ACCOUNTING FOR PARTNERSHIPS
LEARNING OBJECTIVES
Discuss and account for the formation of a partnership.
Explain how to account for net income or net loss of a
partnership.
Explain how to account for the liquidation of a partnership.
LEARNING OBJECTIVES
Describe the characteristics of the partnership form of business
organization.
Account for the formation of a partnership.
Allocate and record profit or loss to partners
Prepare partnership financial statements
Account for the admission of a partner
Account for the withdrawal of a partner.
Account for the liquidation of a partnership
LEARNING OBJECTIVES
Describe the main features of a partnership agreement
Explain what will happen if no agreement exists on how to share
profits or losses
Draw up the ledger accounts and financial statements for a partnership
Explain what happens upon dissolution of a partnership
Record the entries relating to the dissolution of a partnership
Definition of partnership
Partnership is the relation which subsists between persons carrying on a
business in common with a view of profit.
A partnership is an association of two or more persons to carry on as coowners of a business for profit.
Partnerships are sometimes used in small retail, service, or
manufacturing companies. Accountants, lawyers, and doctors also find it
desirable to form partnerships with other professionals in the field.
Partnerships are arrangements between individuals to carry on
business in common with a view to profit.
A partnership, however, involves obligations to others, and so a
partnership is usually governed by a partnership agreement. Unless it
is a limited liability partnership (LLP), partners will be fully liable for
debts and liabilities, for example if the partnership is sued.
In law, partnerships are not separate entities from their owners.
However, a limited liability company is legally a separate entity from
its owners. Contracts can therefore be issued in the company’s name.
Characteristics of Partnerships
A partnership has the following characteristics:
a) It is formed to make profits.
b) It must obey the law as given in the Partnership Act. If there is a limited
partner, it must also comply with the Limited Partnership Act.
c) 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, values, estate agents, land agents, estate
managers, or insurance brokers.
Characteristics of Partnerships
(d) 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.
(e) Partners who are not limited partners are known as general
partners.
Characteristics of Partnerships
Mutual agency means that each partner acts on behalf of the
partnership when engaging in partnership business. The act of any partner
is binding on all other partners.
LIMITED LIFE. Partnership business has a limited liability. A partnership
may be ended voluntarily at any time through the acceptance of a new
partner or the withdrawal of a partner. It may be ended involuntarily by the
death or incapacity of a partner.
 Partnership dissolution occurs whenever a partner withdraws or anew
partner is admitted.
 Dissolution does not necessarily mean that the business ends. If the
continuing partners agree, operations can continue without interruption by
forming a new partnership
Characteristics of Partnerships
UNLIMITED LIABILITY
 Each partner is personally and individually liable for all partnership
liabilities.
 Creditors’ claims attach first to partnership assets. If these are insufficient,
the claims then attach to the personal resources of any partner,
irrespective of that partner’s equity in the partnership.
 Because each partner is responsible for all the debts of the partnership,
each partner is said to have unlimited liability.
CO-OWNERSHIP OF PROPERTY
 Each partner has a claim on total assets.
 This claim does not attach to specific assets.
 All net income or net loss is shared equally by the partners, unless
otherwise stated in the partnership agreement.
ORGANIZATIONS WITH PARTNERSHIPS CHARACTERISTICS
Special forms of business organizations are often used to provide protection
from unlimited liability.
Special partnership forms are:
 Limited Partnerships….In a limited partnership, one or more partners have
unlimited liability and one or more partners have limited liability for the
debts of the firm. Those with unlimited liability are general partners
 Limited Liability Partnerships….The LLP is designed to protect innocent
partners from malpractice or negligence claims resulting from the acts of
another partner.
 Limited Liability Companies ..An LLC usually has a limited life. The owners,
called members, have limited liability like owners of a corporation.
Types of partners
• There are number of different types of partners
(a)General partners This term refers to any partner actively involved in the
running and management of a partnership business
(b)Sleeping partners this type of partner contributes capital to the business
but is not involved in the day to day running of the partnership business
(c)Limited partner. This type of partner is found in a limited partnership, not
in an ordinary partnership
Limited partnerships
Characteristics and restrictions
i. Their liability for the debts of the partnership is limited to the capital they have put in. They can
lose that capital, but they cannot be asked for any more money to pay the debts unless they
contravene the regulations relating to their involvement in the partnership.
ii. They are not allowed to take out or receive back any part of their contribution to the partnership
during its lifetime.
iii. They are not allowed to take part in the management of the partnership or to have the power to
make the partnership take a decision. If they do, they become liable for all the debts and
obligations of the partnership up to the amount taken out or received back or incurred while
taking part in the management of the partnership.
Main features of limited liability partnership
 An LLP is a corporate (corporate body). It has a legal personality, separate from its
individual partners. In this respect, LLP are similar to limited companies and different
from ordinary partnerships.
 LLP must be incorporated in much the same way as a company.
 The liability of all partners is limited to their capital investment in the partnership. An
LLP, like a company, therefore provides limited liability for its owners.
 Each member of the LLP is an agent and can bind the LLP
 The business name of LLP must end with the words Limited Liability Partnership or
LLP
Main features of limited liability partnership
 For tax purposes LLP are treated as a partnership. In other words, the
profit of the partnership are not taxed directly, unlike the profits of a
limited. The individual partners in an LLP are taxed personally on
their share of the partnership profits, which is treated as one of the
sources of taxable income.
ORGANIZATIONS WITH PARTNERSHIPS
CHARACTERISTICS
REGULAR PARTNERSHIP
Major Advantages
Major Disadvantages
 Simple and inexpensive
 Owners (partners)
to create and operate.
personally liable for
business debts.
ORGANIZATIONS WITH PARTNERSHIPS
Major Advantages


“Ltd.,” or “LP”
Limited partners have limited personal
liability for business debts as long as
they do not participate in management.
Major Disadvantages

General partners personally liable for
business debts.
General partners can raise cash without
involving outside investors in
management of business.

More expensive to create than regular
partnership.

Suitable for companies that invest in
real estate.
ORGANIZATIONS WITH PARTNERSHIPS
CHARACTERISTICS
Major Advantages


“LLP”
Mostly of interest to partners in old-line
professions such as law, medicine, and
accounting.
Major Disadvantages

Partners remain personally liable for
many types of obligations owed to
business creditors, lenders, and
landlords.

Often limited to a short list of
professions.
Owners (partners) are not personally liable
for the malpractice of other partners.
ORGANIZATIONS WITH PARTNERSHIPS CHARACTERISTICS
Major Advantages
 Owners have limited
personal liability for
business debts even if
they participate in
management.
“LLC”
Major Disadvantages
 More expensive to
create than regular
partnership.
Partnership agreements
Contents of partnership agreements
The written agreement can contain as much, or as little, as the partners want. The law does not say
what it must contain. The usual accounting contents are:
i. The capital to be contributed by each partner.
ii. The ratio in which profits (or losses) are to be shared.
iii. The rate of interest, if any, to be paid on capital before the profits are shared.
iv. The rate of interest, if any, to be charged on partners’ drawings.
v. Salaries to be paid to partners.
vi. Arrangements for the admission of new partners.
vii. Procedures to be carried out when a partner retires or dies.
PARTNERSHIP AGREEMENT
•
Should specify relationships among the partners:
1. Names and capital contributions of partners.
2. Rights and duties of partners.
3. Basis for sharing net income or net loss.
4. Provision for withdrawals of assets.
5. Procedures for submitting disputes to arbitration.
6. Procedures for the withdrawal or addition of a partner.
7. Rights and duties of surviving partners in the event of a partner’s
death.
Advantages of partnerships
(a) Less stringent reporting obligations – no requirement to make financial accounts
publicly available, no audit requirement, unless the partnership has LLP status.
(b) Additional capital can be raised because more people are investing in the
business.
(c) Division of roles and responsibilities and an increased skill set.
(d) Sharing of risk and losses between more people.
(e) No company tax on the business (profits are distributed to partners and then
subject to personal tax).
Disadvantages of partnerships
(a) Partners are jointly personally liable for all debts (unlimited liability) unless they have
formed a limited liability partnership.
(b) There are costs associated with setting up partnership agreements.
(c) There may be issues of continuity of business in the event of death or illness of the
partners.
(d) Slower decision making due to the need for consensus between partners.
(e) Unless a clause is written into the original agreement, when one partner leaves, the
partnership is automatically dissolved and another agreement is required between existing
partners.
