One of the outcomes on the Paper FA2 syllabus is Explain generally accepted accounting principles and concepts.

This outcome seems to cause difficulties for some candidates. These difficulties may arise because the outcome is,
unlike the majority of the syllabus, theoretical.
This is the first of two articles that will discuss the two subparts of the outcome underlying principles will feature in
this article, while qualitative characteristics will be the focus of a second article.
Another theoretical outcome, The principles and process of bookkeeping, refers to the meaning of the accounting
equation, assets, liabilities and capital. These topics will be covered in a third article.

PRINCIPLES AND CHARACTERISTICS

The differentiation between principles and characteristics is clearly set out in the Study Guide, so its fair to assume
that this isnt something that will cause much difficulty for candidates. Therefore, it is important for candidates to
ensure that attention has been directed to each of the individual items listed on the Study Guide. What candidates
need to know about each of these is:

how it is defined, and

how it should be applied.

Thus, the items dealt with in this article are:

going concern

accruals

consistency

double entry

business entity

materiality

historical cost

Each of these principles is considered below. In each case, where a formal definition is provided by the Conceptual
Framework for Financial Reporting (the Framework), that definition is given, followed by an elaboration of the key
points of that definition that candidates need to understand.

GOING CONCERN
Definition: Financial statements are normally prepared on the assumption that an entity is a going concern and will
continue in operation for the foreseeable future.
Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtail materially the scale of
its operations; if such an intention or need exists, the financial statements may have to be prepared on a different
basis and, if so, the basis used is disclosed.
The basic point about the going concern principle is that it is assumed that the entity will continue to operate for the
foreseeable future. For Paper FA2, candidates do not need to consider the time period that might be regarded as the

foreseeable future. This is an advanced issue that will be considered in later papers. The same can be said of issues
such as:

circumstances in which the going concern assumption might not apply

what different basis could be used and

who decides whether the going concern assumption should apply.

What is relevant to this paper is that there are two key consequences of the going concern assumption being applied.
These are set out in the Framework as:

the entity will not be liquidated, and

in the (foreseeable) future, the scale (ie size and nature) of the entitys operations will not
be materially different to the recent past.

This touches on the principle of materiality, which is considered below.

A further point to bear in mind is that, while an awareness of what might be meant by a different basis might be
expected (for example, break up basis), candidates would not be expected to apply that basis to calculate values.

ACCRUALS
The Framework actually refers to accrual accounting as opposed to accruals (the term that is more widely used in
everyday language and the Study Guide).
Definition: Accrual accounting depicts the effects of transactions and other events and circumstances on a reporting
entitys economic resources and claims in the periods in which those effects occur, even if the resulting cash receipts
and payments occur in a different period.
This is perhaps a more theoretical definition than is given for going concern. However, it can also be understood by
paraphrasing the wording into a more straightforward format.
Essentially, what accrual accounting means is that the date on which cash is paid or received is not treated as the
date on which the transaction took place. The date is that on which the transaction took place. Although the definition
might seem a little impenetrable at first reading, this is essentially a simple idea. If Andrea agrees to buy goods from
Brian on 25 January and Brian agrees that Andrea can wait until 25 March to pay for the goods, accrual accounting
requires that the transaction is recorded. Thus, the transaction is recorded on 25 January.
Accrual accounting means that the accounting records will include balances for receivables (amounts that the entity
expects to receive in the future as a result of past transactions) and payables (amounts that the entity expects to pay
out in the future as a result of past transactions). When preparing final accounts (or, to use an alternative term,
financial statements) it will be necessary to recognise any costs that have been paid, but not yet consumed
(prepayments), as well as costs that have been consumed, but not paid (accrued expenses).
Accrual accounting is closely linked to the definitions of assets and liabilities and the accounting equation. These
will be considered in a future article.
At this stage it is worth remembering that, while a number of the theoretical aspects of the syllabus are linked in the
same way as has been noted above, candidates should ensure that they understand the key points of each principle
or concept in isolation first of all. Once a good understanding has been developed at an individual level, it will be
easier to make the links between the various concepts and principles.

