Accounting For Partnership
Learning Outcomes:
 Understand the concept of partnership
 Understand the journal entries for the formation
of partnership, distributing profit or loss,
admission of new partners and retirement of
partners
 Able to prepare financial statements for
partnership
1
Definition
Partnership Act 1961
“… is the relation which subsists between persons carrying
on business in common with a view of profit.”
Sec 3(1)
2
Characteristics





Separate legal personality (for the purpose of
financial reporting only)
Unlimited liability
Limited life
Co-ownership of property
Co-ownership of profits
3
Advantages & Disadvantages
Advantages



Ease of formation and dissolution
Better management
Greater capital compared to proprietorship
Disadvantages





Easily dissolved/limited life
Unlimited liability
Difficulty in transferring ownership
Conflict among partners
Lesser capital compared to corporation
4
Formation



Minimum members is 2 and should not exceed
20.
Not necessarily in the form of written
agreement. Verbal agreement is accepted.
All matters related to partnership must be
referred to an agreement. If no agreement
exists in relation to certain issues, statutes in
the Partnership Act 1961 would be applied.
5
Partnership Agreement
This agreement is framework which governs the
formation, operations, dissolution and liquidation of
the partnership
Contents:
 Name, nature & scope of partnership
 Authority, rights & duties of each partner
 Methods of sharing profits & losses
 Rates of interest for capital & drawings
 Salaries
 Provision for arbitration of disputes & liquidation of
the partnership
6
Cont.

When no partnership agreement exists:






Profits and losses are to be shared equally
No interest allowed on capital
No interest to be charged on drawings
No salaries are allowed
Interest 8% p.a. is charged on the advance (loan)
made by a partner to the partnership
Each partner has unlimited liability.
7
Partnership vs Proprietorship
Proprietorship
Net Profit
Partnership
Net Profit
Partner’s Account
Balance Sheet
Balance Sheet
8
Reporting Equity in BS
Two methods available to present the equity in the
balance sheet:
i. Fixed Capital Account
ii. Fluctuating Capital Accounts
The capital account will record the initial introduction of
capital, and will normally only be adjusted if the partner
introduces additional capital.
9
Cont.
The current account will record transactions relating to
partners other than transactions related to capital such as
share of profits/losses, interest on withdrawals, interest
on loan etc.
If the partnership maintains fluctuating capital accounts,
there will be no current account, and appropriations of
profit and drawings will be recorded in the capital
account.
10
Cont.
Fixed Capital Account
Capital Account
Ali
Abu
Bank
Ali
Abu
2,000
6,000
11
Cont.
Fixed Capital Account
Current Account
Ali
Abu
Drawings
2,000
2,000
Int. on
drawings
50
100
600
400
2,650
2,500
Bal. c/d
Ali
Abu
Int. on
capital
100
300
Profits
2,550
1,700
Salaries
Bal. b/d
500
2,650
2,500
600
400
12
Cont.
Fluctuating Capital Account
Capital Account
Ali
Abu
Drawings
2,000
2,000
Int. on
drawings
50
100
2,600
6,400
Bal. c/d
Ali
Abu
2,000
6,000
Int. on
capital
100
300
Profits
2,550
Bank
Salaries
4,650
8,500
Bal. b/d
1,700
4,650
500
8,500
2,600
6,400
13
Cont.
See Illustration 1 from Siti et al (2008), PA, p. 8
14
Accounting Treatments
Initial Investment
Initial investment made by partners will be
credited into their respective Capital Account.
Non cash assets need to be recorded at their
fair value at the date of investment.
Liabilities brought into the partnership have to
be recorded at fair value.
15
Accounting Treatments
Additional Investment
Similar accounting entries as to the initial investment:


