Financial Statements of Partnerships (Grade 11 NSC Matric Accounting): Revision Notes

Financial Statements of Partnerships

Introduction to partnership accounting

When preparing financial statements for partnerships, the fundamental accounting rules remain the same as for any other business type. Whether you're dealing with a sole trader, partnership, or company, the accounting cycle and accounting equation still apply. Partners are entitled to the profits earned by the business, and their investment is reflected in the owner's equity section of the balance sheet.

The key differences between partnerships and sole traders lie in two main areas:

• How profits are distributed among the partners
• The structure of owner's equity in the financial statements

Understanding these differences is essential for correctly preparing partnership financial statements.

The appropriation account

What is appropriation?

Appropriation refers to the process of sharing out the net profit among partners. Unlike a sole trader who keeps all the profit, partnerships must divide the profit according to an agreed formula.

In a sole trader business, the net profit from the Trading and Profit & Loss accounts goes directly to the owner's Capital account. However, in a partnership, the net profit is first transferred to a special account called the Appropriation Account.

Purpose of the appropriation account

Components of profit distribution

The partnership agreement typically includes details about four main ways that profits are shared:

1. Interest on capital

Partners who invest more money in the business receive interest on their capital contribution. This compensates partners fairly for the different amounts they have invested. For example, if Partner A invests R500,000 and Partner B invests R300,000, Partner A should receive more interest because they have contributed more capital to the business.

The interest rate (expressed as a percentage per annum or "p.a.") is agreed upon when the partnership is formed.

2. Salaries of partners

Partners who work actively in the business may receive a salary. This is not the same as an employee's salary - it's actually part of the profit distribution. The salary recognises that some partners contribute more time and effort to running the business than others.

For instance, one partner might work full-time managing the shop while another partner only helps with bookkeeping on weekends. The full-time partner would typically receive a higher salary allocation.

3. Bonuses to partners

Some partnership agreements include bonuses as an incentive for partners who achieve specific targets or contribute exceptional effort. Like salaries, bonuses are not expenses of the business - they are part of how the profit is shared out.

4. Share of remaining profit

After allocating interest, salaries, and bonuses, any profit that remains is divided among the partners according to an agreed profit-sharing ratio. This might be equal (50:50 for two partners) or unequal (perhaps 60:40 or 75:25) depending on what the partners have agreed.

Calculating a partner's total earnings

You can work out how much each partner earns from the business using this formula:

$\text{Earnings of partner} = \text{Interest on capital} + \text{Salary} + \text{Bonus} + \text{Share of remaining profit}$

This total amount represents the partner's share of the business profits for the year.

Partner accounts explained

Each partner has two separate accounts in the books of the partnership:

Capital accounts

The Capital Account shows the permanent investment that each partner has made in the business. This account normally doesn't change much from year to year unless:

• A partner invests additional capital
• A partner withdraws some of their capital
• The partnership agreement states that profit should be added to capital

The Capital Account remains fairly stable and shows each partner's long-term commitment to the business.

Current accounts

The Current Account is more active and shows the running total of what the business owes to each partner. This account tracks:

• Credits (increases): The partner's share of profits (their earnings calculated using the formula above)
• Debits (decreases): Money withdrawn by the partner (called drawings)
• Opening balance: What was owed to or by the partner at the start of the year

At the end of each accounting period, the partner's earnings from the Appropriation Account are transferred to their Current Account. If the partner takes out more money than they've earned, their Current Account might show a debit balance, meaning they owe money to the partnership.

Drawings accounts

Drawings represent money or goods that partners take out of the business for personal use. Throughout the year, these withdrawals are recorded in each partner's Drawings account. At year-end, the total drawings are transferred to the partner's Current Account to reduce the amount owed to them.

Owner's equity in partnerships

The owner's equity section of a partnership balance sheet looks different from a sole trader's because it must show each partner's interest separately.

The formula for owner's equity

For each partner, their total equity (ownership interest) in the business is calculated as:

$\text{Owner's equity} = \text{Capital of partner} + \text{Balance of current account}$

This can also be shown as:

$\text{Owner's equity} = \text{Capital} + (\text{Previous balance} + \text{Earnings} - \text{Drawings})$

This formula tells us that a partner's equity consists of:

• Their permanent capital contribution
• Plus any profits earned but not yet withdrawn
• Minus any drawings taken out

Financial statements for partnerships

Partnerships prepare the same basic financial statements as sole traders, but with some important modifications:

1. Trading and profit & loss accounts

These accounts are prepared in the normal way to calculate the net profit for the accounting period. The format and content are identical to a sole trader's final accounts.

