A Level, Partnership Accounts Basics

Accounting 9706 A level Notes
Section 1.4.3
Financial Statements of Partnership
Financial Statements of
Partnership
Candidates should be able to:

To prepare an income statement, appropriation account and
statement of financial position for a partnership from full or
incomplete accounting records with understanding of Current
account and Capital account.
Compiled by; Mohsen Shafiq , A level Teacher 03156222008| [M.S, MBA Finance, B.Com, Cert. AFA]
FINANCIAL STATEMENTS OF PARTNERSHIP

1. Types of business entity
A business entity is a commercial organisation that aims to make a profit from its operations.
There are three main types of business entity;
a sole trader
a business partnership
a company (a limited liability company).
Partnership can be defined as the relationship which exists between persons

carrying on a business in common with a view of profit.
The people who own a partnership are called partners. They do not have to be based or work
in the same place, though most do. However, they maintain one set of accounting records and
share the profits and losses.
In other words, a partnership is an arrangement between two or more individuals in which they
undertake to share the risks and rewards of a joint business operation.
It is usual for a partnership to be established formally by means of a partnership agreement.
However, if individuals act as though they are in partnership even if no written agreement exists,
then it will be presumed that a partnership does exist and that its terms of agreement are
reflected in the way the partners conduct the business, ie the way profits have been divided in
the past, etc. In some countries legislation may exist which governs partnerships.
2. When Partnership is a viable business structure?

Many business ventures carry financial risk should they fail. By forming a partenership, the level
of risk is reduced. Firstly, any loss can be shared by all the partners and, secondly, by involving
more than one persons expertise, the chances of failure are reduced.
3. Advantages and disadvantages of partnership opposed to a sole trader:

The advantages of a partnership are as follows:
More capital can be raised because of the number of partners

Specialised management each partner can work in the area in which they are qualified
or have expertise
Continuation of the business if one partner dies or retires
Partners can better afford to take a long break or holiday.
The disadvantages of a partnership are:
The decision-making process can be slower due to consultation among partners
Many partnerships end in disagreement

The profit has to be shared among partners
There is unlimited liability if the business has to wind up. (Unless a limited liability
partnership (LLP) is formed. LLPs are outside the scope of CIE A level 9706 syllabus.)
4. Nature of a partnership:
1. A partnership has the following characteristics:
2. It is formed to make profits.
3. It must obey the law as given in the Partnership Act 1890. If there is a limited partner
(partner with limited liability), it must also comply with the Limited Partnership Act of
1907.
4. Normally there can be a minimum of two partners and a maximum of twenty partners.
Exceptions are banks, where there cannot be more than ten partners; and there is no
maximum for firms of accountants, solicitors, stock exchange members, surveyors,
auctioneers, valuers, estate agents, land agents, estate managers, or insurance brokers.
5. Each partner (except for limited partners described below) must pay their share of any
debts that the partnership could not pay. If necessary, they could be forced to sell all
their private possessions to pay their share of the debts. This can be said to be unlimited
liability.
6. Partners who are not limited partners are known as general partners.
5. Types of Partnerships:
There are generally three types of partnerships detail of which are given below.
General Partnerships:
Limited Partnerships:
A general partnership
involves two or more
owners carrying out a
business purpose.
General partners share
equal rights and
responsibilities in
connection with
management of the
business, and any
individual partner can bind
the entire group to a legal
obligation. Each individual
partner assumes full
responsibility for all of the
business's debts and
obligations.
A limited partnership allows each

partner to restrict his or her personal
liability to the amount of his or her
business investment. Not every
partner can benefit from this limitation
-- at least one participant must accept
general partnership status, exposing
himself or herself to full personal
liability for the business's debts and
obligations. The general partner
retains the right to control the
business, while the limited partner(s)
do (does) not participate in
management decisions. Both general
and limited partners benefit from
business profits.
Limited Liability
Partnerships (LLP):
Limited liability
partnerships (LLP) retain
the tax advantages of the
general partnership form,
but offer some personal
liability protection to the
participants. Individual
partners in a limited
liability partnership are
not personally
responsible for the
wrongful acts of other
partners, or for the debts
or obligations of the
business.
6. Partnership agreement
Partnership agreement is a voluntary contract between two or among more than two persons to
place their capital, labor, and skills, and corporation in business with the understanding that
there will be a sharing of the profits and losses between/among partners.
This is the agreement made among the partners the policies, formulated by the partners,
under which the partnership business will be governed. Some of the principles that might be
covered under such an
agreement include:
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
Contribution of capital by each partner

