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PARTNERSHIP ACCOUNTING
A. PARTNERSHIP
WHAT IS IT?
Is a relationship between persons who have agreed to share profit and loss of the business carried by all with a profit meditative.
Partners: Are persons making an agreement to carry business for a common purpose/intention.
- Individual – these are partners (Persons by nature).
- Collectively – This is a firm (legal persons).
MAIN FEATURES OF PARTNERSHIP;
- Two or more persons.
- There must be an agreement between partners.
- Lawful business.
- Profit Motive.
- Principal to agent relationship.
- Unlimited liabilities.
B. CAPITAL ACCOUNTS
Capital can be contributed
(a) In kind
Anything equivalent to cash e.g. A house, a car etc
ENTRIES | |
DR Motor car A/c | |
CR Capital A/c | |
b) In cash | |
– It is in cash | |
ENTRIES | |
DR Cash A/c | |
CR Capital A/c | |
c) Both cash and in kind | |
– Partner brought part in cash and part in kind. | |
TYPES OF CAPITAL ACCOUNTS
There are two types of Capital Account
(a) Fluctuating capital Account
- Also it is known as floating capital account.
- This system partners capital account do not remain intact (as its original balance but fluctuates quite frequently)
- It means the capital account changes with all items concerning partners e.g. Interest on drawings, interest on capital, Partners salaries, commission, Drawings, Properties brought in, Profit and less distribution.
(b) Fixed Capital Account
Under this system the original capital invested by the partners remain unaltered unless additional capital is invested or capital itself is withdrawn by mutual agreement.
(c) Partner’s Current Account
It is an account that carries all items concerning Partners e.g. Interest on capital, Interest on drawings, Drawings, Partner’s salaries and wages/ commission to partner.
(d) Profit and Loss Appropriation Account
This is an extension of usual profit and loss Account, it Is prepared for adjusting transaction relating to the partnership deed.
Contents
- Interest on partner’s capital.
- Interest on partner’s drawings.
- Interest on partner’s loans.
- Partners salaries.
- Partner’s commission.
NOTE
These transactions are treated separately without mixing up with general trading transaction.
ENTRIES
DR | CR | ||
1 | Interest on Partner’s Capital | ||
DR; Interest or past Capital a/c | xx | ||
CR; Partner’s capital (current a/c | xx | ||
Transfer (fx) | |||
DR; Profit and loss appropriation a/c | xx | ||
CR; Interest on Partner’s capital | xx | ||
2 | Interest on drawings | ||
DR; Partner’s Capital/Current a/c | xx | ||
CR; Interest on Partner’s Drawings | xx | ||
Transfer (fx) | |||
DR; Interest on Partner’s Drawings a/c | xx | ||
CR; Profit and loss Appropriation a/c | xx | ||
3 | Interest on Partner’s Loans | ||
DR; Interest on Partner’s Loan | xx | ||
CR; Partners capital a/c | Xx | ||
Transfer (fx) | |||
DR; Interest on partner’s Loan | xx | ||
CR; | Xx | ||
4 | Partner’s salaries/Commissions | ||
DR; Partner’s salaries/commission | xx | ||
CR; Partner’s capital a/c | Xx | ||
Transfer (fx) | |||
DR; Profit and loss appropriation a/c | xx | ||
CR; Partner’s salaries/commission | Xx | ||
EXERCISE 1
Amake and Babake started a partnership on 1st January, 2010. Both agreed in the partnership did the following;
- To contribute Shs.100, 000 each as capital.
- To share Profit and loss equally.
- Interest on capital at a rate of 5%.
- Interest on drawings at a rate of 10%.
- Partner’s salary Shs.50, 000 per month each.
