CHAPTER 8

Partnerships:
formation, operation
and reporting

LEARNING OBJECTIVES
1. Define a partnership and the major attributes of a
partnership
2. State the advantages and main characteristics of
the partnership structure of a business
3. Explain the purpose of a partnership agreement
and describe its typical content
4. Describe the special features applicable to
accounting for partnerships
5. Explain the accounting entries for the formation of
a partnership
6. Explain the accounting entries for the allocation of
profits of a partnership
7. Explain the accounting entries for drawings and
advances or loans made by partners

PARTNERSHIP DEFINED
Partnership Act:
The relationship that subsists between
persons carrying on a business in common
with a view to profit

Necessary attributes
1. Must be an agreement (written or verbal)
2. View to earning a profit
3. Co-ownership of the business

ADVANTAGES OF A PARTNERSHIP
Pooling of capital resources and
multiple skills of individual
partners
Formed at little or no cost
Subject to little
regulation/supervision
Partners may be able to operate
with more flexibility because not
subject to control of a board of
directors
May be tax advantages

CHARACTERISTICS OF A
PARTNERSHIP

Mutual Agency
Each partner acts as agent for the partnership
Each partner has authority to act on behalf of
the partnership

Unlimited liability
Each partner personally responsible for all the
debts of the business
No limit to liability
Personal assets are exposed
Unattractive to wealthy individuals

CHARACTERISTICS OF A
PARTNERSHIP

Limited life
Ended if member dies, withdraws or retires,
or becomes incapacitated
Ended on the admission of a new member
Ended via bankruptcy
Ended if formation purpose is over

Transfer of partnership interest

Capital interest is personal asset

PARTNERSHIP
AGREEMENT
Agreement covers:
Name, location and nature
Name, investment and duties of each partner
Sharing of profits and losses
Administrative details/day to day operations
Withdrawals (drawings)
Dispute resolution
Admission/withdrawal of partners
Partnership liquidation

ACCOUNTING FOR A PARTNERSHIP

Accounting is mostly the same as
already presented for a sole trader
The major difference is around
accounting for the partners equity
Ownership interests are generally not equal
Capital investment and drawings vary
Profit distributed according to partnership agreement

Two commonly used methods of

accounting

METHOD 1: FLUCTUATING CAPITAL

ACCOUNTS (The one we are doing)

Capital account credited when

assets are invested in the
partnership
Drawings account debited with
withdrawal of assets or personal
expenses
Drawings account closed to capital
P&L summary closed to Profit
Distribution and allocated to
Capital accounts

METHOD 2: FIXED CAPITAL

ACCOUNTS

Capital account credited with asset

investments and debited with
withdrawals of capital
Drawings account debited with
withdrawal of assets or personal
expenses
Drawings account closed to
Retained Profits
P&L summary closed to Profit
Distribution and allocated to

ACCOUNTING FOR THE FORMATION

OF A PARTNERSHIP

First step is to agree on carrying

amount and fair value of assets to
be contributed and liabilities to be
assumed by the partnership
Fair value is the price that would
be received to sell an asset or paid
to transfer a liability in an orderly
transaction between market
participants at measurement date

ACCOUNTING FOR THE FORMATION

OF A PARTNERSHIP

Assuming that the partners agree

to have capital balances equal to
the fair value of net assets
contributed and that GST is not
applicable the
initial
entry would
General
Journal
Jun 30 Assets
X
be:
Liabilities

Partner A, Capital

(Assets and liabilities contributed

by Partner A to the partnership)

ALLOCATION OF PARTNERSHIP
PROFITS AND LOSSES

Consider for each partner:

services performed
capital invested
business risk assumed

Common methods
fixed ratio
ratio based on capital balances
fixed ratio allowing for interest and salary

ALLOCATION OF PROFIT:
FIXED RATIO

Method 1 Fluctuating Capital

Accounts
Assuming the partners (Becker and
Journal
Cook) agree General
to a 7:3
sharing of
Jun 30 P&L Summary
60
profits
000
Profit Distribution

60
000

(Transfer of profit to distribution

account)
Profit Distribution

60
000

ALLOCATION OF PROFIT: RATIO

BASED ON CAPITAL BALANCES

Used where invested capital is

considered most important factor
and/or the operations require little
of the partners time
Assuming ratio is calculated based
on beginning
capital
balances:
Capital
Profit
Allocation
Investm
ent

Becker
Cook

$150 000 ($150 000/$250 000) x $60

000

$36 000

100 000 ($100 000/$250 000) x $60

000

24 000

ALLOCATION OF PROFIT: RATIO

BASED ON CAPITAL BALANCES

Method 1
General Journal
Jun 30 P&L Summary

60
000

Profit Distribution

60
000

(Transfer of profit to distribution

account)
Profit Distribution

6000
0

M. Becker, Capital

3600
0

R. Cook, Capital

2400

ALLOCATION OF PROFIT:
FIXED RATIO AFTER INTEREST
AND SALARIES

Used where partners make unequal

capital contributions and the amount
of time and the nature of services
performed are not the
same.
Becker
Cook
Total
Interest on Capital
$150 000 x 10%

