1. Accounting for Partnerships
Chapter 006
Accounting for Partnerships
This chapter explains the partnership form of organization.

2. What is Partnership?
A partnership can be defined as the relationship exists between two or more persons carrying on a business in a common with a view of profit.

3. Voluntary Association Partnership Agreement
Partnership Features
Voluntary Association
Limited Life
Taxation
Probably, the first thing new partners should do is prepare a partnership agreement. Without such an agreement, the Uniform Partnership Act will govern many of the key financial questions faced by the partners. A partnership has a limited life. Unless provision is made to the contrary, a partnership ceases to exist upon the death of a partner, the withdrawal of a partner or the admission of a new partner. In a general partnership, each partner has unlimited liability for the acts of all other partners. Income or loss of the partnership flows through to the individual partners. Income or loss from the partnership is taxed as any other income received by an individual. Let’s look at three special types of partnerships.
Partnership Agreement
Unlimited Liability

4. Advantages of a partnership over a sole trader
It shares business risks between more than one person
Each partner can develop special skills upon which the other partners can rely
Greater resources will be available since more individuals will be the contributing to the business

5. Disadvantages of a partnership over a sole trader
There may be disputes in the running of the business
Partners are jointly and severally liable for their partners. Thus if one partner is being sued in relation to business, all partners share responsibility and potential liability.

6. Advantages of a partnership over a Company
The arrangement is less formal than setting up a company which requires the issue of shares and appointment of directors.
If the partners wish to dissolve the business, this is easier to achieve by a partnership than a company.

7. Disadvantages of a partnership over a Company
The partners are not protected from the creditors of business. Unless the partnership is set up as limited liability partnership, Partners have unlimited liability.
The life of partnership is short as compare to company.
Company can raise funds at a large scale than a partnership.

8. The partnership agreement
A partnership agreement may be oral or written, will govern the relationship amongst the partners. Important matters to be covered to be :
Name of firm, type of business, and duration
Capital to introduced by partners
Distribution of profit amongst partners
Drawings by partners
Arrangement of dissolution, or on death or retirement of partners
Setting disputes

9. In the Absence of a Partnership Agreement in the UK, the Partnership Act 1890 states that profits should be shared as follows:
No partner should receive salary
No interest on capital should allowed
Profits should be shared equally
Where partners advance funds in excess of agreed capital amount as loan, they are entitled interest on the excess at 5% pa.

10. Organizing a Partnership
Partners can invest both assets and liabilities in the partnership.
Assets and liabilities are recorded at an agreed-upon value, normally fair market value.
Asset contributions increase the partner’s capital account.
When a partnership is formed, each partner may contribute both assets and liabilities to the partnership. Contributed assets increase partner’s capital and liabilities decrease partner’s capital. Assets are normally recorded at fair market value and liabilities are recorded at the amount payable. Each partner may be entitled to withdraw cash or other assets from the partnership. A withdrawal reduces the partner’s capital account.
Withdrawals from the partnership decrease the partner’s capital account.

11. Organizing a Partnership
On 2/15/08, Smith and Jones form a partnership. Smith contributes $80,000 cash. Jones contributes land valued at $40,000.
Part One
In our example, Smith and Jones decide to form a partnership. Smith contributes eighty thousand dollars cash and Jones contributes land with a fair market value of forty thousand dollars. Let’s look at the journal entry required at inception of the partnership. Part Two On the books of the partnership, we will debit the asset account cash for eighty thousand dollars and land for forty thousand dollars. We will credit Smith’s capital account for eighty thousand dollars and credit Jones’ capital account for forty thousand dollars. Each partner receives credit for the fair market value of the net assets contributed to the partnership.

12. Dividing Income or Loss
Partners are not employees of the partnership but are its owners. This means there are no salaries reported as expense on the income statement. Profits or losses of the partnership are divided on some agreed upon ratio.
Three frequently used methods to divide income or loss are allocation on:
Stated ratios.
Capital balances.
Services, capital and stated ratios.
Part One Partners are not considered employees of the partnership but are owners. There is no salary expense reported on the income statement for distributions to partners. Profits and losses of the partnership are divided among the partners in some agreed upon ratio. Part Two Very often partners agree to divide profit and losses on the basis of some stated ratio, on the capital balance of each partner, or on some combination of these amounts.