Transactions for the Month of January, 2010
1st January,2010 | Invested required capital as per deed | |
“ | Purchased goods from RTC | 700000 |
“ | Purchased goods from Ally cash | 100000 |
“ | Babake inject additional funds in cash | 200000 |
“ | Amake took 50,000 shs from the firm to pay school fees for his son | |
31st January 2010 | Sold goods to NMC worth | 2,000,000 |
Sold goods to NMC by cash | 500,000 | |
Goods counted physically worth | 100,000 | |
Paid rent | 10,000 | |
Rent received | 100,000 | |
Paid to partner’s January salaries | ||
Paid salaries | 2000 | |
Paid productive wages | 5000 |
Required
-Journal Proper to record all the transaction (No narration needed)
-Prepare ledger a/c’s to record all transactions relating to the months 1/2010
-Prepare trading profit and loss a/c and appropriation account for the period in a question.
-Show by extracting financial position of the A and B partnership (Amake and Babake).
PROFIT AND LOSS APPROPRIATION ACCOUNT
Commission | xxx | Net profit b/d | Xxx |
Net loss | xxx | interest on drawings | |
partner’s salaries A- xx | A – xx | ||
B – xx | xxx | B – xx | Xxx |
Bonus to partner’s | |||
Interest on loan xx | |||
general reserve xx | |||
Residual profit | |||
A – xx | |||
B – xx | xxx | ||
xxxx | xxxx | ||
PROFIT APPORTIONMENT BASIS
We are having two Basis of Apportioning residual profits
- Time Basis Apportionment.
- Profit analysis basis.
TIME BASIS APPORTIONMENT
In this method profit is apportioned between the various periods. That is to say the profit is accrued evenly.
Example
A and B are in partnership with share profit of .3:2 respectively on 1st January their capital stood at 500,000 and 400000 respectively. They decided to admit C as a new partner on 1st October, 2010, their new share profit ratio is 2.2.1. During the year the following Transaction took place.
Tshs | ||
Purchases were | ||
Sales were | 2,500,000 | |
Partner’s salaries | 600,000 | |
C brought 100,000 as capital | ||
Interest on capital 10% p.a | ||
Electricity | 100,000 | |
Salaries and wages | 200,000 | |
Required
-Prepare Profit and loss appropriation on time basis for A and B partnership and ABC partnership. Financial year ended 31st Dec. 2010:
Workings (W).
A AND B
PROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE PERIOD ENDED
30TH SEPTEMBER, 2010
(Trading) | (shs) | ||
Purchases | 750,000.00 | sales | 1,875,000.00 |
gross profit c/d | 1,125,000.00 | ||
1,875,000.00 | 1,875,000.00 | ||
electricity | gross profit b/d | 1,125,000.00 | |
salaries and wages | 150,000.00 | ||
net profit c/d | 900,000.00 | ||
1,125,000.00 | 1,125,000.00 | ||
interest on capital | Net profit b/d | 900,000.00 | |
A – 45,000 | |||
B – 30,000 | 75,000.00 | ||
Partner’s salary | 450,000.00 | ||
residual profit | |||
A – 225,000 | |||
B – 150,000 | |||
900,000.00 | 900,000.00 | ||
Working – W2purchases (A, B & C)
Total 1,000,000 x 9/12 = 250,000
Sales (A, B & C)
Total 2,500,000 x 9/12 = 625,000
Electricity (A, B &C)
Total 100,000 x 9/12 = 25,000
Salaries and wages (A, B & C)
Total 200,000 x 9/12= 50
Interest on capital (A, B & C)
Total A – 600,000 x10/100 x9/12 = 15,000
B – 400,000 x10/100 x 9/12= 10,000
C – 100,000 x x = 2500
Partner’s salaries (A, B & C)
Total 600,000 x = 50,000
Residual value
For A; Total 123,500 x = 49,400
For B; Total 123,500 x = 49,400
For c; Total 123,500 x = 24,700
A, B & C PROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE PERIOD END 30TH SEPT.
