Accounting for

Chapter
Partnership

12
1
 Partnership
Learning outcomes:

1. describe the characteristics of partnerships;

2. outline how to prepare accounting entries for partnership formation and

how to allocate and record income and loss among partners;

3. indicate how to prepare the final accounts of partnerships;

4. explain how to account for the admission and withdrawal of partners;

.
5. describe how to prepare entries for partnership dissolution.

2
 General Notes
 Some of the textbook materials are applied
to United States only; e.g. organization with
Partnership characteristics
 You should refer to the rules applied in HK
as discussed in the notes here

3
 What is partnership?
 A partnership is a permanent business arrangement
between two or more individuals or entities, usually in order
to sell a good or a service. Joint venture is usually a one-off
arrangement.
 Partnership accounting can be distinguished from sole
proprietor accounting in that there is more than one
owner and the owners share profits and losses in an
agreed ratio.
 You will need to learn how to process the various entries
required in order to incorporate the agreed ratios into the
financial statements.
 You will also need to learn how to account for changes in
the agreement between the partners (the partnership
agreement) and changes in the partnership (such as when
a partner retires or a new partner joins the partnership).
4
 Partnership- details
 Partnership has many advantages.
 In comparison with a sole proprietorship form of business organization,
a partnership brings together more capital, managerial skills, and
experience than does a sole proprietor.

 In comparison with a corporate form of business organization, a

partnership is relatively easy and inexpensive to organize.
 In addition, as the partners pay income taxes on an individual basis,
there is no income tax for the partnership itself.

 In Hong Kong, partnership businesses are assessed for profits tax and
partners are liable to pay this tax according to their agreed profit and
loss sharing ratio.

 The major disadvantage of the partnership form is perhaps its

unlimited liability feature.

5
 Legal requirement
( For reference only, please refer to Business law
 The definition of a partnershipmaterial )
is ‘the relationship which subsists
between persons carrying on a business with a view to profit’.
 You should bear in mind that in the context of law, the word ‘persons’
does not just refer to individuals. It includes any corporate group, as
well as the executors and administrators. A limited company can also
be one of the partners in a partnership.
 Most of the time, any one of the partners has the power to bind the
firm and the other partners by acting in any usual business transaction
related to the partnership.
 For example, if one of the partners of a partnership signs a lease with
a landlord, all other partners are automatically bound by the terms and
conditions of the lease. Every partner is jointly and severally liable if
one partner, while acting on behalf of the firm, causes loss or injury to
a third party by a wrongful act or omission.
 For example, if one of the partners in an engineering firm gives
incorrect advice to a client, which causes loss to the client though
negligence, all other partners in the firm are liable to indemnify the
client.
6
 Partnership agreement
 Read textbook on requirements of
partnership
 Plus: interest rate agreed for capital
introduced or withdraw
 Plus: details of salaries

7
 Accounting for partnership
 As a partnership is a permanent arrangement, when one is formed a
set of partnership ledgers and accounts must be maintained and, at
the end of each accounting period, a partnership income statement
and balance sheet is prepared.

 Individual partners do not keep details of their own transactions in

another set of records.

 Only the set relating to the partnership as a one set of records whole is
prepared . However, as part of the double entry system, separate
drawings and capital accounts are maintained for each partner.
At the end of each period, the profit or loss earned is divided between
the partners in the agreed ratio

8
 Organizing a Partnership
Partners
Partners can
can invest
invest both
both assets
assets and
and liabilities
liabilities in
in the
the
partnership.
partnership.

Assets
Assets and
and liabilities
liabilities are
are recorded
recorded atat an
an agreed-
agreed-
upon
upon value,
value, normally
normally fair
fair market
market value.
value.

Asset
Asset contributions
contributions increase
increase the
the partner’s
partner’s capital
capital
account.
account.

