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

Overview of Partnerships

Understanding financial accounting is essential before diving into partnership accounting. This note covers the fundamental accounting concepts and adjustments that apply to all business entities, including partnerships. These concepts form the foundation you'll need when preparing financial statements for partnerships.

The purpose of business and financial reporting

Every business, whether a sole trader or partnership, has one main aim: to make a profit. To know if a business is achieving this goal, owners and managers need accurate financial information about their operations during a specific period.

Accounting provides a systematic way of organising and recording all business transactions. This organised information helps business owners see whether their business made a profit or suffered a loss during an accounting period.

The accounting process

At the end of each accounting period, accountants prepare a Trial Balance from the General Ledger. However, before the Trial Balance can be used to prepare the final financial statements, certain adjustments must be made to ensure accuracy.

Once adjustments are complete, the information can be used to prepare two key financial statements:

1. Income Statement - Shows whether the business made a profit or loss during the period
2. Balance Sheet - Shows the financial position of the business at the end of the period (what the business owns and owes)

Calculating profit

Business profit is calculated in two stages:

$\text{Gross profit} = (\text{Sales} - \text{Debtors allowances}) - \text{Cost of sales}$

$\text{Net profit} = \text{Gross profit} + \text{Income} - \text{Expenses}$

This two-step calculation helps business owners understand both their trading profit (gross profit) and their overall profit after all expenses (net profit).

Understanding owner's equity

Owner's equity represents the amount the business owes to its owner. You can think of it as the owner's interest or stake in the business.

What are adjustments?

Adjustments are corrections or changes made to account balances at the end of an accounting period. They ensure that financial statements show everything that happened during a specific period according to Generally Accepted Accounting Practice (GAAP).

Why adjustments are necessary

Financial statements must be accurate and show a true picture of the business's financial position. Adjustments are needed because:

• Some transactions begin in one accounting period and end in another (for example, rent paid in advance)
• Certain events or changes may need to be recorded at year-end (like depreciation)
• Errors may need to be corrected
• The business must ensure all assets, liabilities, and owner's equity are recorded at their correct values

Types of adjustments with practical examples

Let's explore common adjustments using examples from a typical business scenario. Understanding these will help you when preparing partnership financial statements.

1. Adjustments to inventories (stock)

Inventory adjustments ensure that the business records the actual stock on hand at the end of the period.

Common inventory adjustments include:

• Merchandise withdrawn by owner - When the owner takes goods for personal use, this reduces trading stock and drawings (the amount the owner has taken from the business)

• Invoices received for merchandise not yet recorded - Sometimes goods arrive near the end of the accounting period, and the invoice hasn't been processed yet. This increases both creditors (what the business owes) and trading stock

• Physical stock count differences - The actual stock counted may differ from the records. The business must adjust the stock value to match the physical count

• Stationery on hand - If the business has unused stationery at year-end, this should be recorded as an asset rather than an expense

2. Adjustments to debtors (accounts receivable)

These adjustments ensure that the business correctly records what customers owe and accounts for debts that may not be collected.

Common debtor adjustments include:

• Payments received but not recorded - Sometimes cash is received from a debtor, but the accounting entry hasn't been made. This must be corrected by reducing debtors and increasing the bank or cash account

• Bad debts written off - When a debtor becomes insolvent (cannot pay), the business must write off the debt

• Provision for bad debts - Businesses create a provision (an estimated amount) for debts that may not be collected

3. Adjustments to salaries and wages

Salary adjustments ensure that all employee costs are correctly recorded.

Common salary adjustments:

• Omitted employee details - If an employee's salary was accidentally left out of the records, it must be added with all components: gross salary, deductions, net salary, and employer contributions

• Employer contributions - Businesses often contribute to employee benefits, and these contributions must be recorded as additional expenses

4. Adjustments to bank accounts

Bank reconciliation often reveals items that appear on the bank statement but haven't been recorded in the business's books.

Common bank adjustments include:

• Bank charges and fees - Items like cash handling fees, service fees, and interest on overdraft appear on the bank statement and must be recorded as expenses

• Stop orders - Automatic payments like insurance premiums may be deducted by the bank but not recorded in the Cash Payments Journal

5. Adjustments to expenses

Expense adjustments ensure that only expenses relating to the current accounting period are included. This is where the matching principle is most clearly applied.

Common expense adjustments:

• Prepaid expenses - When expenses are paid in advance for a future period, they should be treated as an asset, not an expense
• Accrued expenses - Expenses incurred but not yet paid must be recorded
• Stock of supplies - Unused supplies should be treated as assets, not expenses

6. Adjustments to income

Income adjustments ensure that only income earned during the current period is included. Like expense adjustments, these follow the matching principle.

Common income adjustments:

• Accrued income - Income earned but not yet received must be recorded
• Income received in advance - Income received for future periods should be treated as a liability
• Interest on investments - Interest earned on fixed deposits or investments must be calculated and recorded

Understanding the pre-adjustment trial balance

A Pre-adjustment Trial Balance lists all account balances before adjustments are made. It's divided into two main sections:

Balance Sheet accounts section

This includes:

Assets (debit balances):

• Land and Buildings
• Vehicles
• Equipment
• Trading Stock
• Debtors
• Bank
• Cash
• Fixed Deposits

Liabilities (credit balances):

• Capital
• Bank Overdraft
• Creditors
• Loans

Contra-assets (credit balances):

• Accumulated Depreciation
• Provision for Bad Debts

Nominal accounts section

This includes:

Income (credit balances):

• Sales
• Rent Income
• Discount Received

Expenses (debit balances):

• Cost of Sales
• Salaries
• Rates
• Repairs
• Stationery
• Interest on Loan
• Insurance
• Bank Charges
• Bad Debts
• Water and Electricity

Other items:

• Debtors Allowances
• Discount Allowed
• Drawings

How adjustments affect the accounting equation

Every adjustment affects the accounting equation:

$\text{Assets} = \text{Owner's Equity} + \text{Liabilities}$

When making adjustments, you must identify:

1. How assets are affected (increase or decrease)
2. How owner's equity is affected (increase or decrease)
3. How liabilities are affected (increase or decrease)
4. Which specific accounts to debit
5. Which specific accounts to credit

Practical tips for adjustments

Common calculations you'll need:

$\text{Simple interest} = \text{Principal} \times \text{Rate} \times \text{Time}$

$\text{Prepaid expenses} = \text{Total payment} \times \frac{\text{months in next period}}{\text{total months paid}}$

$\text{Accrued expenses} = \text{Amount owed for the current period not yet paid}$

$\text{Provision for bad debts} = \text{Outstanding debtors} \times \text{Percentage}$