Partnership Accounts

— Accounting · (CAIE) · Formation, Appropriation, Current A/c & SOFP —

★ Exam Tip: Old CAIE papers gave a 40-mark partnership question (income statement + appropriation + SOFP). Now all questions are 20 marks, so the examiner gives “profit for the year” and you only make the appropriation account (+ current accounts / SOFP extract). Formation (amalgamation) and goodwill are favourite topics too.

Order of work: can’t make the SOFP until the current accounts are done

1. Partnership Formation (Amalgamation)

Definition: A partnership = an agreement between two or more individuals to run a business together to earn profit. Formation / amalgamation = two sole traders merge their businesses into one new partnership (“why compete – let’s work hand in hand”).

Business forms: sole trader → partnership → company. Here we study the accounts of a partnership.

Key idea: The partnership is a brand-new business ⇒ no balance b/d in the capital accounts. The old sole-trader capitals (Jay 72,000, Kay 39,600) are ignored – they don’t include the agreed changes (premises left out, loan left out, revaluation, bad debt, goodwill). We build new capital accounts from the assets & liabilities taken over.

Q — Jay & Kay (traded separately to 31 Dec 1996)

Balance sheets 31 Dec 1996	Jay $	Kay $		Jay $	Kay $
Premises	30,000	24,000	Capital	72,000	39,600
Equipment	21,000	13,200	Loan	—	12,000
Stock (inventory)	13,800	8,700	Creditors (trade payables)	6,000	3,000
Debtors (trade receivables)	9,600	11,100	Bank overdraft	—	2,400
Bank	3,600	—
Total	78,000	57,000		78,000	57,000

(Old-style question: balance sheet in T-account format – debit side = assets; credit side = capital & liabilities. Kay’s bank is on the credit side ⇒ it is an overdraft.)

Jay & Kay agree to become equal partners from 1 Jan 1997 (profit ratio 1 : 1). Terms:

Partnership takes over all assets & liabilities except Jay’s premises and Kay’s loan.
Equipment revalued: Jay $18,000, Kay $15,000.
$600 of Kay’s debtors are bad ⇒ write off.
Goodwill valued: Jay $9,000, Kay $7,200.
All other items taken over at balance sheet values.

Required: (a) the two capital accounts showing how the balances at 1 Jan 1997 are obtained. Also (teacher added): SOFP at 1 Jan 1997 + definition of goodwill.

Why leave out? Jay won’t bring his premises (family reasons – great-grandfather bought it). Kay pays off his own loan himself – the firm isn’t responsible for it.

Treatment of each term

Premises: Jay’s excluded; Kay’s $24,000 comes in.
Equipment: if a revalued figure is given use it (18,000 / 15,000), not book value (21,000 / 13,200). If no revalued figure is given → use book value (no other option).
Debtors: Kay: 11,100 − 600 = 10,500 (bad debt already deducted – don’t deduct again later).
Bank: Jay +3,600 (asset); Kay’s overdraft 2,400 (liability).
Loan (Kay) → not taken over.

Golden rule for the capital account

Item coming in	Entry	Effect on capital
Asset (premises, equipment, inventory, receivables, bank, goodwill)	Asset Dr / Capital Cr	capital ↑ (credit side)
Liability (trade payables, bank overdraft)	Liability Cr / Capital Dr	capital ↓ (debit side)

Remember: capital is a credit balance. ↑ capital = Cr, ↓ capital = Dr. Asset ↑ = Dr, liability ↑ = Cr. So assets sit on the credit side of the capital a/c and liabilities on the debit side.

Capital a/c has one column per partner (3 partners → 3 columns) on both sides.

2. Goodwill

Meaning: goodwill = the reputation / standing / image of a business, built by successful trading – courteous staff, pleasant atmosphere, quality & hygiene (e.g. a restaurant with a good chef), convenient location, loyal customers.

Definition (write this in the exam)Goodwill is an intangible asset (cannot be touched). It is the excess of the purchase price over the fair value of the net assets of the business acquired. It is the reputation of the business built over successful years of trading / service.

