Partnership

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Description of Partnership along with Journal Entries.

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Partnership

  1. 1. Learning Objectives <ul><li>Define a partnership and the major attributes of a partnership </li></ul><ul><li>State the advantages and main characteristics of the partnership structure of business </li></ul><ul><li>Explain the purpose of a partnership agreement and describe its typical contents </li></ul><ul><li>Describe the special features applicable to accounting for partnerships </li></ul>
  2. 2. Learning Objectives (cont’d) <ul><li>Explain the accounting entries for the formation of a partnership </li></ul><ul><li>Explain the accounting entries for the allocation of profits and losses of a partnership </li></ul><ul><li>Explain the accounting entries for drawings and advances or loans made by partners </li></ul><ul><li>Describe content of the financial statements of a partnership </li></ul>
  3. 3. Partnership Defined <ul><li>Partnership Act: </li></ul><ul><ul><li>the relationship that ‘ subsists between persons carrying on a business in common, with a view to profit ’ </li></ul></ul><ul><li>Necessary attributes </li></ul><ul><ul><li>Must be an agreement </li></ul></ul><ul><ul><li>View to earning a profit </li></ul></ul><ul><ul><li>Co-ownership of the business </li></ul></ul>
  4. 4. Advantages <ul><li>Pooling of resources </li></ul><ul><li>Low cost </li></ul><ul><ul><li>Formed at little or no cost </li></ul></ul><ul><ul><li>Subject to little regulation </li></ul></ul><ul><ul><li>Not required to publish financial statements </li></ul></ul><ul><li>Taxation </li></ul>
  5. 5. A partnership combines of the partners CAPITAL TALENT EXPERIENCE
  6. 6. Characteristics <ul><li>Mutual Agency </li></ul><ul><ul><li>E ach partner: </li></ul></ul><ul><ul><ul><li>A cts as agent for the partnership </li></ul></ul></ul><ul><ul><ul><li>H as authority to act on behalf of the partnership </li></ul></ul></ul><ul><li>Unlimited liability </li></ul><ul><ul><li>Each partner personally responsible for all the debts of the business </li></ul></ul><ul><ul><li>No limit to liability </li></ul></ul><ul><ul><li>Personal assets are exposed </li></ul></ul><ul><ul><li>Unattractive to wealthy individuals </li></ul></ul>
  7. 7. Characteristics (cont’d) <ul><li>Limited life </li></ul><ul><ul><li>Ended if member dies, withdraws or retires, or becomes incapacitated </li></ul></ul><ul><ul><li>Ended on the admission of a new member </li></ul></ul><ul><ul><li>Ended via bankruptcy </li></ul></ul><ul><ul><li>Ended if formation purpose is over </li></ul></ul><ul><li>Transfer of partnership interest </li></ul><ul><ul><li>Capital interest is personal asset </li></ul></ul>
  8. 8. Partnership Agreement <ul><li>Agreement covers: </li></ul><ul><ul><li>Name, location and nature </li></ul></ul><ul><ul><li>Name, investment and duties of each partner </li></ul></ul><ul><ul><li>Sharing of profits and losses </li></ul></ul><ul><ul><li>Administrative details </li></ul></ul><ul><ul><li>Withdrawals (drawings) </li></ul></ul><ul><ul><li>Dispute resolution </li></ul></ul><ul><ul><li>Admission/withdrawal of partners </li></ul></ul><ul><ul><li>Partnership liquidation </li></ul></ul>
  9. 9. Accounting for a Partnership <ul><li>Formation </li></ul><ul><li>Drawings </li></ul><ul><li>Distribution of profits </li></ul><ul><li>Change in partnership members </li></ul><ul><li>Liquidation </li></ul>
  10. 10. Accounting for a Partnership (cont’d) <ul><li>Method 1: Capital accounts which include profits and losses </li></ul><ul><ul><li>Capital a/c credited with investments </li></ul></ul><ul><ul><li>Drawings a/c debited with withdrawal of assets or personal expenses </li></ul></ul><ul><ul><li>Drawings a/c closed to capital </li></ul></ul><ul><ul><li>P&L summary closed to profit distribution and allocated to capital a/c’s </li></ul></ul>
  11. 11. Accounting for a Partnership (cont’d) <ul><li>Method 2: Fixed capital accounts </li></ul><ul><ul><li>Capital a/c credited with investments and debited with withdrawals of capital </li></ul></ul><ul><ul><li>Drawings a/c debited with withdrawal of assets or personal expenses </li></ul></ul><ul><ul><li>Drawings a/c closed to retained profits </li></ul></ul><ul><ul><li>P&L summary closed to profit distribution and allocated to retained profits a/c’s </li></ul></ul>
  12. 12. Formation of a Partnership <ul><li>Formation </li></ul><ul><ul><li>Investment of both assets and liabilities </li></ul></ul><ul><li>Contributions </li></ul><ul><ul><li>Recorded as for sole trader </li></ul></ul>Date Assets XXXX Liabilities XXX Partner’s Capital XXX being initial investment by partner
  13. 13. Allocation of Partnership Profits and Losses <ul><li>Consider for each partner: </li></ul><ul><ul><li>services performed </li></ul></ul><ul><ul><li>capital invested </li></ul></ul><ul><ul><li>business risk assumed </li></ul></ul><ul><li>Common methods </li></ul><ul><ul><li>fixed ratio </li></ul></ul><ul><ul><li>fixed ratio based on capital balances </li></ul></ul><ul><ul><li>fixed ratio allowing for interest and salary </li></ul></ul>
