ً ‫رب ِز ْدنِي ِع ْلما‬

ِّ
FINANCIAL ACCOUNTING
PARTNERSHIP
Study Methodology & Class Discipline

• Ensure you attend class with A PEN, A NOTEBOOK AND A CALCULATOR.

• At IBA we follow Blended Learning Methodology, we will make use of online
resources available like videos, MOOCs, etc as a part of our learning.
• Concepts will be thoroughly explained. If you have any questions, please do not
hesitate to ask.
• Some numerical problems may be solved in the class but the responsibility of
attempting remaining exercises and problems rests with the students
• In Accounting, PRACTICE is essential to gauge the concepts clearly.
• You will NOT be allowed to use phones and/or laptops during the class.
• Attendance can be taken at anytime during the class.
• You are NOT allowed to leave the class after the attendance has been taken.
PARTNERSHIP

A partnership is an association of two or more persons to

carry on as co-owners of a business for profit.

The relationship between persons who have agreed to

share the profits of a business carried on by all or any one
of them, acting for all.
• Partnerships are sometimes used in small retail, service, or manufacturing companies.
• Accountants, lawyers, and doctors also find it desirable to form partnerships with other
professionals in the field.
PARTNERSHIP

Partnerships in Pakistan are subject to rules set out in The

Partnership Act 1932.

Persons who have entered into partnership with one another are
called individually partners and collectively a firm and the name
under which their business is carried on is called the firm name.

Partnerships are fairly easy to form.

People form partnerships simply by a verbal agreement or more
formally by written agreement.
WHY Partnership?

Why businesses select the partnership form of

organization?
Characteristics of Partnership

1. ASSOCIATION OF INDIVIDUALS:

Legal Entity
Accounting Entity

2. NOT A SEPARATE ENTITY FOR TAXATION:

Each partner’s share is taxable separately at personal tax rates.

Characteristics of Partnership

3. MUTUAL AGENCY

Each partner acts on behalf of the other partners.

Act of one partner is binding on all other partners.
A wrong act/decision of one partner can put all into a difficult situation.
 Characteristics of Partnership

4. LIMITED LIFE
How Sole Properitorship has limited life?
Corporations have unlimited life.
Partnership also has limited life, how?
• Acceptance of a new partner
• Withdrawal of a partner
• Death of a partner
• Incapacity of a partner
Partnership dissolution occurs whenever a partner withdraws or a new partner is
admitted.
Dissolution does not mean that the business has to end, if partners agree they can
continue operations under a anew partnership agreement
Characteristics of Partnership

5. UNLIMITED LIABILITY
Each partner is personally and individually liable for all partnership liabilities
If partnership assets are insufficient, the claims are then attached to personal
assets of the partners, irrespective of the % of ownership of the partner in the
business.
Each partner is responsible for all the debts of the partnership, each partner is said
to have unlimited liability.
• Shop invested in a partnership worth 3.5M
• Partnership is being dissolved
• My share 5M PKR
• Shop worth is 4.5M PKR
• Shop 4.5M + 0.5M worth assets/cash
Characteristics of Partnership