(Trading) | shs | ||
purchases | 250,000 | sales | 625,000 |
gross profit c/d | 375,000 | ||
625,000 | |||
electricity | 25,000 | gross profit b/d | 375,000 |
salaries and wages | 50,000 | ||
net profit c/d | 300,000 | ||
375,000 | 375,000 | ||
net profit b/d | 300,000 | ||
interest on capital | |||
A – 15,000 | |||
B – 10,000 | |||
C – 2500 | 27500 | ||
Partner salary | |||
residual profit | |||
A – 49,400 | |||
B – 49,400 | |||
C – 24,700 | 123,500 | ||
300,000 | 300,000 | ||
SECOND METHOD; PROFIT ANALYSIS BASIS
In this method profit is apportioned by using analyzed profit and loss. This requires the use of separated column in the profit and loss account for the period in question.
a) Gross Profit
a) Gross Profit
Is apportioned between the period on basis of turn over.
b) Fixed charges
Fixed charges are apportioned on the basis of time.
c) Variable charges
Variable charges are apportioned on the basis of turnover.
d) Other charges
Other charges with special information given are apportioned according to that given information.
EXERCISE
X and Y are carrying on a business in partnership sharing profit and losses in the ratio of 3:2 but during the year ended Dec 31st 2007 two other member were admitted namely W and Z on July 1st and sept 30th 2007 respectively. Net sale during the year amounted to shs. 250,000, selling and distribution on expenses amount to shs. 12,000.
However the firms sales break down were; Tshs.
January 1st to march 31st 62,500
April 1st to June 30th 93,750
July 1st to sept 30th 31,250
Oct 1st to Dec 31st 62,500
The firm normally fixes the Gross profit at 25% above the cost
Their profits and losses sharing ratios were;
X and Y and W was 2; 2; 1
X, Y, W and Z was 4; 3; 2; 1
Prepare;
a) The profit and loss account for the year ended 31st Dec 2007
b) An appropriation account for the year ended Dec 2007.
SOLUTION;
W1; GROSS PROFIT AMOUNT
If the gross profit is 25% above the cost
Thus
Sales are at 25%
G.P = x 250,000; from where r = rate
= 50,000
W2 First 6 month’s G.P; (sales; – 62500 + 93750 = 156250)
6 months G.P = Gross profit x sales for the period
= x 156,250 = 31250.
W3; Gross profit from July 1st – 30th sept (sales = 31250)
3 months G.P = x 31250
= 6250
W4 = Gross profit from October1st– Dec 31st (sales = 62500)
Lost 3 month’s G.P
= 12,500
W5; Administrative expenses 12,000
a) X 12,000 = 6000
b) X 12000 = 3000
c) X 12,000 = 3000
Selling and distribution expenses 25,000
a) For 6 month’s sales = 156250
6 month’s selling and distribution exp.
Total expenses x sale for the period
Total sales
25,000 x 156,250
250,000
= 15,625
b) For next 3 months sales = 31,250
3 months selling and distribution exp. = 25,000 x 31250
250,000
= 3125
c) For the last 3 month’s sales = 62,500
Last 3 month’s selling and distribution exp. =
25,000 x 62,500 = 6250
250,000
DR PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31ST DEC 2007 CR
DETAILS | 6 | 3 | 3 | DETAILS | 6 | 3 | 3 |
Admin. Expenses | 3000 | 3000 | Gross profit | 31250 | 6250 | 12500 | |
selling & distr. Exp | 15625 | 3125 | 6250 | ||||
9625 | 125 | 3250 | |||||
31250 | 6250 | 12500 | 31250 | 6250 | 12500 | ||
PROFIT AND LOSS APPROPRIATION A/C FOR THE PERIOD ENDED 30/6/07
SHS | |||
Capital X ½ x 9625 | 5,775.00 | Net profit b/d | 9,625.00 |
Y 2/5 x 9625 | 3,850.00 | ||
9,625.00 | 9,625.00 | ||
PROFIT AND LOSS APPROPRIATION FOR THE PERIOD ENDED 31ST DEC.2007
Capital X; 2/5 x 125 | 50 | |||
Y 2/5 x 125 | 50 | Net profit b/d | 125 | |
| 25 | |||
125 | ||||
PROFIT AND LOSS APPROPRIATION A/C FOR THE PERIOD ENDED 31ST DEC.2007
Capital x: 4/10 x 3250 | 1300 | Net profit b/d | 3250 |
y: 3/10 x 3250 | 775 | ||
z: 2/10 x 3250 | 650 | ||
w: 1/10 x 3250 | 325 | ||
3250 | 3250 | ||
ADMISSION OF PARTNERS
- When additional capital or managerial stalls or both are required in the course of expansion it is quite usual to take new partner or partners into partnership firm.