Withdrawals
Withdrawals from
from the
the partnership
partnership decrease
decrease the
the
partner’s
partner’s capital
capital account.
account. 9
 Organizing a Partnership
- simple case
On
On 2/15/05,
2/15/05, Smith
Smith and
and Jones
Jones form
form aa partnership.
partnership.
Smith
Smith contributes
contributes $80,000
$80,000 cash.
cash. Jones
Jones
contributes
contributes land
land valued
valued at
at $40,000.
$40,000.
Feb. 15 Cash 80,000
Land 40,000
Smith, Capital 80,000
Jones, Capital 40,000
To record initial investment in partnership

10
 Dividing Profit or Loss
 The adjustments to net profit or loss/net income or
loss for interest on capital, interest on drawings,
and partner salaries are made in an appropriation
account.
 Once adjustments have been made in the
appropriation account for these items, the
remaining amount is shared between the partners
in their profit sharing ratio.
 The appropriation account is typically appended to
the foot of the income statement. Exhibit 12.1 is an
example of an appropriation account.
 Appropriation is finally closed to current account

11
Basic format

12
 Appropriation account
 Lets’ do the activity together
 Mak, Lee and So are partners. They share profits and losses in the
ratios of 1/7, 2/7and 4/7 respectively.

 For the year ended 31 December 20X4, their capital accounts

remained fixed at the following amounts:
 Mak $80,000
 Lee $90,000
 So $40,000

 They have agreed to give each other 8% interest per annum on their
capital accounts.

 In addition to the above, partnership salaries are to be charged:

 Lee $120,000
 So $150,000
13
 Appropriation account
 Their drawings for the year were (all on 1 July 20X4):
 Mak $75,000
 Lee $66,000
 So $98,000
 And the partners had agreed to pay 10% interest on any
drawings.
 The net profit of the partnership, before taking any of the
above into account, was $980,000.
 Required:
 Draw up the appropriation account of the partnership for
the year ended 31 December 20X4.
14
 Solution
Mak, Lee and So
Appropriation Account for the year ended 31 December 20X4
$ $ $
Net profit 980,000
Add: Interest on drawings Mak 3,750
Lee 3,300
So 4,900
(=drawings x 10%x 6/12) 11,950 The pool
gathered for
991,950
distribution
Less: Salaries Lee 120,000
So 150,000
270,000
Interest on capital Mak 6,400
Lee 7,200
So 3,200
16,800
(286,800)
705,150
Balance of profits shared Mak 1/7 100,736
Lee 2/7 201,471
So 4/7 402,943
705,150

15
 Current account vs Capital account
 Current account is an account maintained for each partner
in which a partner’s share of the profits and losses of the
partnership are recorded. Drawings, interest on drawings,
interest on capital and a partner’s salary are also recorded
in this account.

 Usually Partnership operates partnership current accounts

as well as capital accounts and record any withdrawals
and other adjustments through that account rather than
through the capital account.

 The capital account balance does not change as a result

of any drawings, interest, salary, or share of profit.

16
 Current account
 All these adjustments are carried out in the
partners’ current accounts. Drawings, interest on
drawings, and share of losses are debited to it
while salaries, interest on capital, and share of
profits are credited to it.

 The other side of the double entry is to the

appropriation account except in the case of
drawings, for which, of course, the other side of
the double entry is a credit entry in the partnership
bank account.
17
 Withdrawal of cash ( use the drawings account or not)

 Dr. Partner’s drawings account (or Partner’s XXX

current account directly)
 Cr. Cash XXXX

 Withdrawal of goods
 Dr. Partner’s drawings account (or Partner’s X
current account)
 Cr. Purchases or Inventory X

 The balance in the drawing account is then transferred to the partner’s

individual current accounts periodically or at the end of the year if
drawing account is used.

 DR Current Account XXX

 CR Partner’s drawings account XXX

18
 1. The appropriation a/c entries
 Dr income Summary XX
 Cr Appropriation A/c XX

 2. The current account entries
 i) Interest on drawings
 Dr Partner C/A XX
 Cr Appropriation a/c XX

 ii) Interest on capital
 Dr Appropriation a/c XX
 Cr. C/A XX
 iii) Partner’s salaries
 Dr Appropriation a/c XX
 Cr. C/A XX
 iv) share of partnership’s profits or losses.
 Dr Appropriation a/c XX
 Cr. C/A XX

