Topic 10 - Accounting For Partnerships

Chapter

10

Accounting for Partnerships 100 Shares

Partnership??? $1 par value

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Learning Learning Objectives Objectives  Define partnership  Identify characteristics of partnerships and similar organizations  Identify advantages and disadvantages of partnership

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 Prepare entries for partnership formation  Dividing profit or loss  Preparing partnership financial statements

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Definition Definition of of partnership partnership AA partnership partnership is is an an unincorporated unincorporated association association of of two two or or more more people people to to pursue pursue aa business business for for profit profit as as co-owners. co-owners. In In Malaysia, Malaysia, this this business business form form is is governed governed under under the the Partnership Partnership Act Act 1961. 1961. According According to to Para Para II, II, Section Section 3(1) 3(1) of of the the Partnership Partnership Act Act 1961, 1961, aa partnership partnership is is defined defined as: as: “the “the relation relation which which subsists subsists between between persons persons carrying carrying on on business business in in common common with with aa view view of of profit”. profit”.

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Characteristics Characteristics of of Partnership Partnership Voluntary Voluntary Association Association

Partnership Partnership Agreement Agreement

Limited Limited Life Life

Taxation Taxation

Mutual Mutual Agency Agency Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

CoCoOwnership Ownership of of Property Property

Unlimited Unlimited Liability Liability © The McGraw-Hill Companies, Inc., 2007

Organizations Organizations with with Partnership Partnership Characteristics Characteristics Limited Limited Partnerships Partnerships (LP) (LP)

••General General partners partners assume assume management management duties duties and and unlimited unlimited liability liability for for partnership partnership debts. debts. ••Limited Limited partners partners have have no no personal personal liability liability beyond beyond invested invested amounts. amounts. Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

Limited Limited Liability Liability Partnerships Partnerships (LLP) (LLP) ••Protects Protects innocent innocent partners partners from from malpractice malpractice or or negligence negligence claims. claims. ••Most Most states states hold hold all all partners partners personally personally liable liable for for partnership partnership debts. debts. © The McGraw-Hill Companies, Inc., 2007

Choosing Choosing aa Business Business Form Form Proprietorship Partnership LLP LLC S Corp. Corporation Business entity yes yes yes yes yes yes Legal entity no no no yes yes yes Limited liability no no limited* yes yes yes Business taxed no no no no no yes One owner allowed yes no no yes yes yes *A partner's personal liability for LLP debts is limited. Most LLPs carry insurance to protect against malpractice.

Many Many factors factors should should be be considered considered when when choosing choosing the the proper proper business business form. form.

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Advantages Advantages of of Partnerships Partnerships Ability Ability to to share share knowledge, knowledge, expertise, expertise, and and experience experience among among cocopartners partners in in the the business. business. Easy Easy to to form form the the partnership partnership firm firm and and lower lower cost cost of of formation formation as as compared compared to to the the other other types types of of business business organizations. organizations.

Enables Enables firm firm to to get get additional additional sources sources of of investment investment capital capital from from each each partner partner since since more more than than one one partner partner is is within within the the partnership partnership firm. firm.

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Advantages Advantages of of Partnerships…cont Partnerships…cont Possible Possible tax tax advantages advantages where where aa partnership partnership has has the the same same tax tax status status as as aa sole sole proprietorship proprietorship and and is, is, therefore, therefore, not not subject subject to to taxes taxes on on its its income. income. Easy Easy to to manage manage and and decisions decisions can can be be made made with with less less bureaucracy bureaucracy since since the the owners owners of of the the partnership partnership firm firm are are usually usually its its managers. managers.

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Disadvantages Disadvantages of of Partnerships Partnerships The The liability liability is is unlimited unlimited where where all all partners partners are are personally personally liable liable for for business business debts debts and and liabilities. liabilities. ItIt is is hard hard to to find find suitable suitable partners partners where where there there is is aa possibility possibility of of conflict conflict between between partners partners in in the the future. future. Partnership Partnership is is dissolved dissolved upon upon the the death death of of aa partner. partner.

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Partnership Partnership Agreement Agreement AA partnership partnership is is based based on on aa contract contract between between individuals. individuals. ItIt is is an an agreement agreement among among the the members members of of aa firm firm for for sharing sharing the the profits profits of of the the business business carried carried on on by by all all or or any any of of them them acting acting for for all. all.

