A. Answer all the questions for the three partners.

B. Should they proceed with incorporation? Are there other factors which they should consider?

Fifteen years ago, John Kerr worked as a production manager for a small manufacturing firm involved in the production of metal furniture. Owing to his keen interest in woodworking, he decided at that time to begin his own business, Woodworkers Anonymous, with the aim of manufacturing dolls’ houses and other wooden toys to retail. 

After moderate success in this venture over a period of 5 years, he decided to form a partnership with two good friends, Alexis Thompson and James Bentley, and to branch out into the manufacture of wooden garden furniture. This partnership traded under the name of The Garden Furniture Store, even though the construction of dolls’ houses and other toys was to continue. John had a 60% interest in the partnership, and both Alexis and James had 20% interests. John took on the role of general manager in the partnership, with Alexis and James being responsible for production and sales respectively. 

After further success in this venture, because of John’s previous experience in the metal industry, the partners decided to expand the business into metal garden furniture and metal fencing. 

As part of these arrangements, they were thinking of applying to ASIC to be registered as a proprietary company. The proposed name for the new company was Relaxaquipment Pty Ltd, and each partner was to continue operating in a similar role. 

Before registering the company, a trial balance of the partnership was as follows:

	THE GARDEN FURNITURE STORE Trial Balance as at 30 June 2016
		Debit			Credit
	Cash at bank Accounts receivable Inventories Prepaid insurance Land Building Accumulated depreciation – building Equipment Accumulated depreciation – equipment Accounts payable Accrued expenses John Kerr, Capital John Kerr, Retained Earnings Alexis Thompson, Capital Alexis Thompson, Retained Earnings James Bentley, Capital James Bentley, Retained Earnings		$  20250 43650 71250 1500 45000 225000 150000			$  37500 30000 63750 2625 200000 19844 70000 31463 70000    31468
			$556650			$556650

It was agreed that the fair values of all assets and liabilities were equal to their carrying amounts, and that each partner would be issued with shares in the new company, valued at $1 each, in accordance with the values of their total equity in the partnership. In order to finance expansion into metal gates and fencing, the three partners decided that the new company would need to apply for a $60 000 loan, interest payable annually at 8%, from the Western Bank, with the principal repayable over a 10-year period. They also agreed that they could ask another friend, Simone Carey, to become a member of the company by taking up shares and contributing further cash requirements of $50 000, if necessary.

Before incorporation, however, they seek your advice on the following questions:

●   What are the advantages and disadvantages of incorporation, compared with remaining a partnership?

●   What is the legal relationship between the shareholders, directors and officers in a company?

●   What portion of the total equity belongs to each partner in the new company? Will the partners be happy with this if they expect the same profit-sharing ratio as in the partnership?

●   Given that it will cost $300 in legal fees to form the company, how should these legal fees be recorded in the company’s accounts?

●   How would the balance sheet of the company appear immediately after registering and taking up the loan from Western Bank?

●   How much profit before income tax and interest would the company have to earn in the first year in order to achieve a rate of return on total assets (net of depreciation) of 15%?

●   Assuming an income tax rate of 30% on profit, how much profit would this represent for the shareholders after interest and after tax? Ignore GST in this situation.