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Partnerships
Theory
- An agreement between two or more people to carry on a business in order to make a profit.
- Advantages:
a. Raise more capital b. More skills & knowledge c. Share the work
- Disadvantages
a. Profits must now be shared b. Disagreements can occur c. Partners cannot act independently
- According to the Partnership Act 1890, in the absence of a partnership agreement:
a. All partners contribute equal capital b. Partners are not entitled to interest on capital or salaries c. Partners will not be charged interest on drawings d. Profits or losses will be shared equally e. Partners are entitled to 5% interest on a loan they make to the partnership
Special accounts for partnerships
1. APPROPRIATION ACCOUNT
- Continues from the Profit and Loss Account and shows how the profit or loss will be treated between the partners.
- Items under the Appropriation Account:
i. Partners’ SALARIES ii. INTEREST ON CAPITAL iii. INTEREST ON DRAWINGS iv. SHARE OF THE REMAINING PROFIT
Example:
Trading and Profit and Loss and Appropriation Account
Net Profit 20 000
ADD Interest on Drawings : Abrahams 2 000 : Peterson 3 000 5 000 25 000
LESS Interest on Capital : Abrahams 4 000 : Peterson 2 000 6 000
LESS Salaries : Abrahams 9 000 15 000 10 000
Share of Profit :Abrahams(1/2) 5 000 : Peterson (1/2) 5 000 10 000
2. DRAWINGS
- Each partner has their own Drawings account.
3. CAPITAL ACCOUNTS
- Each of the partners will have their own Capital accounts
- The capital accounts may either be: o Fluctuating Capital Accounts – all the items in the Appropriation account are entered into the Capital accounts of the partners; the Drawings account of each partner is closed off to the partners Capital accounts.
o Fixed Capital Accounts – The capital account balances do not change unless a partner contributes more capital. The items in the Appropriation account now get entered into the partners’ Current Accounts.
Partnership Changes
What is a change?
- When a new partner joins the business
- When an existing partner leaves the business
- When partners agree to change the profit sharing ratio
IMPORTANT: When a change occurs, a Trading and Profit and Loss account must be drawn up on the same date for the OLD partnership (before the change). A Trading and Profit and Loss account will be drawn up at the end of the year for the NEW partnership (after the change). Most examination questions will therefore consist of two Trading and Profit and Loss accounts next to each other.
REVALUATION OF ASSETS (unrealized Profit)
When one of the above changes occur, the Partners; Capital accounts should show the real net worth of their business. The real net worth depends on a realistic valuation of the businesses’ Assets. Therefore, it is usual to get all assets valued upon a change in the partnership.
A REVALUATION account is opened in the ledger for this purpose.
Journal Entries:
Step one: Transfer any Provisions for depreciation to the Revaluation account: DEBIT Provision for Depreciation CREDIT Revaluation
Step two : If an assets value is increasing (important : NEW VALUE – COST PRICE) DEBIT the asset (eg Vehicles) CREDIT Revaluation
If an assets value is decreasing (important: COST PRICE – NEW VALUE) DEBIT Revaluation CREDIT the asset (eg Vehicles)
Step three: Adjust Provision for Bad Debts (if required)
- Increasing : DEBIT Revaluation CREDIT Provision for Bad Debts
- Decreasing : DEBIT Provision for Bad Debts CREDIT Revaluation
Step four: Close off the Revaluation account to the Partners Capital accounts(profit ratio)
GOODWILL
What is Goodwill?
- an intangible asset representing the value added to a business (over and above the value of net assets) by factors such as:
- a loyal customer base,
- good management,
- good reputation,
- good supplier contacts,
- well known brand names
- good location
Goodwill is usually valued when a change in the partnership occurs.
How to account for Goodwill?
Partners may choose to keep a Goodwill account in the books or not.
- If a Goodwill account is to be kept in the books:
OLD PARTNERS OLD RATIO
DEBIT Goodwill CREDIT the (old) Partners’ Capital accounts
Partnership Dissolution
When a partnership business ceases to exist.
Reasons
- The business is no longer profitable
- Partners simply agree to do so for any personal reasons eg ill health
What happens upon dissolution?
- the assets are all sold off or they may be taken over by a partner
- the liabilities are all paid
- the partners are paid the balances of their capital accounts
A REALISATION account is opened in the ledger for this purpose
Journal Entries:
- Close the Provisions for Depreciation and Provision for Bad debts to the Asset account DEBIT Provision for Depreciation (on vehicles) CREDIT Vehicles
- Close the Asset accounts to the Realisation account DEBIT Realisation CREDIT Vehicles
- Record the money received from the sale of assets and from debtors DEBIT Bank CREDIT Realisation
- Record the assets taken over by the partners (without payment) DEBIT Partners Capital account CREDIT Realisation
- Payment of liabilities DEBIT liability (eg creditors) CREDIT Bank
- Discounts received from creditors DEBIT the creditor CREDIT Realisation
- Payment of costs of dissolution DEBIT Realisation CREDIT Bank
- Close the Realisation account to the partners Capital accounts (profit ratio) If a profit was made: DEBIT Realisation CREDIT Partners Capital accounts Opposite if a loss was made
- Close the partners Current accounts to the Capital accounts DEBIT Current account: Peters CREDIT Capital : Peters
OR
DEBIT Capital : Peters CREDIT Current account: Peters
- Partners get paid out their Capital account balances DEBIT Capital: Peters CREDIT Bank
OR
The partners must pay in if their Capital accounts have a debit balance DEBIT Bank CREDIT Capital: Peters
GARNER versus MURRAY If a partner cannot pay in the amount of their Debit balance in their Capital account, then the remaining partners must pay the amount into the Bank account of the business. The remaining partners share the payment according to their last capital balances on the last balance sheet.
- Close the ABC Limited account to the Ordinary Shares account (and or preference shares and debentures) DEBIT Ordinary Shares (and or Preference shares; Debentures) CREDIT ABC Limited
- Close the Ordinary Shares (and or Preference Shares; Debentures) to the Capital accounts DEBIT Partners Capital accounts CREDIT Ordinary Shares (and or Preference Shares; Debentures)
