Course: S5: Financial Accounting , Topic: Unit 3 PARTNERSHIP ACCOUNTS

General

Unit 3 PARTNERSHIP ACCOUNTS
Key unit competence: To be able to prepare financial statements for a
partnership business
Introductory activity
Observe the picture above and answer the following questions:
1. What do you see on this image?
2. Among forms of business, which one is formed by partners?
3. What do you understand by partnership agreement?
4. Which accounts to be prepared in partnership
3.1. Introduction to partnership
Learning Activity 3.1
Read the following case study and answer the given questions.
A partnership is a business owned by two or more people. In most forms
of partnerships, each partner has unlimited liability for the debts incurred
by the business. The three most prevalent types of for-profit partnerships
are: general partnerships, limited partnerships, and limited liability
partnerships. Partnerships are arrangements between individuals to carry
on business in common with a view to profit. A partnership, however,
involves obligations to others, and so a partnership is usually governed
by a partnership agreement. Unless it is a limited liability partnership
(LLP), partners will be fully liable for debts and liabilities, for example if
the partnership issued. A partnership is a group of individuals who are
trading together with the intention of making a profit. Partnerships are
often created as a sole trader’s business expands and more capital and
expertise are needed within the business. Typical partnerships are those of
accountants, solicitors and dentists and usually comprise between about 2
and 20 partners. As partnerships tend to be larger than sole traders, there
will usually be more employees and a greater likelihood of a bookkeeper
being employed to maintain the accounting records. Each of the partners
will contribute capital to the business and will normally take part in the
business activities. The profits of the business will be shared between the
partners, and this is normally done by setting up a partnership agreement
where the financial rights of each partner are set out. Just as with sole
traders, the partners will withdraw part of the profits that are due to them
in the form of drawings from the business although, in some cases, partners
may also be paid a salary by the business.
After reading this case study, answer the following questions
1. A partnership is a group of individuals who are ……..….. together
with the intention of making profit.
a) Business
b) Arrangements
c) Involves
d) Trading
2. What are the most types of for- profit partnership?
3. What are the advantages and disadvantages of partnership?
3.1.1. Meaning of partnership business
Partnership may be defined as: a relation between persons carrying on a
business in common with a view of profit. A partnership is owned by two
or more people but not more than twenty persons except in certain cases.
In most forms of partnerships, each partner has unlimited liability for the
debts incurred by the business. The three most prevalent types of for-profit
partnerships are:
• General partnerships
• Limited liabilities partnerships
• Limited partnerships. E.g: practicing solicitors, professional
accountants and members of the stock exchange where this figure
may be exceeded.

