Notes · AccountingUK · A-Levels

Partnership accounts

This chapter applies the double-entry model to partnerships. It covers the partnership agreement and the capital and current accounts, the appropriation of profit between partners (interest on capital, salaries, interest on drawings and the residual share), and the accounting for changes in the partnership - the admission and retirement of a partner, goodwill, the revaluation of assets and, in outline, dissolution.

4 sections~18 min reading time3 competenciesLevel Standard 1 · Advanced 3

T·0888 / 18

Exam profile

AO1 · Understand the accounting for partnerships and the partnership agreementAO2 · Prepare the appropriation account, capital and current accounts and account for admission, retirement and revaluationAO3 · Analyse and evaluate the effect of partnership arrangements and changes on the partners

Operators:preparecalculateexplainappropriateanalyseevaluate

basic level

AS-Level may introduce the appropriation of profit and capital and current accounts.

higher level

The full A-Level expects the appropriation account, current accounts, and the accounting for admission, retirement, goodwill and revaluation.

Depth

Text

Contents · 4 sections

Partnership accounts

The partnership agreement, capital and current accounts#

StandardAQA 7127 3.15

Capital and current account entries

Fig. 1The capital account holds the permanent investment; the current account runs the year's rewards (credits) against the partner's drawings (debits).

A partnership shares its profit between the partners according to their agreement, and the accounts must reflect that agreement precisely. The partnership agreement (deed) typically specifies how much capital each partner contributes, the ratio in which residual profits and losses are shared, whether partners receive interest on their capital (to reward those who invested more), whether any partner receives a salary (to reward those who work more in the business), and whether interest is charged on drawings (to discourage partners from taking money out early). Where the agreement is silent on a point, the Partnership Act 1890 defaults apply - equal profit sharing, no salaries, no interest on capital, and interest allowed on loans (not capital) made to the firm.

Partnerships keep two accounts for each partner, and distinguishing them is essential. The capital account records the partner's permanent, long-term investment in the firm - the capital they contributed - and is usually kept 'fixed', changing only when a partner permanently increases or reduces their capital or on admission, retirement or revaluation. The current account records the partner's short-term, running transactions with the firm: it is credited with their share of profit, interest on capital and any salary, and debited with their drawings and interest on drawings. Keeping capital fixed and running the year-to-year entries through the current account keeps the permanent stake separate from the fluctuating one.

The current account is therefore where each partner's share of the year's rewards accumulates against what they have drawn out. A credit balance on a current account means the firm owes the partner (they have left profit in the business); a debit balance means the partner owes the firm (they have drawn out more than they earned), which can be a warning sign. In the statement of financial position, the capital accounts and the current accounts together make up the partners' total interest in the firm, replacing the single capital figure of a sole trader. Both must be shown, because they tell different stories - the permanent investment and the accumulated undrawn profit.

This structure reflects the underlying reality that a partnership is a relationship between individuals who have invested and worked in different amounts and want to be rewarded fairly for each. Interest on capital rewards investment, a salary rewards work, the residual share rewards risk-bearing and enterprise, and interest on drawings discourages premature withdrawals - so the appropriation of profit (the next section) is really a mechanism for translating the partners' agreement about fairness into figures. Understanding what each element is for makes the mechanics of the appropriation account and the current accounts far easier to handle correctly.

Worked example

Classifying entries to the partners' accounts

For a partner, state whether each item goes to the capital account or the current account, and on which side: (a) additional permanent capital paid in; (b) share of this year's profit; (c) drawings; (d) interest on capital.

Permanent capital
Additional permanent capital paid in goes to the capital account, credited (it increases the partner's permanent investment).
Profit share and interest on capital
The share of profit and the interest on capital are rewards for the year, credited to the current account.
Drawings
Drawings are amounts taken out during the year, debited to the current account (they reduce what the firm owes the partner).

Result: Permanent capital -> capital account (credit); share of profit and interest on capital -> current account (credit); drawings -> current account (debit) - the capital account holds the permanent stake, the current account the running rewards and withdrawals.

Typical mistakes

Putting drawings or the share of profit through the capital account instead of the current account.
Assuming interest on capital or salaries apply when the agreement does not provide for them.

Active revision

Explain the difference between a partner's capital account and current account, and state which items are recorded in each.

Active recall

Recall the key points — then reveal.

Sources: AQA A-level Accounting 7127 specification (AQA)

The appropriation of profit#

AdvancedAQA 7127 3.15

The appropriation account

Fig. 2The appropriation account shares the £60,000 net profit: after interest on drawings, interest on capital and B's salary, the residual £48,800 is split 3:2 (A £29,280, B £19,520).

