Learning objectives
1.
Define a partnership and the major attributes of a
partnership
2.
Understand the advantages and disadvantages of the
partnership structure of business
3.
Explain and prepare the accounting entries:
I.
formation of partnership
II.
distribution of profits or losses
III.
drawings made by partners, interest on drawings
4
LO1: Definition of partnership
LO1: Definition of partnership
Partnership Act
Partnership Act
The relationship that subsists between persons carrying on
The relationship that subsists between persons carrying on a business in common with a view to profit.a business in common with a view to profit.
Three Necessary Attributes
Three Necessary Attributes
1.
1.Written or verbal agreement between two or more legally Written or verbal agreement between two or more legally competent persons or entities to carry on a businesscompetent persons or entities to carry on a business
2.
2.Operated with a view to earning a profitOperated with a view to earning a profit
3.
3.Members must be coMembers must be co–owners of the businessowners of the business
5
LO1: Characteristics of a partnership
LO1: Characteristics of a partnership
6
LO1: Partnership agreement
LO1: Partnership agreement
•
•Either written or verbal agreementEither written or verbal agreement
•
•ContentContent: :
Partnership name and locationPartnership name and location
Nature of the businessNature of the business
Name, investment and duties of each partnerName, investment and duties of each partner
Sharing of profits and lossesSharing of profits and losses
Withdrawals (drawings)Withdrawals (drawings)
Dispute resolutionDispute resolution
Admission and withdrawal of partnersAdmission and withdrawal of partners
Partnership liquidationPartnership liquidation
7
LO2: Advantages and disadvantages
LO2: Advantages and disadvantages
Advantages
Advantages
Disadvantages
Disadvantages
Pooling of resources and
Pooling of resources and multiple skills of individual multiple skills of individual partnerspartners
Mutual agency
Mutual agency
Ease of formation
Ease of formation
Unlimited liability
Unlimited liability
Subject to little regulation
Subject to little regulation
Relationships
Relationshipsamong partners among partners may be fragilemay be fragile
Ease of decision
Ease of decisionmaking (there is making (there is no board of directors)no board of directors)
May be tax advantages
May be tax advantages
8
LO3: Accounting entries for partnership
LO3: Accounting entries for partnership
1.
1.Formation of partnershipFormation of partnership
2.
2.Distribution of profits or losses Distribution of profits or losses
3.
3.Drawings made by partners, Drawings made by partners, interest on drawingsinterest on drawings
9
ACCOUNTING FOR A PARTNERSHIP
ACCOUNTING FOR A PARTNERSHIP1. Formation1. Formation
Formation
Formation
•
•Investment of assets (and liabilities)Investment of assets (and liabilities)
Contributions
Contributions
•
•Recorded for each partner in the following Recorded for each partner in the following formatformatof journal entry:of journal entry:
Dr Assets
Dr AssetsXXXX
Cr Liabilities
Cr LiabilitiesXXXX
Cr Partner A, Capital
Cr Partner A, CapitalXXXX
(being initial investment by partner A)
(being initial investment by partner A)
Note:
Note: Assets and liabilities are entered into the books of the partnership at Assets and liabilities are entered into the books of the partnership at ‘fair value’‘fair value’
10
Bieber
BieberandandFoxFoxformedformedaapartnershippartnershiponon11JanuaryJanuary20182018fromfromtheirtheirexistingexistingsolesoletradertraderbusinessesbusinessestotoformformB&FB&Fpartnershippartnership..TheThecarryingcarryingamountamountandandfairfairvaluevalueofofthetheassetsassetsbeingbeingcontributedcontributedandandthetheliabilitiesliabilitiesassumedassumedbybythethepartnershippartnershipwerewereagreedagreedasasfollowsfollows::
Carrying Amount
Carrying Amount
Fair value
Fair value
Bieber
Bieber
Fox
Fox
Bieber
Bieber
Fox
Fox
Cash
Cash
$80 000
$80 000
$30 000
$30 000
$80 000
$80 000
$30 000
$30 000
Accounts Receivable
Accounts Receivable
$45 000
$45 000
$25 000
$25 000
43 000
43 000
22 000
22 000
Inventory
Inventory
35 000
35 000
12 000
12 000
32 000
32 000
12 000
12 000
Land
Land
–
120 000
120 000
–
130 000
130 000
Building
Building
–
115 000
115 000
–
50 000
50 000
Acc Dep
Acc Dep –BuildingBuilding
–
(70 000)
(70 000)
–
–
Total Assets
Total Assets
160 000
160 000
232 000
232 000
155 000
155 000
244 000
244 000
Mortgage Payable
Mortgage Payable
–
80 000
80 000
–
80 000
80 000
Required:
Required: Prepare the journal entries to record the initial investment (i.e. the Prepare the journal entries to record the initial investment (i.e. the formation of the partnership).formation of the partnership).
