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Financial Statements of A Partnership
Financial Statements of A Partnership
Introduction
In your previous studies you looked at financial statements of businesses owned by a single person known as the sole trader or the sole proprietor. Two or
more persons may join to do business together for the purpose of making profit, this form of business is referred to as a partnership form of business.
A partnership is a relationship between two or more persons with the aim of making profits. Many people opt for a partnership form of business with
numerous reasons, which include;
i. For risk sharing-businesses involve many risks .There can be risks of failure. When the business incurs losses the burden of loss will not be borne by
one person but will be shared.
ii. Economies of scale-When partners are many they can pool together large resources or large capital which can help them acquire funds at lower
interest per unit.
iii. Enhanced expertise-Partners are able to share their various experiences which enhances decision making.
Formation of A partnership
A partnership is formed through mutual agreements between partners. These agreements must be documented or be guided by some binding provisions.
The partnership agreements are documented in the Partnership Deed. In the absence of a partnership deep the relationship between partners is
documented in the Partnership Act. A partnership Act is an Act of Parliament.
(ii)Profit or loss sharing ratio-the ratio at which profits or losses will be shared
(iii)Interest on capital-the rate of interest to be paid on capital before profits are shared
Capital refers to the economic resources (assets) given by the partner(s) to the partnership. This may be in form of cash or other non-current assets like
Motor vehicle, furniture’s & fittings etc. In most cases the partners contribute cash. The partnership requires each partner to contribute capital to the
partnership.
The partnership does not make it mandatory for each partner to contribute equal amount. Capital contribution is based on what each partner is willing to
contribute. The partners can also add capital in the life time of the partnership.
How will the journal entries look like when capital is contributed or added by a partner?
The partnership deed stipulates how the profits among the partners are shared. In most cases the profits are shared using the same ratio as capital were
contributed. The essence of this is that a partner who contributed much of resources to the businesses has higher stake that the rest and therefore the
profits or losses be shared in proportion to their level of interest (risk).
Profits share are an income to the individual partners and a withdrawal to the partnership. When profits are shared the entries are as follows;
Interest refers to the cost of capital i.e how much you pay to use the other parties resources .It can also be defined as the opportunity cost of capital i.e.
how much you are compensated for not investing the funds in an interest earning investment. The partnership pays partners an interest as a compensation
to what they could have earned had they invested the funds elsewhere.
Interest on capital is therefore an income to the individual partner and a reduction of retained profits of the partnership. It is the first priority before other
interests of the individual partner’s i.e. it is deducted before profits and salaries are paid.
Entries;
(iv)Interest on Drawings
The partnership agreement does not allow members to withdraw resources from the partnership during the partnership life. This will affect its operations
or will reduce the capital of the partnership. The partnership agreement therefore places restrictions on the resources taken by partners by imposing
interest on Drawings.
Partners may take resources from the partnership by way of cash drawings or stock for personal use.
Reduce the partnership cash account and reduce the partner’s current accounts. The entries are as follows;
Cr: Bank/Cash xx
When partners take from the partnership goods for person use the cost of goods sold or simply cost of sales must be adjusted by the value of goods taken
for personal use and a corresponding entry on the partners current accounts.
Entries;
Dr: Partners current Account xx
Cr:Cost of sale xx
(V)Partners’ salaries
The partnership agreement may provide for payment of salaries to the partners who dedicate their time in the daily operations of the business. Such
partners since they spend much of their time in running the business it is only fair that they be compensated.
The partners’ salaries represent a share out of the partnership’s profits and therefore it is not treated as an expenses in the partnership income statements
as the salaries to employees.
Entries
Where no partnership agreements exists, express or implied, the Partnership act governs the situation .It provides that;
(e) Partners who put a sum of money into a partnership in excess of the capital they have agreed to subscribe is entitled to 5% per annum on such advance.
PARTNERSHIP ACCOUNTS AND FINANCIAL STATEMENTS
(i)INCOME STATEMENT
This is the statement of performance of the entity. It shows the profits realized by an entity over a given accounting period. The format of this statement is
the same as that of a sole trader except that salaries of the partners are not treated as an expense in this account and it may certain times be combined
with the profit or appropriation account.
FORMAT
A,B &C PARTNERSHIP
INCOME STATEMENT
FOR THE PERIOD ENDING 31.12.19X2
Sales xx
Less: Sales return (xx)
Net sales xx
Cost of sales:
Opening inventory xx
Add: Purchases xx
Add: Carriage in xx
Less: Goods taken for personal use (xx)
Less: Return outwards (xx)
Less: Closing inventory (xx)
Cost of goods sold (xx)
Gross profit xx
Expenses
Administrative expenses xx
Distribution and selling expenses xx
Finance costs xx
Total expenses xx
Net profit or loss xx
Illustration
A,B&C are partners sharing profits in the ratio 5:3:2.The following are the details of financial transactions for the year ended 31/12/2019.Net profit for the
year was kshs.1,517,500.The partnership provides interest on capital at the rate of 10% p.a and interest on Drawings are charged at 5% p.a .As at 31
December the capital and Drawings balances were as follows;
Capital accounts Drawings
A 1000,000 A 240,000
B 750,000 B 180,000
C 450,000 C 130,000
i.B and C are entitle to annual salaries of shs 100,000 and shs 175,000 respectively.
Ii.Their current accounts balances stood at shs 100,000 shs 60,000 and shs 50,000 for A,B and C respectively.
Required
Prepare the profit or Loss Appropriation account and Current Accounts
Solution
ABC Partnership
Profit or Loss Appropriation Account
For the period ending 31.12.2019
Net profit per the profit or loss A/c 1,517,500
Add:Interest on Drawing
A(5%X240,000) 12000
B(5%X180,000) 9000
C(5%X130,000) 6500 27,500
Total Distributable profits 1,545,000
Less:Interest on capital
A(10%X1,000,000) (100,000)
B(10%X750,000) (75,000)
B(10%X450,000) (45,000) (220,000)
Less:Salaries
A -
B (100,000)
C (175,000) (275,000)
Profits available for share 1,050,000
Profit share A(5/10X1050,000) (525,000)
B(3/10X1050,000) (315,000)
C(2/10X1050,000) (210,000) (1050,000)
This is to show the financial position of an entity. It shows the assets and liabilities of an entity as at a particular period in time. It is prepared in the same
way as that of the sole trader except that the bet profits for the period may not be shown in it as it will have been diffused into the partners’ current
accounts.
Format
ABC PARTNERSHIP
STATEMENT OF FINANCIAL POSITION
AS AT 31 DEC 2019
Non-Current Assets Cost Acc.Dep NBV
Land& Building xx (xx) xx
Motor vehicle xx (xx) xx
Computers xx (xx) xx
Furnitures &Fittings xx (xx) XX
Total Non Current Assets xx
Current Assets
Inventory xx
Cash in Hand xx
Trade receivable (Net of provisions) xx
Prepayments xx
Total Current Assets xx
Total Assets xx
Illustrative Questions
November 2017 Question 3-CPA I
May 2019 Question 2-CPA I