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PARTNERSHIP ACCOUNTS 6. 2 FORMATION OF A PARTNERSHIP Defined in the Partnership Act 1890 as the...
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Transcript of PARTNERSHIP ACCOUNTS 6. 2 FORMATION OF A PARTNERSHIP Defined in the Partnership Act 1890 as the...
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PARTNERSHIP ACCOUNTSPARTNERSHIP ACCOUNTS
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FORMATION OF A PARTNERSHIP
Defined in the Partnership Act 1890 as the relationship between two or more people engaging in business for profit
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FORMATION OF A PARTNERSHIP Three important factors must be
present in a partnership:
partners must be carrying on a business, not one isolated business transaction
must be agreement between two or more legally competent people who must be the business co-owners
partners must have intent to make a profit
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FORMATION OF A PARTNERSHIP Partnerships are separate accounting
entities to the partners (owners)
Owner’s Capital Accounts are kept for each individual partner
Each partner has the right to share in the profits and manage the business
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PARTNERSHIP AGREEMENT Partnership agreement
doesn’t always exist, making it difficult to establish if a partnership actually exists
if there is no formal partnership agreement then the Partnership Act applies
agreement is essential because partnerships:
have unlimited liabilityhave a limited life
• death of partner• insolvency of partner• retirement of partner
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PARTNERSHIP AGREEMENT name of business details of each
partner nature of business division of profit
and losses capital contributions authority, rights and
duties of partners details of salaries
drawings and interest on drawings
interest on capital voting and decision-
making procedures admission of new
partners resolution of disputes bankruptcy, death or
retirement of partners
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PARTNERSHIP ACT 1890 If there is no partnership agreement in
writing, or if it does not cover an area of dispute, matters may be resolved by reference to the Partnership Act
e.g. Act states all profits and losses are to be shared equally, so if profit ratio is not defined in an agreement, the Act is applied
Partners will receive interest at 5% on excess capital (ie over and above that which they have agreed to contribute)
No interest on drawings No salaries
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ADVANTAGES OF PARTNERSHIP
Creation and dissolution is easier than a company
Minimal statutory regulations Resources can be pooled Expertise can be utilised Co-ownership of assets Duties and responsibilities are shared
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DISADVANTAGES OF PARTNERSHIP Liability is unlimited (partners own personal
possessions can be used to pay debts owed by the business)
Partnership may cease if a partner dies, retires or becomes bankrupt
Disagreements between the partners can occur
Limits to raising large amounts of capital Partners can be sued by creditor, jointly or
individually Partners are likely to pay higher income tax
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LIMITED LIABILITY PARTNER Governed by the Limited Liability
Partnership Act 1907 Liability is limited to the amount of
capital invested by the partner A Limited Partner has no say in the
Management of the Partnership business
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PARTNERSHIP ACCOUNTS CURRENT ACCOUNTS
working accounts containing details of profit, loss, drawings and interest on capital invested or charged on drawings
CAPITAL ACCOUNTSpartner’s original capital put into the
business is considered to be ‘fixed’capital account of each partner is usually
unchanged unless additional capital is invested
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PARTNERSHIP ACCOUNTS CREATION OF NEW PARTNERSHIP -
ACCOUNTING ENTRIES
Can be created in two ways
the introduction of cash only, entered in the cash account and the partner’s capital account
the introduction of cash and other assets; entered in the cash and asset accounts and the partner’s capital account
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PROFIT DISTRIBUTION PROFIT-SHARING RATIOS
Profits and losses are shared in the way partners feel most appropriate
Profit share can be determined in various ways:
Amounts are shared on the basis of the amount of capital contributed by each partner
Higher profit may go to a partner bringing something of particular value into the business, such as specialised expertise
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PROFIT DISTRIBUTION PROFIT AND LOSS APPROPRIATION
ACCOUNTNet profit or loss is transferred to this
account from the profit and loss accountAdditions are made for Interest on
Drawings (this is to discourage partners from making drawings from the business)
