PARTNERSHIP ACCOUNTS

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PARTNERSHIP ACCOUNTS
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FORMATION OF A PARTNERSHIP

• Defined in the Partnership Act 1890 as the
  relationship between two or more people engaging
  in business for profit

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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

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FORMATION OF A PARTNERSHIP

• Partnerships are separate accounting entities to
  the partners (owners)
• Owners Capital Accounts are kept for each
  individual partner
• Each partner has the right to share in the
  profits and manage the business

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PARTNERSHIP AGREEMENT

• Partnership agreement
• doesnt 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

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PARTNERSHIP AGREEMENT

• 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

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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

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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

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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

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LIMITED LIABILITY PARTNER

• Governed by the Limited Liability Partnership Act
  1907
• Liability is limited to the amount of capital
  invested by the partner
• A Limited Partner has no say in the Management of
  the Partnership business

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PARTNERSHIP ACCOUNTS

• CURRENT ACCOUNTS
• working accounts containing details of profit,
  loss, drawings and interest on capital invested
  or charged on drawings
• CAPITAL ACCOUNTS
• partners original capital put into the business
  is considered to be fixed
• capital account of each partner is usually
  unchanged unless additional capital is invested

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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 partners capital account
• the introduction of cash and other assets
  entered in the cash and asset accounts and the
  partners capital account

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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

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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

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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 Residual Profit Shared Able 1/3 Bable
1/3 Cable 1/3
9,000
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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

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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 partners 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

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ADMISSION OF NEW PARTNER

• REASONS FOR A NEW PARTNER
• May bring in new products and/or customers to the
  business
• May bring specialised expertise to the business
• Allows the business access to further capital
• May bring in additional assets
• May provide new business contacts
• May be a requirement due to death, retirement or
  bankruptcy of an existing partner

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ADMISSION OF NEW PARTNERNEW PARTNERSHIP AGREEMENT

• ADJUSTING THE EXISTING BUSINESS
• All existing partners must agree on the admission
  of a new partner
• Assets of the business should be revalued before
  a new partner is admitted
• Liabilities need to be reviewed for accuracy in
  valuation
• Gains and losses to existing partners from new
  business value will be made at the existing
  profit-sharing ratio

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STEPS TO ADMIT NEW PARTNER

1. Review value of assets (see later slide)
2. Consider inclusion of goodwill (see next slide)
3. Record changes in the Ledger Accounts
4. Open a Goodwill Account and adjust the existing
   partners Capital Accounts according to their
   existing profit-sharing ratio
5. Prepare opening ledger entries for new partner
6. Calculate partners new profit-sharing ratio
7. Prepare a new Statement of Financial Position ie
   Balance Sheet

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ADMISSION OF NEW PARTNER

• GOODWILL
• Goodwill can be defined as future benefits from
  assets that cannot be individually identified
  e.g. reputation, customer database, management
  ability, product, location
• Goodwill is an asset and as such appears in the
  Balance Sheet as an Intangible Asset ie one which
  cannot be seen

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Recording Goodwill

• When the partnership is revalued
• Debit the Goodwill Account with the value of the
  increase in the value of the business (premium)
• Credit the existing partners Capital Accounts
  according to their profit-sharing ratio

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REVALUATION OF ASSETS

• Before admitting a new partner to the business,
  the Assets should be revalued
• Some eg Buildings may have appreciated in value
• Some eg Machinery may not be worth as much as the
  Net Book Value in the Balance Sheet perhaps
  insufficient amounts for depreciation has been
  written off over the years

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Accounting for Revaluation

• Adjustments to the relevant accounts should be
  made
• Eg If Buildings have appreciated, the Buildings
  Account would be Debited and the Revaluation
  Account Credited
• If there has been insufficient depreciation
  written off machinery, the Machinery depreciation
  account would be credited and the Revaluation
  Account Debited
• The balance on the Revaluation Account would then
  be transferred to the Partners Capital Accounts
  according to their profit-sharing ratio

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PARTNERSHIP DISSOLUTION

• REASONS FOR DISSOLVING A PARTNERSHIP
• Partner(s) may give notice of intention to
  dissolve
• Insolvency of a partner
• Ownership changes e.g. converting to company
• Inability to trade profitably
• Death of partner
• Voluntary agreement by partners
• Courts may also rule to terminate the partnership

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KEY TERMS
You should be aware of the following terms when
dealing with Partnerships and be able to give
clear definitions as well as know how to account
for each

• Capital Accounts
• Capital Adjustment Account
• Current Account
• Revaluation of Fixed Assets
• Fixed Capital Account

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KEY TERMS

• Interest on Capital
• Interest on Drawings
• Partnership Act
• Partnership Agreement
• Profit and Loss Appropriation Account
• Profit-sharing Ratios