Types of partners:
1. According to participation in the running of the business
a) Active partner: This actively participates in the day to day running
of the business.
b) Dormant/sleeping partner: Does not actively participate in the
day to day running of the business
2. According to age
a) Major partner: This is a partner who is above the maturity age
b) Minor partner: This partner has not attained maturity age and
therefore has limited liability.
3. According to liability
a) Limited partner: This partner has limited liability. This means that
his/her liability towards the debts of the partnership is limited to
his/her capital contributions. Minor partners have limited liability.
b) Unlimited partner: This partner is liable for all the debts of the
partnership to the extent of selling personal property to pay the
debts of the partnership.
4. According to capital contributions
a) Quasi partner: This does not contribute capital, but allows his/her
name to be used by the partnership.
b) General partner: This is a partner because of capital contributions.
Advantages and disadvantages of partnerships
Advantages of partnership:
• More capital is raised from bigger membership
• Better skills from a variety of members
• Better decisions can be made compared to sole proprietors
• Partnerships are easy to form compared to limited companies
• Risks are minimal as they are spread across many members.
• Partnerships can easily access credit from financial institutions
since lenders find it easier to deal with a group of people than one
individual
Disadvantages of partnerships:
• Profits are reduced as they are shared among many members
• Partners have unlimited liability_ they have equal sharing when it
comes to the liabilities of a partnership
• Delays in decision making compared to sole proprietors
• They are not permanent in nature because the death or retirement
of a partner may lead to its dissolution
Business usually depends on active partners and is likely to be affected in
case they die
Application activity 3.1
Read carefully and discuss on the following questions:
a) What are the components of a partnership deed?
b) What happens if no partnership deed exists?
c) State and explain the types of goodwill.
3.1.2. Partnership agreement or deed
This is a written agreement among partners regarding the terms and
conditions of the partnership business.
Components of partnership agreement or deed
A partnership deed usually contains the following;
– Capital to be contributed by each member.
– Names of partners
– Profit and loss sharing ratios
– Salaries paid to partners
– Partners drawing rights and interest on drawings
– Preparation and auditing of books of accounts
– Duties, powers and liabilities of each member.
– Basis of valuation of good will
– Methods of dealing with the death, retirement and insolvency of
partners
– Methods of admission of a new partner
– Method of settling the accounts in case of dissolution.
If no partnership deed that exists
– Profits and losses are shared equally
– There will be no interest on capital
– There will be no interest on drawings
– No payment of salaries to partners
– If a partner gives a loan to the partnership business, he is entitled to
5% interest per annum.
Accounting for goodwill in partnership accounts
Goodwill is an intangible asset arising from the business’s ability to earn more
profits as compared to other firms in the same or similar trade. Goodwill arises
when the value of the business as a going concern is greater than the value
of its separate tangible assets. It is the excess of purchase consideration of a
business sold as a going concern above the fair market value of the business
assets.
Goodwill arises in the business because of the following reasons,
– The business may have enjoyed some form of monopoly either
nationally or locally for example there may not be sufficient trade to
out compete some Engineering firms, which have been managed or
run for a long period.
– A new business may continue to trade under the same name as that
of the original firm. The fact that the firm was well known could mean
that new customers and old customers are attracted for this reason.
– The value of labor force including management skills other than that
of the retiring proprietor may be carried forward. Skilled management
is an asset to the business.
– The possession of patent rights and trademarks may account for
goodwill. These may have cost the original owner little or nothing
and they could be shown in the balance sheet. They are normally
unsellable, unless the business is sold as a going concern.
– The location for the Business premises may be more valuable if the
business does not change. Where the business is strategically located
this is an advantage.
– The cost of research and development, which might have brought
about cheaper manufacturing methods or cheaper products, may be
charged to the current buyer. The amount that the buyer is prepared
to pay will depend on his view of the future profits which will accrue
to the factors mentioned above.
Types of goodwill:
In accounting, goodwill is classified into inherent goodwill, purchased
goodwill and negative goodwill.
1. Purchased goodwill arises from a defined financial transaction and
hence its recorded in the financial statement like any other assets in
accordance with international financial reporting standard 3 IFRS3-
BUSINESS COMBINATION.IFRS3 Provides for immediate write-off of
goodwill after acquisition or amortization for a period not exceeding
twenty years using straight-line method.
