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PARTNERSHIP ACCOUNTS
FORMATION OF A
PARTNERSHIP
 Defined in the Partnership Act 1890 as the
relationship between two or more people
engaging in business for profit
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FORMATION OF A
PARTNERSHIP
 Three important factors must be present in
a partnership:
partners must be carrying on a business, not
one isolated business transaction
must be agreement between two or more
legally competent people who must be the
business co-owners
partners must have intent to make a profit
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FORMATION OF A
PARTNERSHIP
 Partnerships are separate accounting
entities to the partners (owners)
 Owner’s Capital Accounts are kept for each
individual partner
 Each partner has the right to share in the
profits and manage the business
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PARTNERSHIP AGREEMENT
 Partnership agreement
doesn’t always exist, making it difficult to
establish if a partnership actually exists
if there is no formal partnership agreement then
the Partnership Act applies
agreement is essential because partnerships:
have unlimited liability
have a limited life
• death of partner
• insolvency of partner
• retirement of partner
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PARTNERSHIP AGREEMENT
name of business
details of each partner
nature of business
division of profit and
losses
 capital contributions
 authority, rights and
duties of partners
 details of salaries




 drawings and interest
on drawings
 interest on capital
 voting and decisionmaking procedures
 admission of new
partners
 resolution of disputes
 bankruptcy, death or
retirement of partners
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PARTNERSHIP ACT 1890
 If there is no partnership agreement in writing, or
if it does not cover an area of dispute, matters may
be resolved by reference to the Partnership Act
 e.g. Act states all profits and losses are to be shared
equally, so if profit ratio is not defined in an agreement,
the Act is applied
 Partners will receive interest at 5% on excess capital (ie
over and above that which they have agreed to
contribute)
 No interest on drawings
 No salaries
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ADVANTAGES OF
PARTNERSHIP
 Creation and dissolution is easier than a
company
 Minimal statutory regulations
 Resources can be pooled
 Expertise can be utilised
 Co-ownership of assets
 Duties and responsibilities are shared
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DISADVANTAGES OF
PARTNERSHIP
 Liability is unlimited (partners own personal
possessions can be used to pay debts owed by the
business)
 Partnership may cease if a partner dies, retires or
becomes bankrupt
 Disagreements between the partners can occur
 Limits to raising large amounts of capital
 Partners can be sued by creditor, jointly or
individually
 Partners are likely to pay higher income tax
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LIMITED LIABILITY PARTNER
 Governed by the Limited Liability
Partnership Act 1907
 Liability is limited to the amount of capital
invested by the partner
 A Limited Partner has no say in the
Management of the Partnership business
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PARTNERSHIP ACCOUNTS
 CURRENT ACCOUNTS
working accounts containing details of profit,
loss, drawings and interest on capital invested
or charged on drawings
 CAPITAL ACCOUNTS
partner’s original capital put into the business is
considered to be ‘fixed’
capital account of each partner is usually
unchanged unless additional capital is invested
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PARTNERSHIP ACCOUNTS
 CREATION OF NEW PARTNERSHIP ACCOUNTING ENTRIES
Can be created in two ways
the introduction of cash only, entered in the cash
account and the partner’s capital account
the introduction of cash and other assets; entered in
the cash and asset accounts and the partner’s capital
account
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PROFIT DISTRIBUTION
 PROFIT-SHARING RATIOS
Profits and losses are shared in the way
partners feel most appropriate
Profit share can be determined in various ways:
Amounts are shared on the basis of the amount of
capital contributed by each partner
Higher profit may go to a partner bringing something
of particular value into the business, such as
specialised expertise
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PROFIT DISTRIBUTION
 PROFIT AND LOSS APPROPRIATION
ACCOUNT
Net profit or loss is transferred to this account
from the profit and loss account
Additions are made for Interest on Drawings
(this is to discourage partners from making
drawings from the business)
Deductions are made for Interest on Capital or
any Salaries paid to partners
Residual Profits are then shared, as agreed,
according to Profit Sharing ratios
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PROFIT AND LOSS
