UNIT 13: Preparation and Presentation Close Corporations (CC) Accounts

Introduction

Shahieda feels that starting a partnership is quite a risky choice and people have suggested starting a
close corporation. A friend mentioned that a close corporation offered more protection to its owners
that a partnership or a sole proprietorship, but was less complex and less expensive to form and
easier to administer than a company. He said that The Close Corporation Act 69 of 1984 created the
close corporation as a separate legal person, and the rules and regulations that need to be followed
by the close corporation are contained in the Act.

On the similarities that he mentioned between a close corporation and a partnership was that some
(if not all) of the owners are usually involved in the management of the corporation. This differs from
a company, where the shareholders own the company, but the directors manage the company. Close
corporations do not issue shares and therefore have members, not shareholders. Shahieda likes the
fact that the owners have an active role in both a partnership and a close corporation, as she is very
“hands-on” type owner and would not want her business to be managed by someone else.

Objectives

By the end of this chapter you will be able to:

 Understand why the need for close corporations as an arose

 Understand the relationship between the owners and the close corporations (CC)

 Understand the reasoning behind the owners’ equity format of close corporation

 Understand that the underlying concepts of accounting do not change if the type of business
entity charges

 Record the transactions and complete the income statement and balance sheet of a close
corporation.

1. Starting a close corporation

In order to register her close corporation Shahieda would have to reserve a name for her close
corporation. She would also have to submit a founding statement to the Registrar of close
corporation. This would have to be signed by each member of the close corporation. The founding
statement, which is relatively inexpensive to register, must contain the following information:

 The full name of the corporation

 The principal business of the corporation, e.g. dry-cleaning
 The date of the financial year end
 The full names of the members and their identity numbers
 The interest of each member, expressed as a percentage
 The particulars of the contribution each member made to the corporation.

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She would also have to get written consent for her accounting officer. The accounting officer
appointed by the close corporation must be a member of a recognized professional accounting body,
such as CIMA, SAICA, CFA, or ACIS but does not need to be a chartered accountant.

What are responsibilities of the accounting officer?

 To determine whether the financial statements agree with the accounting records.
 To review the appropriateness of the accounting policies used when drawing up the financial
statements.
 To report to the members of the close corporation on the above matters.

Once the registrar has registered the founding statement and has issued a certificate of incorporation
the close corporation will come into existence. The founding statement replaces the memorandum
and articles of association required for a company. Remember that when a partnership is formed that
when a partnership is formed it is recommended that the partners draw up a partnership agreement.

Who are the members?

The owners of a close corporation are known as members. In a partnership the owners are referred to
as partners, and in a company they are known as shareholders. A close corporation can have between
one and ten members, whereas a partnership can have between two and twenty partners.

What do we mean by the interest of each other member?

The interest of each member refers to the percentage ownership that each member has in the close
corporation. The contributions by members need not to be in the same proportion as the members’
percentage interest. It is the members’ interests, and not their contributions, which determine the
proportion in which profits and losses are to be shared.
What do members contribute to the close corporation?

The capital contribution provided by all the members can be in the form of cash, assets and the
provision of services in connection with forming the corporation. These services only include services
provided to form the corporation, e.g. legal services, but may not be in the form of future services,
e.g. future consulting or management services to be provided by the member. In the law of
partnership it is possible that a partner’s contribution could consist of services, knowledge or skill. In a
partnership the contribution of knowledge or skills by any of the partners is recognized in the profit
sharing ratio of the partnership. In the case of a close corporation the contribution of service will
qualify as a contribution only if the services are in connection with the formation of the corporation. If
the amount of a member’s contribution is changed, the details of the increase or decrease in
contribution must be made available and new founding statement will need to be drawn up.

What is a natural person?

We are all natural persons, in that as individuals we have the right to open a bank account, own assets
and enter into contracts in our own right. Some legal entities, like a close corporation or a company,
also have the right to open a bank account, own assets and enter into contracts in the name of the
close corporation or company. These entities are legal persons but are not natural persons. This
means that a company or another close corporation cannot be a member of a close corporation.

Some advantages of a close corporation

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The mayor advantage is limited liability. The liability of the members of a close corporation is limited
to their investment (capital contribution) in the close corporation. This means that if the close
corporation is unable to pay its debts, the maximum that the owners can lose is the amount they have
invested in the close corporation as equity (capital). The protection offered to members because of
limited liability could be lost in certain circumstances, some of which are:

 Entering into transactions using the name of the corporation without the abbreviations “CC”
to indicate that the business is a close corporation
 Failing to make the contributions as stated in the founding statement
 Allowing the number of members to exceed ten for a period of six months
 Carrying on a business recklessly, with gross negligence, with intent to defraud or any
fraudulent purpose
 Making certain payments to members when the corporation does not meet the solvency and
liquidity requirements of the Act.

The loss of limited liability will result in members becoming jointly and severally liable for the debts of
the corporation. Remember that if members are jointly and severally liable, it means that creditors
can claim the personal assets of the members if the close corporation is unable to settle its debts. It
also means that if one of the members does not have sufficient personal assets to settle his or her
share of the debt, the creditors will take this share from the other members.

Although limited liability was an advantage, a number of banks insisted that the members of a close
signed personal surety when they took out a loan on behalf of the close corporation. If the members
signed personal surety and the business was unable to repay its loans, the bank had the right to take
the members’ personal assets.