CONSISTENCY
Definition: The use of the same methods for the same items, either from period to period within a reporting entity or
in a single period across entities.
In essence, consistency is a straightforward principle. It is intended to enhance financial reporting by making it easier
for users to make comparisons. In that sense it contributes to the achievement of comparability (which is considered
in the second article).
By requiring similar items to be treated in the same way (the use of the same method as stated in the Framework), it
is fairly obvious that this contributes to making comparisons more meaningful.
The two key points to note is that consistency should be applied in two ways:

from period to period ie by a single entity, and

across entities ie across entities (in the same period).

DOUBLE ENTRY
It is highly probable that this is one of the major hurdles that any candidate has to overcome. Double entry is often
easier to do than to explain. For that reason, candidates would be wise to complete as many practice questions as
possible before taking the exam,. It is also the reason why the topic can only be touched on in a relatively brief article
such as this.
There is no definition of double entry in the Framework although it is probably fair to say that this is the most
fundamental underpinning principle in accounting. In the absence of a formal definition, it is probably best to start by
noting that double entry arises from the fact that every transaction has a dual aspect (sometimes referred to as
duality). The dual aspect means that each party in a transaction is affected in two ways by the transaction, hence:
every transaction gives rise to both a debit entry and a credit entry.
Given that the value of the debit entries is the same as the value of the credit entries it follows that, when a number of
transactions have been recorded, the total value of the debit entries will be the same as the total value of the credit
entries. This is the basis of the accounting equation (which will be considered in a future article).
All of this might best be explained by considering the transaction that was included in the discussion on accruals. This
was Andrea agrees to buy goods from Brian on 25 January and Brian agrees that Andrea can wait until 25 March to
pay for the goods.
This straightforward example allows a key point about double entry to be made. Clearly there are two parties involved
in the transaction. While both parties will record the transaction, that is not what is meant by double entry. It is
important to remember that when preparing accounting entries, we are only dealing with a single entity. Double entry
is not related to the fact that two parties are involved in a transaction.
From Andreas point of view the dual aspect is:

she has obtained goods

she has also incurred the responsibility to pay for the goods at a later date.

In a real-life situation (and in an exam question), it will be clear whether the goods have been bought with the
intention of selling them at a profit, or if they have been bought for consumption within the business. For the moment,
lets assume that Andrea has bought the goods for resale. That means we can now identify the two accounts in which
entries will be made:

goods for resale (or purchases as is more often used to describe this account)

payables.

The next step is to decide which account will have the debit entry and which will have the credit entry. One way of
doing this is to use a memory AID. The upper case letters have been used because the word itself is the AID Asset
Increase Debit.
This AID reminds us that, if an asset has been increased, then a debit entry is required. The AID can be expanded by
changing one element within it at a time to the opposite state, leading to the opposite entry:

Asset decreased (or reduced)

Credit

Liability increased

Credit

It can therefore be deduced that:

Liability decreased or reduced

Debit

Using this logical approach, it should be possible to, first of all, identify which accounts will be affected and then how
they will be affected.
Of course, this discussion also requires knowledge of the nature of assets and liabilities. As noted above, it is best to
deal with one issue at a time, so the connection between double entry and the accounting equation will be considered
in the third article.
Thus, if Andrea has incurred the responsibility to pay for the goods, she has clearly increased a liability. That means a
credit entry is required in her payables account. It follows that the entry in her purchases account will be a debit.

BUSINESS ENTITY
The business entity principle simply means that, for the purpose of maintaining accounting records, the business is
treated as a separate entity from the owner(s) of the business.
As Paper FA2 only relates to unincorporated businesses (sole traders and partnerships), this might seem like an
unrealistic differentiation. Candidates should avoid getting too concerned about this and simply deal with transactions
from the perspective of the business.
In our example, Andrea has been identified as the owner of the business. As she is a sole trader (ie her business is
unincorporated), there are some important legal points to be noted. The first is that there is no legal differentiation
between Andrea and her business. Following from that, Andrea will be personally responsible for any debts that the
business incurs, and her personal assets may be used to settle business debts.
However, her personal assets are not included in the business records. In addition, if Andrea withdraws money for
personal expenses, the nature of the expense is not recorded. All that is necessary is to record the fact that Andrea
withdrew funds with a debit entry in the drawings account and credit entry in the bank account.

