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

Definition
Partnership Act 1961
is the relation which subsists between persons carrying on business in common with a view of profit. Sec 3(1) * A partnership is a form of business jointly owned by two or more persons, or entities with a view of making profit.

 Partners the people who own a partnership. They are not separate entities from the partnership (legal point of view).
i.e. they are responsible for all the liabilities and actions of the partnership.

Examples of partnership:
Private clinics, auditing and accounting firms, law firms, private institutions. Small retail or manufacturing.

Reasons for forming partnership:

Raise more capital, different skills may be complementary to each others, share risks and responsibilities
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Characteristics
Separate legal personality (from accounting perspective) Unlimited liability Limited life Co-ownership of property Co-ownership of profits

Advantages

Advantages & Disadvantages

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
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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.

Partnership Agreement
This agreement is a 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 Rate of interest for capital Rate of interest to be charged on partners drawings Salaries to be paid to partners (if any) Arrangements for the admission of new partners Procedures to be carried out when a partner retires or dies

Cont.
When no partnership agreement exists (refer to Section 26 or PA1961):
Every partners may take part in the management 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.
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Partnership vs Sole Proprietorship

Proprietorship Partnership Net Profit Net Profit

Partners Account
Balance Sheet Balance Sheet

Reporting Equity in BS
Two methods available to present the equity in the balance sheet: i. Fixed Capital Account ii. Fluctuating Capital Accounts i. Fixed Capital Account The capital account will record the initial introduction of capital, and will normally only be adjusted if the partner introduces additional capital (i.e. to record movement of capital). 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, partners salaries accrued etc.

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Cont.
ii. Fluctuating capital accounts If the partnership maintains fluctuating capital accounts, there will be no current account. All changes in partners equity (appropriation of profit and drawings) will be recorded in partners capital accounts. Capital of each partner will fluctuate every year. Thus, the original value of capital contributed by each partner is no longer known.

Note: Fixed Capital Accounts is favorable over Fluctuating Capital Accounts

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Cont.
Fixed Capital Account
Capital Account Ali Abu Bank Ali 2,000 Abu 6,000

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Cont.
Fixed Capital Account
Current Account Ali Drawings Int. on drawings Bal. c/d 2,000 Abu 2,000 Int. on capital Profits Salaries 2,650 Ali 100 2,550 Abu 300 1,700 500 2,500

50
600 2,650

100
400 2,500

Bal. b/d

600

400

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Cont.
Fluctuating Capital Account
Capital Account Ali Drawings Int. on drawings Bal. c/d 2,000 Abu 2,000 Bank Ali 2,000 100 2,550 Abu 6,000 300 1,700 500 8,500 6,400

50
2,600

100
6,400

Int. on capital
Profits Salaries

4,650

8,500
Bal. b/d

4,650
2,600

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Cont.
Ali and Lee have decided to form a partnership, Alee Tax Consultant. Besides consultancy, the firm supplies taxation books and related materials to colleges and universities. The partnership commences its operation on 1st January 2010. Therefore its financial year begins at 1st January and ended 31st December every year. Capital contributions as agreed:
Ali cash RM10,000 and shop lot with a market value of RM30,000 Lee- Cash RM5,000

On 15th January, Ali took out cash RM2,000 while Lee took out goods amounting to RM500. Required: Prepare journal entries to record the above transactions using both methods. 15

Fixed Capital Accounts

Date Jan 1 2010 Particular Cash Capital Ali Capital Lee (To record cash investment by Ali and Lee) Premise Capital - Ali (To record shop lot investment by Ali) Jan 15 2010 Current a/c Ali Cash (To record cash withdrawal by Ali) Current a/c Lee Purchases (To record goods withdrawal by Lee) Debit (RM) 15,000 5,000 10,000 Credit (RM)

30,000 30,000 2,000 2,000 500 500

Date Jan 1 2010

Particular Cash Capital Ali Capital Lee (To record cash investment by Ali and Lee) Premise Capital - Ali (To record shop lot investment by Ali)

Debit (RM) 15,000

Credit (RM) 5,000 10,000

30,000 30,000 2,000 500 2,000 500

Jan 15 2010

Capital Ali Capital Lee Cash Purchases (To record cash & goods withdrawal by partners)

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.

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Accounting Treatments
Additional Investment Similar accounting entries as to the initial investment:
Record asset at its fair value Credit the amount to partners capital account

Withdrawal of Investment The withdrawal amount needs to be debited to partners capital account
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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.
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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 partners 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 any kind) should be treated as drawings.
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Cont.
Salary 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.
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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'. Profit-Loss Appropriation Account is prepared to determine the current profit received by each partner. 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 23 will increase the residual profit.

The final accounts

Consist of: Trading, profit and loss account Net profit/loss will be transferred to the profit and loss appropriation account Profit and loss appropriation account Shows of profits or losses among partnersobtained by adjusting the amount of net profit with related transactions made by partners. Balance sheet

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Comprehensive Example 1
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 Current accounts: Azlan Chong

RM40,000 RM50,000

RM2,160 RM1,500

In the year 20X8, Azlan withdrew RM2,000 on 31 Mac 20X8.

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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 Appropriation Account or Profit-Loss Appropriation 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 December 20X8

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