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Chapter 1

PARTNERSHIP
ACCOUNT
(Formation)

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Learning objectives
• To explain the meaning of partnership.
• To explain t he rationale to form a
partnership.
• To explain the characteristics of a
partnership.
• To explain the partnership agreement.
• To prepare partnership accounts.
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Formation of Partnership

Definition:
“The relation which subsists between
persons carrying on business in common
view of profit”. (Part II, section 3 (1)
Partnership Act 1961.

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Why partnership business is formed?

1. To obtain larger capital


2. To share skills, knowledge and
experiences
3. To share tasks

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Characteristics of partnership
1. Formed to make profit.

2. Owned by 2 to 20 members. The number of partners for


Professional partnership is between 2 – 50 partners.

3. Each partner is an agent to the other partners. Hence,


his/her actions related to the partnership activities will
legally bind the partnership and the other partners.

4. Each partner is responsible for the liabilities of the


business.

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5. Partnership will dissolve when one of the partners dies,
became mentally unfit or his term has expired.

6. Profits/losses are distributed among the partners


according to the ratio agreed, which is stipulated in the
Partnership Agreement.

7. Remunerations and Drawings of the partners could also


be arranged in any way as agreed by the partners.

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Partnership Agreement

• A Partnership may be created by an agreement


which may either be verbal or written.

• Normally a document called as a “Partnership


Deeds” or “Partnership Agreement” will be drawn
up, stating the rights, duties and liabilities between
the partners.

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Among the clauses that are usually covered in
the agreement are:-

1. Nature of business
2. The amount of capital contributed by each partner
3. Profits or Losses sharing ratio
4. Interest charged on partners’ capital
5. Arrangement as to the amount of drawing and interest on
drawings
6. Arrangement as to partners’ salaries
7. Arrangement as to interest on advances/loan from partners
8. Method for valuation of goodwill upon admission,
retirement or death of a partner.

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What happen when there is no written
Partnership Agreement?

Section 26 of the partnership Act 1961 provides that in cases where


no written agreement is drawn up, then the followings will apply:

1. Profit/ loss are to be shared equally


2. A partner is NOT entitled to remuneration
3. A partner is NOT entitled to interest on capital.
4. NO interest on drawing will be charged on drawing made by partners
5. Partners will received interest of 8% per annum on the amount
advanced/loaned to the business.

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Preparing partnership account
• In general, partnership accounts are similar to that of a sole proprietorship.

• However, there are two areas in which the partnership and a sole
proprietorship accounts differ.

• The differences are basically due to the business having more than one partners.

• Partners need to be informed of their share of the business’s profits or losses –


affecting the Statement of Profit and Loss.

• Partners are also need to be informed of their current net assets and equity
standing - affecting the Owners’ Equity section in the Statement of Financial
Position.

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In such a case….,
1. The Net Profit/Loss earned or incurred during a particular
accounting period will be distributed/appropriated/shared
among partners. (Statement of Profit and Loss section).

2. The amount of capital contributed by partners must be


shown separately. (Statement of Financial Position
section).

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Statement of Profit and Loss

• Therefore, a part from having the normal Statement of


Profit and Loss, an extra account/document known as the
APPROPRIATION ACCOUNT or APPROPRIATION
STATEMENT is needed to show the division of profits or
losses among the partners.

• The format for preparing the Appropriation


Account/Statement is as in the next slide.

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Statement of Profit and Loss and the Appropriation Account for the year ended …

RM
Less: Interest on Loan/Advances
Ali xxx
Bakar xxx (xxx)

Net profit (from Statement of profit and loss) xxx


Add: Interest on drawings
Ali xxx
Bakar xxx xxx
Less: Partners’ salaries
Ali xxx
Bakar xxx (xxx)
Interest on capital
Ali xxx
Bakar xxx (xxx)
Distributable profit/(loss) xxx
Shared profit Ali (% x xxx) xx
Bakar (% x xxx) xx
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Accounting procedures of a
partnership
(Focusing on the items in the Profit and Loss
Appropriation account)

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• In arriving at the “Distributable Profits or Losses” to be
apportioned to partners, there are several items that need to
be accounted for.

• These are items that affect the partners and which are
stated in the Partnership Agreement.

• There are as follows:


1. Interest on Capital
2. Partners’ Salaries
3. Interest on Drawings

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Interest on Capital
• Interest on capital is not treated as an expense to the
partnership. The amount is debited (deducted from the net
profit/loss) in the Appropriation acc. instead of in the P&L.

• The rate of interest depends on the clause in the Partnership


Agreement and is computed from the date the capital is
contributed by the partners.

• DR Appropriation acc
CR Partners’ Current acc

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Partners’ Salaries/Remuneration
• Partners can take an active role in the Partnership.

• In such a case, the partner will be remunerated or will received salary.

• If salary to partners HAS BEEN paid:


DR Partner’s Salary Acc.
CR Cash

DR Appropriation
CR Partners’ Salary Acc

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Partners’ Salaries/Remuneration
• If salary HAS NOT BEEN PAID or is still Accrued:

DR Partner’s salary acc.


CR Current acc.

• The balance in the Partner’s salary acc. will then be closed and
transferred to the Appropriation Account at the end of the accounting
period.