Share of profit and loss
Rate of interest on partners capital,( if any, to be paid on capital before the profits are
shared.)
Rate of interest on any loans or advances salary to be paid to partners
Rate of interest on drawings (if any to be charged.)
Working schedule and specialisation.
Arrangements for the admission of new partners.
Procedures to be carried out when a partner retires or dies.
In the absence of a partnership agreement, section 24 of the Partnership Act 1890 governs the
situation. As an example, in the UK, the Partnership Act of 1890 sets out the following
principles:
i.
ii.
iii.
iv.
v.
Profit or loss should be shared equally between partners

No salary should be paid to partners
No interest on drawings should be charged to partners
No interest should be credited to partners for their capital invested
Partners who put a sum of money into a partnership in excess of the capital they have
agreed
to subscribe are entitled to interest at the rate of 5 per cent per annum on such an
advance.
7. Preparing partnership accounts:

Following are the specific issues that require special attention in case of partnership accounts:
Maintenance of capital accounts of partners;
Ascertainment and allocation of profit and losses;
Adjustment for wrong allocation of profits and losses;
Allocation of profits involving minimum guaranteed profit to a partner;
Reconstitution of the partnership firm; and
Dissolution of the firm
There are two respects in which partnership accounts are different, however.
(a) The funds put into the business by each partner are shown differently.
(b) The net profit must be appropriated by the partners, ie shared out according to the
partnership agreement. This appropriation of profits (sharing out profits in accordance with the
partnership agreement) must be shown in the partnership accounts.
7.1 How to calculate and distribute Profit and Loss of partnership business:
Calculation of profit and loss is similar to sole trader as the income statement (trading and profit
and loss account) would be identical with that as prepared for the sole trader. However, a
partnership would have an extra section shown below the profit and loss section. This section is
called the profit and loss appropriation account, and it is in this account that the distribution of
profits is shown. The heading to the trading and profit and loss account for a partnership does
not normally include the words appropriation account.
7.2 Profit and Loss Appropriation Account

As stated above, the net profit as shown by the profit and loss account of a partnership firm
needs certain adjustments with regard to interest on capitals, interest on drawings, salary,
commission to the partners, if provided, under the agreement. For this purpose, 'Profit and Loss
Appropriation Account' may be prepared. This is merely an extension of the profit and loss
5
account and is prepared to show how net profit is to be distributed among the partners. This
account is credited with net profit and interest on drawings, and debited with interest on capitals,
salary or commission to partners. If, however, the profit and loss appropriation account shows a
net loss, it will be shown on the debit side of the profit and loss appropriation account. After
these adjustments have been made, the Profit and Loss Appropriation Account will show the
amount of profit or loss, which shall be distributed among the partners in the agreed profit
sharing ratio.
8. FORMATS: Financial Statements (Final Accounts) of a Partnership business

Sole Trader (Name)
Income Statement (Trading and Profit and Loss Account) for the year ended
Particulars
Amount $
Amount $
Revenue (sales)
Less Sales returns
Net Sales
Less Cost of sales;
Inventory (opening stock)
Purchases
Less Purchases returns
Less Goods for own use
Carriage inwards
Less Inventory (closing stock)
xxxx
xxxx
xxxx
Xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Xxxx
Xxxx
Xxxx
Gross profit
***Net profit
*
**
***
(xxxx)
xxxx
Add Other income;

