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Chapter 006

Chapter 006. Accounting for Partnerships. 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. Partnership Features. Voluntary Association. Limited Life. Taxation.

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Chapter 006

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  1. Chapter 006 Accounting for Partnerships

  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. Partnership Features Voluntary Association Limited Life Taxation 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. 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.

  12. Dividing Income or Loss Three frequently used methods to divide income or loss are allocation on: Stated ratios. Capital balances. Services, capital and stated ratios. 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.

  13. Allocation Based on Stated Ratios $60,000 × ¾ = $45,000 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.

  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.

  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.

  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.

  17. Allocation Based on Services, Capital, and Stated Ratios $80,000 × 5% = $4,000 $29,000 × ½ = $14,500 P2

  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.

  19. Allocation on Services, Capital, and Stated Ratios ($1,000) × ½ = $500

  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. 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 24000 2000 S 18,000 (1000) N 13,000 1500 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, 2005. 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.

  23. Solution Appropriation Account For the year ended December 31,2005 $ $ Net Profit : (63000-1500) 61,500 Less: Interest on Capital: C: (24,000 x 10%) 2400 S (18,000 x 10%) 1800 N (13,000 x 10%) 1300 Salaries S 8000 N 8000 (21,500) Balance Profit 40,000 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

  24. Example: Financial Statements

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

  26. 2. Non Current Assets: Depreciation of Fixtures and fittings for June 30 2006: Cost $27,000 x 10% = $2,700

  27. 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

  28. Statement of Division of Profit

  29. Chapter End

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