Professional, Practical, Proven Academy 2019/2020 Advanced Financial Accounting Lectures 3 & 4 Accounting for Partnerships
Learning Outcomes Partnerships & the Partnership Agreement • The Capital and Current Accounts • The Appropriation account (Double Entry) • Pro Forma Layouts • Recommended Work • 2
What is a Partnership? A partnership can be defined as the relationship which subsists between persons carrying on a business in common with a view to making profit. There is no legal requirement for a partnership agreement, The provisions of the 1890 Partnership Act (as amended 1907) apply if there is no other agreement in place. 3
The Partnership Act - Main Provisions of the Act as amended: Profits and losses are shared equally All partners have the right to take part in the business All partners have the right to prevent entry of another partner All partners have the right to examine the books of the partnership No interest is paid on the capital advanced by each partner. No remuneration is paid to partners for acting within the business All partners have the right to receive interest at 5%p.a. on loans and advances made to the partnership in excess of their capital subscription. Differences of opinion shall be settled by the majority of the partners but the nature of the business cannot be changed without the consent of all partners. 4
Alternative Partnerships agreements may specify: Any salaries to be paid to partners Interest to be paid on any loans made by a partner to the partnership Interest to be paid on partners capital account balances Interest to be charged on partners drawings The proportion for distribution of profit. 5
Partnership Accounts Capital A/C (SOFP) Original capital introduced (Upward) Revaluations Goodwill Partner’s Total Capital Current A/C (SOFP) Losses Profits Drawings Interest on Loans Interest on Credit Capital balances 6
The appropriation account details the sharing out of profit, in whichever ratio has been agreed, i.e. In the profit sharing ratio e.g. 3:2:1 Appropriation A/C A 60,000 Net profit 120,000 B 40,000 C 20,000 Partners’ Current A/C A B C Share of 60,000 40,000 20,000 profits The statement of Comprehensive Income of a Partnership will have an appropriation section after Total Comprehensive Income in which the profits/losses for the financial period are apportioned. 7
Appropriation Account (Pro-forma) € € Gross Profit X Other Partnership Expenses (X) Interest on Loan extended to business (X) Profit for the Year X Other Comprehensive income/expenditure X Total Comprehensive income for the year X Distributable income X Salaries A X B X C X (X) Interest on Capital/Current Accounts A X B X C X (X) Balance of Profit X Share of profit (as per profit sharing ratio) A X B X 8 C X X
Salaries NB: A partners salary is not a business expense, but a way in which profits are allocated. (e.g. Partner B might be afforded a salary of 40k in the partnership agreement before remaining profits are apportioned according to the PSR) Employees Salaries – treated as an expense in the SOCI Partners Salaries – treated as an appropriation of profit in the appropriation a/c. Paid to the partners at an agreed rate based on the detail in the partnership agreement. Dr The appropriation account Cr The Partners Current A/C Therefore paying agreed salaries out of the final net profit before the distribution of profit according to the PSR. 9
Interest on Capital (The partnership agreement will state whether this is paid on capital and/or current account balances). Paid to the partners at an agreed rate based on the level of capital invested. Dr The appropriation account Cr The Partners Current A/C Therefore paying agreed interest out of the final net profit before the distribution of profit according to the PSR. Also: some partnerships will charge interest on debit balances in the partners current accounts Dr The Partners Current A/C Cr The Appropriation A/C 10
Drawings As noted agreed salaries are credited to the partners current a/c’s. These earnings, and the withdrawal of other profits, are recorded in the partner’s current a/c. I.E. Dr Partners Current A/C Cr Bank Remember that the affect of Drawings is on the balance sheet, it is not an appropriation of profit as such. Interest on Drawings Penalties may be applied to partners who ‘overdraw’ from the business: Dr Partners Current A/C Cr Appropriation A/C 11
Example: Appropriation A/C A – Salary 20,000 Net profit 120,000 B “ 10,000 A - Share of profits 45,000 The statement of Comprehensive Income of a B “ 30,000 Partnership will have an appropriation section after C “ 15,000 Total Comprehensive Income in which the profits/losses for the financial period are apportioned. Partners’ Current A/C A B C A B C Drawings - 45,000 - Salary 20,000 10,000 - Share of 45,000 30,000 15,000 profits 12
Profit Sharing Ratio e.g. 3:2:1 (i.e. Profits will be apportioned six ways, with the ratio weighting allocated to each partner respectively) Share of Profits: Dr Appropriation A/C (to distribute the profits) Cr Partners Current A/C (in the appropriate ratio) Share of Losses: Dr Partners Current A/C (in the appropriate ratio) Cr Appropriation A/C (to distribute the profits) 13
Share of Profits: Appropriation A/C A - Share of profits 60,000 Net profit (from SOCI) 120,000 B “ 40,000 C “ 20,000 Partners’ Current A/C A B C A B C Share of 60,000 40,000 20,000 profits 14
Share of Losses: Appropriation A/C Net Loss (from SOCI) 120,000 A - Share of Loss 60,000 B “ 40,000 C “ 20,000 Partners’ Current A/C A B C A B C Share of 60,000 40,000 20,000 Loss 15
Guaranteed Minimum Profit A partner may be guaranteed a minimum share of the profits. Any deficiency must be deducted from the share of the profits allocated to the other partners in accordance with the agreed PSR. Loans extended to the business by a Partner Interest on Loans extended to the business by a partner is treated as though the loan were provided by any financial institution e.g. Dr Loan Interest A/C (Expense, SOCI) Cr Bank (if the interest has been paid) or Cr Partners Current A/C (if the interest is outstanding to the partner at the period end.) 16
Revaluations of Non-Current Assets Where the asset is revalued upwards, the double entry will be: Dr Non Current A/C (with the increase in asset value) Cr Partners Capital A/C (showing their increased interest) The revaluation will be apportioned in the profit sharing ratio. 17
Where a partnership exists and there is no partnership agreement, then: [a] the partners share profits in relation to the combined balances on their capital and current account. [b] the partners share profits equally and interest is paid on capital balances at 5% per annum. [c] the partners share profits in relation to the balances on their capital accounts. [d] the partners share the profits equally and no remuneration is paid to the partners for acting in the business. Partners drawing are: [a] charged against the partners in their current accounts. [b] charged against the partners in their capital accounts. [c] credited to the partners capital accounts. [d] credited to the partners current accounts. Interest paid to a partner for a loan extended to the business must be accounted for: [a] in the partners current account. [b] in the appropriation account. [c] in the partners capital account. [d] in the income statement as an expense. 18
Jen and Brad are in partnership and their capital account balances are £/€63,000 and £/€92,000 respectively. The partnership agreement details appropriation of partnership profits as follows: Jen Brad Annual salary £/€18,000 £/€24,000 Interest on capital 8% 8% Share of residual profit 45% 55% If the profit for the year, before appropriation, was £/€124,000, what would Jen’s entitlement be in total: [a] £/€23,040 [b] £/€36,360 [c] £/€54,360 [d] £/€49,320 what would Brad’s entitlement be in total: [a] £/€69,640 [b] £/€45,640 [c] £/€31,360 [d] £/€62,280 20
Recommended Work 22
Recommended Work 1) Review Chapter 5 – Partnerships Remember that Partnerships may be examined as a full question, part question or in MCQs. Remember to complete the T-Accounts where same are requested i.e. Show the balances b/f. Remember that adjustments (additional info) will usually affect the SOCI and the SOFP; Other info will affect the appropriation account and the SOFP . 23
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