2. The association agreement

Members of a close corporation will generally draw up an association agreement. This agreement will
cover the relationship between the members themselves and between the members and close
corporation. The agreement could cover areas such as:

 How profits and losses are distributed (this information is also covered in the founding
statement of the close corporation)
 What each member’s duties to the corporation are and how much they will be paid
 When meetings will be held

Registration with the local authorities

A close corporation will need to register with the local authorities in order to run a business. The
registration is the same as for any other local business. A close corporation will need to register with
the following bodies:

 Regional services council

 Local municipality
 South African revenue services.

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The following general principals will apply unless they have been specifically changed by an
association agreement:
 Every member has the right to participate in the running of the business
 Members have equal rights with regards to the management of the business
 Differences between members will be decided by majority vote
 The number of votes per member corresponds to the percentage interest in the close
corporation.
 Distribution to the members (by the close corporation) will be in the same proportion as their
interest in the close corporation.

3. Accounting for transaction in a close corporation

Once the close corporation is established, trading will begin. The daily transactions are recorded in
precisely the same manner as for a company, sole proprietor and partnership. The asset, liability,
income and expenses accounts will be similar whatever the entity form we choose. What will differ is
dramatically is the way we record and disclose equity.

Accounting and disclosure requirements

A close corporation is required by section 58 of the Close Corporations Act to prepare the following
financial statements within nine months of the end of the financial period:
 An income statement
 A balance sheet
 Notes to the annual financial statements
 The report of the accounting officer

There are certain requirements relating to companies that are not included in the Close Corporation
Act, namely, a directors’ report, the auditor’s report, the preparation of a cash flow statement and
disclosure of comparative figures (last year’s figures). Given that the cash flow statement and
comparative figures provide information that will be useful to members, it is highly recommended
that this information form part of the annual financial statements of a corporation.

The following additional information must be disclosed in the notes to the financial statements:
 Contributions by members
 Undrawn income
 Loans to and from members
 Transactions with the members

This information can be presented on a statement of the Members’ Net Investment in the close
corporation; alternatively the information can be presented on a Statement of Changes in Equity and
a statement and a Statement of Movement in Loans to and from members.

The following information will be presented on the Statement of Changes in Equity:

 Contributions by means
 Undrawn income
 Revaluations with members

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Information on loans to and from members will be presented on the Statement of Loans to and from
members. We can see that the only additional financial reports to be drawn up for a close corporation
rather than a sole proprietor are:
 The report of the accounting officer
 A Statement of the members’ Net Investment in the close corporation.

Illustration 1

Let’s assume that Shahieda has decided to start a close corporation with her cousin, Joseph. Shahieda
has decided to keep her other business separate from her new venture with her cousin. She will keep
the existing business in her own name and has decided to open two new Laundromats with him.

If they work well together, she will consider bringing the rest of her business into the close
corporation. After a great deal of deliberation, they decided the business would be called Cassiem’s
Laundromat CC. the business started on 1 July 2002.

The founding statement contained the following information:

 Shahieda and Joseph’s interest were 80% and 20% respectively.
 The members, contributions were to be N$75 000 from Shahieda (N$5 000 in cash and assets
valued at N$70 000) and N$15 000 from Joseph (N$1 000 in cash and assets valued at
N$14 000).

Joseph needed to cash in some of his gold shares to reach the N$1 000 and believed that the gold
price was going to increase and would reach $360 within the next few months. He only paid N$100 of
his contribution up front. He promised to pay the rest within the next three months. Joseph also
contributed a delivery vehicle (valued at N$14 000). Shahieda contributed N$20 000 in cash, an
existing shop valued at N$50 000 and three industrial machines valued at N$20 000. The cash she
contributed to the business was in the form of her N$5 000 contribution and a loan of N$15 000.

Note: Members of a close corporation often contribute a small amount as their members’
contribution. The reason that only a small amount of contribution is made is because the member’s
liability is limited to the amount of capital contribution invested in the business. In order to protect
creditors and banks that have dealings with the close corporation, the Act prevents members from
withdrawing their capital contribution. This is known as the capital maintenance. The cash is put into
the close corporation as a loan from members instead.

Required:

1. Prepare the general journal entry to record the initial transactions.

2. Prepare the balance sheet as at 1 July 2002.

Solution:
General journal
Debit Credit
Bank 20 000
Member’s contribution 5 000
Long-term loan from members – Shahieda 15 000
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Property, plant and equipment 70 000
Member’s contribution 70 000

Short-term loan to member – Joseph 900

Bank 100
Members contribution

Vehicles 14 000
Member’s contribution 14 000

Balance sheet
Cassiem’s Laundromat cc
Balance Sheet as at 1 July 2002
Particulars N$
Assets
Non-current assets 84 000
Property, plant and equipment 70 000
Vehicles 14 000
Current assets 21 000
Cash 20 100
Short-term loans to members 900

Total assets 105 000

Equity and Liabilities

Members’ Funds
Members contribution 90 000
Liabilities
Non-current liabilities
Long-term loan from members 15 000

Total equity and liabilities 105 000

Note: The N$900 that Joseph owes has been debited to a loan account and credited to members’
contributions. This treatment has been followed because section 24(4) of the Act allows for payment
of contributions to be delayed. In terms of the section, outstanding contributions must be paid within
90 days of the date of incorporation.

