BOOK KEEPING O LEVEL(FORM FOUR) NOTES – PARTNERSHIP ACCOUNT

PARTNERSHIP ACCOUNT

Partnership may be defined as a relationship between persons carrying on a business in common with a view of profit.

In a business partnership, two or more persons jointly run a business.

Partnership may be defined as an association of two to twenty persons carrying on business in common with the view of profit.

PARTNERSHIP AGREEMENT (ARTICLES OF PARTNERSHIP)

The points usually covered by such agreement are as follows:

1. The duration of the partnership
2. The name of the partnership
3. The sum to be contributed as capital by each partner
4. The ratio of profit or losses should be noted or stated
5. The rate of interest, if any, to be allowed on capital (interest on capital)
6. The rate of interest on drawings
7. Address or place of the business
8. The date of starting the business

IN THE ABSENCE OF ANY PARTNERSHIP AGREEMENT

a) All profit or losses are to be shared equally between the partners.

b) All partners are entitled to share equally in the capital (equal contribution of capital).

c) No partner is entitled to interest on capital before profits are ascertained.

THE USUAL ACCOUNTING REQUIREMENTS:

(i) The capital to be contributed by each partner.

(ii) The rate of interest, if any, to be given on capital.

(iii) The ratio in which profit or loss is to be shared.

(iv) The rate of interest, if any, to be charged on partners’ drawings.

(v) Salaries to be paid to partners.

INTEREST ON CAPITAL

It is a reward to the partners for investing their private capital in the business. Since the partner investing the most is taking the greatest risk.

INTEREST ON DRAWINGS

Acts as a penalty to the partner to deter them from taking out more money from the partnership in anticipation of profit than necessary.

The main purpose of this interest is to discourage the partners from withdrawing money unnecessarily.

SALARIES

Are given for investing more time for management in partnership. A partner may be responsible to perform some extra duties as compared to the other partners. Then the only one partner who works in the firm may receive salary allocated from profit.

PROFIT

Profit can be shared according to:

• The capital which is contributed.
• Profit can be shared equally.
• Can be shared according to partner’s agreement (deed) e.g., 2:3:1, etc.

This means A, B, and C will be given two sixths, three sixths, and one sixth respectively.

CURRENT ACCOUNT

For each partner, credited with profits, interest on capital, and salaries, and debited with drawings and interest on drawings. The balance of this account at the end of the financial year will represent the amount of undrawn (credit balance) or withdrawn profit (debit balance).

The debit balance of current account shows assets while credit balance shows liabilities.

RESERVES

This is voluntary appropriation in order to strengthen the financial position of the business.

The amount settled for reserve can be debited to profit & loss appropriation account.

THE ACCOUNT ENTRIES

PROFIT & LOSS APPROPRIATION ACCOUNT

• Net profit: DR Profit & Loss A/c, CR Appropriation of P & L A/c
• Interest on capital: DR Appropriation A/c, CR Current A/c
• Interest on drawings: DR Current A/c, CR Appropriation A/c
• Partners’ salaries: DR Appropriation A/c, CR Current A/c
• Share of profit: DR Appropriation A/c, CR Current A/c
• Share of loss (if any): DR Current A/c, CR Appropriation A/c
• Drawing: DR Current A/c, CR Drawing A/c for each partner

NOTE: If salaries have already been paid then cash account had already been credited.

Means: DR Appropriation A/c, CR Cash A/c

EXAMPLE

Karim and Rashid are in partnership sharing P & L in the ratio of 3:2. They are entitled to 5% interest on capital.

Karim’s capital: 40,000/=

Rashid’s capital: 120,000/=

Karim receives a salary of 5,000, Interest on drawing:

Karim 1,000

Rashid 2,000

Net profit 100,000

Required: Show (a) Profit & Loss Appropriation A/C, (b) Partners current A/C

Solution:

DR PROFIT & LOSS APPROPRIATION A/C CR

DR PARTNERS CURRENT A/C CR

METHOD OF CAPITAL IN PARTNERSHIP ACCOUNT

Partner’s capital account can be maintained either in:

• Fixed capital method
• Fluctuating capital method

(i) FIXED CAPITAL METHOD

In case of fixed capital method there are two accounts:

• Partners capital account
• Partners current account

In this method, the capital account for each partner remains by year at the figure of capital put into the firm by the partner.

