1
PARTNERSHIPS
1.1 Definition
Two or more persons carrying on a business in
common with a view to profit.
- Examples
- Accountants
- Doctors
- Dentists
- Solicitors/Lawyers
- Husband and wife owning a small kiosk
- Types of partner
- General
- Local
- Salaried (income is earnings)
- Limited
- "Sleeping" (income is investment not earned)
1.2 Nature
- Partners are working in
the business (they are "owner managers"), unlike most
shareholders.
- An agreement exists (usually) to regulate business conduct and dealings.
A partnership does not have a separate legal form, it is
just a collection of people.
Liability is UNlimited.
1.3 Legal liability
The partnership is liable if any individual partner acting in normal course of business carries out any wrong going.
If one partner is sued for wrong doing, the other partners may be sued also – "joint and several liability".
1.4 Partnership agreement
Typical contents
- Who the partners are or
may be
- The objects
- Capital paid in to finance partnership
- Interest on capital
- Profit sharing ratio (PSR)
- Salaries (if only some partners provide services for firm)
- Whether drawings (advances on profits) are allowed
- Procedures if partnership changes
- Taxation.
- Signed by all
existing members.
If no agreement
- No interest on capital
or current accounts
- No salaries
- Profits and losses shared equally
- 5% interest on loans made by partners to the partnership
1.5 Advantages and disadvantages
1.5.1 Compared with a sole trader
|
Risk is spread |
|
May be disputes |
|
Partners provide a range of specialised skills |
|
Some partners work harder for firm than others |
|
More capital available |
|
Joint and several liability |
1.5.2 Compared with incorporated enterprises
|
Less formal set up |
|
|
|
No company formalities (eg statutory audits and
accounts filing) |
|
Much easier to sell shares than to realise capital in a partnership |
|
|
|
Liability unlimited |
2 ACCOUNTS
2.1 Format
Balance sheet (BS) – instead of just one capital line, one reserves line and one drawings line, one is needed for each partner.
Income statement – Profit is determined in same way as for a sole trader. However, an "appendix" is needed to allow calculation of how the profit (or loss) is divided up between the partners
3 BALANCE
SHEET
3.1 Capital and current accounts
|
3.1.1 Capital accounts |
3.1.2 Current accounts |
|
· Show the partners’
share of profits/losses and drawings made |
When capital accounts are not distinguished from current accounts
- each partner has just one a/c
- the capital base may be eroded by excess drawings
Overdrawn accounts are not prohibited in law
T accounts
3.2 Disclosure
4 INCOME
STATEMENT
4.1 Loans from partners
More temporary in nature than fixed capital.
Shown as a long-term liability on balance sheet.
Loan interest – charged to income
statement as normal business expense;
not an appropriation of profit.
4.2 Appropriation statement
Calculate net profit in exactly the same way as for a sole trader.
Divide profit between partners, via an appropriation statement, in accordance with the terms of the partnership agreement.
Typical appropriations are
- interest on capital (%) – gives recognition to partners contributing different amounts of capital to the firm
- salary (annual) – not to be confused with salaries paid to employees (which are an expense in the income statement)
- profit share (PSR applied to balance).
|
Example 1 A and B are in partnership. They share
profits in the ratio 2:1. At the start of the partnership, they both
paid in capital as follows: A $3,000 No salaries are paid and there is no
interest on capital. During the year, the partnership made a
profit of $10,000. Required Prepare the partnership accounts for the year. |
|
Example 2 C and D are in partnership. They share
profits equally. Initial capital paid in by the two partners was as follows C $18,000 The partners receive salaries from the
partnership as follows C $6,000
pa Interest is paid on (initial) capital at
10% pa. Year 1 During the year the partnership earned a
profit of $18,000, after deducing C’s salary. Drawings during the year were C $12,000 Year 2 Profit for the year, after C’s salary was
$5,000. No drawings were made during the year. Required Prepare the partners’ accounts. |
Proforma appropriation statement
4.3 Drawings
This is the normal
means by which partners take funds out of the
partnership*.
