Partnership Accounts and accounting for the partnership

1          Introduction

1 Definition

A partnership can be defined as a form of business organization in which two or more people join together to carry on a business with a view to make profit.

 

1.2 Formation of partnership

 

In the formation of a partnership, a partnership deed is generally drawn up to define the rights and obligations of the partners.  However, in the absence of a partnership deed or an agreement the following provisions contained in the Partnership Ordinance apply:

 

  1. Partners contribute capital equally;

  2. Partners share profits and contribute equally towards losses;

  3. Partners are not entitled to interest on capital;

  4. Partners are not entitled to receive salaries;

  5. Partners are entitled to interest at 8% per annum on any advances beyond their agreed capital from the date of advance;

  6. A new partner may not be introduced without the consent of all the existing partners;

  7. Matter arising from disagreements must be decided by a majority of partners.

 

Accounting records required

The way to prepare the accounts of partnerships is similar to that of other trading concerns.  However, in partnerships, separate capital accounts, current accounts and advance (loan) accounts should be kept. These accounts can be prepared in columnar form for examination purposes.

 

Also, when preparing the final accounts, an appropriation account is required to show the rights and interests of the various partners immediately after the preparation of the trading and profit and loss account.

(1)Capital accounts

– A separate capital account is required for each partner.  This is to show the agreed amount of capital to be contributed by each of them.  The amount should be kept fixed until further agreement is reached.

 

Accounting entries:

 

Dr.

Cash or assets

With the amount of agreed capital introduced by each partner

Cr.

Capital accounts

 

(2)Current accounts

– A separate current account for each partner.  This shows the various amounts due to/from partners.

 

Accounting entries:

 

Dr.

Appropriation account

With interest on capital, interest on advance and salaries

Cr.

Partners’ current accounts

 

Dr.

Partners’ current accounts

With interest on drawings

Cr.

Appropriation account

 

Dr.

Partners’ current accounts

With amount of drawings during the year transferred to current accounts

Cr.

Drawings

 

(3)Loan accounts

 

Accounting entries:

 

Dr.

Cash or assets

With the amount of loan beyond the agreed capital

Cr.

Advance (loan) accounts

 

 

 

Preparation of Appropriation accounts

 

        EXAMPLE:

Alan and Bob are in partnership selling kitchen utensils.  Their net profit for the year ended 31st December, 2005 was $228,000.  The two partners’ annual salaries were: Alan $44,000, Bob $40,000.  Interest was paid on capital as follows: Alan $27,000, Bob 13,000.  Alan was charged interest on drawings for the year of $4,000.  The remaining profit is to be shared equally.  Prepare the profit and loss appropriation account for Alan and Bob for the year ended 31st December, 2005.

 

Alan and Bob

Profit and Loss Appropriation Account

For the year ended 31st December, 2005

 

 

 

$000

$000

 

$000

Interest on capital

 

 

 

Net profit before appropriation

228

Alan

 

27

 

 

 

    Bob

 

13

        40

Interest on drawings - Alan

4

 

 

 

 

 

 

Salaries

 

 

 

 

 

    Alan

 

44

 

 

 

    Bob

 

40

84

 

 

 

 

 

 

 

 

Share of profit

 

 

 

 

 

    Alan (50%)

 

54

 

 

 

    Bob (50%)

 

54

108

 

 

 

 

 

-----------------

 

-------------

 

 

 

232

===

 

232

===

 

 

 

 

 

Admission of a new partner

 

For admission of a new partner, a new partnership deed should be drawn up to state the rights and obligations of each partner with their respective profit and loss sharing ratio.

 

        Accounting entries:

 

Dr.

Cash and/or assets

With the amount of agreed capital introduced by the new partners

Cr.

Capital accounts

 

When a prospective partner is admitted into an existing partnership, the partnership assets including goodwill will be revalued.  For revaluation and treatment of goodwill, please see the following sections.

 

Revaluation of assets

 

Revaluation will usually be done upon a change in partnership such as:

a)admission of a new partner,

b)change in profit and loss sharing ratio, and

c)withdrawal of the existing partner, etc.

 

A revaluation account is opened to record any increase or decrease in the value of assets. Any profit and loss on the revaluation is shared among the partners in the agreed profit and loss sharing ratio.

 

Accounting entries:

 

Dr.

Assets

With increase in assets value

Cr.

Revaluation

 

Dr.

Revaluation

With decrease in assets value

Cr.

Assets

 

Dr.

Revaluation

With profit on revaluation shared in the agreed ratio

Cr.

Partners’ capital accounts

 

Or

 

Dr.

Partners’ capital accounts

With loss on revaluation shared in the agreed ratio

Cr.

