ACCOUNTING FOR
PARTNERSHIPS
Characteristics of a partnership
Sources of finance for a partnership
Formation of a partnership
Producing information for a partnership
Admission of a partner
Partnership dissolution
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© Kolitz & Quinn, 2005
OUTCOMES
Recall the characteristics of a partnership
Describe the sources of finance, the distinction
between capital contributions and profits
retained and the composition of a partnership’s
equity
Describe the formation process of a partnership
Produce financial information for a partnership
Process accounting entries to admit a new
partner to a partnership
Process accounting entries to dissolve a
partnership
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CHARACTERISTICS OF A
PARTNERSHIP
Can be used for small businesses to
combine financial capital and managerial
talent
Between 2 - 20 persons, except for
organised professions
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Characteristics of a partnership . . .
No legislation, so common law applies
not a separate legal entity
partners are
joint owners of assets
jointly and severally liable for liabilities
Partnership entails mutual agency
No formalities
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SOURCES OF FINANCE FOR
A PARTNERSHIP
Financed from two
sources
contributions by
partners to equity
amounts borrowed, a
liability of the
partnership
loans from financial
institutions or private
individuals
loans from a partner,
not part of capital
contribution
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Distinction between capital
contribution and profit retained
The capital contribution is the long-
term or relatively permanent contribution
by the owner
The profit retained is the cumulative
excess of profit over distributions
To distinguish the above,
capital a/c reflects fixed capital contribution
current a/c records allocation of profits to,
and distributions to partners
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Equity of a partnership
Capital accounts
Current accounts
Reserves
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FORMATION OF A
PARTNERSHIP
Partners contribute
cash or other
assets
Fair value to be
placed on non-
cash assets
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PRODUCING INFORMATION
FOR A PARTNERSHIP
Accounting is an information system that
selects data
processes that data
produces information
Selection and processing of data identical
for all entity forms
Procedure to produce information differs
for all entity forms
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Determination and
appropriation of profit
Profit computed according to accrual
basis of accounting
Appropriation of profit necessary where
resources invested and services provided
are not equal.
Adjust the accounts
Appropriation of profit
PRODUCING THE INFORMATION
Prepare annual financial statements
Close the accounts
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Appropriation of profit
Objective is to reward each partner
for resources and services provided
to the firm
interest on capital allocated for
unequal capital contributions
partners’ salaries allocated for
unequal service contributions
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Appropriation of profit ...
Conceptual and legal arguments
entity concept
partners and partnership separate
accounting entities
interest on capital, partners’ salaries and
interest on partners’ loans treated as
expenses in determination of profit
legal perspective
partners and partnership same legal entity
interest on capital, partners’ salaries and
interest on partners’ loans treated as
appropriation of profit
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Interest on capital
Not a charge against income
It is an appropriation of profit
Accounting entry
Dr Cr
Interest on capital 60 500
Current a/c : Simon 28 000
Current a/c : Gary 32 500
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Partners’ salaries
Not a charge against income
It is an appropriation of profit
It is not a cash payment to partners
Accounting entry
Dr Cr
Partners salaries 212 000
Current a/c : Simon 132 000
Current a/c : Gary 80 000
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Interest on drawings
Is charged against a partner to
compensate other partners for unequal
drawings
Interest on drawings charged when
debit balance on partner’s drawings a/c
exceeds credit balance on current a/c
Accounting entry
Dr Cr
Current a/c : Simon 2 400
Current a/c : Gary 3 000
Interest on drawings 5 400
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Interest on loans
Interest on loans to outside parties
treated as expense on I/S
Accounting entry
Dr Cr
Interest expense 12 000
Interest accrued 12 000
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Transfers to reserves
The profits earned by the business are
available for withdrawal by the partners in
cash
Partners may reduce amount available for
withdrawal and retain profits for
expansion by transferring profits to a
reserve
The reserve forms part of equity
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Transfers to reserves ...
Accounting entry
Dr Cr
Appropriation account 60 000
Reserve 60 000
No movement in cash in the transfer
to a reserve
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Preparation of the financial
statements
Once the appropriating entries are
completed, the financial statements are
prepared
I/S of partnership extended to
accommodate appropriation section
SOCIE discloses details of capital and
current accounts for each partner
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Closing entries for a
partnership
Profit from P & L a/c is transferred to an
appropriation a/c
Dr Cr
Profit & loss account 452 000
Appropriation account 452 000
Closing entries required to transfer interest
on capital, partners’ salaries and interest on
drawings to appropriation a/c
Dr Cr
Appropriation account 272 500
Interest on capital 60 500
Partners salaries 212 000
Interest on drawings 5 400
Appropriation account 5 400
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Closing entries for a
partnership . . .