MATERIALITY
Definition: Information is material if omitting it or misstating it could influence decisions that users make on the basis
of financial information about a specific reporting entity.
There are some key issues within this definition that candidates should be aware of.
The first is that materiality is different to accuracy. An example from the ACCA website may help to explain this:
ACCA is the global body for professional accountants with 162,000 members and 428,000 students.
Anyone who is considering becoming an ACCA student will recognise that it is highly unlikely that there are exactly
162,000 members and exactly 428,000 students. However, those numbers (or a paraphrase of the combined total into
the statement over half a million members and students) convey the important and useful information that ACCA is a
very large and influential organisation.
We can also see this in the published financial statements of large businesses. These often report values in $000 or
$m. While the exact values are not communicated, the essential information is provided as an aid to decision making.
This leads to the second issue materiality is related to the fact that the purpose of financial statements is to provide
information so that it can be used to make decisions about whether to undertake transactions with a particular
business.
The final issue is that materiality is affected both by (i) whether information is included or omitted from financial
statements and (ii) whether it is sufficiently informative.
Candidates in Paper FA2 will not be required to make a decision on an appropriate cut off level for materiality. This is
a more advanced issue, which requires the exercise of professional judgment.

HISTORICAL COST
Theoretically, there are a number of bases that could be used to derive the value at which transactions are recorded.
However, historical cost is the only one of these that needs to be considered in the context of Paper FA2.
Definition: Assets are recorded at the amount of cash paid to acquire them at the time of their acquisition.
Liabilities are recorded at the amount of proceeds received in exchange for the obligation.
(Some elements of the definition provided by the Conceptual Framework have been omitted as they are beyond the
scope of the Paper FA2 syllabus.)
In simple terms this means that, for Paper FA2, assets and liabilities will continue to be recorded at the value at which
they were initially recorded and that value will be based on the cash value at the date of the transaction.

SUMMARY
By ensuring that the key points of each of these principles are understood, candidates should be better prepared to
answer questions that might arise in the exam.
Written by a member of the Paper FA2 examining team

PARTNERSHIPS
SHARE ON EMAILEMAILSHARE ON PRINTPRINTSHARE ON TWITTERTWITTERSHARE ON FACEBOOKFACEBOOKSHARE ON
LINKEDINLINKEDINMORE SHARING SERVICESADD THIS

This article considers partnerships and the calculations that would be needed to attempt the relevant questions in the
Foundations in Accountancy Paper FA2.
A partnership is where two or more individuals are in business together making and sharing the profits. In Paper FA2,
although more than two individuals can be a partnership, it will usually be two individuals you are being asked to deal
with.
The partnership will set up an agreement which states the terms for each partner such as any salary they are entitled
to, if interest will be payable for capital invested and what the profit sharing ratio is. However, before we get to deal
with this we need to know the net profit for the period this is calculated exactly the same as for a sole trader.
However, you do need to be careful with partners salaries these are not an expense to be deducted from the profits;
instead they are just an appropriation of profit.
Once we have found the net profit, or have been given it in the question, we then need to share this out among the
partners per the terms of the partnership agreement. The easiest way is to set up an appropriation statement and
then allocate the profits as follows:
1.
2.
3.