Revaluation

 

 

 

  1. Treatment of goodwill

 

Goodwill is an intangible value developed over the years of the business by the existing partners.  Such intangible value may be made up of the business’ name and reputation, the loyalty of its workforce, its customer base and its links with suppliers, etc.  The existing partners will consider the goodwill of the business as an asset and expect the new partner to recompense them for acquiring a share of it.

 

5.1       Treatment of goodwill upon admission of a new partner

 

Example:

Ada and Betty have been in partnership for many years sharing profit and loss equally. Goodwill is to be valued at $80,000 upon the admission of Cammy as a new partner. Their new profit and loss sharing ratio will be Ada 3: Betty 1: Cammy 1.   

 

A. With a goodwill account to be opened

 

Accounting entries:

 

Dr.

Goodwill

With agreed amount of goodwill credited to capital accounts according to old ratio.

Cr.

Capital accounts of old partners

 

Answer to the example:

 

Dr.

Goodwill

$           80,000

 

Cr.

Capital account – Ada

 

$           40,000

 

Capital account – Betty

 

$           40,000

 

Note: This goodwill account can be left in the books, or it can either be written off immediately in the partners’ newly agreed profit-sharing ratios with their capital accounts debited, or it can be written off over a number of years in the profit and loss account.

 

 (i) When goodwill account is opened and written off immediately

 

Dr.

Capital accounts of new partners

With agreed amount of goodwill written off in the capital accounts according to new ratio

Cr.

Goodwill

 

Answer to the example

 

Dr.

Capital account – Ada (3/5)

$           48,000

 

 

Capital account – Betty (1/5)

$           16,000

 

 

Capital account – Cammy (1/5)

$           16,000

 

Cr.

Goodwill

 

$           80,000

 

 

(ii) When goodwill account is written off over a number of years

 

Dr.

Profit and loss

With agreed amount of goodwill written off in the profit and loss accounts before appropriation

Cr.

Goodwill

 

B.  No goodwill account to be opened

 

Sometimes, if the goodwill is created and to be written off immediately, the adjustment of goodwill can be done simply in the partners’ capital accounts instead of opening the goodwill account, i.e. only the net amount being recorded.

 

Accounting entries

 

Dr.

Partners’ capital account (loss)

 

With net adjustment shown respectively in their capital accounts for the loss (to be debited) / gain (to be credited) in the share of goodwill.

Cr.

Partners’ capital account (gain)

 

Example:

 

Repeating the same example with no goodwill account to be opened and all the adjustment to be done in the partners’ capital accounts. 

 

Share of goodwill

Old sharing ratio

New sharing ratio

Net gain/(loss)

 

 

 

 

 

 

Ada (1/2)

$   40,000

Ada (3/5)

$   48,000

$

(8,000)

Betty (1/2)

$   40,000

Betty (1/5)

$   16,000

$

  24,000

 

 

Cammy (1/5)

$   16,000

$

(16,000)

 

------------

 

------------

 

-------------

 

$   80,000

=======

 

$   80,000

=======

$

     -    ========

 

Accounting entries

 

Dr.

Capital account – Ada

$            8,000

 

 

Capital account – Cammy

$           16,000

 

Cr.

Capital account – Betty

 

$           24,000

 

5.2 Treatment of goodwill upon change in profit and loss sharing ratio

        (Please follow the same method as per admission of new partners)

 

        5.3 Treatment of goodwill upon retirement/death of a partner, please see Section 6.

Retirement and death of partners

 

Upon the retirement or death of a partner, it is necessary to ascertain the amount of capital due to the retired or deceased partner.  Assets, including goodwill, may be revalued and adjustments are made before the repayment of capital to the outgoing partners.

 

All the account balances of the outgoing partners’ current accounts after the revaluation and adjustments will be closed and transferred to their respective capital accounts.  Amount owed to the outgoing partners may be settled in full in one transaction.  If not, a loan account will to be shown with money being settled at a later date or by a series of instalments.  Interest is usually credited to the outstanding balance and paid annually.

 

Valuation of goodwill upon retirement of a partner

 

Accounting entries

 

A)If goodwill is to be credited in full value

       

Dr.

Goodwill

With their profit sharing ratio

Cr.

Capital – all partners

 

B)If only the outgoing partner’s share of goodwill to be recorded

  

Dr.

Goodwill

With the outgoing partner’s share of goodwill

Cr.

Capital – outgoing partner

 

C)If no goodwill account to be opened

 

Dr.

Capital account – remaining partners

With the outgoing partner’s share of goodwill to be borne by the remaining partners in the new sharing ratios.

Cr.

