Topic 10 - Accounting for Partnerships

Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana © The McGraw-Hill Companies, Inc., 2007

Accounting for PartnershipsChapter

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Partnership???


Learning ObjectivesLearning Objectives

Define partnership Identify characteristics

of partnerships and similar organizations

Identify advantages and disadvantages of partnership

Prepare entries for partnership formation

Dividing profit or loss Preparing partnership

financial statements


Definition of partnershipDefinition of partnership

A partnership is an unincorporated association of two or more people to pursue a business for profit as co-owners. In Malaysia, this business form is governed under the Partnership Act 1961.

A partnership is an unincorporated association of two or more people to pursue a business for profit as co-owners. In Malaysia, this business form is governed under the Partnership Act 1961.

According to Para II, Section 3(1) of the Partnership Act 1961, a partnership is defined as:

“the relation which subsists between persons carrying on business in common with a view of profit”.

According to Para II, Section 3(1) of the Partnership Act 1961, a partnership is defined as:

“the relation which subsists between persons carrying on business in common with a view of profit”.


Characteristics of PartnershipCharacteristics of Partnership

Partnership Agreement

Partnership Agreement

Voluntary Association

Voluntary Association

Limited Life

Limited Life

TaxationTaxation

Unlimited Liability

Unlimited Liability

Mutual Agency

Mutual Agency Co-

Ownership of Property

Co-Ownership of Property


Organizations with Partnership Characteristics

Organizations with Partnership Characteristics

Limited Partnerships

(LP)

Limited Partnerships

(LP)

•General partners assume management duties and unlimited liability for partnership debts.•Limited partners have no personal liability beyond invested amounts.

•General partners assume management duties and unlimited liability for partnership debts.•Limited partners have no personal liability beyond invested amounts.

Limited Liability

Partnerships(LLP)

Limited Liability

Partnerships(LLP)

•Protects innocent partners from malpractice or negligence claims.

•Most states hold all partners personally liable for partnership debts.

•Protects innocent partners from malpractice or negligence claims.

•Most states hold all partners personally liable for partnership debts.


Choosing a Business FormChoosing a Business Form

Proprietorship Partnership LLP LLC S Corp. CorporationBusiness entity yes yes yes yes yes yesLegal entity no no no yes yes yesLimited liability no no limited* yes yes yesBusiness taxed no no no no no yesOne owner allowed yes no no yes yes yes

*A partner's personal liability for LLP debts is limited. Most LLPs carry insurance to protect against malpractice.

Many factors should be considered when choosing the proper business form.

Many factors should be considered when choosing the proper business form.


Advantages of PartnershipsAdvantages of Partnerships

Ability to share knowledge, expertise, and experience among co-partners in the business.Ability to share knowledge, expertise, and experience among co-partners in the business.

Easy to form the partnership firm and lower cost of formation as compared to the other types of business organizations. Easy to form the partnership firm and lower cost of formation as compared to the other types of business organizations.

Enables firm to get additional sources of investment capital from each partner since more than one partner is within the partnership firm.

Enables firm to get additional sources of investment capital from each partner since more than one partner is within the partnership firm.


Advantages of Partnerships…contAdvantages of Partnerships…cont

Possible tax advantages where a partnership has the same tax status as a sole proprietorship and is, therefore, not subject to taxes on its income.

Possible tax advantages where a partnership has the same tax status as a sole proprietorship and is, therefore, not subject to taxes on its income.

Easy to manage and decisions can be made with less bureaucracy since the owners of the partnership firm are usually its managers. Easy to manage and decisions can be made with less bureaucracy since the owners of the partnership firm are usually its managers.


Disadvantages of PartnershipsDisadvantages of Partnerships

The liability is unlimited where all partners are personally liable for business debts and liabilities.The liability is unlimited where all partners are personally liable for business debts and liabilities.

It is hard to find suitable partners where there is a possibility of conflict between partners in the future. It is hard to find suitable partners where there is a possibility of conflict between partners in the future.

Partnership is dissolved upon the death of a partner. Partnership is dissolved upon the death of a partner.


Partnership AgreementPartnership Agreement

A partnership is based on a contract between individuals. It is an agreement among the members of a firm for sharing the profits of the business carried on by all or any of them acting for all.

A partnership is based on a contract between individuals. It is an agreement among the members of a firm for sharing the profits of the business carried on by all or any of them acting for all.

Partnership agreements normally include the following details:

1. Name of the firm.

2. Name of all partners and contributions made by each

partner.

