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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