
Balance

Decrease Debit
Increase
Credit
Normal
Balance

— OWNER’S CAPITAL

Debits Credits
Decrease owner’s capital Increase owner’s capital

NORMAL BALANCE — OWNER’S
CAPITAL
Owner’s Capital
Decrease Increase

Normal
Balance
Debit
Credit

— OWNER’S DRAWING

Debits Credits
Increase owner’s drawing Decrease owner’s
drawing

Remember, Drawing is a contra-account – an account that is
backwards from the account it accompanies (the Capital
account).

NORMAL BALANCE —
OWNER’S DRAWING
Owner’s Drawing
Decrease Increase

Normal
Balance
Debit
Credit

— REVENUES AND EXPENSES

Debits Credits
Decrease revenues Increase revenues
Increase expenses Decrease expenses

NORMAL BALANCES —
REVENUES AND EXPENSES
Revenues
Decrease Increase

Normal
Balance

Expenses
Increase Debit
Decrease
Credit
Normal
Balance

EXPANDED BASIC EQUATION
AND DEBIT/CREDIT RULES
AND EFFECTS
Asset = Liabilities + Owner’s Equity
s
Owner’s Owner’s
Assets = Liabilities + -
Capital Drawing
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
+ - - + - + + -

+ Revenues - Expense
s
Dr. Cr. Dr. Cr.
- + + -

Which of the following is not true of the
terms debit and credit.
a. They can be abbreviated as Dr. and Cr.
b. They can be interpreted to mean increase and
decrease.
c. They can be used to describe the balance of an
account.
d. They can be interpreted to mean left and right.

Chapter 2

THE RECORDING
PROCESS
STUDY OBJECTIVE 3

1 analyze each transaction (+, -)
2 enter transaction in a journal
3 transfer journal information to
ledger accounts

THE JOURNAL
STUDY OBJECTIVE 4

 Transactions
 Are initially recorded in chronological
order before they are transferred to the
ledger accounts.
A general journal has
1 spaces for dates
2 account titles and explanations
3 references
4 two amount columns

THE JOURNAL
A journal makes several contributions to
recording process:
1 discloses in one place the complete effect of a
transaction
2 provides a chronological record of transactions
3 helps to prevent or locate errors as debit and
credit amounts for each entry can be compared

JOURNALIZING

 Entering transaction data in the journal
is known as journalizing.
 Separate journal entries are made for
each transaction.
 A complete entry consists of:
1 the date of the transaction,
2 the accounts and amounts to be
debited and credited,
3 a brief explanation of transaction.

TECHNIQUE OF
JOURNALIZING
The date of the transaction is entered into the
date column.

GENERAL JOURNAL J1
Date Account Titles and Explanation Ref. Debit Credit
2005
Sept. 1 Cash 15,000
R. Neal, Capital 15,000
(Invested cash in business)

1 Computer Equipment 7,000
Cash 7,000
(Purchased equipment for
cash)

TECHNIQUE OF
JOURNALIZING
The debit account title is entered at the extreme
left margin of the Account Titles and Explanation
column. The credit account title is indented on
the next line.
GENERAL JOURNAL J1
2005
Sept. 1 Cash 15,000

Cash 7,000
cash)

TECHNIQUE OF
JOURNALIZING
The amounts for the debits are recorded in the
Debit column and the amounts for the credits
are recorded in the Credit column.

TECHNIQUE OF
JOURNALIZING
A brief explanation of the transaction is given.

TECHNIQUE OF
JOURNALIZING
A space is left between journal entries. The
blank space separates individual journal entries
and makes the entire journal easier to read.

GENERAL JOURNAL J1
2005
Sept. 1 Cash 15,000

Cash 7,000
cash)

TECHNIQUE OF
JOURNALIZING
The column entitled Ref. is left blank at the time
journal entry is made and is used later when the
journal entries are transferred to the ledger
accounts.

SIMPLE AND COMPOUND
JOURNAL ENTRIES

If an entry involves only two accounts, one debit
and one credit, it is considered a simple entry.

COMPOUND JOURNAL
ENTRY
When three or more accounts are required in
one journal entry, the entry is referred to as a
compound entry.

1

2

3

COMPOUND JOURNAL
ENTRY
This is the wrong format; all debits must be listed
before the credits are listed.