19
 In this example:
1. The appropriation a/c entries
Dr income Summary 980,000
Cr Appropriation A/c 980,000

2. The current account entries

i) Interest on drawings
DR C/A Mak 3,750
DR C/A Lee 3,300
DR C/A So 4,900
CR Appropriation a/c 11,950

20
ii) Interest on capital
Dr Appropriation a/c 16,800
Cr. C/A Mak 6,400
Cr. C/A Lee 7,200
Cr. C/A So 3,200

iii) Partner’s salaries

Dr Appropriation a/c 270,000
Cr. C/A Lee 120,000
Cr. C/A So 150,000
iv) share of partnership’s profits or losses.
Dr Appropriation a/c 705,150
Cr. C/A Mak 100,736
Cr. C/A Lee 201,471
Cr. C/A So 402,943

21
 Appropriation a/c
Interest on capital 16,800 Net Income 980,000
　 Interest on drawing 11,950
Partner's salaries 270,000
　
Share of profit or losses 705,150
　
　 　 　 　 　
991,950 991,950
　
　

22
 Current account
Partner’s current account
$ $
Drawings X Beginning X
balance

Interest on X Interest on X
drawings capital

Partner’s X
salaries

Share of X
profits
Ending X
balance

23
 Current a/c--example
 Assuming Mak, Lee and So (from Activity
above) had balances on their current
accounts at the start of 20X4 of $30,000;
$20,000 and $5,000 respectively ; what
are the capital a/c and current a/c
balances?

24
Current a/c
Capital — Mak
$ $
Beginning 80,000
Balance

Capital — Lee
$ $
Beginning 90,000
Balance

Capital — So
$ $
Beginning 40,000
Balance

25
 Current a/c
Current — Mak
$ $
Bank: Drawings 75,000 Beginning balance 30,000
Appropriation account Appropriation account
Interest on drawings 3,750 Interest on capital 6,400
Share of profit 100,736
Ending balance 58,386

Current — Lee
$ $
Bank: Drawings 66,000 Beginning balance 20,000
Appropriation account Appropriation account
Interest on drawings 3,300 Interest on capital 7,200
Balance c/d 279,371 Salary 120,000
Share of profit 201,471
Ending balance 279,371

26
 Current a/c
Current — So

$ $
Bank: 98,000 Beginning 5,000
Drawings balance
Appropriation Appropriation
account account:
Interest on 4,900 Interest on 3,200
drawings capital
Balance c/d 458,243 Salary 150,000

Share of profit 402,943

Ending balance 458,243

27
 Partnership Financial Statements
 In summary:
 The income statement of a partnership is identical
to that of a sole proprietor. The only difference is
that an appropriation section is added after the net
profit figure.
 The balance sheet/ statement of financial position
of a partnership is also similar to that produced for
a sole proprietor.
 However, there is a major difference in the capital
section, where the capital and current accounts of
each partner are shown, along with details of the
adjustments made to them during the accounting
28
period.
 Partnership Financial Statements
Balance Sheet as at 31 December 20X4 (extract)
$
Capital accounts

Mak 80,000
Lee 90,000
So 40,000

Mak Lee So
Current accounts
$ $ $ $ $ $
Balance at 1 30,000 20,000 5,000
January 20X4
Interest on capital 6,400 7,200 3,200
Salary 120,000 150,000
Share of profit 100,736 201,471 402,943
137,136 348,671 561,143
Less:
Drawings 75,000 66,000 98,000
Interest on 3,750 3,300 4,900
Drawings
(78,750) (69,300) (102,900)
58,386 279,371 458,243

29
Exercise

30
 Admission and Withdrawal of
Partners

 When
When the
the makeup
makeup ofof the
the partnership
partnership
changes,
changes, the
the partnership
partnership is is dissolved.
dissolved.

 AA new
new partnership
partnership may
may be be immediately
immediately
formed.
formed.