Capital contributions
Partners’ Capital Accounts
A capital account is maintained for each partner. The total balance in the partners’ capital account
after year end closing entries represents the partner’s ownership equity in the business. Each partner’s
capital account its:
 Credited with the original investment
 Credited with the subsequent investment
 Credited with agreed share of net assets
 Debited with agreed share of net loss
 Debited with permanent capital reductions
 Debited with the balance of the partner’s drawing account at the end of each fiscal period
Profit (or loss) sharing ratios
• Partners can agree to share profits/losses in any ratio or any way that
they may wish. However, it is often thought by students that profits
should be shared in the same ratio as that in which capital is contributed.
Interest on capital
 If the work to be done by each partner is of equal value but the capital
contributed is unequal, it is reasonable to pay interest on the partners’
capitals out of partnership profits. This interest is treated as a deduction
prior to the calculation of profits and their distribution among the partners
according to the profit sharing ratio.
The rate of interest is a matter of agreement between the partners, but it
should equal the return which they would have received if they had invested
the capital elsewhere.
Interest on drawings
It is obviously in the best interests of the firm if cash is withdrawn from the firm by the
partners in accordance with the two basic principles of: (a) as little as possible, and (b) as
late as possible.
 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.

The amount charged to them helps to swell the profits divisible between the partners.
 The rate of interest should be sufficient to achieve this without being too harsh.
Partners’ Drawings Accounts
Partners may withdraw either cash or merchandise from the business.
Withdrawals of cash are charged to the partner’s drawings account
and credited to cash.
The partnership agreement should specify whether withdrawals of
merchandise are to be valued at cost or selling price.
 If merchandise is valued at cost, the withdrawals is debited to the
partners’ drawing account and credited to the purchases
 If the merchandise is valued at selling price, the withdrawal is debited
to the partner’s drawing account and credited to sales
Division of Partnership Income or Loss
Partnership income and loss are divided in accordance with the
provisions in the partnership agreements.
 The agreed way that a partnership’s income or losses are to be shared
is called the income and loss ratio (profit and loss ratio or earnings and
loss ratio).
If the agreement is silent with respect to the division income, income
is divided equally among the partners.
 If the agreement is silent as to loss distribution, losses are also
divided equally among the partners.
Accounting for a Partnership Formation
When forming a partnership, each partner’s initial investment in a
partnership is entered in the partnership records. The partnership
should record these investments at the fair value of the assets at the
date of their transfer to the partnership. All partners must agree to the
values assigned.
Example
A. Taboo and T. Amanda combine their proprietorships to start a
partnership named ZM Software. The firm will specialize in developing
financial modelling software. Taboo and Amanda have the following
assets prior to the formation of the partnership.
Example ‘
Book Value
Fair Value
A. Taboo T. Amanda A. Taboo
T. Amanda
Cash
K 8,000
K 9,000
K 8,000
K 9,000
Equipment
5,000
4,000
Accumulated dep—equipment
(2,000)
Accounts receivable
4,000
4,000
Allowance for doubtful accounts
(700)
(1,000)
K11,000
K12,300
K12,000
K12,000
Required
Make journal entries to record the partners investments
Solutions
Investment of A. Taboo
Cash
Equipment
A. Taboo, Capital
(To record investment of Taboo)
Investment of T. Amanda
Cash
Accounts Receivable
Allowance for Doubtful Accounts
T. Amanda, Capital
(To record investment of Amanda)
8,000
4,000
12,000
9,000
4,000
1,000
12,000
LO2. Explain how to account for net
income or net loss of a partnership.
Dividing Net Income or Net Loss
Partners equally share partnership net income or net loss unless the
partnership contract indicates otherwise. The same basis of division
usually applies to both net income and net loss.
Because of its wide acceptance, we use the term income ratio to
identify the basis for dividing net income and net loss.
The partnership recognizes a partner’s share of net income or net loss
in the accounts through closing entries
CLOSING ENTRIES
As in the case of a proprietorship, a partnership must make four entries in preparing
closing entries. The entries are:
1. Debit each revenue account for its balance, and credit Income Summary for
total revenues.
2. Debit Income Summary for total expenses, and credit each expense account
for its balance.
3. Debit Income Summary for its balance, and credit each partner’s capital
account for his or her share of net income. Or, credit Income Summary, and
debit each partner’s capital account for his or her share of net loss.
4. Debit each partner’s capital account for the balance in that partner’s drawings
account, and credit each partner’s drawings account for the same amount
DIVIDING NET INCOME OR NET LOSS
Example
Sara King and Ray Lee are co-partners in the Kingslee Company. The
partnership agreement provides for: (1) salary allowances of K8,400 to
King and K6,000 to Lee, (2) interest allowances of 10% on capital
balances at the beginning of the year, and (3) the remainder equally.
Capital balances on January 1 were King K28,000, and Lee K24,000. In
2017, partnership net income is K22,000.
Required
(a) Prepare a schedule showing the distribution of net income.
(b) Journalize the allocation of net income.
Net income ……………………………………………………K22,000
Less salary Sarah ……………………K8400
Lee………………………. 6, 000
14400
7, 600
Less interest on capital
sarah( K28000 x 10%)
2, 800
Lee ( K24000 x 10%)
2, 400
5, 200
2, 400
Share of profit sarah (1/2 x 2400) 1200
lee (1/2 x 2400) 1200
DIVIDING NET INCOME OR NET LOSS
DIVIDING NET INCOME OR NET LOSS
Kingslee records the division of net income as follows.
Dec. 31 Income Summary
22,000
Sara King, Capital
12,400
Ray Lee, Capital
9,600
(To close net income to partners’ capital
DIVIDING NET INCOME OR NET LOSS
Illustration: Prepare a schedule showing the distribution of net
income assuming net income is only K18,000.
Example on the distribution of profits
Taylor and Clarke have been in partnership for one year sharing profits and
losses in the ratio of Taylor 3:5, Clarke 2:5. They are entitled to 5 per cent per
annum interest on capitals, Taylor having K 20, 000 capital and Clarke K 60,
000. Clarke is to have a salary of K 15,000. They charge interest on drawings,
Taylor being charged K 500 and Clarke K1, 000. The net profit, before any
distributions to the partners, amounted to K 50, 000 for the year ended 31
December 2007. Required. Show how the profit has been distributed
Solutions
K
K
Net profit
K
50, 000
Add Charged for interest on drawings:
Taylor
500
Clarke
1000
1500
51, 500
Salary Clarke
15, 000
Interest on capital
Taylor (5% x 20,000)
1, 000
Clarke (5% x 60, 000)
3, 000
Solutions
4000
(19, 000)
32, 500
Balance of Profit
Shared:
Taylor (3/5 x 32, 500)
19, 500
Clarke (2/5 x 32,500)
13, 000
32, 500
Solutions
The K50, 000 net profits have therefore been shared:
Taylor
Clarke
K
K
Balance of profits
19,500
13,000
Interest on capital
1,000
3,000
–
15,000
20,500
31,000
(500)
(1,000)
20,000
30,000
Salary
Less Interest on drawings
K 50, 000
Preparing partnership accounts
If a partner makes a loan to the business, he will receive interest on it
in the normal way. Loan interest due, interest on capital and partners
salaries are deducted and the remaining net profit is apportioned
according to the profit sharing ratio.
How does accounting for partnerships differ from accounting for sole
traders?
Partnership accounts are identical in many respects to the accounts of
sole traders.
(a) The assets of a partnership are like the assets of any other business,
and are accounted for in the same way.
(b) The net profit of a partnership is calculated in the same way as the net
profit of a sole trader. The only minor difference is that if a partner makes a
loan to the business (as distinct from capital contribution) then interest on
the loan will be an expense in the income statement, in the same way as
interest on any other loan from a person or organisation who is not a
partner.
There are two respects in which partnership accounts are different, however.
(1) The funds put into the business by each partner are shown differently.
(b) The net profit must be appropriated by the partners, i.e shared out
according to the partnership agreement. This appropriation of profits must
be shown in the partnership accounts.
Appropriation of profit means sharing out profits in accordance with the
partnership agreement.
EXAMPLE
Kimberly and Lucifer are in partnership sharing profits and losses in the ratio
7:3 respectively. The following information has been taken from the
partnership records for the financial year ended 31 May 2009.
