topic 14 financial statements of partnerships

• A partnership is a business that has more than one owner but is not a limited liability company
• The partnership act 1980 is the most important and the most important terms for our purposes are:

  • a partnership has a minimum of two but since 2002 no legal maximum
  • can be formed in two ways: with a deed of partnership and without a deed of partnership
• Where a deed of partnership exits it must contain:

  • capital contributed by each partner
  • interest on drawings
  • interest on capital
  • any salaries
  • the ratio in which profits or losses are to be shared
• When there is no deed of partnership:

  • no interest on capital or drawings
  • no salaries
  • profits or losses are shared equally
  • partners are entitled to interest at 5% per annum on loans made to the partnership
• Advantages of a partnership:

  • more owners means more access to capital than a sole trader
  • banks more willing to lend money as there is more security for the loans
  • decisions can be discussed
  • some partners have specialist skills
  • suppliers may be more willing to sell on credit because there are a number of owners to turn to if the business cannot pay
• Disadvantages of a partnership:

  • profits must be shared with partners
  • unlimited liability
  • any agreement made by one partner binds them all
  • if a partnership fails and one partner cannot pay towards its debts the other partners must pay
• The financial statements:

  • up to profit (loss) for the year a partnership income statement is the same as that of a sole trader
  • the profit (loss) for the year must then be shared between the partners according the terms of any deed of partnership in an appropriation account
• The SOFP:

  • the assets and liabilities sections of the partnership's SOFP are the same as that of a sole trader
  • it is the capital section that shows the major differences due to there being more than one owner
• Current account:

  DR - Interest on drawings and bal cd

  CR - Bal bd, salaries, interest on capital and profit share
• In surplus means bal bd is on CR. In deficit means bal bd is on DR side
• Keeping separate capital and current accounts advantages:

  • easy to identify when a partner is overdrawn
  • reduces risk to other partners
  • easy to calculate interest on capital
  • capital accounts are change only when there is a change in the partnership agreement
• Keeping separate capital and current account disadvantages:

  • possibly extra work - another account to prepare
  • only worth doing if the partnership agreement includes 'interest on capital'
• Assess the disadvantages of a business remaining as a sole trader:

  • more owners mean that a partnership will have access to more capital than a sole trader
  • less likely to receive loans - less security
  • decisions can't be discussed with partners
  • partners could have specialist skills - sole trader will be restricted to only their skills
  • some suppliers may not be willing to sell on credit because there is only 1 owner to turn to if the business can not pay
• Assess the benefits to a partnership of maintaining separate capital and current accounts:

  • easy to identify when a partner is overdrawn
  • reduces risk to other partners (if one partner can't pay up)
  • easy to calculate interest on capital
  • capital accounts are changed only when there is change in the partnership agreement and therefore isn't that burdensome
• Explain the implications to a partnership of not drawing up a formal partnership agreement:

  • no interest on capital or drawings
  • no salaries to partners
  • profits or losses are shared equally
  • partners are entitled to interest at 5% per annum on loans made to the partnership
• Explain the difference between the capital account and the current account of a partner - Current account is a personal accounting record of each partners short term financial balance within the partnership based on what they are each owed eg. interest on capital, salaries, profit share and what they each owe eg. drawings/interest on drawings. Capital account is a fixed account which records long term investment each partner has contributed and accumulated within the partnership