The balance in the appropriation a/c is the
amount available to allocate to the partners in
their profit sharing ratio.
Dr Cr
Appropriation account 124 900
Current a/c : Simon 74 940
Current a/c : Gary 49 960
Final closing entry is to transfer the drawings
a/c balances to the partners’ current a/c’s
Dr Cr
Current a/c : Simon 24 000
Current a/c : Gary 30 000
Drawings a/c : Simon 24 000
Drawings a/c : Gary 30 000
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ADMISSION OF A PARTNER
Procedure on admission
Adjustment to the profit-
sharing ratio
Revaluation of the assets of
the partnership
Accounting for goodwill
Recording the new
partner’s contribution
Redistribution of the
reserve
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Adjustment to profit-sharing
ratio
Possible agreements
New partner’s share relinquished by existing
partners according to existing ratio
New partner’s share relinquished by existing
partners equally
New partner’s share relinquished by existing
partners according to agreed ratio
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Revaluation of assets
Need to determine true value of equity at
date of admission
Underlying assets and liabilities are valued
to determine consideration to be paid by
incoming partner
to recognise change in share of equity of
existing partners
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Revaluation of assets . . .
Revaluation
account used
gain or loss allocated
to existing partners in
existing ratio
existing partners must
benefit or lose from
changes in equity
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Accounting entries
Non-depreciable non-current assets
Dr Cr
Land and buildings 130 000
Revaluation 130 000
Depreciable non-current assets
Dr Cr
Accumulated 20 000
depreciation
Machinery 20 000
Machinery 10 000
Revaluation 10 000
Current assets
Dr Cr
Revaluation 5 000
Inventory 5 000
Revaluation 10 000
Allowance for doubtful debts 10 000 26
Accounting entries . . .
Surplus/loss transferred to capital
accounts
Dr Cr
Revaluation 125 000
Capital - Simon 75 000
Capital - Gary 50 000
surplus on revaluation is unrealised
not available for withdrawal
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Identification of goodwill
Nature of goodwill
Excess of value of business as whole over fair
value of identifiable net assets is goodwill
intangible asset
Represents anticipated future economic
benefits from assets not capable of being
individually identified and separately
recognised
Distinguish between
internally generated goodwill
purchased goodwill
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Internally generated goodwill
and purchased goodwill
Internally generated goodwill
not recognised as an asset
not identifiable resource
cost cannot be measured reliably
Purchased goodwill
valued based on arms length transaction
represents a payment made by the
acquirer in anticipation of future economic
benefits
Recognition of goodwill is an owner
change in equity and appears on
SOCIE as adjustment to partners’
capital accounts
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Accounting for goodwill
If value for goodwill on latest SOFP, only
account for difference between goodwill
as currently valued and latest B/S value
Purchased goodwill recognised as an
asset and carried at cost less
accumulated impairment losses
Impairment test should be performed on
goodwill annually
Based on principles of Impairment Standard
(IAS 36)
Impairment loss recognised as expense
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Contribution to capital
Record new partners
contribution to equity of
partnership
Cap
Dr Cr i tal
a/c
Cash 440 000
Capital Mark 440 000
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Redistribution of the reserve
Underlying profits in the reserve earned
before new partner admitted
Equity of existing partners must be adjusted
to reflect their share of the reserve
Dr Cr
Capital -Mark 20 000
(60 000 x 5/15)
Capital - Simon 16 000
(60 000 x 4/15)
Capital - Gary 4 000
(60 000 x 1/15)
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PARTNERSHIP DISSOLUTION
Retirement or death
of a partner
Liquidation, where
activities are
terminated
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Retirement or death of a partner
Retired or deceased partner is entitled to
the settlement of his interest
balance on capital a/c
balance on current a/c
share of reserves
share of gains or losses on revaluation
share of movement in goodwill
charge for assets taken over
share of costs incurred
Adjustments made through a
revaluation a/c
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Liquidation of the partnership
Cessation of activities
Assets are sold and liabilities settled
Procedure
Transfer current a/c balances to capital a/c s
Transfer assets at carrying amount to
realisation a/c
Record proceeds on realisation, other profits
or losses in realisation a/c
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Liquidation of the partnership...
Procedure...
Settle liabilities and expenses
liabilities transferred to realisation a/c if business is
sold as a going concern
otherwise liabilities are not normally transferred to
realisation a/c
Profit on realisation transferred to partners’
capital a/c s
Remaining cash paid to partners to settle
balanced on their capital a/cs
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