THE LEDGER
STUDY OBJECTIVE 5

A Group of accounts maintained by a
company is called the ledger.
A general ledger contains all the
assets, liabilities, and owner’s
equity accounts

POSTING A JOURNAL ENTRY
STUDY OBJECTIVE 6

In the ledger, enter in the appropriate columns of the account(s) debited
the date, journal page, and debit amount shown in the journal.

POSTING A JOURNAL ENTRY

In the ledger, enter in the appropriate columns of the account(s) debited
the date, journal page, and debit amount shown in the journal.

POSTING A JOURNAL
ENTRY

In the reference column of the journal, write the account
number to which the debit amount was posted.

POSTING A JOURNAL
ENTRY

GENERAL LEDGER
CASH NO. 10
Date Explanation Ref. Debit Credit Balance
2005
Sept. 1 J1 15,000 15,000

In the ledger, enter in the appropriate columns of the account(s) credited the date, journal page, and
credit amount shown in the journal.

POSTING A JOURNAL
ENTRY

In the reference column of the journal, write the account number to which the
credit amount was posted.

CHART OF ACCOUNTS

A Chart of Accounts lists the accounts and the
account numbers which identify their location in
the ledger.

INVESTMENT OF CASH BY
OWNER
October 1, C.R. Byrd invests $10,000 cash in an
Transaction advertising business known as:
The Pioneer Advertising Agency.

Basic •The asset Cash is increased $10,000
Analysis •Owner’s equity, C. R. Byrd, Capital is increased
$10,000.

Debits increase assets: debit Cash $10,000.
Debit-Credit
Credits increase owner’s equity: credit C.R. Byrd,
Analysis Capital $10,000.

PURCHASE OF OFFICE
EQUIPMENT
JOURNAL ENTRY

POSTING

RECEIPT OF CASH FOR
FUTURE SERVICE
October 2, a $1,200 cash advance is received from a
Transaction client, for advertising services expected to be
completed by December 31.

Asset Cash is increased $1,200
Liability Unearned Fees is increased $1,200
Basic •Service has not been rendered yet.
Analysis
Liabilities often have the word “payable” in their
title, Unearned fees are a liability.

Debits increase assets: debit Cash $1,200.
Debit-Credit
Credits increase liabilities: credit Unearned Fees
Analysis $1,200.

RECEIPT OF CASH FOR
FUTURE SERVICE
JOURNAL ENTRY

POSTING

PAYMENT OF
MONTHLY RENT

October 3, office rent for October is paid in cash,
Transaction $900.

Basic The expense Rent is increased $900
Analysis Payment pertains only to the current month
Asset Cash is decreased $900.

Debit-Credit Debits increase expenses: debit Rent Expense $900.
Analysis Credits decrease assets: credit Cash $900.

PAYMENT OF MONTHLY
RENT
JOURNAL ENTRY

POSTING

PAYMENT FOR INSURANCE

October 4, $600 Paid one-year insurance policy-
Transaction expires next year on September 30.

-Asset Prepaid Insurance increases $600
-Payment extends to more than the current month
Basic -Asset Cash is decreased $600.
Analysis -Payments of expenses benefiting more than one
period are prepaid expenses or prepayments.

Debit-Credit Debits increase assets: debit Prepaid Insurance
Analysis $600. Credits decrease assets: credit Cash $600.

PAYMENT FOR
INSURANCE
JOURNAL ENTRY

POSTING

Prepaid Insurance 130
Oct. 4 600

PURCHASE OF
SUPPLIES ON CREDIT
October 5, an estimated 3-month supply of
Transaction advertising materials is purchased on account from
Aero Supply for $2,500.

Basic The asset Advertising Supplies is increased $2,500;
Analysis the liability Accounts Payable is increased $2,500.

Debits increase assets: debit Advertising Supplies
Debit-Credit
$2,500. Credits increase liabilities: credit
Analysis Accounts Payable $2,500.

PURCHASE OF
SUPPLIES ON CREDIT
JOURNAL ENTRY

POSTING

HIRING OF EMPLOYEES

October 9, hire four employees to begin work on
October 15. Each employee is to receive a weekly
Transaction salary of $500 for a 5-day work week, payable every
2 weeks -- first payment made on October 26.