Joseph’s liability will be limited to the amount of his contribution (N$1 000) for 90 days. If he
does not pay the outstanding N$900 within the 90 days, he will lose his limited liability status and will
be liable for every debt of the date of incorporation incurred from 1 July 2002 to the date on which he
pays the outstanding N$900.

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4. How are members of the close corporation rewarded by the business?

Shahieda and Joseph are both involved in the management and operations of the close corporation
and have invested capital in the business. They would want to be rewarded for this investment in the
following ways:
 A market-related interest rate on the member’s invested capital. The invested capital can be in
the form of equity capital, loan capital, or a combination of both equity and loan capital
 A salary or fees for services performed for the close corporation
 A share of the distributed profit or loss

The details of these rewards are not automatic and would have to be agreed by Shahieda and Joseph
and recorded in an association agreement. It is important to remember that the profit made by the
close corporation does not automatically belong to the members. They will need to decide on the
amount of profit that will be distributed. The members are then entitled to their share of their
distribution.

A market-related interest rate on the members’ invested capital The invested capital we are
referring to includes the member’s contribution and any additional amounts invested by the
members to fund the operations of the close corporation. These additional amounts are credited to
loan accounts termed members’ loans. In the example above Shahieda invested an additional
N$15 000 in the close corporation. This amount was credited to the long- term from members’
account.

Members of the close corporation do not necessary share profits in proportion to the capital each has
contributed. In this case Shahieds’s interest is 80% and Joseph’s is 20%. This interest is not based on
the contribution each made to the close corporation. The members are compensated, at a market
related rate, for their capital investments. Interest on the capital invested is treated as a normal
expense by the close corporation.

Salary to the members’ Salaries must be agreed upon by the members according to what members
are employed to do in the close corporation. These salaries will be treated as normal operating
expenses by the close corporation.
Note: The members of the close corporation will have to pay income tax on the salary and interest
received from the close corporation. As discussed below, the close corporation is a separate taxpayer
and will have deductions in the form of expenses.

Short-term loan accounts The salaries and interest that members of a close corporation are paid are
treated as normal operating expenses, which reduce the net profit of the close corporation. If these
amounts are paid to members on a monthly basis, the following journal entry will record the
payment:

Debit Credit
Salaries X
Interest X
Bank X

The members of the close corporation may choose not to have their salary and interest paid out on a
monthly basis. These amounts are owed by the close corporation to the members. A liability account
known as Short-term loan from members account is credited. A separate short-term loan account
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will be opened for each member (when necessary). If the interest and salaries owed to the members
are not paid out on a monthly basis, the following journal entry will be processed:

Debit Credit
Salaries X
Interest X
Short-term loan from members – member A X
Short-term loan from members – member B X

Illustration 2

Shahieda and Joseph have decided to pay a market related interest 12% on the members’ invested
capital. This interest will only be paid to members whose capital contributions are fully paid up.
Joseph has told some of his gold shares and has paid his contribution. It was decided not to have her
interest portion paid out to her at the end of each month.

Shahieda has invested the following in the business:

 Member’s contribution of N$75 000 (N$5 000 + N$70 000)
 Long-term loan of N$15 000

Remember that she will be paid interest on her member’s contribution and her long-term loan
account. Joseph has invested the following in the business:
 Member’s contribution of N$15 000 (N$1 000 + N$14 000)

Prepare the journal entries that are necessary to record these transactions.
Solution:

Debit Credit
Bank 900
Member’s contribution 900
Joseph paid up outstanding member’s contribution

Debit Credit
Interest on capital 1 050
Bank (N$90 000 x 12% x 1/12) 900
Short-term loan from members – Joseph (N$15 000 x 12% x 1/12) 150
One month’s interest paid to Shahieda and one month’s interest
accruing to Joseph

Shahieda is involved full time in running the business, whereas Joseph is involved in finding
appropriate premises and setting up new Laundromats where suitable. According to the members’
agreement Shahieda is paid a monthly salary of N$8 000 and Joseph receives a salary of N$4 000.
Shahieda prefers to be paid on a monthly basis whereas Joseph prefers to withdraw money owing to
him when he needs it.

Prepare the journal entry required to record these transactions.

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Solution:

Debit Credit
Salary 12 000
Bank 8 000
Short-term loan from members – Joseph 4 000
One month salary paid to Shahieda and one month salary accruing to
Joseph

Taxation
The taxable income of a close corporation is subject to income tax at the same rate as a company
(currently at 29%). The tax is treated as an expense to the business. Profits distributed to members
(dividends) are not taxed in the members’ hands, like a company, the close corporation will need to
pay secondary tax on companies of 12.5% on the distributions (dividends) declared.

Sharing the profits or losses

A portion of the net profit of the close corporation (after tax) is distributed between the members.
The amount to be distributed is agreed on by the members at a special meeting. The amount to be
distributed is shared according to the interest that each member has in the close corporation. It is
important to note that the net profit of the close corporation does not automatically belong to the
members; it belongs to the close corporation itself. This differs from a sole proprietor or a
partnership, where the owners have the right to withdraw profits from the business.