2. Inherent goodwill on the other hand arises out of normal carrying
out of the business activities. It is never recorded in the books because
recording it would mean anticipating gains that would only be realized
on the sale of the business that may never happen.
3. Negative goodwill arises when the realizable value of the business
sold as a going concern is exceeded by the fair market value realized
from individual assets.
Circumstances that lead to ascertainment of good will
When dealing with partnership accounts, goodwill may be recognized under
the following circumstances:
-Admission of a new partner into the established partnership especially
when the old partners have built goodwill into the business. This is to enable
the new partner to compensate for the share of the good will he/she is going
to enjoy.
– On death or retirement of one partner from an established
partnership.
– At dissolution of the partnership.
– When there is a change in the mode of ascertaining profit and loss of
the firm.
– When there is a change in the profit sharing ratios.
3.2. Introduction to partnership accounts
Learning Activity 3.2
On 01.01.2020. Kefa and Sifa started a partnership business which is
located in HUYE district. They agreed to contribute equally and their capital
contribution amounted to 250,000 RWF. Upon their agreement Kefa and
Sifa injected in addition capital of 20,000 RWF. On 31.3.2020, they shared
interest on the capital on the profit made. On 5.3.2020, they withdrew
money for personal use. On 30.5.2020, they paid interest on drawings. A
salary was also paid to Sifa. After paying all the expense profit was shared
by the partners by using their sharing ratios. After two years their business
made a loss.
Required:
After understanding this scenario, as an accountant who completed in S4
Accounting,
What are the necessary accounting entries for this partnership?
3.2.1. Meaning of accounting entry
An accounting entry is a formal record that documents transaction. In most
cases, an accounting entry is made using the double entry bookkeeping system,
which requires one to make both a debit and credit entry, and which eventually
leads to the creation of a complete set of financial statements. An accounting
entry can also be made in a single entry accounting system; this system typically
tracks only cash receipts and cash disbursements and shows only those results
needed to construct an income statement.
Types of accounting entries:
They are three primary types of accounting entries, which are noted below
1. Transaction entry
A transaction entry is the primary type of business event for which the accountant
would create an accounting entry. Examples of accounting transactions are the
record of an invoice to a Customer, an invoice from a supplier, the receipt of
cash and the purchase of a fixed asset. This type of accounting entry is used
under both the accrual basis and cash basis of accounting.
2. Adjusting entry
An adjusting entry is a journal entry used at the end of an accounting period to
adjust the balances in various general ledger accounts to more closely align the
reported results and financial position of a business to meet the requirements
of an accounting framework, such as GAAP or IFRS. This type of accounting
entry is used under the accrual basis of accounting
3. Closing entry
A closing entry is a journal entry used at the end of an accounting period to shift
the ending balances in all revenue, expense, gain, and loss accounts (known
as temporary accounts) into the retained earnings account. Doing so empties
out the temporary accounts, so that they can begin accumulating transactional
information in the next accounting period.
How to create accounting entries?
Accounting entries for transactions are typically created through a transaction
interface in the accounting software, so that you may not even realize that
you are creating an accounting entry (such as, for example: when creating a
customer invoice). If you are creating an adjusting accounting entry, then you
will use a journal entry format (assuming that a double entry accounting system
is being used). If you are closing the books at the end of an accounting period,
the accounting software will likely create the closing entry automatically; you
will not even see the entry.
Accounting entries
1. In case of additional capital contributed.
Dr. cash/bank/asset a/c
Cr. Individual partner capital a/c
2. In case of interest on capital
Dr. Interest on capital a/c
Cr. Individual partner`s current a/c
3. In case of any drawings
Dr. Individual partner’s current a/c
Cr. Cash/bank/asset a/c
4. In case of any interest on drawings
Dr. individual partner`s current a/c
Cr. Interest on drawings
5. Salaries paid to a partner
Dr. salaries a/c
Cr. Individual partner`s current a/c
6. Share of profits by a partner
Dr. income statement a/c
Cr. Individual partner current a/c
7. Share of loss by a partner
Dr. Individual partner current a/c
Cr. Income statement a/c
3.3. Components of Partnership Final accounts
Learning Activity 3.3
On 01.01.2010, Ineza, Louise and Gisa started a partnership firm in
Nyagatare District, buying and selling cars. After 1 year, they needed to
ascertain if they got a profit or loss.
1. Which document can help them to know if they made a profit or
loss?
3.3.1. Income statement of partnerships
The trading on profit and loss of a partnership is the same as that of a sole
trader only that it has an extension called the appropriation account.
Format of the income statement of partnerships