A business transaction has not occurred only an
Basic agreement between the employer and the
Analysis employees to enter into a business transaction
beginning on October 15.

Debit-Credit A debit-credit analysis is not needed because there is
Analysis no accounting entry.

WITHDRAWAL OF CASH
BY OWNER

October 20, C. R. Byrd withdraws $500 cash for
Transaction personal use.

Basic The owner’s equity account C. R. Byrd, Drawing is
Analysis increased $50
The asset Cash is decreased $500.

Debits increase drawings: debit C. R. Byrd,
Debit-Credit
Drawing $500. Credits decrease assets: credit
Analysis Cash $500.

WITHDRAWAL OF CASH
BY OWNER
JOURNAL ENTRY

POSTING

PAYMENT OF SALARIES

October 26, employee salaries of $4,000 are owed
Transaction and paid in cash. (See October 9 transaction.)

Basic The expense account Salaries Expense is increased
Analysis $4,000; the asset Cash is decreased $4,000.

Debit-Credit Debits increase expenses: debit Salaries Expense
Analysis $4,000. Credits decrease assets: credit Cash $4,000.

PAYMENT OF SALARIES

JOURNAL ENTRY

POSTING
Salaries Expense 726
Oct. 26 4,000

RECEIPT OF CASH FOR FEES
EARNED
October 31, received $10,000 in cash from Copa
Transaction Company for advertising services rendered in
October.

Basic The asset Cash is increased $10,000; the revenue
Analysis Fees Earned is increased $10,000.

Debit-Credit Debits increase assets: debit Cash $10,000. Credits
Analysis increase revenues: credit Fees Earned $10,000.

RECEIPT OF CASH FOR FEES
EARNED
JOURNAL ENTRY

POSTING

THE TRIAL BALANCE
STUDY OBJECTIVE 7

 The trial balance is a list of accounts and
their balances at a given time.

 The primary purpose of a trial balance is
to prove debits = credits after posting.

 If debits and credits do not agree, the
trial balance can be used to uncover
errors in journalizing and posting.

THE TRIAL BALANCE
The Steps in preparing the Trial Balance are:
1. List the account titles and balances
2. Total the debit and credit columns
3. Prove the equality of the two columns

A TRIAL BALANCE

The total debits
must equal the
total credits.

LIMITATIONS OF A TRIAL
BALANCE
A trial balance does not prove all transactions
have been recorded or the ledger is correct.

 Numerouserrors may exist even though the trial
balance columns agree. For example, the trial
balance may balance even when:
 a transaction is not journalized
 a correct journal entry is not posted
 a journal entry is posted twice
 incorrect accounts used in journalizing or
posting
 offsetting errors are made in recording

Which one of the following represents the expanded
basic accounting equation?

a. Assets = Liabilities + Owner’s Capital + Owner’s
Drawings – Revenue - Expenses.
b. Assets + Owner’s Drawings + Expenses = Liabilities
+ Owner’s Capital + Revenue.
c. Assets – Liabilities – Owner’s Drawings = Owner’s
Capital + Revenue – Expenses.
d. Assets = Revenue + Expenses – Liabilities.

Chapter 2

Stockholders’ Equity
Fundamentals of Corporate
Finance
by Robert Parrino and David S.
Kidwell
John Wiley & Sons, Inc.. (c) 2009.
Copying Prohibited

Fundamentals of Corporate Finance
by Robert Parrino and David S. Kidwell
John Wiley & Sons, Inc.. (c) 2010. Copying
Prohibited.
Reprinted for Sai Chakrala, Bank of
America
Reprinted with permission as a
subscription benefit of Books24x7,

Learning Objectives
• Explain the advantages and disadvantages of a
corporation
• Measure the effect of issuing stock on a
company’s financial position
• Describe how treasury stock transactions affect
a company
• Account for dividends and measure their impact
on a company
• Use different stock values in decision making
• Evaluate a company’s return on assets and
return on common equity

Characteristics of Corporate Form

• Separate legal entity
• Continuous life and transferability of
ownership
• Limited liability for stockholders
• Separation of ownership and management
• Corporate taxation – income is taxed at
the corporate level; dividends are taxed at
the shareholder level
• Government regulation

