Partnership account

1          Introduction

            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:

(a)         Partners contribute capital equally;

(b)        Partners share profits and contribute equally towards losses;

(c)         Partners are not entitled to interest on capital;

(d)        Partners are not entitled to receive salaries;

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

(f)         A new partner may not be introduced without the consent of all the existing partners;

(g)        Matter arising from disagreements must be decided by a majority of partners.

2.        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 31^st 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 31^st December, 2005.

Alan and Bob

Profit and Loss Appropriation Account

For the year ended 31^st 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 ===

3.        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.

4.        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

5         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.

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

7.        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 31^st 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 1^st 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 ===