NB:
– Interest on a loan is a business expense and treated as a business
expense and treated in the profit and loss a/c
– If a partnership gives out a loan in return for interest, the interest
received is treated as an income.
– If a partner gives a loan to a partnership, interest charges on the loan is
a business expense and charged against the profit and loss a/c.
Illustration1:
The following trial balance was extracted from the books of Nema, keza and
Manzi at 31 December 1990 (trading account has already been prepared
Required: The preparation of a profit and Loss account for the year ended 31
December1990
Addition information:
– Interest is to be allowed at 6% per annum on partners ‘capital accounts.
– RWF 5,000 is to be allowed as a salary to Manzi
Answer:
Nema, Keza Manzi
P&L a/c for the year ended 31 December 1990

Illustration 2
Martin and Melvin are in a partnership sharing profits and losses equally. The
following is their trial balance as at 30.06.2010

Required: Prepare profit and loss account for the year ended 30.06.2010
a) Stock 30.06.2010 was 56,340
b) Expenses to be accrued; office expenses 96, wages 200
c) Depreciate fixtures 10% on reducing balance basis, buildings 1,000
d) Reduce provision for bad debts to 320
e) Partnership salary 800 to Martin not yet paid.
f) Interest on drawings: Martin 180
Melvin 120
g) Interest on capital account at 10%.
Solution
Martin and Melvin
Income statement for the year ended 31.12.2010
Partnership appropriation account
The appropriation account is prepared after preparing Profit & Loss A/C. In the
case of partnership firms, it is prepared to show how profits are distributed
among the partners involved in the partnership.
In the case of LLC (Limited Liability Company), the purpose of preparing this
account is the same but the format is different. We will start with the year’s
profit before the taxation figure, from which we will subtract corporate taxes
and dividends to find the retained earnings for the year.
In the government’s case, the appropriation account is used to show the funds
allocated to the specific project. Any expenses are reduced from the funds
allocated.
The following are the adjustment/items included in this account:
1. Net Profit: It is the opening balance of appropriation a/c. This balance is
taken from Profit & Loss a/c after making all the necessary adjustments
for the period.
2. Interest on Capital: The expense for the company as a partner will be
paid interest on the amount of capital invested in the business.
3. Interest on Drawings: It is an income for the company. The company
will charge interest from the partner on any amount of capital withdrawn
during the year.
4. Partner’s Salary: It is pre-agreed as per the partnership deed and is an
expense for the business.
5. Partner’s Commission: It is pre-agreed as per the partnership deed
and is an expense for the business.
6. Net Profit transferred to Partner’s Account: After making all the
above adjustments, this is the final profit amount.
Format of profit and loss appropriation (P&L)
P&L appropriation a/c for the year ended 31/12/xxx

Profit & Loss (P&L) Appropriation A/c
A & B started a partnership firm on 01.01.2017. They contributed RWF 50,000
each as their capital. The terms of a partnership are as under:
– A& B to get monthly salary of RWF 1,000 & RWF 1,500 respectively
– B is allowed a commission at the rate of 5% of Net profit
– Interest on capital & drawings will be 10% p.a.
– Sharing of profit & Loss will be in the ratio of capital sharing.
Before making the above appropriations, the profit for the year ending
31.12.2017 is RWF 75,000. Drawings of A & B were RWF 10,000 & RWF 20,000
respectively. Prepare Profit & Loss Appropriation Account.
Solution
Working
WN 1 Interest on Capital @10% of the Capital Invested
Partner A = 50000*10% = 5000
Partner B = 50000*10% = 5000
WN2 Commission @5% of Net Profits
Partner B = 75000*5% = 3750
WN3 Interest on Drawings @ 10% of Amount of Drawings
Partner A = 10000*10% = 1000
Partner B = 20000*10% = 2000
WN4 Net Profit divided among partners in ratio of their capital i.e 50% each
Partner A = (78000-(5000+5000+12000+18000+3750))/2 =17125
Partner B = (78000-(5000+5000+12000+18000+3750))/2 =17125
P&L Appropriation A/C for the year ended 31/12/2017

Illustration 2:
Hirwa and Manzi started business in partnership on 1st January, 2015 without
any agreement. Mr. Hirwa introduced capital RWF. 60,000 and Mr. Manzi RWF
40,000. On March 1st, 2015Mr. Manzi advanced RWF 20,000 by way of loan at
an interest rate of 6% per annum. The profit for the year ended 31st, December
2015, was amounted to RWF 18,000.
Required: Prepare Profit and Loss Appropriation Account at the end of 2015.
Solution:
Hirwa and Manzi P&L Appropriation A/C for the period ended 31st
December, 2015

Illustration 3
Tony, Feza and Sifa are in partnership with capital of RWF 200,000; 80,000 and
RWF 20,000 respectively. Their partnership deed provides for the following:
i. Interest on capital at 4% per annum
ii. Interest chargeable on drawings at 5% per annum
iii. Tony and Feza to receive salaries of RWF20,000 each per annum
iv. Tony, Feza and Sifa are to share the profits and losses in the ratio 6:3:1
respectively.
The following information is available for the year ended 30 June 2000:

Required:
The appropriation account for the year ended 30 June 2000
Solution
Tony, Feza and Sifa
The appropriation account for the year ended 30 June 2000