6. Co-Ownership of Assets
Partners jointly own partnership assets.
If the partnership is dissolved, each partner has a claim on total assets equal to the
balance in his or her respective capital or as they have declared in the partnership
agreement.
This claim does not attach to specific assets that an individual partner invests. If a
partner invests a building/shop/machinery in the partnership and if later it is sold
as a gain then that gain will be shared by all partners as agreed.
Partnership net income (or net loss) is also co-owned.
If the partnership contract does not specify to the contrary, all net income or net
loss is shared equally by the partners.
 ADVANTAGES OF PARTNERSHIP
Advantages of a partnership include that:
• Better decision-making. Two heads (or more) are better than one. Compared
with operating on your own, in a partnership the business benefits from the
unique perspective brought by each partner. In business, very often two heads
really are better than one, with the combined conclusion of debating a situation
far better than what each partner could have achieved individually.
• Easy to get started. Business is easy to establish and start-up costs are low
• more capital is available for the business
• you’ll have greater borrowing capacity
• high-calibre people can be made partners
• there is opportunity for income splitting, an advantage of particular importance
due to resultant tax savings
 ADVANTAGES OF PARTNERSHIP
Advantages of a partnership include that:
• Privacy. Partners’ business affairs are private i.e. there is limited external
regulation. Compared to a limited company, the affairs of a partnership business
can be kept confidential by the partners. By contrast, in a limited company
certain documents are available for public inspection at Companies House and a
company’s shareholders can choose to inspect various registers and other
documents the company is required to keep.
• it’s easy to change your legal structure later if circumstances change.
• Partners can share out tasks, with each specialising in areas they’re best at and
enjoy most. So if one partner has a financial background, they could focus on
maintaining the company books, while another may have previously worked
extensively in sales and therefore take ownership of that side of the business.
 ADVANTAGES OF PARTNERSHIP
Advantages of a partnership include that:
• Less formal with fewer legal obligations
• The accounting process is generally simpler for partnerships than for limited
companies.
• There are also fewer records to maintain: in particular, a business partnership
does not need to maintain a set of statutory books like a limited company has to.
• Sharing the burden. Compared to operating on your own as a sole trader, by
working in a business partnership you can benefit from companionship and mutual
support. Starting and managing a business alone can feel stressful and daunting,
particularly if you’ve not done it before. In a partnership, you’re in it together.
• Access to knowledge, skills, experience and contacts. Each partner will bring their
own knowledge, skills, experience and contacts to the business, potentially giving
it a better chance of success than any of the partners trading individually.
 ADVANTAGES OF PARTNERSHIP
Advantages of a partnership include that:
• Easy access to profits. In a business partnership, the profits of the business are
shared between the partners. They flow directly through to the partners’ personal
tax returns rather than initially being retained within the partnership. In a limited
company, by contrast, profits are retained by the company until paid out, whether
as salaries under PAYE or, with the approval of shareholders, as dividends.
• Ownership and control are combined. In a limited company, ownership and day to
day management of the business is split between shareholders and directors. That
can mean that directors are constrained by shareholder preferences in pursuing
what they see as the best interests of the business. By contrast, in a business
partnership, the partners both own and control the business. As long as the
partners can agree how to operate and drive forward the partnership, they’re free
to pursue that without interference from any shareholders. This can make a
partnership business potentially more flexible than a limited company, with the
ability to adapt more quickly to changing circumstances.
 DISADVANTAGES OF PARTNERSHIP
Disadvantages of a partnership include that:
• A business partnership has no independent legal existence distinct from the
partners. By default, unless a partnership agreement with alternative provisions is
put in place, it will be dissolved upon the resignation or death of one of the partners.
This possibility can cause insecurity and instability, divert attention from developing
the business and will often not be the preferred outcome of the remaining partners.
Even if a partnership agreement is in place, the remaining partners may not be in a
position to purchase the outgoing partner’s share of the business. In that case, the
business will likely still need to be dissolved.
• Perceived lack of prestige. Like a sole trader, the partnership business model often
appears to lack the sense of prestige more associated with a limited company.
Especially given their lack of independent existence aside from the partners
themselves.
DISADVANTAGES OF PARTNERSHIP

Disadvantages of a partnership include that:

• Unlimited liability. Again because the business does not have a separate legal
personality, the partners are personally liable for debts and losses incurred. So if
the business runs into trouble your personal assets may be at risk of being seized
by creditors, which would generally not be the case if the business was a limited
company.
The partners are jointly and severally liable. As one partner can bind the
partnership, you can effectively find yourself paying for the actions of the other
partners. If your partners are unable to settle debts, you’ll be responsible for doing
so. In an extreme example where you only own 10% of the partnership, if your
partners have no assets you might end up having to settle 100% of the debts of the
partnership and need to sell your possessions in order to do so. The liability of the
partners for the debts of the business is unlimited. Each partner is ‘jointly and
severally’ liable for the partnership’s debts; that is, each partner is liable for their
share of the partnership debts as well as being liable for all the debts
DISADVANTAGES OF PARTNERSHIP

Disadvantages of a partnership include that:

• there is a risk of disagreements and friction among partners and management
• each partner is an agent of the partnership and is liable for actions by other partners
• if partners join or leave, you will probably have to value all the partnership assets
and this can be costly.
• Impermanence Partnerships can appear to be temporary enterprises, although many
partnerships are in fact very long-lasting.
This appearance of impermanence, and the fact that the partnership’s financials cannot
be independently checked at Companies House, can appear to present more risk.
Because of this, some clients (more so in certain industries) will prefer to deal with a
limited company and even refuse to transact with a partnership business.
 DISADVANTAGES OF PARTNERSHIP
Disadvantages of a partnership include that:
•Limited access to capital
•While a combination of partners is likely to be able to contribute more capital than a sole trader,
a partnership will often still find it more difficult to raise money than a limited company.
Banks may prefer the greater accounting transparency, separate legal personality and sense of
permanence that a limited company provides. To the extent that a partnership business is seen as
higher risk, a bank will either be unwilling to lend or will only do so on less generous terms.
Several other forms of long-term finance are not available to partnerships. Most importantly, they
cannot issue shares or other securities in exchange for investment in the way a limited company
can.
• Slower, more difficult decision making
Compared to running a business as a sole trader, decision-making can be slower as you’ll need to
consult and discuss matters with your partners. Where you disagree, time will be spent
negotiating to build agreement or consensus. Sometimes this might mean opportunities are
missed. More often, it will frustrate a partner who has been used to making all the decisions for
their business.
 DISADVANTAGES OF PARTNERSHIP
Disadvantages of a partnership include that:
• Potential for differences and conflict. By going into business as a general partnership rather than a sole trader, you
lose your autonomy. You probably won’t always get your own way, and each partner will need to demonstrate
flexibility and the ability to compromise.
There will be the potential for differences, large or small, with other partners. These might relate to:
• The strategic direction in which the business should go (or how to get there)
• How to handle any number of discrete business issues that may arise
• Different views on how partners should be rewarded when they put different amounts of time, skills and level of
investment into the business
• Ambition. Some may want to dedicate every waking moment to growing and developing the business, while others
may want a quieter life
• Differences might not be evident immediately. Over time, partners’ preferences, personal situations and
expectations may change so the fact they are aligned at the start is far from a guarantee that cracks won’t appear
later.
• Disagreements and disputes can not only harm the business but also damage the relationship between the
individuals involved. Conflict can be a major distraction, absorbing the partners’ time, energy and money.
• That’s why is generally advisable to draft a partnership agreement (sometimes called a deed of partnership) when
forming the business partnership. This document ensures the partners’ respective rights and responsibilities are
enshrined, and that there is a common understanding of the procedures to be followed in the case of disputes. If the
partnership needs to be dissolved, the partnership agreement will also detail what then happens.
 DISADVANTAGES OF PARTNERSHIP
Disadvantages of a partnership include that:
•Profits must be shared
•Sharing profits equitably can raise difficult questions. How do you value
different partners’ respective skills? What happens when one partner is seen to
be putting in less time and effort into the partnership, but still taking their share
of the profits? It’s easy for resentment to occur if there doesn’t appear to be a
fair balance between effort and reward.

•Personally demanding
Although there’s at least one other person to share the worry and workload
with, in a partnership business the partners still essentially are the business. It
can absorb a lot of time and energy and disrupt your work/life balance,
particularly where you end up covering for other partners who don’t have such
a strong work ethic.
TYPES OF PARTNERSHIP

LIMITED PARTNERSHIPS
In a limited partnership, one or more partners have unlimited liability and one or
more partners have limited liability for the debts of the firm. Those with
unlimited liability are general partners. Those with limited liability are limited
partners. Limited partners are responsible for the debts of the partnership up to
the limit of their investment in the firm. The words “Limited Partnership,” “Ltd.,”
or “LP” identify this type of organization. For the privilege of limited liability, the
limited partner usually accepts less compensation than a general partner and
exercises less influence in the affairs of the firm. If the limited partners get
involved in management, they risk their liability protection.
TYPES OF PARTNERSHIP

LIMITED LIABILITY PARTNERSHIP

In an LLP, all partners have limited liability. There are no general partners.
Most states allow professionals such as lawyers, doctors, and accountants to form
a limited liability partnership or “LLP.” The LLP is designed to protect innocent
partners from malpractice or negligence claims resulting from the acts of another
partner. LLPs generally carry large insurance policies as protection against
malpractice suits. These professional partnerships vary in size from a medical
partnership of three to five doctors, to 150 to 200 partners in a large law firm, to
more than 2,000 partners in an international accounting firm.
TYPES OF PARTNERSHIP