*Usually taken out on
a regular basis.
|
Example 3 Alpha and Beta are in partnership, sharing profits in the ratio 3:2. Alpha is to be allowed an annual salary of $6,000, and Beta $10,000. Interest on fixed capital accounts is to be paid at 5% per annum. Interest is charged on drawings at 5% per annum. Both capital and current accounts are to be kept for each partner. The capital balances held by each partner throughout the year are Alpha $25,000 Drawings were made in equal instalments, the first 50% being drawn half way through the year and the rest at the end of the year. Total drawings were Alpha $10,000 The profit for the year was $44,375. Required Prepare the appropriation account and current accounts for the partners for the year. Also prepare the balance sheet capital section. |
4.4 Interest on drawings
Treatment is as for
interest on capital but "in reverse".
A partnership pays
interest on capital to compensate partners for their money tied up in the firm.
If partners make drawings early, they compensate the firm.
4.5 Guaranteed minimum profits
|
Illustration A, B and C are in partnership sharing profits in the ratio 4: 2: 1. C is guaranteed a minimum profit of $10,000. |
Solution
Depends on conditions
in partnership agreement. For example
- irrespective of the firm’s results
- only if the firm makes a profit
- only if the firm makes a
profit of at least $10,000.
Unless told otherwise assume it means irrespective of
results.
|
Example 4 A, B and C are in partnership, sharing
profits in the ratio 4:2:1 but C has a guaranteed minimum profit share of
$10,000. A is paid a salary of $1,000 per annum. Total profit in year 1 was $81,000. Required Prepare the partnership current accounts for both years. |
(hints:…)
|
(1) |
|
C’s share 1/7 |
|
(2) |
|
C’s share 1/7 |
|
|
C |
10,000 |
80,000
= 11,429 (exceeds $10,000 
5 CHANGES
IN COMPOSITION OF A PARTNERSHIP
5.1 Situations
Admission – of incoming partner(s)
Change in PSR – by consent of all partners
Retirement – where no fixed term has been agreed, partners may retire at will.
5.2 Revaluation
|
Any change in partnership affects partners’ rights to profits and assets. The extent to which fair values differ from book values must be fairly allocated between partners. |
Changes in value of assets at the date of change are shared between existing partners in their ("old") PSR.
If many assets are revalued
- accumulate in a revaluation a/c, then
- post net revaluation to partners in PSR.
5.3 Goodwill
5.3.1 Admission
A new partner admitted to an existing partnership buys a share of business assets.
- Tangible assets – individual assets have "fair value" greater than book value.
- Intangible asset – attributable to reputation of firm, customer base, etc (= goodwill).
5.3.2 Methods
Revalue goodwill just like any other asset. Two methods
- revalue individual assets
- overall calculation ("global method").
5.3.3 Accounting entries
To record goodwill
However, it is not usually carried in the balance sheet. Therefore eliminate after change
goodwill is not usually recognised since it is only likely to be of
value when the partnership is sold
|
Example 5 Two partners, C and G sharing profits 2:1. The balance sheet as at 31 December 1998 is as follows. The balance sheet has been prepared using
historic cost. C and G are aware that
B joins the partnership by paying in
capital of $25,000. The new profit sharing ratio is 2:1:1. Required (a) Show the changes in the partnership
accounts for B’s joining without taking (b) Rework the example, taking into
account goodwill adjustments, using the
|
5.3.4 In summary
Net effect of
revaluing goodwill and then eliminating it
5.4 Changes during year
Need to split income
statement into old and new partnerships, and appropriate profit for each part
of the year according to relevant profit sharing arrangements in force.