  14. 14. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Allocation entry — Method 1 : </li></ul>June 30 P & L Summary XXX Profit Distribution XXX transfer of profit to distribution account June 30 Profit Distribution XXX Partner A, Capital XX Partner B, Capital XX distribution of profit to partners
  15. 15. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Allocation entry — Method 2 : </li></ul>June 30 P & L Summary XXX Profit Distribution XXX transfer of profit to distribution account June 30 Profit Distribution XXX Partner A, Retained Earnings XX Partner B, Retained Earnings XX distribution of profit to partners
  16. 16. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Fixed ratio </li></ul><ul><ul><li>split based as stated e.g. 7:3, say profit of $60 000 </li></ul></ul>June 30 P & L Summary $60 000 Profit Distribution $60 000 transfer of profit to distribution account June 30 Profit Distribution $60 000 Becker, Capital $42 000 Cook, Capital $18 000 distribution of profit to partners
  17. 17. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Ratio based on capital balances </li></ul><ul><ul><li>profit of $60 000 </li></ul></ul>Capital investment Becker $150 000 Cook 100 000 $ 250 000 Profit allocation Becker (150 000/250 000) x 60 000 = $36 000 Cook (100 000/250 000) x 60 000 = 24 000 $ 60 000
  18. 18. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Ratio based on capital balances (method 1) </li></ul>June 30 P & L Summary $60 000 Profit Distribution $60 000 transfer of profit to distribution account June 30 Profit Distribution $60 000 Becker, Capital $36 000 Cook, Capital $24 000 distribution of profit to partners
  19. 19. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Ratio based on capital balances (method 2) </li></ul>June 30 P & L Summary $60 000 Profit Distribution $60 000 transfer of profit to distribution account June 30 Profit Distribution $60 000 Becker, Retained Earnings $36 000 Cook, Retained Earnings $24 000 distribution of profit to partners
  20. 20. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Fixed ratio allowing for interest and salaries </li></ul>Becker Cook Total Interest on capital $150 000 x 10% $15 000 $100 000 x 10% $10 000 $25 000 Salaries to partners 18 000 10 000 28 000 Total interest & salary credited 33 000 20 000 53 000 Residual to be divided equally 3 500 3 500 7 000 Equity increase $36 500 $23 500 $60 000
  21. 21. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Ratio based on capital balances (method 1) </li></ul>June 30 P & L Summary $60 000 Profit Distribution $60 000 transfer of profit to distribution account June 30 Profit Distribution $ 25 000 Becker, Capital $ 15 0 00 Cook, Capital $ 10 0 00 distribution of interest on capital to partners
  22. 22. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Ratio based on capital balances (method 1) </li></ul>June 30 Profit Distribution $ 7 000 Becker, Capital $ 3 50 0 Cook, Capital $ 3 500 distribution of residual profit to partners June 30 Profit Distribution $ 28 000 Becker, Capital $ 18 0 00 Cook, Capital $ 10 0 00 distribution of salaries to partners
  23. 23. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Ratio based on capital balances (method 2) </li></ul>June 30 P & L Summary $60 000 Profit Distribution $60 000 transfer of profit to distribution account June 30 Profit Distribution $ 25 000 Becker, Retained Earnings $ 15 0 00 Cook, Retained Earnings $ 10 0 00 distribution of interest on capital to partners
  24. 24. Allocation of Partnership Profits and Losses (cont’d) <ul><li>Ratio based on capital balances (method 2) </li></ul>June 30 Profit Distribution $ 7 000 Becker, Retained Earnings $ 3 50 0 Cook, Retained Earnings $ 3 500 distribution of residual profit to partners June 30 Profit Distribution $ 28 000 Becker, Retained Earnings $ 18 0 00 Cook, Retained Earnings $ 10 0 00 distribution of salaries to partners
  25. 25. Drawings and Loans Made by Partners <ul><li>Drawings (method 1) </li></ul>20 March Partner , Drawings XXX Cash at Bank XXX cash drawings by partner 30 June Partner , Capital XXX Partner , Drawings XXX closing entry for partner’s drawings
  26. 26. Drawings and Loans Made by Partners (cont’d) <ul><li>Drawings (method 2) </li></ul>20 Mar Partner , Drawings XXX Cash at Bank XXX cash drawings by partner 30 June Partner , Capital XXX Partner , Retained Earnings XXX closing entry for partner’s drawings
  27. 27. Drawings and Loans Made by Partners (cont’d) <ul><li>Interest on drawings (method 1) </li></ul>30 June Partner , Capital XXX Profit Distribution XXX charging interest on drawings <ul><li>Interest on drawings (method 2) </li></ul>30 June Partner, Retained Earnings XXX Profit Distribution XXX charging interest on drawings
  28. 28. Loans or Advances Date Cash at Bank XX Advance from partner A XX Date Interest expense X Cash at bank/Interest Payable X
  29. 29. Financial Statements <ul><li>General-purpose or special-purpose report? </li></ul><ul><li>Each partner’s equity reported separately on the Balance Sheet </li></ul><ul><li>Salaries, interest on capital and interest on drawings are not expenses </li></ul>
  30. 30. Financial Statements (cont’d) <ul><li>No income tax expense </li></ul><ul><li>Profit/loss allocation disclosed </li></ul><ul><ul><li>Balance Sheet </li></ul></ul><ul><ul><li>Statement of Partner’s Equity </li></ul></ul>

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