Partnership accounts

by Neil Stein 16 Jan 2000

This article concentrates on the preparation of partnership financial statements. There are no material differences between UK and international practice in partnership accounts apart from minor variations in terminology and format. This article uses international terminology. For students taking the UK paper the conversion is: International term UK equivalent Income statement Profit and loss account Statement of division of profit Appropriation account Differences between sole traders' accounts and partnership accounts If you can handle the financial statements of sole traders, with adjustments for accruals, prepayments, depreciation and the like, it is an easy matter to add the requirements for partnership accounts. The differences are: Balance sheet there is a separate capital account for each partner instead of just the one required for a sole trader we often maintain a separate current account for each partner, recording drawings and profit shares. If this is done, the capital account is only used for 'capital' transactions such as the introduction of extra long-term capital by partners. Income statement - the division of the net profit among the partners has to be shown. There are several possibilities: profit is shared in agreed proportions as (a), but partners are credited with a 'salary' to allow for the work they put into the partnership as (a) or (b), but partners are credited with 'interest on capital' to allow for differences in the amounts of fixed capital partners have contributed. It is important to note that partners' salaries and interest on capital are not charges in the main part of the Income statement. They are simply part of the process of dividing up the profit among the partners. The division is shown in the statement of division of profit. This may be presented in a tabular format as shown in the next section. Preparing partnership financial statements Income statement The main part of the income statement is prepared exactly as for a sole trader. Points to watch: Do not put partners' salaries or interest on capital into the main income statement. They belong only in the division of profit statement section. Do not include drawings anywhere in the income statement or statement of division of profit. Drawings are debited to partners' current accounts. Statement of division of profit The easiest format to adopt here is a simple columnar presentation. See Figure 1 below (figures invented). Points to watch: One partner may guarantee that another partner's total profit share is not less than a certain minimum amount. To deal with this, make a transfer from one column to another in the tabulated statement. Changes to the profit-sharing arrangements or changes in partnership personnel part way through the year. You have to divide the profit on a time basis between the periods, then apply the details given to the apportioned profits. Remember to take half a year's salary for a half-year period. Your table then shows the total profit shares for the year calculated for the two periods involved. Change in partnership personnel part way through the year, with an agreement that certain expenses charged in the income statement relate to one part of the year only. This is a variation on (b) above and always causes problems for candidates. What you have to realise is that for the partners not bearing the expense, the profit is that shown by the income statement plus the special expense. You have to split that increased profit among the partners, then deduct the special expense from the partners who are to bear it. Figure 1: statement of division of profit A B C Total $ $ $ $ Salaries 20,000 15,000 - 35,000 Interest on capital 4,000 3,000 2,000 9,000 Share of balance 3:2:1 90,000 60,000 30,000 180,000 114,000 78,000 32,000 224,000 P, after having been a sole trader for some years, entered into partnership with Q on 1 July 20X2, sharing profits equally. The business profit for the year ended 31 December 20X2 was $340,000, accruing evenly over the year apart from a charge of $20,000 for a bad debt relating to trading before 1 July 20X2, which it was agreed P should bear entirely. How is the profit for the year to be divided between P and Q? P $000 Q $000 A 245 95 B 250 90 C 270 90 D 255 85 Decide what you think the answer should be, and then read on. Discussion A little clear thinking is required. The profit excluding the $20,000 is to be used, then $20,000 deducted from P's share.Thus we have: P $000 Q $000 6 months to 30 June 20X2 180 6 months to 31 December 20X2 90 90 270 90 less: bad debt 20 250 90 The answer is B. If you didn't get it right, re-read note (c). d the question states that there is no partnership agreement and tells you nothing about profit shares. In this case, assume the following (Partnership