Partnership accounting

Introduction

The partnership Act of 1890 defines a partnership as the relationship which subsists between two or
more persons carrying out a business in common with a view of making a profit.

Partnerships are part of a larger classification called unincorporated businesses, which refers rrefers a
group of persons whose operation is not distinctly separated from the members themselves.

Where the operation has a profit oriented goal, it is called a partnership. However, where there is
primarily a social or spiritual objective, the association may be called a club, society, fraternity, church,
etc. In some cases, the group of persons does not carry out a business in common and this association is
called a syndicate.

Partnerships usually emerge from a sole trader, or are formed from professional practices such as
Lawyers, surveyors, or custom brokers or from trades that require the owners to be the managers or the
operators in the business.

It offers the following advantages; pooling of resources, sharing of responsibility, increase capital base
while remaining a private concern. However, there are some disadvantages to the formation of a
partnership; unlimited liability, potentials for conflict of interest, and the need for consultation amongst
each other for decision making and control.ve

Partnership agreement or partnership Deed

Partnerships must have clearly defined terms of agreement. This is usually outlined in the
partnership Agreement , or(partnership DEED or Articles of Association), and may either be; (a)
an adoption of all the terms in the partnership Act , (b) a modification of the of some of the
terms in the Act or (c) a rejection of all the terms in the Act and the establishment of the firm’s
own terms of agreement. Generally, firms establish their agreement as in (b), since the Act may
be too general in nature to be adopted in all situations in all firms, and too extensive in coverage
to be completely abandoned and replaced.

The agreement usually includes the following;

 The amount of capital to be contributed by each partner

 The profit and loss sharing ratio
 Interest to be paid on capital
 Salaries to be paid to partners
 Interest to be charged on drawings
 The function of each partner of the firm
 The procedure to be followed whenever a partner is leaving or a new partner is to be
admitted etc. situations not covered in the Partnership agreement are usually dealt with in

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 accordance to the ruling of the partnership Act, e.g., It may be that partners failed to agree
in advance how they should share profit or treat other aspects of the business. However, if
there is no agreement, then section 24 of the Act of 1890 provides that;
∞ Profit and losses are shared equally,
∞ No interest is allowed on capital
∞ No interest is charged on drawings
∞ Salaries are not allowed
∞ 5% interest is allowed on loans to the partnership by members.

There are three major types of partners;

a. Dormant Partner, contributes capital but has no involvement in the regular operations.
b. General Partner, contributes capital and is fully involved in the operations of the firm.
c. Limited Partner contributes capital and is assured limited liability.

Final accounts of a partnership

A) Trading, profit and loss and Appropriation accounts

The trading and profit and loss account is usually the same as that obtained in a sole
proprietorship, with the four general sections for (a) net sales, (b) cost of sales (c) income
and (d) other expenses. These relate to the business in general.

The appropriation account

This is the section purposefully to show how the net profit is adjusted and distributed
amongst the partners in particular. i.e., the account is prepared to show the sharing of
profits or losses by partners. Some other items treated here are;

Interest on Capital; it is calculated on the capital at the beginning of the trading period. If a
partner contributes additional capital, interest is calculated for the period beginning from
the date the capital is injected into the business. Interest is deducted from the profit and the
remaining profit is distributed amongst partners.

Interests on Drawings; withdrawals made by partners are called drawings. These drawings
may be cash or in form of goods. The firm charges interest on these drawings. Interest is
from date of the withdrawal to the end of the trading period. Interest on drawings is debited
to the Current account of the partner(s) who makes the drawings.

Loans from Partners; when a partner makes a cash loan separate from the capital
contributed, it is credited to the partner’s capital account. Or a separate loans account is
opened and credited with the loan amount. The amount received is debited to the Cash

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 account. Interest is payable to the partner or partners who made the loan and recorded as
follows;

∞ Credited to the partner’s current account and

∞ Debited to the loans interest account as it is an expense to the firm.

Partners’ salaries; salaries paid to partners is credited to their respective Current Accounts.
If salary is paid in cash, then Cash is credited instead of the Partners’ Current Account and the
partnership salaries account is debited and later on transferred to the Profit and loss and
appropriation account.

