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PARTNERSHIP

Notes By Talha Mahmood Bhatti.

Partnerships

There are two other types of businesses, apart from sole proprietors, that you are required to know. These are partnerships and limited liability companies.

A partnership is a type of business entity that is owned by a minimum of two persons and a maximum of 20.

All partnership firm's must adhere to the laws laid out in the partnership Act of 1980. When a partnership is set up, the partners usually form an agreement called a 'Partnership Agreement' or 'Deed of Partnership'.

This agreement usually contains the following details.

  • The total capital contributed by each partner.

  • The rate of interest to be paid on each partner's capital.

  • The rate of interest to be charged on Drawings.

  • Salary (s) to be paid to a partner(s)

  • The ratio in which profits and losses should be shared.

  • The procedures to be followed if a partner dies, or if a new partner wishes to enter.

The Trading and Profit and Loss account of a partnership is the same as that of a Sole Trader, as long as it is a Trading concern.

However, the profit and loss extends to another section called the appropriation account. The Net Profit is brought down in this account and is shared up among the partners. Using the horizontal format, here is an example of the appropriation account. Each item is later discussed.

Appropriation A/c for Dick and Jane Ltd for the year ended Dec 20 th 2005

Net Profit B/D

$

$

$

xxx

Add Interest on Drawings

xxx

Less: Interest on Capital

 

(xxx)

Salary: Dick

xxx

Jane

xxx

(xxx)

(xxx)

xxx

Share of Profits:

 

Dick

50%

xxx

Jane

50%

xxx

xxx

INTEREST ON DRAWINGS

This is an amount that is charged to each partner in an effort to discourage them from withdrawing profits from the firm. The lesser the amount withdrawn, the greater the amount that will be available for distribution.

INTEREST ON CAPITAL

This represents revenue to each partner, as sometimes they contribute different amounts of capital. The idea is that, if the partners had invested or saved that money otherwise, they would have earned interest on it.

SALARY

A partner may be awarded an additional amount as 'salary', if he has additional responsibilities.

SALARY A partner may be awarded an additional amount as 'salary', if he has additional responsibilities.

The interest on Drawings is added to the Net Profit, in order to 'swell' the firm's revenue. Interest on Capital and Salary are paid before profits are shared up.

SHARE OF PROFITS

After paying the interest on capital and salary, the balance of profits is shared up according to the 'profit sharing ratio' decided by the partners. This ratio may vary, for example, they may decide to share profits according to the proportion in which capital was contributed.

Current Accounts

The Current Accounts of partners is like a mirror image of the appropriation account. On the credit side are items which represent what the partners are entitled to, that is, salaries, share of profits and interest on capital.

The Debit side has items which represent a cost to the partners, such as "drawings" and "interest on drawings". The current account is balanced off at the end of the month.

Here is an example of the format.

Here is an example of the format.

Merged Current A/c

It is also possible to merge the partners current a/c into one. As is shown in the example below:

Details

Details

Dick

Dick

$$

Jane

Jane

$$

Details

Details

Dick

Dick

$$

Jane

Jane

$$

Drawings

Drawings

 
  • Xxx Xxx Bal

Xxx

Xxx

Bal b/f

b/f

Salary Salary

Xxx

Xxx

Xxx

Xxx

Xxx

Xxx

___

___

Interest

Interest onon

 

drawings

drawings

Balance c/d

Balance

c/d

  • Xxx Xxx Xxx

  • xxx xxx xxx

  • Xxx Xxx Interest

Xxx

Xxx

Xxx

xxx

Interest onon

capital

capital

Xxx

Xxx

____

____

xxx

xxx

Xxx

Xxx

____

____

xxx

xxx

Problem 1

Joan and John are in partnerships sharing profits and/or losses equally. The following balance were extracted from there books at 31 December 2003:

 

Joan

John

Capitals

$ 40,000

20,000

30,000

Current A/c’s

10,000

5,000

Drawings

8,000

6,000

Net Profit

The partnership agreement provides that:

Interest on capital is to be paid at 10% per annum Joan is to receive a salary of $8,000 Interest on drawings is 15%

Required:

Construct Joan and John’s appropriation a/c.

Draw up the merged/joint current account for the partners showing the balances at the end.