This article concentrates on the preparation of partnership financial statements.
There are no material differences between UK and international practice in partnership accounts apart from minor variations in terminology and format. This article uses international terminology. For students taking the UK paper the conversion is:
International term UK equivalent
Income statement Profit and loss account
Statement of division of profit Appropriation account
Differences between sole traders' accounts and partnership accounts
If you can handle the financial statements of sole traders, with adjustments for accruals, prepayments, depreciation and the like, it is an easy matter to add the requirements for partnership accounts. The differences are:
1. Balance sheet
(a) There is a separate capital account for each partner instead of just the one required for a sole trader
(b) We often maintain a separate current account for each partner, recording drawings and profit shares. If this is done, the capital account is only used for 'capital' transactions such as the introduction of extra long-term capital by partners.
2.Income statement – the division of the net profit among the partners has to be shown. There are several possibilities:
(a) profit is shared in agreed proportions
(b) as (a), but partners are credited with a 'salary' to allow for the work they put into the partnership
(c) as (a) or (b), but partners are credited with 'interest on capital' to allow for differences in the amounts of fixed capital partners have contributed.
It is important to note that partners' salaries and interest on capital are not charges in the main part of the Income statement. They are simply part of the process of dividing up the profit among the partners. The division is shown in the statement of division of profit. This may be presented in a tabular format as shown in the next section.
Preparing partnership financial statements
The main part of the income statement is prepared exactly as for a sole trader.
Points to watch:
(a) Do not put partners' salaries or interest on capital into the main income statement. They belong only in the division of profit statement section.
(b) Do not include drawings anywhere in the income statement or statement of division of profit. Drawings are debited to partners' current accounts.
Statement of division of profit
The easiest format to adopt here is a simple columnar presentation. See Figure 1 below (figures invented). Points to watch:
(a) One partner may guarantee that another partner's total profit share is not less than a certain minimum amount. To deal with this, make a transfer from one column to another in the tabulated statement.
(b) Changes to the profit-sharing arrangements or changes in partnership personnel part way through the year. You have to divide the profit on a time basis between the periods, then apply the details given to the apportioned profits. Remember to take half a year's salary for a half-year period. Your table then shows the total profit shares for the year calculated for the two periods involved.
(c) Change in partnership personnel part way through the year, with an agreement that certain expenses charged in the income statement relate to one part of the year only. This is a variation on (b) above and always causes problems for candidates. What you have to realise is that for the partners not bearing the expense, the profit is that shown by the income statement plus the special expense. You have to split that increased profit among the partners, then deduct the special expense from the partners who are to bear it.