Partnership Accounts – SS2 Financial Accounting Lesson Note (Second Term)

What is a partnership?

A partnership is a business owned and run by two or more people who share its profits and losses in an agreed ratio. Each partner brings in capital, skills or both, and each acts as an agent of the firm. Because the profit belongs to more than one owner, a partnership keeps extra accounts that a sole trader does not need.

Behavioural objectives

By the end of the lesson, students should be able to:

1. define a partnership;
2. explain why people form partnerships;
3. state four features of a partnership;
4. explain what a partnership deed is and list what it usually contains;
5. state the rules that apply when partners have no deed;
6. define the key terms used in partnership accounts.

Why do people form partnerships?

A sole trader often runs short of capital, skills or time. Taking in partners solves this: each partner adds money or expertise, the work and the risk are shared, and the business can grow faster than one owner could manage alone.

Features of a partnership

1. Agreement. Partners agree, in writing or by word of mouth, how they will share profits and run the business. The agreement tells every partner their rights and duties.
2. Business for profit. A partnership exists to carry on a trade, profession or occupation with a view to profit. A group running a charity is not a partnership.
3. Sharing of profits and losses. Every partner takes a share of the profit (and bears a share of any loss). Someone who works for the firm without sharing its profit is an employee, not a partner.
4. Agency. Each partner is an agent of the firm and of the other partners. One partner can act on behalf of all of them, and all are bound by what that partner does for the business.

What is a partnership deed?

A partnership deed is the written agreement that sets out the terms of the partnership. Partners can agree terms orally, but a written deed avoids disputes later. A deed usually states:

• the name of the firm and the nature of its business;
• the capital each partner will contribute;
• the ratio for sharing profits and losses;
• interest on capital and interest on drawings, if any;
• salaries for partners, if any;
• interest on loans made by partners to the firm;
• how accounts will be kept and audited;
• what happens when a partner is admitted, retires or dies, or when the firm is dissolved.

What happens when there is no partnership deed?

Where partners have no deed, or the deed is silent on a point, the Partnership Act 1890 applies:

Key terms in partnership accounts

1. Capital: the money or assets each partner puts into the business, recorded in that partner’s capital account.
2. Drawings: money or goods a partner takes out of the business for personal use.
3. Profit-sharing ratio: the agreed proportion in which partners share profits and losses, for example 3:2.
4. Appropriation account: the account that shows how the net profit is shared among partners, after allowing for interest on capital, salaries and interest on drawings.
5. Current account: the account that records each partner’s share of profit, interest on capital, salary, drawings and interest on drawings. Capital itself stays in the capital account.
6. Interest on capital: a share of profit given to each partner as a return on the capital they invested. It is an appropriation of profit and is not charged as a business expense.
7. Interest on drawings: a charge made on partners for money they withdraw. It adds to the profit available for sharing.
8. Goodwill: the value of the firm’s reputation and customer base, shown as an intangible asset.
9. Reserves: profits kept back for future needs instead of being shared.
10. Dissolution: the ending of a partnership, for example when a partner retires or dies, or when the partners agree to close the firm.

Evaluation

1. Define a partnership.
2. State four features of a partnership.
3. What is a partnership deed? List five things it usually contains.
4. State the rules that apply under the Partnership Act 1890 when partners have no deed.
5. Explain the difference between a partner’s capital account and current account.

Assignment

Ade and Bola start a partnership with no written deed. Ade puts in ₦600,000 and Bola puts in ₦400,000. The net profit for the year is ₦200,000, and Bola lent the firm ₦100,000 for the whole year. Using the Partnership Act 1890 rules, show how much interest Bola receives on the loan and how the remaining profit is shared.