Act 1890 provisions): no partnership salaries no interest on capital profit shared equally among the partners but if any partner has loaned money to the partnership (as opposed to introducing capital), the loan carries interest at 5 per cent per year, charged in the income statement. Questions rarely bring in this point, because it makes the question easier. e Interest on drawings - partners sometimes agree that interest should be charged on drawings made. In reality, partners will agree the amount of drawings the business can stand rather than charge interest. If the point should come up, calculate the total interest due from all partners and add that to the net profit in the statement of division of profit. Then deduct each partner's interest charge from the individual shares at the end of the statement. Balance sheet Each partner has to have a capital account and, probably, a current account in the balance sheet. The easiest way to present these is to use columns. See Figure 2 (figures invented). Figure 2 Capital accounts A B C $ $ $ Balance at 1 January 40,000 30,000 20,000 Capital introduced 20,000 10,000 -        Balance at 31 December 60,000 40,000 20,000 120,000   A B C $ $ $ Balance at 1 January 14,800 16,100 12,400 Profit share (the total from the division of profit statement) 68,000 49,000 46,000 82,800 65,100 58,400 Drawings (70,000) (60,000) (60,000) Balance at 31 December 12,800 5,100 (1,600) 16,300 If a partner has a debit balance, as does C here, it is easy to include it in the tabulation as shown. There is no need to complicate matters by putting C's account on the assets side of the balance sheet. A practice question Here is a practice question to test your understanding. Try to complete it for yourself, then take a look at the discussion and answer below. Alamute and Brador have been in partnership for several years, compiling their financial statements for the year ended 31 March and sharing profits in the ratio 60:40 after allowing for interest on capital account balances at 5 per cent per year. Extracts from their trial balance at 31 March 20X3 are given in Figure 3. Figure 3: extract from Alamute and Brador trial balance Reference to notes $ Capital accounts: Alamute 50,000 Brador 50,000 Current accounts Alamute 3,800 credit Brador 2,600 debit Drawings: Alamute 48,400 Brador 36,900 Office equipment cost 1 48,300 accumulated depreciation, 1 April 20X2 12,800 Inventory, 1 April 20X2 2 15,600 Trade receivables 3 68,400 Allowances for receivables, 1 April 20X2 3 3,800 Sales revenue 448,700 Purchases 184,600 Rent paid 4 30,000 Salaries 88,000 Insurance 5 4,000 Sundry expenses 39,400 Notes to Figure 3 Office equipment should be depreciated at 20% per year on the reducing balance basis. Closing inventory amounted to $21,400. Debts of $2,400 are to be written off, and the allowance for receivables is to be adjusted to 5% of trade receivables. Rent paid of $30,000 is the amount for the nine months to 31 December 20X2. From that date the rent was increased by 10%. Insurance paid in advance amounted to $1,500. Required: Prepare the partnership's trading and income statement and statement of division of profit for the year ended 31 March 20X3 (9 marks) Write up the partners' current accounts for the year ended 31 March 20X3 (3 marks) (12 marks in total). Discussion This is quite a simple question, but care is needed on several points: The drawings figures are given. They go into the current accounts and do not appear in theincome statement or statement of division of profit. Note 3 gives details of receivables. The charge in the income statement is: $  $  Debts written off 2,400 Movement in allowance Original allowance 3,800 New allowance required 5% x (68,400 - 2,400) 3,300 (500) 1,900   Note 4 explains the rent. $30,000 is the cost for nine months. That means $10,000 per quarter. The fourth quarter must therefore be $11,000, giving a total of $41,000. a Alumute and Brador Income statement for the year ended 31 March 20X3 $ $ Sales revenue 448,700 Cost of sales: opening inventory 15,600 purchases 184,600 200,200 less: closing inventory 21,400 (178,800) Gross profit 269,900 Less: expenses salaries 88,000 rent (30,000 + 11,000) 41,000 insurance (4,000 + 1,500) 2,500 sundry expenses 39,400 depreciation (35,500 x 20%) 7,100 receivables expense (2,400 - 500) 1,900          (179,900) Net profit 90,000 Statement of division of profit Alamute Brador Total $ $ $ Net profit 90,000 Interest on capital 2,500 2,500 (5,000) 85,000 Balance of profit 60:40 51,000 34,000 (85,000) 53,500 36,500 -            b Current accounts Alamute Brador Alamute Brador $ $ $ $ Balance - 2,600 Balance 3,800 - Drawings 48,400 36,900 Share of profit 53,500 36,500 Balance 8,900 -         Balance -          3,000 57,300 39,500 57,300 39,500 Neil Stein is former examiner for Paper 1.1

