Lecture notes –chapter 15

Sole trader and Partnership

FSs under UK GAAP

truongthihanhdung@uel.edu.vn
Topic list
1. Sole traders FSs
2. Partnerships
3. Preparing partnership accounts
4. Accounting for changes in partnership structure

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Type of business
1. Sole traders:
 Business owned and operated by one person
 As in the case of a sole trader, the profits of the business are owed
to the owners
2. Partnerships:
 Business owned and operated by two or more people
 The profits of the business is shared amongst the partners.

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Sole trader FSs

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Sole trader FSs example
Prepare the SPL and SFP with the following matters have now been discovered:
1. On 1/1/x4 Wasto injected a further £190,000 into the business. The entry made
was to debit cash at bank and credit the suspense account.
2. On 1/1/x4 an item of plant that had cost £350,000 and on which depreciation of
£74,000 had been charged was disposed of for £230,000. The only entry made
was to debit cash at bank and credit the suspense account.
3. Depreciation of £36,000 needs to be charged on the remaining plant and
machinery, and £5,000 on the land and buildings.
4. Loan interest of £10,000 should be accrued at 31/12/x4.
5. Stock on hand at 31/12/x4 cost £220,000

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Partnership agreement
Partnership agreement is an internal written document detailing the terms of a partnership,
covers following issues:
Capital: each partner puts in a share of the capital. Any minimum fixed amount should be
stated.
Interest on capital: treated as profit appropriation.
Partners’ salaries: partners can pay themselves salaries. These are not salaries in the same
way that an employee of the business is paid a wage or salary; partners’ salaries are an
appropriation of profit, and not a profit and loss account expense. Paying salaries give
each partner an income before the residual profits are shared out in PSR.
Profit-sharing ratio (PSR): partners can agree to share residual profits and losses after
interest and salaries in any profit-sharing ratio they choose. For example, three partners might
agree to share profit equally, but if one partner does a greater share of the work, or has more
experience and ability, or puts in more capital, the ratio of profit sharing might be different.

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Partnership agreement
Guaranteed minimum profit shares: partners can agree that one or more partners
should get a guaranteed minimum profit share, even if the partnership makes a smaller
than expected profit, or a loss. If the amount allocated by using interest on capital,
salaries and the profit-sharing ratio (PSR) is lower than this, the partner receives the
guaranteed minimum profit share and the remaining profits are shared between the other
partners in the profit-sharing ratio. Occasionally, one partner will guarantee another
partner’s minimum profit share. That partner will alone make up the difference.
Drawings: partners can withdraw profits from the business just like sole traders. They
can agree to put a limit on how much they should draw out in any period, and they can
be charged interest on their drawings during the year. Interest on drawings is
treated as a negative appropriation of profit.
Withdrawals: withdraw long-term capital (legal capital) of each partners

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Profit and loss account

The profit and loss account for a partnership is exactly the

same as that for a sole trader.

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Appropriation statement (extension of the profit and
loss statement)
The partnership’s net profit sharing statement:
 Allocate interest on capital, interest on drawings, and salaries to each partner (first and foremost).
 Shares out the residual profit in the PSR (profit-sharing ratio).

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Guaranteed minimum profit share

• A partner may be guaranteed a minimum share of the

profits.
• This amount is funded by the other partners in accordan
ce with the profit share ratio.

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Example
A, B, C share profits in the ratio of 2:2:1 but C has a guaranteed minimum profit
of £18,000. The net profit for the year is £75,000.

Ratio 2 2 1 Total
A B C £
£ £ £
Initial profit share 30,000 30,000 15,000 (<18,000 guaranteed 75,000
minimum profit) - we
have to reallocate:
PSR 30,000 30,000 15,000 75,000
Reallocate (adjust for (1,500) (1,500) 3,000 0
guaranteed profit)
28,500 28,500 18,000 75,000

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Preparing partnership accounts

1. Accounting for each partner’s ownership interest (capital accounts

and current accounts)
2. Accounting for loans by partners
3. Accounting for appropriation of net profit/loss

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Capital accounts
• The partner’ s Capital Account records the initial capital invested in the business by
each partner.
• Transactions in this account are rare, being the injection of further capital or withdrawal
of capital by a partner:

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Current accounts
Current accounts: a record of the profits retained in the business (less drawings)
by the partner.

