Partnership accounting. Introduction You need to know about: Advantages and disadvantages of...

Partnership accounting

Introduction

You need to know about:Advantages and disadvantages of partnership accountingThe partnership agreementCapital accountsCurrent accountsShare of profitsGoodwill.

Advantages

Increased capitalIncreased knowledge and specialist skillsShared riskFlexible working and cover for holidays and illness.

Disadvantages

Less profit because profit is shared Possible disagreement over moneyPossible disagreement over the direction of the business.

The partnership agreementThe Partnership Act states that if there is no written, legal agreement for the partnership then the following must apply: Equal profit sharesNo salariesNo interest on capital.

Capital accounts

Each partner must have a capital account to show the amount of capital owed to the partner by the business.

Debit Bank account

Credit Capital account

Fixed capital accounts

The amount of capital will remain fixed and will only change if the agreement changes and goodwill is introduced.

All transactions for each partner will be recorded in the partner’s current account.

Fluctuating capital accountsThis is used when the partnership does not operate a system of current accounts.

Opening capital plus profit share minus drawings = closing capital.

ExampleMike and Dave start a business on 1 January 2007 with the following capital:

Dave £30,000 Mike £10,000

They will share profits equally. Dave will take a salary of £20,000. Each partner will receive 10% interest on their capital.

At 31 December 2007 the business had made a net profit of £55,000.

Drawings:

Dave £35,000 Mike £18,000

The net profit for the year must be shared between Dave and Mike according to the partnership agreement.

The profit and loss appropriation account will be used to share out the profit to the current account of each partner.

Debit Profit and loss appropriation account

Credit Partner’s current account

The amount of drawings made by a partner must be debited to the partner’s current account.

Profit and loss appropriation account

Interest: Mike 1,000 Bal b/d 55,000

Interest: Dave 3,000

Salary: Dave 20,000

Profit: Dave 15,500

Profit: Mike 15,500

55,000 55,000

Current accounts

Dave Mike Dave Mike

Drawings 35,000 18,000 Interest 3,000 1,000

Salaries 20,000

Profit 15,500 15,500

Bal c/d 3,500 Bal c/d 1,500

38,500 18,000 38,500 18,000

Bal b/d 1,500 Bal b/d 3,500

DrawingsA partner will take drawings from the partnership. The partnership agreement may state that the partners will be charged interest on the amount of drawings they make.

The reason for charging interest on drawings is to stop a partner from drawing large amounts of cash from the business.

It may help to prevent a cash flow problem.

Interest on drawingsAccounting entries for interest on drawings:

Debit Partners’ current accounts

Credit Appropriation account

Exam tip: make the interest on drawings your first entry in the appropriation account and current accounts.

Goodwill

You must have a knowledge and understanding of the following:The definition of goodwillAccounting for goodwill in the ledgerMaking adjustments in the capital accounts.

Goodwill is known as an intangible fixed asset.

Goodwill results through the good reputation that a business has built up over a period of time.

Goodwill = market value – book value

Market value £380,000

Book value £300,000

Goodwill £80,000

A new partner may be required to pay goodwill to the existing partners.

In the UK, good accounting practice requires that goodwill should not remain as a fixed asset in the books of the partnership.

When a new partner joins the partnership, goodwill will be written out of the ledger by making an adjustment in the capital accounts of the partners.

Accounting entries for goodwillIn the original profit share agreement:

Debit Goodwill account

Credit Existing partners’ capital accounts

In the new profit share agreement:

Debit Capital accounts of all the partners

Credit Goodwill account