The preparation of final accounts for partnership

Learning Objectives:1) Define ‘Partnership’

2) The characteristics of Partnership

3) Advantages and disadvantages of forming a partnership

4) The SEVEN items in the Partnership Act regarding Partnership

5) The differences between Sole Trader and Partnership in terms of accounting entries

6) The preparation of final accounts for Partnership

The preparation of final accounts for partnership

Introduction:For a number of commercial reasons, it may be mutually advantageous for two or more people to form a partnership. Question: Have you ever wondered what a ‘partnership’ means? What characteristics a partnership has?

Answers: The Partnership Act defines a partnership as ‘the relationship which subsists

between persons carrying on business in common with a view of profit’. The

people who won a partnership are called ‘partners’. They do not have to be based or work in the same place, though most do. However, they maintain one set of

accounting records and share the profits and losses.

The characteristics of Partnership

Five characteristics of a partnership:

1)  It is formed to make profits.

2) It must obey the law as given in the Partnership Act 1890. If there is a limited partner, it must also comply with the Limited Partnership Act of 1907.

3) Normally there can be a minimum of two partners and a maximum of twenty partners. Exception are banks, where there cannot be more than ten partner; and there is no maximum for firms of accountants, solicitors, stock exchange members, surveys, auctioneers, valuers, estate agents, land agents, estate managers, or insurance brokers.

The characteristics of Partnership

Five characteristics of a partnership:

4)  Each partner (except for limited partners) must pay their share of any debts that the partnership could

not pay. If necessary, they could be forced to sell all their privates possessions to pay their share of the debts. This can be said to be unlimited liability.

5) Partners who are not limited partners are known as general partners.

The characteristics of Partnership

Limited Partnership:

Limited partnership are partnerships containing one or more limited partners. Limited partnerships must be registered with the Registrar of Companies. Limited partners are not liable for the debts as in Section 41.2. Limited partners have the following characteristics and restrictions on their role in the partnership.

1) 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.

Limited Partnership:

2) They are not allowed to take out or receive back any part of their contribution to the partnership during its lifetime.

3) 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.

4) All the partners cannot be limited partners, so there must be at least one general partner with unlimited

liability.

Advantages and disadvantages of forming a partnership

The advantages of Partnership:1) Spreading of business risk

2) Different partners can develop special skills because each partner can focus on one skill

3) Some partners have more ability to invest capital resources than other partners

The disadvantages of partnership:

1) Disputes between partners on business matters

2) All are ‘jointly and severally liable’ for his partners. If one partner incurs a liability, then the others will also share it.

The Deed of Partnership

Partners in a partnership are largely free to make whateveragreements between themselves that they wish to cover theirmutual relationships. The powers and rights of the partnersbetween themselves are governed by any written agreement theymay make. This is referred to as the articles or deed ofpartnership. The deed of partnership is prepared to avoidmisunderstanding between partners.

It states the followings:

1) The capital to be contributed by each partner

2) The ratio in which profits (or losses) are to be shared

3) The rate of interest, if any, to be paid on capital before the profits are shared

The Deed of Partnership

It states the followings:

4) The rate of interest, if any, to be charged on partners’ drawing

5) Salaries to be paid to partners

6) Arrangements for the admission of new partners.

7) Procedures to be carried out when a partner retires or

dies.

Where no partnership agreement exists

When no partnership agreement exists, express or implied, Section 24 of Partnership Act 1890 governs the situation. The accounting content of this section states:

1) Profit and losses are to be shared equally

2) There is to be no interest allowed on capital

3) No interest is to be charged on drawings

4) Salaries are not allowed

5) 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 annum on such an advance

The SEVEN items in the Partnership Act regarding Partnership

In the absence of any partnership agreement, a partner is subjectto the provision of Partnership Act. There are SEVENitems in the Partnership Act regarding this issue.

1) Each partner has unlimited liability. That is, if the debts of the partnership cannot be paid because the business has insufficient assets to do so, the creditors have recourse to the private property of the individual partners. The partners are said to be jointly and severally liable for the debts of the firm and therefore a creditor may sue the partnership or any individual partner.

The SEVEN items in the Partnership Act regarding Partnership

2) Every partner is entitled to take part in the management of the business. However, some partnership agreements provide for certain partners to be sleeping or limited partners. Neither of these normally takes part in the management of the business.

3) Every partner is entitled to access to the books and papers of the partnership. This includes sleeping and limited partners.