Partners' capital account balances:
Kimberly
K200, 000
Lucifer
K140,000
Partners' current accounts, balances as at 1 June 2008:
Kimberly K15,000 Cr
Lucifer K13, 000 Cr
EXAMPLE CONT’
During the year ended 31 May 2009 the partners made the following withdrawals
from the partnership bank account.
Kimberly K10, 000 on 31 August 2008
K10, 000 on 30 November 2008
K10, 000 on 28 February 2009
K10, 000 on 31 May 2009
Lucifer K7, 000 on 31 August 2008
K7, 000 on 30 November 2008
K7, 000 on 28 February 2009
K7, 000 on 31 May 2009
EXAMPLE CONT’
Interest is to be charged on drawings at the rate of 12% per annum. Interest is
allowed on capital accounts t the rate of 12% and interest to charged on credit
balances on current accounts at the rate of 10% per annum.
Lucifer is to be allowed a salary of K15, 000 per annum.
The net profit of the partnership for the year ended 31 May 2009 is K102, 940.
Required
(a) Calculate the amount of interest chargeable on each partner's drawings for the
year ended 31 May 2009.
(b) Produce the partnership appropriation account for the year ended 31 May 2009.
(c) Calculate the balance on each partner's current account as at 31 May 2009.
Solutions
(a) Interest on partners' drawings for the year ended 31 May 2009
Kimberly
K
31.8.08
K10, 000 x 12% x 9/12
900
30.11.08
K10, 000 x 12% x 6/12
600
28.2.09
K10, 000 x 12% x 3/12
300
1,800
Lucifer
31.8.08
K7, 000 x 12% x 9/12
630
30.11.08
K7, 000 x 12% x 6/12
420
28.2.09
K7, 000 x 12% x 3/12
210
1,260
Total
3,060
Solution cont’
(b) KIMBERLY AND LUCIFER
APPROPRIATION ACCOUNT
FOR THE YEAR ENDED 31 MAY 2009
K
K
Net profit b/d
102,940
Add: interest on drawings paid to partnership
3,060
106,000
Less salary: Lucifer
15,000
Less interest on capital accounts
Kimberly (12% x K200, 000)
24, 000
Lucifer (12% x K140, 000)
16,800
55, 800
Solution
Less interest on current accounts
Kimberly (10% x K15, 000)
Lucifer (10% x K13, 000)
Profit share
Kimberly (7/10 x 47 400)
Lucifer (3/10 x 47, 400)
1, 500
1, 300
2,800
47, 400
33, 180
14, 220
47, 400
Solution
© PARTNERS' CURRENT ACCOUNTS
Kimberly Lucifer
Kimberly
K
K
K
Drawings
40,000
28,000 Balances b/d 15,000
Interest on drawings1,800
1,260 Salary
–
Balances c/d
31, 880
31, 060 Interest capital 24, 000
interest Current
1,500
Profit share
33, 180
73,680
60,320
73, 680
Lucifer
K
13,000
15,000
16, 800
1, 300
14,220
60, 320
Example
Mazuba and Mutinta just set up a partnership business sharing profits and
losses in the ratio 4:3 respectively. Under their partnership agreement, the
partners are entitled to 5% per annum interest on capital and interest is charged
on their drawings at 6% per annum.
As Mutinta has more operational responsibilities, she is entitled to a salary of
K50,000 per annum. Interest is not calculated on the partners’ current account
balances.
The partners’ accounting period ends 31 March 2020 and the following
transactions took place during the year under review:
Example cont’
(i) Mazuba’s capital contribution on 1 April 2019 was K600,000 and a further K250,000
was introduced on 1 July 2019. On the other hand, Mutinta’s capital contribution was
introduced into the business on 1 October 2019 amounting to K400,000.
(ii) On 1 October 2019, Mazuba and Mutinta made drawings of K80,000 and
K100,000 respectively.
(iii) Mutinta’s salary was to be paid to her effective 1 July 2019 when her
responsibilities were enhanced.
(iv) The partnership business made profits for the year ending 31 March 2020
amounting to K350,500. This was before taking any of the above items into
consideration.
(v) Being the first year of trading, there was no balance on any one’s current account
at the beginning of the period.
Cont’
Required:
Prepare for the partnership, for the year ended 31 March 2020:
(a) Mazuba and Mutinta’s appropriation account for the year ended 31
March 2020
(b) The partners’ current accounts
Solutions
Mazuba and Mutinta
Appropriation Account for the year ended 31 March
2020
Net profit for the year’
K350,500
Add: interest on drawings:
Mazuba (6% x K80,000 x 6/12)
2,400
Mutinta (6% x K100,000 x 6/12)
3,000
355,900
Less interest on capital:
Mazuba (5% x K600,000 +( 5% x K250,000 x 9/12)) 39,375
Mutinta (5% x K400,000 x 6/12)
10,000
Salary – Mutinta (9/12 x K50,000)
37,500
Residual profits
Share of profit:
Mazuba (4/7 x 269,025)
153,729
Mutinta (3/7 x 269,025)
115,296
(86,875)
269,025
269, 025
Partners current accounts
Mazuba
‘K’
Drawings
80,000
Interest on drawings
2,400
Mutinta
Mazuba
Mutinta
‘K’
‘K’
‘K’
100,000
salary
37,500
3,000
Int on Capital 39,375
10,000
Share of profit 153,729 115,296
Balance c/d
110,704
59,796
------------------193,104 162,796
193,104
162,796
Balance c/f 110,704
59,796
In this account all entries such as, drawings, interest on capital, interest on
drawings, salary of partners, share of profit or loss are recorded. Current a/c for
partners may fall either on debit or credit side.
Example
MAINZA and MULENGA has been in partnership business fro several years
running an hair dressing business trading as Twin-sisters’ Hair Salon. They
introduced capital of K40, 000 and K20, 000 respectively. MAINZA made
drawings of K900 on 1 October 2017, while MULENGA’s drawings on 1
January 2018 were K600. The partnership Agreement provides for:
1). A salary of K8, 000. per annum to be paid to MAINZA.
2.) Interest on partners’ capital at the rate of 6% per annum.
3.) Interest on drawings at the rate of 20% per annum.
4.) Any remaining profit or loss to be shared between Mainza and Mulenga
in the ratio of 2:1 respectively.
Example
Further, MAINZA who has some basic knowledge of accounting prepared
draft accounts for the period ended 31 March 2018. The accounts showed a
loss of K4, 500. It was discovered that when preparing these accounts,
MAINZA charged expenditure of K35, 500 for purchase of a motor vehicle on
1 July 2017, to the Income Statement as an expense. The vehicle has an
estimated life of 5 years and no depreciation has been charged on the cost
yet.
Required:
(i) Calculate the corrected total profit to be shared between the partners for
the period to 31 March 2018.
(ii) Produce the Partnership appropriation account for the period ended 31
March 2018.
(iii) Prepare each Partner’s current account as at 31 March 2018.
Solutions
(i)
Mainza and Mulenga Partnership
Adjustment of profit
Loss as Given
Add Motor Vehicle
Less Depreciation 35 500/5 x 9/12
Total adjustment profit
K
(4, 500)
35, 500
31, 000
5, 325
25, 675
Mainza and Mulenga Partnership
Appropriation account for the year ended 31 March 2018
Revised net Profit
K 25, 675
Mainza Mulenga
K
K
Salary Mainza
8, 000 x 9/12
6, 000
Interest on Capital
Mainza 6% x 40, 000 x 9/12
1, 800
Mulenga 6% x 20, 000 x 9/12
900
Interest on drawing
Mainza 20% x 900 x 6/12
(90)
Mulenga 20% x 600 x 3/12
Sub- Total
7, 710
Share of profit
Mainza 2/3 x 17, 095
11,397
Mulenga 1/3 x 17, 095
Grand Total
19, 107
(30)
870 (8, 580) 17, 095
5, 698
6, 568
17, 095
SOLUTIONS CONT’
Partner’s current account
MAINZA MULENGA
MAINZA
MULENGA
K000
K000
K000
K000
Drawings
900
600
Salary
6000
Int on drawings 90
30
Int on capital 1800
900
31/3/17 Bal c/d 18, 207 5, 968 Share of profit 11, 397
5, 698
19, 197 6, 598
19, 197
6, 598
Example
Martha and Timothy have been trading as a partnership for many years,
sharing profits and loss equally. You prepared their income statement for
the year ended 31December 2021 which reported a profit of K255,784
before considering the items below:
(1) Partners are charged interest on drawings at a rate of 8% per year.
