Which item is recorded on the credit side of partner’s current accounts : *
1 point
On the debit side of Partners’ Current Account
On the debit side of Partners’ Capital Account
On the credit side of Partners’ Current Account
None of the above
Answers
Answer:
There are a number of ways in which a partnership may be defined, but there are four key elements.
Two or more individuals
A partnership includes at least two individuals (partners). In certain jurisdictions, there may be an upper limit to the number of partners but, as that is a legal point, it is not part of the FA2 syllabus.
Business arrangement
A partnership exists to carry on a business.
Profit motive
As it is a business, the partners seek to generate a profit.
Unincorporated business entity
A partnership is an unincorporated business entity. That means:
the reporting entity (business entity) principle applies to a partnership, so for accounting purposes, the partnership is a separate entity from the partners;
the partners have unlimited liability; and
if the partnership is unable to pay its liabilities, the partners may be called upon to use their personal assets to settle unpaid liabilities of the partnership.
How is a partnership controlled?
It is good practice to set out the terms agreed by the partners in a partnership agreement. While this is not mandatory, it can reduce the possibility of expensive and acrimonious disputes in the future. As a formal agreement is not mandatory, there is no definitive list of what it should contain, but FA2 exams will not go beyond the following:
Share of residual profit
This is the amount of profit available to be shared between the partners in the profit and loss sharing ratio, after all other appropriations have been made. The profit and loss sharing ratio is sometimes simply called the ‘profit sharing ratio’ or ‘PSR’.
Therefore, candidates need to be aware that there is a distinction to be made between the profit for the year (income minus expenses), which is calculated in exactly the same way as for a sole trader and residual profit (the remaining profit after profit for the year has been adjusted by the appropriations in accordance with the partnership agreement).
It is worth pointing out that when a question states the profit or loss sharing ratio, that the proportions are always applied to the residual profit – not the profit for the year.
Appropriations of profit
As there is no requirement for all of the appropriations considered below to be included by a specific partnership, exam questions may only include some of them. That means that you only need to deal with the appropriations referred to in the question.
Another point to remember is that the ‘appropriation account’ is an additional accounting statement that is required for a partnership. For a sole trader, the profit for the year is simply transferred to the credit side of the proprietor’s capital account (the double entry is completed by a debit entry in the statement of profit or loss, resulting in a nil balance on that statement). In the case of a partnership, the statement of profit or loss will still be debited, but the profit will be credited to the appropriation account, rather than the capital account. As each appropriation is dealt with, the double entry is completed through entries in both the appropriation account and the partner’s current account (if current accounts are not maintained by the partnership, the entries will be made in the capital accounts).
Partners’ salaries
In some ways, the term ‘salaries’ is a misleading description. The salaries of employees are business expenses that are written off to the statement of profit or loss, thereby reducing profit for the year. However, as partners are the owners of the business, any amounts that are paid to them under the partnership agreement are part of their share of the profit. As the amount is guaranteed, it must be dealt with through a credit entry in the partner’s account (usually the current account) before the residual profit is shared.
The double entry is completed by a debit entry in the appropriation account.
Interest on capital
Almost always, interest on capital will be paid on partners’ capital balances only – although the balances on the current accounts are actually part of the total capital balance, it is normal to exclude them from the value of capital on which interest is paid.
Paying interest on capital is a means of rewarding partners for investing funds in the partnership as opposed to alternative investments. As such, it reduces the amount of profit available for sharing in the profit and loss sharing ratio. This means that a debit entry is needed in the appropriation account. The double entry is completed by a credit entry in the current account of the partner to whom the salary is paid.
Interest on drawings
Charging interest on drawings is a means of discouraging partners from withdrawing excessive amounts from the business. From this, it follows that interest on drawings is a debit entry in the partners’ current accounts and a credit entry in the appropriation account.
Depending on what the question is testing, it will either provide the amounts of interest on capital and drawings or give details of how to calculate the amounts.