LIMITED LIABILITY PARTNERSHIP

In an LLP, all partners have limited liability. There are no general partners.
Most states allow professionals such as lawyers, doctors, and accountants to form
a limited liability partnership or “LLP.” The LLP is designed to protect innocent
partners from malpractice or negligence claims resulting from the acts of another
partner. LLPs generally carry large insurance policies as protection against
malpractice suits. These professional partnerships vary in size from a medical
partnership of three to five doctors, to 150 to 200 partners in a large law firm, to
more than 2,000 partners in an international accounting firm.
PARTNERSHIP ACCOUNTS

Partnership accounts are the financial accounts of a partnership business.

The financial statements of partnerships are the same as those of a sole
proprietor with the exception of capital.
The major difference between a partnership and a sole proprietor business is
that a partnership has several joint owners.
Statement of financial position of a partnership must reflect the fact that
there is more than one owner.
The accounts of the partnership must record the capital and profits that are
attributable to each individual partner. Partners’ shares are then added to their
personal capital accounts.
PARTNER’S CAPITAL

Each partner contributes capital to the business and shares in the profit (or loss)
of the business. The capital of each partner must be identified separately.
The capital of each partner is usually contained in two accounts.
- Capital account - Current account
Capital account
The partnership agreement usually specifies that each partner must contribute a
minimum amount of ‘fixed’ capital and that partners cannot draw out any of their
fixed capital.
The capital account records the fixed capital or long-term capital of the partner that
the partner must retain in the business and cannot take out in drawings.
The balance on this account does not change very often.
PARTNER’S CAPITAL

Current account
A current account is used to record the accumulated profits of the partner and the
partner’s drawings.
- The profits of the business are shared between the partners. The share of each
partner is credited to (added to) his or her current account.
- Each partner may take drawings out of the business. Drawings are a withdrawal
of profit. These are recorded by debiting the current account of the partner (and
crediting the Bank account).
PROFIT-SHARING RATIO

The profit or loss for the financial period is calculated according to the normal
rules (as described already for a sole trader). This total profit or loss figure is
then divided between the partners and credited to their current account.
The partners are free to decide on how the profit (or loss) of the partnership is
shared between the partners. The profit sharing arrangements are set out in
the partnership agreement.
The profit for the period might be shared in agreed profit sharing ratio. This is
sometimes abbreviated as PSR. (The term profit sharing ratio covers the sharing
of both profit and loss).
PROFIT-SHARING RATIO

The WXY Partnership has three partners, W, X and Y, who share profits and
losses in an agreed ratio of [Link]. Profits for the year were Rs. 1,920,000.
PROFIT-SHARING RATIO

The WXY Partnership has three partners, W, X and Y, who share profits and
losses in an agreed ratio of [Link]. Profits for the year were Rs. 1,920,000.
PROFIT-SHARING RATIO

The profit would first be transferred into the appropriation account and then transferred
to current accounts of the partners.
NOTIONAL SALARIES FOR PARTNERS

A partnership agreement might recognise the different amount of work done

by partners by awarding one or more of the partners with a notional salary.
A notional salary is an agreed amount awarded to the individual partner from
the partnership profits.
Note that a notional salary is not a business expense in the same way that
salary to employees is. It is a share of the partnership profits.
Also note that notional salary may not be paid to a partner in the same way
that salary is paid to employees. A partner takes cash out of the business
through drawings.
The salary is awarded to each partner from the profits, and the residual profit
after deduction of notional salaries is then divided between the partners in
the agreed profit-sharing ratio.
NOTIONAL SALARIES FOR PARTNERS

The PQR Partnership has three partners, P, Q and R.