The appropriation account is prepared after the income statement and shows how the net profit is divided between the partners according to their agreement. It is not part of calculating the profit - the profit has already been found - but part of sharing it out. The account starts with the net profit for the year, adds any interest charged on partners' drawings (which comes back into the pool to be shared), then deducts the interest on capital and any partners' salaries (the prior claims each partner is entitled to before the residue is split), leaving the residual profit. The residual profit is then divided between the partners in their agreed profit-sharing ratio.

A worked appropriation makes the order clear. Suppose the net profit is £60,000 for partners A and B, who share residual profits 3:2. The agreement gives interest on capital of 5% (A's capital £50,000, so £2,500; B's £30,000, so £1,500), a salary to B of £8,000, and charges interest on drawings (A £500, B £300). Starting from £60,000 and adding the interest on drawings (£800) gives £60,800 to appropriate. Deducting interest on capital (£4,000) and B's salary (£8,000) leaves a residual profit of £48,800. Sharing this 3:2, A receives 3/5 x £48,800 = £29,280 and B receives 2/5 x £48,800 = £19,520.

Each figure in the appropriation then flows to the partners' current accounts, and it is worth tracing them through to see the whole picture. A's current account is credited with interest on capital £2,500 and the profit share £29,280, and debited with drawings (say £15,000) and interest on drawings £500; starting from an opening credit balance of £2,000, this gives a closing balance of £18,280 credit. B's current account is credited with interest on capital £1,500, the salary £8,000 and the profit share £19,520, and debited with drawings (say £12,000) and interest on drawings £300; from an opening £1,000 credit, this gives £17,720 credit. The total appropriated back to the partners equals the net profit, because the interest on drawings that was added in is exactly recovered from the partners.

The appropriation account is where the fairness embedded in the agreement is made concrete, and interpreting it is instructive. A partner who contributes more capital is compensated through interest on capital; one who works more through a salary; the residual, shared in the profit-sharing ratio, rewards the partners for the risk and enterprise of the business. Errors here usually come from the wrong order (deducting the salary and interest before adding interest on drawings, or sharing the whole net profit instead of the residual) or from applying the profit-sharing ratio to the wrong figure. Working methodically down the account - net profit, add interest on drawings, deduct interest on capital and salaries, share the residual - and then posting each element to the correct current account, is what secures the marks.

\text{Residual profit} = \text{Net profit} + \text{Interest on drawings} - \text{Interest on capital} - \text{Salaries}

Residual profit

The residual is shared in the profit-sharing ratio. Here 60,000 + 800 - 4,000 - 8,000 = 48,800.

Partners' current accounts

Fig. 3The appropriation flows to the current accounts: A closes at £18,280 credit and B at £17,720 credit after their drawings and interest on drawings.

Worked example

Preparing the appropriation account

A and B share residual profits 3:2. Net profit is £60,000. Interest on capital is A £2,500 and B £1,500; B has a salary of £8,000; interest on drawings is A £500 and B £300. Prepare the appropriation and each partner's total share.

Profit available to appropriate
Net profit £60,000 + interest on drawings (£500 + £300 = £800) = £60,800.
Deduct prior claims
Less interest on capital (£2,500 + £1,500 = £4,000) and B's salary (£8,000): residual profit = £60,800 - £12,000 = £48,800.
Share the residual
A: 3/5 x £48,800 = £29,280. B: 2/5 x £48,800 = £19,520. A's total credit = interest £2,500 + share £29,280 = £31,780 (less £500 interest on drawings); B's = interest £1,500 + salary £8,000 + share £19,520 = £29,020 (less £300).

Result: The residual profit of £48,800 is shared £29,280 to A and £19,520 to B; with interest on capital and B's salary added, and interest on drawings deducted, the appropriation exactly distributes the £60,000 net profit.

Typical mistakes

Sharing the whole net profit instead of the residual after interest and salaries.
Deducting interest on drawings instead of adding it back into the pool of profit to be shared.

Active revision

Net profit £60,000; interest on capital A £2,500, B £1,500; B's salary £8,000; interest on drawings A £500, B £300; residual shared 3:2. Prepare the appropriation account and each partner's share.

Active recall

Recall the key points — then reveal.

Sources: AQA A-level Accounting 7127 specification (AQA)

Admission, retirement and goodwill#

AdvancedAQA 7127 3.15

Goodwill adjustment on admission

Fig. 4Goodwill created in the old ratio (3:2) and written off in the new (2:2:1) passes £6,000 from the incoming partner C to A - compensating the old partners without leaving goodwill on the books.

