4B Partnerships

Partnerships 4B When a Sole Trader wants to expand the business but has insufficient capital, one option is to look for a business partner(s) The partner(s) will contribute capital which will help expand the business – in return for a share of the profits

Partnerships 4B A partnership is a legal business arrangement A formal partnership agreement should be drawn up to prevent disagreements This partnership agreement states (among other things: The name the partnership will trade under How much capital each partner contributes On what basis profits/losses are to be shared What the role of each partner will be The salary (if any) each partner will be paid

Partnerships 4B Any profit made for the year must be allocated to the partners according to the partnership agreement This is done in an account called an Appropriation Account The Appropriation Account begins where the Profit and Loss Account ends

Partnerships 4B Here is an example of a Trading and Profit and Loss and Appropriation Account for a Partnership Here, Hamilton is entitled to a salary (always deducted from Net Profit first) The remaining profit, called residual profit, is split between the partners as agreed in the Partnership Agreement

Partnership 4B Each partner has 2 accounts in the ledger: A Capital Account A Current Account is credited when a partner puts capital into the business and debited when capital is taken out by that partner is credited with anything the business gives the partner - eg salary, share of profit, interest given on capital and debited with drawings, share of losses, interest paid by partners on drawings

Partnerships 4B Here are the partners’ accounts in the ledger Partners’ respective capital contributed If Foster had taken out drawings of £500 during the year, then Dec 31 Drawings 500 5,500(Cr) The balances on the Capital and Current Accounts are then transferred to the Balance Sheet 30,000 Cr 20,000 Cr 5,500 Cr 8,000 Cr

Partnerships 4B Here is the Partnership’s Balance Sheet with the Capital and Current Account balances transferred The Current and Capital Accounts balances are transferred to the ‘Financed by’ section

Key Words 4B Partnership – a business type of 2-20 people working in common to make a profit Partnership Agreement/Deed – a formal legal contract Appropriation Account – shows how the net profit is allocated/distributed/shared out among partners Residual Profit – profit remaining after salaries are paid Capital Account – separate accounts in the ledger show the capital contributed by each partner Current Account – separate accounts in the ledger show the undrawn/uncollected profits each partner has left in the business. Credit salary, share of profit, interest on capital. Debit drawings and interest on drawings.

More Key Words 4B Interest on Capital – sometimes paid by the business to partners to encourage them to contribute/keep capital in the business – credited to the Current Account Interest on Drawings – sometimes paid by partners to the business to discourage them from taking drawings out of the business – debited to the Current Account Partnership Salary – some partners get a salary to reflect the amount of work they put in. Sleeping Partners – do not get involved in the running of the business but invest capital for financial gain