Allocate any salaries

Allocate any interest on capital
Allocate the remaining profit in the profit sharing ratio (PSR)

This remaining profit may be referred to as the residual profit therefore if a question asks for a partners share of the
residual profit, it is asking for the share of the remaining profit after all other allocations.
So if Alan and Betty are in partnership, both having invested $20,000, with a partnership agreement that states
interest on capital is 5% pa, Alan gets a salary if $6,000 and the residual profit is allocated 60:40. If the total profit for
the period is $22,400 the appropriation would be as follows:

The final item that could be in the appropriation statement is interest on any drawings made by the partners; these are
owed by the partners into the partnership and are showing as negative figures within the appropriation statement. So
if we add in drawings of $9,000 and $5,000 for Alan and Betty respectively, and interest on drawings of 3%, the
appropriation statement would be as follows:

The questions may ask for any part of the appropriation statement, and can be for one or both partners. Alternatively,
the questions may ask for figures from the statement of financial position.
The partners each have two accounts in the statement of financial position, the capital account which is the fixed
amount of capital invested by the partner this rarely changes within questions. They also have a current account,
which shows the accumulated profits less drawings for each partner and the balance of which is frequently asked for
in exam questions. The easiest way to calculate the current accounts is through using a T account.
If we continue with Alan and Betty, and they have current account balances brought forward of $17,300 and $2,100
respectively, then the T account would be as follows:

The balance b/f along with the balance on the capital accounts will be included together in the capital section of the
statement of financial position.
With multiple choice questions, only certain figures will be asked for so full workings are not required. However, taking
short cuts will often result in errors, so the key is to know the appropriation statement and the current account T
account thoroughly these can then be produced as quick workings and hopefully the correct answer can be quickly
established. Lots of question practice will also help.
Written by a member of the paper FA2 examining team

The purpose of this article is to assist candidates to develop their understanding of the topic of accounting for
partnerships. As such, it covers all of the outcomes in Section H of the Study Guide for Paper FA2. It also provides
underpinning knowledge for candidates studying Papers FFA and F3, Financial Accounting but it is not intended to
comprehensively cover the Study Guides for those papers.

WHAT IS A PARTNERSHIP?
There are a number of ways in which a partnership may be defined, but there are four key elements.
Two or more individuals
A partnership includes at least two individuals (partners). In certain jurisdictions, there may be an upper limit to the
number of partners but, as that is a legal point, it is not part of the Paper FA2 syllabus.
Business arrangement
A partnership exists to carry on a business.
Profit motive
As it is a business, the partners seek to generate a profit.
Unincorporated business entity
A partnership is an unincorporated business entity. That means:

the reporting entity (business entity) principle applies to a partnership, so for accounting purposes, the
partnership is a separate entity from the partners
the partners have unlimited liability, and
if the partnership is unable to pay its liabilities, the partners may be called upon to use their personal assets
to clear unpaid liabilities of the partnership.

HOW IS A PARTNERSHIP CONTROLLED?

It is good practice to set out the terms agreed by the partners in a partnership agreement. While this is not mandatory,
it can reduce the possibility of expensive and acrimonious disputes in the future. As a formal agreement is not
mandatory, there is no definitive list of what it should contain, but Paper FA2 exams will not go beyond the following:
Share of residual profit
The Paper FA2 Study Guide defines this as the amount of profit available to be shared between the partners in the
profit and loss sharing ratio, after all other appropriations have been made.
Therefore, candidates need to be aware that there is a distinction to be made between the profit for the year (income
minus expenses), which is calculated in exactly the same way as for a sole trader and residual profit (the remaining
profit after profit for the year has been adjusted by the appropriations in accordance with the partnership agreement).
Its worth pointing out that when a question states the profit or loss sharing ratio, that the proportions
are always applied to the residual profit not the profit for the year.
Appropriations of profit
As there is no requirement for all of the appropriations considered below to be included by a specific partnership,
exam questions may only include some of them. That means that you only need to deal with the appropriations
referred to in the question.
Another point to remember is that the Appropriation Account is an additional accounting statement that is required for
a partnership. For a sole trader, the profit for the year is simply transferred to the credit side of the proprietors capital
account (the double entry is completed by a debit entry in the income statement, resulting in a nil balance on that
statement). In the case of a partnership, the income statement will still be debited, but the profit will be credited to the
appropriation account, rather than the capital account. As each appropriation is dealt with, the double entry is
completed through entries in both the appropriation account and the partners current account (if current accounts are
not maintained by the partnership, the entries will be made in the capital accounts).
Partners salaries
In some ways, the term salaries is a misleading description. The salaries of employees are business expenses that
are written off to the income statement, thereby reducing profit for the year. However, as partners are the owners of
the business, any amounts that are paid to them under the partnership agreement are part of their share of the profit.
As the amount is guaranteed, it must be dealt with through a credit entry in the partners account (usually the current
account) before the residual profit is shared.
The double entry is completed by a debit entry in the Appropriation Account.
Interest on capital
Almost always, interest on capital will be paid on partners capital balances only although the balances on the
current accounts are actually part of the total capital balance, it is normal to exclude them from the value of capital on
which interest is paid.
Paying interest on capital is a means of rewarding partners for investing funds in the partnership as opposed to
alternative investments. As such, it reduces the amount of profit available for sharing in the profit and loss sharing
ratio. This means that a debit entry is needed in the Appropriation Account. The double entry is completed by a credit
entry in the current account of the partner to whom the salary is paid.