Use a columnar income
statement
Possible bases for
splitting income statement
- Gross profit – according to turnover
- Expenses and overheads – time basis
- Specific costs – as a fact eg legal expenses
associated with an outgoing partner to old partnership
EXAMPLE
SOLUTIONS
Solution 1 – Appropriation
statement
|
Appropriation a/c |
|||||
|
|
|
$ |
|
|
$ |
|
|
A |
6,667 |
Profit |
10,000 |
|
|
|
B |
3,333 |
|
|
|
|
|
|
______ |
|
______ |
|
|
|
|
10,000 |
|
10,000 |
|
|
|
|
______ |
|
______ |
|
|
Current a/c |
||||||
|
|
A |
B |
|
|
A |
B |
|
|
$ |
$ |
|
$ |
$ |
|
|
|
|
|
Profit share |
6,667 |
3,333 |
|
|
|
|
|
|
|
|
|
|
Capital a/c |
||||||
|
|
A |
B |
|
|
A |
B |
|
|
$ |
$ |
|
$ |
$ |
|
|
|
|
|
B/f |
3,000 |
2,000 |
|
Solution 2 – Salaries and
profit appropriation
|
Appropriation a/c |
||||||||
|
|
C |
D |
Total |
|
|
C |
D |
Total |
|
|
$ |
$ |
$ |
|
$ |
$ |
$ |
|
|
Year 1 |
|
|
|
Year 1 |
|
|
|
|
|
Salaries |
6,000 |
3,000 |
9,000 |
Profit (18,000 |
|
|
|
|
|
Interest on |
|
|
|
+ 6,000) |
|
|
24,000 |
|
|
capital (10%) |
1,800 |
1,200 |
3,000 |
|
|
|
|
|
|
Profit (1:1) |
6,000 |
6,000 |
12,000 |
|
|
|
|
|
|
|
______ |
______ |
______ |
|
|
|
______ |
|
|
|
13,800 |
10,200 |
24,000 |
|
|
|
24,000 |
|
|
|
______ |
______ |
______ |
|
|
|
______ |
|
|
|
|
|
|
Year 2 |
|
|
|
|
|
Salaries |
6,000 |
3,000 |
9,000 |
Profit (5,000 |
|
|
|
|
|
Interest |
1,800 |
1,200 |
3,000 |
+ 6,000) |
|
|
11,000 |
|
|
|
|
|
|
"Loss" (1:1) |
500 |
500 |
1,000 |
|
|
|
|
|
|
|
___ |
___ |
______ |
|
|
|
_____ |
_____ |
______ |
|
500 |
500 |
12,000 |
|
|
|
7,800 |
4,200 |
12,000 |
|
___ |
___ |
______ |
|
|
|
_____ |
_____ |
______ |
|
|
|
|
|
|
Current a/c |
||||||
|
|
C |
D |
|
|
C |
D |
|
|
$ |
$ |
|
$ |
$ |
|
|
Year 1 |
|
|
Salaries |
6,000 |
3,000 |
|
|
Drawings |
12,000 |
9,000 |
Interest on capital |
1,800 |
1,200 |
|
|
Bal c/f |
1,800 |
1,200 |
Profit |
6,000 |
6,000 |
|
|
|
______ |
______ |
|
______ |
______ |
|
|
|
13,800 |
10,200 |
|
13,800 |
10,200 |
|
|
|
______ |
______ |
|
______ |
______ |
|
|
Year 2 |
|
|
B/f |
1,800 |
1,200 |
|
|
Loss share |
500 |
500 |
Salaries |
6,000 |
3,000 |
|
|
Bal c/f |
9,100 |
4,900 |
Interest on capital |
1,800 |
1,200 |
|
|
|
_____ |
_____ |
|
_____ |
_____ |
|
|
|
9,600 |
5,400 |
|
9,600 |
5,400 |
|
|
|
_____ |
_____ |
|
_____ |
_____ |
|
|
|
|
|
B/f |
9,100 |
4,900 |
|
|
Capital a/c |
||||||
|
|
C |
D |
|
|
C |
D |
|
|
$ |
$ |
|
$ |
$ |
|
|
|
|
|
Initial capital |
18,000 |
12,000 |
|
|
|
|
|
|
|
|
|
Solution 3 – Salaries,
interest and drawings
|
Appropriation a/c |
||||||||
|
|
A |
B |
Total |
|
|
A |
B |
Total |
|
|
$ |
$ |
$ |
|
$ |
$ |
$ |
|
|
Salaries |