The SEVEN items in the Partnership Act regarding Partnership

4) Voting powers: in the ordinary day-to day running of a partnership, individual partners often make routine business decisions without consulting the other partners. At the other extreme, certain fundamental decisions, such as to change the type of business in which the partnership is engaged, or the admission of a new partner, require the consent of all the partners. Other decisions are supposed to be determined by a majority vote. Each partner has one vote. However, a partnership deed may specify some other distribution of voting power.

The SEVEN items in the Partnership Act regarding Partnership

5) Each partner is an agent of the partnership and can this sign contracts on behalf of the partnership, which will then be legally bound to honour them.

6) A new partner can only be admitted to the partnership if all existing partners give their consent. However, a partnership deed may specify otherwise.

7) A partnership will be dissolved by:

a) any partner giving notice to the other partner(s) of his or her intention to leave the partnership;

b) the death, insanity or bankruptcy of a partner.

The differences between Sole Trader and Partnership in terms of accounting entries

Differences between a Sole Trader (Proprietorship) and apartnership:

Sole Trader Partnership1) Only Capital Account

- All Capital invested, Drawings and Profit and Loss are closed to the Capital Account

1) Two accounts:

a) Partners’ Fixed A/C

This account contains only amount of capital invested.

b) Partners’ Current A/C

This account contains each partner’s Drawings, and Share of Profit

The differences between Sole Trader and Partnership in terms of accounting entries

Differences between a Sole Trader (Proprietorship) and apartnership:

Sole Trader Partnership

2) No division of profit – all belongs to the Sole Trader

2) Profit is put into Appropriation A/C – divided according to the Profit Sharing ratio to each partner

The differences between Sole Trader and Partnership in terms of accounting entries

Capital and Current AccountsIn the accounts of sole trader, there would be a capital accountand usually a drawing account. In the books of a partnership,there will be:

1) A Capital Account for each partner. Unlike the capital account of a sole trader, this will only contain the original capital put into the business plus any further capital introduced at a later date. It is fixed in nature and used to record:Capital introduced or withdrawn by new/retiring partners.

The differences between Sole Trader and Partnership in terms of accounting entries

Capital and Current Accounts (continues)

2) A Current Account for each partner recording:a) drawings of money or goods taken by the partner for his or her own use (debit)b) interest charged on drawings (debit)c) interest on loans to the partnership (credit)d) salary (credit)e) interest on capital (credit)f) the partner’s share of the residual profit and loss

The differences between Sole Trader and Partnership in terms of accounting entries

The following factors have to be taken into consideration, beforeany profits are divided:

a) Interest on capitalPartners can agree to credit themselves with Interest onCapital.

b) Salaries Partners can agree to credit themselves with fixed salaries, eg for a partner who contributes valuable service to the Partnership.c) Share of Residual Profits (or Losses) Partners can share out the remaining Profit and Loss after allowing for (a) and (b) above (Interest and Salaries), according to the profit and sharing ratio.

The preparation of final accounts for partnership

Example1 : Appropriation AccountPeter and Paul commenced business in partnership on 1 Jan 2002as food wholesalers, contributing as fixed capital £2,000 and£3,000 cash each. Their partnership deed states that:

a) Profits and losses are to be shared equallyb) Salaries are Peter £2,500 per annum and Paul £1,800.c) Interest on capital of 10% is allowedd) Interest on drawings of 5% is chargede) Interest on loan from partners is given at the rate shown in

Section 24 of Partnership Act 1890. (5% per annum)During the year, Peter and Paul withdrawn £500 and £400 fromthe partnership, respectively. In addition, Paul has lent £1,000 asloan to the partnership on 1 July 2002. Profit for the year is£10,000.

The preparation of final accounts for partnership

Answers:

Appropriation Account for the year ended 31 Dec 2002

£ £ £

Ch 9: The preparation of final accounts for partnership

Once the Appropriation account has been completed, then weshould record those amounts in the Partners’ Current Account.(continues Example 1)

The preparation of final accounts for partnership

Once the Appropriation account has been completed, then weshould record those amounts in the Partners’ Current Account.(continues Example 1)

Partners’ Capital Account

Partners’ Current Account

The preparation of final accounts for partnership

In conclusion, the flow of preparing the whole set of partnershipaccount is as follow:

Step 1: You’ll be given a trial balance as usual

Step 2: Profit and Loss Account

Step 3: Appropriation Account

Step 4: Partners’ Current Account

Step 5: Balance Sheet

The preparation of final accounts for partnership

THE END

Any questions to ask?