Deductions are made for Interest on Capital or any Salaries paid to partners
Residual Profits are then shared, as agreed, according to Profit Sharing ratios
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PROFIT AND LOSS APPROPRIATION ACCOUNT
Profit and Loss Appropriation Account for Able, Bable and CableNet ProfitAdd Interest on Drawings
Less Interest on Capital Salary – Able
Residual Profit:Shared: Able 1/3
Bable 1/3 Cable 1/3
£16,000
500
16,500£2,500£5,000 £7,500
£9,000£3,000£3,000£3,000 £9,000
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PROFIT DISTRIBUTION ALLOCATION AS PER PARTNERSHIP
AGREEMENTInterest on capital may be payableInterest may be charged for drawings
taken out of the businessThere may be a provision for the payment
of a salary of a particular partnerInterest may be payable on loans to
partners by the business or loans by partners to the business
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PROFIT DISTRIBUTION LOAN ACCOUNTS
Where a partner makes a loan to the business, the debit is to bank and the credit to loan account in that partner’s name
DRAWINGSWhere a partner withdraws cash from the
business in anticipation of profits earned, the current account is debited and cash/bank is credited
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ADMISSION OF NEW PARTNER
REASONS FOR A NEW PARTNERMay bring in new products and/or customers
to the businessMay bring specialised expertise to the
businessAllows the business access to further capitalMay bring in additional assetsMay provide new business contactsMay be a requirement due to death,
retirement or bankruptcy of an existing partner
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ADMISSION OF NEW PARTNERNEW PARTNERSHIP AGREEMENT
ADJUSTING THE EXISTING BUSINESSAll existing partners must agree on the
admission of a new partnerAssets of the business should be revalued
before a new partner is admittedLiabilities need to be reviewed for
accuracy in valuationGains and losses to existing partners from
new business value will be made at the existing profit-sharing ratio
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STEPS TO ADMIT NEW PARTNER1. Review value of assets (see later slide)2. Consider inclusion of goodwill (see next slide)3. Record changes in the Ledger Accounts4. Open a Goodwill Account and adjust the
existing partners Capital Accounts according to their existing profit-sharing ratio
5. Prepare opening ledger entries for new partner6. Calculate partners’ new profit-sharing ratio7. Prepare a new Statement of Financial Position
ie Balance Sheet
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ADMISSION OF NEW PARTNER
GOODWILL
Goodwill can be defined as future benefits from assets that cannot be individually identified e.g. reputation, customer database, management ability, product, location
Goodwill is an asset and as such appears in the Balance Sheet as an Intangible Asset ie one which cannot be seen
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Recording Goodwill When the partnership is revalued:
Debit the Goodwill Account with the value of the increase in the value of the business (premium)
Credit the existing partners Capital Accounts according to their profit-sharing ratio
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REVALUATION OF ASSETS Before admitting a new partner to the
business, the Assets should be revalued:Some eg Buildings may have appreciated
in valueSome eg Machinery may not be worth as
much as the Net Book Value in the Balance Sheet – perhaps insufficient amounts for depreciation has been written off over the years
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Accounting for Revaluation Adjustments to the relevant accounts
should be madeEg If Buildings have appreciated, the
Buildings Account would be Debited and the Revaluation Account Credited
If there has been insufficient depreciation written off machinery, the Machinery depreciation account would be credited and the Revaluation Account Debited
The balance on the Revaluation Account would then be transferred to the Partners Capital Accounts according to their profit-sharing ratio
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PARTNERSHIP DISSOLUTION
REASONS FOR DISSOLVING A PARTNERSHIP
Partner(s) may give notice of intention to dissolve
Insolvency of a partnerOwnership changes e.g. converting to company Inability to trade profitablyDeath of partnerVoluntary agreement by partnersCourts may also rule to terminate the
partnership
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KEY TERMS
Capital Accounts Capital Adjustment Account Current Account Revaluation of Fixed Assets Fixed Capital Account
You should be aware of the following terms when dealing with Partnerships and be able to give clear definitions as well as know how to account for each:
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KEY TERMS Interest on Capital Interest on Drawings Partnership Act Partnership Agreement Profit and Loss Appropriation Account Profit-sharing Ratios