PARTNERSHIP ACCOUNTS

Definition of a partnership

It is an agreement between two or more people but not more than twenty to carry on a business for a
profit.

In this case, the partners will contribute resources as capital

Formation of a partnership

It is guided by the partnership Act which specifies provisions of how the partnership should operate.

These provisions include the following:

(i) All partners should contribute capital equally

(ii) Duties and responsibilities must be shared equally

(iii) No partner is entitled to receiving interest on capital

(iv) No salaries are given to partners

(v) No interest is charged on drawings

(vi) Interest on loan from a partner should not exceed 5%

However, the partnership act allows partners to form their own agreement

Partnership Agreement/ Partnership Deed

This is a legal document which is drafted by partners to stipulate the terms and conditions under
which the partnership will operate.

The agreement will have the following contents

(i) The names and addresses of the partners

(ii) Amount of capital contributed by each partner
(iii) Any interest allowed on capital
(iv) Any salaries to be given to partners
(v) Duties and responsibilities of each partner
(vi) The terms and conditions under which the partnership can be terminated
(vii) Procedures taken when the partner retires or upon admission of a new partner
(viii) Interest to be charged on the drawings by partners
(ix) Interest on loan from a partner
(x) Any profit or loss sharing ratio
Give reasons for the following conditions

(i) Interest on capital

 Reward to partners who contributed more capital
 To encourage partners to invest more capital

(ii) interest is charged on drawings

 To discourage partners from withdrawing resources from the business for personal
use
 This increases some income in the business to be shared by partners

(iii) Salaries to partners

 Reward partners who are directly working in the business
 To encourage partners to work hard in the business

The main reason why a partnership agreement is drafted is to minimize/reduce the chances of conflicts

Advantages of a partnership

 There is sharing of business ideas and skills

 Capital is contributed by two or more hence more capital is raised
 There is sharing of duties and responsibilities
 Risk of loss is shared by partners
 The formation is relatively easy and cheap because there are few legal formalities

Disadvantages of partnership

 No continuity
 Profit is shared
 Decision making takes longer due to possible conflicts
 There is unlimited liability
 Sources of capital are limited to personal contributions and some loans from friends and
relatives(lack of collateral security)
 If one partner is not honest then all the partners are affected

Financial statements of a partnership

(i) Income statement

(ii) Statement of financial position

Income Statement

It is a financial statement used to determine the financial performance of the business for a particular
year. Financial performance is determined by the profitability (profit or loss) of the business.
However in the partnership, profit or loss must be shared by the partners. As such there is an extra
financial statement which is attached to the income statement.

In fact there is an extension of the income statement which is known as the Appropriation Account.

Appropriation Account

It is an account showing how profits or losses are allocated or distributed among partners

How are profits or losses shared in the partnership business?

(i) Interest on capital

(ii) Salaries to partners
(iii) Sharing using profit or loss sharing ratio

However, before profits are shared there is need to add interest on drawings charged on partners
Partnerships: Practice Question: preparation of the appropriation account

Samuel and Martha are in partnership sharing profits and losses equally. Their financial year ends on 31
December 2016. Their partnership agreement provides the following

Interest on capital 10%

Interest on drawings 5%

Salaries: Samuel 2000

Martha 1500

Capital accounts: Samuel 40 000

Martha 30 000

Drawings: Samuel 8 000

Martha 4 000

Current accounts: Samuel 6 000 cr

Martha 1 200dr

During the year ended 31 December 2016 the partnership made a net profit of $22 400

Prepare the partnership’s appropriation account for the year ended 31 December 2016

Net profit for the year 22 400

Add interest on drawings: Samuel (5%×8000) 400
Martha(5%×4000) 200 600
23 000

Less interest on capital: Samuel (10%×40 000) 4000

Martha(10%×30 000) 3000 ( 7000)
16 000
Less salaries to partners: Samuel 2 000
Martha 1 500 ( 3 500)
12 500
Share of remaining profit: Samuel (1/2×12 500) 6 250
Martha(1/2×12500) 6 250 (12 500)