The net profit, or a portion of it, will only be distributed to the members once an amount has been
authorized by the members. The amount paid out to the members is known as distributions
(dividends) and the profit that is retained by the corporation is known as undrawn income
(accumulated profit). This is similar to what would happen in a company. Shareholders are only
entitled to dividends once the directors have declared them. The profit available for distribution is
closed off to the undistributed income account.

Distribution to members
It is important to remember that members do not have an automatic claim on the undrawn income of
the close corporation. The distribution can only occur once the members have made a formal decision
to do so. This distribution is nature similar to a dividend declared by a company. The total distribution
of undistributed income in each period should, as is the case with dividends for companies, be
disclosed in the financial statements of the corporation. The distribution can only occur if the
following conditions are met:

 The corporation’s assets, fairly valued, exceed its liabilities, after such payment is made (the
close corporation is solvent) (its current assets are greater that its current liabilities)
 The corporation is able to pay its debts as they become due in the ordinary course of its
business (the close corporation is liquid).

These are referred to as the solvency and liquidity requirements. The following information is
available for the year that Cassiem’s Laundromat has been in business:
 The business made a profit of N$225 000 during the year. This profit was before any of the
members’ salaries or interest on contribution had been accounted for.
 Interest on capital invested is charged at 12% per annum
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  Salary per member: Shahieda N$8 000 per month and Joseph N$4 000 per month
 The business needs to provide for taxation amounting to N$20 250

The income statement for the year (before taking into account the salaries and interest owed to
members) is provided below:

Income statement for the business N$ N$

Services rendered 350 000
Less: expenses
Accounting officer’s remuneration 1 200
Depreciation 12 000
Salaries: Staff 35 000
Consumables 25 000
Delivery expenses 7 000
Repairs and maintenance 5 000
Water and electricity 33 800
Telephone 6 000

Let’s look at how to prepare the journal entries to record the interest and salary payments to the
members. Shahieda withdrew both interest and salaries on a monthly basis whereas Joseph has
chosen to withdraw either of these when he needs it.

Debit Credit
Salary [(8 000 x 12) + (4 000 x 12)] 144 000
Bank 96 000
Short-term loan from members – Joseph 48 000

Interest on capital 12 600

Bank [90 000 (75 + 15) x 12% 10 800
Short-term loan from members - Joseph 1 800

Simple interest has been used in the example. In practice Joseph would earn compound interest
(interest on interest), as the interest earned would have been reinvested. Shahieda has been paid her
salary immediately (we have credited Bank) whereas Joseph has reinvested his into the business until
he chooses to withdraw it (we have credited short-term loan from members). At the end of the
financial year it was authorized that N$20 000 of the net profit for the year be made available for
distribution to the members. The profit is shared according to the interest that the members have in
the business: Shahieda receives 80% and Joseph 20%. Neither Shahieda nor Joseph withdrew their
share of the profit out of the business.

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Let’s look at how to prepare the closing entries for the business at the end of the year.

Debit Credit
Services rendered 350 000
Profit or loss 350 000

Profit and loss 281 600

Accounting officer’s remuneration 1 200
Depreciation (PPE = 9 000, vehicle = 3 000) 12 000
Salaries: staff 35 000
Consumables 25 000
Delivery expenses 7 000
Repairs and maintenance 5 000
Water and electricity 33 800
Telephone 6 000
Interest expense 12 600
Salary – members 144 000

Taxation expense 20 520

SARS (income tax) 20 520

Taxation expense 2 500

SARS (STC) (20 000 x 12.5%) 2 500

Profit and loss 45 380

Undrawn income (350 000 (income) – 281 600 (expenses) – 20 520
(income tax) – 2 500 (STC) – 17 500 (distribution) 27 880
Distribution 17 500

Distribution 17 500
Short-term loan from members - Shahieda 14 000
Short-term loan members – Joseph 3 500

The amount of profit available for distribution amounts to N$20 000. Secondary tax on
companies amounting to 12.5% will need to be paid over to SARS (N$20 000 x 12.5% =
N$2 500). The remainder will be shared between the members according to their member’s
interest in the close corporation:
N$20 000 – N$2 500 = N$17 500

Shahieda: N$17 500 x 80% = N$14 000

Joseph: N$17 500 x 20% = N$3 500
Secondary tax on companies (STC) When a distribution of profits is declared and made
available to the members, the close corporation has to pay STC amounting to 12.5% of the
distribution declared.

Joseph was really excited about how well his gold shares were doing but did not have cash
available to purchase additional shares. Prepare the journal entry is required to record this
entry:

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 Debit Credit
Short-term loan from members – Joseph 25 000
Bank 25 000

Let’s draw up the income statement for Cassiem’s Laundromat CC for the year ending 31 June
2003:
Cassiem’s Laundromat CC
Income and distribution statement for the year ended 31 June 2003
Debit Credit
N$ NS
Services rendered 350 000
Less: expenses (281 600)
Accounting officer’s remuneration 1 200
Depreciation 12 000
Salaries: staff 35 000
Salaries: members 144 000
Consumables 25 000
Delivery expenses 7 000
Repairs and maintenance 5 000
Water and electricity 33 800
Telephone 6 000
Interest to members 12 600

Net profit before taxation 68 400

Taxation (20 520 + 2 500) (23 020)
Net profit after taxation 45 380

The distribution of proof to members needs to be shown. The information could be

presented as below, but in practice it is becoming more common to show the information in
a statement of changes in equity.