When a partner joins or leaves, the partnership is in effect dissolved and reformed, and the accounts must deal fairly with the value built up under the old arrangement - above all with goodwill. Goodwill is the value of the business over and above its identifiable net assets: its reputation, customer base, established name and expertise, built up over years by the existing partners. When a new partner is admitted, they will share in future profits that this goodwill helps to generate, so it is only fair that they contribute to the goodwill the old partners created; conversely, a retiring partner should be compensated for the share of the goodwill they helped build. Accounting for goodwill on a change of partners is how this fairness is achieved.

The standard method, where goodwill is not to remain in the books, has two steps. First, goodwill is valued and created in the accounts by crediting the old partners' capital accounts in the old profit-sharing ratio (debiting a goodwill account) - this recognises the goodwill as belonging to the partners who built it. Second, immediately afterwards, the goodwill is written off by debiting all the partners' capital accounts (including the new partner) in the new profit-sharing ratio (crediting the goodwill account) - so the goodwill does not remain as an asset, but the adjustment has passed value from the incoming partner to the outgoing arrangement. The net effect on each partner's capital account is what matters.

A worked example shows the transfer of value. Goodwill is valued at £30,000; the old partners A and B shared 3:2; a new partner C is admitted and the new ratio is A:B:C = 2:2:1. Creating goodwill credits A £18,000 and B £12,000 (old ratio 3:2). Writing it off debits A £12,000, B £12,000 and C £6,000 (new ratio 2:2:1). The net effect is A +£6,000, B nil, and C -£6,000. In substance, C has contributed £6,000 for the share of the accumulated goodwill they now enjoy, and that £6,000 has passed to A (whose share of profits fell most on admission). The mechanism compensates the existing partners without leaving goodwill on the statement of financial position.

The same principle governs a partner's retirement, and evaluating these adjustments is about fairness between the partners. On retirement, goodwill is created in the old ratio (crediting the retiring partner with their share, so they are paid for the goodwill they helped build) and, if it is not to remain, written off in the new ratio among the continuing partners. The amount due to a retiring partner - their capital, their current-account balance and their share of goodwill and of any revaluation surplus - may be paid out or, often, left as a loan to the firm. These adjustments can significantly change each partner's stake, so a good answer explains not just the mechanics but who gains and who loses, and why the treatment is a fair recognition of the value each partner contributed or takes away.

Worked example

Goodwill on the admission of a partner

A and B share profits 3:2. They admit C and change the ratio to 2:2:1. Goodwill is valued at £30,000 and is not to remain in the books. Show the goodwill adjustment and its net effect on each capital account.

Create goodwill in the old ratio
Credit the old partners 3:2: A = 3/5 x £30,000 = £18,000; B = 2/5 x £30,000 = £12,000. (Debit the goodwill account £30,000.)
Write off goodwill in the new ratio
Debit all partners 2:2:1: A = 2/5 x £30,000 = £12,000; B = £12,000; C = 1/5 x £30,000 = £6,000. (Credit the goodwill account £30,000.)
Net effect
A: +£18,000 - £12,000 = +£6,000. B: +£12,000 - £12,000 = £0. C: £0 - £6,000 = -£6,000. C effectively pays £6,000 for the goodwill share, which passes to A.

Result: The net effect is A +£6,000, B nil and C -£6,000: the incoming partner contributes £6,000 for the goodwill they now share, compensating A, and no goodwill remains on the statement of financial position.

Typical mistakes

Creating and writing off goodwill in the same ratio (which cancels out and transfers nothing), instead of old then new ratio.
Leaving goodwill on the statement of financial position when the agreement is to write it off.

Active revision

Goodwill is £30,000. Old partners A and B share 3:2; C is admitted and the new ratio is 2:2:1. Show the net effect on each partner's capital account of creating and writing off the goodwill.

Active recall

Recall the key points — then reveal.

Sources: AQA A-level Accounting 7127 specification (AQA)

Revaluation of assets and dissolution#

AdvancedAQA 7127 3.15

The revaluation account

Fig. 5The revaluation account: the £20,000 rise in premises less the £3,000 inventory write-down and £2,000 higher allowance gives a £15,000 profit, shared to the old partners 3:2 (A £9,000, B £6,000).

