Ch 9: The preparation of final accounts

for partnership
Learning Objectives:
1) Define ‘Partnership’

2) The characteristics of Partnership

3) Advantages and disadvantages of forming a partnership

4) The SEVEN items in the Partnership Act regarding

Partnership

5) The differences between Sole Trader and Partnership in terms

of accounting entries

6) The preparation of final accounts for Partnership

Ch 9: The preparation of final accounts for partnership
Introduction:
For a number of commercial reasons, it may be mutually
advantageous for two or more people to form a
partnership.
Question: Have you ever wondered what a ‘partnership’
means? What characteristics a partnership
has?
Answers: The Partnership Act defines a partnership
as ‘the relationship which subsists
between persons carrying on business
in common with a view of profit’. The
people who won a partnership are called
‘partners’. They do not have to be based or
work in the same place, though most do.
However, they maintain one set of
accounting records and share the profits and
 Ch 9: The characteristics of Partnership
Five characteristics of a partnership:
1) It is formed to make profits.
2) It must obey the law as given in the Partnership Act
1890. If there is a limited partner, it must also
comply with the Limited Partnership Act of 1907.

3) Normally there can be a minimum of two partners

and a maximum of twenty partners. Exception are
banks, where there cannot be more than ten partner;
and there is no maximum for firms of accountants,
solicitors, stock exchange members, surveys,
auctioneers, valuers, estate agents, land agents,
estate managers, or insurance brokers.
 Ch 9: The characteristics of Partnership
Five characteristics of a partnership:
4) Each partner (except for limited partners) must pay
their share of any debts that the partnership could
not pay. If necessary, they could be forced to sell
all their privates possessions to pay their share of
the debts. This can be said to be unlimited liability.

5) Partners who are not limited partners are

known as general partners.
 Ch 9: The characteristics of Partnership
Limited Partnership:
Limited partnership are partnerships containing one or
more limited partners. Limited partnerships must be
registered with the Registrar of Companies. Limited
partners are not liable for the debts as in Section 41.2.
Limited partners have the following characteristics and
restrictions on their role in the partnership.
1) Their liability for the debts of the partnership is
limited to the capital they have put in. They can
lose that capital, but they cannot be asked for any
more money to pay the debts unless they
contravene the regulations relating to their
involvement in the partnership.
Limited Partnership:

2) They are not allowed to take out or receive back

any part of their contribution to the partnership
during its lifetime.
3) They are not allowed to take part in the
management of the partnership or to have the
power to make the partnership take a decision.
If they do, they become liable for all the debts
and obligations of the partnership up to the
amount taken out or received back or incurred
while taking part in the management of the
partnership.
4) All the partners cannot be limited partners, so there
must be at least one general partner with unlimited
liability.
 Ch 9: Advantages and disadvantages of
forming a partnership
The advantages of Partnership:
1) Spreading of business risk
2) Different partners can develop special skills because each
partner can focus on one skill
3) Some partners have more ability to invest capital resources
than other partners

The disadvantages of partnership:

1) Disputes between partners on business matters
2) All are ‘jointly and severally liable’ for his partners. If one
partner incurs a liability, then the others will also share it.
 Ch 9: The Deed of Partnership
Partners in a partnership are largely free to make whatever
agreements between themselves that they wish to cover their
mutual relationships. The powers and rights of the partners
between themselves are governed by any written agreement they
may make. This is referred to as the articles or deed of
partnership. The deed of partnership is prepared to avoid
misunderstanding between partners.

It states the followings:

1) The capital to be contributed by each partner

2) The ratio in which profits (or losses) are to be shared

3) The rate of interest, if any, to be paid on capital before the

profits are shared
 Ch 9: The Deed of Partnership
It states the followings:

4) The rate of interest, if any, to be charged on partners’

drawing
5) Salaries to be paid to partners

6) Arrangements for the admission of new partners.

7) Procedures to be carried out when a partner retires or

dies.
 Ch 9: Where no partnership agreement
exists
When no partnership agreement exists, express or implied, Section 24
of Partnership Act 1890 governs the situation. The accounting content
of this section states:

1) Profit and losses are to be shared equally

2) There is to be no interest allowed on capital

3) No interest is to be charged on drawings

4) Salaries are not allowed

5) Partners who put a sum of money into a partnership in

excess of the capital they have agreed to subscribe are
entitled to interest at the rate of 5% per annum on such
an advance
Ch 9: The SEVEN items in the Partnership
Act regarding Partnership
In the absence of any partnership agreement, a partner is subject
to the provision of Partnership Act. There are SEVEN
items in the Partnership Act regarding this issue.

1) Each partner has unlimited liability. That is, if

the debts of the partnership cannot be paid
because the business has insufficient assets to do
so, the creditors have recourse to the private
property of the individual partners. The partners
are said to be jointly and severally liable for the
debts of the firm and therefore a creditor may sue
the partnership or any individual partner.
Ch 9: The SEVEN items in the Partnership
Act regarding Partnership
2) Every partner is entitled to take part in the
management of the business. However, some
partnership agreements provide for certain
partners to be sleeping or limited partners.
Neither of these normally takes part in the
management of the business.

