KHALID AZIZ

PARTNERSHIP JOIN KHALID AZIZ COACHING CLASSES ICMAP STAGE 1,2,3,4,5 ICAP MODULE A,B,C,D PIPFA BBA & MBA B.COM & M.COM ACCOUNTING OF O/A LEVEL MA-ECONOMICS KARACHI, PAKISTAN.

KHALID AZIZ Learning Objectives 1.Define a partnership and the major attributes of a partnership 2.State the advantages and main characteristics of the partnership structure of business 3.Explain the purpose of a partnership agreement and describe its typical contents 4.Describe the special features applicable to accounting for partnerships

KHALID AZIZ Learning Objectives (cont’d) 5.Explain the accounting entries for the formation of a partnership 6.Explain the accounting entries for the allocation of profits and losses of a partnership 7.Explain the accounting entries for drawings and advances or loans made by partners 8.Describe content of the financial statements of a partnership

KHALID AZIZ Partnership Defined Partnership Act: –the relationship that ‘subsists between persons carrying on a business in common, with a view to profit’ Necessary attributes –Must be an agreement –View to earning a profit –Co-ownership of the business

KHALID AZIZ Advantages Pooling of resources Low cost –Formed at little or no cost –Subject to little regulation –Not required to publish financial statements Taxation

A partnership combines of the partners CAPITAL TALENTEXPERIENCE

KHALID AZIZ Characteristics Mutual Agency –Each partner: Acts as agent for the partnership Has authority to act on behalf of the partnership Unlimited liability –Each partner personally responsible for all the debts of the business –No limit to liability –Personal assets are exposed –Unattractive to wealthy individuals

KHALID AZIZ Characteristics (cont’d) Limited life –Ended if member dies, withdraws or retires, or becomes incapacitated –Ended on the admission of a new member –Ended via bankruptcy –Ended if formation purpose is over Transfer of partnership interest –Capital interest is personal asset

KHALID AZIZ Partnership Agreement Agreement covers: –Name, location and nature –Name, investment and duties of each partner –Sharing of profits and losses –Administrative details –Withdrawals (drawings) –Dispute resolution –Admission/withdrawal of partners –Partnership liquidation

KHALID AZIZ Accounting for a Partnership Formation Drawings Distribution of profits Change in partnership members Liquidation

KHALID AZIZ Accounting for a Partnership (cont’d) Method 1: Capital accounts which include profits and losses –Capital a/c credited with investments –Drawings a/c debited with withdrawal of assets or personal expenses –Drawings a/c closed to capital –P&L summary closed to profit distribution and allocated to capital a/c’s

KHALID AZIZ Accounting for a Partnership (cont’d) Method 2: Fixed capital accounts –Capital a/c credited with investments and debited with withdrawals of capital –Drawings a/c debited with withdrawal of assets or personal expenses –Drawings a/c closed to retained profits –P&L summary closed to profit distribution and allocated to retained profits a/c’s

Formation of a Partnership Formation –Investment of both assets and liabilities Contributions –Recorded as for sole trader DateAssetsXXXX LiabilitiesXXX Partner’s CapitalXXX being initial investment by partner DateAssetsXXXX LiabilitiesXXX Partner’s CapitalXXX being initial investment by partner

KHALID AZIZ Allocation of Partnership Profits and Losses Consider for each partner: –services performed –capital invested –business risk assumed Common methods –fixed ratio –fixed ratio based on capital balances –fixed ratio allowing for interest and salary

Allocation of Partnership Profits and Losses (cont’d) Allocation entry — Method 1: June 30P & L SummaryXXX Profit DistributionXXX transfer of profit to distribution account June 30P & L SummaryXXX Profit DistributionXXX transfer of profit to distribution account June 30Profit DistributionXXX Partner A, CapitalXX Partner B, CapitalXX distribution of profit to partners June 30Profit DistributionXXX Partner A, CapitalXX Partner B, CapitalXX distribution of profit to partners

Allocation of Partnership Profits and Losses (cont’d) Allocation entry — Method 2: June 30P & L SummaryXXX Profit DistributionXXX transfer of profit to distribution account June 30P & L SummaryXXX Profit DistributionXXX transfer of profit to distribution account June 30Profit DistributionXXX Partner A, Retained EarningsXX Partner B, Retained EarningsXX distribution of profit to partners June 30Profit DistributionXXX Partner A, Retained EarningsXX Partner B, Retained EarningsXX distribution of profit to partners

Allocation of Partnership Profits and Losses (cont’d) Fixed ratio –split based as stated e.g. 7:3, say profit of $ June 30P & L Summary$ Profit Distribution$ transfer of profit to distribution account June 30P & L Summary$ Profit Distribution$ transfer of profit to distribution account June 30Profit Distribution$ Becker, Capital $ Cook, Capital $ distribution of profit to partners June 30Profit Distribution$ Becker, Capital $ Cook, Capital $ distribution of profit to partners

Allocation of Partnership Profits and Losses (cont’d) Ratio based on capital balances –profit of $ Capital investment Becker$ Cook $ Profit allocation Becker( / ) x =$ Cook( / ) x = $ Capital investment Becker$ Cook $ Profit allocation Becker( / ) x =$ Cook( / ) x = $60 000

