FINANCIAL

ACCOUNTING II

Dr NSUBILI ISAGA
SCHOOL OF BUSINESS (DAF)
Textbooks
• Wood, Frank and Alan Sangster (latest edition)
Business accounting, Vol. I and II, Longman,
London
• LEWIS, R. and Pendrill, D. (latest edition),
Advanced Financial Accounting, Prentice Hall.
• Richard E. Baker [et al].(2008), Advanced
financial accounting, 7th ed. - New York :
McGraw-Hill
Course outline
• 7 topics
• 2 assignments
• Two tests
• Final exam

3
Partnership
Accounting
TOPIC I
Learning objectives
After you have studied this chapter, you
should be able to:
• Explain what a partnership is and how it
differs from a joint venture
• Explain the rules relating to the number
of partners
• Distinguish between limited partners
and general partners
Learning objectives (Continued)
• Describe the main features of a
partnership agreement
• Explain what will happen if no agreement
exists on how to share profits or losses
• Draw up the ledger accounts and
financial statements for a partnership
What is partnership
Partnership can be defined as the
relationship which exists between persons
carrying on a business in common with a
view of profit.
 The need for a partnership
• If a permanent relationship exists with
two or more parties working together to
earn a profit, they may form a
partnership.
• It requires a long-term commitment to
operate in business together.
• They usually, though they do not have
to, work in the same location.
• They maintain one set of accounting
records and share the profits and
losses.
The nature of a partnership
• It is formed to make profits.
• It must obey the law as given in the
Partnership Act 1890, and if there is a
limited partner, it must comply with the
Limited Partnership Act 1907.
• There are a minimum of 2 and a
maximum of 20 partners, with some
exceptions.
• Each general partner (i.e. not limited
partners) must pay their share of any
debts that the partnership cannot pay
(unlimited liability)
Limited partnerships
A limited partnership contains one or
more limited partners – there must be
one general partner – and must be
registered with the Registrar of
Companies.
Limited partners
• Are not liable for any debts above the
level of capital they invested.
Limited partner
• They are not allowed to retrieve the
capital they invested.
• They cannot make management
decisions.
• Partners who are not limited partners
are known as general partner
• What advantages do you think there
might be to general partners in
having limited partners?
• Limited partners contribute capital. They may
also contribute expertise. Either of these is a
benefit
• to the general partners – they have to contribute
less capital and they can rely on the additional
expertise when appropriate without needing to
seek assistance from people outside the
partnership.
• Also, because limited partners cannot be
involved in the management of the partnership,
general partners can take decisions without
consulting a limited partner, thus saving time and
effort
Partnership agreements
It is best to have a written agreement drawn
up by a lawyer or accountant to avoid
problems later on. It should include:
• The capital to be contributed by each partner
• The profit/loss sharing ratio
• The rate of interest paid on capital
• The rate of interest charged on drawings
• Salaries to be paid
• Arrangements for admitting new partners
• The procedures for the exit of a partner
Activity
• Some partnership don’t bother
drawing up a partnership agreement.
How do the partners in those
partnerships know what rights and
responsibilities they have?
answer
• The partnership act 1890 imposes a standard
partnership agreement upon partnerships
that do not draw partnership agreement.
• Section 24 of the partnership act
• Profit and loss are to be shared equally
• There is to be no interest allowed or charged
on/to capital and drawings respectively.
• Salaries are not allowed
• Additional money invested entitled 5%
answer
• The partnership act 1890 imposes a standard
partnership agreement upon partnerships
that do not draw partnership agreement.
• Section 24 of the partnership act
• Profit and loss are to be shared equally
• There is to be no interest allowed or charged
on/to capital and drawings respectively.
• Salaries are not allowed
• Additional money invested entitled 5%
Where no partnership agreement exists
If there is no partnership agreement, Section
24 of the Partnership Act 1890 governs the
situation and states.
• Profits/losses are to be shared equally.
• There is no interest allowed on capital or
drawings.
• Salaries are not allowed.
• Additional capital invested may receive an
interest of 5%.
Appropriation of net profits
• The net profit of a partnership is shared
out between them according to the terms
of their agreement. This sharing out is
shown in an appropriation account, which
follows on from the income statement
Accounting entries
• The accounting entries are
• DrIncome and expense account with
net profit c/d
• Cr Appropriation account with net
profit b/d
• DrAppropriation account
• Cr Current account of each partner
 Activity
• Taylor and Clarke share profits in the ratio:
Taylor, three-fifths; Clarke, two-fifths.
• They are entitled to 5% interest on capital.
• Taylor invested £20,000 capital and Clarke
invested £60,000 capital.
• Clarke receives a salary of £15,000.
• Taylor is to be charged £500 interest on
drawings and Clarke £1,000.
• Net profits amounted to £50,000.
Profit and loss appropriation a/c
Activity (Continued)
Example II
Kenneth and Kevon are partners
sharing profit in the ratio 2:1 and that
they agree to pay themselves a salary
of $10,000 each. If profits before
deducting salaries are $26,000, how
much income would each partner
receive?
Solution
First, the two salaries are deducted from
profit, leaving $6,000 ($26,000 – $20,000).
This $6,000 has to be distributed between
Keneth and Kevon in the ratio 2:1. In other
words, Keneth will receive twice as much
as Kevon. You can probably work this out in
your head and see that Keneth will get
$4,000 and Kevon $2,000.
• Add the 'parts' of the ratio together.
For our example, 2 + 1 = 3. Divide this
total into whatever it is that has to be
shared out. In our example, $6,000/3
= $2,000. Each 'part' is worth $2,000,
so Kenneth receives 2 × $2,000 =
$4,000 and Kevon will receive 1 ×
$2,000 = $2,000.
question
Suppose Keneth, Kevon and Kenzo want
to share out $150 in the ratio 7:3:5.
How much would each get?
Solution
• The sum of the ratio 'parts' is 7 + 3 + 5
= 15. Each part is therefore worth
$150/15 = $10. So the $150 would be
shared as follows.
• (a) Keneth: 7 × $10 = 70
• (b) Kevon: 3 × $10 = 30
• (c) Kenzo: 5 × $10 = 50
150
Capital accounts
There are two choices open to
partnerships:
• Fixed capital accounts plus current
accounts
• Fluctuating capital accounts
Fixed capital accounts
• The capital account for each partner remains at
the figure of capital put into the partnership by
the partners.
• The profits, interest on capital and salaries that
the partner may receive are credited to, and the
drawings and interest on drawings are debited to,
a separate current account.
• A credit balance on the current account at the
end of each financial year will represent the
amount of undrawn profits.
Fixed capital accounts (Continued)
Fluctuating capital accounts
• The balance on a fluctuating capital
account will change each year.
• Instead of using a current account, the
distribution of profits will be credited,
and the drawings and interest on
drawings will be debited to the capital
account .
Fluctuating capital accounts (Continued)
The statement of financial
position
• The last part of the statement of financial
position for a partnership is formatted to
show both partners’ capital accounts.
• It also shows what has happened during
the year in terms of the share of profits,
drawings, interest on capital and interest
on drawings.
The statement of financial
position (Continued)
Learning outcomes
You should have now learnt:

1.That there is no limited liability in

partnerships except for ‘limited partners’
2.That limited partners cannot withdraw
any of the capital they invested in the
partnership or take part in the
management of the partnership
Learning outcomes (Continued)
3. That apart from some professions, if more
than twenty owners of an organisation are
needed, a limited company would need to be
formed, not a partnership
4. That the contents of a partnership agreement
will override anything written in this chapter.
Partners can agree to anything they want to,
in as much or as little detail as they wish
Learning outcomes (Continued)
5.That if there is no partnership
agreement, then the provisions of the
Partnership Act 1890 will apply
6.That partners can agree to show their
capital accounts using either the fixed
capital or fluctuating capital methods
7.How to prepare the ledger accounts
and financial statements of
partnerships
Goodwill in partnerships
• Goodwill is the price paid for a business, over
and above the value of the assets purchased.
• Goodwill exists for many reasons, including:
• Regular customers
• Good reputation
• Experienced, efficient, reliable employees
• The business is sited in a good location
• Good contacts with suppliers
• It has well-known brand names
Goodwill in partnership
• Although goodwill is not normally
entered in the financial statements
unless it has been purchased, sometimes
it is necessary where partnerships are
concerned.
Goodwill in the books
Goodwill only exists in the books of a
partnership when it has been purchased
or the ownership of goodwill by partners
has changed in some way, such as:
• A change in profit/loss sharing ratios
• A new partner being introduced
• A partner leaving the partnership
Allocation of goodwill
• Goodwill is allocated to the partners
before the change in the old PSR.
After the change, goodwill is then
written back to all the new partners in
the new PSR
Activity
The partners agree that the goodwill should
be valued at £30,000. Answer (1) shows the
solution when a goodwill account is
opened.
Answer (2) is the solution when a goodwill
account is not opened.
Activity (Continued)
Option 1

Open a goodwill account and debit the

total value of goodwill. Credit the partners’
capital accounts with their share of the
goodwill in the old profit sharing ratio.
Activity (Continued)
Activity (Continued)
Option 2

Work out the effect the change in ratio

will have on the share of goodwill each
partner has and make the relevant
adjustments in the capital accounts.
Activity (Continued)
Activity (Continued)
Admission of new partners
• A new partner(s) may be admitted because
the firm has grown or to replace a partner
who is leaving.
• The new partner will be entitled to a share of
the profits and the same share of the value of
goodwill.
• It is correct to charge the new partner for
taking over that share of the goodwill.
Goodwill adjustments for new
partners
1. Show the value of the goodwill divided
between the old partners in the old profit
sharing ratios.
2. Show the value of the goodwill divided
between the current partners in the new profit
sharing ratios.
3. Charge any partners who gain goodwill.
4. Give any partners who lose goodwill an
allowance for their losses.
 Activity
• A and B are in partnership sharing profits
equally.
• C is admitted as a new partner.
• The three partners will share profits equally.
• Goodwill is valued at £60,000.
Activity (Continued)
Activity (Continued)
Activity (Continued)
• This means that A and B need to have
their capital increased by 10,000
each. C’s capital needs to be reduced
by 20000. remember A and B have
kept their profit ratio to each other.
While they used to have one half
each, now they have on third each
Activity when existing partners
take different PSR
• D and E are in partnership sharing
profits equally.
• F is admitted to the partnership.
• Profits will now be shared: D, one-fifth;
E and F, two-fifths each.
• Goodwill is valued at £60,000.
Activity (Continued)
Activity (Continued)
Activity (Continued)
 Accounting entries for goodwill
adjustments
• F would pay D and E for his share of the
goodwill – £18,000 to D and £6,000 to E
personally. No entry is made in the
partnership’s accounts for this.
• F pays money into the partnership’s business
bank account as his invested capital. A
goodwill account is opened and the total
value of goodwill is debited. The capital
accounts of the old partners are credited
with their shares of goodwill in the old profit
sharing ratios.