13. Allocation Based on Stated Ratios
Smith and Jones agree to divide profits or losses ¾ for Smith and ¼ for Jones. For 2008, the partnership reported net income of $60,000.
Part One In the partnership agreement of Smith and Jones, there is a stipulation that profits and losses are to be divided three-fourths to Smith and one-fourth to Jones. What would be the journal entry to record the division of profits of sixty thousand dollars earned in 2008? Part Two Assuming we have closed all revenue and expense accounts to the income summary, we will debit the income summary for sixty thousand dollars. This will reduce the balance in the income summary to zero. Next, we credit Smith, Capital for forty-five thousand dollars (three-fourths of sixty thousand dollars of income), and credit Jones, Capital for fifteen thousand dollars (one-fourth of sixty thousand net income).
$60,000 × ¾ = $45,000

14. Allocation Based on Capital Balances
Smith’s capital balance, before division of profits or losses is $80,000 and Jones’s capital balance is $40,000. The partnership agreement calls for income or loss to be allocated based on the relative capital balances. Net income for 2008 is $60,000.
Part One Now let’s assume that the partnership agreement between Smith and Jones states that profits and losses are to be divided on the basis of capital balances prior to the division. At December thirty first, 2008, Smith has a capital balance of eighty thousand dollars and Jones shows a balance of forty thousand dollars. Let’s see how we will divide the sixty thousand dollars of income reported for Part Two The partnership has total capital of one hundred twenty thousand dollars. Smith’s capital balance of eighty thousand dollars is two-thirds of the total and Jones’ balance represents one-third. We will divide the income two-thirds to Smith and one-third to Jones, so Smith will be credited with forty thousand dollars and Jones will be credited with twenty thousand dollars.

15. Allocation Based on Capital Balances
Smith’s capital balance, before division of profits or losses is $80,000 and Jones’s capital balance is $40,000. The partnership agreement calls for income or loss to be allocated based on the relative capital balances. Net income for 2008 is $60,000.
Here is the journal entry to close the income summary account and increase the capital accounts of Smith and Jones.

16. Allocation Based on Services, Capital, and Stated Ratios
Smith and Jones have a partnership agreement with the following conditions:
Smith receives $15,000 and Jones receives $10,000 as annual salaries.
Each partner is allowed an annual interest allowance of 5% on the beginning-of-year capital balance.
Any remaining balance of income or loss is allocated equally.
Net income for 2008 is $60,000.
Now, let’s look at a more complex, and realistic way that partners may decide to divide profits and losses. First, Smith is entitled to receive fifteen thousand dollars per year in the form of a salary allowance and Jones has an allowance of ten thousand dollars. Recall that Smith has a beginning capital balance of eighty thousand dollars and Jones has a beginning capital balance of forty thousand dollars. Next, both Smith and Jones are to be paid interest at five percent on the beginning of the period capital balances. Finally, any remaining amount of income or loss is to be divided equally between the two partners. Let’s see how Smith and Jones will divide the sixty thousand dollars of income reported in 2008.

17. Allocation Based on Services, Capital, and Stated Ratios
$80,000 × 5% = $4,000
$29,000 × ½ = $14,500
Part One We begin with the sixty thousand dollars of income to divide between the two partners. Part Two
Next, we provide an allowance for salary of fifteen thousand to Smith and ten thousand to Jones. After this allowance, we have thirty-five thousand dollars remaining to be divided. Part Three Next, we provide the interest on beginning capital. Smith will receive credit for four thousand dollars: eighty thousand times five percent, and Jones will receive credit for two thousand dollars. After this division, we have twenty-nine thousand dollars remaining to be divided. Part Four Finally, we divide the twenty-nine thousand dollars evenly between Smith and Jones. Each partner will receive credit for fourteen thousand, five hundred dollars. Now, we can see that Smith will receive credit for thirty-three thousand, five hundred dollars and Jones will be credited with twenty-six thousand, five hundred dollars.

