Cambridge IGCSE Accounting · 0452
Chapter 5: Preparation of Financial Statements — Part 2
Section 5.2 · Partnerships
A partnership is formed when two or more people (usually up to 20) agree to run a business together to make a profit. Partners share responsibility, capital, and profit according to a partnership agreement or, if none exists, according to the Partnership Act.
Advantages and Disadvantages
- Advantages
- More capital available than a sole trader, shared responsibility and workload, and access to a wider range of skills.
- Disadvantages
- Profits must be shared, potential for conflict between partners, and unlimited liability (partners are personally liable for all business debts).
The Partnership Agreement
This is a legal document outlining the rules of the partnership. Without an agreement, profits are shared equally and no interest on capital or drawings is allowed. A typical agreement includes:
- The Profit-Sharing Ratio (PSR) for residual profit.
- Interest on Capital — a percentage reward on each partner’s fixed investment.
- Interest on Drawings — a percentage charge on withdrawals to discourage excessive drawings.
- Partner Salaries — fixed amounts for partners who contribute more management time.
- Admission and retirement of partners — rules for goodwill and capital adjustments.
- Dispute resolution and procedures if the partnership is dissolved.
Important: Interest on a Partner’s Loan is not in the agreement as an appropriation. It is a business expense in the Income Statement, paid before profit is shared.
The Appropriation Account
This account is prepared after the Income Statement to show how the Profit for the Year is distributed among partners.
Appropriation layout:
- Profit for the year (brought from the Income Statement).
- Add: Interest on Drawings (total of all partners).
- Less: Interest on Capital (total for all partners).
- Less: Partner Salaries.
- Residual profit: Divided between partners according to the PSR.
Worked Example 1: Full Appropriation Account
Ahmed and Belinda are partners sharing residual profit 2:1. Their partnership agreement provides: interest on capital 5%; interest on drawings 10%; salary to Belinda $6,000. Capital balances: Ahmed $40,000; Belinda $20,000. Drawings: Ahmed $8,000; Belinda $4,000. Profit for the year (after all expenses including any partner loan interest) = $30,000.
| Appropriation Account | $ | $ |
|---|---|---|
| Profit for the year | 30,000 | |
| Add: Interest on drawings — Ahmed (10% × 8,000) | 800 | |
| Add: Interest on drawings — Belinda (10% × 4,000) | 400 | 1,200 |
| 31,200 | ||
| Less: Interest on capital — Ahmed (5% × 40,000) | 2,000 | |
| Less: Interest on capital — Belinda (5% × 20,000) | 1,000 | |
| Less: Salary — Belinda | 6,000 | (9,000) |
| Residual profit | 22,200 | |
| Share of profit — Ahmed (2/3) | 14,800 | |
| Share of profit — Belinda (1/3) | 7,400 | 22,200 |
Capital and Current Accounts
Partnerships maintain two accounts for each partner to separate long-term investment from day-to-day transactions.
- Capital Account
- Usually remains fixed at the original amount invested. Only permanent changes (additional capital introduced or capital withdrawn on retirement) are recorded here.
- Current Account
- Records all appropriation items and drawings during the year.
- Credit side: Interest on capital, salary, share of profit.
- Debit side: Drawings, interest on drawings.
Worked Example 2: Current Accounts and SFP Presentation
Using the figures from Worked Example 1, the partners’ Current Accounts are:
Ahmed — Current Account
| Details | $ | Details | $ |
|---|---|---|---|
| Drawings | 8,000 | Interest on capital | 2,000 |
| Interest on drawings | 800 | Share of profit | 14,800 |
| Balance c/d | 8,000 | 16,800 | |
| 16,800 | Balance b/d | 8,000 |
Belinda — Current Account (credit balance $10,400): Interest on capital $1,000 + Salary $6,000 + Share of profit $7,400 − Drawings $4,000 − Interest on drawings $400.
SFP Capital Section (extract):
| Details | $ |
|---|---|
| Capital accounts — Ahmed | 40,000 |
| Capital accounts — Belinda | 20,000 |
| Current accounts — Ahmed | 8,000 |
| Current accounts — Belinda | 10,400 |
| Total partners’ equity | 78,400 |
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