Prepare the capital account for each partner to show closing capital balances
 Flexible Capital Accounts

Date Details Samuel Martha Date Details Samuel Martha

Dec 31 Drawings 8 000 4 000 Jan 01 Balance b/d 40 000 30 000

Interest on drawings 400 200 Dec 31 Interest on capital 4 000 3 000
Salary 2 000 1 500
Share of profits 6 250 6 250
Balance c/d 43 850 36 550
52250 40750 52 250 40750

Jan 01 Balance b/d 43 850 36 550

Flexible capital accounts can distort the figures and fails to show the actual amount contributed by
each partner.

To solve this problem, partners will agree to keep fixed capital accounts and open separate current
accounts

CURRENT ACCOUNTS OF PARTNERS

The current accounts are opened to record the gains from profits and the drawings made by each
partner as well as interest on drawings

Items to be recorded in the current accounts

Credit side: gains from profits

(i) salaries to partners

(ii) interest on capital
(iii) share of remaining profits

Debit side:

(i) drawings
(ii) interest on drawings
(iii) share of losses

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 Prepare the Current Accounts for the partners

Current Accounts

Date Details Samuel Martha Date Details Samuel Martha

Dec 31 Balance b/d 1 200 Jan 01 Balance b/d 6 000

Drawings 8 000 4 000 Dec 31 Interest on capital 4 000 3 000
Interest on drawings 400 200 Salary 2 000 1 500
Share of profits 6 250 6 250

Balance c/d 9 850 5 350

18 250 10 750 18 250 10 750

Jan 01 Balance b/d 9 850 5 350

Capital Accounts

Date Details Samuel Martha Date Details Samuel Martha

Dec 31 Jan 01 Balance b/d 40 000 30 000

Balance c/d 40 000 30 000

40 000 30 000 40 000 30 000

Jan 01 Balance b/d 40 000 30 000

Calculate the equity of the partners

Financed by

Capital accounts: Samuel 40 000

Martha 30 000 70 000

Current account: Samuel 9 850

Martha 5 350 15 200

Total equity 85 200

STATEMENT OF FINANCIAL POSITION OF A PARTNERSHIP

 The statement of financial position shows the financial position of the business at a
particular date.
 Financial position is determined by comparing assets and liabilities to get the net worth
of the business (Networth = Assets – Liabilities)
 The statement of financial position of the partnership is prepared in a similar way to
that of a sole trader.
 However, the difference is noted on the financed by section where the current account
balances and capital account balances are shown.

The format below shows the statement of financial position of a partnership

  Sometimes the full details of current accounts will be required in the statement of
financial position.
 The following format shows how the presentation must be done

 Interest on drawings must also be deducted from the balances

EXAMPLE USING SAMUEL AND MARTHA

EQUITY AND LIABILITIES Samuel Martha Total

Capital accounts 40 000 30 000 70 000
Current accounts
Opening balance 6 000 (1 200)
Interest on capital 4 000 3 000
Salary 2 000 1 500
Share of profit 6 250 6 250

Drawings (8000) (4000)

Interest on drawings (400) (200)
Closing balance 9850 5350 15 200
Total equity 85 200
EXERCISE : Partnerships Appropriation Account and Current accounts

Trust and Trevor are in partnership sharing profits and losses in the ratio 3:2. Their partnership
agreement shows the following

1. Interest on capital is allowed at 5%

2. Salary to be paid trust is $15 000
3. Interest to be charged on each partner’s drawings for the year at 4% per annum

The balances on the partners’ capital accounts at 01 January 2016 were

Trust $30 000

Travor $ 40 000

Drawings: Trust $35 000

Travor $15 000

Current accounts: Trust $ 2 300 credit

Travor $ 3 000 credit

Profit for the year ended 31 December 2016 were $89 000

(a) Prepare the partnership appropriation account for the year ended 31 December 2016
(a) Prepare the partners current account for the partners in column form