Discount received
Rent received
Commission received
*Profit on disposal of fixed assets
**Reduction in provision for doubtful debts
Less Expenses;
Wages and salaries
Office expenses
Rent and rates
Insurance
Office expenses
Motor vehicle expenses
Selling expenses
Loan interest
*Loss on disposal of fixed assets
**Provision for doubtful debts
Depreciation of fixtures and fittings
Depreciation of office equipment
Depreciation of motor vehicles
Amount $
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Xxxx
Xxxx
Xxxx
Xxxx
Xxxx
Xxxx
Xxxx
Xxxx
Xxxx
Xxxx
Xxxx
Xxxx
Xxxx
xxxx
xxxx
If only one asset was sold during the year only one of these items will appear
If the provision reduces, the surplus amount is added to the gross profit: if the provision increases,
the amount required is included in the expenses
If the expenses exceed the gross profit plus other income the resulting figure is described
as a net loss
Partnership (Name)
Profit and Loss Appropriation Account for the year ended .
Particulars
Net profit/loss
(carried down from income statement)
Add **Interest on drawings Partner A
Partner B
Less **Interest on capital
Less **Partners salary
Partner A
Partner B
Partner A / B
Amount $
Amount $
Amount $
xxxx
Xxxx
Xxxx
xxxx
xxxx
Xxxx
Xxxx
xxxx
xxxx
xxxx
xxxx
*Profit/loss shares (to be

appropriated)
Partner A
Xxxx
Partner B
Xxxx
xxxx
*
Residual profit is shared in the ratio stated in the partnership agreement. If there is nothing about
profit and loss sharing among partners in agreement then as per Partnership Act 1890 (UK) profit and
loss would be shared equally among all partners.
**
No interest on capital, interest on drawings and partners salary would be charged if not mention
in agreement.
9. Why and how to maintain Partners' Capital Accounts:

In case of partnership firm, the transactions relating to partners are recorded in
their respective capital accounts. Normally, each partner's capital account is prepared
separately. But these accounts can also be shown in a tabular form as shown later in this
chapter.
There are two methods by which the funds from partners (capital accounts of partners) can be
maintained. These are: (i) Fluctuating Capital Method; and (ii) Fixed Capital Method.
i.
Fluctuating Capital Method;
Under the fluctuating capital method, only one account viz., the capital account for each partner, is
maintained. It records all items affecting partner's account like interest on capital, drawings, interest on
drawings, salary, commission, and share of profit or loss in the capital account itself. As a result of these,
the balance in the capital account keeps on fluctuating.
The items that usually appear on the debit and the credit side of the Partners' capital account are shown
in following Capital Account
Partners' Capital Account (fluctuating capital method)

Dr.
Cr.
Partner
A
Amount
($)
Partner
B
Amount
($)
Drawings (if any)

Interest on
drawings
Transfer to Loan
(if any)
***
***
***
***
***
***
Share of loss
***
Date
Particulars
Folio
Withdrawal of
capital (if any)
Balance c/f
Partner
A
Amount
($)
Partner
B
Amount
($)
Balance b/f
Additional capital
(if any)
***
***
***
***
***
***
***
Interest on capital
Salary of partner
(if any)
***
***
***
Commission /
Bonus received by
partner (if any)
***
***
***
***
***
***
Share of profit
Any other amount
owing to partner
***
***
***
***
***
***
***
***
***
Date
Particulars
Balance b/f
ii.
Folio
Fixed Capital Method;
Under the fixed capital method, the capitals of the partners shall remain fixed unless some
additional capital is introduced or some amount of capital is withdrawn by an agreement among
the partners. Therefore, all items like interest on capital, drawings, interest on drawings, salary
of partner, commission received by partner, and share of profit or loss are not to be shown in
the capital accounts.
For all these transactions, a separate account called 'Partner's Current Account' is opened.
Thus, under fixed capital method, two accounts are maintained for each partner viz., (i) Capital
Account, and (ii) Current Account.
It may be noted that the capital account will continue to show the same balance from year to
year unless some amount of capital is introduced or withdrawn into business, while the balance
of current account will fluctuate from year to year. In other words, fluctuations in capital (except
additional and withdrawn capital) will be recorded in current account instead of capital account.
Under the fixed capital account method, the capital account and the current account would
appear as shown below:
Partners' Current Account (under fixed capital method)