18. Allocation Based on Services, Capital, and Stated Ratios
Smith and Jones have a partnership agreement with the following conditions:
Smith receives $15,000 and Jones receives $10,000 as annual salaries.
Each partner is allowed an annual interest allowance of 5% on the beginning-of-year capital balance.
Any remaining balance of income or loss is allocated equally.
Net income for 2008 is $30,000.
In this example, let’s keep all the division of income and loss provisions of the partnership agreement the same, but assume that the partnership reported thirty thousand dollars of income in 2008, rather than the sixty thousand dollars we used previously. How do you think we will divide the thirty thousand dollars?

19. Allocation on Services, Capital, and Stated Ratios
($1,000) × ½ = $500
As you can see, each partner is given an allowance for the stated salary and interest on the beginning capital balance. However, after these allowances we have a negative one thousand dollars to distribute equally between the two partners. Each partner’s distribution is reduced by five hundred dollars. The thirty thousand dollars is divided eighteen thousand, five hundred for Smith and eleven thousand, five hundred for Jones. We hope you did a good job on this distribution. Now, let’s change the subject and discuss admission of a new partner to the partnership and withdrawal of an existing partner from the partnership.

20. Partnership Accounts
Profit and Loss Appropriation Account: In this account profit or loss is distributed among partners according to agreement.
Partners’ Capital Account: In this account the amount of capital invested by owner is recorded. It is kept constant.
Partners’ current Account: In this account all changes in the business due to financial transaction are recorded.

21. Profit and Loss Appropriation Account
Net Profit : x
Add: Interest on drawings x
Less: Salaries to partners (x)
Interest on Capital (x)
Commission to partners (x)
Balance Profit: x
A: 3 x
B: 2 x

22. Capital Account Date Narrative Ref A B 2008 1-Jan Balance b/d x x
1-Jan
Balance b/d x  x
31-Dec
Balance c/d
 (x)
(X)
 Total  x

23. Current Account Date Narrative Ref A B 2008 31-Dec Drawings X x 1-Jan
31-Dec
Drawings X x
1-Jan
Balance b/d
Interest on Drawings
Interest on Capital
Balance c/d
(X)
Salaries
Profit share x 
Total   x
 Total

24. Example
C, S and N are partners in a music business, sharing profits in the ratio of 5:3:2 respectively. Their capital and current account balances on January 1,2005 are as:
Capital Current Account C
S 18,000 (1000)
N 13,
Interest on fixed capital is 10% per annum and salaries of $8,000 P.A are credited to S and N.
C made a personal loan of $20,000 on July 1, the loan was to be repaid in full on June 30,2008 and loan interest is at the rate of 15% per annum was to be credited C’s every half year.
The partnership profit before charging interest on loans for the year ended December 31, 2005 was $63,000 and partners’ drawings were C $16000, S $16,500 and N $19,000 during the year.
Required: Prepare Appropriation Account, Capital Account and Current account of partners.

25. For the year ended December 31,2005
Solution
Appropriation Account
For the year ended December 31,2005
$ $
Net Profit : ( ) 61,500
Less: Interest on Capital:
C: (24,000 x 10%) 2400
S (18,000 x 10%)
N (13,000 x 10%)
Salaries S
N (21,500)
Balance Profit ,000
Partner’s Share
C: 5/10 x 40,000 = 20,000
S: 3/10 x 40,000 = 12,000
N: 2/10 x 40,000 = 8,000

26. Capital Account Date Narrative Ref C S N 2005 1-Jan Balance b/d 31-Dec
1-Jan
Balance b/d
24000
18000
13000
31-Dec
Balance c/d

27. Current Account Date Narrative Ref C S N 2005 2005 1-Jan Balance b/d
Jan
Balance b/d
2000
1500
1-Jan
Balance c/d
1000
31-Dec
Interest on Capital
2400
1800
1300
Drawings
16000
16500
19000
Interest on Loan
9900
4300
Salaries
8000
Profit share
20,000
12,000
8,000
(200)
25900
21800