Interest on drawings
Charging interest on drawings is a means of discouraging partners from withdrawing excessive amounts from the
business. From this, it follows that interest on drawings is a debit entry in the partners current accounts and a credit
entry in the Appropriation Account.
Depending on what the question is testing, it will either provide the amounts of interest on capital and drawings or give
details of how to calculate the amounts.
Remember to deal with each of these appropriations before sharing the residual profit between the partners.
A final point in this context is that, if the total of the appropriations is greater than the profit for the year, the amount to
be shared between the partners will be a loss. This will mean that the entries for the share of the residual profit will be
a credit in the Appropriation Account (thus resulting in a nil balance) and debits in the partners current accounts.

WHAT IS THE DIFFERENCE BETWEEN CAPITAL AND CURRENT ACCOUNTS?

In one sense, there is no difference. A partners total capital is the sum of the balances on their capital account and
their current account.
In practice, however, it is convenient to separate the amount invested by the partner (the capital account) from the
amount they have earned through the trading activities of the partnership (the current account). Therefore, the capital
account is usually fixed, while the current account is the current total of appropriations and the share of residual
profit/loss, less drawings.
Remember that a partners drawings will be a debit entry in the partners current account.

WHAT HAPPENS WHEN THERE IS A NEW PARTNER?

When a new partner is admitted to the partnership, the new partners effectively buy the assets of the old partnership
from the old partners.
The admission of a new partner will also mean that the profit/loss sharing ratio will change.

HOW DOES GOODWILL ARISE, AND HOW IS IT TREATED?

Goodwill is defined as the amount by which the fair value of the net assets of the business exceeds the book value of
the net assets. It arises due to factors such as the reputation, location, customer base, expertise or market position of
the business. (In simple terms, fair value can be thought of as being the same as market value.)
In the Paper FA2 exam, the following points will not be examined:

the reasons for goodwill

the calculation of goodwill

the definition of fair value

the calculation of fair value.

The question will provide either the value of goodwill, or information to allow it to be calculated without much difficulty
(see Example (ii)).

The first step is to create the asset of goodwill. This is a debit entry for the value of the goodwill in the goodwill
account. The double entry is completed with credit entries in the old partners capital accounts. The value of each
entry is calculated by sharing the value of the goodwill between the partners in the old profit and loss sharing ratio.
If goodwill is to be retained in the partnership (sometimes referred to as carried in the books) no further entries are
required.
If goodwill is not to be carried in the books, it is eliminated by a credit entry in the goodwill account. The double entry
is completed with debit entries in the partners capital accounts. The value of each entry is calculated by sharing the
value of the goodwill between the new partners in the new profit and loss sharing ratio.
If a partner is contributing (or withdrawing) capital, the relevant amount will be recorded in both the partners capital
account and the bank account. A contribution will be a credit entry in the capital account and a debit entry in the bank
account, and a withdrawal will be a debit entry in the capital account and a credit entry in the bank account.

HOW ARE LOANS FROM PARTNERS TREATED?

