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Interactive Worksheet on Partnership Accounts (1)

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

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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)

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.

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.

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:

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:

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

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

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:

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

You can now attempt the objective assessment on partnership accounts (excluding questions 6, 9, 10, 14 & 15). The interactive worksheet on partnership accounts (2) will help further prepare you for those questions.