Distribution to members (17 500)

Undistributed profit for the year 45 380
Undistributed profit at the beginning of the year 0
Undistributed profit at the end of the year 27 880

5. Revaluation on non-current assets

A new shopping centre has been built across the road from the Laundromat, which has increased the
value of surrounding business properties. It has been decided to revalue the land and building from
N$50 000 to N$70 000.

Illustration 3

Prepare the journal entry to record the transaction relating to the revaluation of the land and
buildings.

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Solution:
Debit Credit
Property, plant and equipment 20 000
Revaluation reserve 20 000

Use the additional information below as well as the information already recorded with respect to
Cassiem’s Laundromat CC to draw up the balance sheet as at 30 June 2003, the end of the financial
year.

During the year Cassiem’s Laundromat CC had purchased new machinery at a cost of N$42 000 and on
1 June they purchased a second delivery vehicle for N$45 000. The accounts receivable balance at the
end of the year amounted to N$13 400 and the business had N$25 800 in the bank. Land and
buildings are not depreciated.

Solution:
Cassiem’s Laundromat CC
Balance sheet as at 30 June 2003

Assets N$
Non-current assets 179 000
Property, plant and equipment
(70 000 (50 + 20) + 62 000 (20 + 42) – 9000 (depreciation) 123 000
Vehicles (14 000 + 45 000 – 3 000 (depreciation)) 56 000
Current assets 39 200
Accounts receivables 13 400
Cash 25 800

Total assets 218 200

Equity and Liabilities

Members Funds 137 880
Members contribution 90 000
Undrawn income (45 380 + 17 500) 27 880
Surplus on revaluation of land 20 000
Liabilities
Non-current liabilities
Long term loans from members 15 000
Current liabilities 65 320
Short-term loan from members 42 300
SARS 23 020

Total equity and liabilities 218 200

We can see that only the total amount of short-term loans is shown in the balance sheet above. The
detailed will be shown in a note on the Movement in loans to and from members.

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Short-term loan from members Shahieda Joseph
Balance at the beginning of the year 0 0
Amounts transferred in 14 000 53 300
Amounts repaid 0 (25 000)
Balance at the end of the year 14 000 28 300

*48 000 + 1 800 + 3 500 = N$53 300

Loans to members,
As with a company, a close corporation is a legal person in its own right. In other words, the close
corporation and the owners are separate legal entities. This means that all the transactions between
the members and the close corporation must be separately disclosed. We have already seen that the
members of a close corporation can lend the corporation money. This will appear on the balance
sheet as a liability. If the members earn interest, salaries or distributed profit and they have not been
withdrawn from the business, these amounts appear as a current liability on the balance sheet,
known as Members’ short-term loan accounts.

We have seen that members can lend money to the close corporation and are seen as creditors of the
close corporation. The close corporation can also lend money to the members and in this case the
members will be seen as debtors of the corporation. Loans to and loans from members need to be
separately disclosed. If the amounts will be repaid in the short-term they should be disclosed as
current assets or current liabilities. If these loans are long-term in nature, they should be disclosed as
non-current assets and non-current liabilities.

Some points about the example

 The recording and reporting process in a close corporation is exactly the same as for a sole
proprietor, partnership or company.
 All the concepts, principles, and the recording and reporting process that you have learnt in
the text book until now apply as much to close corporations as they do to any other business
entity.
 The equity section of each entity will differ. The equity section of a close corporation is
referred to as members’ funds. The members’ funds will include: members’ contributions,
surplus on revaluation of land and indrawn income.
 Close corporations can make loans to or from members. These loans should be separately
disclosed on the balance sheet as either assets or liabilities.

6. Financial reporting requirements in more details

Let’s look at the example of the required disclosure for the income statement:

Income statement for the year ended 30 June 2003

Sales
Less: Cost of goods sold
Gross profit
Operating expenses
Administrative expenses
Marketing expenses
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Selling and distribution expenses
Depreciation
Members’ salaries
Operating income
Interest
Net profit before taxation
Taxation
Net profit after taxation

In order to provide members of the close corporation with useful information a Transaction with
members’ statement is provided. This statement includes all the transactions with individual
members that have been included in the income statement above in arriving at the net income. These
transactions include: salaries accruing to members, interest accruing to members, and distributions of
profit accruing to members.

Here is an example of the Transaction with members’ statement.

Transactions with members statement
Member A Member B Member C
Members’ salaries
Members’ interest
Distribution of profit

Illustration 4

Prepare the Transactions with members’ statement for Cassiem’s Laundromat as at 30 June 2003

Solution:

Transactions with members’ statement as at 30 June 2003

Shahieda Joseph
N$ N$
Members’ salaries 96 000 48 000
Members’ interest 10 800 1 800
Distribution of profit 14 000 3 500

Let’s look at an example of the required disclosure for the balance sheet.
Balance sheet as at 30 June 2002
ASSETS
Non-current assets
Property, plant and equipment
Vehicles
Long-term loans to members
Current assets
Inventory
Accounts receivable
Cash
Short-term loan to members
Total assets
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Funds employed
Members’ Funds
Members’ contribution
Undistributed profit
Liabilities
Non-current liabilities
Long-term loans from members
Current liabilities
Accounts payable
SARS
Total funds employed

Notes to the balance sheet

1. Accounting policies
The following are the principal accounting policies used by the corporation:

a) Property, plant and equipment

Land and buildings are not depreciated and are revalued by the members on 31
December every year.
Equipment and vehicles are shown at cost and are depreciation on a straight-line
basis over their expected useful lives. The annual rates used for this purpose are:
Equipment 20%, Vehicles 20%
b) Inventory
Inventory is valued at the lower of cost (determine on a first in first out basis)
and net realizable value.