Organizing a Corporation

• Obtain a charter from the state
• Bylaws
• Stockholders elect Board of Directors
• Board of Directors sets policy and
appoints officers
• Board elects a chairperson
• Board selects the president

Stockholders’ Rights

• Vote – one vote for each share of stock
• Dividends –right to participate in dividend
distributions
• Liquidation – right to receive proportionate
share of assets remaining after creditors
have been paid
• Preemption – right to maintain one’s
proportionate share of ownership in the
corporation

Stockholders’ Equity

• Paid-in capital (contributed capital)
• Retained earnings
• Classes of stock
– Common and Preferred
– Par or No-Par

Issuing Stock
Issue 6.2 million shares of $10 par value stock at par.
Cash 62,000,000
Common Stock 62,000,000
To issue common stock

Issue 6.2 million shares of $0.01 par value stock at $10 per
share.
Cash 62,000,000
Common Stock 62,000
Paid-in Capital in Excess of Par – Common
(6,200,000 x 9.99) 61,938,000

Issuing Stock
Issue 3,000 shares of no-par stock for $20 per share.
Cash 60,000
Common Stock 60,000

Issued 3,000 shares of no-par stock with a stated value of $1
for $20 per share
Cash 60,000
Common Stock (3,000 x $1 stated value) 3,000
Paid-in Capital in Excess of Stated Value
– Common (3,000 x 19) 57,000

Common Stock Issued for Other Assets

• Value the exchange at the current market
value of the assets received.
Issued 15,000 shares of $1 par common for equipment worth
$4,000 and a building worth $120,000.

Equipment 4,000
Building 120,000
Common Stock (15,000 x $1 par) 15,000
Paid-in Capital in Excess of Par
– Common (124,000 – 15,000) 109,000

Ethical Issues

• When shares are issued for assets other
than cash, care should be taken to not
over-value those assets and thus inflate
values on the balance sheet.

Treasury Stock

• A company’s own stock that it has issued
and later reacquired is treasury stock.
• Reasons companies have treasury stock
– to use for employee stock purchase plans
– to increase net assets by buying shares at a
low price and selling at a higher price
– to avoid takeover by outside parties
• Treasury Stock is a contra stockholders’
equity account

Preferred Stock

• Entries are similar to entries for common
stock.
• Paid-in Capital in Excess of Par –
Preferred is a separate equity account.

Treasury Stock
Purchased shares of treasury stock for $19,000.
Treasury Stock 19,000
Cash 19,000
To purchase treasury stock

Sold treasury stock for $25,000 that was previously
purchased for $19,000.

Cash 25,000
Treasury Stock 19,000
Paid-in Capital in from Treasury Stock 6,000
Sold treasury stock

Other Stock-Related Issues

• If treasury stock is sold below its cost,
retained earnings is debited for the
difference between cost and selling price.
• Stock retirement involves purchasing
stock and removing it from “issued” status.

• To retire stock, remove the stock account,
any related paid-in capital accounts, and
increase cash.

Dividends

• To pay dividends, a company must have
– enough retained earnings to declare the
dividend
– enough cash to pay the dividend
• Relevant dates related to dividends
– Declaration date
– Date of record
– Payment date

Dividends
Declaration date – a liability is created.
Retained Earnings 50,000
Dividends Payable 50,000
Declared a cash dividend

Date of record – no entry required

Date of payment – a liability is settled
Dividends Payable 50,000
Cash 50,000
Paid cash dividend

Computing Dividends

• Dividends on preferred stock are either
– percentage rate
– dollar amount
• Preferred stock may be
– cumulative (dividends in arrears must be paid
before other stockholders receive a dividend)
– non-cumulative – dividends not paid in one
year are not made up later.

Stock Dividend
• A proportional distribution by a corporation
of its own stock to the stockholders
• Increase stock account and decrease
retained earnings.
• Total equity is unchanged, and assets and
liabilities are unaffected.
• Reasons for stock dividends:
– to conserve cash
– to reduce the per-share market price of the
stock

Stock Dividend

• Small stock dividend (less that 25%)
reduces retained earnings for the current
market value of the stock
• Large stock dividend (greater than 25%)
reduces retained earnings for par value of
the stock.