Partnership agreements normally include the following details: 1. Name of the firm. 2. Name of all partners and contributions made by each partner. 3. Nature of the business. 4. Date of commencement of partnership. 5. Duration of partnership, if any. Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

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Partnership Partnership Agreement…cont Agreement…cont 6. Rights and duties of all partners. 7. Sharing of profit and losses. 8. Interest charged on capital. 9. Withdrawal arrangement and interest charged on drawings. 10. Salaries, bonus, commissions, etc to the partners. 11. Interest on loan by the partner(s) of the firm. 12. Dispute procedures. 13. Admission and withdrawal of partners. 14. Rights and duties in the event of partner dies. 15. Dissolution of partnership.

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In In the the Absence Absence of of aa Partnership Partnership Agreement Agreement Profits Profits or or losses losses sharing sharing Every Every partner partner should should share share the the profits profits or or losses losses of of the the firm firm equally equally regardless regardless of of the the amounts amounts of of the the capital capital contributed contributed by by them. them. Salary Salary (remuneration) (remuneration) and and commission commission to to partners partners No No partner partner is is entitled entitled to to any any salary salary or or commission commission for for acting acting in in the the partnership partnership business. business. Interest Interest on on capital capital No No interest interest on on capital capital is is allowed allowed to to all all partners. partners. Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

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In In the the Absence Absence of of aa Partnership Partnership Agreement…cont Agreement…cont Interest Interest on on drawings drawings No No interest interest will will be be charged charged on on any any drawings drawings made made by by the the partners. partners. Advance/loan Advance/loan to to the the business business A A partner(s) partner(s) is is entitled entitled to to an an interest interest of of 8% 8% per per annum annum for for any any advance advance made made to to the the business business beyond beyond the the amount amount of of capital capital subscribed. subscribed. Participation Participation in in business business Every Every partner partner may may take take part part in in the the management management of of the the partnership partnership business. business. Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

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In In the the Absence Absence of of aa Partnership Partnership Agreement..cont Agreement..cont Admission Admission of of new new partner(s) partner(s) No No admission admission of of new new partners partners into into the the business business except except that that all all partners partners agree agree to to it. it. Books Books of of accounts accounts All All books books of of accounts accounts of of the the partnership partnership shall shall be be kept kept at at the the place place of of the the partnership’s partnership’s business. business. Each Each partner partner is is entitled entitled to to access access to to all all of of them. them.

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Organizing Organizing aa Partnership Partnership  When When partners partners invest invest in in aa partnership, partnership, their their capital capital accounts accounts are are credited credited for for the the invested invested amounts. amounts.  Each Each partner’s partner’s investment investment is is recorded recorded at at an an agreed-on agreed-on value, value, normally normally the the market market values values of of the the contributed contributed assets assets and and liabilities liabilities at at the the date date of of contribution. contribution.

Journal Journal entry entry is: is: Cash/ Cash/ Bank/ Bank/ Assets Assets Accounts Accounts Partner’s Partner’s Capital Capital Accounts Accounts

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XX XX XX XX

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Organizing Organizing aa Partnership Partnership Kayla Kayla Zayn Zayn and and Hector Hector Perez Perez organize organize aa partnership partnership called called BOARDS BOARDS that that offers offers year-round year-round facilities facilities for for skateboarding skateboarding and and snowboarding. snowboarding. Zayn’s Zayn’s initial initial investment investment in in BOARDS BOARDS is is $30,000, $30,000, made made up up of of cash cash ($7,000), ($7,000), boarding boarding facilities facilities ($33,000), ($33,000), aa note note payable payable reflecting reflecting aa bank bank loan loan for for the the new new business business ($10,000). ($10,000). Perez’s Perez’s initial initial investment investment is is cash cash of of $10,000. $10,000. Zayn’s investment Cash Boarding facilities Note payable K. Zayn, Capital Perez’s investment Cash H. Perez, Capital Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

7,000 33,000

10,000 30,000

10,000 10,000 © The McGraw-Hill Companies, Inc., 2007

Partner’s Partner’s Capital Capital Account Account  The capital accounts of partners can be maintained based on two methods, namely: • Fixed Capital Method, and • Fluctuating Capital Method