The profit, interest on capital, and salaries to which the partner may be entitled are then credited to the separate current account for the partner, and drawings and interest on drawings are debited to it.

EXAMPLE

Twalib and Kassim have been in partnership for one year sharing profit and loss in the ratio of Twalib 3/5, Kassim 2/5. They are entitled to 5% interest on capital. Twalib has 200,000 capital and Kassim 600,000.

Kassim is to have salary of 50,000.

They are charged interest on drawing, Twalib being charged 5,000 and Kassim 10,000.

The net profit before any distribution to the partners amounted to 500,000 for the year ended 31^st Dec 2012.

NB: Drawing of 200,000 for each will appear.

Required: Show the necessary entries using the fixed capital method.

DR PARTNERS CAPITAL ACCOUNT CR

(ii) FLUCTUATING CAPITAL METHOD

In case of fluctuating capital method there is only one account termed as capital account. The distribution of profit would be credited to the capital account and the drawings and interest on drawings debited.

Therefore, the balance on the capital account will change each year, i.e., it will fluctuate. The system is therefore called fluctuating capital method.

EXAMPLE

Refer example 1 above.

DR PARTNERS CAPITAL A/C CR

EXAMPLE 2

Yusuph and Christopher began to trade in partnership on Jan 1980. Yusuph contributed Tshs 3,000/= and Christopher 1,000/= in cash. They agreed as follows:

• To share profit equally
• To allow interest on capital 6% p.a
• Christopher to get salary of Tshs 400/=
• Drawings: Yusuph Tshs 400/= on 1^st July and Christopher Tshs 200/= on 1^st April, 1^st July and 1^st October
• To charge interest on drawings 6% p.a

The net profit was Tshs 2,500/=.

Show:

• a) Appropriation account
• b) Partners capital
• c) Partners current account

WORKINGS

a) Interest on drawings

Yusuph: 6 x 400 x 6 / 100 x 12 = 12

Christopher: 6 x 200 x 9 / 100 x 12 = 9

6 x 200 x 6 / 100 x 12 = 6

6 x 200 x 3 / 100 x 12 = 3

Total interest on drawings from Christopher is 9 + 6 + 3 = 18

b) Interest on capital

Yusuph = 6 x 3,000 / 100 = 180

Christopher = 6 x 1,000 / 100 = 60

EXERCISE 1

The partnership agreement between A, B, and C contains the following agreement:

• The partnership fixed capital shall be A 10,000/=, B 8,000/=, C 6,000/=
• A and B are each to receive a salary of 600/= a year
• Interest on capital is to be calculated at 5% per annum
• A, B, and C are to share profit and losses in the ratio of 3:2:1
• No interest to be allowed on drawings or current account

On 1^st Jan 1978, the balance on current account were A credit balance 500/=, B credit 200/=, C credit 350/=.

During the year the drawings were A 4,500/=, B 3,000/=, and C 5,000/=.

The profit and loss account for the year showed a net profit of 14,500/= before charging interest on capital and partners’ salaries.

Required:

• a) Capital account of A, B, and C
• b) Partners current account
• c) Profit and loss appropriation account

EXERCISE 2

Record the following facts on the personal account of A and B, two partners who share profit and loss in the ratio of 5 to 3 and allow interest on capital at the rate of 4 percent per annum. No interest is to be allowed on current charges or drawings.

B is to be credited with a salary of 300/= for the year.

A and B:

• 1^st Jan: capital account 4,000 and 3,000
• 30^th Jan: additional capital brought 1,000 and –
• 1^st Jan: current account 72 DR and 100 CR
• 1^st Jan – 31^st Dec: drawings 3,650 and 3,650/=

The partnership total divisible for the year after charging the salary was 7,188/=.