Net assets = assets − liabilities = balance-sheet value (= capital). Intangible = no physical existence (goodwill); tangible = premises, buildings, equipment…

Two kinds of goodwill

Internally generated	Purchased
Built by the owner’s own hard work & good service – not bought from anyone.	Bought by buying a whole business (there is no “market” to buy 1 kg of goodwill!).
NOT allowed in the accounts	Allowed in the accounts

Example — the restaurant story:

Friend sells his restaurant. Break-up sale (building, furniture, ovens… separately) gives less than selling it as a running business.
Balance-sheet value (assets − liabilities) = $10,000 → he’ll want more; asks 15,000, you negotiate to 13,000.
Extra paid = 13,000 − 10,000 = $3,000 = goodwill (you skip starting from scratch: customers, chef, taste, name already exist).
For your friend it was internally generated; for you it is purchased goodwill.

price − net assets = goodwill

Why internally generated goodwill is NOT recorded: ① Prudence – don’t overstate assets & profit. ② Money measurement – only items with an objective $ value are recorded; self-made goodwill has only a subjective value (you can’t be sure you’d get $10,000 for it). Purchased goodwill has an objective value – you actually paid for it.

3. Goodwill Adjustment in Formation — NDOC

Goodwill (Jay $9,000, Kay $7,200) is self-created, so it must be eliminated – that needs two entries:

Create goodwill: Goodwill Dr / Capital Cr – in the OLD ratio (what each brought: 9,000 & 7,200).
Eliminate goodwill: Goodwill Cr / Capital Dr – in the NEW ratio (1 : 1).

Mnemonic (board: ND – OC)N D O C = New ratio Debit, Old ratio Credit

Old ratio = before the change (sole traders: “my goodwill 9,000, your goodwill 7,200”). New ratio = after (equal partners 1 : 1 → “our goodwill”).

Question to ask: if goodwill is credited then debited by the same total, why bother? Because the amounts per partner differ – the two entries shift value between partners:

Total goodwill = 9,000 + 7,200 = 16,200 New ratio 1 : 1 → each 16,200 ÷ 2 = 8,100 debited Jay: 9,000 Cr − 8,100 Dr = +900 Kay: 7,200 Cr − 8,100 Dr = −900

Kay effectively buys half of Jay’s extra goodwill for $900

Why it’s fair: Jay’s shop was more popular (more customers, higher sales) – goodwill is $1,800 more than Kay’s. Future profits are shared equally, so Jay would complain “I worked harder!”. Fix: Kay pays Jay 50 % of the extra = 900. (Credit 9,000, debit 8,100 → Jay +900; Credit 7,200, debit 8,100 → Kay −900.)

If the question says “goodwill account is to be maintained / remain in the books”: make only the credit entry (Goodwill Dr / Capital Cr, old ratio) – no elimination. Goodwill then shows in the SOFP under non-current assets → intangible. If nothing is said → always eliminate goodwill (as in this question).

4. Capital Accounts — Jay & Kay (1 Jan 1997)

Capital Accounts (no b/d – new partnership)
Debit	Jay $	Kay $	Credit	Jay $	Kay $
Trade payables	6,000	3,000	Premises	—	24,000
Bank overdraft	—	2,400	Equipment	18,000	15,000
Goodwill (1 : 1)	8,100	8,100	Inventory	13,800	8,700
Balance c/d	39,900	51,900	Trade receivables	9,600	10,500
			Bank	3,600	—
			Goodwill	9,000	7,200
Total	54,000	65,400	Total	54,000	65,400
			Balance b/d	39,900	51,900

Jay Cr: 18,000 + 13,800 + 9,600 + 3,600 + 9,000 = 54,000 Dr: 6,000 + 8,100 = 14,100 54,000 − 14,100 = 39,900

Kay Cr: 24,000 + 15,000 + 8,700 + 10,500 + 7,200 = 65,400 Dr: 3,000 + 2,400 + 8,100 = 13,500 65,400 − 13,500 = 51,900

Capital a/c: greater side = credit; balance the lesser (debit) side with balance c/d → becomes balance b/d on the credit side (normal balance).

5. Statement of Financial Position — Jay & Kay (1 Jan 1997)

Normally made at year-end, here it is made at the start (opening position of the new partnership). Term used now: SOFP (not “balance sheet”).

Jay & Kay — Statement of Financial Position as at 1 Jan 1997
	$	$
Non-current assets
Premises		24,000
Equipment [18,000 + 15,000]		33,000
Non-current assets total		57,000
Current assets
Inventory [13,800 + 8,700]	22,500
Trade receivables [9,600 + 10,500]	20,100
Bank [3,600 − 2,400]	1,200	43,800
Total assets		100,800
Capital & liabilities
Capital a/c — Jay	39,900
Capital a/c — Kay	51,900	91,800
Current liabilities: Trade payables [6,000 + 3,000]		9,000
Total capital & liabilities		100,800

Check: total assets 100,800 = capital 91,800 + liabilities 9,000 ✓

Goodwill is not shown (eliminated). If it were kept → non-current assets → intangible.
Bank: net the debit balance with the overdraft. Net positive ⇒ current asset; net negative ⇒ current liability.
No current accounts yet – the business has just started (current account balances are given only when the partnership has run in earlier years).
A loan, if any: non-current liability first, then current liabilities. Here only one current liability – trade payables.
Bad debt already deducted – don’t deduct again.