Working:
W-1. Interest on drawing, 5% per annum
Tony: drawing 2,400; Interest: 2,400*5/100=120
Feza: drawing 1,800; Interest: 1,800*5/100=90
Sifa: drawing 1, 800; Interest: 1,800*5/100=90
W-2. Interest on capital 4% per annum
Tony: capital 200,000; Interest: 200,000*4%=8,000
Feza: capital 80,000; Interest: 80,000*4%=3,200
Sifa: capital 20,000; Interest: 20,000*4%=800
W-3. Balance of profit to be shared
Total profits=RWF 53,300
Tony, Feza, and Sifa =6:3:1
Tony: 53,300*6/100=3,198
Feza: 53,300*3/100=1,599
Sifa: 53,300*1/100=533
Importance of Appropriation Account
This account shows the number of profits divided among various heads.
It shows the number of profits transferred to reserves and distributed as
dividends.
It gives information on how the profits are divided among partners and how
the various adjustments are made during the year.
Conclusion
Hence, the appropriation account shows how the profits are appropriated or
distributed among various heads. This account is prepared on behalf of the
firm.
3.3.2. Partnership capital accounts
Definition:
A partnership capital account is an account that contains all the transactions
occurring between the partners and the partnership firm, such as the initial
contribution of capital in partnership, the interest of capital paid, drawings,
the share of profit, and others adjustments. It is required to maintain proper
accountability and transparency between the partners and the firm.
Fixed capital accounts, Current accounts, Fluctuating capital accounts:
When fixed capital accounts are maintained, the capital account records the
partner’s capital contribution only.
A current account is opened up where partner’s dealings with the partnership
are recorded e.g. interest on capital, interest on drawings, partner’s salaries etc.
Under fluctuating capital balance method, the capital account records the
capital contributions and other partners’ dealings with the partnership e.g.
salaries, interest on capital, drawings, interest on drawings, share of profits etc.
Fixed capitals are more preferable than fluctuating capitals. With current
accounts where a partner is drawing more than his share of profit, the partner’s
current account will show a debit balance and this is a warning that his drawings
are excessive.
Note: Fluctuating capital accounts is a combination of Fixed capital accounts
and Current accounts
Fixed capital balance method
Capital account

Current account

Capital accounts

Illustration 1
Charles and Robert are in partnership sharing profits and losses in a ratio 3:2
respectively. They are entitled to 5% per annum interest on capitals. Their
capitals are; Charles 20,000 and Robert 60,000.
Robert is to have a salary of 5,000.
They charge interest on drawings Charles being 500 and Robert 1,000.
During the year drawings for Charles and Robert were 20,000 each.
Their share of profits is 25,500 and 17,000.
Required: Show the partners’ capital accounts.
Fixed capital accounts

Current accounts

Fluctuating capital accounts

Illustration2
ABC and Co. are a partnership firm with the three partners, A, B, and C. Profit
sharing ratio of each partner is equal, and the capital contribution of each
partner is also equal. The total requirement of investment in the business is
FWR 300,000. The firm does not maintain a separate current account and all the
transactions are to be recorded in the capital account itself. Other details are as
under:

Required: Draw the Partners Capital account and record the above transactions.
Solution:
Capital Contribution = RWF 300,000 / 3 = RWF 100,000
Interest on Capital = RWF 100,000 * 12% = RWF 12,000 per partner.
Profit Share =RWF 75,000/3 =RWF 25,000 per partner
3.3.3 Balance sheet (statement of financial position)
Definition:
Balance sheet summarized a company’s assets, liabilities and shareholders’
equity at a specific point in time (as indicated at the top of the statement).
It is one of the fundamental documents that make up a company’s financial
statements. The balance sheet also reveals the book value of a company’s assets,
liabilities and shareholder’s equity.
Structure of the balance sheet

NB: A positive balance means a credit balance while a negative balance
means a debit balance.
We used the same example which is above
Illustration1
Martin and Melvin are in a partnership sharing profits and losses equally. The
following is their trial balance as at 30.06.2010

Required: Prepare balance sheet for the year ended 30.06.2010
Additional information:
a) Stock 30.06.2010 was 56,340
b) Expenses to be accrued; office expenses 96, wages 200
c) Depreciate fixtures 10% on reducing balance basis, buildings 1,000
d) Reduce provision for bad debts to 320
e) Partnership salary 800 to Martin not yet paid.
f) Interest on drawings: Martin 180
Melvin 120
g) Interest on capital account at 10%.
Solution:
Balance sheet as at 30.06.2010