Required:

• a) Partners capital account
• b) Partners current account
• c) Profit and loss appropriation account

FINAL ACCOUNT IN PARTNERSHIP

1. Profit and Loss Appropriation Account
2. Capital account for each partner (carrying the fixed capital and fluctuating capital)
3. Current Account
4. Balance Sheet

Example 1

Mohamed and Mcharo are in partnership sharing profit and loss equally. The following is their Trial balance as at 30^th June 2010.

Stock at 30^th 2010

Required:

Prepare Trading and Profit and Loss, Appropriation account for the year ended 30^th June 2010 and the Balance sheet as at that date:

• Expenses to be accrued: Office exp 96.
• Depreciation Fixture 10% on reducing balance basis building Tshs. 1,000
• Reduce provision for bad debt to 320
• Partnership salaries Tshs. 800 to Mohamed not yet entered.
• Interest on drawing Mohamed 180 and Mcharo 120.
• Interest on capital account balance at 10%

WORKING

Interest on capital:

Mohamed = 35,000 x 10/100 = 3,500

Mcharo = 29,500 x 10/100 = 2,950

DR PROFIT & LOSS APPROPRIATION CR

DR PARTNERS CURRENT A/C CR

ADMISSION OF A NEW PARTNER

New partner may be admitted usually for one of two reasons:

1. For the sake of increasing capital
2. For the sake of management (supervision)
3. As an extra partner, either because the firm has grown or someone is needed with different skills.
4. To replace partners who are leaving the firm, this might be because of retirement or death of a partner
5. To avoid competition

In admitting a new partner two major problems arise:

1. Treatment of premium or goodwill of the firm.
2. Revaluation of assets and liabilities of the old firm.

Condition of new partner:

1. To bring capital
2. To bring premium or goodwill

Example

Yusuph and Christopher began to trade in partnership on Jan 1980. Yusuph contributed Tshs 3,000/= and Christopher 1,000/= in cash. They agreed as follows:

• To share profit equally
• To allow interest on capital 6% p.a
• Christopher to get salary of Tshs 400/=
• Drawings: Yusuph Tshs 400/= on 1^st July and Christopher Tshs 200/= on 1^st April, 1^st July and 1^st October
• To charge interest on drawings 6% p.a

Show:

• a) Appropriation account
• b) Partners capital
• c) Partners current account

Treatment of Premium or Goodwill

The new partner is required to pay some premium for goodwill as compensation to the old partners.

The amount is different from the amount paid in a business as capital.

Premium for goodwill may be looked at as compensation paid by a new partner in an established business to the old partners to bring the business to its present state.

There are five methods of dealing with questions of goodwill upon the admission of a new partner:

(1) When goodwill is raised:

If the new partner has no cash resources beyond the capital introduced, the old partners agree to raise the goodwill account.

Accounting entries:

(a) When a new partner introduces capital:

DR Bank / Cash A/c

CR New partner capital A/c

(b) When goodwill is raised:

DR Goodwill A/c

CR Old partner capital A/c

Example:

Mill and Salum are in partnership sharing profit and loss in proportion to the capital invested. Mill’s capital is 180,000 and Salum’s capital is 120,000.

They agreed to admit Nassor as a new partner but have no other sources apart from 60,000 he is to contribute as capital. It is arranged that goodwill of 45,000 be raised and the capital accounts of the old partners be credited in the proportion in which they share profits. The profit in future is to be shared in the ratio of 3:2:1 respectively.

Make journal entries to admit Nassor.

JOURNAL ENTRIES

DR PARTNERS CAPITAL ACCOUNT CR

DR GOODWILL A/C CR

2) When goodwill is paid and withdrawn by the old partners:

Accounting entries:

(a) When goodwill is paid:

DR Cash A/C

CR Goodwill A/C

(b) When goodwill is shared by the old partners:

DR Goodwill A/C

CR Old partner capital A/C

(c) When goodwill is withdrawn by the old partners:

DR Partners capital A/C

CR Cash A/C

Example:

Hamis and Ally are in partnership sharing profit and losses in proportion to their capital which are Tshs. 150,000 and 90,000 respectively.

