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PARTNERSHIP ACCOUNTS
FORMATION OF A
PARTNERSHIP
2
FORMATION OF A
PARTNERSHIP
Three important factors must be present in
a partnership:
partners must be carrying on a business, not
one isolated business transaction
must be agreement between two or more
legally competent people who must be the
business co-owners
partners must have intent to make a profit
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FORMATION OF A
PARTNERSHIP
Partnerships are separate accounting
entities to the partners (owners)
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PARTNERSHIP AGREEMENT
Partnership agreement
doesn’t always exist, making it difficult to
establish if a partnership actually exists
if there is no formal partnership agreement then
the Partnership Act applies
agreement is essential because partnerships:
have unlimited liability
have a limited life
• death of partner
• insolvency of partner
• retirement of partner
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PARTNERSHIP AGREEMENT
name of business drawings and interest
details of each partner on drawings
nature of business interest on capital
division of profit and voting and decision-
losses making procedures
capital contributions admission of new
authority, rights and partners
duties of partners resolution of disputes
details of salaries bankruptcy, death or
retirement of partners
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PARTNERSHIP ACT 1890
If there is no partnership agreement in writing, or
if it does not cover an area of dispute, matters may
be resolved by reference to the Partnership Act
e.g. Act states all profits and losses are to be shared
equally, so if profit ratio is not defined in an agreement,
the Act is applied
Partners will receive interest at 5% on excess capital (ie
over and above that which they have agreed to
contribute)
No interest on drawings
No salaries
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ADVANTAGES OF
PARTNERSHIP
Creation and dissolution is easier than a
company
Minimal statutory regulations
Resources can be pooled
Expertise can be utilised
Co-ownership of assets
Duties and responsibilities are shared
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DISADVANTAGES OF
PARTNERSHIP
Liability is unlimited (partners own personal
possessions can be used to pay debts owed by the
business)
Partnership may cease if a partner dies, retires or
becomes bankrupt
Disagreements between the partners can occur
Limits to raising large amounts of capital
Partners can be sued by creditor, jointly or
individually
Partners are likely to pay higher income tax
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LIMITED LIABILITY PARTNER
Governed by the Limited Liability
Partnership Act 1907
Liability is limited to the amount of capital
invested by the partner
A Limited Partner has no say in the
Management of the Partnership business
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PARTNERSHIP ACCOUNTS
CURRENT ACCOUNTS
working accounts containing details of profit,
loss, drawings and interest on capital invested
or charged on drawings
CAPITAL ACCOUNTS
partner’s original capital put into the business is
considered to be ‘fixed’
capital account of each partner is usually
unchanged unless additional capital is invested
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PARTNERSHIP ACCOUNTS
CREATION OF NEW PARTNERSHIP -
ACCOUNTING ENTRIES
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PROFIT DISTRIBUTION
PROFIT-SHARING RATIOS
Profits and losses are shared in the way
partners feel most appropriate
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PROFIT DISTRIBUTION
PROFIT AND LOSS APPROPRIATION
ACCOUNT
Net profit or loss is transferred to this account
from the profit and loss account
Additions are made for Interest on Drawings
(this is to discourage partners from making
drawings from the business)
Deductions are made for Interest on Capital or
any Salaries paid to partners
Residual Profits are then shared, as agreed,
according to Profit Sharing ratios
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PROFIT AND LOSS
APPROPRIATION ACCOUNT
Profit and Loss Appropriation Account for
Able, Bable and Cable
Net Profit £16,000
Add Interest on Drawings 500
16,500
Less Interest on Capital £2,500
Salary – Able £5,000 £7,500
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PROFIT DISTRIBUTION
ALLOCATION AS PER PARTNERSHIP
AGREEMENT
Interest on capital may be payable
Interest may be charged for drawings taken out
of the business
There may be a provision for the payment of a
salary of a particular partner
Interest may be payable on loans to partners by
the business or loans by partners to the
business
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PROFIT DISTRIBUTION
LOAN ACCOUNTS
Where a partner makes a loan to the business,
the debit is to bank and the credit to loan
account in that partner’s name
DRAWINGS
Where a partner withdraws cash from the
business in anticipation of profits earned, the
current account is debited and cash/bank is
credited
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ADMISSION OF NEW PARTNER
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ADMISSION OF NEW PARTNER
NEW PARTNERSHIP AGREEMENT
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STEPS TO ADMIT
NEW PARTNER
1. Review value of assets (see later slide)
2. Consider inclusion of goodwill (see next slide)
3. Record changes in the Ledger Accounts
4. Open a Goodwill Account and adjust the existing
partners Capital Accounts according to their
existing profit-sharing ratio
5. Prepare opening ledger entries for new partner
6. Calculate partners’ new profit-sharing ratio
7. Prepare a new Statement of Financial Position ie
Balance Sheet
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ADMISSION OF NEW PARTNER
GOODWILL
Goodwill can be defined as future benefits from
assets that cannot be individually identified e.g.
reputation, customer database, management
ability, product, location
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Recording Goodwill
When the partnership is revalued:
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REVALUATION OF ASSETS
Before admitting a new partner to the
business, the Assets should be revalued:
Some eg Buildings may have appreciated in
value
Some eg Machinery may not be worth as much
as the Net Book Value in the Balance Sheet –
perhaps insufficient amounts for depreciation
has been written off over the years
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Accounting for Revaluation
Adjustments to the relevant accounts
should be made
Eg If Buildings have appreciated, the Buildings
Account would be Debited and the Revaluation
Account Credited
If there has been insufficient depreciation
written off machinery, the Machinery
depreciation account would be credited and the
Revaluation Account Debited
The balance on the Revaluation Account would
then be transferred to the Partners Capital
Accounts according to their profit-sharing ratio
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PARTNERSHIP DISSOLUTION
REASONS FOR DISSOLVING A PARTNERSHIP
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KEY TERMS
You should be aware of the following terms when dealing
with Partnerships and be able to give clear definitions as
well as know how to account for each:
Capital Accounts
Capital Adjustment Account
Current Account
Revaluation of Fixed Assets
Fixed Capital Account
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KEY TERMS
Interest on Capital
Interest on Drawings
Partnership Act
Partnership Agreement
Profit and Loss Appropriation Account
Profit-sharing Ratios
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