Revision Notes
Revision Notes: Accounting for Partnerships
These condensed notes cover the key concepts, formulas and steps of Chapter 4, Accounting for Partnerships, from formation to dissolution, for quick pre-exam revision.
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1. Foundations of a Partnership Business
- A partnership is a business owned by 2 to 20 partners who combine capital and expertise to earn profit together.
- Purpose of formation: to pool larger capital, share risks and liabilities, and combine varied skills and experience.
- Advantages of changing a sole proprietorship into a partnership: more capital, shared workload and risk, more balanced decisions, and easier expansion.
- In accounting terms, a partnership needs an Appropriation Account and several Capital Accounts (and Current Accounts), whereas a sole proprietorship has only one Capital Account.
2. Section 26 & the Partnership Agreement
- The Partnership Agreement is a written document setting out accounting terms such as capital contributed, interest on capital, interest on drawings, interest on partner's loan, salary/allowance/bonus, and the profit and loss sharing ratio.
- Purpose of the Agreement: to avoid disputes by clearly setting out each partner's rights and duties in writing.
- If there is NO Partnership Agreement, Section 26 of the Partnership Act 1961 automatically applies to the accounting terms.
- Remember the effect of having no Agreement: no interest on capital, no interest on drawings, no partner's salary, profit/loss shared EQUALLY, and a partner's loan earns interest at 8% per year.
3. Profit and Loss Appropriation Account
- Its purpose is to divide the business's net profit (or net loss) among the partners according to the Partnership Agreement.
- It is prepared AFTER the Profit and Loss Account and may be shown in 'T' form or statement format.
- Added to net profit: Interest on Drawings (because partners 'pay' interest to the firm).
- Deducted from net profit: Interest on Capital, and partners' Salary/Allowance/Bonus; the final balance is the divisible profit shared by ratio.
- Interest on a partner's loan is NOT in the Appropriation Account; it is an expense in the Profit and Loss Account because the loan is a liability of the firm.
4. Key Calculation Formulas
- Interest on Capital = Opening Capital Balance × Rate % × (number of months ÷ 12).
- Interest on Drawings = Amount of Drawings × Rate % × (period of drawing ÷ 12); computed from the drawing date to year-end.
- Interest on Partner's Loan = Loan Amount × Rate % × (months ÷ 12); if no Agreement, use 8% per year.
- Profit/Loss sharing may follow three methods: equally, by opening-capital ratio, or by an agreed fixed ratio.
5. Owner's Equity: Capital & Current Accounts
- Fluctuating Capital Method: one Capital Account per partner; all interest, salary, profit share and drawings are recorded in it, so the capital balance changes yearly.
- Fixed Capital Method: the Capital Account stays at the original amount, while the Current Account records interest, salary, profit share, drawings and interest on drawings.
- Unpaid interest on a partner's loan is credited to that partner's Current Account.
- A credit Current Account balance = the firm owes the partner (equity); a debit balance = the partner owes the firm.
- Equity difference: a sole proprietorship has one Capital + profit − drawings; a partnership shows multiple Capital and Current Accounts separately.
6. Dissolution of a Partnership
- Reasons for dissolution: the agreed term ends, a partner dies/becomes bankrupt, continuous losses, or mutual agreement to end the business.
- Procedure: sell all assets, settle all liabilities and dissolution expenses, then distribute the remaining cash to partners by their Capital Account balances.
- The Realisation Account records the book value of assets (debit), sale proceeds and discounts received (credit); its balance is the profit or loss on realisation shared by ratio.
- The Bank Account receives sale proceeds and payments from debit-balance partners, and is used to pay liabilities and partners' capital balances.
- If a partner's Capital Account has a debit balance, that partner must bring in cash; if insolvent (Garner v Murray rule), the deficiency is borne by the others in their capital-balance ratio.
| Accounting Aspect | Rule Applied |
|---|---|
| Interest on capital | Not allowed |
| Interest on drawings | Not charged |
| Partner's salary / allowance | Not allowed |
| Profit / loss sharing | Shared equally |
| Interest on partner's loan | 8% per year |
| Item | Fluctuating Capital | Fixed Capital |
|---|---|---|
| Number of accounts | Capital Account only | Capital + Current Account |
| Capital balance | Changes yearly | Stays fixed |
| Records interest, salary, drawings | In the Capital Account | In the Current Account |
Why is interest on drawings added in the Appropriation Account?
Because partners are treated as 'paying' interest to the firm when they take money or goods for personal use, so it increases the profit available for sharing.
What is the difference between the Realisation Account and the Appropriation Account?
The Appropriation Account divides operating profit while the business runs, whereas the Realisation Account is used only during dissolution to find the profit or loss on selling assets.
Where is interest on a partner's loan recorded?
It is an expense in the Profit and Loss Account (not the Appropriation Account) because the loan is a liability; if unpaid, it is credited to the partner's Current Account.
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