They admit Ponda as a partner on bringing into the business Tshs. 100,000 which was duly paid into the firm’s bank account.

If this sum Tshs. 60,000 represented Ponda’s capital and Tshs. 40,000 is the goodwill for the admission into business.

The goodwill is taken out by the old partners. They agreed new share ratio should be 5:3:2 respectively.

Show the necessary entries for the admission of Ponda:

Solution

DR JOURNAL ENTRIES CR

DR PARTNERS CAPITAL A/C CR

3) When goodwill is retained within a business:

In this method the new partner pays a premium and the old partners decide to leave it in the business.

Account entries:

When goodwill paid in cash:

DR Cash A/C

CR Old partner capital A/C

EXAMPLE

On 1^st Jan, Juma and Hamis are in partnership, each with capital of 15,000/= and sharing profit equally. They decide to admit Hamada as a partner on condition that he brings in shs 10,000/= as capital and pays them a premium of 10,000/=.

The profits in future are to be shared as follows: Juma 2/5, Hamis 2/5, and Hamada 1/5.

Record the above transaction showing the admission of Hamada and how the premium remains in the partnership firm.

EXERCISE 1

X, Y, and Z are in partnership sharing profit and losses in the ratio of 3:3:2. Their balance sheet as at 1^st Jan 1980 was as follows:

EXAMPLE 2

On the above data they agreed to admit P into partnership on condition that he contributes Tshs 18,000/= as his capital for a fourth share in the future profit. In addition, he must pay Tshs 12,000/= as goodwill which remains in the business.

Required: Show the necessary entries for P’s admission and how the goodwill remains in the business or partnership.

(4) When goodwill is raised and immediately written off:

This is when the new partner does not pay any cash into the business as goodwill rather than capital and the old partners decide to write it off.

Account entries:

(i) When goodwill is written off:

DR All partner capital A/C

CR Goodwill A/C

(ii) When goodwill is written off:

DR All partner capital A/C

CR Goodwill A/C

Example:

Tamim and Nuhu are in partnership with capital of 400,000 cash, sharing profit and loss equally. They agreed to admit Ally as a third partner on condition that all pay 400,000 as capital since Ally cannot raise any more funds. The partners decided that the goodwill of the business be valued at 150,000 and written off immediately. The new profit sharing ratio is 1/3 for each partner.

Show the entries for the above transactions:

DR PARTNERS CAPITAL A/C CR

EXERCISE 1

MAGE and ANA are in partnership sharing profit and losses in proportion to their capital which are 300,000/= and Tshs 200,000/= respectively. They agreed to admit Chekundu as a partner on condition that he pays into the firm Tshs 250,000/= of which Tshs 150,000/= is to DANIEL capital contribution and Tshs 100,000/= the premium for his admission. The cash is paid into the firm’s banking account and the premium paid out to MAGE and ANA. The profits are shared in future as follows: MAGE 3/8 and ANA 1/4.

Required:

Record DANIEL’s admission to the firm and the payment out of premium.

EXERCISE 2

Bwire and Wangaeli are in partnership sharing profit and losses equally. Interest on capital is allowed at 5% per annum.

On 1^st Jan 1989 the partners Gichomi on similar making the following arrangement:

• Gichomi to pay Tshs 150,000/= as capital
• Gichomi to pay Tshs 5,000/= to the credit of current account
• The money drawn immediately to repay the mortgage loan
• The profit for the year ended 31^st May 1990 amounted to Tshs 142,500/=
• The partners’ drawings were as follows: Bwire 45,000/=, Wangaeli 47,000/=, Gichomi 50,000/=

Required:

1. Show balance sheet of the new partnership on 1^st June 1989 just after the admission of Gichomi.
2. Prepare a profit and loss appropriation account and the current account of the partners for the year ended 31^st May 1990.