Allocation of Partnership Profits and Losses (cont’d) Ratio based on capital balances (method 1) June 30P & L Summary$ Profit Distribution$ transfer of profit to distribution account June 30P & L Summary$ Profit Distribution$ transfer of profit to distribution account June 30Profit Distribution$ Becker, Capital$ Cook, Capital $ distribution of profit to partners June 30Profit Distribution$ Becker, Capital$ Cook, Capital $ distribution of profit to partners

Allocation of Partnership Profits and Losses (cont’d) Ratio based on capital balances (method 2) June 30P & L Summary$ Profit Distribution$ transfer of profit to distribution account June 30P & L Summary$ Profit Distribution$ transfer of profit to distribution account June 30Profit Distribution$ Becker, Retained Earnings$ Cook, Retained Earnings$ distribution of profit to partners June 30Profit Distribution$ Becker, Retained Earnings$ Cook, Retained Earnings$ distribution of profit to partners

Allocation of Partnership Profits and Losses (cont’d) Fixed ratio allowing for interest and salaries BeckerCookTotal Interest on capital $ x 10%$ $ x 10%$10 000$ Salaries to partners Total interest & salary credited Residual to be divided equally Equity increase$36 500$23 500$ BeckerCookTotal Interest on capital $ x 10%$ $ x 10%$10 000$ Salaries to partners Total interest & salary credited Residual to be divided equally Equity increase$36 500$23 500$60 000

Allocation of Partnership Profits and Losses (cont’d) Ratio based on capital balances (method 1) June 30P & L Summary$ Profit Distribution$ transfer of profit to distribution account June 30P & L Summary$ Profit Distribution$ transfer of profit to distribution account June 30Profit Distribution$ Becker, Capital$ Cook, Capital$ distribution of interest on capital to partners June 30Profit Distribution$ Becker, Capital$ Cook, Capital$ distribution of interest on capital to partners

Allocation of Partnership Profits and Losses (cont’d) Ratio based on capital balances (method 1) June 30Profit Distribution$7 000 Becker, Capital$3 500 Cook, Capital$3 500 distribution of residual profit to partners June 30Profit Distribution$7 000 Becker, Capital$3 500 Cook, Capital$3 500 distribution of residual profit to partners June 30Profit Distribution$ Becker, Capital$ Cook, Capital$ distribution of salaries to partners June 30Profit Distribution$ Becker, Capital$ Cook, Capital$ distribution of salaries to partners

Allocation of Partnership Profits and Losses (cont’d) Ratio based on capital balances (method 2) June 30P & L Summary$ Profit Distribution$ transfer of profit to distribution account June 30P & L Summary$ Profit Distribution$ transfer of profit to distribution account June 30Profit Distribution$ Becker, Retained Earnings$ Cook, Retained Earnings$ distribution of interest on capital to partners June 30Profit Distribution$ Becker, Retained Earnings$ Cook, Retained Earnings$ distribution of interest on capital to partners

Allocation of Partnership Profits and Losses (cont’d) Ratio based on capital balances (method 2) June 30Profit Distribution$7 000 Becker, Retained Earnings $3 500 Cook, Retained Earnings $3 500 distribution of residual profit to partners June 30Profit Distribution$7 000 Becker, Retained Earnings $3 500 Cook, Retained Earnings $3 500 distribution of residual profit to partners June 30Profit Distribution$ Becker, Retained Earnings$ Cook, Retained Earnings $ distribution of salaries to partners June 30Profit Distribution$ Becker, Retained Earnings$ Cook, Retained Earnings $ distribution of salaries to partners

Drawings and Loans Made by Partners Drawings (method 1) 20 MarchPartner, DrawingsXXX Cash at BankXXX cash drawings by partner 20 MarchPartner, DrawingsXXX Cash at BankXXX cash drawings by partner 30 JunePartner, CapitalXXX Partner, DrawingsXXX closing entry for partner’s drawings

Drawings and Loans Made by Partners (cont’d) Drawings (method 2) 20 MarPartner, DrawingsXXX Cash at BankXXX cash drawings by partner 20 MarPartner, DrawingsXXX Cash at BankXXX cash drawings by partner 30 JunePartner, CapitalXXX Partner, Retained EarningsXXX closing entry for partner’s drawings 30 JunePartner, CapitalXXX Partner, Retained EarningsXXX closing entry for partner’s drawings

Drawings and Loans Made by Partners (cont’d) Interest on drawings (method 1) 30 JunePartner, CapitalXXX Profit DistributionXXX charging interest on drawings Interest on drawings (method 2) 30 June Partner, Retained EarningsXXX Profit Distribution XXX charging interest on drawings

Loans or Advances DateCash at BankXX Advance from partner AXX Date Interest expenseX Cash at bank/Interest Payable X

KHALID AZIZ Financial Statements General-purpose or special-purpose report? Each partner’s equity reported separately on the Balance Sheet Salaries, interest on capital and interest on drawings are not expenses

KHALID AZIZ Financial Statements (cont’d) No income tax expense Profit/loss allocation disclosed –Balance Sheet –Statement of Partner’s Equity

KHALID AZIZ