When partners change, the assets are usually revalued to their current worth so that any gain or loss belongs to the partners who owned the business while that change in value occurred - the existing partners, in the old ratio - rather than being shared with an incoming partner who had no part in it. A revaluation account is opened: increases in asset values and decreases in liabilities are credited to it, and decreases in asset values and increases in provisions (such as a larger allowance for doubtful debts) are debited to it. The balance is the profit or loss on revaluation, which is transferred to the existing partners' capital accounts in the old profit-sharing ratio.

A worked revaluation shows the mechanics. Suppose on admitting a new partner the premises are revalued upward by £20,000, inventory is written down by £3,000, and the allowance for doubtful debts is increased by £2,000. The revaluation account is credited with the £20,000 increase in premises and debited with the £3,000 fall in inventory and the £2,000 increase in the allowance, leaving a credit balance - a revaluation profit - of £20,000 - £3,000 - £2,000 = £15,000. This £15,000 is shared between the existing partners A and B in their old 3:2 ratio: A £9,000 and B £6,000, credited to their capital accounts. The incoming partner does not share this gain, because it accrued before they joined.

Dissolution is the ending of the partnership altogether - because the partners decide to stop, or the business fails - and, though the specification requires only an awareness of the process, it is worth understanding its shape. On dissolution a realisation account is used: the assets (other than cash) are transferred to it at book value, they are then sold and the proceeds credited to it, the costs of dissolution are debited, and the balance is the profit or loss on realisation, shared between the partners in their profit-sharing ratio. The cash raised is then applied in a set order: to pay the external liabilities first, then any partners' loans, and finally to repay the partners' capital and current-account balances.

Where a partner's capital account is left with a debit balance after the realisation - meaning they owe the firm - they must bring in cash to clear it; and if a partner cannot pay (is insolvent), the deficiency is borne by the solvent partners under the rule in Garner v Murray, in proportion to their last agreed capitals. For A-Level purposes the emphasis is on understanding that dissolution winds the firm up fairly, paying outsiders before insiders and sharing gains and losses by the agreed ratio, rather than on the fine detail. In evaluation, all these adjustments - goodwill, revaluation, the order of payment on dissolution - exist to ensure that when a partnership changes or ends, each partner receives or bears exactly the value they are entitled to under the agreement and the law, which is the recurring theme of partnership accounting.

\text{Profit on revaluation} = \text{Increases in net assets} - \text{Decreases in net assets}

Revaluation profit

Shared among the existing partners in the old ratio. Here 20,000 - 3,000 - 2,000 = 15,000.

Worked example

Preparing a revaluation account

Before admitting a new partner, A and B (who share 3:2) revalue their assets: premises up £20,000, inventory down £3,000, and the allowance for doubtful debts increased by £2,000. Prepare the revaluation account and share the outcome.

Credit the increases
The £20,000 rise in premises is credited to the revaluation account (an increase in net assets).
Debit the decreases
The £3,000 fall in inventory and the £2,000 increase in the allowance for doubtful debts are debited (decreases in net assets).
Find and share the profit
Revaluation profit = £20,000 - £3,000 - £2,000 = £15,000. Shared in the old 3:2 ratio: A = 3/5 x £15,000 = £9,000; B = 2/5 x £15,000 = £6,000, credited to their capital accounts.

Result: The revaluation profit is £15,000, shared £9,000 to A and £6,000 to B in their old 3:2 ratio - so the gain accruing before the change belongs to the partners who owned the business when it arose.

Typical mistakes

Sharing the revaluation profit in the new ratio or with an incoming partner, instead of the old partners' ratio.
On dissolution, repaying partners before external liabilities are settled.

Active revision

On admitting a partner, premises are revalued up £20,000, inventory down £3,000 and the allowance for doubtful debts raised by £2,000. Prepare the revaluation account and share the result between the old partners A and B (3:2).

Active recall

Recall the key points — then reveal.

Sources: AQA A-level Accounting 7127 specification (AQA) · Ofqual - GCE AS and A level qualifications (Ofqual)

References & sources

Sources

AQA

AQA A-level Accounting 7127 specification

Ofqual

Ofqual - GCE AS and A level qualifications

Partnership accounts

4 sections~18 min reading time3 competenciesLevel Standard 1 · Advanced 3

Partnership accounts

Key points

Classifying entries to the partners' accounts

Key points

Preparing the appropriation account

Key points

Goodwill on the admission of a partner

Key points

Preparing a revaluation account

Sources

Partnership accounts

Key points

Classifying entries to the partners' accounts

Key points

Preparing the appropriation account

Key points

Goodwill on the admission of a partner

Key points

Preparing a revaluation account

Sources