NATURE OF A PARTNERSHIP

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1 Slide 1.1 NATURE OF A PARTNERSHIP Being a sole trader means a) being in control of the business b) being responsible for all the decision making c) being entitled to all the profits of the business or having to suffer all losses. A sole trader can be restrictive in two main ways as follows a) Limited time available (i.e. hours put in by the sole trader himself) b) Limited resources available (i.e. capital contributed by the sole trader, although loans etc. may be available).

2 Slide 1.2 NATURE OF A PARTNERSHIP CONTINUED Forming a partnership may lift these restrictions in that: a) More man hours and capital become available b) It may also become easier to obtain a loan. However, in a partnership no one person has total control nor a right to all the profits. Partnerships are commonly found in: a) In family businesses b) Where two or more sole traders have come together to form a partnership. c) In professional firms such as lawyers, accountants and doctors

3 Slide 1.3 REASONS FOR FORMING PARTNERSHIPS The capital required is more than one person can provide. The experience or ability required to manage the business cannot be found in one person alone. Many people want to share management instead of doing everything on their own. Very often the partners will be members of the same family.

4 Slide 1.4 NATURE OF A PARTNERSHIP A partnership has the following characteristics: a) It is formed to make profits. b) It must obey the law as given in the Partnership Act of 1890,if there is a limited partner it must also comply with the limited Partnership Act of c) 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 partners, and there is no maximum for firms of accountants, solicitors,stock exchange members, surveyors,auctioneers,valuers,estate agents, land agents,estate managers or insurance brokers

5 Slide 1.5 NATURE OF A PARTNERSHIP d) 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 private possessions to pay their share of the debts. This can be said to be unlimited liability. e) Partners who are not limited partners are known as general partners.

6 Slide 1.6 DEFINITION OF A PARTNERSHIP The partnership Act of 1890 defines a partnership as follows: The relation which subsists between persons carrying on a business in common with a view to profit. In keeping with this definition the essential elements of a partnership are as follows: a) There must be a business. Under the term we include trades of all kinds and professions. b) The business must be carried on in common. c) The partners must carry on the business with the object of gain. There are many associations of persons where operations in common are carried on, but as they are not carried on with the view to profit they are not to be considered as partnerships, e.g. a sports club.

7 Slide 1.7 TYPES OF PARTNERSHIPS There are two types of partnership as follows: a) Ordinary or general partnership: in this type of partnership, each partner contributes an agreed amount of capital, is entitled to take part in the running of the business (but is not entitled to a salary for so doing, unless specially agreed) is also entitled to receive a specified share of the profits or losses. Each partner is jointly liable to the extent of his full estate for all the debts of the partnership.

8 Slide 1.8 TYPES OF PARTNERSHIPS CONTINUED b) Limited partnerships: Limited partnerships were introduced by the Limited partnership Act 1907.

9 Slide 1.9 LIMITED PARTNERSHIPS Limited liability partnerships are partnerships containing one or more limited partners. Limited partners are not liable for the debts of the partnership. They have the following characteristics and restrictions on their role in the partnership: a) 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 money to pay the debts unless they contravene the regulations relating to their involvement in the partnership. b) They are not allowed to take out or receive back any part of their contributions to the partnership during its lifetime.

10 Slide 1.10 LIMITED PARTNERSHIPS c) 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 they were taking part in the management of the partnership. d) All the partners cannot be limited partners, so there must be at least one general partner with unlimited liability.

11 Slide 1.11 TYPES OF PARTNERS There are four types of partners as follows: a) Active partner: one who takes an active part in the business. b) Dormant or sleeping partner: one who retires from active participation in the business but who leaves capital in the business and receives a reduced share of the profits.

12 Slide 1.12 TYPES OF PARTNERS CONTINUED c) Quasi-partner: One who retires and leaves capital in the business as a loan.interest,based on a proportion is credited to the retired partner's account each year and debited as an expense to profit and loss account. This type of partner would be more accurately described as a deferred creditor,i.e. one who receives payment after all other creditors. d) Limited partner: one who is excluded from active participation and who is liable only up to the amount he has contributed as capital.

13 Slide 1.13 PARTNERSHIP AGREEMENT To show the terms of that partnership (Smith V Jeyes). Where the terms of the partnership are embodied in writing, they may be varied by consent of all the partners. They need not be in writing. However, it is better if a written agreement is drawn up by a lawyer or Accountant. A written agreement will mean fewer problems between partners. It also means less confusion about what has been agreed.