Drawings: rút dòng tiền hoạt động của liên doanh trong năm ra sử dụng 16
Withdrawals: rút một phần vốn góp ban đầu
Current accounts & capital accounts on the BS
• The closing balances on the partners’ Current and Capital Accounts
form the Capital section of the statement of financial position:
• The remainder of the balance sheet (assets and liabilities) is as for a sole
trader

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Current accounts & capital accounts on the BS

If the partnership agreement provides for interest on

capital - partners receive interest on the balance in
their capital account, but not on the balance on their
current account.

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Example

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Partnership losses

If a partnership profit and loss account shows a loss, the

appropriation works in the same way as if a profit were made.
• The salaries, interest on capital etc. are allocated.
• The balance is divided according to the PSR.

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Example
Britney, Justin and Cameron are in partnership selling CDs and DVDs via their website bigstars.com. They
haven’ t been very successful in the past year and in the year ended 30 June 20X6, recorded a loss of
£120,000 Their partnership agreement states the following:
• Interest on capital to be provided at 4% per annum
• Cameron to be allocated a salary of £25,000, and Justin £14,000
• No interest to be charged on drawings
• Balance of profits to be shared in the ratio 4:3:1

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Interest on drawings
Some partnership agreements require interest to be charged on drawings by partners:
• This is charged in order to discourage excessive drawings by partners
• This is added back to profit in the appropriation statement and deducted from the
partners’ total share.
• Interest on drawings is apportioned for the number of months in the year that the
drawings were taken.
• If no dates are given, we assume all drawings took place at the start of the year
and charge a full year's interest.

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Example
Twig and Bark are in partnership manufacturing and selling rustic wooden furniture. The business was
set up two years ago when Twig invested £10,000 capital, and Bark £15,000. No further capital has be
en injected since. In the year ended 31 December 20X5 they made a profit of £67,000. Their
partnership agreement states the following:
• Interest on capital to be provided at 6% per annum
• Twig to be allocated a salary of £12,000
• Interest to be charged on drawings at a rate of 3% per annum
• Balance of profits to be shared in the ratio 3:2
Twig drew £5,000 from the business on 1 January 20X5 and another £7,000 on 1 July 20X5. Bark
drew £10,000 on 1 July 20X5.
At the start of the year the balances on the current accounts were:
Twig £7,700 Cr
Bark £3,200 Dr
Show how this information is presented in the partners’ current and capital accounts and in
the Capital section of the balance sheet.

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Loans from partners
A partner may loan the business some money and may then receive interest on this loan.
• The double entry when the loan is made is:
Dr Cash X
Cr Loan (liability) X
• The interest arising is treated as a business expense which is charged to profits before
the profits are shared between the partners
• The double entry for the loan interest is:
Dr loan interest expense X
Cr Bank (if paid) X
or Cr Partner’s current account (if outstanding) X

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Partnership accounts and the TB
Example:

Frank and Mira are in partnership sharing profits 2:1. Each partner has
an annual salary of £6,750. Frank's loan to the partnership attracts
interest at 5% per annum.
Prepare Frank and Myra’s final TB at 30/6/x4, the profit appropriation
statement for the year and the FSs of the year.
Their Trial balance at 30 June 20X4 is as follows:

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Accounts at June 30 X4

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Changes in partnership structure
When a new partner is admitted to the partnership the partners will
agree a certain amount of cash/assets that the new partner must pay
for his share in the partnership.
The basic double entry for the cash that the new partner brings into the
partnership is:
Dr Bank
Cr New partner’ s capital account
The partnership structure will also change.

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ACCOUNTING FOR CHANGES IN
PARTNERSHIP STRUCTURE

Step 1: Calculate the profits up to the date of change and approriate

them according to the old PSR.
Step 2: Approriate the profits after the date of change according to the
new PSR

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Ex: changes in partnership structure

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Retirement or death of a partner

Introduction
When a partner retires from a partnership the full amounts due to him must be calculated,
these being:
• capital account balance
• current account balance
• share of any goodwill in the partnership.
Goodwill
As well as the net assets that a partnership have recorded in their ledger accounts, most
businesses will have another asset which is not recorded in the ledger accounts =
goodwill.

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Additional issues
1. Goodwill in the partnership accounts
2. Admission of a partner
-- see in the excel file

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Homework

Self test textbook chap 15

Testbank chap 15

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