$15 000

$100 000 x 10%

$10 000 $25 000

Salaries to partners

18 000

10 000

28 000

Total interest and

salary

33 000

20 000

53 000

3 500

3 500

7 000

Residual divided
equally
Equity Increase

$36 500 $23 500 $60 000

ALLOCATION OF PROFIT:
FIXED RATIO AFTER INTEREST
AND SALARIES
Method 1

General Journal
Jun 30 P&L Summary

60
000

Profit Distribution

60
000

(Transfer of profit to distribution

account)

Profit Distribution

25000

M. Becker, Capital

15000

R. Cook, Capital

10000

ALLOCATION OF PROFIT:
FIXED RATIO AFTER
INTEREST AND SALARIES
Method 1
General Journal
Jun 30 Profit Distribution

28
000

M. Becker, Capital/Retained
Earnings

18
000

R. Cook, Capital/Retained
Earnings

10
000

(Distribution of salaries to partners)

Profit Distribution

7 000

M. Becker, Capital

3 500

R. Cook, Capital

3 500

(Distribution of residual profit to

partners)

DRAWINGS MADE BY
PARTNERS
Partners may withdraw cash or
other assets from the partnership.
Drawings may be from earnings or
capital
Under method 1 there is no
General Journal
distinction.
Partner A, Drawings
X
Cash at Bank or Other Asset
(Cash or asset drawing by Partner
A)

DRAWINGS MADE BY PARTNERS

Method 1 - Closing drawings
General Journal
account
Jun 30 Partner A, Capital
Partner A, Drawings
(Closing entry for drawings)

X
X

Accounting for Drawings

Method 1
General Journal
Dec Becker Drawings
31

14,00
0

Cash at Bank

14,00
0

(Cash drawings by Becker)

Mar
31

Cook Drawings

8,000

Cash at bank

8,000

(Cash drawings by Cook)

Jun 30 Becker Capital
Cook Capital
Becker Drawings

14,00
0
8,000
14,00
0

22

INTEREST ON
DRAWINGS
Partners may agree to pay interest
on drawings of profits or capital
This provides an incentive to retain
investment in the partnership (and
disincentive to withdraw)
General Journal

Jun 30 Partner A, Capital

Profit Distribution
(Charging interest on drawings)

X
X

LOANS OR ADVANCES
BY PARTNERS

Partners may lend money to the

partnership on a short term basis
rather than investing
General
This represents
a Journal
liability of the
Cash at Bank
X
partnership
Advance from Partner A

(Advance from partner)

Interest Expense
Cash at Bank / Interest
Payable
(Interest on partner advance)

X
X

ALLOCATION OF PROFIT:
FIXED RATIO AFTER INTEREST
AND SALARIES, & INTEREST
ON
DRAWINGS
Used where partners make unequal capital
contributions and the amount of time and the
nature of services performed
are notTotal
the same .
Becke Cook
r
Interest on Capital
credited
$150 000 x 10%
$100 000 x 10%
Salaries to partners
credited

$15,00
0
$10,00
0

$25,000

18,000 10,000

28,000

Interest on drawings *(560) *(160)

(720)
Interestdebited
of 8% pa on drawings. Becker 14000*.08*6/12. Cook 8000*.08*3
25

FINANCIAL STATEMENTS
FOR A PARTNERSHIP

Special-purpose vs general-purpose
report
If the partnership is not a reporting entity it
will prepare special-purpose financial
statements
If the partnership is a reporting entity it will
prepare general-purpose financial
statements

Each partners equity reported

separately on the Balance Sheet (or
Statement of Changes in Equity)

FINANCIAL STATEMENTS
FOR A PARTNERSHIP

Salaries, interest on capital and

interest on drawings are not expenses
Allocation of profit

No income tax expense because

partnership is not a legal entity and
not subject to tax
Profit or loss allocation disclosed in a
separate statement of changes in
partners equity

STATEMENT OF CHANGES IN
PARTNERS EQUITY
BC PARTNERSHIP
Statement of Changes in Partners Equity
For the year ended 30 June 2015

28

Attempt this problemConstruct a profit allocation table

Kerrie & Connie are in a partnership sharing
profits equally. The partnership agreement
allows for Kerrie to receive a $60,000 salary
and Connie to receive a $50,000 salary.
Interest is also charged on closing capital
balances of 8% p.a. and interest on drawing
balances of 10% p.a.
Kerrie
Connie
The capital and drawings accounts are as
Capital
96 000 Capital
108 000
below:
Drawings

24 000 Drawings

30 000

Profit before allowing for interest was $144,

All drawings made in expectation of profits
29

ALLOCATION OF PROFIT:
FIXED RATIO AFTER INTEREST
AND SALARIES, & INTEREST
ON DRAWINGS
Kerrie

Conni
e

Total

Interest on Capital
credited
$

x 8%

x 8%

Salaries to partners
credited
Interest on drawings
debited
x 10%
Residual divided

30

Reminder
Submit your Accounting Practice
set assignment on due time
Attend MYOB tutorial in computer
lab (part of the minimum
attendance requirement in this
unit)
Review lecture in week 13 (week 610)
Review lecture in week 14 (week
11-12)
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