3. Nature of the business.

4. Date of commencement of partnership.

5. Duration of partnership, if any.


Partnership Agreement…contPartnership Agreement…cont

6. Rights and duties of all partners.

7. Sharing of profit and losses.

8. Interest charged on capital.

9. Withdrawal arrangement and interest charged on drawings.

10. Salaries, bonus, commissions, etc to the partners.

11. Interest on loan by the partner(s) of the firm.

12. Dispute procedures.

13. Admission and withdrawal of partners.

14. Rights and duties in the event of partner dies.

15. Dissolution of partnership.


In the Absence of a Partnership Agreement

In the Absence of a Partnership Agreement

Profits or losses sharing

Every partner should share the profits or losses of the firm equally regardless of the amounts of the capital contributed by them.

Profits or losses sharing

Every partner should share the profits or losses of the firm equally regardless of the amounts of the capital contributed by them.

Salary (remuneration) and commission to partners

No partner is entitled to any salary or commission for acting in the partnership business.

Salary (remuneration) and commission to partners

No partner is entitled to any salary or commission for acting in the partnership business.

Interest on capital

No interest on capital is allowed to all partners.

Interest on capital

No interest on capital is allowed to all partners.


In the Absence of a Partnership Agreement…cont

In the Absence of a Partnership Agreement…cont

Interest on drawings

No interest will be charged on any drawings made by the partners.


No interest will be charged on any drawings made by the partners.

Advance/loan to the business

A partner(s) is entitled to an interest of 8% per annum for any advance made to the business beyond the amount of capital subscribed.

Advance/loan to the business

A partner(s) is entitled to an interest of 8% per annum for any advance made to the business beyond the amount of capital subscribed.

Participation in business

Every partner may take part in the management of the partnership business.

Participation in business

Every partner may take part in the management of the partnership business.


In the Absence of a Partnership Agreement..cont

In the Absence of a Partnership Agreement..cont

Admission of new partner(s)

No admission of new partners into the business except that all partners agree to it.

Admission of new partner(s)

No admission of new partners into the business except that all partners agree to it.

Books of accounts

All books of accounts of the partnership shall be kept at the place of the partnership’s business. Each partner is entitled to access to all of them.

Books of accounts

All books of accounts of the partnership shall be kept at the place of the partnership’s business. Each partner is entitled to access to all of them.


Organizing a PartnershipOrganizing a Partnership

When partners invest in a partnership, their capital accounts are credited for the invested amounts.

Each partner’s investment is recorded at an agreed-on value, normally the market values of the contributed assets and liabilities at the date of contribution.

When partners invest in a partnership, their capital accounts are credited for the invested amounts.

Each partner’s investment is recorded at an agreed-on value, normally the market values of the contributed assets and liabilities at the date of contribution.

Journal entry is:

Cash/ Bank/ Assets Accounts XX

Partner’s Capital Accounts XX

Journal entry is:

Cash/ Bank/ Assets Accounts XX

Partner’s Capital Accounts XX


Organizing a PartnershipOrganizing a Partnership

Kayla Zayn and Hector Perez organize a partnership called BOARDS that offers year-round facilities for skateboarding and snowboarding. Zayn’s initial investment in BOARDS is $30,000, made up of cash ($7,000), boarding facilities ($33,000), a note payable reflecting a bank loan for the new business ($10,000). Perez’s initial investment is cash of $10,000.

Kayla Zayn and Hector Perez organize a partnership called BOARDS that offers year-round facilities for skateboarding and snowboarding. Zayn’s initial investment in BOARDS is $30,000, made up of cash ($7,000), boarding facilities ($33,000), a note payable reflecting a bank loan for the new business ($10,000). Perez’s initial investment is cash of $10,000.

Zayn’s investmentZayn’s investmentCash 7,000Boarding facilities 33,000

Note payable 10,000K. Zayn, Capital 30,000

Zayn’s investmentZayn’s investmentCash 7,000Boarding facilities 33,000

Note payable 10,000K. Zayn, Capital 30,000

Perez’s investmentPerez’s investmentCash 10,000

H. Perez, Capital 10,000

Perez’s investmentPerez’s investmentCash 10,000

H. Perez, Capital 10,000


Partner’s Capital AccountPartner’s Capital Account

The capital accounts of partners can be maintained based on two methods, namely:

• Fixed Capital Method, and

• Fluctuating Capital Method


(1) Fixed Capital Method(1) Fixed Capital Method

Under this method, the amount of capital of the partners remains fixed unless there is some additional capital brought in or there is any capital withdrawn by the partners during the period. This method requires two types of accounts to be opened. These accounts are:

• Capital Account, and• Current Account

Any accounts that reflect the changes in the partners’ capital accounts such as additional capital (increase capital) and drawings of capital (decrease capital) will be shown in the partner’s capital account as below:


(1) Fixed Capital Method (Cont…)(1) Fixed Capital Method (Cont…)

Partner’s Capital Account

Date Description Ref Amount Date Description Ref Amount

Drawings of capital

$ XX Beginning balance $ XX

Ending balance *

XX Additional capital XX

$ XXX $ XXX

* balancing figureNote: Separate capital account is kept for each partner in the business.