DR Appropriation
CR Partners’ Salary

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Partners’ Drawings
• If the Partnership Agreement provide a clause allowing a
partner/s to make withdrawals from the business either in the
form of cash or goods for personal use, then:

• Drawing of cash
DR Partners’ Current account
CR Cash account

• Drawing of goods
DR Partners’ Current account
CR Purchases account

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Interest on Drawings
• Interest on drawings is treated as an income to the partnership.

• However, since it is related to the partners, the amount will be


credited (added) in the Appropriation Account instead of the
Profit and Loss Account.

• Interest on drawing is charged on the partners starting from


the date of withdrawal to the date when the final accounts are
prepared.

• DR Partners’ Current acc.


CR Appropriation acc. 20
Loan/Advances from Partners
• If a partner provides a loan or advances to the business
besides the capital he/she has already contributed, this
amount will be credited to a separate Loan account and
NOT to the partner’s capital account.

• This loan is considered as an outside liability and is to be


treated just like any other loan (eg; Loan from Bank).

• In the event of dissolution, priority for payment will be


given to this account before the balances in the partners’
Capital and Current account are paid off.
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Guaranteed Share of profit
• Sometimes, a partner may be guaranteed with a fixed amount
of profits as stated in the partnership agreement.

• If there is such a clause in the Partnership Agreement, the


partner will receive nothing less than the minimum amount.

• The implication is that, if the distributable profit is insufficient


to pay the partner's minimum share of profits, other partners
will have to surrender their shares/portions to the partner, so
that he/she receives the minimum or guaranteed amount.

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Example
Ali, Bala and Chan are partners in a partnership. The partnership agreement states the
following:

a) Ali and Bala are both entitled to salaries of RM1,000 per annum
b) Interest of 10% p.a will be paid on capital
c) Interest of 5% p.a will be charged on partners’ drawings
d) Profit and loss will be shared by the partners as follows:
Ali 5/10, Bala 3/10 and Chan 2/10 and Chan is guaranteed to receive a minimum
profits of RM1,000 a year.

• Capital acc balances for Ali, Bala and Chan were RM5,000,RM3,000 and RM2,000
respectively.

• Cash drawing made by Ali, Bala and Chan were RM2,500,RM3,000 and RM1,000
respectively.

• Net profit for the year is RM5,312

Required:
Show the distribution of profit among the partner. 23
Answer:
Appropriation Statement for the year ended …
RM RM
Net profit 5,312
Add: Interest on drawings
Ali (2500 x 5%) 125
Bala (3000 x 5%) 150
Chan (1000 x 5%) 50 325
Less: Interest on capital
Ali (5000 x 10%) 500
Bala (3000 x 10%) 300
Chan (2000 x 10%) 200 (1000)
Partner's salaries
Ali 1000
Bala 1000 (2000)
Distributable profits: 2637

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Answer:
RM RM
Distributable profits: 2,637
Ali (2637 x 5/10) 1,318.50
Bala (2637 x 310) 791.10
Chan (2637 x 2/10) 527.40 2,637

 However, since Chan is guaranteed a minimum of RM1,000, the distribution of


profit will then be :
Distributable profits: 2,637
Chan (1,000) 1,637
Ali (1637 x 5/8) 1,023.13
Bala (1637 x 3/8) 613.89

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Statement of Financial Position section

The balance sheet of a partnership is identical to that of a


sole trader EXCEPT that the Owner’s Equity section is
shown as follows:-

Owners’ Equity:
Capital Acc. - Ali xxx
Bakar xxx
Current Acc. - Ali xxx
Bakar xxx
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Accounting procedures of a partnership
(focusing on the Statement of Financial Position Section)

Partners’ Capital Account

• Upon formation of a partnership, each partner usually


contributes a certain amount of capital. Thus, each partner
should have his/her own capital account.

Capital account can be prepared in two ways:-


1. Fixed capital account method or
2. Fluctuating capital account method

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Fixed capital account method
Under this method, partners’ are required to maintain two sets of
accounts namely:-

1. Partners’ capital account


- records only transactions relating to capital contribution.

2. Partners’ current account


- records adjustments other than movement of capital e.g drawings, interest
on drawing, interest on capital, salaries paid to partners and shared profit or
loss.

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Example
Partners’ Capital account***

Ali Bakar Ali Bakar


Cash xxx xxx

Partners’ Current account***

Ali Bakar Ali Bakar


Drawings xxx xxx Interest on capital xxx xxx
Interest on drawing xxx xxx Salaries xxx xxx
Shared loss** xxx xxx Shared profit** xxx xxx

** whichever is applicable
*** the account can also be prepared using the ‘statement’ format29
Fluctuating Capital Account Method

• Under this method, all transactions affecting the partners


are to be recorded in the respective partners’ capital
accounts.

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Example

Partners’ Capital account***

Ali Bakar Ali Bakar


Drawings xxx xxx Cash xxx xxx
Interest on drawing xxx xxx Interest on capital xxx xxx
Shared loss** xxx xxx Salaries xxx xxx
Shared profit** xxx xxx

** whichever is applicable
*** the account can also be prepared using the ‘statement’ format
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