2. Appropriation account

This additional statement shows how the net profit is divided among the partners. It includes:

• The net profit figure (brought forward from the Profit & Loss account)
• Interest on capital for each partner
• Salaries for each partner
• Bonuses for each partner
• The remaining profit split according to the profit-sharing ratio

3. Balance sheet

The balance sheet shows the financial position of the partnership, with the owner's equity section displaying each partner's capital and current account separately. This provides transparency about each partner's stake in the business.

4. Notes to financial statements

Like any business, partnerships must provide additional disclosure notes explaining details about:

• Inventories
• Trade and other receivables
• Trade and other payables
• Fixed assets and depreciation
• Loans and their classification (current vs. non-current)

Worked example: NM Stores

Let's look at how this works in practice using the NM Stores partnership between Mphendulo Ntuli and Themba Mathe.

Preparing the capital accounts

Capital Account: Ntuli	Debit (R)	Credit (R)
Balance b/d		550,000
Bank (vehicle)		100,000
Balance c/d	650,000
	650,000	650,000
Balance b/d		650,000

Capital Account: Mathe	Debit (R)	Credit (R)
Balance b/d		430,000
Bank (withdrawal)	20,000
Balance c/d	410,000
	430,000	430,000
Balance b/d		410,000

Preparing the current accounts

Current Account: Ntuli	Debit (R)	Credit (R)
Drawings	90,000	Balance b/d
Balance c/d	92,875	Appropriation (earnings)
	182,875
		Balance b/d

Current Account: Mathe	Debit (R)	Credit (R)
Balance b/d	1,200
Drawings (cash)	150,000
Drawings (stock)	18,000
Balance c/d		15,925
	169,200	Appropriation (earnings)
		Balance b/d

Important considerations when preparing partnership statements

Common adjustments in partnerships

Just like sole traders, partnerships must process various adjustments before finalising their financial statements:

• Stock adjustments: Stocktake results must be recorded, and closing stock valued correctly at the lower of cost or net realisable value
• Accruals and prepayments: Expenses and income must be matched to the correct period using the accrual basis of accounting
• Depreciation: Fixed assets must be depreciated according to the business policy (e.g., 20% per annum on diminishing balance)
• Bad debts: Specific debts must be written off and provision for bad debts adjusted to the appropriate level
• Interest calculations: Interest on capital, interest on drawings, and interest on loans must all be calculated and recorded correctly

Recording partner transactions

Some common transactions requiring careful attention include:

Partner contributions of assets:

When a partner contributes an asset (like the vehicle in our example):

• Debit: Asset account (e.g., Vehicles)
• Credit: Partner's Capital Account

Capital withdrawals:

If a partner reduces their permanent investment:

• Debit: Partner's Capital Account
• Credit: Bank

Goods for own use:

Partners taking goods from stock:

• Debit: Drawings
• Credit: Trading Stock (at cost price)
• This also requires an adjustment to Cost of Sales

Cash drawings:

Money withdrawn for personal use:

• Debit: Drawings
• Credit: Bank

At year-end, all drawings are transferred:

• Debit: Current Account
• Credit: Drawings

Salary treatment in partnerships

Classification in financial statements

When preparing notes to the financial statements, remember the correct classification:

Current assets include:

• Inventories (trading stock, stationery)
• Trade and other receivables (debtors less provision for bad debts, prepaid expenses, accrued income)
• Cash and cash equivalents (petty cash, cash float, bank accounts in credit)

Non-current assets include:

• Property, plant and equipment (land and buildings, vehicles, equipment, furniture)
• Less: Accumulated depreciation
• Fixed deposits maturing after 12 months
• Long-term investments

Current liabilities include:

• Trade and other payables (creditors, accrued expenses, prepaid income)
• Bank overdraft
• SARS (PAYE owing)
• Pension fund contributions owing
• Current portion of long-term loans (amount due within 12 months)

Non-current liabilities include:

• Long-term loans (portion due after more than 12 months)
• Mortgage bonds

Loan classification example

Exam tips and common mistakes

Exam tips

1. Read the partnership agreement carefully: Make sure you understand exactly how profits should be divided. Look for details about interest rates, salaries, bonuses, and profit-sharing ratios.

2. Show all workings: When calculating interest on capital or salaries, show your calculations step-by-step. This helps you earn method marks even if you make a small error.

3. Watch out for mid-year changes: Salary increases or changes in capital during the year require split calculations. Calculate amounts separately for the period before and after the change.

4. Balance your appropriation account: The total appropriation must equal the net profit. If they don't balance, you've made an error.

5. Remember the correct signs: Current accounts can be either debit or credit balances. A credit balance means the business owes the partner; a debit balance means the partner owes the business.

6. Don't forget adjustments: Before preparing the appropriation account, make sure all adjustments have been processed, including partner drawings of stock and additional capital contributions.

7. Classify loans correctly: Long-term loans must be split between current liabilities (amount payable within 12 months) and non-current liabilities (amount payable after 12 months).

Common mistakes to avoid

Summary