6,000 |
10,000 |
16,000 |
Profit |
|
|
44,375 |
|
|
Interest on |
|
|
|
Interest on |
|
|
|
|
|
capital (5%) |
1,250 |
2,500 |
3,750 |
drawings (W) |
125 |
250 |
375 |
|
|
Profit share |
|
|
|
|
|
|
|
|
|
(3:2) |
15,000 |
10,000 |
25,000 |
|
|
|
|
|
|
|
______ |
______ |
______ |
|
___ |
___ |
______ |
|
|
|
22,250 |
22,500 |
44,750 |
|
125 |
250 |
44,750 |
|
|
|
______ |
______ |
______ |
|
___ |
___ |
______ |
|
|
Current a/c |
||||||
|
|
A |
B |
|
|
A |
B |
|
|
$ |
$ |
|
$ |
$ |
|
|
Interest on drawings |
125 |
250 |
Salaries |
6,000 |
10,000 |
|
|
Drawings |
10,000 |
20,000 |
Interest on capital |
1,250 |
2,500 |
|
|
C/f |
12,125 |
2,250 |
Profit share |
15,000 |
10,000 |
|
|
|
______ |
______ |
|
______ |
______ |
|
|
|
22,250 |
22,500 |
|
22,250 |
22,500 |
|
|
|
______ |
______ |
|
______ |
______ |
|
|
Capital a/c |
||||||
|
|
A |
B |
|
|
A |
B |
|
|
$ |
$ |
|
$ |
$ |
|
|
|
|
|
B/f |
25,000 |
50,000 |
|
WORKING
Balance sheet
|
|
A |
B |
Total |
|
|
$ |
$ |
$ |
|
Capital |
25,000 |
50,000 |
75,000 |
|
|
______ |
______ |
|
|
Current |
|
|
|
|
Opening balance |
– |
– |
|
|
Salary |
6,000 |
10,000 |
|
|
Interest on capital |
1,250 |
2,500 |
|
|
Profit |
15,000 |
10,000 |
|
|
|
______ |
______ |
|
|
|
22,250 |
22,500 |
|
|
Drawings |
|
|
|
|
Drawings |
(10,000) |
(20,000) |
|
|
Interest on drawings |
(125) |
(250) |
|
|
|
______ |
______ |
|
|
Closing balance |
12,125 |
2,250 |
14,375 |
|
|
______ |
______ |
______ |
|
Total owner’s equity |
|
|
89,375 |
|
|
|
|
______ |
Solution 4 – Guaranteed
minimum profit
|
Appropriation a/c |
||||||||||
|
|
A |
B |
C |
Total |
|
|
A |
B |
C |
Total |
|
|
$ |
$ |
$ |
$ |
|
$ |
$ |
$ |
$ |
|
|
Salary |
1,000 |
|
|
1,000 |
Profit |
|
|
|
81,000 |
|
|
Profit share (W1) |
|
|
|
|
|
|
|
|
|
|
|
(4:2:1) |
45,714 |
22,857 |
11,429 |
80,000 |
|
|
|
|
|
|
|
|
______ |
______ |
______ |
______ |
|
|
|
|
|
|
|
|
46,714 |
22,857 |
11,429 |
81,000 |
|
|
|
|
______ |
|
|
|
______ |
______ |
______ |
______ |
|
|
|
|
81,000 |
|
|
Salary |
1,000 |
|
|
1,000 |
|
|
|
|
______ |
|
|
Profit share |
|
|
|
|
Profit |
|
|
|
40,000 |
|
|
(W2) |
|
|
|
19,333 |
|
|
9,667 |
10,000 |
39,000 |
|
|
|
______ |
______ |
______ |
______ |
|
|
|
|
______ |
|
|
|
20,333 |
9,667 |
10,000 |
40,000 |
|
|
|
|
40,000 |
|
|
|
______ |
______ |
______ |
______ |
|
|
|
|
______ |
|
|
Current a/c |
||||||||
|
|
A |
B |
C |
|
|
A |
B |
C |
|
|
$ |
$ |
$ |
|
$ |
$ |
$ |
|
|
|
|
|
|
Salary |
1,000 |
– |
– |
|
|
C/f |
46,714 |
22,857 |
11,429 |
Profit share |
45,714 |
22,857 |
11,429 |
|
|
|
______ |
______ |
______ |
|
______ |
______ |
______ |
|
|
|
46,714 |
22,857 |
11,429 |
|
46,714 |
22,857 |