6. Appropriation Account

Sole trader vs partnership: the income statement is exactly the same (sales → cost of sales → gross profit → + other income → − expenses → profit for the year). The new thing is the appropriation account: how the profit is divided among the partners. It is a continuation of the income statement (two-column format) and starts at “profit for the year”.

Exam: profit for the year is usually given – start straight from it. Only three adjustments: interest on drawings, interest on capital, salary / bonus / commission.

ARD Partnership — Appropriation Account for the year ended 31 December 2017
	Profit for the year		XXX
Add:	Interest on drawings — Mr A	XXX
	— Mr R	XXX	XXX
Less:	Interest on capital — Mr A	XXX
	— Mr R	XXX	(XXX)
Less:	Salaries / Bonus / Commission — Mr A	XXX
	— Mr R	XXX	(XXX)
	Residual profits		XXX
	Mr A (remaining profit × share)	XX
	Mr R (remaining profit × share)	XX	XXX

① Interest on drawings (ADD)

Drawings = money or stock an owner/partner takes out of the business.

Why charge it? Partners (Ahmed: holiday; Raza: luxury car) all want to draw once profits come. Too much drawn ⇒ not enough capital left to run the business. We can’t stop owners, so we discourage drawing by charging interest.
Amount = drawings × rate % (rate given in the question).
Why ADD to profit? The business (“we”) charges the partners, so the money comes into the business ⇒ profit available to share ↑.

Mr A drawings 100,000 at 5 %100,000 × 5 % = 5,000 (add)

② Interest on capital (LESS)

Why? Ahmed invested 500,000, Raza only 200,000, but both work equally hard so profit ratio is equal. Ahmed would be upset – more invested ⇒ expects more return. So pay interest on the capital each invested first: more capital → more interest.
Amount = capital × rate %.

Mr Ahmed500,000 × 6 %= 30,000

Mr Raza200,000 × 6 %= 12,000

③ Salaries / bonus / commission (LESS)

A partner who works more (decision-making, running the business) – or the only working partner while the other is a silent / sleeping partner – gets a salary (sometimes a bonus or commission).

Careful: salary to a partner is not a business expense → deduct in the appropriation account. Salary to an employee is an expense in the income statement (before the appropriation account).

④ Residual profit / loss and sharing

Profit for the year + interest on drawings − interest on capital − salaries = residual profit (what remains in the business). It is shared in the profit-sharing ratio given (not given to charity!):

equal partners → 1 : 1
2 : 1 (2+1 = 3) → A gets 23, R gets 13 of residual profit
in ratio of capital: A 500,000, R 200,000 → total 700,000 → A = 500700 = 57, R = 200700 = 27 × residual profit

Goal: the appropriation account must finish at zero. Residual profit ⇒ deduct shares. Residual loss ⇒ add shares of loss.

Residual loss: if profit + interest on drawings − interest on capital − salaries comes out negative, it is a residual loss, not a profit. Positive figure → deduct share to make it zero; negative figure → add share of loss to make it zero.

7. Current Accounts

Disclaimer: nothing to do with the “current account (deficit)” of economics!

Why do we need it? Profit ↑ capital, loss ↓ capital, drawings ↓ capital, additional investment ↑ capital. A sole trader doesn’t care if capital goes up and down. In a partnership fluctuating capital is a problem – interest on capital is calculated on capital, so we want capital to stay fixed.

Capital account = fixed (investment agreed in the question)
Current account = extension of the capital account – everything that fluctuates capital goes here (profit, loss, drawings, interest, salaries…)

Order: income statement → appropriation a/c → current a/c → SOFP. No SOFP until current accounts are done.

Current Account (columns A and R)
Debit	A	R	Credit	A	R
Balance b/d (only if Dr – abnormal)	XXX	XXX	Balance b/d (normal – Cr)	XXX	XXX
Drawings	XXX	XXX	Interest on capital	XXX	XXX
Interest on drawings	XXX	XXX	Salaries	XXX	XXX
Share of loss	XXX	XXX	Bonus / commission	XXX	XXX
Salary drawings	XXX		Profit share	XXX	XXX
			Interest on loan	XXX	XXX
Balance c/d (if Cr – normal)	XXX	XXX	Balance c/d (Dr – abnormal)	XXX	XXX
Total	XXX	XXX	Total	XXX	XXX
Balance b/d (Dr – abnormal)	XXX	XXX	Balance b/d (Cr – normal)	XXX	XXX

“OR” on the board: each balance b/d, c/d is either on the debit side (abnormal) or on the credit side (normal) – only one of the two applies for each partner.