Drawings made at the beginning of the year were; Martha K56,000 and
Timothy K48,000.
(2) Partners were paid annual salaries: Martha K44, 000 and Timothy
K16,000.
Example cont’
(3) Each partner contributed K250,000 as capital at the beginning of
the partnership.
(4) At 1 January 2021 partners current accounts balances were Martha
K34,840 (Debit) and Timothy K19,094 (Credit)
Required:
(i) Prepare partnership appropriation account.
(3marks)
(ii) Prepare partners (Martha and Timothy) current accounts. (6marks)
Solution
(i) Partner appropriation account as at 31 December 2021
Net profit
255, 784
Add: Interest on drawings: Martha 56,000 x 8%
4, 480
Interest on drawings: Timothy 48,000 x 8%
3,840
Less Salary: Martha
(44, 000)
Salary: Timothy
(16, 000)
(60, 000)
Profit to share
204, 104
Share of profit:
Martha
½ x 204, 104
Timothy
½ x 204, 104
Profit to share
102, 052
102, 052
204, 104
Solutions
(ii) Dr.
Martha Current Account
Cr
Opening Balance
34, 840
Profit
102, 052
Drawings
56, 000
Salary
44, 000
Interest on drawings 4, 480
Balance c/d
50, 735
146, 052
146, 052
) Dr.
Timothy Current Account
Cr
Drawings
48, 000
Opening balance 19, 094
Interest on drawings 3, 840
Profit
102, 052
Balance c/d
85, 306
Salary
16, 000
137, 146
137, 146
Partnership Financial Statements
The financial statements of a partnership are similar to those of a
proprietorship.
 The differences are due to the number of owners involved. The income
statement for a partnership is identical to the income statement for a
proprietorship except for the division of net income.
The owners’ equity statement for a partnership is called the partners’
capital statement. It explains the changes in each partner’s capital account
and in total partnership capital during the year
The only distinctive feature of a partnership balance sheet is presentation
of the capital accounts in the owners’ equity section.
 Instead of a single capital account, the owners’ equity section contain a
separate capital account for each partner.
Example
Matimba and Innocent are trading in partnership, sharing profits and
losses and equally. Interest at 5% per annum is allowed or charged on
both the capital account and the current account balances at the
beginning of the year. Interest is charged on drawings at 5% per annum.
The partners are entitled to annual salaries of: Matimba K12, 000;
Innocent K8, 000.
Matimba and Innocent
Trial Balance as at 31 December 2017
Dr
K
Capital accounts: Matimba
Innocent
Current accounts: Matimba
Innocent
Cash drawings for the year: Matimba
Innocent
600
15,000
10,000
Cr
K
100,000
50,000
2,000
Freehold premises at cost
50,000
Inventory at 1 January 2017
75,000
Fixtures and fittings at cost
15,000
Purchases
380,000
Purchase returns
12,000
Bank
31,600
Sales returns
6,000
Sales
Trade receivables
Trade payables
508,000
52,400
33,300
Example
Carriage inwards
21,500
Carriage outwards
3,000
Staff salaries
42,000
VAT
Office expenses
7,500
Provision for doubtful debts
Advertising
5,000
Discounts received
Discounts allowed
1,200
Bad debts
1,400
Rent and business rates
2,800
Accumulated provision for depreciation of fixtures and fittings
720,000
8,700
2,000
1,000
3,000
720,000
Example cont’
At 31 December 2017:
(a) inventory on hand was valued at K68,000.
(b) Purchase invoices amounting to K3, 000 for goods included in the
inventory valuation in (a) above had not been recorded.
(c) Staff salaries owing K900.
(d) Business rates paid in advance K200.
(e) Provision for doubtful debts to be increased to K2, 400.
(f ) Goods withdrawn by partners for private use had not been recorded and were
valued at: Matimba K500, Innocent K630. No interest is to be charged on these
amounts.
(g) Provision is to be made for depreciation of fixtures and fittings at 10% on cost.
(h) Interest on drawings for the year is to be charged: Matimba K360, Innocent K280.
Required: From the information given above, Prepare:
(i) The partnership profit and loss account for the year ended 31 December 2017,
(ii) The Appropriation accounts for the year ended 31 December 2017
(iii) The balance sheet as at 31 December, 2017.
Solutions
MATIMBA AND INNOCENT
PROFIT AND LOSS ACCOUNTS FOR THE YEAR ENDING 31 DECEMBER
2017
K
Sales (508, 000 -6000)
Opening inventory
Purchases (380, 000 + 3, 000-12000)
Carriage in
K
K
502, 000
75, 000
371, 000
21, 500
467, 500
Closing inventory
(68, 000)
*Drawings (500 + 630)
(1, 130)
398, 370
* Goods withdrawn by partners for private use treat it as an expense
Discount received
Gross profit
Expenses
Salaries (42, 000 + 900)
Office expenses
Carriage out
Adverts
103, 630
1, 000
104, 630
42, 900
7,500
3, 000
5, 000
Discount allowed
1,200
Rents & rates (2, 800 -200)
2, 600
Bad debts
1, 400
Depreciation – Fixtures & fittings (15000% x 10%) 1, 500
Provision for Doubtful debts (2,400- 2000)
400
Net profit
(65, 500)
39, 130
SOLUTIONS
MATIMBA AND INNOCENT
APPROPRIATION ACCONT
FOR THE YEAR ENDED 31 DEC 2017
NET PROFIT
Add
Interest on drawings (360+280)
Interest on current account (600 x 5%)
Less
Interest on capital: Matimba (100, 000 x 5%)
Innocent (50, 000 x 5%)
Interest on current account (2000 x 5%)
Salaries
(12000 + 8, 000)
Balance of Profits
39,130
640
30
39, 800
5, 000
2, 500
100
20, 000
(27, 600)
12, 200
Shared:
Matimba
Innocent
(1/2 x 12, 200)
(1/2 x 12, 200)
6, 100
6, 100
12, 200
MATIMBA AND INNOCENT
(c)
Balance Sheet as at 31 December 2017
Fixed assets
K
K
K
Cost
Acc dep
Carrying book value
Freehold – Cost
50,000
50, 000
Fixtures and fittings – Cost
15,000
4,500
10, 500
– Depreciation ( (15000 x 10% ) +3000)
60,500
Current assets
Inventory
Receivable (52,400 − 2,400)
Bank
Prepayments
68,000
50,000
31,600
200
149,800
Current liabilities
Payables (33,300 + 3000+900)
37,200
VAT
8,700
(45, 900)
103, 900
164, 400
Financed by
Capital Accounts
Matimba
Innocent
100,000
50,000
150,000
Current Accounts
Matimba Innocent
Balance b/d
2,000
(600)
Interest on capital
5,000
2,500
Interest on current account
100
(30)
Salaries
12,000 8,000
Profit
6,100 6,100
Drawings/Int/Goods
(15,860) (10,910)
(15000 +360 + 500) 9,340 5,060 (10000+ 280 +630)
14,400
164,400
Example on profit & loss & Balance sheet
Buumba Stephen and Sharon runs a partnership business trading as BSS. Below are the transactions of their
business
(i ) Net profits K111,100.
(ii ) Interest to be charged on capitals: Buumba K3,000; Stephen K2,000; Sharon K1,500.
(iii ) Interest to be charged on drawings: Buumba K400; Stephen K300; Sharon K200.
(iv) Salaries to be credited: Stephen K20, 000; Sharon K25, 000.
(v) Profits to be shared: Buumba 70%; Stephen 20%; Sharon 10%.
(vi) Current accounts: balances b/d Buumba K18, 600; Stephen K9, 460; Sharon K8, 200.
(vii) Capital accounts: balances b/d Buumba K100, 000; Stephen K50, 000; Sharon K25, 000.
(viii) Drawings: Buumba K39, 000; Stephen K27, 100; Sharon K16, 800.
Required
Draw up a profit and loss appropriation account for the year ended 31 December, 2018 and balance sheet
extracts at that date.