Stock Dividend
10% stock dividend declared when 20,000,000 shares of
common stock are outstanding. Market price of the stock is
$15.
20,000,000 shares of common outstanding
x .10 stock dividend
x $15 market value per share of common

Retained Earnings 30,000,000
Common Stock 20,000
Paid-in Capital in Excess of Par –
Common 29,980,000
Distributed a 10% stock dividend
20,000,000 x 0.10 x $.01 par
value per share

Stock Split

• An increase in the number of authorized,
issued, and outstanding shares of stock,
coupled with a proportionate reduction in
the stock’s par value.
• Total equity does not change. Only par
value, number of shares issued, and
number of shares authorized are affected.

Chapter 10
Partnerships: Formation,
Operation and Basis

Corporations, Partnerships,
Estates & Trusts
© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 101

Partnership Definition
• An association of two or more persons to carry
on a trade or business
– Contribute money, property, labor
– Expect to share in profit and losses
• For tax purposes, includes:
– Syndicate
Joint venture, etc

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
102

Entities Taxed as Partnerships
(slide 1 of 4)

• General partnership
– Consists of at least 2 partners
– Partners are jointly and severally liable
• Creditors can collect from both partnership and
partners’ personal assets
• General partner’s assets are at risk for malpractice of
other partners even though not personally involved

103

(slide 2 of 4)

• Limited liability partnership (LLP)
– An LLP partner is not personally liable for
malpractice committed by other partners
– Popular organizational form for large accounting
firms

104

(slide 3 of 4)

• Limited partnership
– Has at least one general partner
• One or more limited partners
– Only general partner(s) are personally liable to
creditors
• Limited partners’ loss is limited to equity investment

105

(slide 4 of 4)

• Limited liability company (LLC)
– Combines the corporate benefit of limited liability
with benefits of partnership taxation
• Unlike corporations, income is subject to tax only once
• Special allocations of income, losses, and cash flow are
available
– Owners are “members,” not partners, but if
properly structured will receive partnership tax
treatment

106

“Check-The-Box” Regs
(slide 1 of 2)

• Allows most unincorporated entities to select
their federal tax status
– If 2 or more owners, can choose to be treated as:
• Partnership, or
• Corporation
– Permits some flexibility
• Not all entities have a choice
• e.g., New publicly traded partnerships must be taxed as
corporations

107

“Check-The-Box” Regs
(slide 2 of 2)

• Some entities can be excluded from
partnership treatment if organized for:
– Investment (not active trade or business)
– Joint production, extraction, or use of property
– Underwriting, selling, or distributing a specific
security
• Owners simply report their share of operations
on their own tax return

108

Partnership Taxation
(slide 1 of 3)

• Partnership is not a taxable entity
– Flow through entity
• Income taxed to owners, not entity
• Partners report their share of partnership income or loss
on their own tax return

109

(slide 2 of 3)

• Generally, the calculation of partnership
income is a 2-step approach
– Step 1: Net ordinary income and expenses
related to the trade or business of the
partnership
– Step 2: Segregate and report separately
some partnership items
– If an item of income, expense, gain or loss might affect any 2
partners’ tax liabilities differently, it is separately stated
– e.g., Charitable contributions

110

(slide 3 of 3)

• Electing large partnerships can net some items
that would otherwise be separately stated
– Must have at least 100 partners and elect
simplified reporting procedures
– Such partnerships separately report less than a
dozen categories of items to their partners
• e.g., Combine interest, nonqualifying dividends, and
royalty income into one amount, and report the net
amount to partners

111

Partnership Reporting
• Partnership files Form 1065
– On page 1 of Form 1065, partnership reports ordinary
income or loss from its trade or business activities
– Schedule K accumulates information to be reported to
partners
• Provides ordinary income (loss) and separately stated items in total
– Each partner (and the IRS) receives a Schedule K-1
• Reports each partner’s share of ordinary income (loss) and
separately stated items

112

Conceptual Basis for
Partnership Taxation (slide 1 of 2)
• Involves 2 legal concepts:
– Aggregate (or conduit) concept—Treats
partnership as a channel with income, expense,
gains, etc. flowing through to partners
• Concept is reflected by the imposition of tax on the
partners, not the partnership