Dr.
Date
Cr.
Particulars
Balance b/f (if it's
Dr.) *
Drawings
Interest on
drawings
Folio
Partner
A
Amount
($)
Partner
B
Amount
($)
***
***
***
***
***
***
Interest on capital
Salary of partner
(if any)
Date
Particulars
Folio
Partner
A
Amount
($)
Partner
B
Amount
($)
***
***
***
***
***
***
Balance b/f (if it's

Cr.) *
Transfer to Loan
(if any)
***
***
Commission /
Bonus received by
partner (if any)
***
***
Share of loss
***
***
Share of profit
***
***
***
***
***
***
Any other amount

owing to partner (if
any)
Balance c/f *
***
***
***
***
***
***
***
***
***
***
Balance c/f *
Balance b/f
Balance b/f
* NOTE: In Partners' Current Account, opening balance (balance b/f) and closing balance
(balance c/f) may appear on either side, i.e. debit or credit.
Fixed capital accounts preferred:

The keeping of fixed capital accounts plus current accounts is considered preferable to
fluctuating capital accounts. When partners are taking out greater amounts than the share of the
profits that they are entitled to, this is shown up by a debit balance on the current account and
so acts as a warning.
10. Calculation of Interest on Capital

If the partnership agreement specifically provides for the payment of the interest on the capital
contributed by the partners, then same is to mention. Interest to be allowed on capital is to be
calculated with respect to the time, rate and amount. Generally, following points are to be borne
in mind while calculating the interest on capital:
1. Normally, interest on the opening balance at the beginning of the year is allowed for the
whole accounting year.
2. If additional capital is invested during the year, interest for the relevant period is
calculated.
3. If part of the capital is withdrawn during the year, interest on the part of the capital that
was invested for the whole year, interest is calculated for the whole year and it is added
with the amount of interest that is calculated on the remaining capital that was invested
10
for the relevant period. For example, Aslam has $100,000 as balance in his capital
account at the beginning of the year. After three months of the year he withdrew $10,000
from his capital. He is entitled for interest on capital @ 10% p.a.
In this case, interest will be calculated in the following manner:
($ 100,000 x 10% x 3/12= $2,500) + (90,000 x 10% x 9/12=$ 6750) = $ 9250
11. Calculation of Interest on Drawings:

For meeting personal needs, partners may require to draw money from the firm in varying
amounts. They can make drawings against their salaries, commission and interest on capital.
To deter the partners from taking out cash unnecessarily the concept can be used of charging
the partners interest on each withdrawal, calculated from the date of withdrawal to the end of
the financial year.
Interest on drawings is to be charged from the partners, if the same has been specifically
provided in the partnership deed. Interest on drawings is to be calculated with reference to the
time period for which the money was withdrawn. For example, Aslam and Bashar are agreed to
form a partnership whose financial year ends on 31st December each year. interest of drawings
will be at 10% per annum. Aslam took $ 10,000 on 31st March, 2015 and $ 15,000 on 30th September,
2015. On the other side Bashar took $ 18,000 on 30th April, 2015 and $ 7,000 on 31st October, 2015.
Aslam: Interest on drawings= $ 1125 (sum of $750 and $ 375)
($10,000 x 10% x 9/12= $ 750) + ($15,000 x 10% x 3/12= $ 375)
Bashar: Interest on drawings= $ 1317 (sum of $1200 and $ 117)
($ 18,000 x 10% x 8/12= $ 1,200) + ($ 7,000 x 10% x 2/12= $ 117)
12. Loans by partners

In addition, it is sometimes the case that an existing or previous partner will make a loan to the
partnership in which case he becomes a creditor of the partnership. On the statement of
financial position, such a loan is not included as partners' funds, but is shown separately as a
long-term liability (unless repayable within twelve months in which case it is a current liability).
This is the case whether or not the loan creditor is also an existing partner.
However, interest on such loans will be credited to the partner's current account. This
is administratively more convenient, especially when the partner does not particularly want to
be paid the loan interest in cash immediately it becomes due. You should remember the
following.
(a)
(b)
Interest on loans from a partner is accounted for as an expense in the income

statement, and not as an appropriation of profit, even though the interest is added to the
current account of the partners.
If there is no interest rate specified, then Partnership Act 1890 provides for interest to
be paid at 5% p.a. on loans by partners.
11
13. Performance-related payments to partners

