Accounting for Partnership_additional Notes on Formation

8/2/2019 Accounting for Partnership_additional Notes on Formation

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Accounting For Partnership

Learning Outcomes:

Understand the concept of partnership

Understand the journal entries for theformation of partnership, distributing profit or

loss, admission of new partners andretirement of partners

Able to prepare financial statements forpartnership


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Partnership Act 1961

is the relation which subsists between personscarrying on business in common with a view ofprofit.

Sec 3(1)

* A partnership is a form of business jointly owned by

two or more persons, or entities with a view ofmaking profit.

Definition


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Partners the people who own a partnership. They are not separate entities from the partnership

(legal point of view).

i.e. they are responsible for all the liabilities and actions of

the partnership. Examples of partnership:

Private clinics, auditing and accounting firms, law firms,private institutions.

Small retail or manufacturing. Reasons for forming partnership:

Raise more capital, different skills may be complementaryto each others, share risks and responsibilities

3


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Separate legal personality (from accountingperspective)

Unlimited liability

Limited life

Co-ownership of propertyCo-ownership of profits

Characteristics


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Advantages

Ease of formation and dissolution

Better management

Greater capital compared to proprietorship

Disadvantages

Easily dissolved/limited life

Unlimited liability

Difficulty in transferring ownership

Conflict among partners

Lesser capital compared to corporation

Advantages &Disadvantages


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Minimum members is 2 and should notexceed 20.

Not necessarily in the form of writtenagreement. Verbal agreement is accepted.

All matters related to partnership must bereferred to an agreement. If no agreementexists in relation to certain issues, statutesin the Partnership Act 1961 would be

applied.

Formation


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This agreement is a framework which governs

the formation, operations, dissolution andliquidation of the partnership.

Contents: Name, nature & scope of partnership Authority, rights & duties of each partnerMethods of sharing profits & losses Rate of interest for capital Rate of interest to be charged on partners

drawings Salaries to be paid to partners (if any) Arrangements for the admission of new

partners Procedures to be carried out when a partner

retires or dies

Partnership Agreement


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When nopartnership agreement exists(refer to Section 26 or PA1961):

Every partners may take part in themanagement

Profits and losses are to be shared equally

No interest allowed on capital

No interest to be charged on drawings

No salaries are allowed

Interest 8% p.a. is charged on the advance(loan) made by a partner to the partnership

Each partner has unlimited liability.

Cont.


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Partnership vs SoleProprietorship

Proprietorship

Net Profit

Partnership

Net Profit

Balance Sheet

Balance Sheet

Partners Account


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Two methods available to present the equity in the

balance sheet:

i. Fixed Capital Account

ii. Fluctuating Capital Accounts

i. Fixed Capital Account

The capital account will record the initial introductionof capital, and will normally only be adjusted if thepartner introduces additional capital (i.e. to record

movement of capital). The current account will record transactions relating

to partners other than transactions related to capitalsuch as share of profits/losses, interest onwithdrawals, interest on loan, partners salaries

accrued etc.

Reporting Equity in BS


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ii. Fluctuating capital accounts

If the partnership maintains fluctuating capitalaccounts, there will be no current account.

All changes in partners equity (appropriation of

profit and drawings) will be recorded in partners

capital accounts. Capital of each partner will fluctuate every year.

Thus, the original value of capital contributed byeach partner is no longer known.

Note: Fixed Capital Accounts is favorable overFluctuating Capital Accounts

Cont.


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Fixed Capital Account

Cont.

Capital Account

Ali Abu Ali Abu

Bank 2,000 6,000


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Fixed Capital Account

Cont.

Current Account

Ali Abu Ali Abu

Int. on

capital

100 300

Int. ondrawings

Drawings

Bal. c/d

2,000 2,000

10050

600 400

2,650 2,500

Profits 2,550 1,700

Salaries 500

2,650 2,500

Bal. b/d 600 400


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Fluctuating Capital Account

Cont.

Capital Account

Ali Abu Ali Abu

Int. oncapital

100 300

Int. ondrawings

Drawings

Bal. c/d

2,000 2,000

10050

2,600 6,400

4,650 8,500

Profits 2,550 1,700

Salaries 5004,650 8,500

Bal. b/d 2,600 6,400

Bank 2,000 6,000


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Ali and Lee have decided to form a partnership, Alee Tax

Consultant. Besides consultancy, the firm suppliestaxation books and related materials to colleges anduniversities. The partnership commences its operationon 1st January 2010. Therefore its financial year beginsat 1st January and ended 31st December every year.

