Chapter 006 Accounting for Partnerships. What is Partnership? A partnership can be defined as the...
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Transcript of Chapter 006 Accounting for Partnerships. What is Partnership? A partnership can be defined as the...
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
Partnership Agreement
Partnership Agreement
Voluntary Association
Voluntary Association
Limited Life
Limited Life
TaxationTaxation
Unlimited Liability
Unlimited Liability
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
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.
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.
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.
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
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.
Organizing a Partnership
Partners can invest both assets and liabilities in the 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.
Assets and liabilities are recorded at an agreed-upon value, normally fair market value.
Asset contributions increase the partner’s capital account.
Asset contributions increase the partner’s capital account.
Withdrawals from the partnership decrease the partner’s capital account.
Withdrawals from the partnership decrease the partner’s capital account.
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.
On 2/15/08, Smith and Jones form a partnership. Smith contributes
$80,000 cash. Jones contributes land valued at $40,000.
Feb. 15 Cash 80,000 Land 40,000
Smith, Capital 80,000 Jones, Capital 40,000
To record initial investment in partnership
Dividing Income or Loss
Three frequently used methods to divide income or loss are allocation on:
1. Stated ratios.2. Capital balances.3. Services, capital and stated ratios.
Three frequently used methods to divide income or loss are allocation on:
1. Stated ratios.2. Capital balances.3. 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.
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.
Dec. 31 Income Summary 60,000 Smith, Capital 45,000 Jones, Capital 15,000
To record division of 2008 net income.
$60,000 × ¾ = $45,000
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.
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 $60,000.
Balance Ratio Income AllocationSmith, Capital 80,000$ 66.67% 60,000$ 40,000$ Jones, Capital 40,000 33.33% 60,000 20,000 Totals 120,000$ 100.00% 60,000$
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.
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.
Dr. Cr. Dec. 31 Income Summary 60,000
Smith, Capital 40,000 Jones, Capital 20,000
To record division of 2008 net income.
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.
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 $60,000.
Smith Jones Remainder60,000$
15,000$ 10,000$ 35,000 4,000 2,000 29,000
14,500 14,500 - 33,500 26,500
SalariesNet income
Income Distribution
InterestEqual allocationIncome to each partner
Allocation Based on Services, Capital, and
Stated RatiosSmith Jones Remainder
60,000$ 15,000$ 10,000$ 35,000 4,000 2,000 29,000
14,500 14,500 - 33,500 26,500
SalariesNet income
Income Distribution
InterestEqual allocationIncome to each partner
Smith Jones Remainder60,000$
15,000$ 10,000$ 35,000 4,000 2,000 29,000
14,500 14,500 - 33,500 26,500
SalariesNet income
Income Distribution
InterestEqual allocationIncome to each partner
Smith Jones Remainder60,000$
15,000$ 10,000$ 35,000 4,000 2,000 29,000
14,500 14,500 - 33,500 26,500
InterestEqual allocationIncome to each partner
Net income
Income Distribution
Salaries
$80,000 × 5% = $4,000$80,000 × 5% = $4,000
$29,000 × ½ = $14,500$29,000 × ½ = $14,500
P2
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.
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 $30,000.
Allocation on Services, Capital, and Stated Ratios
Smith Jones Remainder30,000$
15,000$ 10,000$ 5,000 4,000 2,000 (1,000) (500) (500) -
18,500 11,500
SalariesNet income
Income Distribution
InterestEqual allocationIncome to each partner
($1,000) × ½ = $500($1,000) × ½ = $500
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.
Profit and Loss Appropriation Account
Net Profit : xAdd: Interest on drawings xLess: Salaries to partners (x)
Interest on Capital (x) Commission to partners (x)
Balance Profit: xA: 3 xB: 2 x
Capital Account
Date Narrative Ref A B Date Narrative Ref A B
2008 2008
1-Jan Balance b/d x x
31-Dec Balance c/d (x) (X)
Total x x Total x x
Current Account
Date NarrativeRef A B Date Narrative Ref A B
2008 2008
31-Dec Drawings X x 1-Jan Balance b/d x x
Interest on Drawings X x 31-Dec
Interest on Capital X x
31-Dec Balance c/d (X) (X) Salaries X x
Profit share x x
Total x x Total x x
ExampleC, 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:
CapitalCurrent AccountC 24000 2000S 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.
SolutionAppropriation Account
For the year ended December 31,2005
$ $Net Profit : (63000-1500) 61,500
Less: Interest on Capital:C: (24,000 x 10%) 2400S (18,000 x 10%) 1800N (13,000 x 10%) 1300SalariesS 8000N 8000 (21,500)
Balance Profit 40,000Partner’s ShareC: 5/10 x 40,000 = 20,000S: 3/10 x 40,000 = 12,000N: 2/10 x 40,000 = 8,000
Capital Account
DateNarrative
Ref C S N
Date
Narrative
Ref C S N
2005 200
5
1-
JanBalance b/d
24000
18000
13000
31-Dec
Balance c/d
24000
18000 13000
2400
01800
0 13000 2400
01800
01300
0
Current Account
DateNarrative
Ref C S N Date
Narrative
Ref C S N
2005 2005 1-Jan
Balance b/d 2000 1500
1-JanBalance c/d 1000
31-Dec
Interest on Capital 2400 1800 1300
Drawings 1600
01650
01900
0
31-Dec
Interest on Loan 1500
31-Dec
Balance c/d 9900
4300 Salaries
8000 8000
Profit share
20,000
12,000 8,000
Balance c/d (200)
2590
02180
01900
0 2590
02180
0 19000
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
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 273,247 273,247
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: 1. Prepare income statement2. Statement of division of profits3. Partners’ current accounts 4. Balance sheet
Solution1. 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
2. Non Current Assets:Depreciation of Fixtures and
fittings for June 30 2006:Cost $27,000 x 10% = $2,700
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 = $35,000Less: Prepaid Rent: =($2,500)Rent Expense = $32,500
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
Less: Expenses:
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)
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) (9,565) (19,130)
Total (6765) (465)
Current Account
Date Narrative Ref Ken Barbie 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 15,000June
30, 06Balance c/d 12,610 6,201
20,265 15,465 20,265 15,465
Ken and Barbie
Balance Sheet
As on June 30, 2006
AssetsNon Current Assets: $ $ $
Motor Van 32,750
Less: Accum Dep: (15,578) 17,172
Fixtures and Fittings 27,000
Less: Accum Dep: (16,200) 10,800 27,972
Current Assets $ $ $
Inventory 4,500
Receivables 16,000
Less: Allowance for Receivables (5,450) 10,550
Prepayments 2,500
Cash at Bank (467 + 13,000) 13,467 31,017
Total Assets 58,989
Capital and Laibilities $ $
Capitals: $
Ken: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