2. Gross revenue
Gross revenue, which excludes Value Added Tax, comprises the amounts invoiced for goods
supplied to customers.

A further requirement of the Act is the separate disclosure in the financial statements of the
aggregate amounts at the end of the financial year and movements during the year of each of the
following:
 Contributions by members
 Undrawn (undistributed) profit
 Revaluations of fixed assets
 Amounts of loans to members
 Amounts of loans from members

The information above can be disclosed by preparing a Members’ Net Investment statement or
preparing a Statement of Changes in Equity and a Statement of Movement in Loans (per individual
member). The following information will be disclosed in the statement of changes in equity:
 Contributions by members
 Undrawn (undistributed) profit
 Revaluations of fixed assets

The following information will appear in the Statement of Movement in Loans to and from Members:
 Amounts of loans to members
 Amounts of loans from members
16
Let’s look at an example of the Members’ Net Investment statement.

Illustration 5

Use the information presented in the chapter above and prepare the Members Net Investment
statement for the year ended 30 June 2003.
Solution:

Members’ net investment statement for the year ended 30 June 2003

Members’ contribution 90 000

Balance at beginning of year 0
Contributions introduced 90 000
Contributions repaid 0
Balance at the end of the year 90 000

Revaluation surplus 20 000

Balance at beginning of year 0
Revaluation during the year 20 000
Balance at the end of the year 0

Undrawn income 27 880

Balance at beginning of year 0
Net income after tax 45 380
Distributions to members (17 500)
Balance at the end of the year 0

Long-term loans from members 15 000

Balance at beginning of year 0
Amounts introduced 15 000
Amounts repaid 0
Balance at the end of the year 15 000

Short-term loans from members 42 300

Balance at beginning of year 0
Amounts transferred in 67 300
Amounts repaid (25 000)
Balance at the end of the year 42 300

Loans to members (0)

Balance at beginning for year 0
Amounts advanced (900)
Amounts repaid 900
Balance at the end of the year 0

Members’ interest at the end of the year 195 180

17
7. Close corporations and GAAP

The annual financial statements must conform with generally accepted accounting practice that is
appropriate to the business of the corporation and in so doing fairly present the state of affairs of the
close corporation at the financial year end the results of its operations for that year. The two basic
principles underlying the preparation of the financial statements for a close corporation are:
 Going concern
 Accrual concept

The Close Corporations Act does not contain a schedule setting out the disclosure requirements for
financial statements. For companies these requirements have been set out in Schedule 4 of the
Companies Act.

What have we learnt in this chapter?

Summary of close of corporations

 The owners are separate from the close corporation and have limited liability.
 The format of the Capital account is different from a sole proprietors and a partnership;
members’ members’ accounts are grouped together and collectively known as members
contributions.
 The profits of the close corporation do not automatically accrue to the members.
 The salary, interest on capital contribution and profit distribution accruing to the members is
recorded in the short-term loan to members’ account.
 The undistributed profit remains in the close corporation as undistributed profits
 There are liquidity requirements that have to be met before profit can be distributed
 Members can lend money to or borrow from the close corporation. This information needs to
be separately.
 There are instances where members can lose their limited liability

QUESTIONS
Question 1 (A)

IGNORE VAT AND STC.

Granny Gear is a bicycle shop run by members Dirk and Johann. The business was incorporated as a
close corporation on 1 January 1999 and has been operating at a profit each year. The following
balances were obtained from the books of Granny Gear CC at 31 December 2004:

N$
Members’ contributions (1.1.2004) 270 000
Equipment at cost 128 100
Accumulated depreciation – equipments (31.12.2004) 34 275
Land and buildings 210 000
Surplus on revaluation of land reserve (1.1.2004) 30 000
Investment at cost: 22 500 ordinary shares in Pedal Planet (Pty) Ltd 27 000
Long-term loan from member – Dirk 18 000
Short-term interest free loan to member – Johann 6 000
Inventory (31.12.2004) 30 450
18
Bank 36 000
Accounts receivable 64 100
Accounts payable 27 735
Gross profit 91 500
Sundry expenses 32 500
Rent received 18 600
Dividends received from Pedal Planet (Pty) Ltd 5 100
Undrawn income (accumulated profit) (1.1.2004) 38 940

Except for items 5, 6, and 7 below, all transactions for the year have been recorded and posted to
the general ledger.