Solutions
Buumba , Stephen and Sharon
Appropriation Account for the year ended 31 December 2018
K
K
Net profit b/d
K
111,100
Add Interest on drawings: Buumba
400
Stephen
300
Sharon
200
900
112,000
solution
Less Interest on Capitals:
Buumba 3,000
Stephen
2,000
Sharon
1,500
Salaries:
Stephen 20,000
Sharon
25,000
6,500
45,000
(51,500
60,500
Solutions
Balance of Profits:
Shared: Buumba (70% x 60, 500)
42,350
Stephen (20% x 60, 500)
12,100
Sharon (10% x 60, 500)
6,050
60,500
SOLUTIONS CONT’
BUUMBA STEPHEN SHARONE
BALANCE SHEET AS AT 31 MARCH 2018
Capital Accounts: Buumba
Stephen
Sharon
100,000
50,000
25,000
175,000
Current Accounts:
Balances 1/4/2007
Add Interest on capital
Buumba
18,600
3,000
Stephen
9,460
2,000
Sharon
8,200
1,500
Solutions CONT’
Salaries
Share of profits
42,350
63,950
Less Interest on drawings (400)
Drawings
(39,000)
24,550
20,000
12,100
43,560
(300)
(27,100)
16,160
25,000
6,050
40,750
(200)
(16,800)
23,750
64,460
Kimberly and Amanda are in partnership sharing profits and losses in the ratio 3/5,
2/5, respectively. The following is their trial balance as at 30 September 2015.
Dr
Cr
K
K
Buildings (cost K210, 000)
160,000
Fixtures at cost
8,200
Provision for depreciation: Fixtures
4,200
Receivables
61,400
Payables
26,590
Cash at bank
6,130
Inventory at 30 September 2014
62,740
Sales
Purchases
Carriage outwards
Discounts allowed
Loan interest: Kimberly
Office expenses
Salaries and wages
Bad debts
Provision for doubtful debts
Loan from Kimberly
363,111
210,000
3,410
620
3,900
4,760
57,809
1,632
1,400
65,000
Capitals: Kimberly
Amanda
Current accounts Kimberly
Amanda
Drawings: Kimberly
Amanda
100,000
75,000
4, 100
1,200
31,800
28,200
640,601
640,601
Example cont’
Additional information.
(a) Inventory, 30 June 2015, K74,210.
(b) Expenses to be accrued: Office Expenses K215; Wages K720.
(c) Depreciate fixtures 15 per cent on reducing balance basis, buildings K5, 000.
(d) Reduce provision for doubtful debts to K1, 250.
(e) Partnership salary: K30, 000 to Kimberly. Not yet entered.
(f ) Interest on drawings: Kimberly K900; Amanda K600.
(g) Interest on capital account balances at 5 per cent.
Required:
(a)Prepare a trading profit and loss Account for the ended 30 September 2015
(b)Prepare an appropriation account for the year ended 30 SEPTEMBER 2015,
(c)Draw up the statement of the financial position as at that date.
Solution
KIMBERLY AND AMANDA
TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30 SEPTEMBER 2019
K
Sales
363,111
Less Cost of goods sold:
Opening Inventory
62,740
Add Purchases
210,000
272,740
Less Closing Inventory
(74,210)
Cost of goods sold
(198,530)
Gross profit
164,581
Add Reduction in provision for doubtful debts (1400 -1250)
150
164,731
Less Expenses
Salaries and wages (57,809 + 720)
Office expenses (4,760 + 215)
Carriage outwards
Discounts allowed
Bad debts
Loan interest
Depreciation:
Fixtures (8200-4200) x 15%
600
Buildings
5,000 5,600
Net profit
58,529
4,975
3,410
620
1,632
3,900
(78,666)
86,065
BUUMBA STEPHEN & SHARONE
APPROPRIATION STATEMENT FOR THE YEAR ENDED 30 SEPT, 2015
Net profit
86,065
Add Interest on drawings: Kimberly
900
Amanda
600
1,500
87,565
Less Interest on capitals:
Kimberly (100, 000 x 5%)
5,000
Amanda (75000 x 5%)
3,750
Salary: Kimberly
8,750
30,000
(38,750)
48, 815
Balance of Profits
Shared:
Kimberly (3/5 x 48, 815)
29,289
Amanda (2/5 x 48, 815)
19,526
48,815
BUUMBA, STEPHEN & SHARON
Balance sheet as at 30 September 2015
Fixed assets
Cost
Depn
Buildings (50, 000 + 5,000)
210, 000
55, 000
Fixtures
(4200+600)
8, 200
4, 800
218, 200
59, 800
Current Assets
Inventory
74, 210
Receivables
61, 400
Less Provision for doubtful debts
(1, 250)
60, 150
Bank
6, 130
140, 490
Carrying value
155, 000
3, 400
158, 400
Less current Liabilities
Payables
Expenses owing (215 + 720)
Net current Assets
Less Loan from Kimberly
TOTAL ASSETS
Financed by
Capital accounts Kimberly
Amanda
26, 590
935
(27, 525)
112, 965
271, 365
(65, 000)
206, 365
100, 000
75, 000
175, 000
SOLUTIONS CONT’
Current Accounts
Balance 1.10.2014
Add interest on Capital
Salary
Balance of profit
Less Drawings
Interest on drawings
Kimberly Amanda
4, 100
1, 200
5, 000
3,750
30, 000
29, 000
19, 526
68, 389
24, 476
31, 800
28, 200
900
600
35, 689
(4, 324)
31, 365
206, 365
Where no partnership agreement exists
Where no partnership agreement exists, express or implied, of the
Partnership Act governs the situation. The accounting content of this
section states:
(a) Profits and losses are to be shared equally.
(b) There is to be no interest allowed on capital.
(c) No interest is to be charged on drawings.
(d) Salaries are not allowed.
(e) 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.
Revaluation of partnership assets
Need for revaluation
When a business is sold, and the sale price of the assets differs from their book
values, there will be a profit or loss on the sale. This profit or loss will be shared
between the partners in their profit and loss sharing ratios.
This sharing of profits and losses on changing asset values doesn’t just need to be
done when a partnership is sold. It should also be done whenever any of the
following happens:
A new partner is admitted;
A partner leaves the firm;
The partners change profit and loss sharing ratios.
As no sale has taken place in any of these circumstances, the assets will have to be
revalued to reflect what they are worth at the date when the change occurs, in
order for the gains and losses to be identified.
Revaluation of partnership assets
Once the assets have been revalued, you need to record the changes
and gains and losses in the ledger accounts of the partnership.
Profit or loss on revaluation
If the revaluation shows no difference in asset values, no further action
is needed. This will not happen very often, especially if assets include
buildings. These are normally shown at cost less accumulated
depreciation, but this is very rarely the actual value of buildings after
they have been owned for a few years.
Accounting for revaluation
Revaluation account is opened
The first thing you do upon revaluing partnership assets is to open a
revaluation account and make the appropriate entries:
1 For each asset showing a gain on revaluation:
Debit asset account with gain.
Credit revaluation account.
2 For each asset showing a loss on revaluation:
Debit revaluation account.
Credit asset account with loss.
3 If there is an increase in total valuation of assets:
Debit profit to revaluation account.
Credit old partners’ capital accounts in old profit and loss sharing
ratios.*
4 If there is a fall in total valuations of assets:
Debit old partners’ capital accounts in old profit and loss sharing
ratios.*
Credit loss to revaluation account.
*If current accounts are kept for the partners, the entries should be
made in their current accounts.
Example
Kimberly and Amanda are in partnership, sharing profits and losses in the
ratio of 2 : 1. On July 1, 2014 they agree to change the profit-sharing ratio so
that they will share profits and losses equally in the future. The partnership
Balance sheet at 31 December, 2013 was as follows.
K
K
Fixed asset at net book value
Freehold Premises
60, 000
Plant and Machinery
35, 000
Motor vehicles
23, 000
118, 000
Example cont’
Current assets
Inventory
Accounts Receivable
Bank
Current liabilities
Accounts Payable
29, 000
13, 000
8, 000
50, 000
7, 000
43, 000
161, 000
Capital
Kimberly
Amanda
90, 000
71, 000
161, 000
The partners agree that the assets shall be revalued at 30 June 2014 as
follows.
Freehold Premises
K 100, 000
Plant and machinery
K 30, 000
Motor Vehicles
K 20, 000
Inventory
K 25 000
Accounts Receivable
K 12, 000
Required
(a)Prepare Journal entries to give effect to the revaluation of the assets in
the partnership books.
(b)Prepare a redrafted Balance Sheet as at 30 June 2014 after the assets
have been revalued.