Partner’s Current Account


Beginning balance $ XX Beginning balance $ XX

Drawings XX Interest on capital XX

Interest on drawings XX Salary to partners XX

Share of loss – P & L Appropriation

XX Commission/bonus XX

Share of profit – P & L Appropriation

XX

Ending balance * XX Ending balance * XX

$ XXX $ XXX

* balancing figureNote: In Partners' Current Account, beginning balance and ending balance can be either debit or credit side.


Example:Example: On 1 July 2006, Aidiel and Fitrie commenced a

partnership where they contributed RM60,000 and RM45,000 each. P/L sharing ratio is 2:1.

Additional information:

i) Salary for Aidiel and Fitrie RM10,000 per annum and RM 8,000 per annum respectively and the interest for the capital was 8% per year.

ii) Aidiel and Fitrie also made a withdrawal of RM 3,000 and RM6,000 respectively.

iii) The profit of the firm after providing Aidiel and Fitrie’s salary as well as interest of capital was RM16,500.



Partner’s Capital Account (Aidiel)


30/6/07 Ending balance 60,000

1/7/06 Cash 60,000

60,000 60,000

* balancing figureNote: Separate capital account is kept for each partner in the business.



Partner’s Current Account (Aidiel)


Beginning balance -

Drawings 3,000 Interest on capital 4800

Salary to partners 10,000

Share of profit – P & L Appropriation

(2/3 x 16,500)

11,000

Ending balance * 22,800

25,800 25,800

* balancing figureNote: In Partners' Current Account, beginning balance and ending balance can be either debit or credit side.


(2) Fluctuating Capital Method(2) Fluctuating Capital Method

This method is not similar to the fixed capital method. Only one capital account for each partner will be opened. Any items that reflect the partner’s account such as

interest on capital, drawings, interest on drawings, salary/remuneration, commission, and share of profits or losses of partners for the period will be recorded in the partner’s capital account.


(2) Fluctuating Capital Method (Cont…)(2) Fluctuating Capital Method (Cont…)

Partner’s Capital Account


Drawings $ XX Beginning balance $ XX

Interest on drawings XX Additional capital XX

Share of loss – P & L Appropriation

XX Interest on capital XX

Salary to partners XX

Commission/bonus XX

Ending balance * XX Share of profit – P & L Appropriation

XX

$ XXX $ XXX

* balancing figureNote: A Partners' Capital Account usually shows a credit balance. However, under certain situations, it can show a debit balance, such as over withdrawal or insolvency of the partner.


Example:

On 1 July 2006, Aidiel and Fitrie commenced a partnership where they contributed RM60,000 and RM45,000 each. P/L sharing ratio is 2:1.

Additional information:

i) Salary for Aidiel and Fitrie RM10,000 per annum and RM 8,000 per annum respectively and the interest for the capital was 8% per year.

ii) Aidiel and Fitrie also made a withdrawal of RM 3,000 and RM6,000 respectively.

iii) The profit of the firm after providing Aidiel and Fitrie’s salary as well as interest of capital was RM16,500.


(2) Fluctuating Capital Method (Cont…)(2) Fluctuating Capital Method (Cont…)

Partner’s Capital Account (Aidiel)


Drawings 3,000 1/7/

06

Cash 60,000

Interest on capital 4,800

Salary to partners 10,000

30/6/07

Ending balance * 82,800 Share of profit – P & L Appropriation

(2/3 x 16,500)

11,000

85,800 85,800

* balancing figureNote: A Partners' Capital Account usually shows a credit balance. However, under certain situations, it can show a debit balance, such as over withdrawal or insolvency of the partner.


Dividing Profit or LossDividing Profit or Loss

Before the preparation of the Profit and Loss Appropriation, an income statement should be prepared first whereby at the end, the profit or loss for the period is calculated and then transferred to the Profit and Loss Appropriation.

Before the preparation of the Profit and Loss Appropriation, an income statement should be prepared first whereby at the end, the profit or loss for the period is calculated and then transferred to the Profit and Loss Appropriation.


