Partnership Notes

Partnership: An Introduction

A partnership is an association of 2 or more persons who operate a business for profits. Every partnership should draw up a Partnership Agreement

However, if a partnership is formed without a Partnership Agreement, any dispute arose can be settled by referring to the Partnership Act

Main Differences between Partnership & Sole-Proprietorship

Business Partnership Advantages

1. Partnerships are relatively easy to establish.

2. The ability to raise funds may be increased.

3. Prospective employees may be attracted to the business if given the incentive to become a partner.

4. There is a wider pool of knowledge, skills and contacts.

Business Partnership Disadvantages

1. Partners are jointly and individually liable for the actions of the other partners.

2. Profits must be shared with others and decision also be shared.

3. The partnership may have a limited life; it may end upon the withdrawal or death of a partner.

4. A major disadvantage of a partnership is unlimited liability.

Contents of Partnership agreement

Following are normally included in Partnership (written) agreement:

• Capital invested by each partner

• Profit and loss sharing ratio

• Interest on capital (% per annum)

• Interest on drawings (% per annum)

• Partners’ salaries

• Conditions for admission of a new partner

• Procedures, when a partner dies or retire

If there is no Partnership agreement, Following rules should apply (given by Partnership act 1890)

1. Profit and loss are to be shared equally(50:50)

2. Interest on capital is not allowed

3. Interest on drawing is not allowed

4. Partner’s salaries are not allowed

5. If any partner provides a loan to partnership, he will get 5% per annum interest on loan.

Final Accounts of a Partnership:

1. Profit & Loss Account (including Profit & Loss Appropriation Account)

In Partnership up to Net Profit everything is same as sole trader.

Net Profit obtained from the Profit & Loss Account is then transferred to “Profit & Loss Appropriation Account”. The main purpose of Appropriation Account is to appropriate the net profit among all partners based on the Partnership Agreement.

Partnership (Name)

Profit and Loss Appropriation Account for the year ended ……………………….

$ $

Net profit xxx

Add: Interest on drawings

• Partner A xx

• Partner B xx xxx

xxx

Less: Interest on capital

• Partner A xx

• Partner B xx (xx)

Less: Partner’s salary

Partner A (xx)

Residual Profit xxx

Profit share

• Partner A xx

• Partner B xx xxx

**Residual profit is shared in the ratio stated in the partnership agreement

*Now we will look at the items of appropriation account in detail:

1. Interest on Drawings

Partners are entitled to drawings from time to time. To discourage drawings, an interest on drawings is levied. (Note: Interest on drawings will increase the net profit distributable to the partners)

2. Interest on Capital

Partners may not contribute equal amount of capital. Hence, it is reasonable to grant interest on capital contributed as Partner contributing more capital can place the extra amount in other investments.

3. Partners’ Salaries

In a partnership business, there are some partners who are active and others who are not (or “sleeping”). Hence, it is fair to pay salary to active partners. (Note: No salary should be paid to a Sole-Trader since he is entitled to the entire profits from his business)

(i) When Partner’s salary is paid by cash, the accounting entries are as follows:

(ii) When Partner’s salary has NOT been paid, the accounting entries are as follows:

(Note: When the partner’s salary is not paid, the Current Account of the partner concerned is credited, showing the amount due to him)

4. Distribution of Profits

Before distribution of profits,

• Interest on capital & Partners’ salaries should be deducted from the net trading profit

• Interest on Drawings should be added to the net trading profit

Then the remaining profit is shared according to the profit and loss sharing ratio.

5. Loans from Partners and Interest on loans

Loans from partners are treated in the same manner as loans from external source.

Occasionally, a partner may give a loan to the partnership during times of financial difficulty. This loan cannot be treated as capital contribution. Hence, an interest should be paid on the loans (Note: At year-end, the Interest on Loans Account is closed, and the total is transferred to Profit & Loss Account [TPL])

i) When interest on loan is paid by cash, the accounting entries are as follows:

(ii) When interest on loan has NOT...

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