Capital contributions as agreed: Ali cash RM10,000 and shop lot with a market value of

RM30,000

Lee- Cash RM5,000

On 15th January, Ali took out cash RM2,000 while Leetook out goods amounting to RM500.

Required:

Prepare journal entries to record the above transactions

using both methods.

Cont.


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Date Particular Debit(RM)

Credit

(RM)

Jan 1

2010Cash

CapitalAli

CapitalLee

(To record cash investment by Ali and

Lee)

15,000

5,000

10,000

Premise

Capital - Ali

(To record shop lot investment by Ali)

30,00030,000

Jan 15

2010Current a/cAli

Cash

(To record cash withdrawal by Ali)

2,0002,000

Current a/cLee

Purchases

(To record goods withdrawal by Lee)

500500

Fixed Capital Accounts


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Date Particular Debit (RM) Credit (RM)

Jan 1 2010 CashCapitalAli

CapitalLee

(To record cash investment by Ali and

Lee)

15,0005,000

10,000

PremiseCapital - Ali

(To record shop lot investment by Ali)

30,000 30,000

Jan 15

2010CapitalAli

CapitalLee

Cash

Purchases

(To record cash & goods withdrawal by

partners)

2,000

5002,000

500


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Initial Investment

Initial investment made by partners will becredited into their respective Capital

Account. Non cash assets need to be recorded at

their fair value at the date of investment.

Liabilities brought into the partnership have

to be recorded at fair value.

Accounting Treatments


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Additional Investment Similar accounting entries as to the

initial investment:

Record asset at its fair value

Credit the amount to partners capital

account

Withdrawal of Investment The withdrawal amount needs to be

debited to partners capital account

Accounting Treatments


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Loan

Any loan provided by a partner is a liability tothe partnership. This partner is entitled toreceive a certain percentage of interest on theloan given. Interest on loan will be treated as

expenses of the firm & will be recorded inincome statement.

Interest on capital

Interest was given for the purpose ofencouraging partners to invest in the

business.

Cont.


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Other issues

All amounts received by each partnerfor the current period (e.g. salaries,interest on capital, profit-loss, bonus

etc.) would be credited to respectivepartners Current Account.

A key point to remember is that as in a

sole trader's accounts, any amountsactually paid to the owners (whether incash or in any kind) should be treatedas drawings.

Cont.


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Salary

If a partner is entitled to a salary, it is dealt

with as part of the appropriation of profit. It is not an expense of the business, and

should not be charged to the incomestatement in order to calculate profit.

Only salaries paid to employees of thebusiness are charged to the incomestatement.

Cont.


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Residual Profit

Profit which is divided between the partners in theprofit and loss sharing ratio.

It is the amount of profit remaining after taking intoaccount the fact that the partners will be entitled to a

proportion of the profit under the terms of thepartnership agreement.

These proportions are the 'appropriations of profit'.Profit-Loss Appropriation Account is prepared to

determine the current profit received by each partner. It should be noted that while salaries and interest on

capital will reduce the amount of residual profit to beshared between the partners, interest on drawings

will increase the residual profit.

Cont.


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The final accounts

Consist of:

Trading, profit and loss account

Net profit/loss will be transferred to theprofit and loss appropriation account

Profit and loss appropriation account

Shows of profits or losses among partners-

obtained by adjusting the amount of netprofit with related transactions made bypartners.

Balance sheet 24


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Comprehensive Example 1

The net profit for the partnership between Azlan and Chong for the year

ended 31 December 20X8 was RM28,500. The capital accounts andcurrent accounts for the partnership on 1 January 20X8 were as follow:

Capital accounts:

Azlan RM40,000

Chong RM50,000

Current accounts:

Azlan RM2,160

Chong RM1,500

In the year 20X8, Azlan withdrew RM2,000 on 31 Mac 20X8.
http://../ACT3120_ridzwana/Accounting%20for%20partnership/Solution%20to%20Comprehensive%20Example%20-%20Lecturer's%20copy.dochttp://../ACT3120_ridzwana/Accounting%20for%20partnership/Solution%20to%20Comprehensive%20Example%20-%20Lecturer's%20copy.doc


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Cont.

The contents of the partnership agreement are as follow:

i. Interest on the initial capital is 5% per year

ii. Azlan would be paid RM12,000 per year for his salary

iii. 8% interest per year would be levied on withdrawals by the partners

iv. Azlan and Chong share a profit/loss in a ratio of 2:3

Prepare:

(a) The allocation of profit-loss using Profit-Loss Appropriation Account orProfit-Loss Appropriation statement for the year ending 31 December20X8.

(b) Capital account and current account for each partner

(c) A balance sheet (equity section) as at 31 December 20X8

Documents

Accounting for Partnership_additional Notes on Formation