The following items treated in the appropriation account usually have their double entry in the
Current account;

1. Interest on drawings; Dr current account, Cr Appropriation account

2. Interest on Capital; Cr Appropriation , Cr Current Account
3. Salary to partners ; Cr Appropriation, Cr Current Account
4. Share of profit; Cr Appropriation, Cr Current Account(reversed in case of a loss)

These items are usually obtained from footnotes from the trial balance.

A) The Current Account

It shows the adjustments to the partners’ claims from the business arising from a trading
transaction, and is maintained where the firm wishes to keep their initial capital
contributions as a fixed sum. There are some partnerships sharing situations that are
decided upon based on the initial capital sharing ratio, while others are based on the
profit sharing ratio. Where there is no need for a fixed capital determination, the
adjustments would be shown in the capital accounts, thus eliminating the need for a
current account.
Most of the items in the Current Account are double entries items from the
Appropriation Account shown above. The Current Account will also include drawings as
Dr entry.
The Current Account is prepared separately and the balance taken to the Balance Sheet.
However, these current account adjustments may be treated in the Balance Sheet.
Generally, the Current Account has Cr balance. In some instances there is an overdraft
with the balance on the Dr Side.

B) The Balance Sheet; the Balance Sheet of a Partnership carries the following information;
∞ Capital Account of all the Partners
∞ Current Account of all the partners

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 This is usually the same as that of the a sole trader, except for the owners’ equity section is
now consist of each partner’s initial capital as well as the balance from the Current Account.

Examples

1. Ant, Bee and Cheese went into a partnership on January 1, 2010. Their deed reeds;
Profits and losses are to be shared in the ratio of 1;2;3. The first year’s net profit was
9,800,000 cfa frs. 10% interest to be paid on fixed capital contributions, Bee entitled to a
350,000frs annual salary. Capital balances at the start of business were; Ant, 7million frs,
Bee 6,000,000frs and Cheese 10,000,000 frs.
Required; Draw up the appropriation account for the year ended 31st December 2010.

2. The following balances are extract from the books of John and Mary Partnership as at
31st December 1979

CAPITAL A/C(000) CURRENT A/C DRAWINGS (000) SALARIES

(000) (000)
JOHN 18000 2300 5600 7000
MAR 16000 1300 4000 5000
Y

Interest is to be charged on drawings at 11% flat rate and 10% interest to be charged on
capital contributions. If the partnership’s net profit was 31,350,000 frs, draw up the
following;

a. Appropriation account at the end of the period

b. Johan and Mary’s current accounts.

Partnership Changes

Changes in a partnership may be brought about by the death of a partner, retirement, admission of a
new partner, changes in legislation etc. Technically speaking, changes mean the termination of one
partnership arrangement and the start of another.

The changes are usually shown in the year end statements, even if the changes occurred during the year.
The final accounting statements may be prepared to reflect the pre- and post- change situations.

Goodwill
Changes in a partnership may give rise to a revised value of the business. Any excess in the value of the
business over its book value after the revision is called goodwill.

Goodwill may arise due to the following reasons;

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  The staff is experience, efficient and reliable
 The business has good market reputation
 The business is situated in a good location
 There are good relations with the suppliers
 There is a large amount of regular customers who will continue to trade with the new firm.

Methods of valuing goodwill

There are several methods of valuing goodwill. Very often each industry or occupation has its own
customary way of calculating goodwill.

a. Average weekly sales X an agreed index (retail business)

b. Gross annual fees(revenue) X an agreed index (professional firms)
c. Average annual profit over a number of years X an agreed index
d. Super profits X an agreed index.

Accounting treatment of Goodwill

Once goodwill is valued, the partners may decide to either maintain or eliminate it in their books.

1) To recognise the goodwill; Dr Goodwill and Cr Capital account( in old profit sharing ratio)
2) To eliminate the goodwill; Dr capital account (in new profit sharing ratio) and Cr goodwill
account

Admission of a new member,

When a new partner is admitted, he is required to bring in a certain sum of money as his capital to the
partnership and sometimes may be asked to pay for goodwill. E.g Mary and John shares profits equally
with the following balance sheet;

Balance sheet as at date

Assets = 60,000 Capital; Mary = 30,000

John = 30,000

On admission of Peter, he is to contribute 35,000 FRS and goodwill is valued at 10,000 FRS. The
new profit sharing ratio will be 2:2:1.

