Smith & Stewart (Stewart) is a partnership of lawyers. It was recently formed from a merger of two predecessor partnerships: Becker and Brackman (Becker) and Copp and Copp (Copp). The merged firm has 38 partners, six from Becker and 32 from Copp, and a total of 75 employees. At the date of the merger, Stewart purchased land and an office building for $1.25 million and fully computerized the new offices. The partners have decided that the financial statements will be audited annually, although neither of the predecessor firms was audited.
The partnership agreement requires an annual valuation of the assets and liabilities of the firm. This valuation is to be used to determine the payment to be made by the partnership to a withdrawing partner, and the contribution to be made to the partnership by a newly admitted partner. The partners are unsure of the accounting implications of this requirement.
The partners have been actively engaged in establishing and managing the practice and have paid little attention to the accounting policies.
Before the merger, Becker recorded revenue when it invoiced the client. Time reports were used to keep track of the number of hours worked for each client, although this information was not recorded in the accounting system. In general, its accounting records were not well maintained.
In contrast, work in progress was recorded for employees of Copp at their regular billing rate, on a client-by-client basis, based on the hours worked, even though the full amount was not always recoverable. At year-end, an adjust ment was made to reduce work in progress to reflect the actual costs incurred by Copp. Copp recorded revenue for partner hours at the time that clients were invoiced.
The new partnership agreement requires a valuation of the work in progress at the merger date, with this amount to be recorded as goodwill. This amount has not yet been determined.
Stewart has arranged a line of credit with a bank that allows the partnership to borrow up to 75% of the carrying amount of receivables and 40% of the carrying amount of work in progress, as recorded in the monthly financial statements. The bank has also provided mortgage financing of $750,000 on the recently acquired land and building. As well as annually audited financial statements, the bank requires unaudited financial statements monthly.
As of the date of the merger, property, plant, and equipment owned by the predecessor firms were transferred to the new partnership. Each partner receives a monthly "draw" payment, which represents an advance on the partner's share of annual profit. Although the individual partners cannot incorporate, the partnership is con sidering incorporating a company to provide management services to the partner ship. If it proceeds with this idea, the land and building and related mortgage, and the equipment would be transferred to this company.
Your firm has been engaged by Stewart to prepare a report advising the part nership on financial accounting issues. The manager in charge of the Stewart engagement has asked you, a CA, to prepare a draft report to the client addressing its concerns.
Prepare the draft report.