Partnership accounting Unit 3 Further aspects of Financial Accounting Mr. BarryYear 13 A-level Accounting

Topic 1 Sharing profits and losses Mr. BarryYear 13 A-level Accounting

FORMATION OF A PARTNERSHIP Defined in the Partnership Act 1890 as the relationship between two or more people engaging in business for profit Mr. BarryYear 13 A-level Accounting

FORMATION OF A PARTNERSHIP Three important factors must be present in a partnership: – partners must be carrying on a business, not one isolated business transaction – must be agreement between two or more legally competent people who must be the business co- owners – partners must have intent to make a profit Mr. BarryYear 13 A-level Accounting

FORMATION OF A PARTNERSHIP Partnerships are separate accounting entities to the partners (owners) Owner’s Capital Accounts are kept for each individual partner Each partner has the right to share in the profits and manage the business Mr. BarryYear 13 A-level Accounting

PARTNERSHIP AGREEMENT Partnership agreement – doesn’t always exist, making it difficult to establish if a partnership actually exists – if there is no formal partnership agreement then the Partnership Act applies – agreement is essential because partnerships: have unlimited liability have a limited life – death of partner – insolvency of partner – retirement of partner Mr. BarryYear 13 A-level Accounting

PARTNERSHIP AGREEMENT Mr. BarryYear 13 A-level Accounting name of business details of each partner nature of business division of profit and losses capital contributions authority, rights and duties of partners details of salaries drawings and interest on drawings interest on capital voting and decision-making procedures admission of new partners resolution of disputes bankruptcy, death or retirement of partners

PARTNERSHIP ACT 1890 If there is no partnership agreement in writing, or if it does not cover an area of dispute, matters may be resolved by reference to the Partnership Act – e.g. Act states all profits and losses are to be shared equally, so if profit ratio is not defined in an agreement, the Act is applied – Partners will receive interest at 5% on excess capital (ie over and above that which they have agreed to contribute) – No interest on drawings – No salaries Mr. BarryYear 13 A-level Accounting

ADVANTAGES OF PARTNERSHIP Creation and dissolution is easier than a company Minimal statutory regulations Resources can be pooled Expertise can be utilised Co-ownership of assets Duties and responsibilities are shared Mr. BarryYear 13 A-level Accounting

DISADVANTAGES OF PARTNERSHIP Liability is unlimited (partners own personal possessions can be used to pay debts owed by the business) Partnership may cease if a partner dies, retires or becomes bankrupt Disagreements between the partners can occur Limits to raising large amounts of capital Partners can be sued by creditor, jointly or individually Partners are likely to pay higher income tax Mr. BarryYear 13 A-level Accounting

PARTNERSHIP ACCOUNTS CURRENT ACCOUNTS – working accounts containing details of profit, loss, drawings and interest on capital invested or charged on drawings CAPITAL ACCOUNTS – partner’s original capital put into the business is considered to be ‘fixed’ – capital account of each partner is usually unchanged unless additional capital is invested Mr. BarryYear 13 A-level Accounting

Current account All the entries relating to drawings, interest on drawings, interest on capital account, salary, commission, profit or loss share etc are recorded in the capital accounts. The opening balance could be a debit or credit. Debit balance = Partner has withdrawn more money than they are entitled to, so are in debt to the business. Credit balance = Partner has increased their level of current investment. Mr. BarryYear 13 A-level Accounting

Contents of a capital account Mr. BarryYear 13 A-level Accounting

Example of current account Mr. BarryYear 13 A-level Accounting

Fixed Capital Account The first difference we can notice, between accounting for sole proprietary form of business organisation and partnership form of business organisation is with regard to capital and its related aspects. In place of a single capital account, we see as many capital accounts as there are partners. Under the fixed method the capital invested by the partners remains constant unless additional capital is brought in or some part of the existing capital is withdrawn permanently by agreement. Mr. BarryYear 13 A-level Accounting