Example 1
Example 1
11
Example 1 cont.
Example 1 cont.
Jan 1
Jan 1
Cash
Cash
Accounts Receivable
Accounts Receivable
Inventory
Inventory
80 000
80 000
43 000
43 000
32 000
32 000
Bieber, Capital
Bieber, Capital
155 000
155 000
Record Bieber’ initial investment into the partnership
Record Bieber’ initial investment into the partnership
Jan 1
Jan 1
Cash
Cash
Accounts Receivable
Accounts Receivable
Inventory
Inventory
Land
Land
Building
Building
30 000
30 000
22 000
22 000
12 000
12 000
130 000
130 000
50 000
50 000
Mortgage Payable
Mortgage Payable
Fox, Capital
Fox, Capital
80 000
80 000
164 000
164 000
Record Fox’s initial investment into the partnership
Record Fox’s initial investment into the partnership 12
- ALLOCATION OF PROFITS AND LOSSES IN PARTNERSHIPS
- ALLOCATION OF PROFITS AND LOSSES IN PARTNERSHIPS
The allocation should consider each partner’s
The allocation should consider each partner’s
Services performedServices performed
Capital investedCapital invested
Business risk assumedBusiness risk assumed
Common allocation methods include:
Common allocation methods include:
1.
1.Fixed ratioFixed ratio
2.
2.A ratio based on capital balanceA ratio based on capital balance
3.
3.Fixed ratio after allowing for interest and salaryFixed ratio after allowing for interest and salary
Accounting methods:
Accounting methods:
Method 1: Capital accounts that include drawings, and profits and losses
Method 1: Capital accounts that include drawings, and profits and losses
Under this method,
Under this method, Capital Capital accounts are used to account for investments, drawings and profits/lossesaccounts are used to account for investments, drawings and profits/losses
Method 2: Fixed Capital accounts
Method 2: Fixed Capital accounts
Under this method,
Under this method, CapitalCapitalaccounts are used to account for investments and accounts are used to account for investments and Retained Earnings Retained Earnings accounts are used to account for drawings and profits/ lossesaccounts are used to account for drawings and profits/ losses 13
Method 1: Capital Accounts
Method 1: Capital Accounts
Capital a/c credited with investmentsCapital a/c credited with investments
Drawings a/c debited with withdrawal of assets or personal Drawings a/c debited with withdrawal of assets or personal expenses, and expenses, and closed to closed to capitalcapital
P&L summary closed to profit distribution and allocated (credited) to P&L summary closed to profit distribution and allocated (credited) to capital a/c’scapital a/c’s
June 30
June 30 P & L SummaryP & L SummaryXXXX
Profit Distribution
Profit DistributionXXXX
transfer of profit to distribution account
transfer of profit to distribution account
June 30
June 30 Profit DistributionProfit DistributionXXXX
Partner A,
Partner A, CapitalCapitalXXXX
Partner B,
Partner B, CapitalCapitalXXXX
distribution of profit to partners
distribution of profit to partners
Method 2: Fixed Capital & Retained Earnings
Method 2: Fixed Capital & Retained Earnings
Capital a/c credited with investmentsCapital a/c credited with investments
Drawings a/c debited with withdrawal of assets or personal Drawings a/c debited with withdrawal of assets or personal expenses, and expenses, and closed toclosed toretained earningsretained earnings
