Partnerships (Copy)

3.1.2 Partnerships – Cheat Sheet

Key Concepts in Partnerships

1. Goodwill in Partnerships
   • Goodwill: The value of the business over and above its net asset value, due to factors like reputation, customer loyalty, and brand recognition.
   • Purchased Goodwill: Goodwill that is acquired from another business during an acquisition.
   • Inherent Goodwill: Goodwill that exists due to the efforts of the partners, and it is not purchased.

Changes in the Partnership

1. Change in Profit-Sharing Ratio
   • Impact on Goodwill: The existing goodwill should be revalued to reflect the new profit-sharing ratio.
   • Capital Accounts Adjustment: Adjustments are made to partners’ capital accounts to reflect the change in their share of the goodwill.
2. Introduction of a New Partner
   • Goodwill: The new partner may contribute towards goodwill, either by purchasing goodwill or through a capital contribution.
   • Revaluation of Assets: Assets may need to be revalued to reflect their current market value.
   • Capital and Current Accounts: Adjustments to the capital accounts of the existing partners are necessary, and a current account for the new partner is opened.
3. Retirement of an Existing Partner
   • Goodwill: The retiring partner is entitled to their share of the existing goodwill.
   • Revaluation of Assets: Assets should be revalued to reflect current market conditions.
   • Adjustment of Capital Accounts: The retiring partner’s share of capital and goodwill is settled, and their share is transferred to the remaining partners based on the new profit-sharing ratio.
4. Dissolution of a Partnership
   • Realisation Account: The partnership dissolves when the business is closed. A realisation account is used to account for the sale of assets and payment of liabilities.
   • Revaluation Account: Any revaluation of assets before the dissolution is recorded in a revaluation account.

Partnership Accounts

1. Partners’ Capital Accounts
   • Purpose: Used to track the individual contributions of each partner to the capital of the partnership.
   • Adjustments: Changes in the capital accounts can occur due to changes in the profit-sharing ratio, introduction or retirement of partners, or revaluation of assets.
2. Partners’ Current Accounts
   • Purpose: Used to track amounts owed to or by individual partners, typically related to their share of profits, withdrawals, or advances.
   • Adjustments: When goodwill is introduced, or assets are revalued, adjustments may be required in the current accounts.
3. Partnership Appropriation Account
   • Purpose: Allocates the net profit of the partnership among the partners, based on the profit-sharing ratio, after considering the following:
     • Interest on capital: Fixed rate applied to each partner’s capital balance.
     • Salaries: Fixed salaries given to each partner if agreed.
     • Profit Sharing: The remaining profits (or losses) are divided according to the profit-sharing ratio.
4. Statement of Profit or Loss
   • Purpose: This statement shows the income and expenses for the partnership and calculates the net profit or net loss.
5. Statement of Financial Position
   • Purpose: Similar to a balance sheet, it shows the assets, liabilities, and partners’ equity at the end of the financial period. It reflects the final position of the business, including any adjustments for goodwill or revaluation of assets.

Realisation and Revaluation Accounts

1. Realisation Account
   • Purpose: Used when dissolving a partnership to close out the business. It records the sale of assets and settlement of liabilities.
   • Process:
     • Debit: Assets sold and liabilities settled.
     • Credit: Capital accounts of the partners based on their final capital balances.
2. Revaluation Account
   • Purpose: Used to adjust the value of assets during a partnership change (e.g., when a new partner is introduced or a partner retires).
   • Process:
     • Debit: Assets that have decreased in value.
     • Credit: Assets that have increased in value.

Adjustments and Key Considerations

1. Goodwill Adjustments: If goodwill is involved, it may either be written off against the partners’ capital accounts or recorded in the partnership’s books if there is a purchased goodwill.
2. Interest on Capital: If the partnership agreement specifies interest on capital, this will be recorded in the appropriation account. This can be adjusted in the partners’ current accounts.
3. Profit-Sharing Ratio: The new profit-sharing ratio must be agreed upon and applied for future profits. This can be done by:
   • Revaluing assets.
   • Making adjustments to partners’ capital accounts.
   • Calculating goodwill or revaluing goodwill.
4. Salaries and Drawings: If the partnership agreement specifies any partner salaries or drawings, these must be recorded in the appropriation account. Drawings should also be recorded in the current accounts of the partners.
5. Retirement or Death of a Partner: Special adjustments are needed for the retirement or death of a partner. The goodwill, assets, and capital accounts are adjusted to reflect the partner’s exit.

Summary

• The Partnership Appropriation Account allocates profits among partners based on agreed terms, including interest on capital, salaries, and the profit-sharing ratio.
• Goodwill is an important consideration when there is a change in profit-sharing ratio, introduction of a new partner, or retirement of an existing partner.
• Revaluation accounts and realisation accounts are used for adjusting asset values and winding up a partnership.
• Proper preparation of capital accounts, current accounts, and the statement of profit or loss is essential when there are changes in the partnership.