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(1) (1) Fixed Fixed Capital Capital Method Method  Under this method, the amount of capital of the partners remains fixed unless there is some additional capital brought in or there is any capital withdrawn by the partners during the period. This method requires two types of accounts to be opened. These accounts are: • Capital Account, and • Current Account  Any accounts that reflect the changes in the partners’ capital accounts such as additional capital (increase capital) and drawings of capital (decrease capital) will be shown in the partner’s capital account as below:

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(1) (1) Fixed Fixed Capital Capital Method Method (Cont…) (Cont…) Partner’s Capital Account Date

Description

Ref

Amount

Drawings of capital Ending balance *

$

Date

Description

XX

Beginning balance

XX

Additional capital

$ XXX

Ref

Amount $

XX XX

$ XXX

* balancing figure Note: Separate capital account is kept for each partner in the business. Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

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(1) (1) Fixed Fixed Capital Capital Method Method (Cont…) (Cont…) Partner’s Current Account Date

Description Beginning balance

Ref

Amount $

Date

Description

Ref

Amount

XX

Beginning balance

Drawings

XX

Interest on capital

XX

Interest on drawings

XX

Salary to partners

XX

Share of loss – P & L Appropriation

XX

Commission/bonus

XX

Share of profit – P & L Appropriation

XX

Ending balance *

XX

Ending balance *

XX

$ XXX

$

$ XXX

* balancing figure Note: In Partners' Current Account, beginning balance and ending balance can be either debit or credit side.

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XX

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Example: Example: On 1 July 2006, Aidiel and Fitrie commenced a partnership where they contributed RM60,000 and RM45,000 each. P/L sharing ratio is 2:1. Additional information: i) Salary for Aidiel and Fitrie RM10,000 per annum and RM 8,000 per annum respectively and the interest for the capital was 8% per year. ii) Aidiel and Fitrie also made a withdrawal of RM 3,000 and RM6,000 respectively. iii) The profit of the firm after providing Aidiel and Fitrie’s salary as well as interest of capital was RM16,500. 

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(1) (1) Fixed Fixed Capital Capital Method Method (Cont…) (Cont…) Partner’s Capital Account (Aidiel) Date 30/6/07

Description Ending balance

Ref

Amount 60,000

Date 1/7/06

Description Cash

60,000

Ref

Amount 60,000

60,000

* balancing figure Note: Separate capital account is kept for each partner in the business. Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

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(1) (1) Fixed Fixed Capital Capital Method Method (Cont…) (Cont…) Partner’s Current Account (Aidiel) Date

Description

Ref

Amount

Date

Description

Ref

Amount

Beginning balance Drawings

Ending balance *

3,000

-

Interest on capital

4800

Salary to partners

10,000

Share of profit – P & L Appropriation (2/3 x 16,500)

11,000

22,800

25,800

25,800

* balancing figure Note: In Partners' Current Account, beginning balance and ending balance can be either debit or credit side.

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(2) (2) Fluctuating Fluctuating Capital Capital Method Method  This method is not similar to the fixed capital method.  Only one capital account for each partner will be opened.  Any items that reflect the partner’s account such as interest on capital, drawings, interest on drawings, salary/remuneration, commission, and share of profits or losses of partners for the period will be recorded in the partner’s capital account.

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(2) (2) Fluctuating Fluctuating Capital Capital Method Method (Cont…) (Cont…) Partner’s Capital Account Date

Description Drawings

Ref

Amount $

Date

Description

Ref

Amount

XX

Beginning balance

Interest on drawings

XX

Additional capital

XX

Share of loss – P & L Appropriation

XX

Interest on capital

XX

Salary to partners

XX

Commission/bonus

XX

Share of profit – P & L Appropriation

XX

Ending balance *

XX

$ XXX

$

XX

$ XXX

* balancing figure Note: A Partners' Capital Account usually shows a credit balance. However, under certain situations, it can show a debit balance, such as over withdrawal or insolvency of the partner. Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

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Example: 

On 1 July 2006, Aidiel and Fitrie commenced a partnership where they contributed RM60,000 and RM45,000 each. P/L sharing ratio is 2:1.