14 Slide 1.14 PARTNERSHIP AGREEMENT CONTINUED It is not necessary for a partnership contract to be in any special form. In practice,however,the terms of the partnership are normally drawn up in writing(usually under seal) though an unsigned document drawn up by one of the partners and acted upon by the others has been held to constitute the terms of the partnership (Baxter VS West ). Where no written document sets out the terms of the partnership, the method of dealing which the partners adopt is admissible in evidence.

15 USUAL PROVISIONS OF THE PARTNERSHIP AGREEMENT A properly drawn partnership agreement would normally contain the following provisions: 1. Nature of the business to be carried on by the firm. 2.Capital and property of the partnership, and the respective capitals of each partner. 3.How the profits should be divided between the partners, and how the losses should be shared. 4. Payment of interest on capital, and the drawings rights of the partners if any.

16 Slide 1.16 USUAL PROVISIONS OF THE PARTNERSHIP AGREEMENT 5. Keeping of accounts and how they should be audited. 6. Powers of partners 7.Provision for dissolution of the partnership. 8.How the value of goodwill should be determined upon the retirement or death of a partner. 9. Method to be employed in computing the amount payable to an out-going partner, or to the representatives of a deceased partner

17 Slide 1.17 USUAL PROVISIONS OF THE PARTNERSHIP AGREEMENT CONTINUED 10. Right of the majority of partners to expel one their members. 11.A clause to the effect that disputes to be submitted to arbitration.

18 WHERE NO PARTNERSHIP AGREEMENT EXISTS If no prior agreement exists then section 24 of the 1890 Partnership Act will apply and it states that: 1. Profits 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 are entitled to 5% interest on any contributions in excess of the agreed capital contributions.

19 Slide 1.19 CAPITAL CONTRIBUTIONS AND SHARING OF PROFITS a) Capital contributions: partners need not contribute equal amounts of capital. What matters is how much capital each partner agrees to contribute. It is not unusual for partners to increase the amount of capital they have invested in the partnership.

20 Slide 1.20 CAPITAL CONTRIBUTIONS AND SHARING OF PROFITS b) Partners can agree to share profits in any ratio or any way that they may wish. However, it is often thought by students profits should be shared in the same ratio as that in which capital is contributed. c) If work to be done by each partner is of equal value but the capital contributed is unequal, it is reasonable to pay interest on the partner s capital out of partnership profits.

21 Slide 1.21 INTEREST ON CAPITAL This interest is treated as deduction prior to the calculation of profits and their distribution among the partners according to the profit sharing ratio. The rate of interest is a matter of agreement between the partners. Often it will be based upon the return which they would have received if they had invested the capital elsewhere.

22 Slide 1.22 INTEREST ON DRAWINGS It is in the best interest of the partnership if cash is withdrawn from it by the partners in accordance with the two basic principles a) As little as possible b) As late as possible. The more the cash is left in the partnership, the more expansion can be financed, the greater the economies of having ample cash to take advantage of bargains and of not missing cash discounts because cash is not available. To deter the partners from taking out cash unnecessarily the concept can be used of charging the partners interest on each withdrawal,calculated from the date of withdrawal to the end of the financial year.

23 Slide 1.23 INTEREST ON DRAWINGS The amount charged to them helps swell the profits divisible between the partners. The rate of interest should be sufficient to achieve this without being to harsh. Allen and Beet are in partnership and have decided to charge interest on drawings at 5 percent per annum, and their year end was 31 December.Calculate interest on drawings chargeable to each partner for the Year ended 31 December 2012.

24 Slide 1.24 SOLUTION EXAMPLE INTEREST ON DRAWINGS ALLEN Drawings Interest Date Calculation of interest 2,000 x 5% x 12 months/12 1 January 2,000 months 100 4,800 x 5% x 10 months/12 1 March 4,800 months MAY 2,400 2,400 x 5% x 8 months/12 months 80 1 July 4,800 4,800 x 5% x 6 months/12 months October 1,600 1,600 x 5% x 3 months/12 months 20 Interest charged to Allen 520 BEET Drawings Interest Date Calculation of interest 1 January 1,200 1,200 x 5% x 12 months/12 months 60 1 August 9,600 9,600 x 5% x 5months/12 months December 4,800 4,800 x 5% x 1 months/12 months 20 Interest charged to Beet 280

25 Slide 1.25 PARTNERSHIP SALARIES AND PERFROAMNEC RELATED BONUSES Partnership salaries: One partner may have more responsibility or tasks than the others. A reward for this, rather than change the profit and loss sharing ratio, the partner may have a partnership salary which is deducted before sharing the balance of profits. Performance related payments to partners: partners may agree that commissions or performance related bonuses be payable to some or all of the partners linked to their individual performance. As with salaries,these would be deducted before sharing the balance of profits.

