Interactive Worksheet on Partnership Accounts (1)

by Ken Delaney-Moore, Sheffield Hallam University

Aims:

This worksheet deals with:

• Partnership creation
• Contents of the Deed of Partnership
• Profit-sharing in a partnership
• Appropriation accounts
• Partners current accounts

After having completed the worksheet you should have a greater understanding of these issues. In conjunction with the Interactive worksheet on partnership accounts (2), this worksheet should help you prepare for the objective assessment on partnership accounts

Partnership Creation

A 'partnership' (in this context) is the relationship between two or more persons carrying on business together with a view to profit.

The current (i.e. at the time of writing) legal situation in the UK is that a partnership can be created merely by a verbal agreement, although in practice many partners prefer to have important aspects of the agreement written down in a 'deed of partnership'.

Contents of the Deed of Partnership

The 'deed' will often contain some or all of the following clauses:

1. The capital to be contributed by each partner
2. The rate of interest to be allowed on partners capitals
3. The rate of interest to be charged on partners drawings
4. Any salaries payable to partners
5. The ratio in which the remaining profit / loss is to be shared

Should the partners fail to agree on any of 2-5 (above) the Partnership Act 1890 states that the following will apply on a piecemeal basis:

• Partners will receive interest at 5% on excess capital (i.e. over and above that which they have agreed to contribute)
• No interest on drawings
• No salaries
• Profits / losses shared equally

Profit-sharing in a partnership

Imagine that Mr. Sowerby ('S') and Mr. Trestle ('T') have a partnership deed with the following clauses (all figures in £ unless otherwise stated)

Deed of Partnership	S	T
Capital contribution	20000	30000
Interest on capital	10%	10%
Interest charged on drawings	12%	12%
Drawings	8000	10000
Salary payable	4000	Nil
Profit / loss sharing ratio	one third	two thirds

Suppose also that the net profit for the year ended 31st December was £22,600. We will now work through the profit-sharing (profit 'appropriation');

Step 1 is to charge the partners interest on their 'drawings'. If all drawings made by partners took place at the start of the year, then the amount of interest charged would be exactly equal to:

the amount of drawings multiplied by the interest rate charged on drawings

In the following questions you will be allowed TWO attempts at the answer, unless you are told otherwise.

Q1. Assuming that all money withdrawn by S is done so at the start of the year, how much interest should S be charged? (enter your answer without a £ sign) (Type your answer)

It is more common for a partner to make drawings at several points through the year, in which case the interest will be charged from the date the drawings were made (although the calculations are normally made to the nearest month).

Using the above example, notice that 'T' withdrew £10,000 during the year. Imagine that this was taken in two instalments as follows:

£6,000 on 1st March; and
£4,000 on 1st August

Interest charged on the March drawings would most likely be calculated as follows: £6,000 X by 10, divided by 12, X by 12%, = £600

The amount is multiplied by 10 and divided by 12 because 10/12 represents the proportion of the year for which the money was absent from the business, i.e. 10 months.

Q2. How much interest should T be charged for drawing out £4,000 on 1st August? (enter your answer without a £ sign) (Type your answer)

Q3. What is the total interest charged on both partners drawings? (enter your answer without a £ sign, no commas) (Type your answer)

The interest charged to partners increases the amount of money available for distribution; so it is added onto the net profit. The amount of money available for re-distribution becomes £22,600 (original profit) plus £1,760 = £24,360.

Profit-sharing: Step 2 is to 'give' the partners interest on the capital they have invested. This money is deducted from the 'pot' which now stands at £24,360. To avoid your having to scroll back upwards, the original Deed of Partnership has been re-produced below:

Deed of Partnership	S	T
Capital contribution	20000	30000
Interest on capital	10%	10%
Interest charged on drawings	12%	12%
Drawings	8000	10000
Salary payable	4000	Nil
Profit / loss sharing ratio	one third	two thirds

Q4. Using the information known so far, try to fill-in the gaps in the following: You are only allowed ONE attempt at this question. Don't include a £ sign or any commas. Notice that in this question the correct answers are provided in a separate window, once you have pressed 'Mark'. (Type your answer)

Profit-sharing: Step 3 is to 'give' the partners the credit for any salaries they are due. This money is deducted from the amount left in the 'pot', i.e. from £19,360. As you can see from the 'Deed', only S is due a salary, that being £4,000. This leaves £19,360 minus £4,000 = £15,360 in the 'pot'.

Profit-sharing: Step 4 is to share out the remaining profits in the ratio stipulated in the Deed:

Q5. Fill-in the gaps in the following. Notice that in this question the correct answers have been provided in a separate box, you only have to choose the right ones for your answer. You are only allowed ONE attempt at this question. Remember no £ sign or commas! (Type your answer)

We can now calculate the net income of each partner as follows (using S as an example):

	S (£)	T (£)
interest on capital	2000	3000
plus: salary due	4000	nil
plus: share of remainder of profits	5120	10240
	11120
less: interest charged on drawings	960	800
equals: net income	10160

Q6. Using the above, try to calculate the net income of T. Enter your answer without a £ sign or comma. (Type your answer)

Appropriation accounts

Appropriation (in this context) means profit distribution. We have already done the hard work; the calculations. Now, all of the above figures are entered in an 'Appropriation account', using the rule (for a 'horizontal' or T-shaped account):

Profit and other incomes accruing to the partnership appear as credits;
Profit distributions appear as debits.

S and T, Profit and Loss Appropriation account for the year ended 31.12

	Debits	£		Credits	£
	Interest on capitals: S	2000		Net Profit	22,600
	T	3000		Interest on drawings:
	Salary: S	4000		S	960
	Share of remainder: S	5120		T	800
	T	10240
		24,360			24,360

Partners 'current' accounts

Each partner needs to have their own capital account. In addition it is considered 'good practice' these days for the profit - share and drawings of each partner to be kept separate from their long-term capital. The profit-share and drawings are shown on the 'current account' which is almost a mirror-image to the appropriation account, with the following exceptions:

1. Only items relating to partner S will be in Partner S's current account, whereas the appropriation account relates to all partners.
2. Drawings appear in the current account but not in the appropriation account.
3. Net profit appears in the appropriation account but not in the current accounts.

Suppose that each of S and T started this year with a £8500 owed to each of them by the partnership, because they had not 'drawn' their full entitlement last year. The £8500 would appear as an opening balance and S's current account would appear thus:

Date	Debits	£	Date	Credits	£
1.1	Drawings	8000	1.1	Balance b/d	8500
31.12	Interest on drawings	960	31.12	Profit Appropriation
				Interest on capital	2000
				Salary	4000
31.12	Balance c/d	10660		Share of remainder	5120
		19620			19620

This means that S finishes the year with £10,660 owed to him by the partnership.

Q7. If T also starts the year with £8500 owed to him, how much will be owing to him at the end of the year? (No £ sign or comma) (Type your answer)

Q8. Now try to fill-in the gaps in the following text. The answers are already provided for you in a separate box. Just pick from the list. You are allowed only ONE attempt at this question. (Type your answer)