A loan is not part of the partners capital, and the loan is treated is the same way as a loan from a third party. The
liability of the partnership will be recorded by the creation of a liability, resulting in a credit balance for the amount of
the loan. The debit entry will depend on how the loan was made. If the partner deposited cash in the bank account,
the debit entry will be in the bank account. If the loan was created by converting a proportion of the partners capital
into a loan, the debit entry will be in the capital account.
The interest on the loan will be a business expense and should therefore be debited to the income statement.
Examples
(i) Appropriations of profit
Based on the following information:

prepare the Partnership Appropriation Account

calculate each partners share of the residual profit and total profit share

prepare the partners current accounts

Amit and Burton are in partnership sharing profits in the ratio 3:2. The partnerships profit for the year was $65,460.
The partnership agreement provides for:

interest to be paid on the partners opening capital balances at a rate of 5% per annum

interest on drawings at a rate of 8% per annum on all drawings during the year

partners salaries of Amit, $9,000; Burton, $5,000.

At the beginning of the year, the partners capital and current account balances were:

Capital

Current

Amit

$120,000 Cr

15,655 Cr

Burton

$80,000 Cr

$4,137 Dr

During the year, Amits drawings were $18,000 and Burtons drawings were $31,000.

Solution

The closing balances are thus:

Amit $38,443 Cr
Burton $10,465 Dr
(ii) Change in partnership
Amit and Binta have been in partnership, sharing profits and losses in the ratio 4:3. They agreed to admit Chen to the
partnership, with profits and losses being shared between Amit, Binta and Chen in the ratio 3:2:1. On the date of the
change in partnership, the partners capital and current account balances were:

Capital

Current

Amit

$60,000 Cr

12,800 Cr

Binta

$40,000 Cr

$9,500 Cr

It was agreed that, at the date of Chens admission, the partnership was to be valued at $164,300.
Step 1 Calculate goodwill
The total book value of the partnership is equal to the combined value of the partners capital and current accounts, or
$122,300 ($60,000 + $12,800 + $40,000 + $9,500)
The partnership is valued at $164,300.
Therefore, the goodwill is valued at $42,000 ($164,300 $122,300).
Step 2 Create goodwill asset in books
The goodwill account is created by a debit entry of $42,000.
This value is credited to the old partners in the old profit and loss sharing ratio ie 4/7 (or $24,000) to Amit and 3/7
(or $18,000) to Binta.
Thus, the new capital balances are:

Amit

$84,000 Cr

($60,000 Cr and $24,000 Cr)

Binta

$58,000 Cr

($40,000 Cr and $18,000 Cr)

If goodwill is to be carried in the books, no further entries are needed, as the only change is that a new asset of
goodwill has been created, and the capital balances of the old partners have increased by the same value.
Step 3 Eliminate goodwill (if required by question)
If goodwill is not to be carried in the books, it is eliminated by a credit entry in the goodwill account, and debit entries
in the partners capital accounts, based in the new profit and loss sharing ratio:

Amit

$21,000

($42,000 x 3/6)

Binta

$14,000

($42,000 x 2/6)

Chen

$7,000

($42,000 x 1/6)

As a result, the new capital balances are:

Amit

$63,000 Cr

($84,000 Cr and $21,000 Dr)

Binta

$44,000 Cr

($58,000 Cr and 14,000 Dr)

Chen

$7,000 Dr

(share of goodwill eliminated)

Step 4 Contribution of capital by new partner (if required by question)

If the question requires a contribution by any of the partners (or a repayment of capital) we simply need to follow the
normal principles of double-entry bookkeeping.
For example, the question may require the new partner to contribute cash so that the opening capital balance is nil.
In this case, a credit of $7,000 is needed in Chens capital account, so this is the amount of cash that must be
contributed.
The entries will therefore be:
Debit Bank $7,000
Credit Capital Chen $7,000
Table 1 Summary of entries
* if the interest has been paid to the partner
** if the interest remains unpaid

if funds were deposited in the partnership bank account

if capital was converted into a loan

Written by a member of the Foundations in Accountancy Paper FA2 examining team