Partners may agree that commission, salaries or performance-related remuneration be payable
to some or all the partners linked to their individual performance. As with salaries, these would
be deducted before sharing the balance of profits. In absence of any specific agreement this
amount cannot be claimed.
14. Distribution of Profit and loss:

In case of partnership firm, the net profit (after charging the interest on capital, partners' salary
and commission and after taking into account the interest on drawings) is to be shared by all the
partners in the agreed profit sharing ratio. As stated earlier, in the absence of any specific
agreement to this effect, the profit is to be distributed equally among the various partners.
Summary of Journal Entries:
Profit for year
Partners salaries
Interest on capital
Interest on drawings
Residual profit
Interest on loan
from partner
Loan made by
Partner
Debit
Income statement
Credit
Appropriation account
Debit
Credit
Partners Current Accounts
Debit
Credit
Partners current accounts
Debit
Credit
if profit is greater than total of appropriations:
Debit
Credit
if total of appropriations is greater than profit for
year:
Debit
Credit
Debit
Income statement
Credit
Bank account* or
Accrued expenses**
Bank account or
Debit
Capital account
Credit
Loan account
* if the interest has been paid to the partner

** if the interest remains unpaid
if funds were deposited in the partnership bank account
if capital was converted into a loan
12
Example 01: (Calculation and formation of Profit and Loss Appropriation account)
Aslam and Bashar are agreed to form a partnership. They have drawn up a deed (agreement)
which states that:
Aslam and Bashar is to contribute $100,000 and $150,000 respectively as their capital
Both will jointly manage the day to day business matters
Neither of the partners is permitted to withdraw more than $25,000 per annum as drawings
Aslam and Bashar will share profits and losses in the ratio 4:3 respectively.
Interest on capital and interest of drawings will be at 10% per annum.
Aslam is entitled to take salary from business for $ 10,000 per annum.
During the year ended 31 December, 2015, the partnership made a profit of $ 50,000.
Moreover, each partners drawings were:
st
Aslam took $ 10,000 on 31 March, 2015 and $ 15,000 on 30th September, 2015.
Bashar took $ 18,000 on 30th April, 2015 and $ 7,000 on 31st October, 2015.
Solution of Example 01:

Partnership Aslam and Bashar
Profit and Loss Appropriation Account for the year ended 31st December, 2015.
Particulars
Net profit/loss
(carried down from income statement)
Add Interest on drawings Aslam (W-1)
Bashar (W-2)
Less Interest on capital
Aslam (W-3)
Bashar (W-4)
Amount $
Amount $ Amount $
50,000
1125
1317
10,000
15,000
2442
52,442
25,000
Less Partners salary

Aslam
10,000
Aslam ( x17442)
17,442
9967
Profit/loss shares (appropriated)

Bashar( x17442)
W-1:
7475
($10,000 x 10% x 9/12= $ 750) + ($15,000 x 10% x 3/12= $ 375)
W-2:
($ 18,000 x 10% x 8/12= $ 1,200) + ($ 7,000 x 10% x 2/12= $ 117)
W-3:
($ 100,000 x 10%= $10,000)
W-4:
($ 150,000 x 10%= $15,000)
13
(35,000)
17,442
Example 02: (Formation of financial statements)