Capital – outgoing partner

 

 

Dissolution of partnership

 

Upon dissolution, the assets of the partnership will be applied in the following order in accordance with Section 46(6) of the Partnership Ordinance:

 

(a)To settle the firm’s creditors;

(b)To repay partners’ advances;

(c)To repay partners’ capital;

(d)Any surplus remaining to be divided among the partners in profit sharing ratio.

 

       In case of losses after dissolution, according to Section 46(a) of the Partnership Ordinance, it will be repaid according to the following order:

 

(a)To be paid out of profits;

(b)To be paid out of capital;

(c)To be paid by partners individually in the profit and loss sharing ratio.

 

        Accounting entries:

 

A realisation account is opened in order to ascertain whether a profit or a loss has been resulted upon the dissolution.

 

(1)

Dr.

Realisation

Transfer the book values of assets except cash and bank balance

 

Cr.

Assets

 

(2)

Dr.

Realisation

With realisation expenses paid

 

Cr.

Bank

 

(3)

Dr.

Capital

With agreed values of any assets taken over by a partner

 

Cr.

Realisation

 

(4)

Dr.

Cash

With amounts realized for the assets

 

Cr.

Realisation

 

(5)

Dr.

Creditors

With discount received on cash paid to settle balance sheet liabilities

 

Cr.

Cash

 

Cr.

Realisation

 

(6)

Dr.

Capital

With balance of realisation transferred to capital accounts in profit sharing ratio

 

Cr.

Realisation (if loss incurred)

 

(7)

Dr.

Capital

With balance due to partners as shown by capital accounts

 

Cr.

Bank

 

 

        EXAMPLE:

 

        The following is a balance sheet for Alan and Bob as at 31st December, 2005.

Alan and Bob

Balance Sheet as at 31st December, 2005

 

 

 

 

 

 

 

 

 

$     ‘000

$     ‘000

$    ‘000

 

Fixed assets

 

 

 

 

 

Premises

 

 

300

 

 

Equipment

 

 

60

360

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

Stock

 

148

 

 

 

Debtors

 

196

344

 

 

 

 

 

 

 

Less:

Creditors: Amount due within 1 year

 

 

 

 

 

Creditors

 

37

 

 

 

Bank overdraft

 

93

130

214

 

 

 

 

 

-------------

 

 

 

 

 

574

 

 

 

 

 

====

 

Representing -

 

 

 

 

 

 

 

 

 

 

 

Capital accounts

Alan

 

270

 

 

 

Bob

 

130

400

 

 

 

 

 

 

 

Current accounts

Alan

 

88

 

 

 

Bob

 

86

174

 

 

 

 

 

-------------

 

 

 

 

 

574

====

Both Alan and Bob share profit and loss equally and they decided to dissolve the partnership on 1st January, 2006 and the following events occurred:

 

The premises were sold for $260,000 and the equipment for $54,000.  The debtors paid $193,000 and the stock was sold for $141,000.  The creditors were paid $35,000 for a full settlement. 

 

Required:

 

Show the following ledger accounts to record the dissolution:

(1)Realisation account

(2)Bank account

(3)Partners’ capital account (in columnar form)

(4)Partners’ current account (in columnar form)

 

Answer:

 

Realisation account

 

$      ‘000

 

$     ‘000

Premises

300

Bank: Sale of premises

260

Equipment

60

Bank : Sale of equipment

54

Stock

148

Bank : Sale of stock

141

Debtors

196

Bank: Debtors realized

193

 

 

Creditors: Discount received (37,000-35,000)

 

 

2

 

 

Loss on realisation: Alan

27

 

 

                Bob

27

 

----------------

 

------------

 

704

====

 

704

====

 

Bank

 

$      ‘000

 

$     ‘000

Realisation: Premises

260

Balance b/f

93

Realisation: Equipment

54

Creditors

36

Realisation: Stock

141

Capital accounts: Alan

335

Realisation: Debotrs

193

              Bob

193

 

---------------

 

-----------

 

648

===

 

648

====

 

Capital accounts

 

Alan

Bob

 

Alan

Bob

 

$   ‘000

$    ‘000

 

$    ‘000

$     ‘000

Loss on realisation

27

27

Balance b/f

270

130

Bank

331

189

Current accounts

88

86

 

------------

-----------

 

-----------

-----------

 

358

===

216

===

 

358

===

216

===

 

Current accounts

 

Alan

Bob

 

Alan

Bob

 

$   ‘000

$    ‘000

 

$    ‘000

$     ‘000

Capital account

88

86

Balance b/f

88

86

 

-----------

----------

 

-----------

----------

 

88

===

86

===

 

88

===

86

===

 

 

 

 

 

 

 

 

 


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