Solutions
Journal
K
K
Freehold premises
40, 000
Plant and machinery
5, 000
Motor vehicles
3, 000
Inventory
4, 000
Receivable control
1, 000
Revaluation account
27, 000
Revaluation of assets at 30 June 2014
Revolution account
27, 000
Kimberly (2/3 x 27000)
18, 000
Amanda (1/3 x 27,000)
9, 000
Profit on revaluation of assets credited to the partners’ capital accounts in their old sharing rations
(b)
Kimberly and Amanda
Balance sheet 30 June, 2014
Fixed asset at net book value
Freehold premises (60,000 + 40, 000)
Plant and Machinery (35, 000 -5000)
Motor Vehicle (23, 000-3000)
Current assets
Inventory(29, 000-4000)
Receivables (13,000-1000)
Bank
K
25, 000
12, 000
8, 000
45, 000
K
100, 000
30, 000
20, 000
150, 000
Current liabilities
Payables
Capitals
Kimberly (90, 000 + 18, 000)
Amanda (71, 000 + 9,000)
7, 000
38, 000
188, 000
108,000
80, 000
188, 000
Example on revaluation of Assets
Following is the balance sheet as at 31 December 2015 of Chanda and
Chelsea, who shared profits and losses in the ratios: Chanda two-thirds;
Chelsea one-third. From 1 January 2016 the profit and loss sharing ratio
is to be altered to Chanda one-half; Chelsea one-half.
Balance Sheet as at 31 December 2015
K
K
Premises (at cost)
65,000
Equipment (at cost less depreciation)
15,000
80,000
Example cont’
Inventory
Receivables
Bank
20,000
12,000
8,000
40,000
120,000
Capitals: Chanda
70,000
Chelsea
50,000
120,000
The assets were revalued on 1 January 2016 to be: Premises K90, 000;
Equipment K11, 000. Other assets values were unchanged.
Required
Reflect the assets at revalued amounts in the following accounts
(a) Revaluation account
(b) Assets Accounts
(c)
Capital account
Solutions
Revaluation account
Assets reduced in value:
K
K
Assets increased in value: K
Equipment (15000-11000)
4,000
Premises (90000-65000) 25,000
Gain on revaluation carried
to Capital accounts:
Chanda (2/3 x 21000)
14,000
Chelsea (1/3 x 21000)
7,000
21,000
25,000
25,000
Solutions
ASSETS ACCOUNT (Premises)
K
K
Balance b/d
65,000
Balance c/d 90,000
Revaluation: Increase 25,000
90,000
90,000
Balance b/d
90,000
Solutions
Equipment
Balance b/d
K
15, 000
Balance b/d
15,000
11,000
Balance c/d
Revaluation: Reduction
K
11,000
4,000
15,000
Solutions
Capital: Chanda
Balance c/d
K
84,000
Balance b/d
84,000
84,000
K
Balance b/d
70,000
Revaluation: Share of gain 14,000
84,000
Capital: Chelsea
Balance c/d
K
57, 000
Balance b/d
57,000
57,000
K
Balance b/d
50,000
Revaluation: Share of gain 7,000
57,000
PARTNERSHIP DISSOLUTION
Partnerships do change when a partner leaves. And they do change when a
new partner joins.
However, for accounting purposes, we only consider partnerships as
changing sufficiently to merit treating them as ceasing to exist when the
partners go their separate ways. When they do, this is known as partnership
dissolution – the partnership has been dissolved.
Reasons for dissolution include the following:
(a) The partnership is no longer profitable, and there is no longer any reason
to carry on trading.
(b) The partners cannot agree between themselves how to operate the
partnership. They therefore decide to finish the partnership.
(c) Factors such as ill-health or old age may bring about the close of the
partnership.
Upon dissolution the partnership firm stops trading or operating. Then,
in accordance with the Partnership Act
(a) The assets are disposed of;
(b) The liabilities of the firm are paid to everyone other than partners;
(c) The partners are repaid their advances and current balances –
advances are the amounts they have put in above and beyond the
capital;
(d) The partners are paid the final amounts due to them on their capital
accounts.
Any profit or loss on dissolution would be shared by all the partners in
their profit and loss sharing ratios. Profits would increase capitals
repayable to partners. Losses would reduce the capitals repayable.
If a partner’s final balance on his capital and current accounts is in
deficit, he will have to pay that amount into the partnership bank
account.
Disposal of assets
The assets do not have to be sold to external parties. Quite often one
or more existing partners will take assets at values agreed by all the
partners. In such a case the partner may not pay in cash for such
assets; instead they will be charged to his capital account.
Accounting for partnership dissolution
The main account around which the dissolution entries are made is
known as the realisation account. It is this account in which it is
calculated whether the realisation of the assets is at a profit or at a
loss.
Example
The last balance sheet of Ramirez and Fernando, who share profits
Ramirez two-thirds: Fernando one-third is shown below. On this date
they are to dissolve the partnership.
Balance Sheet at 31 December 2009
K
K
Fixed assets
Buildings
100,000
Motor vehicle
12,000
112,000
Current assets
Inventory
Accounts receivable
Bank
Current liabilities
Creditors
6,000
8,000
2,000
16,000
(5,000)
11,000
123,000
Example
Capitals: Ramirez
Fernando
82,000
41,000
123,000
The buildings were sold for K105, 000 and the inventory for K4, 600. K6, 800
was collected from accounts receivables. The motor vehicle was taken over
by Ramirez at an agreed value of K9, 400, but he did not pay any cash for it.
K5, 000 was paid to creditors. The K400 cost of the dissolution was paid.
Required
(a) Show the accounting entries for the above transactions by way of journal
entries
(b) Show the above transactions
(i)
Assets accounts
(ii)
Realisation accounts
(iii) Capital accounts
(iv) Receivable and Payables
Solutions
The accounting entries needed are:
(A) Transfer book values of all assets to the realisation account:
Dr Realisation account
Cr
asset accounts
Solution cont’
(B) Amounts received from disposal of assets:
Dr Bank
Cr Realisation account
(C) Values of assets taken over by partner without payment:
Dr Partner’s capital account
Cr Realisation account
(D) Creditors paid:
Dr Creditors’ accounts
Cr Bank
(E) Costs of dissolution:
Dr Realisation account
Cr Bank
Solutions
(F) Profit or loss on realisation to be shared between partners in profit and loss sharing
ratios:
If a profit:
Dr Realisation account
Cr Partners’ capital accounts
If a loss:
Dr Partners’ capital accounts
Cr Realisation account
(G) Pay to the partners their final balances on their capital accounts:
Dr Capital accounts
Cr Bank
The entries are now shown. The letters (A) to (G) as above are shown against
SOLUTIONS
Buildings
Balance b/d K100,000 Realisation (A) K 100,000
Motor Vehicles
Balance b/d K12,000 Realisation (A) K12,000
Inventory
Balance b/d 6,000 Realisation (A) K6000
SOLUTIONS
Accounts receivable
Balance b/d K8,000 Realisation (A) K8,000
Realisation
Assets to be realised:
Buildings (A)
Motor vehicle (A)
Inventory (A)
Accounts receivables (A)
Bank:
Dissolution costs (E)
K 100,000
12,000
6,000
8,000
400
126,400
Bank: Assets sold
Buildings (B)
K 105,000
Inventory (B)
4,600
Accounts Receivable (B)
6,800
Taken over by partner A:
Motor vehicle (C)
9,400
Loss on realisation
K
Ramirez (2/3 x 600) (F) 400
Fernando (1/3 x 600)(F 200
600
126,400
EXPLAIN HOW TO ACCOUNT FOR THE LIQUIDATION OF A
PARTNERSHIP.
Liquidation of a business involves selling the assets of the firm, paying
liabilities, and distributing any remaining assets.
 Liquidation may result from the sale of the business by mutual agreement
of the partners, from the death of a partner, or from bankruptcy.
Partnership liquidation ends both the legal and economic life of the entity.
 From an accounting standpoint, the partnership should complete the
accounting cycle for the final operating period prior to liquidation.
This includes preparing adjusting entries and financial statements.
 It also involves preparing closing entries and a post-closing trial balance.
Thus, only balance sheet accounts should be open as the liquidation
process begins
EXPLAIN HOW TO ACCOUNT FOR THE LIQUIDATION OF A
PARTNERSHIP.
In liquidation, the sale of noncash assets for cash is called realization. Any
difference between book value and the cash proceeds is called the gain or loss
on realization.