11,429 |
|
|
|
______ |
______ |
______ |
|
______ |
______ |
______ |
|
|
|
|
|
|
B/f |
46,714 |
22,857 |
11,429 |
|
|
|
|
|
|
Salary |
1,000 |
– |
– |
|
|
C/f |
67,047 |
32,523 |
21,429 |
Profit share |
19,333 |
9,666 |
10,000 |
|
|
|
______ |
______ |
______ |
|
______ |
______ |
______ |
|
|
|
67,047 |
32,523 |
21,429 |
|
67,047 |
32,523 |
21,429 |
|
|
|
______ |
______ |
______ |
|
______ |
______ |
______ |
|
WORKINGS
|
(1) |
C’s share 1/7 |
|
|
(2) |
C’s share 1/7 |
|
|
|
C ® |
10,000 |
|
|
A ® |
4/6
|
|
|
B ® |
2/6
|
Solution 5 – Admission
(a) Without goodwill
|
Balance sheet at 31 December 1998 |
|
|
|
|
$ |
$ |
|
Non-current assets |
|
|
|
Property |
|
40,000 |
|
Equipment |
|
10,000 |
|
|
|
______ |
|
|
|
50,000 |
|
Current assets |
|
|
|
Inventories |
10,000 |
|
|
Trade receivables |
10,000 |
|
|
Cash (5,000 + 25,000) |
30,000 |
|
|
|
______ |
50,000 |
|
|
|
______ |
|
Total assets |
|
100,000 |
|
|
|
______ |
|
Capital |
|
|
|
C |
40,000 |
|
|
G |
25,000 |
|
|
B |
25,000 |
|
|
|
______ |
90,000 |
|
Current liabilities |
|
|
|
Trade payables |
|
10,000 |
|
|
|
______ |
|
|
|
100,000 |
|
|
|
______ |
(b) (i) Individual assets method
|
Revaln a/c (in) |
|
Revaln (out) |
||||||||||
|
|
|
$ |
|
|
$ |
|
$ |
|
|
|
$ |
|
|
Equip |
|
5,000 |
Property |
25,000 |
Property |
25,000 |
Equip |
|
5,000 |
|||
|
Bad debt |
|
1,000 |
Goodwill |
11,000 |
Goodwill |
11,000 |
Bad debt |
|
1,000 |
|||
|
To be shared |
|
|
|
|
|
|
To be shared |
|
|
|||
|
30,000 (2:1) |
|
|
|
|
|
|
30,000 (2:1:1) |
|
|
|||
|
|
C |
20,000 |
|
|
|
|
|
C |
15,000 |
|||
|
|
G |
10,000 |
|
|
|
|
|
G |
7,500 |
|||
|
|
|
|
|
______ |
|
______ |
|
B |
7,500 |
|||
|
|
|
______ |
|
36,000 |
|
36,000 |
|
|
______ |
|||
|
|
|
36,000 |
|
______ |
|
______ |
|
|
36,000 |
|||
|
|
|
______ |
|
|
|
|
|
|
______ |
|||
Old Ps in old ratio and new Ps in new
ratio
|
Capital a/c |
||||||||
|
|
C |
G |
B |
|
|
C |
G |
B |
|
|
$ |
$ |
$ |
|
$ |
$ |
$ |
|
|
Goodwill out |
15,000 |
7,500 |
7,500 |
B/f |
40,000 |
25,000 |
– |
|
|
C/f |
45,000 |
27,500 |
17,500 |
Goodwill in |
20,000 |
10,000 |
– |
|
|
|
|
|
|
B in |
– |
– |
25,000 |
|
|
|
______ |
______ |
______ |
|
______ |
______ |
______ |
|
|
|
60,000 |
35,000 |
25,000 |
|
60,000 |
35,000 |
25,000 |
|
|
|
______ |
______ |
______ |
|
______ |
______ |
______ |
|
(b) (ii) Global method
Balance sheet not restated
item by item just adjust for goodwill in and out through partners’ capital
a/cs.
|
|
Old 2:1 |
New 2:1:1 |
|
|
$ |
$ |
|
C |
20,000 |
15,000 |
|
G |
10,000 |
7,500 |
|
B |
– |
7,500 |
|
|
______ |
______ |
|
|
30,000 |
30,000 |
|
|
______ |
______ |
\ Capital a/c as above (b)(i).