Partnership accounting

Introduction You need to know about:   Advantages and disadvantages of partnership accounting   The partnership agreement   Capital accounts   Current accounts   Share of profits   Goodwill.

Advantages   Increased capital   Increased knowledge and specialist skills   Shared risk   Flexible working and cover for holidays and illness.

Disadvantages   Less profit because profit is shared   Possible disagreement over money   Possible disagreement over the direction of the business.

The partnership agreement The Partnership Act states that if there is no written, legal agreement for the partnership then the following must apply:   Equal profit shares   No salaries   No interest on capital.

Capital accounts Each partner must have a capital account to show the amount of capital owed to the partner by the business. DebitBank account CreditCapital account

Fixed capital accounts The amount of capital will remain fixed and will only change if the agreement changes and goodwill is introduced. All transactions for each partner will be recorded in the partner’s current account.

Fluctuating capital accounts This is used when the partnership does not operate a system of current accounts. Opening capital plus profit share minus drawings = closing capital.

Example Mike and Dave start a business on 1 January 2007 with the following capital: Dave£30,000Mike£10,000 They will share profits equally. Dave will take a salary of £20,000. Each partner will receive 10% interest on their capital. At 31 December 2007 the business had made a net profit of £55,000. Drawings: Dave£35,000Mike£18,000

The net profit for the year must be shared between Dave and Mike according to the partnership agreement. The profit and loss appropriation account will be used to share out the profit to the current account of each partner. DebitProfit and loss appropriation account CreditPartner’s current account The amount of drawings made by a partner must be debited to the partner’s current account.

Profit and loss appropriation account Interest: Mike 1,000 Bal b/d 55,000 Interest: Dave 3,000 Salary: Dave20,000 Profit: Dave15,500 Profit: Mike15,500 55,000

Current accounts Dave Mike DaveMike Drawings35,00018,000Interest 3,0001,000 Salaries20,000 Profit15,500 15,500 Bal c/d3,500Bal c/d 1,500 38,50018,00038,500 18,000 Bal b/d 1,500Bal b/d3,500

Drawings A partner will take drawings from the partnership. The partnership agreement may state that the partners will be charged interest on the amount of drawings they make. The reason for charging interest on drawings is to stop a partner from drawing large amounts of cash from the business. It may help to prevent a cash flow problem.

Interest on drawings Accounting entries for interest on drawings: DebitPartners’ current accounts CreditAppropriation account Exam tip: make the interest on drawings your first entry in the appropriation account and current accounts.

Goodwill You must have a knowledge and understanding of the following:   The definition of goodwill   Accounting for goodwill in the ledger   Making adjustments in the capital accounts.

Goodwill is known as an intangible fixed asset. Goodwill results through the good reputation that a business has built up over a period of time. Goodwill = market value – book value Market value£380,000 Book value£300,000 Goodwill £80,000

A new partner may be required to pay goodwill to the existing partners. In the UK, good accounting practice requires that goodwill should not remain as a fixed asset in the books of the partnership. When a new partner joins the partnership, goodwill will be written out of the ledger by making an adjustment in the capital accounts of the partners.

Accounting entries for goodwill In the original profit share agreement: DebitGoodwill account CreditExisting partners’ capital accounts In the new profit share agreement: DebitCapital accounts of all the partners CreditGoodwill account