To liquidate a partnership, it is necessary to:
1. Sell noncash assets for cash and recognize a gain or loss on realization.
2. Allocate gain/loss on realization to the partners based on their income ratios.
3. Pay partnership liabilities in cash.
4. Distribute remaining cash to partners on the basis of their capital balances.
Each of the steps must be performed in sequence. The partnership must pay
creditors before partners receive any cash distributions. Also, an accounting
entry must record each step.
EXPLAIN HOW TO ACCOUNT FOR THE LIQUIDATION OF A
PARTNERSHIP.
When a partnership is liquidated, all partners may have credit balances
in their capital accounts. This situation is called no capital
deficiency. Or, one or more partners may have a debit balance in
the capital account. This situation is termed a capital deficiency.
Example
R Arnet, P Carey and W Eaton are in the partnership business called ACE Company sharing
profits/losses in the ratio 3 : 2 :1 respectively. ACE company is liquidated when its ledger shows the
following assets, liabilities, and owners’ equity accounts.
Liabilities and Owners’ Equity
Assets
Cash K
5,000
Notes Payable
K15,000
Accounts Receivable
15,000
Accounts Payable
16,000
Inventory
18,000
R. Arnet, Capital
15,000
Equipment
35,000
P. Carey, Capital
17,800
Accum. Depr.—Equipment (8,000)
K65,000
W. Eaton, Capital
1,200
K65,000
Solutions
Solutions
No Capital Deficiency
The partners of Ace Company agree to liquidate the partnership on the following
terms.
(1) The partnership will sell its noncash assets to Jackson Enterprises for K75,000
cash.
(2) (2) The partnership will pay its partnership liabilities. The income ratios of the
partners are 3:2:1, respectively.
The steps in the liquidation process are as follows.
1. ACE sells the noncash assets (accounts receivable, inventory, and equipment)
for K75,000. The book value of these assets is K60,000 (K15,000 + K18,000 +
K35,000 - K8,000). Thus, Ace realizes a gain of K15,000 on the sale.
Solutions
The entry is:
Cash
Accumulated Depreciation–Equipment
Accounts Receivable
Inventory
Equipment
Gain on Realization
(To record realization of noncash assets
75,000
8,000
15,000
18,000
35,000
15,000
Solutions
2. Ace allocates the K15,000 gain on realization to the partners based
on their income ratios, which are 3:2:1. The entry is:
Gain on Realization
15,000
R. Arnet, Capital (K15,000 x 3/6)
7,500
P. Carey, Capital (K15,000 x 2/6)
5,000
W. Eaton, Capital (K15,000 x 1/6)
2,500
(To allocate gain to partners’ capital accounts)
3. Partnership liabilities consist of Notes Payable K15,000 and Accounts
Payable K16,000. Ace pays creditors in full by a cash payment of
K31,000. The entry is:
Notes Payable
15,000
Accounts Payable
16,000
Cash
31,000
(To record payment of partnership liabilities)
PARTNERSHIP LIQUIDATION
Illustration: (4) Record the distribution of cash
R. Arnet, Capital
P. Carey, Capital
W. Eaton, Capital
Cash
22,500
22,800
3,700
49,000
No Capital
Deficiency
SCHEDULE OF CASH PAYMENTS
The schedule of cash payments shows the distribution of cash to the
partners in a partnership liquidation. The schedule of cash payments is
organized aroundthe basic accounting equation.
Partnership Liquidation—No Capital Deficiency
The partners of Grafton Company have decided to liquidate their business.
Noncash assets were sold for K115,000. The income ratios of the partners
Kale D., Croix D., and Marais K. are 2:3:3, respectively. Complete the
following schedule of cash payments for Grafton Company.
Cash
K10, 000
Non – Cash
k85,000
Liabilities
K40,000
Kale
K40, 000
Croix
K35, 000
Marais
K5, 000
Solution
PARTNERSHIP LIQUIDATION
PARTNERSHIP LIQUIDATION
example
Ace Company is on the brink of bankruptcy. They sell merchandise at substantial
discounts, and sell the equipment at auction. Cash proceeds from these sales and
collections from customers totals K42,000. (1) Prepare the entry for the realization
of noncash assets.
The entry for the realization of noncash assets is: (1)
Cash
42,000
Accumulated Depreciation—Equipment
8,000
Loss on Realization
18,000
Accounts Receivable
15,000
Inventory
18,000
Equipment
35,000
(To record realization of noncash assets)
PARTNERSHIP LIQUIDATION
R. Arnet, Capital (K18,000 x 3/6)
9,000
P. Carey, Capital (K18,000 x 2/6)
6,000
W. Eaton, Capital (K18,000 x 1/6)
3,000
Loss on Realization
(To allocate loss on realization to partners)
18,000
PARTNERSHIP LIQUIDATION
Notes Payable
15,000
Accounts Payable
16,000
Cash
31,000
(To record payment of partnership liabilities
Partnership Liquidation—Capital Deficiency
example
Kimberly Company wishes to liquidate the firm by distributing the
company’s cash to the three partners. Prior to the distribution of cash,
the company’s balances are Cash K45,000; Rollings, Capital (Cr.)
K28,000; Havens, Capital (Dr.) K12,000; and Oscar, Capital (Cr.) K29,000.
The income ratios of the three partners are 4:4:2, respectively.
Prepare the entry to record the absorption of Havens’ capital deficiency
by the other partners and the distribution of cash to the partners with
credit balance
Solutions
Rollings, Capital (K12,000 x 4/6)
8,000
Oscar, Capital (K12,000 x 2/6)
4,000
Havens, Capital
(To record write-off of capital deficiency)
Rollings, Capital (K28,000 - K8,000)
20,000
Oscar, Capital (K29,000 - K4,000)
25,000
Cash
(To record distribution of cash to partners
12,000
45,000
Prepare journal entries when a partner is either
admitted or withdraws.
ADMISSION OF A PARTNER
The admission of a new partner results in the legal dissolution of the existing
partnership and the beginning of a new one. From an economic standpoint,
however, the admission of a new partner (or partners) may be of minor
significance in the continuity of the business.
For example, in large public accounting or law firms, partners are admitted
annually without any change in operating policies.
Results in the legal dissolution of the existing partnership and the
beginning of a new one.
New partner may be admitted either by
1. Purchasing the interest of one or more existing partners or
2. Investing assets in the partnership.
PURCHASE OF A PARTNER’S INTEREST
Illustration: L. Carson agrees to pay K10,000 each to C. Ames and D.
Barker for 33.33 % or 1/3 of their interest in the Ames-Barker
partnership. At the time of admission of Carson, each partner has a
K30,000 capital balance. Both partners, therefore, give up K10,000 of
their capital equity. The entry to record the admission of Carson is:
Solutions
C. Ames, Capital
10,000
D. Barker, Capital
10,000
L. Carson, Capital
20,000
(To record admission of Carson by purchase)
INVESTMENT OF ASSETS IN A PARTNERSHIP
Illustration: Assume that L. Carson agrees to invest K30,000 in cash in
the Ames-barker partnership for a 33 1/3% capital interest. At the time
of admission of Carson, each partner has a K30,000 capital balance.
The entry to record the admission of Carson is:
Solutions
Cash
30,000
L. Carson, Capital
30,000
(To record admission of Carson by investment)
ADMISSION OF A PARTNER
INVESTMENT OF ASSETS IN A PARTNERSHIP
BONUS TO OLD PARTNERS
Illustration: Assume that the Bart-Cohen partnership, owned by Sam
Bart and Tom Cohen, has total capital of K120,000. Lea Eden acquires a
25% ownership (capital) interest in the partnership by making a cash
investment of K80,000. The procedure for determining Eden’s capital
credit and the bonus to the old partners is as follows.
1.
Determine the total capital of the new partnership.
BONUS TO OLD PARTNERS
Illustration: Assume that the Bart-Cohen partnership, owned by Sam
Bart and Tom Cohen, has total capital of K120,000. Lea Eden acquires a
25% ownership (capital) interest in the partnership by making a cash
investment of K80,000. The procedure for determining Eden’s capital
credit and the bonus to the old partners is as follows.
2.
Determine the new partner’s capital credit.
Total capital of new partnership
K 200,000
New partner’s ownership interest
x
25%
New partner’s capital credit
K 50,000
BONUS TO OLD PARTNERS
Illustration: Assume that the Bart-Cohen partnership, owned by Sam
Bart and Tom Cohen, has total capital of K120,000. Lea Eden acquires a
25% ownership (capital) interest in the partnership by making a cash
investment of K80,000. The procedure for determining Eden’s capital
credit and the bonus to the old partners is as follows.