 New
New partner
partner acquires
acquires partnership
partnership interest
interest
by:
by:
1.
1. Purchasing
Purchasing itit from
from the
the other
other partners,
partners, or
or
2.
2. Investing
Investing assets
assets in in the
the partnership.
partnership.
31
Admission of a Partner
Purchase of Partnership Interest
A
 A new
new partner
partner can
can purchase
purchase
partnership
partnership interest
interest directly
directly
from
from the
the existing
existing partners.
partners.
The
 The cash
cash goes
goes to
to the
the partners,
partners,
not
not to
to the
the partnership.
partnership.
To
 To become
become aa partner,
partner, the
the new
new
partner
partner must
must be
be accepted
accepted by
by
the
the current
current partners.
partners.
32
 Purchase of Partnership Interest
On January 2, 2006, Jones agrees to sell Johnson
$10,000 of her partnership interest for $25,000
cash. Smith agrees with this arrangement.
Smith Jones Johnson Total
Capital balances before new partner $ 108,500 $ 65,500 $ - $ 174,000
Allocation to new partner (10,000) 10,000 -
Capital balances after new partner $ 108,500 $ 55,500 $ 10,000 $ 174,000

Jan 2 Jones, Capital 10,000

Johnson, Capital 10,000
To record admission of new partner

33
Investing Assets in a Partnership
The
 The new
new partner
partner can
can gain
gain
partnership
partnership interest
interest by by
contributing
contributing assets
assets to to the
the
partnership.
partnership.
The
 The new
new assets
assets will
will increase
increase
the
the partnership’s
partnership’s netnet assets.
assets.
After
 After admission,
admission, both
both assets
assets
and
and equity
equity will
will increase.
increase.
34
 Investing Assets in a Partnership
On January 2, 2006, Smith and Jones agree to accept
Johnson as a partner upon his investment of $30,000
cash in the partnership.
Smith Jones Johnson Total
Capital balances before new partner $ 108,500 $ 65,500 $ - $ 174,000
Allocation to new partner 30,000 30,000
Capital balances after new partner $ 108,500 $ 65,500 $ 30,000 $ 204,000

Jan 2 Cash 30,000

Johnson, Capital 30,000
To record admission of new partner

35
 Bonus( Goodwill) to Old or New
Partners
When
When the
the current
current value
value of
of aa
partnership
partnership isis greater
greater than
than the
the
Bonus
Bonus to
to Old
Old recorded
recorded amounts
amounts of of equity,
equity, the
the old
old
Partners
Partners partners
partners usually
usually require
require aa new
new partner
partner
to
to pay
pay aa bonus
bonus when
when joining.
joining.

The
The partnership
partnership may may grant
grant aa bonus
bonus to to
Bonus
Bonus to
to New
New aa new
new partner
partner ifif the
the business
business is
is in
in
Partners=
Partners= need
need ofof cash
cash or
or ifif the
the new
new partner
partner has
has
negative exceptional
exceptional talents.
talents.
negative
bonus
bonus

36
 Bonus to Old Partners
On January 2, 2006, Smith and Jones agree to accept
Johnson as a partner upon his investment of $60,000
cash in the partnership. Johnson is to receive a 20%
ownership interest in the new partnership. Any bonus
is attributable to the existing partners and is shared
equally.

Equity of Smith and Jones $174,000

Investment by Johnson 60,000
Total partnership equity 234,000
Johnson's ownership percent 20%
Johnson's equity balance $ 46,800
37
 Bonus to Old Partners
On January 2, 2006, Smith and Jones agree to accept
Johnson as a partner upon his investment of $60,000
cash in the partnership. Johnson is to receive a 20%
ownership interest in the new partnership. Any bonus
is attributable to the existing partners and is shared
equally.
Jan 2 Cash 60,000
Johnson, Capital 46,800
Smith, Capital 6,600
Jones, Capital 6,600
To record admission of new partner
$60,000 - $46,800 = $13,200 × ½ = $6,600
38
 Bonus to New Partner
On January 2, 2006, Smith and Jones agree to accept
Johnson as a partner upon his investment of $60,000
cash in the partnership. Johnson is to receive a 30%
ownership interest in the new partnership. Any bonus
is attributable to the new partner and is shared
equally by the existing partners.
Equity of Smith and Jones $174,000
Investment by Johnson 60,000
Total partnership equity 234,000
Johnson's ownership percent 30%
Johnson's equity balance $ 70,200