Required; show the capital accounts of the partners with

a. Goodwill maintained and

b. Goodwill eliminated

Revaluation of assets and liabilities

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Changes in the partnership arrangement, whether for admission of a new partner, retirement etc,
may also result in the revision of the value of the business as a whole. This is accounted for as
goodwill.

However, individual items of the assets and or liabilities may be revised in their value. This is treated
as a revaluation, with the opening up a Revaluation Account. It is credited for increases in assets and
debited for increases in liabilities and vise versa. The net difference in revaluation account which is
called revaluation surplus or deficit is transferred to the capital account in the old profit sharing
ratio.

There are two approaches to the use of the revaluation account;

1. Make full use of the Revaluation Account; all the revised assets and liabilities are closed to
Revaluation account in their book value and re-open them in their prescribed value, whether
new or otherwise. The net difference would be the closing balance in the revaluation account.
2. Show the net changes only; here, we only record the actual changes in the respective items of
asset and liabilities. The double entry is made to the revaluation account. The sum of these
entries represents the difference in the revaluation.

Either method is acceptable, unless precisely stipulated. It is possible to have both goodwill and
revaluation at the same time.

Example;
John and Paul are in partnership sharing profits and losses in the ratio of 2:1. As at December
31st 2000, their balance sheet was as follows;

Asset 000 Capital 000

Cash 2700 John 6000
Van 2500 Paul 1100
0
machine 4100 creditors 2300
Premise 1000
s 0
1930 1930
0 0

The introduction of Buba with his capital contribution of 4,000,000 Frs saw profits sharing ratio
changed to 1:2:2. The following revaluations were also agreed upon.
Van 2,000,000
Machine 3,100,000
Premisse 20,000,000

Required;
Show the ledger accounts and the resulting balance sheet.

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 Partnership Dissolution

AS we have seen, changes in the partnership arrangement, whether for admission of a new partner,
retirement etc means the partnership is dissolved. Some reasons that may lead to the dissolution of
a partnership include;

 Insolvency
 Death or bankruptcy of a partner
 If entered into for a fixed duration and by the expiry of the period
 A decision of the partners.

The dissolution of a partnership involves the disposal (realization) of the assets. Dissolution accounts
means the debts of the partnership are paid off and the assets distributed in accordance with the
partnership deed. The assets of the firm including the sum, if any, contributed by the partners to make
up losses or deficiencies of capital, shall be applied in the following manner and order;

1) Paying the debts or liabilities of the firm to outsiders

2) Paying to each partner what the firm owes him/her e.g. personal loans to the
partnership
3) Paying to each partner the amount finally due to him/her according to capital
contributions

Accounting entries on dissolution

The accounts to be opened for dissolution are;

- The Realisation accounts

- The cash/bank account
- Other ledger accounts to close the books

The realisation accounts

This account determines the profits or losses on realisation. The following entries are made in this
account.

a) Debit the realisation account with the book values of the assets realized.
b) Credit Realisation account with the amount realized for the assets
c) Debit realisation account and credit the expenses incurred on dissolution
d) Debit the creditors account and credit cash/bank account as and when the liabilities are
discharged.
e) Debit the creditors account and credit realisation account with the discounts and allowances
made by creditors
f) Determine the profit/loss and share it to the partners in their profit/loss sharing ratio and
transfer it to their capital accounts.

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Example;

Robert, Gareth, and Ricardo are partners in a firm called the Busters. They share profits/losses equally
and their balance sheet as at December 2000 was as follows;

Building 40,000 Capital;

Machinery 20,000 -Robert 40,000

Motor vehicle 30,000 -Gareth 40,000

-Ricardo 40,000

Stock 15,000

Debtors 8,000 Creditors 15,000

Bank 22,000

135,000 135,000

Robert has decided to retire and will be replaced by Marlon, who will contribute 50,000 FRS. The new
profit sharing ration is 2:2: 1.

Goodwill is taken at 30,000 frs. Machinery is to be revalued at 23,000frs, motor vehicle is to be sold for
22,000frs. The firm will settle debtors for 6000frs and the creditors for 14,000frs.

Required;

Show the revaluation, realisation, bank, capital accounts as well as the Balance sheet after the
partnership changes.

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