3.
Determine the amount of bonus.
New partner’s capital credit
K 80,000
New partner’s investment
- 50,000
Bonus amount
K 30,000
BONUS TO OLD PARTNERS
Illustration: Assume that the Bart-Cohen partnership, owned by Sam
Bart and Tom Cohen, has total capital of K120,000. Lea Eden acquires a
25% ownership (capital) interest in the partnership by making a cash
investment of K80,000. The procedure for determining Eden’s capital
credit and the bonus to the old partners is as follows.
4. Allocate the bonus to the old partners on the basis of their income
ratios. (Assume Bart 60% and Cohen 40%)
Bart (K30,000 x 60%)
K 18,000
Cohen (K30,000 x 40%)
12,000
Total bonus
K 30,000
BONUS TO OLD PARTNERS
Illustration: Assume that the Bart-Cohen partnership, owned by Sam
Bart and Tom Cohen, has total capital of K120,000. Lea Eden acquires a
25% ownership (capital) interest in the partnership by making a cash
investment of K80,000. The procedure for determining Eden’s capital
credit and the bonus to the old partners is as follows.
Journal entry to record the admission of Eden is:
Cash
80,000
Sam Bart, Capital
18,000
Tom Cohen, Capital
12,000
Lea Eden, Capital
50,000
INVESTMENT OF ASSETS IN A PARTNERSHIP
BONUS TO NEW PARTNER
Results when the new partner’s investment in the firm is less than his
or her capital credit.
Bonus results in a decrease in the capital balances of the old partners.
Decrease for each partner is based on the income ratios before the
admission of the new partner.
BONUS TO NEW PARTNER
Illustration: Assume that the Bart-Cohen partnership, owned by Sam
Bart and Tom Cohen, has total capital of K120,000. Lea Eden acquires a
25% ownership (capital) interest in the partnership by making a cash
investment of K20,000.
The computations for Eden’s capital credit and the bonus are as follows
along with the journal entry to record the admission of Eden into the
partnership.
BONUS TO NEW PARTNER
Total capital of Bart–Cohen partnership
K 120,000
Investment by new partner, Eden
20,000
Total capital of new partnership
K 140,000
Eden’s capital credit (25% x K140,000)
K 35,000
Bonus to Eden (K35,000 - K20,000)
K 15,000
Allocation of bonus to old partners:
Bart (K15,000 x 60%)
K 9,000
Cohen (K15,000 x 40%)
6,000 K 15,000
BONUS TO NEW PARTNER
The partnership records the admission of Eden as follows.
Cash
20,000
Sam Bart, Capital
9,000
Tom Cohen, Capital
6,000
Lea Eden, Capital
35,000
(To record Eden’s admission and bonus)
WITHDRAWAL OF A PARTNER
A partner may withdraw from a partnership
voluntarily, by selling his or her equity in the firm.
Or, he or she may withdraw involuntarily, by
reaching mandatory retirement age or by dying.
The withdrawal of a partner, like the admission of a
partner, legally dissolves the partnership.
PAYMENT FROM PARTNERS’ PERSONAL ASSETS
Illustration: Partners Morz, Nead, and Odom have capital balances of
K25,000, K15,000, and K10,000, respectively. Morz and Nead agree to
buy out Odom’s interest. Each of them agrees to pay Odom K8,000 in
exchange for one-half of Odom’s total interest of K10,000. The entry to
record the withdrawal is:
J. Odom, Capital
10,000
A. Morz, Capital
5,000
M. Nead, Capital
5,000
PAYMENT FROM PARTNERS’ PERSONAL ASSETS
Illustration:
Assume that the following capital balances exist in the RST partnership:
Roman K50,000, Sand K30,000, and Terk K20,000. The partners share
income in the ratio of 3:2:1, respectively. Terk retires from the
partnership and receives a cash payment of K25,000 from the firm.
Note: A bonus is paid to the retiring partner since the cash paid
to the retiring partner is more than his/her capital balance
(K25,000 – K20,000 = K5,000).
PAYMENT FROM PARTNERSHIP ASSETS
BONUS TO RETIRING PARTNER
A partnership may pay a bonus to a retiring partner when:
The fair value of partnership assets is more than their book value,
There is unrecorded goodwill resulting from the partnership’s superior
earnings record, or
The remaining partners are eager to remove the partner from the firm.
The partnership deducts the bonus from the remaining partners’
capital balances on the basis of their income ratios at the time of the
withdrawal.
PAYMENT FROM PARTNERSHIP ASSETS
Illustration: Assume that the following capital balances exist in the RST
partnership: Roman K50,000, Sand K30,000, and Terk K20,000. The partners
share income in the ratio of 3:2:1, respectively. Terk retires from the
partnership and receives a cash payment of K25,000 from the firm.
Journal entry to record the withdrawal of Terk:
B. Terk, Capital
20,000
F. Roman, Capital
3,000
D. Sand, Capital
2,000
Cash
25,000
(To record withdrawal of and bonus to Terk)
PAYMENT FROM PARTNERSHIP ASSETS
The remaining partners, Roman and Sand, will recover the bonus given to Terk
as the partnership sells or uses the undervalued assets.
BONUS TO REMAINING PARTNERS The retiring partner may give a bonus to the
remaining partners when:
1. Recorded assets are overvalued.
2. The partnership has a poor earnings record.
3. The partner is eager to leave the partnership.
In such cases, the cash paid to the retiring partner will be less than the retiring
partner’s capital balance. The partnership allocates (credits) the bonus to the
capital accounts of the remaining partners on the basis of their income
ratios.
PAYMENT FROM PARTNERSHIP ASSETS
Illustration: Assume that the partnership pays Terk only K16,000 for her
K20,000 equity when she withdraws from the partnership. In that case:
The bonus to remaining partners is K4,000 (K20,000 - K16,000).
The allocation of the K4,000 bonus is Roman K2,400 (K4,000 x 3/5) and Sand
K1,600 (K4,000 x 2/5).
The entry to record the withdrawal is as follows.
B. Terk, Capital
20,000
F. Roman, Capital
3,000
D. Sand, Capital
2,000
Cash
25,000
(To record withdrawal of and bonus to Terk)
The remaining partners, Roman and Sand, will recover the bonus given to Terk
as the partnership sells or uses the undervalued assets.
BONUS TO REMAINING PARTNERS The retiring partner may give a bonus to the
remaining partners when:
1. Recorded assets are overvalued.
2. The partnership has a poor earnings record.
3. The partner is eager to leave the partnership.
In such cases, the cash paid to the retiring partner will be less than the retiring
partner’s capital balance. The partnership allocates (credits) the bonus to the
capital accounts of the remaining partners on the basis of their income
ratios.
BONUS TO REMAINING PARTNERS
To illustrate, assume instead that the partnership pays Terk only
K16,000 for her K20,000 equity when she withdraws from the
partnership. In that case:
1. The bonus to remaining partners is (K20,000 - K16,000)= K4, 000.
2. The allocation of the K4,000 bonus is Roman K2,400 (K4,000 x 3/5)
and Sand K1,600 = (K4,000 x 2/5).
Under these circumstances, the entry to record the withdrawal is as
follows
BONUS TO REMAINING PARTNERS
B. Terk, Capital
20,000
F. Roman, Capital
2,400
D. Sand, Capital
1,600
Cash
16,000
(To record withdrawal of Terk and bonus to remaining partners)
DEATH OF A PARTNER
The death of a partner dissolves the partnership. However, partnership
agreements usually contain a provision for the surviving partners to
continue operations. When a partner dies, it usually is necessary to
determine the partner’s equity at the date of death. This is done by
(1) Determining the net income or loss for the year to date,
(2) Closing the books, and
(3) Preparing financial statements.
The partnership agreement may also require an independent audit and
a revaluation of assets.
DEATH OF A PARTNER
The surviving partners may agree to purchase the deceased partner’s
equity from their personal assets. Or they may use partnership assets
to settle with the deceased partner’s estate. In both instances, the
entries to record the withdrawal of the partner are similar to those
presented earlier.
To facilitate payment from partnership assets, some partnerships
obtain life insurance policies on each partner, with the partnership
named as the beneficiary. The partnership then uses the proceeds from
the insurance policy on the deceased partner to settle with the estate.