113

Conceptual Basis for
Partnership Taxation (slide 2 of 2)
• Involves 2 legal concepts (cont’d):
– Entity concept—Treats partners and partnerships
as separate and is reflected by:
• Partnership requirement to file its own information
return
• Treating partners as separate from the partnership in
certain transactions between the two

114

Partner’s Ownership Interest
• Each owner normally has a:
– Capital interest
• Measured by capital sharing ratio
– Partner’s percentage ownership of capital
– Profits (loss) interest
• Partner’s % allocation of partnership ordinary income
(loss) and separately stated items
• Certain items may be “specially allocated”
– Specified in the partnership agreement

115

Inside and Outside Bases
• Inside basis
– Refers to adjusted basis of each partnership asset
– Each partner “owns” a share of the partnership’s
inside basis for all its assets
• Outside basis
– Represents each partner’s basis in the partnership
interest
– All partners should maintain a record of their
respective outside bases

116

Basis Issues
(slide 1 of 3)

• Partner’s outside basis is adjusted for income
and losses that flow through from partnership
• This ensures that partnership income is only taxed once

117

Basis Issues
(slide 2 of 3)

• Partner’s basis is important for determining:
– Deductibility of partnership losses
– Tax treatment of partnership distributions
– Calculating gain or loss on the partner’s
disposition of the partnership interest

118

Basis Issues
(slide 3 of 3)

• Partner’s capital account balance is usually not
a good measure of a partner’s adjusted basis in
a partnership interest for several reasons
• e.g., Basis includes partner’s share of partnership
liabilities; Capital account does not

119

Partnership Formation Transaction

120

Tax Consequences of
Partnership Formation (slide 1 of 2)
• Usually, no gain or loss is recognized by a
partner or partnership on the contribution of
money or property in exchange for a
partnership interest
• Gain (loss) is deferred until taxable disposition
of:
– Property by partnership, or
– Partnership interest by partner

121

Tax Consequences of
Partnership Formation (slide 2 of 2)
• Partner’s basis in partnership interest = basis
of contributed property
– If partner contributes capital assets and §1231
assets, holding period of partnership interest
includes holding period of assets contributed
– For other assets including cash, holding period
begins on date partnership interest is acquired
– If multiple assets are contributed, partnership
interest is apportioned and separate holding period
applies to each portion

122

WST Partnership Formation
Example (slide 1 of 2)
• William contributes cash
– Amount $20,000
• Sarah contributes land
– Basis $ 6,000
– FMV $20,000
• Todd contributes equipment
– Basis $22,000
– FMV $20,000

123

WST Partnership Formation
Gain or loss Basis in Partnership’s
Partner Recognized Interest Property
Basis

William $-0- $20,000 $20,000
Sarah $-0- $ 6,000 $ 6,000
Todd $-0- $22,000 $22,000

Neither the partnership nor any of the partners recognizes
gain or loss on the transaction

124

Exceptions to Tax-Free Treatment on Partnership
Formation (slide 1 of 4)
• Transfers of appreciated stock to investment
partnership
– Gain will be recognized by contributing partner
– Prevents multiple investors from diversifying their
portfolios tax-free

125

• If transaction is essentially a taxable exchange
of properties, gain will be recognized
– e.g., Individual A contributes land and Individual
B contributes equipment to a new partnership;
shortly thereafter, the partnership distributes the
land to B and the equipment to A; Partnership
liquidates
– IRS will disregard transfer to partnership and treat
as taxable exchange between A & B

126

• Disguised Sale
– e.g., Partner contributes property to a partnership;
Shortly thereafter, partner receives a distribution
from the partnership
• Payment may be viewed as a purchase of the property
by the partnership

127

• Receipt of partnership interest in exchange for
services rendered to partnership
– Services are not treated as “property”
– Partner recognizes ordinary compensation income = FMV
of partnership interest received
• Partnership may deduct the amount included in the
service partner’s income if the services are of a
deductible nature
– If the services are not deductible by the partnership, they
must be capitalized to an asset account

128

Tax Issues Relative to Contributed Property
(slide 1 of 3)

• Contributions of depreciable property and
intangible assets
– Partnership “steps into shoes” of contributing
partner
• Continues the same cost recovery and amortization
calculations
• Cannot expense contributed depreciable property under
§179

129

(slide 2 of 3)

