Accounting III: Partnership Accounts
❦
A partnership is a business owned by two or more people who share profits, governed in Sri Lanka by the Partnership Ordinance of 1890 (as referred to in the NIE syllabus; NIE, n.d.-a). A partnership agreement (deed) sets out the terms. If there is no agreement, the Ordinance's default rules apply, including equal sharing of profits.
Terms of a Typical Agreement
- Capital contributions and profit-sharing ratio.
- Interest on capital and interest on drawings.
- Partners' salaries.
- Interest on loans from partners, and rules on admission, retirement, and dissolution.
Capital and Current Accounts
- Fixed capital accounts: the capital balance stays unchanged except for agreed changes; the current accounts record profit shares, salaries, interest, and drawings.
- Fluctuating capital accounts: all adjustments go through the capital account.
The Appropriation Account
After the income statement, the appropriation account distributes the net profit.
Worked example. A and B share profits and losses in the ratio 3:2. Net profit is 500 000. Capitals: A 1 000 000 and B 500 000, with interest on capital at 10 percent. B receives a salary of 60 000.
| Item | A | B | Total |
|---|---|---|---|
| Interest on capital | 100 000 | 50 000 | 150 000 |
| Salary | 0 | 60 000 | 60 000 |
| Remaining profit (500 000 − 150 000 − 60 000 = 290 000) shared 3:2 | 174 000 | 116 000 | 290 000 |
| Total share of profit | 274 000 | 226 000 | 500 000 |
Changes in Partnership
On a change (admission, retirement, or change in profit-sharing ratio), the partnership revalues assets and liabilities and accounts for goodwill: the excess of the value of the business over the fair value of its net assets. Goodwill may be created, shared, and written off, depending on the rules in your syllabus.
Financial Statements of a Partnership
The statement of financial position shows the capital and current accounts of each partner; the income statement is followed by the appropriation account.
Common Mistakes
- Charging interest on capital and salaries to the wrong account.
- Sharing profit in the wrong ratio after allowing for salaries.
- Confusing capital and current accounts.
CHAPTER 6