Incomplete records

by Neil Stein 26 Aug 2004

Examiners like questions on incomplete records because they provide the opportunity to test a variety of bookkeeping and accounting techniques. The two main instances in which incomplete records can be found are where: there are no records at all some records exist and information is available to calculate missing figures. No records at all It is still possible to calculate a profit or loss figure by using the fact that the profit of a business must be represented by more assets. We list and value the opening and closing net assets, then calculate the profit as the difference between the two: Profit = Closing net assets - Opening net assets Allowance must be made for proprietor's drawings and extra capital introduced, so the formula becomes: Profit = Closing net assets - Opening net assets + Drawings - Capital introduced There is little scope here for a major question, but it could form the basis of a two-mark multiple-choice question. Incomplete records This a more common scenario, both in exam questions and in practice. There are standard techniques for calculating missing figures: Opening capital Missing figures for sales and purchases Missing figures for cash. Opening capital We need to have the opening capital of the business at the beginning of a period to provide a starting point - the capital in the balance sheet account. Questions will usually give us a list of opening assets and liabilities, and we use this to arrive at the opening capital. Missing figures for sales and purchases If we know the opening and closing debtors of a business, and the cash received from customers, we can calculate sales. All we need to do is set up a sales ledger total account (see Figure 1). Figure 1: Sales ledger total account (figures invented) £ £ Opening debtors 38,600 Cash received 218,650 Sales (balancing figure) 221,250 Closing debtors 41,200 259,850 259,850 If any three of these figures is known, the fourth can be calculated. All we are doing here is using the sales ledger control account format, but instead of proving the accuracy of the sales ledger, we are calculating what the sales must have been in order for the other figures to be what they are. The same technique may be used to calculate credit purchases. If the sales figure is given we can calculate the cash received. There is another way to calculate sales, purchases or stock figures, and that is to use the trading account format. We normally set up the trading account as (figures invented): £ £ Sales 100,000 Less: cost of sales opening stock 10,000 purchases 78,000 88,000 less: closing stock 13,000 75,000 gross profit 25,000 Suppose the closing stock has been destroyed by fire, along with all the stock records. Then we wouldn't have the closing stock total to include in our trading account. However, we can calculate it if we know the gross profit percentage on sales - or, of course, the mark-up on cost of sales. In the example above, gross profit is 25 per cent of sales. If we are told this, we can insert the gross profit of £25,000 and so calculate the missing stock figure as a balancing item. We can also find a missing purchases figure, or even a missing sales figure. Suppose we are given: £ £ Cost of sales opening stock 10,000 purchases 78,000 88,000 less: closing stock 13,000 75,000 We are also told that gross profit percentage on sales is 25 per cent. If gross profit is 25 per cent on sales, cost of sales must be 75 per cent of sales. The sales total is therefore: £75,000 x 100/75 = £100,000. Whenever the gross profit percentage is given in an incomplete records question, you know that this technique is needed. Missing figures for cash We may be given details of cash receipts and payments plus details of opening and closing balances, but with one figure missing, often the proprietor's drawings. We can calculate the missing figure by setting up a cash account to find the balancing item required. Here are the incomplete records techniques: Construct To calculate 1 Opening assets and liabilities Opening capital 2 Sales or purchases ledger total accounts Any missing figure 3 Trading account (gross profit percentage must be given) Any missing figure 4 Cash account Any missing figure There is only one way to develop fluency in incomplete records questions, and that is to practise as many questions as you can. Here are three short exercises: The net assets of Altese, a trader, at 1 January 2003 amounted to £128,000. During the year to 31 December 2003, Altese introduced a further £50,000 of capital and made drawings of £48,000. At 31 December 2003, Altese's net assets totalled £184,000. Using this information compute Altese's total profit for the year ended 31 December 2003. Senji does not keep proper accounting records, and it is necessary to calculate her total purchases for the year ended 31 January 2004 from the following information: £ Trade creditors 31 January 2003 130,400 31 January 2004 171,250 Payments to suppliers 888,400 Cost of goods taken by Senji for her personal use 1,000 Refunds received from suppliers 2,400 Discounts received 11,200 Compute the figure for purchases for inclusion in Senji's financial statements. Aluki fixes prices to make a standard gross profit percentage on sales of 331/3%. The following information is available for the year ended 31 January 2004 to compute her sales total for the year: £ Stock 1 February 2003 243,000 31 January 2004 261,700 Purchases 595,400 Purchases returns 41,200 Calculate the sales figure for the year ended 31 January 2004. Answers   £ Opening capital 128,000 Capital introduced 50,000 178,000 less: Drawings 48,000 130,000 Closing capital 184,000 Profit is therefore 54,000   See Figure 2. Figure 2: Purchases total account £ £ Payments to suppliers 888,400 Balance brought forward 130,400 Discounts received 11,200 Goods taken by Senji 1,000 Balance carried forward 171,250 Refunds from suppliers 2,400 Purchases (balancing figure) 937,050 1,070,850 1,070,850     £ £ Cost of sales Opening stock 243,000 Purchases 595,400 less: Returns 41,200 554,200 797,200 less: Closing stock 261,700 535,500 Sales figure is therefore: £535,500 x 3/2 = 803,250 These three examples are quite elementary, but they illustrate techniques that you will find in nearly all incomplete records questions. Neil Stein is examiner for Paper 1.1