Record asset at it’s fair value
Credit the amount to partner’s capital account
Withdrawal of Investment
The withdrawal amount needs to be debited to partner’s
capital account
16
Cont.
Loan
Any loan provided by a partner is a liability to the
partnership. This partner is entitled to receive a certain
percentage of interest on the loan given. Interest on loan
will be treated as expenses of the firm & will be recorded
in income statement.
Interest on capital
Interest was given for the purpose of encouraging
partners to invest in the business.
17
Cont.
Other issues
All amounts received by each partner for the current
period (e.g. salaries, interest on capital, profit-loss, bonus
etc.) would be credited to respective partner’s Current
Account.
A key point to remember is that as in a sole trader's
accounts, any amounts actually paid to the owners
(whether in cash or in kind) should be treated as
drawings.
18
Cont.
If a partner is entitled to a salary, it is dealt with as part of
the appropriation of profit.
It is not an expense of the business, and should not be
charged to the income statement in order to calculate
profit.
Only salaries paid to employees of the business are
charged to the income statement.
19
Cont.
Residual Profit
Profit which is divided between the partners in the profit
and loss sharing ratio.
It is the amount of profit remaining after taking into
account the fact that the partners will be entitled to a
proportion of the profit under the terms of the partnership
agreement.
These proportions are the 'appropriations of profit'. ProfitLoss Appropriation Account is prepared to determine the
current profit received by each partner.
20
Cont.
It should be noted that while salaries and interest on
capital will reduce the amount of residual profit to be
shared between the partners, interest on drawings will
increase the residual profit.
21
Comprehensive Example
The net profit for the partnership between Azlan and Chong for the year
ended 31 December 20X8 was RM28,500. The capital accounts and
current accounts for the partnership on 1 January 20X8 were as follow:
Capital accounts:
Azlan
Chong
RM40,000
RM50,000
Current accounts:
Azlan
Chong
RM2,160
RM1,500
In the year 20X8, Azlan has withdraws RM2,000 on 31 Mac 20X8.
Azlan has been paid RM10,000 for his salary.
22
Cont.
The contents of the partnership agreement are as follow:
i. Interest on the initial capital is 5% per year
ii. Azlan would be paid RM12,000 per year for his salary
iii. 8% interest per year would be levied on withdrawals by the partners
iv. Azlan and Chong share a profit/loss in a ratio of 2:3
Prepare:
(a)
The allocation of profit-loss using Profit-Loss Separation Account or
Profit-Loss Separation statement for the year ending 31 December
20X8.
(b)
Capital account and current account for each partner
(c)
A balance sheet (equity section) as at 31 December20X8
23
Changes in Partnership Structure
Typical events that requires special treatment and may
change the partnership structures:
1.
2.
3.
Change in profit sharing ratio
Admission of new partners
Death or retirement of existing partner
If this happened, 2 issues are considered:


Revaluation of assets
Goodwill
24
Revaluation of Assets
The fair value of partnership needs to be determined whenever
there is a change in the partners.
Why?
Partnerships net assets are usually recorded at historical cost,
not at fair market value. But, the purchase or settlement of price
is based on number of factors, including the fair value of the
partnership’s net assets. Thus providing an equitable measure
of each partner’s capital interest before any admission or
retirement takes place.
25
Cont.
Revaluation Account
When assets or liabilities are revalued, the increments
(credit) or decrement (debit) to an account called
Revaluation Account.
The balance of this account will be transferred to the
existing partner’s capital account or retained profits
accounts based on the profit sharing ratios.
See Illustration 2 (Handout)
26
Cont.
One contentious issue is whether to value the
unidentifiable assets, i.e. goodwill and to record their
fair value.
Goodwill Recorded
The preferred approach is to revalue all the assets and
liabilities to fair value including identifiable and
unidentifiable assets and liabilities.
27
Cont.
Any increase or decrease in net assets is allocated to the
existing partners according to profit sharing ratios.
By using this approach, the fair value of the net assets is
recognised, thus providing an equitable measure of each
partner’s capital interest before any admission or retirement
takes place.
See Illustration 4 from Siti et al (2008), PA, p. 39
28
Cont.
Goodwill Not Recorded
Two arguments for this approach:
i. Even though the old partnership is dissolved, the
business activity continues without interruptions. No
justification for valuing and raising goodwill.
ii. The value of goodwill is subjective and therefore should
not be recorded.
See Illustration 3 from Siti et al (2008), PA, p. 37
29
Changes to the Profit Sharing Ratio
The partners decide to change the existing profit & loss sharing ratio.
Reasons:
i. A partner cannot perform as well as before may be due to illhealth, old age etc.
ii. The partner’s skills & competency have changed that affect
his/her performance
iii. A partner become more efficient
See Illustration 6
30
Admission of a New Partner
The admission of a new partner results in legal dissolution of the
existing partnership and the beginning a new one.
There are three steps in the admission of a new partner:
i. Revalue identifiable assets of old partnership
ii. Resolve whether the to record the goodwill of old partnership
iii. Admit the new partner
31
Cont.
A person wishing to acquire an interest in an existing partner may
do so by:
i. Purchasing an interest directly from an existing partner



The admission of a partner by purchase of an interest in the
firm is a personal transaction between one or more existing
partners and the new partner.
The price paid is negotiated and determined by the individuals
involved; it may be equal to or different from the capital equity
acquired.
Any money or other consideration exchanged is the personal
property of the participants and not the property of the
partnership.
32
Cont.
ii. Contributing assets (investment) to the partnership.
When a partner is admitted by investment, both the total net assets
and the total partnership capital change.
33
Retirement/Death of a Partner
The retirement/death of a partner dissolves the partnership.
It is necessary to determine the partner’s equity at the date of
retirement 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.
34
Retirement of a Partner
The surviving partners will agree to either:
1) purchase the deceased partner’s equity from their
personal assets or
2) use partnership assets to settle with the deceased
partner’s estate.
See illustration 8 (handout)
35