Additional information:
1. The two members of the CC are Dirk and Johann. Their contributions were made in the ratio of
2:1 respectively, but their members’ interest ratio is 1:1. The members’ contributions are fully
paid up.
2. Sundry expenses consist of the following:
Depreciation (equipment) 4 500
Salaries to members (paid in cash) – Dirk 8 000
- Johann 6 000
Accounting officer’s remuneration 4 750
General office expenses 1 800
Administration and selling expenses 3 450

Dirk is a technical expert and has connections in the bicycle trade, and therefore is paid an additional
salary amount of N$4 000 per annum in cash. This is not included in the N$8 000 salary amount above
but is included in the sundry expenses amount given.

3. During the year, the CC lent Johann a further N$2 100 and he repaid N$3 300 on the above
short term loan.
4. On 31 August 2004 the CC needed short-term finance and borrowed an additional N$6 000
from Dirk. This amount is included in the long term loan from member – Dirk.
5. In terms of the founding statement, interest is calculated on long term loans from members at
a rate of 10% per annum. Such interest accrues and is credited to the members’ short term
loan accounts on the 30 June and 31 December each year. The relevant interest entries have
not been posted during the 2004 financial year.
6. Dirk and Johann resolved on 31 December 2004 to make a distribution of N$16000(excluding
STC) to themselves, payable on 15 January 2005, and that this not yet been recorded by
Granny Gear CC.
7. The taxation expense of N$45 000(excluding STC) must still be recorded for the 2004 financial
year.

You are required to:

a) Prepare the general journal entries to record the additional information given in points
5-7, including the effect of STC.
b) Calculate the net profit after tax for the year ended 31 December 2004.
c) Prepare the transactions with members’ statement (that would be disclosed at the
bottom of the income statement) for the year ended 31 December 2004
d) Prepare the statement of changes in equity for the year ended 31 December 2004
19
 e) Prepare the equity and liabilities section of the balance sheet for Granny Gear CC as at
31 December 2004

Suggested solution 1
a) General journal of Granny Gear CC
Dr Interest expense 1 400
Cr Short term loan from member – Dirk 1 400
(12 000 x 10%) + (6 000 x 10% x 4/12)
Dr Distribution 16 000 8 000
Cr Short-term loan from member – Dirk 8 000
Cr Short-term loan from member - Johann
Dr Taxation expense 45 000
Cr SARS (income tax) 45 000

Dr Taxation expense 1 363

Cr SARS (STC) 1 363
(16 000 – 5 100 x 12.5%)

b) Calculation of net profit

Gross profit 91 500
Rent received 18 600
Dividends received 5 100
Sundry expenses (32 500)
Interest expense (1 400)
Income tax expense (45 000)
STC Charge (1 363)
34 937

c) Transaction with members’ statement for the year 31 December 2004

Dirk Johann
Members’ salaries 12 000 6 000
Members’ interest on long term loans 1 400
Distribution of profit 8 000 8 000
21 400 14 000

d) Statement of changes in equity for the year ended 31 December 2004

Members’ Undrawn Revaluation Total
contribution income reserve
Opening balances (1.1.2004) 270 000 38 940 30 000 338 940
Profit for the year after taxation - 34 937 34 937
Distribution of profits to - (16 000) - (16 000)
members
Surplus on revaluation of land & - - - -
buildings
Balance at end of year 270 000 57 877 30 000 357 7
(31/12/2004)

20
 Granny Gear CC
Balance sheet at 31 December 2004
Equity and Liabilities
Members’ interest and reserves 357 877
Members’ contributions 270 000
Undrawn income (accumulated profit) 57 877
Revaluation reserve 30 000

Non-current liabilities 18 000

Long term loan from member – Dirk 18 000

Current liabilities 91 498

Short-term loans from members ( 1 400 + 16 000) 17 400
Accounts payable 27 735
SARS (income tax) 45 000
SARS (STC) 1 363

467 375

Question 2

The following balances were obtained from the books of Inventive CC at 31 December 2001:
Retained income 1 January 2001 N$ 19 475
Members’ contributions 112 500
Equipment 64 050
Accumulated depreciation – equipment 17 100
Land and buildings 105 000
Surplus on revaluation of land & buildings 15 000
Investments at cost 13 500
Loan from members: A Abacus 6 900
Loan to member: B Baracus 2 400
Loan to member: I Ilias 7 500
Inventory at 31.12.2001 15 225
Accounts payable (Creditors) 18 000
Accounts receivables (Debtors) 13 900
Provisional tax payments 1 500
Gross profit 45 750
Sundry expenses 15 300
Rent received 9 300
Dividends received 2 550

Additional information
1. Sundry expenses consist of:
Salaries to members (in proportion to their interests) N$ 9 000
Interest paid on members’ loan from A Abacus
Remuneration to accounting officer
Other interest paid
Administrative and selling expenses (including N$225 relating to January 2002
Depreciation: equipment
21
 2. The members authorized a distribution of N$6 000 of the income for 2001 amongst
themselves, which has been posted.
3. The accountant estimated that the firm’s tax liability for 2001 to be N$3 900. No provision has
yet been made for this.
4. Interest was paid at 7.5% per annum on the members’ loan from A Abacus. During the year
end the CC repaid N$600.
5. Inventory is valued at the lower of cost or net realizable value on a first-in-first-out basis.
6. The loans to I Ilias and B Baracus are interest free. The CC lent B Baracus a further N$1 050
during the year and he repaid N$1 650 during the year.
7. The three members of the CC were A Abacus, B Baracus and I Ilias. Their members’
contributions were in the same ratio as their interest, being 1:2:1 respectively. The
contributions of A Abacus and B Baracus were fully paid up, but I Ilias still owed an amount of
N$7 500 in respect of his contribution.
8. Investments consist of:
 7 500 ordinary shares in Alto (Pty) Ltd (valuation – N$10 000)
 3 000 ordinary shares in Efraim Industries (Pty) Ltd (valuation – N$7 000)
Investments are maintained at cost in the ledger.
9. The opening and closing bank balances are NIL

You are required to:

Draft the financial statements for Inventive CC for the year ended 31 December 2001 in accordance
with generally accepted accounting practice (GAAP).