• Gain or loss is ordinary when partnership
disposes of:
– Contributed unrealized receivables
– Contributed property that was inventory in
contributor’s hands, if disposed of within 5 years
of contribution
• Inventory includes all tangible property except capital
assets and real or depreciable business assets

130

(slide 3 of 3)

• If contributed property is disposed of at a loss
and the property had a ‘‘built-in’’ capital loss
on the contribution date
– Loss is treated as a capital loss if disposed of
within 5 years of the contribution
– Capital loss is limited to amount of ‘‘built-in’’ loss
on date of contribution

131

Elections Made by Partnership
(slide 1 of 2)

• Inventory method
• Accounting method
– Cash, accrual or hybrid
• Depreciation method
• Tax year
• Organizational cost amortization
• Start-up expense amortization

132

Elections Made by Partnership
(slide 2 of 2)

• Optional basis adjustment (§754)
• §179 deduction
• Nonrecognition treatment for involuntary
conversions
• Election out of partnership rules

133

Organizational Costs
(slide 1 of 2)

• For organization costs incurred after October 22,
2004, the partnership may elect to deduct up to
$5,000 of the costs in year business begins
– Deductible amount must be reduced by organization costs
that exceed $50,000
– Remaining amounts are amortizable over 180 months
beginning with month the partnership begins business
• For organization costs incurred before that date, the
taxpayer could elect to amortize the amount over 60
months

134

Organizational Costs
(slide 2 of 2)

• Organizational costs include costs:
– Incident to creation of the partnership, chargeable to a
capital account, and of a character that, if incident to the
creation of a partnership with an ascertainable life, would
be amortized over that life
• Includes accounting fees and legal fees connected with the
partnership’s formation
• Costs incurred for the following items are not
organization costs:
– Acquiring and transferring assets to the partnership
– Admitting and removing partners, other than at formation
– Negotiating operating contracts
– Syndication costs

135

Start-up Costs
(slide 1 of 2)

• Start-up costs—include operating costs incurred after
entity is formed but before it begins business
including:
– Marketing surveys prior to conducting business
– Pre-operating advertising expenses
– Costs of establishing an accounting system
– Costs incurred to train employees before business begins,
and
– Salaries paid to executives and employees before the start
of business

136

Start-up Costs
(slide 2 of 2)

• Partnership may elect to deduct up to $5,000 of start-
up costs in the year it begins business
– Deductible amount must be reduced by start-up costs in
excess of $50,000
– Costs that are not deductible under this provision are
amortizable over 180 months beginning with the month in
which the partnership begins business
• For start-up costs incurred before October 23, 2004,
the taxpayer could elect to amortize those costs over
60 months

137

Method of Accounting
(slide 1 of 2)

• New partnership may adopt cash, accrual or
hybrid method
– Cash method cannot be adopted if partnership:
• Has one or more C corporation partners
• Is a tax shelter

138

Method of Accounting
(slide 2 of 2)

• New partnership may adopt cash, accrual or
hybrid method (cont’d)
– C Corp partner does not preclude use of cash
method if:
• Partnership has average annual gross receipts of $5
million or less for preceding 3 year period
• C corp partner(s) is a qualified personal service corp, or
• Partnership is engaged in farming business

139

Required Taxable Year
• Partnership must adopt tax year under earliest
of following tests met:
– Majority partner’s tax year (partners with same tax
year owning >50%)
– Principal partners’ tax year (all partners owning
5% or more)
– Least aggregate deferral rule

140

Least Aggregate Deferral Example
(slide 1 of 2)

• George owns 50% and has June 30 year end
• Henry owns 50% and has October 31 year end
• Neither partner owns a “majority” (>50%)
• Both are “principal partners” (5% or more),
but do not have same year end
– Must use least aggregate deferral test to determine
required taxable year

141

Least Aggregate Deferral Example
(slide 2 of 2)

1. Test June 30 as possible year end:
Partner. Year End % Mo. Deferral Weight
George June 50% 0 0.0
Henry October 50% 4 2.0
Total weighted deferral 2.0

2. Test October 31 as possible year end:
George June 50% 8 4.0
Henry October 50% 0 0.0
Total weighted deferral 4.0

June has the least aggregate deferral so it is the tax year for partnership.