Bush, Home and Wilson share profits and losses in the ratios 4:1:3 respectively. Their trial balance as at
30 April 2014 was as follows:
Dr
$
Sales
Returns inwards
Purchases
Carriage inwards
Stock 30 April 2013
Discounts allowed
Salaries and wages
Bad debts
Provision for doubtful debts 30 April 2013
General expenses
Business rates
Postage
Computers at cost
Office equipment at cost
Provisions for depreciation at 30 April 2013:
Computers
Office equipment
Creditors
Debtors
Cash at bank
Drawings: Bush
Home
Wilson
Current accounts: Bush
Home
Wilson
Capital accounts: Bush
Home
Wilson
Cr
$
334,618
10,200
196,239
3,100
68,127
190
54,117
1,620
950
1,017
2,900
845
8,400
5,700
3,600
2,900
36,480
51,320
5,214
39,000
16,000
28,000
5,940
2,117
494,106
9,618
60,000
10,000
30,000
494,106
Additional Information:
Inventory (stock) 30 April 2014, $74,223.
1)
2)
3)
4)
5)
6)
Business rates in advance $200; Stock of postage stamps $68.

Increase provision for doubtful debts to $1,400.
Salaries: Home $18,000; Wilson $14,000. Not yet recorded.
Interest on Drawings: Bush $300; Home $200; Wilson $240.
Interest on Capitals at 8 per cent.
Depreciate Computers $2,800; Office equipment $1,100.
14
Solution of Example 02:

Bush, Home and Wilson
Income Statement for the year ending 30 April 2014
Sales
Less Returns inwards
Less Cost of goods sold:

Opening inventory
Add Purchases
Carriage inwards
68,127
196,239
3,100
Less Closing inventory

Gross profit
Less Expenses:
Salaries and wages
Discounts allowed
Business rates (2,900 200)
Postages (845 68)
Bad debts
Allowance for doubtful debts
General expenses
Depreciation: Computers
Office equipment
Net profit
Add Interest on drawings: Bush
Home
Wilson
2,800
1,100
3,900
300
200
240
18,000
14,000
4,800
800
2,400
1
Balance of profit shared: Bush /2

1
Home /8
3
Wilson /8
Non-current assets
Office equipment
Computers
Current assets
Inventory
Accounts receivable
Less Allowance for doubtful debts
Prepayments (200 68)
Bank
15
199,339
267,466
74,223
193,243
131,175
54,117
190
2,700
777
1,620
450
1,017
Less Salaries: Home

Wilson
Interest on capital: Bush
Home
Wilson
Current liabilities
Accounts payable
334,618
10,200
324,418
64,771
66,404
740
67,144
32,000
8,000
13,572
3,393
10,179
40,000
27,144
27,144
Bush, Home and Wilson

Statement of Financial Position as at 30 April 2014
Cost
Depreciation Net Book
$
$
Value $
5,700
4,000
1,700
8,400
6,400
2,000
14,100
10,400
3,700
74,223
51,320
1,400
49,920
268
5,214
129,625
133,325
36,480
96,845
Financed by:
Capital: Bush
Home
Wilson
Current accounts: *
Balances 1.5.2003
Add Salaries
Interest on capital
Share of profit
Less Drawings
Interest on drawings
60,000
10,000
30,000
Bush
5,940
4,800
13,572
24,312
(39,000)
( 300)
( 14,988 )
Home
(2,117)
18,000
800
3,393
20,076
(16,000)
( 200)
3,876
Wilson
9,618
14,000
2,400
10,179
36,197
(28,000)
( 240)
7,957
100,000
( 3,155)
96,845
*Alternative format of current account that can be placed within statement of financial position.
_____________________________
16

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Profit or loss should be shared equally between partners

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Maintenance of capital accounts of partners;

Ascertainment and allocation of profit and losses;

Adjustment for wrong allocation of profits and losses;

Allocation of profits involving minimum guaranteed profit to a partner;

Reconstitution of the partnership firm; and

Dissolution of the firm

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Add Other income;

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*Profit/loss shares (to be

9. Why and how to maintain Partners' Capital Accounts:

Fluctuating Capital Method;

Accounting 9706 A level Notes

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Partners' Capital Account (fluctuating capital method)

Drawings (if any)

Fixed Capital Method;

Accounting 9706 A level Notes

Financial Statements of Partnership

Partners' Current Account (under fixed capital method)

Balance b/f (if it's

Any other amount

Fixed capital accounts preferred:

10. Calculation of Interest on Capital