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Partnership accounts

Partnership accounts
by Neil Stein
27 May 2004

Professional Scheme, Certified Accounting Technician scheme
Relevant to Paper 1.1, Paper 6

This article concentrates on the preparation of partnership financial statements. This is the only aspect of partnership accounts examinable in Paper 1.1. CAT Paper 6 also requires knowledge of the accounting entries necessary to record changes in partnership personnel and dissolution of partnerships.

There are no material differences between UK and international practice in partnership accounts apart from minor variations in terminology and format. This article uses UK terminology. For students taking the international paper the conversion is:

UK term International equivalent
Profit and loss account Income statement
Appropriation account Statement of division of profit

Differences between sole traders' accounts and partnership accounts
If you can handle the financial statements of sole traders, with adjustments for accruals, prepayments, depreciation and the like, it is an easy matter to add the requirements for partnership accounts. The differences are:

  1. Balance sheet -
    1. there is a separate capital account for each partner instead of just the one required for a sole trader
    2. we often maintain a separate current account for each partner, recording drawings and profit shares. If this is done, the capital account is only used for 'capital' transactions such as the introduction of extra long-term capital by partners.
  2. Profit and loss account - the division of the net profit among the partners has to be shown. There are several possibilities:
    1. profit is shared in agreed proportions
    2. as (a), but partners are credited with a 'salary' to allow for the work they put into the partnership
    3. as (a) or (b), but partners are credited with 'interest on capital' to allow for differences in the amounts of fixed capital partners have contributed.

It is important to note that partners' salaries and interest on capital are not charges in the main part of the profit and loss account. They are simply part of the process of dividing up the profit among the partners. The division is shown in an additional section of the profit and loss account called the appropriation account. This may be presented in a tabular format as shown in the next section.

Preparing partnership financial statements
Profit and loss account

The main part of the profit and loss account is prepared exactly as for a sole trader.
Points to watch:

  1. Do not put partners' salaries or interest on capital into the main profit and loss account. They belong only in the appropriation account section.
  2. Do not include drawings anywhere in the profit and loss account or appropriation account. Drawings are debited to partners' current accounts.

Profit and loss appropriation account
The easiest format to adopt here is a simple columnar presentation. See Figure 1 below (figures invented). Points to watch:

  1. One partner may guarantee that another partner's total profit share is not less than a certain minimum amount. To deal with this, make a transfer from one column to another in the tabulated appropriation account.
  2. Changes to the profit-sharing arrangements or changes in partnership personnel part way through the year. You have to divide the profit on a time basis between the periods, then apply the details given to the apportioned profits. Remember to take half a year's salary for a half-year period. Your table then shows the total profit shares for the year calculated for the two periods involved.
  3. Change in partnership personnel part way through the year, with an agreement that certain expenses charged in the profit and loss account relate to one part of the year only. This is a variation on (b) above and always causes problems for candidates in the Paper 1.1 examination. What you have to realise is that for the partners not bearing the expense, the profit is that shown by the profit and loss account plus the special expense. You have to split that increased profit among the partners, then deduct the special expense from the partners who are to bear it.

  1. Figure 1: profit and loss appropriation account
  2. A
    £
    B
    £
    C
    £
    Total
    £
    Salaries
    20,000
    15,000
    -
    35,000
    Interest on capital
    4,000
    3,000
    2,000
    9,000
    Share of balance 3:2:1
    90,000
    60,000
    30,000
    180,000
    114,000
    78,000
    32,000
    224,000

Try this multiple-choice question from the December 2003 exam:

P, after having been a sole trader for some years, entered into partnership with Q on 1 July 2002, sharing profits equally. The business profit for the year ended 31 December 2002 was £340,000, accruing evenly over the year apart from a charge of £20,000 for a bad debt relating to trading before 1 July 2002, which it was agreed P should bear entirely.

How is the profit for the year to be divided between P and Q?

P
£000
Q
£000
A
245
95
B
250
90
C
270
90
D
255
85

Decide what you think the answer should be, and then read on.