Dividing Profit or Loss (Cont…)Dividing Profit or Loss (Cont…)

In preparing the Profit and Loss Appropriation, the following adjustments need to be considered:In preparing the Profit and Loss Appropriation, the following adjustments need to be considered:

1. Interest on Capital1. Interest on CapitalPartners can agree to allocate “interest allowance (or interest on Partners can agree to allocate “interest allowance (or interest on capital)” based on the amounts invested by each partner. capital)” based on the amounts invested by each partner. Expense to partnership firm but gain for partners.

1. Interest on Capital1. Interest on CapitalPartners can agree to allocate “interest allowance (or interest on Partners can agree to allocate “interest allowance (or interest on capital)” based on the amounts invested by each partner. capital)” based on the amounts invested by each partner. Expense to partnership firm but gain for partners.

2. Drawings2. Drawings

Similar to other business types of organizations, the partners in the partnership firm can make a withdrawal of cash or goods from the business. -NO EFFECT ON PROFIT AND LOSS APPROPRIATION-

2. Drawings2. Drawings

Similar to other business types of organizations, the partners in the partnership firm can make a withdrawal of cash or goods from the business. -NO EFFECT ON PROFIT AND LOSS APPROPRIATION-



3. Interest on Drawings3. Interest on DrawingsGain to the partnership firm.Gain to the partnership firm.

3. Interest on Drawings3. Interest on DrawingsGain to the partnership firm.Gain to the partnership firm.

4. 4. Partner's Salary/RemunerationPartner's Salary/Remuneration

Gain to partners but an expense to the partnership firm. 4. 4. Partner's Salary/RemunerationPartner's Salary/Remuneration

Gain to partners but an expense to the partnership firm.

5.5. Partner's CommissionPartner's Commission

Any commission paid to the partners is a gain to partners but an expense to the partnership firm.

5.5. Partner's CommissionPartner's Commission

Any commission paid to the partners is a gain to partners but an expense to the partnership firm.



6.6. Transfer to ReserveTransfer to Reserve

Reduction of profit to the partnership firm.6.6. Transfer to ReserveTransfer to Reserve

Reduction of profit to the partnership firm.

7. Share of Profits or Losses7. Share of Profits or Losses

Partners can agree to any method of dividing profits or losses. Partners can agree to any method of dividing profits or losses. In the absence of an agreement, the law says that the partners In the absence of an agreement, the law says that the partners

share profits or losses of a partnership equally.share profits or losses of a partnership equally.

7. Share of Profits or Losses7. Share of Profits or Losses

Partners can agree to any method of dividing profits or losses. Partners can agree to any method of dividing profits or losses. In the absence of an agreement, the law says that the partners In the absence of an agreement, the law says that the partners

share profits or losses of a partnership equally.share profits or losses of a partnership equally.


Example of Profit and Loss Appropriation

Example of Profit and Loss Appropriation

Farid and Fara are in partnership named Waja Ent. since 1st January 2006, sharing profit for the ratio 2:1. For the year ended 31 December 2006, Waja Ent. managed to obtained a profit of RM16,855. The partners entitled to interest on capital and drawings at 10% and 5% per annum respectively based on their agreement. Farid also entitled to receives a salary of RM 200 per month.

Additional info: i) Farid and Fara contributed capital of RM78,000 and RM48,000

respectively. ii) Farid withdrawn RM4,800 while Fariq RM 3,600. iii) Farid also received a commission of RM 1,000 from the partnership.

Prepare profit and loss appropriation for Waja Enterprise.


RM

Profit as per I/S 16,855


Farid (5% x 4,800) 240

Fara (5% x 3,600) 180

Interest on capital

Farid (10% x 78,000) (7,800)

Fara (10% x 48,000) (4,800)

Salary

Farid (200x12) (2,400)

Fara -

Commission

Farid (1,000)

Fara - .

1,275

Share of profit:

Farid (2/3 x RM 1,275) RM850

Fara (1/3 x RM 1,275) RM425 1,275


Death of a Partner Death of a Partner

A partner’s death dissolves a partnership. A deceased partner’s estate is entitled to receive his or her equity. The partnership contract should contain provisions for settlement in this case.

A partner’s death dissolves a partnership. A deceased partner’s estate is entitled to receive his or her equity. The partnership contract should contain provisions for settlement in this case.

These provisions usually require:

(1) Closing the books to determine profit or loss since the end of the previous period, and

(2) Determining and recording current market values for both assets and liabilities.

These provisions usually require:

(1) Closing the books to determine profit or loss since the end of the previous period, and

(2) Determining and recording current market values for both assets and liabilities.


End of Chapter 10End of Chapter 10

Topic 10 - Accounting for Partnerships

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