26 Slide 1.26 INCOME STATEMENT,AND APPROPRIATION ACCOUNT In the case of a partnership, the income statement (profit and loss account)is really in two sections. a) The first section is drawn up as already indicated earlier like for a sole trader and is debited with the net profit made (or credited with the net loss). To complete the double entry, the amount of net profit is then carried down as an ordinary balance and credited to the second section of the income statement. (N.B. a net loss would be carried down to the debit side of this section.) It is this second section that shows how the net profit is allocated to the various partners, and it is called the profit and loss appropriation account, or just the appropriation account.

27 Slide 1.27 DOUBLE ENTRY FOR THE APPROPRIATION ACCOUNT The appropriation account starts with profits from the profit and loss account or income which is accounted for as follows: If net profit Dr Profit and loss account or income statement Cr Appropriation account If a net loss Dr Appropriation account Cr Profit and loss account or income statement The interest on drawings is transferred to the appropriation account as follows; Dr Drawings account Cr appropriation account

28 Slide 1.28 DOUBLE ENTRY FOR THE APPROPRIATION ACCOUNT Then all the appropriations or share of profits and debited to the appropriation account as follows: a) Salary payable to the any of the partners Dr appropriation account Cr Current account b) Interest on capital payable to the partners Dr appropriation account Cr Current account c) The balancing figure in the appropriation account is the balance of net profit to be shared or net loss to be shared in the profit and loss sharing ratio.

29 Slide 1.29 DOUBLE ENTRY FOR THE APPROPRIATION ACCOUNT If the total on the credit side is more than the total on the debit side the balancing figure is a profit accounted for as follows: Dr appropriation account with each partner s share of profits Cr each partner s current accounts If the total on the debit side is more than the total on the credit side the balance is a share of the loss which is accounted as follows; Dr each partner s current account Cr the appropriation account with each partner s share of the loss

30 Slide 1.30 EXAMPLE APPROPRIATION ACCOUNT Taylor and Clarke have been in partnership for one year sharing profits and losses in the ratio of 3 to 2 respectively. They are entitled to 5 percent per annum interest on capitals, Taylor having $20,000 capital and Clarke $60,000. Cash drawings during the year amounted to Taylor $15,000 and Clarke $26,000. Clarke is to have a salary of $15,000. They charge interest on drawings, Taylor being charged $500 and Clarke $1,000. The net profit before any distribution to the partners amounted to $50,000 for the year ended 31 December 2013.

31 Slide 1.31 APPROPRIATION ACCOUNT AS PART OF FINANCIAL STATEMENTS The appropriation account of a partnership is prepared as an extension to the income when preparing financial statements. This means the income statement of a partnership will be dawn the normal like in sole trader business but for the partnership an extra section called the appropriation section is shown. So for exam purpose you prepare an appropriation account as a continuation from where the net profit of the income statement is calculated adding the interest on drawings and subtracting the partner s salary and the interest on capital. The remaining profits or losses are shared according to the profit and loss sharing ratios.

32 Slide 1.32 FORMAT APPROPRIATION SECTION OF INCOME STATEMENT APPROPRIATION SECTION OF THE INCOME STATEMENT Net profit Add:Interest on drawings Taylor Clarke Less: Salary :clarke Interest on capitals Taylor Clarke Balance share of profits Taylor (3/5 x XXXX) Clarke (2/5 x XXXX) XXX XXX XXX XXX XXX XXX XXX XXXX XXXX XXX XXX XXX XXX XXXX

33 Slide 1.33 FIXED ACCOUNTS AND CURRENT ACCOUNTS The capital account for each partner remains year by year at the figure of capital put in the partnership by the partners. The profits,interest on capital and the salaries to which the partner may be entitled are then credited to a separate current account for the partner, and the drawings and interest on drawings are debited to it. The balance of the current account at the end of the financial year will represent the amount of undrawn (or withdrawn) profits. A credit balance will be undrawn profits,while a debit balance will be drawings in excess of the profits to which the partner was entitled.

34 Slide 1.34 FIXED CAPITAL ACCOUNTS AND CURRENT ACCOUNT Credit balance on the current account is added to capital in the statement of financial position and debit balance is subtracted from capital in the statement of financial position. For examination purposes the capital and current accounts of the partners should be drawn in columnar form i.e. side by side on both the debit and the credit side. Show the capital and current account of Taylor and Clarke in columnar forma and prepare a statement of financial position extract that shows how the current accounts and capital accounts will appear.