P&L summary closed to profit distribution and allocated (credited) to P&L summary closed to profit distribution and allocated (credited) to retained earnings a/c’sretained earnings a/c’s
June 30
June 30 P & L SummaryP & L SummaryXXXX
Profit Distribution
Profit DistributionXXXX
transfer of profit to distribution account
transfer of profit to distribution account
June 30
June 30 Profit DistributionProfit DistributionXXXX
Partner A, Retained Earnings
Partner A, Retained Earnings XXXX
Partner B, Retained Earnings
Partner B, Retained Earnings XXXX
distribution of profit to partners
distribution of profit to partners
Example 2: Profit allocation using fixed ratio
Example 2: Profit allocation using fixed ratio(Methods 1 & 2)(Methods 1 & 2)
Bieber
BieberandandFoxFoxagreedagreedtotoaa22::33sharingsharingofofprofitsprofitsandandlosseslossesrespectivelyrespectively..AtAtJuneJune3030,,thetheprofitprofitwaswas$$6060,,000000..PreparePreparethethejournaljournalentriesentriesunderunderMethodMethod11andand22forforthethedistributiondistributionofofthetheprofitprofit..
Date
Date
Method 1
Method 1
DR CR
DR CR
Method 2
Method 2
DR CR
DR CR
30/6
30/6
Profit or Loss Summary
Profit or Loss Summary
60 000
60 000
60 000
60 000
Profit Distribution
Profit Distribution
60000
60000
60 000
60 000
Transfer of partnership profit to profit distribution account
Transfer of partnership profit to profit distribution account
30/6
30/6
Profit Distribution
Profit Distribution
60 000
60 000
60 000
60 000
Bieber, Retained Earnings
Bieber, Retained Earnings
Fox, Retained Earnings
Fox, Retained Earnings
24 000
24 000
36 000
36 000
Bieber, Capital
Bieber, Capital
Fox, Capital
Fox, Capital
24 000
24 000
36 000
36 000 16
Bieber: 2/5 X $60,000 = $24,000
Bieber: 2/5 X $60,000 = $24,000
Fox: 3/5 x $60,000 = $36,000
Fox: 3/5 x $60,000 = $36,000
Example 3: Profit allocation based on capital balances
Example 3: Profit allocation based on capital balances(Methods 1 & 2)(Methods 1 & 2)
Bieber
Bieber –Capital ($155000) and Fox Capital ($155000) and Fox ––Capital ($Capital ($164164000) agreed to a sharing of 000) agreed to a sharing of profits and losses based on their capital balances. At June 30, the profit was profits and losses based on their capital balances. At June 30, the profit was $60,000. Prepare the journal entries under Method 1 and 2 for the $60,000. Prepare the journal entries under Method 1 and 2 for the distribution of the profit. [Total Capital = $319000]distribution of the profit. [Total Capital = $319000]
•
•Distribution Calculation: Bieber = 155000/319000 x $60000 = $29154Distribution Calculation: Bieber = 155000/319000 x $60000 = $29154
•
•Distribution Calculation: Fox = Distribution Calculation: Fox = 164164000/319000 x $60000 = $30846000/319000 x $60000 = $30846
Date
Date
Method 1
Method 1
DR CR
DR CR
Method 2
Method 2
DR CR
DR CR
30/6
30/6
Profit or Loss Summary
Profit or Loss Summary
60 000
60 000
60 000
60 000
Profit Distribution
Profit Distribution
60000
60000
60 000
60 000
Transfer of partnership profit to profit distribution account
Transfer of partnership profit to profit distribution account
30/6
30/6
Profit Distribution
Profit Distribution
60 000
60 000
60 000
60 000
Bieber, Retained Earnings
Bieber, Retained Earnings
Fox, Retained Earnings
Fox, Retained Earnings
29 154
29 154
30 846
30 846
Bieber, Capital
Bieber, Capital
Fox, Capital
Fox, Capital
29 154
29 154
30 846
30 846 17
Bieber and Fox agreed:
Bieber and Fox agreed:
1.