142

Alternative Tax Years
• Other alternatives may be available if:
– Establish to IRS’s satisfaction that a business
purpose exists for another tax year
• e.g., Natural business year at end of peak season
– Choose tax year with no more than 3 month
deferral
• Partnership must maintain with the IRS a prepaid, non-
interest-bearing deposit of estimated deferred taxes
– • Elect a 52- to 53-week taxable year

143

Measuring Income of Partnership
• Calculation of partnership income is a
2-step approach
– Step 1: Net ordinary income and expenses
related to the trade or business of
the partnership
– Step 2: Segregate and report separately
some partnership items

144

Separately Stated Items
(slide 1 of 2)

• If an item of income, expense, gain or loss
might affect any 2 partners’ tax liabilities
differently, it is separately stated

145

Separately Stated Items
(slide 2 of 2)

• Separately stated items fall under the
“aggregate” concept
– Each partner owns a specific share of each item of
partnership income, gain, loss or deduction
• Character is determined at partnership level
• Taxation is determined at partner level

146

Examples of Separately Stated Items
(slide 1 of 2)

• Short and long-term capital gains and losses
• §1231 gains and losses
• Domestic production activities deduction
• Charitable contributions
• Interest income and other portfolio income
• Expenses related to portfolio income

147

Examples of Separately Stated Items
(slide 2 of 2)

• Personalty expensed under §179
• Special allocations of income or expense
• AMT preference and adjustment items
• Passive activity items
• Self-employment income
• Foreign taxes paid

148

Partnership Taxable Income
Sales revenue $100,000
Salaries 35,000
Rent 15,000
Utilities 6,000
Interest income 1,500
Charitable contribution 2,000
AMT adjustment for depreciation 3,600
Payment of partner’s medical expenses 4,000

149

• Partnership ordinary taxable income:
Sales revenue $100,000
Salaries -35,000
Rent -15,000
Utilities -6,000
Partnership Ordinary Income $ 44,000

150

• Separately stated items:
– Interest income $1,500
– Charitable contribution 2,000
– AMT adjustment for depreciation 3,600

• Distribution to partner:
– Payment of partner’s medical exp. $4,000

151

Partnership Allocations
(slide 1 of 3)

• Partnership agreement can provide that a
partner share capital, profits, and losses in
different ratios
– e.g., Partnership agreement may provide that a
partner has a 30% capital sharing ratio, yet be
allocated 40% of the profits and 20% of the losses
– Such special allocations are permissible if certain
rules are followed
• e.g., Economic effect test

152

(slide 2 of 3)

• The economic effect test requires that:
– An allocation must be reflected in a partner’s
capital account
– When partner’s interest is liquidated, partner must
receive assets with FMV = the positive balance in
the capital account
– A partner with a negative capital account must
restore that account upon liquidation

153

(slide 3 of 3)

• Precontribution gain or loss
– Must be allocated to partners taking into account the
difference between basis and FMV of property on date of
contribution
• For nondepreciable property this means any built-in gain or loss
must be allocated to the contributing partner when disposed of by
partnership in taxable transaction
• For depreciable property, allocations related to the built-in loss can
be made only to the contributing partner
– For allocations to other partners, the partnership’s basis in the loss
property is treated as being the fair market value of the property at the
contribution date

154

Basis of Partnership Interest
(slide 1 of 3)

• For new partnerships, partner’s basis usually
equals:
– Adjusted basis of property contributed, plus
– FMV of any services performed by partner in
exchange for partnership interest

155

(slide 2 of 3)

• For existing partnerships, basis depends on
how interest was acquired
– If purchased from another partner, basis = amount
paid for the interest
– If acquired by gift, basis = donor’s basis plus, in
certain cases, a portion of the gift tax paid on the
transfer
– If acquired through inheritance, basis = FMV on
date of death (or alternate valuation date)

156

(slide 3 of 3)

• A partner’s basis in partnership interest is
adjusted to reflect partnership activity
– This prevents double taxation of partnership
income

157

Basis Example
(slide 1 of 2)

• Pam is a 30% partner in the PDQ partnership
• Pam’s beginning basis is $20,000
• PDQ reports current income of $50,000
• Pam sells her interest for $35,000 at the end of
the year

158

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