39
 Bonus to New Partner
On January 2, 2006, Smith and Jones agree to accept
Johnson as a partner upon his investment of $60,000
cash in the partnership. Johnson is to receive a 30%
ownership interest in the new partnership. Any bonus
is attributable to the new partner and is shared
equally by the existing partners.
Jan 2 Cash 60,000
Smith, Capital 5,100
Jones, Capital 5,100
Johnson, Capital 70,200
To record admission of new partner

$70,200 - $60,000 = $10,200 × ½ = $5,100

40
 Goodwill
 If the existing partners continue to share profits
and losses in the same ratio to each other as
they did under the previous partnership
agreement, the adjustments to the capital
accounts to be made as a result of a new
partner paying a bonus (i.e. goodwill) of this type
are the same as in your textbook and above
examples
 Debit the new partner’s capital account with
the amount of the bonus and credit the capital
account of each of the existing partners with
their share of the bonus calculated on the basis
of their profit sharing ratio.
41
 Goodwill
 Ifthe partners in the new partnership agree
on a new profit sharing ratio that means the
ratio relationship between the old partners
has changed, it is the new ratio that must be
used.

42
 Example Poon and Wang are in partnership and share profits and
losses equally. Tung joins as a partner and pays $18,000 as a
bonus over and above his capital investment. The three partners
agree to share profits and losses in the ratio Poon: 1/3; Wang: 4/9;
Tung: 2/9.
 Step 1 — calculate total goodwill: $18,000 represents 2/9 of the total
goodwill so the total is $81,000.

 Step 2 — split the total goodwill among the old partners under the old
profit sharing ratio: Poon ½: Wang ½ = Poon: $40,500; Wang: $40,500.

 Step 3 — split the total goodwill among all the partners in the new
profit sharing ratio: Poon 1/3 : Wang 4/9 : Tung 2/9 = Poon: $27,000;
Wang: $36,000; Tung: $18,000.

 Step 4 — calculate the difference between the two sets of answers for
the old partners: Poon = $40,500 minus $27,000 = a loss of $13,500;
Wang = $40,500 minus $36,000 = a loss of $4,500.

 Step 5 — make the entries in the capital accounts.

43
Total Value of investment = C+G where C is
the share of capital and G= goodwill
Sharing Ratio
Old New
P: 0.5G P:3/9 G
W: 0.5G W: 4/9G
T:2/9G

44
 2/9G=$18,000
G=$18,000*9/2=$81,000
Sharing Ratio
Old New Difference
P: 0.5G=$40,500 P:3/9 G=$27,000 Loss=$13,500
W: 0.5G=$40,500 W: 4/9G=$36,000 Loss=$4,500

JE
Dr Bank 18,000
Cr Capital –Tung 18,000
DR Capital Tung 18,000
CRCapital- Poon 13,500
CRCapital- Wang 4,500
45
 Capital — Poon (extract)

$ $

Capital — Tung (bonus) 13,500

Capital — Wang (extract)

$ $
Capital — Tung (bonus) 4,500

Capital — Tung (extract)

$ $
Capital — Poon 13,500 Bank: Bonus 18,000
Capital — Wang 4,500
18,000 18,000

46
Withdrawal of a Partner
A
A partner
partner can
can withdraw
withdraw in
in
two
two ways:
ways:
The
 The partner
partner can
can sell
sell his/her
his/her
partnership
partnership interest
interest to
to
another
another person.
person.
The
 The partnership
partnership can
can
distribute
distribute cash
cash and/or
and/or other
other
assets
assets to
to the
the withdrawing
withdrawing
partner.
partner.
47
 Withdrawal of a Partner
Jones has a capital balance of $65,500. She decides to
withdraw from the partnership of Smith, Jones, and Johnson
for $50,000 cash. Any bonus is attributable to the remaining
partners and is divided equally.