Note: Ignore STC (Secondary Tax on Companies and Close Corporations)

SUGGESTED SOLUTION 2

Inventive CC
Balance sheet at 31 December 2001
ASSETS Note N$
Non-current assets 2 151 950
Investment 3 13 500
Loans to members 4 9 900

Current assets 33 450

Inventory 15 225
Accounts Receivable 18 000
Prepaid expenses 225
208 800

Equity and Liabilities

Members’ interests and reserves 179 600
Members’ contributions 4 112 500
Revaluation surplus 15 000
Accumulated profit 52 100

Loan from member 4 6 900

22
Current liabilities 22 300
Accounts payable 13 900
Members for distribution 6 000
Taxation owing (N$3 900 – 1 500) 2 400
208 800

Income statement of inventive CC for the year ended 31 December 2001

N$
Turnover XXX
Gross profit 45 750
Selling, administrative and general expenses 1 500
Depreciation 2 250
Salaries 9 000
Accounting officer’s fee 1 425
Operating income 31 575
Other income 11 850
Dividends received from investment
Rent received
Net income before interest paid 43 425
Interest paid (N$525 – 375) 900

Net income before taxation 42 525

Taxation 3 900
Net income after taxation 38 625

Inventive CC
Statement of changes in equity for the year ended 31 December 2001
Members’ Revaluation Accumulated Total
Interest Reserve Profit
N$ N$ N$ N$
Balance 31 December 2000 112 500 15 000 19 475 146 975
New capital contributions
Surplus on revaluation of
Properties
Surplus/Deficit on revaluation
Of investments
Net profit after taxation
For the period 38 625 38 625
Distribution to members (6 000) (6 000)
Balance at 31 December 2001 112 500 15 000 52 100 179 600

Notes to the financial statements for the year ended 31 December 2001

23
 1. Accounting policies
The financial statements are prepared on the historical cost basis, modified by the revaluation of land
and buildings, in accordance with the following accounting policies. The accounting policies adopted
are consistent with those of the previous year.

Inventory
Inventory is valued at the lowest of cost and net realizable value on a first-in-first-out basis.

Fixed assets
Land and buildings are not depreciated and are revalued. Equipment is depreciated on a reducing
balance basis to reduce assets to estimated residual value over the lives of the assets.

Investments
Investments are shown at cost.

2. Cost/valuation Accumulated Carrying

Depreciation amount
Non-current assets
Land and buildings 105 000 - 105 000
Equipment 64 050 17 100 46 950
169 050 17 100 151 950

Land and Equipment Total

Buildings
N$ N$ N$
Cost
Balance at 1 January 2000 105 000 64 050 169 050
Add: Acquisitions
Less: Disposals
Balance at 31 December 2000 105 000 64 050 169 050

Accumulated depreciation
At 1 January 2000 14 850 14 850
Depreciation charge 2 250 2 250

Accumulated depreciation
On disposal
Balance at 31 December 2000 17 100 17 100

Carrying amount at the end

Of the year 105 000 46 950 151 950
 Details of the cost price of the land and buildings, the valuation basis, etc, should also be
disclosed.

3. Investments
 Unlisted
7 500 ordinary shares in Alto (Pty) Ltd XXX
(Directors’ valuation N$10 000)

24
 3 000 ordinary shares in Efraim Industries (Pty) Ltd XXX
(Directors’ valuation N$7 000)

4. Members’ net investment statement

A B I Total
Members’ interest: 25% 50% 25% 100%

Members’ contributions 28 125 56 250 28 125 112 500

Revaluation surplus 3 750 7 500 3 750 15 000

Undrawn income 13 025 26 050 13 025 52 100

Balance at the beginning of the year 4 869 9 737 4 869 19 475
Net income 9 656 19 313 9 656 38 625
Distributions (1 500) (3 000) (1 500) (6 000)
Loan from member 6 900 6 900
Balance at the beginning of the year 7 500 7 500
Repayment to member (600) (600)

Loans to members (2 400) (7 500) (9 900)

At the beginning of the year (3 000) (7 500) (10 500)
Advances to member (1 050) (1 050)
Repayments from member 1 650 1 650

Balance at the end of the year 176 600

Represent by:
Members’ contributions 112 500
Revaluations surplus 15 000
Undrawn income 52 100
Loan from member 6 900
Loans to members’ (9 900)
176 600

5. Transactions with members

Net income is arrived at after the following transactions with members:

A B I TOTAL
Salaries 2 250 4 500 2 250 9 000
Interest paid 525 - - 525
2 775 4 500 2 250 9 525

25