Additional information: i) Salary for Aidiel and Fitrie RM10,000 per annum and RM 8,000 per annum respectively and the interest for the capital was 8% per year. ii) Aidiel and Fitrie also made a withdrawal of RM 3,000 and RM6,000 respectively. iii) The profit of the firm after providing Aidiel and Fitrie’s salary as well as interest of capital was RM16,500.

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(2) (2) Fluctuating Fluctuating Capital Capital Method Method (Cont…) (Cont…) Partner’s Capital Account (Aidiel) Date

Description

Ref

Amount

Drawings

30/6/07 Ending balance *

3,000

82,800

85,800

Date 1/7/ 06

Description Cash

Ref

Amount 60,000

Interest on capital

4,800

Salary to partners

10,000

Share of profit – P & L Appropriation (2/3 x 16,500)

11,000

85,800

* balancing figure Note: A Partners' Capital Account usually shows a credit balance. However, under certain situations, it can show a debit balance, such as over withdrawal or insolvency of the partner. Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

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Dividing Dividing Profit Profit or or Loss Loss Before the preparation of the Profit and Loss Appropriation, an income statement should be prepared first whereby at the end, the profit or loss for the period is calculated and then transferred to the Profit and Loss Appropriation.

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Dividing Dividing Profit Profit or or Loss Loss (Cont…) (Cont…) In preparing the Profit and Loss Appropriation, the following adjustments need to be considered: 1. Interest on Capital Partners can agree to allocate “interest allowance (or interest on capital)” based on the amounts invested by each partner. Expense to partnership firm but gain for partners. 2. Drawings Similar to other business types of organizations, the partners in the partnership firm can make a withdrawal of cash or goods from the business. -NO EFFECT ON PROFIT AND LOSS APPROPRIATIONLarson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

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Dividing Dividing Profit Profit or or Loss Loss (Cont…) (Cont…) 3. Interest on Drawings Gain to the partnership firm.

4. Partner's Salary/Remuneration

Gain to partners but an expense to the partnership firm.

5. Partner's Commission Any commission paid to the partners is a gain to partners but an expense to the partnership firm.

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Dividing Dividing Profit Profit or or Loss Loss (Cont…) (Cont…) 6. Transfer to Reserve

Reduction of profit to the partnership firm.  7. 7. Share Share of of Profits Profits or or Losses Losses  

Partners Partners can any method can agree agree to to any method of of dividing dividing profits profits or or losses. losses. In In the the absence absence of of an an agreement, agreement, the the law law says says that that the the partners partners share share profits profits or or losses losses of of aa partnership partnership equally. equally.

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Example Example of of Profit Profit and and Loss Loss Appropriation Appropriation  Farid and Fara are in partnership named Waja Ent. since 1st January 2006, sharing profit for the ratio 2:1. For the year ended 31 December 2006, Waja Ent. managed to obtained a profit of RM16,855. The partners entitled to interest on capital and drawings at 10% and 5% per annum respectively based on their agreement. Farid also entitled to receives a salary of RM 200 per month.  Additional info: i) Farid and Fara contributed capital of RM78,000 and RM48,000 respectively. ii) Farid withdrawn RM4,800 while Fariq RM 3,600. iii) Farid also received a commission of RM 1,000 from the partnership. Prepare profit and loss appropriation for Waja Enterprise. Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

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RM Profit as per I/S

16,855

Interest on drawings Farid (5% x 4,800) Fara (5% x 3,600) Interest on capital Farid (10% x 78,000) Fara (10% x 48,000) Salary Farid (200x12) Fara Commission Farid Fara Share of profit: Farid (2/3 x RM 1,275) Fara (1/3 x RM 1,275) Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

240 180 (7,800) (4,800) (2,400) (1,000) - . 1,275 RM850 RM425

1,275 © The McGraw-Hill Companies, Inc., 2007

Death Death of of aa Partner Partner A partner’s death dissolves a partnership. A deceased partner’s estate is entitled to receive his or her equity. The partnership contract should contain provisions for settlement in this case. These Theseprovisions provisionsusually usuallyrequire: require: (1) (1)Closing Closingthe thebooks booksto to determine determineprofit profit or or loss losssince sincethe theend end of of the theprevious previousperiod, period,and and (2) (2)Determining Determiningand andrecording recording current currentmarket market values valuesfor forboth both assets assetsand andliabilities. liabilities.

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End of Chapter 10

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