1.Each partner is to be allowed interest of 10% on initial capital investment.Each partner is to be allowed interest of 10% on initial capital investment.
2.
2.Bieber and Fox are to receive salary allowances of $18000 and $10000 per year, Bieber and Fox are to receive salary allowances of $18000 and $10000 per year, respectively.respectively.
3.
3.Any residual profit/loss is to be shared equally.Any residual profit/loss is to be shared equally.
The partnership had a profit of $60000 for the current year.
The partnership had a profit of $60000 for the current year.
Example 4: Profit allocation based on a fixed
Example 4: Profit allocation based on a fixed ratio after allowing for interest and salaryratio after allowing for interest and salary(Methods 1 & 2)(Methods 1 & 2)
Bieber
Bieber
Fox
Fox
Total ($)
Total ($)
Interest on capital
Interest on capital
$150000 x 10%
$150000 x 10%
$100000 x 10%
$100000 x 10%
$15000
$15000
$10000
$10000
25000
25000
Salaries to partners
Salaries to partners
$18000
$18000
$10000
$10000
28000
28000
Total interest and salary
Total interest and salary creditedcredited
$33000
$33000
$20000
$20000
53000
53000
Residual profit
Residual profit
$3500
$3500
$3500
$3500
7000
7000
Equity increase
Equity increase
$36500
$36500
$23500
$23500
60000
60000
18
Let us assume Bieber and Fox initially contributed capital of
Let us assume Bieber and Fox initially contributed capital of $150,000 and $100,000, respectively.$150,000 and $100,000, respectively.
Example 4 journal entries
Example 4 journal entries
Date
Date
Method 1
Method 1
DR CR
DR CR
Method 2
Method 2
DR CR
DR CR
30/6
30/6
Profit or Loss Summary
Profit or Loss Summary
60 000
60 000
60 000
60 000
Profit Distribution
Profit Distribution
60000
60000
60 000
60 000
Transfer of partnership profit to profit distribution account
Transfer of partnership profit to profit distribution account
30/6
30/6
Profit Distribution
Profit Distribution
25 000
25 000
25 000
25 000
Bieber, Retained Earnings
Bieber, Retained Earnings
Fox, Retained Earnings
Fox, Retained Earnings
15 000
15 000
10 000
10 000
Bieber, Capital
Bieber, Capital
Fox, Capital
Fox, Capital
15 000
15 000
10 000
10 000
Recording interest on capital
Recording interest on capital
19
Example 4 journal entries Cont’d
Example 4 journal entries Cont’d
Method 1
Method 1
Method 2
Method 2
30/6
30/6
Profit Distribution
Profit Distribution
28 000
28 000
28 000
28 000
Bieber, Retained Earnings
Bieber, Retained Earnings
Fox, Retained Earnings
Fox, Retained Earnings
18 000
18 000
10 000
10 000
Bieber, Capital
Bieber, Capital
Fox, Capital
Fox, Capital
18 000
18 000
10 000
10 000
Recording salaries to partners
Recording salaries to partners
30/6
30/6
Profit Distribution
Profit Distribution
7 000
7 000
7 000
7 000
Bieber, Retained Earnings
Bieber, Retained Earnings
Fox, Retained Earnings
Fox, Retained Earnings
3 500
3 500
3 500
3 500
Bieber, Capital
Bieber, Capital
Fox, Capital
Fox, Capital
3 500
3 500
3 500
3 500
Recording allocation of residual profit
Recording allocation of residual profit
20
Method 1:
Method 1: Drawings a/c closed to Drawings a/c closed to CapitalCapital
Date(s)
Date(s)Partner APartner A, Drawings , Drawings XXXX
Cash at Bank
Cash at Bank XXXX
