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.

Salient features :-
1. Feature of Partnership: Two or more persons, Agreement between partners, Existence of
business with profit motive, Relationship of principal and agent.
2. Partnership deed is a written agreement between partners containing all terms and
conditions about partnership.
3. For calculating Divisible Profit among partners Profit & Loss Appropriation A/c is
opened.
4. Rules applicable in the Absence of Partnership Deed.
a. The partners shall share firms profits or losses equally.
b. If any partner has given some loan to the firm, he is entitled to take interest on
such loan @ 6% p.a.
c. No partner is entitled to get any remuneration as salary, commission, fees etc.
d. No interest is allowed to partners on the capital invested by them.
e. No interest will be charged on drawings made by the partners.
(5) There are two methods of maintaining capital account of partners
f. Fixed capital method- two accounts (Capital a/c and Current a/c are maintained)
g. Fluctuating capital method- only on (Capital a/c) is maintained
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

Cr. Capital accounts introduced by each partner

(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

Cr. Partners current accounts advance and salaries

Dr. Partners current accounts With interest on drawings

Cr. Appropriation account

Dr. Partners current accounts With amount of drawings during the year
Cr. Drawings transferred to current accounts

(3) Loan accounts

Accounting entries:

Dr. Cash or assets With the amount of loan beyond the

Cr. Advance (loan) accounts agreed capital
 Preparation of Appropriation accounts

EXAMPLE:

Alan and Bob are in partnership selling kitchen utensils. Their net profit for the year ended
31st December, 2005 was Rs.2,28,000. The two partners annual salaries were: Alan
Rs.44,000, Bob Rs.40,000. Interest was paid on capital as follows: Alan Rs.27,000, Bob
Rs.13,000. Alan was charged interest on drawings for the year of Rs.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 31st December, 2005.

Alan and Bob

Profit and Loss Appropriation Account
For the year ended 31st December, 2005

$000 Rs. 000 Rs. 000

Interest on capital Net profit before 228
appropriation
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

Cr. Capital accounts introduced by the new partners

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

Cr. Partners capital accounts agreed ratio

Or

Dr. Partners capital accounts With loss on revaluation shared in the

Cr. Revaluation agreed ratio
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:
Ashok and Ravi have been in partnership for many years sharing profit and loss equally.
Goodwill is to be valued at Rs.80,000 upon the admission of Sahil as a new partner. Their
new profit and loss sharing ratio will be Ashok 3: Ravi 1: Sahil 1.

A. With a goodwill account to be opened

Accounting entries:

Dr. Goodwill With agreed amount of goodwill credited to

Cr.. Capital accounts of old partners capital accounts according to old ratio.

Answer to the example:

Dr. Goodwill Rs. 80,000

Cr. Capital account Ashok Rs. 40,000
Cr. Capital account Ravi Rs. 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
Cr. Goodwill in the capital accounts according to new
ratio

Answer to the example

Dr. Capital account Ashok(3/5) Rs. 48,000

Capital account Ravi (1/5) Rs. 16,000
Capital account Sahil (1/5) Rs. 16,000
Cr. Goodwill Rs. 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
Cr. Goodwill in the profit and loss accounts before
appropriation

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
Cr. Partners capital account (gain) debited) / gain (to be credited) in the share
of goodwill.

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)

Ashok (1/2) Rs.40,000 Ashok (3/5) Rs.48,000 Rs. (8,000)

Ravi (1/2) Rs.40,000 Ravi (1/5) Rs.16,000 Rs. 24,000
Sahil (1/5) Rs.16,000 Rs. (16,000)
------------ ------------ -------------
Rs.80,000 Rs.80,000 Rs. -
======= ======= ========

Accounting entries

Dr. Capital account Ashok Rs. 8,000

Capital account Ravi Rs. 16,000
Cr. Capital account Sahil Rs. 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 partners share of goodwill to be recorded

Dr. Goodwill With the outgoing partners share of

Cr. Capital outgoing partner goodwill

C) If no goodwill account to be opened

Dr. Capital account remaining partners With the outgoing partners share of
Cr. Capital outgoing partner goodwill to be borne by the remaining
partners in the new sharing ratios.
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 firms 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
Cr. Assets and bank balance

(2) Dr. Realisation With realisation expenses paid

Cr. Bank

(3) Dr. Capital With agreed values of any assets taken over by
Cr. Realisation a partner

(4) Dr. Cash With amounts realized for the assets

Cr. Realisation

(5) Dr. Creditors With discount received on cash paid to settle

Cr. Cash balance sheet liabilities
Cr. Realisation

(6) Dr. Capital With balance of realisation transferred to

Cr. Realisation (if loss incurred) capital accounts in profit sharing ratio

(7) Dr. Capital With balance due to partners as shown by

Cr. Bank capital accounts
 EXAMPLE:

The following is a balance sheet for Alan and Bob as at 31st December, 2005.
Alan and Bob
Balance Sheet as at 31st December, 2005

Rs. 000 Rs. 000 Rs. 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 1st January, 2006 and the following events occurred:

The premises were sold for Rs.260,000 and the equipment for Rs.54,000. The debtors paid
$193,000 and the stock was sold for Rs.1,41,000. The creditors were paid Rs.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
Rs. 000 Rs. 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
Rs. 000 Rs. 000
Realisation: Premises 260 Balance b/f 93
Realisation: 54 Creditors 36
Equipment
Realisation: Stock 141 Capital accounts: Alan 335
Realisation: Debotrs 193 Bob 193
--------------- -----------
648 648
=== ====

Capital accounts
Alan Bob Alan Bob
Rs. 000 Rs. 000 Rs. 000 Rs. 000
Loss on 27 27 Balance b/f 270 130
realisation
Bank 331 189 Current 88 86
accounts
------------ ----------- ----------- -----------
358 216 358 216
=== === === ===

Current accounts
Alan Bob Alan Bob
Rs. 000 Rs. 000 Rs. 000 Rs. 000
Capital 88 86 Balance b/f 88 86
account