35 Slide 1.35 PARTNERSHIP ACCOUNTS EXAMPLE ONE Rush and Aldridge are in partnership sharing profits and losses in the ratio 3:2 respectively. The following list of balances has been extracted from the books, of the business, for the year ended 30 November 2014.

36 Slide 1.36 PARTNERSHIP ACCOUNTS EXAMPLE ONE K Land at cost 120,000 Fixtures and fittings (cost) 70,000 Fixtures and fittings (depreciation) 20,000 Creditors 17,000 Debtors 21,000 Balance at bank (cr) 7,500 Bank loan 20,000

37 Slide 1.37 PARTNERSHIP ACCOUNTS EXAMPLE ONE K Provision for bad debts 1,000 Sales 98,000 Purchases 39,000 Stock ( ) 11,000 Rent and rates 3,000 Insurance 1,500 Salaries and wages 13,700

38 Slide 1.38 PARTNERSHIP ACCOUNTS EXAMPLE ONE K Office expenses 2,800 Heating and lighting 1,750 Advertising 900 Capital account Rush 80,000 Aldridge 50,000 Current account Rush (cr) 3,850 Aldridge (dr) (2,000) Drawings Rush 3,700 Aldridge 7,000

39 Slide 1.39 PARTNERSHIP ACCOUNTS EXAMPLE ONE The following information is also available: At : Closing stock K13, 800 Rent outstanding K500 Salaries outstanding K1,120 K80 insurance prepaid for the following year Provision for bad debts needs increasing to K1,150 Interest of K2,000 on the bank loan needs to be included in the accounts

40 Slide 1.40 PARTNERSHIP ACCOUNTS EXAMPLE ONE Fixtures and fittings are depreciated at 10% on a reducing balance basis Partnership salaries are as follows: Rush K8,000 Aldridge K2,000 Interest on capital is allowed at 10%

41 Slide 1.41 PARTNERSHIP ACCOUNTS EXAMPLE ONE Required: a) From the list of balances (at ) prepare the trial balance for Rush and Aldridge. (5 marks) b) (Prepare a trading and profit and loss account and a balance sheet as at 30 November (25 marks) (Total 30 marks)

42 Slide 1.42 PRACTICE QUESTION Dixon and Phillips are in partnership sharing profits and losses in the ratio 2:1 respectively. The following trial balance has been drawn up at 31 March 214.

43 Slide 1.43 DR K CR K Land - at cost 100,000 Buildings - at cost 126,000 Fixtures - at cost 8,000 Cumulative depreciation (at 1 April 2014) - buildings 9,450 - fixtures 1,600 Stock (at 1 April 2014) 2,100 Debtors 4,900 Creditors 1,300

44 Slide 1.44 Bank overdraft 840 Sales 78,600 Purchases 31,700 Rent 1,120 Rates 2,360 Insurance 3,540 Heating 8,020 Salaries and wages 14,290

45 Slide 1.45 Capital - Dixon 150,000 - Phillips 75,000 Current - Dixon 1,750 - Phillips 2,650 Drawings - Dixon 4,180 - Phillips 6, , ,790

46 Slide 1.46 The following information is also available: 1. Closing stock at 31 March 2009 was K4, Rent accrued at 31 March 2009 was K Insurance prepaid at 31 March 2009 was K Depreciation was to be provided as follows: - buildings at 2.5% per year on a straight line basis assuming nil residual value. - fixtures at 20% per year on a reducing balance basis. 5. Partnership salaries are as follows: - Dixon K2,000 - Phillips K Interest on capital is allowed at 5% per year.

47 Slide 1.47 Required: (a) Prepare the trading, profi t and loss account and appropriation account for Dixon and Phillips for the year ended 31 March (12 marks) (b) Prepare a balance sheet for Dixon and Phillips at 31 March (13 marks) (Total 25 marks)

INTRODUCTION PARTNERSHIPS

INTRODUCTION PARTNERSHIPS NCEA LEVEL 3 ACCOUNTING By Elizabeth Pitu 2013 BOOK 1 INTRODUCTION and PARTNERSHIPS Teacher Manual NCEA LEVEL 3 ACCOUNTING By Elizabeth Pitu 2013 BOOK 1 INTRODUCTION and PARTNERSHIPS Student Workbook STUDENT