cash drawings by partner
cash drawings by partner
30 June
30 JunePartner APartner A, , CapitalCapitalXXXX
Partner
Partner, Drawings, DrawingsXXXX
closing entry for
closing entry for partner’s partner’s drawingsdrawings
Method 2: Drawings a/c closed to
Method 2: Drawings a/c closed to Retained EarningsRetained Earnings
Date(s)
Date(s)Partner APartner A, Drawings , Drawings XXXX
Cash at Bank
Cash at Bank XXXX
cash drawings by partner
cash drawings by partner
30 June
30 JunePartner APartner A, , Retained Earnings Retained Earnings XXXX
Partner
Partner, Drawings, DrawingsXXXX
closing entry for
closing entry for partner’s partner’s drawingsdrawings - Drawings
- Drawings
21 - Interest on drawings
- Interest on drawings
Method 1:
Method 1:
Jun 30
Jun 30Partner A, Partner A, CapitalCapitalXXXXXX
Profit Distribution
Profit DistributionXXXXXX
(Charging interest on drawings)
(Charging interest on drawings)
Method 2:
Method 2:
Jun 30
Jun 30Partner A, Partner A, Retained Earnings Retained Earnings XXXXXX
Profit Distribution XXX
Profit Distribution XXX
(Charging interest on drawings)
(Charging interest on drawings)
22
•
•Interest on drawings increased the profit available for Interest on drawings increased the profit available for distribution to partners distribution to partners
23
24
Lecture exercise solution (part a)
Lecture exercise solution (part a)
Jack
Jack
Jill
Jill
Total ($)
Total ($)
Interest on capital
Interest on capital
$300000 x 10% = 30000
$300000 x 10% = 30000
$250000 x 10% = 25000
$250000 x 10% = 25000
$30 000
$30 000
$25 000
$25 000
55 000
55 000
Salaries to partners
Salaries to partners
$80 000
$80 000
$70 000
$70 000
150 000
150 000
Total of above
Total of above
110,000
110,000
95,000
95,000
205,000
205,000
Residual profit
Residual profit
147 500
147 500
147 500
147 500
295 000
295 000
Equity increase
Equity increase
257 500
257 500
242 500
242 500
500 000
500 000
25
1 Jan Dr Jack, Drawings 12 000
Cr Cash 12 000
Drawings by Jack
31 Mar Dr Jill, Drawings 20 000
Cr Cash 20 000
Drawings by Jill
Lecture exercise solution (part b)
30 June Dr Jack, Capital 12 000
Dr Jill, Capital 20 000
Cr Jack, Drawings 12 000
Cr Jill, Drawings 20 000
Closing entry for drawings
30 June Dr Profit and Loss Summary 500 000
Cr Profit Distribution 500 000
Transfer of profit to Profit Distribution
30 June Dr Profit Distribution 55 000
Cr Jack, Capital 30 000
Cr Jill, Capital 25 000
Interest on capital
30 June Dr Profit Distribution 150 000
Cr Jack, Capital 80 000
Cr Jill, Capital 70 000
Salary allowances to partners
30 June Dr Profit Distribution 295,000
Cr Jack, Capital 147 500
Cr Jill, Capital 147 500
Residual profit to partners
Lecture exercise solution (part b)
Summary of the lecture
Summary of the lecture
27
•
•Understand the attributes of partnershipUnderstand the attributes of partnership
•
•Understand the advantages and disadvantages of partnershipUnderstand the advantages and disadvantages of partnership
•
•Accounting for: Accounting for:
formation of partnership formation of partnership
distribution of profitsdistribution of profits
drawings made by partners, and interest ondrawings made by partners, and interest ondrawingsdrawings
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