28. Example: Financial Statements
The Trial Balance of two partners Ken and Barbie at 30 June 2006
Accounts $
Irrecoverable debts
2350
Rent and rates
35,000
Motor expenses
17,400
Allowance for receivables
5,450
Motor vehicle- cost
32,750
Accumulated Dep- Motor vehicle
15,578
Cash at bank
467
Drawings – Ken
13,500
Drawings- Barbie
15,000
Inventory
3,000

29. Fixtures and fittings- cost
27,000
Accumulated Dep- Fixtures& Fittings
13,500
Sundry Expenses
14,780
Sales
157,000
Payables
9,800
Receivables
16,000
Purchases
96,000
Current account- Ken,
7,655
Current account – Barbie
9,264
Capital Account – Ken
35,000
Capital Account – Barbie
20,000
Total
273,247

30. Adjustments:
1. Closing Inventory is valued $4,500.
2. Fixtures and Fittings have not yet been depreciated , the applicable rate is 10% straight line.
3. Prepayments at the year end were $2,500 in respect of Rates.
4. On the last day of the year Ken paid $13,000 to the business bank account as loan.
5. Barbie is allowed a salary of $7,500.
6.Interest on capital is provided at 8% per annum.
7. The balance of profits is split equally.
Required:
Prepare income statement
Statement of division of profits
Partners’ current accounts
Balance sheet

31. Solution 1. Inventory For closing inventory: For Opening Inventory:
Dr: Inventory 4,500
Cr: Income Statement 4,500
For Opening Inventory:
Dr: Income Statement 3,000
Cr: Inventory 3,000

32. 2. Non Current Assets:
Depreciation of Fixtures and fittings for June :
Cost $27,000 x 10% = $2,700

33. 3. For Ken loan entry would be: Dr: Cash $13,000
Cr: Ken’s Loan $13,000
4. Rent and rates: Prepaid Expenses:
Total Rent Paid = $35,000
Less: Prepaid Rent: =($2,500)
Rent Expense = $32,500

34. $ 157,000 (4,500) Revenues: Sales Less: Cost of Goods Sold: 3,000
Ken and Barbie
Income Statement
For the year ended June 30, 2006 $
Revenues:
Sales
157,000
Less: Cost of Goods Sold:
Opening Inventory
3,000
Add: Purchases
96,000
Less: Closing inventory
(4,500)
(94,500)
Gross Profit
62,500

35. Less: Expenses: (69,730) Net Profit (Loss) (7,230) Irrecoverable debts
2,350
Rent and rates
32,500
Motor expenses
17,400
Sundry expenses
14,780
Depreciation expenses
2,700
(69,730)
Net Profit (Loss)
(7,230)

36. Statement of Division of Profit
KEN
BARBIE
Balance $
Net Loss
(7,230)
Salary
7,500
(14,730)
Interest on capital
2,800
1,600
(19,130)
Loss share
(9,565)
Total
(6765)
(465)

37. Current Account Ken Barbie June30, 06 6,765 465 7,655 9,264 13,500
Date
Narrative
Ref
Ken
Barbie
June30, 06
Share of loss
6,765
465
1-Jul,05
Balance b/d
7,655
9,264
Drawings
13,500
15,000
June 30, 06
Balance c/d
12,610
6,201
20,265
15,465

38. Ken and Barbie Balance Sheet As on June 30, 2006
Assets
Non Current Assets: $
Motor Van
32,750
Less: Accum Dep:
(15,578)
17,172
Fixtures and Fittings
27,000
(16,200)
10,800
27,972

39. 2,500 31,017 Current Assets Total Assets 58,989 $ Inventory 4,500
Receivables
16,000
Less: Allowance for Receivables
(5,450)
10,550
Prepayments
2,500
Cash at Bank
( ,000)
13,467
31,017
Total Assets
58,989

40. $ Ken: Barbie: Capital and Laibilities Capitals: Capital
35,000
Current Account
(12,610)
22,390
Barbie:
Capital account
20,000
Current account
(62,01)
14,799
37189
Current Liabilities
Payables
9,800
Loans
13,000
21,800
Total Capital and Liabilities
58,989

41. Chapter End