Fixed Capital Account Entry is made in the Capital accounts only to record the capital introduced or withdrawn permanently by the partners. All the other transactions relating to drawings, interest on capital or drawings, salary or commission to the partners, share of profit or loss etc are recorded in the newly opened Current Accounts. Mr. BarryYear 13 A-level Accounting

Contents of a fixed capital account Dr > Capital withdrawn > Intangible assets written off > Balance c/d (closing capital balance) Mr. BarryYear 13 A-level Accounting Cr > Balance b/d (opening capital balance) > Capital introduced > Intangible assets (created)

Example of a fixed capital account Mr. BarryYear 13 A-level Accounting

PARTNERSHIP ACCOUNTS CREATION OF NEW PARTNERSHIP - ACCOUNTING ENTRIES – Can be created in two ways the introduction of cash only, entered in the cash account and the partner’s capital account the introduction of cash and other assets; entered in the cash and asset accounts and the partner’s capital account Mr. BarryYear 13 A-level Accounting

PROFIT DISTRIBUTION PROFIT-SHARING RATIOS – Profits and losses are shared in the way partners feel most appropriate – Profit share can be determined in various ways: Amounts are shared on the basis of the amount of capital contributed by each partner Higher profit may go to a partner bringing something of particular value into the business, such as specialised expertise Mr. BarryYear 13 A-level Accounting

PROFIT DISTRIBUTION PROFIT AND LOSS APPROPRIATION ACCOUNT – Net profit or loss is transferred to this account from the profit and loss account – Additions are made for Interest on Drawings (this is to discourage partners from making drawings from the business) – Deductions are made for Interest on Capital or any Salaries paid to partners – Residual Profits are then shared, as agreed, according to Profit Sharing ratios Mr. BarryYear 13 A-level Accounting

Mr. BarryYear 13 A-level Accounting PROFIT AND LOSS APPROPRIATION ACCOUNT Profit and Loss Appropriation Account for Able, Bable and Cable Net Profit Add Interest on Drawings Less Interest on Capital Salary – Able Shared: Able 1/3 Bable 1/3 Cable 1/3 £16, ,500 £2,500 £5,000 £7,500 £9,000 £3,000 £9,000

PROFIT DISTRIBUTION ALLOCATION AS PER PARTNERSHIP AGREEMENT – Interest on capital may be payable – Interest may be charged for drawings taken out of the business – There may be a provision for the payment of a salary of a particular partner – Interest may be payable on loans to partners by the business or loans by partners to the business Mr. BarryYear 13 A-level Accounting

PROFIT DISTRIBUTION LOAN ACCOUNTS – Where a partner makes a loan to the business, the debit is to bank and the credit to loan account in that partner’s name DRAWINGS – Where a partner withdraws cash from the business in anticipation of profits earned, the current account is debited and cash/bank is credited Mr. BarryYear 13 A-level Accounting

Question 3 Textbook George, Joseph and Stuart are in partnership together and have provided the following information for the year ended 31 December 2013: It should be noted that interest is allowed on partners’ capitals at the rate of 6% per annum. (Interest on capital has been take account of in calculating each partner’s share of the residual profit.) Mr. BarryYear 13 A-level Accounting George £ Joseph £ Stuart £ Drawings4,0003,8003,000 Interest on drawings Capital22,00033,50019,500 Partnership salaries010,0005,000 Opening balances of current accounts 600 credit400 debit350 debit Share of residual profit8,000

Solution Mr. BarryYear 13 A-level Accounting

Question 4 Textbook Mitesh, Sailesh and Kishen own a sports equipment shop. They share profits and losses in the ratios of 2:2:1 respectively and have provided the following information for the year ended 30 September There is no interest on drawings. Interest on capital is to be allowed at 8% per annum. The profit for the year was £62,800 Prepare an appropriation account for the year ended 30 September 2013 Mr. BarryYear 13 A-level Accounting Mitesh £ Sailesh £ Kishen £ Capital78,00042,00095,500 Partnership salaries10,000015,000 Drawings4,0002,5003,300

Mr. BarryYear 13 A-level Accounting

Challenge Can you complete page 29 of the textbook now? Mr. BarryYear 13 A-level Accounting