- The new partner usually invests additional capital to the firm.
- Admission of a new partner raises the following thins.
- Treatment of Goodwill
- Revaluation
of Assets and liabilities - Re-arrangement of old partners capital balances after admission
- Re-arrangement of old partners profit sharing rations
GOODWILL
- Goodwill simply means the good name or the reputation of the business
- Attraction of more customers depends on Goodwill and helps in earning more profit in future
- Goodwill is an asset
- New partner gets benefit of the extra asset and old ones lose their shares
- In other words when a new partner get some shares in the profit of the firm he acquire the same rights in the existing Assets of the firm and in the extra Asset (Goodwill).
- If that’s the case automatically incoming partner, he has to compensate the old partners either:
By paying in cash for his share of Goodwill
By allowing the old partners capital account to be raised rate-ably
Method of Valuing Goodwill/Methods of calculating Goodwill
- The Goodwill of any business whether sole trader, Firm or company is generally determined by sharing.
- But it depends upon the following factors;
- Present earning capacity of the business.
- Results of the operations of a few previous years.
- The future prospectors of the business.
- Efficiency of management and employers.
- Efficiency of advertising machinery and possession of trade marks.
WHEN VALUATION NEEDED
(a) On admission of a new partner.
(b) On retirement of a new partner.
(c) When changing profit sharing ratios.
(d) On sale of the business.
(e) During Amalgamation.
(f) On dissolution.
METHOD OF VALUATION OF GOODWILL
We are having four methods of valuation of Goodwill
- Purchases of Past profit methods
- Purchase of super profits methods
- Inferred or Implied Goodwill method
- Valuation by bargaining (Arbitrary methods).
– The value of goodwill is decided by direct bargaining between the buyer and seller.
– For Examination purposes such an amount is usually mentioned.
(a) Purchase of Past Profit Method
In this method Goodwill is valued at an agreed number of years (2-3 years) of an average profits of a given number of past years) illustration.
Goodwill is valued at two years purchased of the average profits of four years.
- It means average of four years profit multiply by two
PROFITS | YEARS |
60,000 | 2011 |
50,000 | 2010 |
40,000 | |
5,000 | 2008 |
Goodwill = x no. years of purchase
= x 2= 100,000/=
Goodwill = 100,000
B. Purchase of super profit method
Super profit is the difference (Excess) between average annual earning (actual) of the business and the expected or normal return on capital invested. If the average annual profit of the business is Shs.5000,000/= and the normal earning capacity is 6%, if the capital invested is shs.300,000. Find super profits.
Super Profit = Average profit (Actual) – Normal return of capital invested.
= 50000 – x 800,000
= 50000 – 48,000
= 2000
Then super profit is taken as a base in compilation of Goodwill.
The goodwill be valued at a certain years of purchase of that super profit
3 years purchase: 2000 x 3 = 6,000
C. Inferred or implied goodwill method
When a prospective buyer of a business agrees to pay more than the value of the business taken over, the difference between the purchase price and actual value of the business is known as inferred or implied goodwill.
Example
If the Assets worth 1,000,000 Tshs along with the liabilities of Tshs.30, 000 Tshs are taken over by a buyer for Shs.1, 000,000 then the goodwill is;
Goodwill = Purchase Price – Value of the business
= 1,000,000 = [1,000,000 – 30,000]
= 1,000,000 – 970,000
:. Goodwill 30,000
D. Valuation by bargaining (arbitrary valuation)
– The value of goodwill is decided by direct bargaining between the buyer and seller.
– For examination purposes such an amount is usually mentioned.
ACCOUNTING TREATMENT OF GOODWILL ON ADMISSION
There are two methods in which goodwill can be accounted in the books on admission
(a) When the goodwill is not appeared in the books
(b) When the goodwill is already appearing in the books (in the balance sheet)
(c) When goodwill is not appearing in the books
(d) When new partner pays cash for goodwill, it is always equal to his share in the total goodwill.
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