Changes in ownership of partnership
These include:
– Admission of a partner
– Death of a partner
– Dissolution
i. Admission of a partner
A new partner(s) can be introduced after all partners are in agreement to
this effect. The old partnership ceases to exist and a new partnership starts.
The accounts of the old partnership can be closed then a new set of accounts
prepared for the new partnership. This is really followed. So admission of a
partner merely entails addition of a capital column for the new partner and the
following entries thereafter:
Dr Asset accounts
Cr Capital account (with assets received from the joining partner which can
be cash)
However, both admission and retirement/death bring about the following
additional issues:
Goodwill will be recorded during any change in ownership as follows:
Dr Goodwill account
Cr Capital accounts (in old profit sharing ratio)
This can remain in the accounts like this or it can be eliminated. If it remains
in the accounts, then the partners’ capital would have increased.
Goodwill can be eliminated as soon as transition in ownership is complete by:
Dr Capital accounts (in new profit sharing ratio)
Cr Goodwill
This is of course, subject to continuance of the business. Goodwill will not be
eliminated if there is no business continuance like in dissolution.
This process ensures that the joining partner pays for the goodwill that
had already existed. This is because the new profit share ratio will include
the new partner.
Revaluation account
Revaluation of assets and liabilities are usually carried out during changes in
ownership. In such cases account will be opened.

After opening the revaluation account is just to find increase or decrease due
to revaluation, which is dealt with in the following way.
Loss from revaluation (using the old profit sharing ratios)
If there any changes in between the year then the profit or loss up to this date
has to be shared to the old partners. After the changes the profit/loss earned
or incurred is shared to the new partnership in the new structure. Sometimes
the expenses can be divided between the periods to be able to determine the
profit that period.
Nziza and Mwiza are in partnership sharing profits and losses equally. The
following is their balance as at 30 June 2001
Additional information:
i. Stock, 30 June, RWF 650,000
ii. Expenses to be accrued: Office expenses RWF 800, wages RWF1,500
iii. Depreciate fixtures 10 per cent on reducing balance basis, building
RWF 12,000
iv. Reduce provision for bad debts to RWF 3,200
v. Partnership salary: RWF1,500 to Nziza
vi. Interest on drawings: Nziza RWF 1,500; Mwiza RWF 1,100
vii. Interest on capital account balances at 10 per cent.
Required:
Prepare a trading and Profit and Loss appropriation account for the year
ended 30 June 2001, and a balance sheet as at that date.
End unit assessment 3
1. What do you understand about:
– Fixed capital accounts
– Current accounts
– Fluctuating capital accounts
2. Where partners do not prepare an agreement.
3. Okello, Opio and Ouma are in partnership. At the end of the first
year they had the following details; on 31/12/2006.

Additional information
i. Depreciate all fixed assets at a rate of 10% p.a
ii. There was no partnership agreement.
Required:
a) Prepare a profit and Loss Appropriation account
b) Prepare partners current accounts
3. 3. The following list of balances as at 30 September 2009 has been
extracted from the books of Brick and Stone, trading partnership,
sharing the balance of profits and losses in the proportions 3:2
respectively.

Additional information
i. RWF 10,000 is to be transferred from Brick’s capital account to a
newly opened Brick Loan
Account on 1 July 2009, interest at 10 per cent p.an on the loan is to
be credited to Brick
ii. Stone is to be credited with a salary at the rate of RWF12,000 per
annum from 1 April 2009.
iii. Inventory at 30 September 2009 has been valued at cost at
RWF32,000.
iv. Telephone charges accrued due at 30 September 2009 amounted to
RWF400 and rent of RWF600 prepaid at that date.
v. During the year ended 30 September 2009 Stone has taken goods
costing RWF1,000 for his own use.
vi. Depreciation is to be provided at the following annual rates on the
straight line basis: Fixtures and fittings 10% Motor vehicles 20%
Required:
a) Income statement and appropriation account for the year ended
30 September 2009.
b) Prepare a Statement of financial position as at 30 September
2009, which should include summaries of the partners’ capital
and current accounts for the year ended on that date

S5: Financial Accounting

General

Unit 3 PARTNERSHIP ACCOUNTS

Unit 3 PARTNERSHIP ACCOUNTS

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