Sorting rule: what we owe the partner (↑ capital) → CREDIT: interest on capital, salaries, bonus/commission, profit share, interest on loan. What reduces the partner’s claim → DEBIT: drawings, interest on drawings (taken from partner), share of loss, salary drawings.

Normal balance = credit (capital is credit). The business owes it to the partner ⇒ liability.
Abnormal balance = debit: partner over-withdrew – took more than his share/profits ⇒ he owes the business ⇒ asset for the business.
Balance the account: bigger side on both sides; shorter side gets balance c/d → balance b/d below.

Interest on loan (a partner’s loan to the firm): use the % given in the question – higher or lower, doesn’t matter. If not given → assume 5 % (Partnership Act 1890, English law – applies when there is no formal agreement). 5 % only for interest on loan – nothing else! It is an expense in the income statement (like bank-loan interest), but is credited to the partner’s current account instead of accrued expenses.

Salary drawings: normally salary is only credited (and shown in the appropriation account). Only if the question says the salary has been paid / withdrawn to the partner, also debit it (cancels the credit) – as a separate “salary drawings” line or added into drawings. Not stated paid → credit side only.

8. SOFP — Treatment of Partners’ Equity

Name now: SOFP (balance sheet is no longer used by examiners / IAS). Layout same as a sole trader: non-current assets (cost, acc. depreciation, NBV) → current assets → total assets → capital → non-current liabilities → current liabilities. The only difference is the capital section:

Sole trader / manufacturing: opening capital + profit − drawings = closing capital. Partnership: only two items – capital accounts and current accounts. Nothing else.

STATEMENT OF FINANCIAL POSITION EXTRACT
Equity
Capital accounts	— A	XXX
	— B	XXX	XXX
Current accounts	— A	XX
	— B	(XX)	XX
Total partners’ equity / net assets			XXX

Capital a/c balances are given in the question (fixed investment).
Current a/c balances = the balance b/d figures from the current accounts just made.
Credit (normal) current balance → ADD to capital. Debit (abnormal) balance → DEDUCT (shown in brackets).
Total = closing capital / total equity. Then assets = capital + liabilities.

Example:

Mr A current a/c 10,000 (Cr), Mr B current a/c 7,000 (Dr, abnormal).

10,000 − 7,000 = 3,000net still a normal credit → added to capital

If both are debit balances: both deducted (−, −) → total current accounts is a negative figure deducted from capital.

Think: normal balance = we owe partner (add). Abnormal = partner owes us (subtract).

9. Quick Recap — Cheat-Sheet

✓ Formation (Jay & Kay)

New business ⇒ no b/d. Assets Dr / capital Cr; liabilities Cr / capital Dr.
Use revalued figures if given, else book value. Write off bad debts (11,100 − 600 = 10,500). Leave out items agreed excluded (Jay’s premises, Kay’s loan).
Goodwill: NDOC – Cr in old ratio (9,000 / 7,200), Dr in new ratio (8,100 / 8,100). Jay +900, Kay −900. Kept in books → only the credit entry, show under intangible NCA.
Answers: capital c/d Jay 39,900, Kay 51,900; total assets 100,800; trade payables 9,000.
Goodwill = intangible asset; excess of purchase price over fair value of net assets; reputation built over years. Only purchased goodwill recorded (prudence + money measurement).

✓ Appropriation & current accounts

Income statement same as sole trader → profit for the year → appropriation a/c → current a/c → SOFP.
Profit + interest on drawings − interest on capital − salaries / bonus / commission = residual profit → share in ratio (loss → add share of loss).
Partner salary → appropriation a/c; employee salary → income statement. Interest on loan → income-statement expense, credited to current a/c; 5 % if rate not given (Partnership Act 1890).
Current a/c: Cr = interest on capital, salaries, bonus, profit share, interest on loan. Dr = drawings, interest on drawings, share of loss, salary drawings (only if paid).
Normal = credit = liability; abnormal = debit = asset (over-withdrawn).
SOFP equity = capital a/cs (fixed) ± current a/cs (credit add, debit deduct) = total partners’ equity.