Jan 2 Jones, Capital 65,500

Cash 50,000
Smith, Capital 7,750
Johnson, Capital 7,750
To record withdrawal of partner

$65,500 - $50,000 = $15,500 × ½ = $7,750

48
 Liquidation of a Partnership
 There are two different situations that may
be described as liquidation of a partnership.
The first involves the realization of all the
assets and liabilities of the partnership, i.e.
all assets are sold and all liabilities are paid.
 The second situation involves the partners
terminating the partnership and then
transferring the assets and liabilities to a
new partnership
49
 Liquidation of a Partnership


 Any
Any balance
balance of of funds
funds is is then
then distributed
distributed amongamong the the
partners,
partners, thereby
thereby reducing
reducing the the balances
balances on on their
their capital
capital
and
and current
current accounts
accounts to to zero.
zero. This
This is is always
always the the outcome,
outcome,
as
as the
the gains
gains andand losses
losses on on realization
realization of of the
the assets
assets and and
liabilities
liabilities are
are shared
shared amongamong the the partners,
partners, usually
usually in in their
their
profit
profit and
and loss
loss sharing
sharing ratio.
ratio.

 we
we shall
shall bebe using
using aa partnership
partnership realization
realization account
account to to
record
record thethe gains
gains andand losses
losses on on realization
realization of of the
the
partnership
partnership assets
assets and and liabilities
liabilities and
and to to transfer
transfer thethe overall
overall
gain
gain oror loss
loss among
among the the partners
partners in in their
their profit
profit sharing
sharing ratioratio

 WeWe will
will then
then pay
pay allall the
the partners
partners thethe amount
amount due due to to them
them
as
as shown
shown by by their
their capital
capital accounts
accounts and and close
close offoff the
the
accounts
accounts of of the
the partnership.
partnership.

50
 Example 9.8
 Sun and Chan, who share profits and losses in the ratio of ¼ :
¾, decide to terminate their partnership as at 31 March 20X4.
Their balance sheet on that date was as follows:
Fixed assets $ $
Office 500,000
Furniture 20,000
IT equipment 5,000
525,000
Current assets
Debtors (Account 46,000
receivables)
Bank 62,000
108,000
Less: Current
liabilities
Creditors/AP (63,000)
45,000
570,000
Capital accounts
Sun 160,000
Chan 410,000
570,000

51
The following amounts were realized:

$
Office 480,000
Furniture 12,000
IT equipment 2,800
Debtors (accounts receivable) 43,000

The following amounts were paid out:

$

Dissolution expenses 1,200

Creditors (accounts payable) after 62,200

discount of $800

52
Dr Realization A/c 500,000
Cr Office 500,000
Dr Bank 480,000
CR Realization A/c 480,000
Same JE for Furniture, IT equipment, Debtors,

DR Creditor/AP 63,000
CR Realization a/c 63,000
DR Realization a/c 62,200
Cr Bank 62,200
Dr Realization a/c 1,200
Cr Bank 1,200

Total Loss =$33,600

Sharing in ratio Sun and Chan, 1/4 : 3/4=$8400 : $25,200

Dr Capital – Sun 8,400
Cr Realization a/c 8,400
DR Capital- Chan 25,200
Cr Realization a/c 25,200
53
Sharing in ratio Sun and Chan, 1/4 : 3/4=$8400 : $25,200
Dr Capital – Sun 151,600
Cr Bank 151,600
DR Capital- Chan 384,800
Cr Bank 384,800

54
 Sun and Chan
Realization Account
$ $
Office 500,000 Creditors 63,000
Furniture 20,000 Bank: Office 480,00
0
IT equipment 5,000 Furniture 12,000
Debtors 46,000 IT equipment 2,800
Dissolution expenses 1,200 Debtors 43,000
Bank: Creditors 62,200 Loss on realization
Sun 8,400
Chan
25,200

Capital — Sun
$ $
Loss on realization 8,400 Beginning balance 160,000
Bank 151,600

55
 Capital — Chan
$ $
Loss on realization 25,200 Beginning balance 410,000
Bank 384,800

Bank
$ $
Balance b/d 62,000 Dissolution expenses 1,200
Realization - Office 480,000 Creditors 62,200
Furniture 12,000 Capital — Sun 151,600
IT equipment 2,800 Capital — Chan 384,800
Debtors 43,000

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Exercise

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End of Ch12

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