3) Every partner is entitled to access to the books

and papers of the partnership. This includes
sleeping and limited partners.
Ch 9: The SEVEN items in the Partnership
Act regarding Partnership
4) Voting powers: in the ordinary day-to day
running of a partnership, individual partners
often make routine business decisions without
consulting the other partners. At the other
extreme, certain fundamental decisions, such as
to change the type of business in which the
partnership is engaged, or the admission of a new
partner, require the consent of all the partners.
Other decisions are supposed to be determined
by a majority vote. Each partner has one vote.
However, a partnership deed may specify some
other distribution of voting power.
 Ch 9: The SEVEN items in the Partnership
Act regarding Partnership
5) Each partner is an agent of the partnership and can
this sign contracts on behalf of the partnership,
which will then be legally bound to honour them.

6) A new partner can only be admitted to the partnership

if all existing partners give their consent. However, a
partnership deed may specify otherwise.

7) A partnership will be dissolved by:

a) any partner giving notice to the other partner(s)
of his or her intention to leave the partnership;
b) the death, insanity or bankruptcy of a partner.
 Ch 9: The differences between Sole Trader and
Partnership in terms of accounting entries
Differences between a Sole Trader (Proprietorship) and a
partnership:

Sole Trader Partnership

1) Only Capital Account 1) Two accounts:
- All Capital invested, a) Partners’ Fixed A/C
Drawings and Profit and This account contains only
Loss are closed to the amount of capital invested.
Capital Account b) Partners’ Current A/C
This account contains each
partner’s Drawings, and
Share of Profit
 Ch 9: The differences between Sole Trader and
Partnership in terms of accounting entries
Differences between a Sole Trader (Proprietorship) and a
partnership:

Sole Trader Partnership

2) No division of profit 2) Profit is put into
– all belongs to the Appropriation A/C –
Sole Trader divided according to
the Profit Sharing
ratio to each partner
 Ch 9: The differences between Sole Trader and
Partnership in terms of accounting entries
Capital and Current Accounts
In the accounts of sole trader, there would be a capital account
and usually a drawing account. In the books of a partnership,
there will be:

1) A Capital Account for each partner. Unlike the capital

account of a sole trader, this will only contain the original
capital put into the business plus any further capital
introduced at a later date. It is fixed in nature and used to
record:
Capital introduced or withdrawn by new/retiring partners.
 Ch 9: The differences between Sole Trader and
Partnership in terms of accounting entries
Capital and Current Accounts (continues)

2) A Current Account for each partner recording:

a) drawings of money or goods taken by the partner for his
or her own use (debit)
b) interest charged on drawings (debit)
c) interest on loans to the partnership (credit)
d) salary (credit)
e) interest on capital (credit)
f) the partner’s share of the residual profit and loss
 Ch 9: The differences between Sole Trader and
Partnership in terms of accounting entries
The following factors have to be taken into consideration, before
any profits are divided:
a) Interest on capital
Partners can agree to credit themselves with Interest on
Capital.
b) Salaries
Partners can agree to credit themselves with fixed salaries,
eg for a partner who contributes valuable service to the
Partnership.
c) Share of Residual Profits (or Losses)
Partners can share out the remaining Profit and Loss after
allowing for (a) and (b) above (Interest and Salaries), according
to the profit and sharing ratio.
 Ch 9: The preparation of final accounts for
partnership
Example1 : Appropriation Account
Peter and Paul commenced business in partnership on 1 Jan 2002
as food wholesalers, contributing as fixed capital £2,000 and
£3,000 cash each. Their partnership deed states that:

a) Profits and losses are to be shared equally

b) Salaries are Peter £2,500 per annum and Paul £1,800.
c) Interest on capital of 10% is allowed
d) Interest on drawings of 5% is charged
e) Interest on loan from partners is given at the rate shown in
Section 24 of Partnership Act 1890. (5% per annum)
During the year, Peter and Paul withdrawn £500 and £400 from
the partnership, respectively. In addition, Paul has lent £1,000 as
loan to the partnership on 1 July 2002. Profit for the year is
£10,000.
 Ch 9: The preparation of final accounts
for partnership
Answers:
Appropriation Account for the year ended 31 Dec 2002
£ £ £
 Ch 9: The preparation of final accounts for
partnership
Once the Appropriation account has been completed, then we
should record those amounts in the Partners’ Current Account.
(continues Example 1)
Partners’ Capital Account

Partners’ Current Account

 Ch 9: The preparation of final accounts
for partnership
In conclusion, the flow of preparing the whole set of partnership
account is as follow:

Step 1: You’ll be given a trial balance as usual

Step 2: Profit and Loss Account

Step 3: Appropriation Account

Step 4: Partners’ Current Account

Step 5: Balance Sheet

Ch 9: The preparation of final accounts
for partnership

THE END

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