APPROPRIATION ACCOUNT
Profit and Loss Appropriation Account for
Able, Bable and Cable
Net Profit
Add Interest on Drawings
Less Interest on Capital
Salary – Able
Residual Profit:
Shared: Able 1/3
Bable 1/3
Cable 1/3
£2,500
£5,000
£16,000
500
16,500
£7,500
£9,000
£3,000
£3,000
£3,000
£9,000
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PROFIT DISTRIBUTION
 ALLOCATION AS PER PARTNERSHIP
AGREEMENT
Interest on capital may be payable
Interest may be charged for drawings taken out
of the business
There may be a provision for the payment of a
salary of a particular partner
Interest may be payable on loans to partners by
the business or loans by partners to the
business
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PROFIT DISTRIBUTION
 LOAN ACCOUNTS
Where a partner makes a loan to the business,
the debit is to bank and the credit to loan
account in that partner’s name
 DRAWINGS
Where a partner withdraws cash from the
business in anticipation of profits earned, the
current account is debited and cash/bank is
credited
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ADMISSION OF NEW PARTNER
 REASONS FOR A NEW PARTNER
May bring in new products and/or customers to
the business
May bring specialised expertise to the business
Allows the business access to further capital
May bring in additional assets
May provide new business contacts
May be a requirement due to death, retirement
or bankruptcy of an existing partner
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ADMISSION OF NEW PARTNER
NEW PARTNERSHIP AGREEMENT
 ADJUSTING THE EXISTING BUSINESS
All existing partners must agree on the
admission of a new partner
Assets of the business should be revalued
before a new partner is admitted
Liabilities need to be reviewed for accuracy in
valuation
Gains and losses to existing partners from new
business value will be made at the existing
profit-sharing ratio
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STEPS TO ADMIT
NEW PARTNER
1.
2.
3.
4.
Review value of assets (see later slide)
Consider inclusion of goodwill (see next slide)
Record changes in the Ledger Accounts
Open a Goodwill Account and adjust the existing
partners Capital Accounts according to their
existing profit-sharing ratio
5. Prepare opening ledger entries for new partner
6. Calculate partners’ new profit-sharing ratio
7. Prepare a new Statement of Financial Position ie
Balance Sheet
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ADMISSION OF NEW PARTNER
 GOODWILL
Goodwill can be defined as future benefits from
assets that cannot be individually identified e.g.
reputation, customer database, management
ability, product, location
Goodwill is an asset and as such appears in the
Balance Sheet as an Intangible Asset ie one
which cannot be seen
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Recording Goodwill
 When the partnership is revalued:
Debit the Goodwill Account with the value of the
increase in the value of the business (premium)
Credit the existing partners Capital Accounts
according to their profit-sharing ratio
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REVALUATION OF ASSETS
 Before admitting a new partner to the
business, the Assets should be revalued:
Some eg Buildings may have appreciated in
value
Some eg Machinery may not be worth as much
as the Net Book Value in the Balance Sheet –
perhaps insufficient amounts for depreciation
has been written off over the years
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Accounting for Revaluation
 Adjustments to the relevant accounts
should be made
Eg If Buildings have appreciated, the Buildings
Account would be Debited and the Revaluation
Account Credited
If there has been insufficient depreciation
written off machinery, the Machinery
depreciation account would be credited and the
Revaluation Account Debited
The balance on the Revaluation Account would
then be transferred to the Partners Capital
Accounts according to their profit-sharing ratio
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PARTNERSHIP DISSOLUTION
 REASONS FOR DISSOLVING A PARTNERSHIP
Partner(s) may give notice of intention to dissolve
Insolvency of a partner
Ownership changes e.g. converting to company
Inability to trade profitably
Death of partner
Voluntary agreement by partners
Courts may also rule to terminate the partnership
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KEY TERMS
You should be aware of the following terms when dealing
with Partnerships and be able to give clear definitions as
well as know how to account for each:





Capital Accounts
Capital Adjustment Account
Current Account
Revaluation of Fixed Assets
Fixed Capital Account
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KEY TERMS






Interest on Capital
Interest on Drawings
Partnership Act
Partnership Agreement
Profit and Loss Appropriation Account
Profit-sharing Ratios
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