Discussion
A little clear thinking is required. The profit excluding the £20,000 is to be used, then £20,000 deducted from P's share.Thus we have:

P
£000
Q
£000
6 months to 30 June 2002
180
6 months to 31 December 2002
90
90
270
90
less: bad debt
20
250
90

The answer is B. If you didn't get it right, re-read note (c).

d the question states that there is no partnership agreement and tells you nothing about profit shares. In this case, the Partnership Act 1890 applies (UK only). This means:

  1. no partnership salaries
  2. no interest on capital
  3. profit shared equally among the partners
    but
  4. if any partner has loaned money to the partnership (as opposed to introducing capital), the loan carries interest at 5 per cent per year, charged in the profit and loss account. Questions rarely bring in this point, because it makes the question easier.
    e Interest on drawings - partners sometimes agree that interest should be charged on drawings made. In reality, partners will agree the amount of drawings the business can stand rather than charge interest. If the point should come up, calculate the total interest due from all partners and add that to the net profit in the appropriation account. Then deduct each partner's interest charge from the individual shares at the end of the appropriation account.

Balance sheet
Each partner has to have a capital account and, probably, a current account in the balance sheet. The easiest way to present these is to use columns. See Figure 2 (figures invented).

Capital accounts
A
£
B
£
C
£
Balance at 1 January
40,000
30,000
20,000
Capital introduced
20,000
10,000
-
Balance at 31 December
60,000
40,000
20,000
120,000
Capital accounts
A
£
B
£
C
£
Balance at 1 January
14,800
16,100
12,400
Profit share (the total from the appropriation account)
68,000
49,000
46,000
82,800
65,100
58,400
Drawings
(70,000)
(60,000)
(60,000)
Balance at 31 December
12,800
5,100
(1,600)
16,300

If a partner has a debit balance, as C does here, it is easy to include it in the tabulation as shown. There's no need to complicate matters by putting C's account on the assets side of the balance sheet.figure 2: balance sheet

Important point
If the question asks you to prepare the partners' capital accounts and current accounts as they would appear in the ledger, do them first, before completing the balance sheet. Then you can enter the final balances into the balance sheet. You obviously don't want to waste time copying all the details again into the balance sheet.

A practice question
Here is a question from the June 2003 Paper 1.1 exam. Try to complete it for yourself, then take a look at the discussion and answer below.

Alamute and Brador have been in partnership for several years, compiling their financial statements for the year ended 31 March and sharing profits in the ratio 60:40 after allowing for interest on capital account balances at 5 per cent per year. Extracts from their trial balance at 31 March 2003 are given in Figure 3.

Figure 3: extract from alamute and brador trial balance

Reference to notes
£
Capital accounts: Alamute
50,000
Brador
50,000
Current accounts: Alamute
3,800
credit
Brador
2,600
debit
Drawings: Alamute
48,400
Brador
36,900
Office equipment: cost 1
48,300
accumulated depreciation, 1 April 2002
12,800
Stock, 1 April 2002 2
15,600
Trade debtors 3
68,400
Provision for doubtful debts, 1 April 2002 3
3,800
Sales revenue
448,700
Purchases
184,600
Rent paid 4
30,000
Salaries
88,000
Insurance 5
4,000
Sundry expenses
39,400

Notes to Figure 3

  1. Office equipment should be depreciated at 20 per cent per year on the reducing balance basis.
  2. Closing stock amounted to £21,400.
  3. Debts of £2,400 are to be written off, and the provision for doubtful debts is to be adjusted to 5 per cent of trade debtors.
  4. Rent paid of £30,000 is the amount for the nine months to 31 December 2002. From that date the rent was increased by 10 per cent.
  5. Insurance paid in advance amounted to £1,500.

Required:

  1. Prepare the partnership's trading and profit and loss account and appropriation account for the year ended 31 March 2003 (9 marks)
  2. Write up the partners' current accounts for the year ended 31 March 2003
    (3 marks) (12 marks in total).

Discussion
This is quite a simple question, but care is needed on several points:

  1. The drawings figures are given. They go into the current accounts and do not appear in the profit and loss account or appropriation account.
  2. Note 3 gives details of bad and doubtful debts. The charge in the profit and loss account is:
    £
    £
    Debts written off
    2,400
    Movement in provision / allowance
    Original provision
    3,800
    New provision required
    5% x (68,400 - 2,400)
    3,300
    (500)
    1,900

  3. Note 4 explains the rent. £30,000 is the cost for nine months. That means £10,000 per quarter. The fourth quarter must therefore be £11,000, giving a total of £41,000.

Neil Stein is examiner for Paper 1.1

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