The partnership agreement provides for the residual profit (or loss) to be
shared between them in the ratio [Link], after allowing a notional salary of Rs.
30,000 to R.
The profit for the year is Rs. 345,000.
 NOTIONAL SALARIES FOR PARTNERS
The PQR Partnership has three partners, P, Q and R. The partnership agreement
provides for the residual profit (or loss) to be shared between them in the ratio [Link],
after allowing a notional salary of Rs. 30,000 to R. The profit for the year is Rs.
345,000.
The profit share of each
partner is added to the
balance on their individual
current accounts.
NOTIONAL SALARIES FOR PARTNERS

PRACTICE QUESTION
A, B and C are in partnership sharing profits and losses in the ratio of 2: 2: 1.
B is allowed a salary of Rs. 10,000 per annum and C is allowed a salary of Rs.
15,000 per annum. The net profit for year was Rs. 100,000.
Show how profit should be shared between the partners.
NOTIONAL INTEREST ON LONG-TERM CAPITAL

The partnership agreement might provide for the partners to obtain notional
interest on the long-term capital they have invested in the business. This is
interest on the balance in their capital account.
Notional interest on long-term capital is not interest expense, because the
capital in the partners’ capital account is equity, not a liability of the business.
The notional interest is a share of the partnership profits. Like notional salaries,
the notional interest is awarded to each partner in accordance with the
partnership agreement.
The residual profit shared between the partners in the profit-sharing ratio is the
profit after notional salaries and notional interest on capital are deducted.
NOTIONAL INTEREST ON LONG-TERM CAPITAL

Partnership DEF has three partners, D, E and F.

Partner D has contributed Rs. 100,000 of fixed capital, Partner E Rs. 120,000
and Partner F Rs. 60,000.
They have agreed to share profits in the following way.
1. Partner D to receive a salary of Rs. 4,000 and Partner F a salary of Rs. 7,000.
2. All three partners receive interest at 5% on the fixed capital contributed.
3. Residual profit or loss to be shared between D, E and F in the ratio [Link].
The profit of the partnership for the year is Rs. 95,000.
NOTIONAL INTEREST ON LONG-TERM CAPITAL
NOTIONAL INTEREST ON LONG-TERM CAPITAL

PRACTICE QUESTION
G, H and I are in partnership.
The profit of the partnership for the year is Rs. 1,146,000.
Partner G has contributed Rs. 500,000 of fixed capital, Partner H Rs. 400,000 and
Partner I Rs. 300,000. The partners have agreed to share profits in the following
way.
1. Partner H should receive a salary of Rs. 50,000 and Partner I a salary of Rs.
100,000.
2 All three partners should receive interest at 8% on the fixed capital contributed.
3 Residual profit (or losses) should be shared between G, H and I in the ratio 3: 2: 1.
Show how the partnership profits should be shared between the partners.
GUARANTEED MINIMUM PROFIT SHARE

Guaranteed minimum profit share

A partnership agreement might guarantee a minimum profit share for one (or
more) of the partners.
In these cases:
- The partnership profits are shared according to the partnership agreement,
ignoring the minimum profit agreement.
- If the normal sharing mechanism does not result in a partner receiving the
minimum guaranteed profit the other partners must make up the shortfall out
of their profit share, in their profit-sharing ratio.
GUARANTEED MINIMUM PROFIT SHARE

Guaranteed minimum profit share

The XYZ Partnership has three partners, X, Y and Z.
The partnership agreement provides for Partner X to receive a notional salary of
Rs. 20,000 and residual profits or losses are shared between X, Y and Z in the
ratio [Link].
In addition, the agreement guarantees a minimum profit share of Rs. 32,000 to
Partner Y.
The partnership profit for the current year is Rs. 80,000.
GUARANTEED MINIMUM PROFIT SHARE
GUARANTEED MINIMUM PROFIT SHARE

Guaranteed minimum profit share

The XYZ Partnership has three partners, X, Y and Z.
The partnership agreement provides for Partner X to receive a notional salary of
Rs. 20,000 and residual profits or losses are shared between X, Y and Z in the
ratio [Link].
In addition, the agreement guarantees a minimum profit share of Rs. 32,000 to
Partner Y.
The partnership profit for the current year is Rs. 180,000.
CHANGES IN THE PARTNERSHIP AGREEMENT ON PROFIT-
SHARING

The agreement on how the partners should share the profits of the business
may be changed during a financial year.
When this happens, the total profits for the year should be apportioned, on a
time basis, between:
- profits of the business during the time of the ‘old’ profit-sharing
arrangements, and
- profits of the business during the time of the ‘new’ profit-sharing
arrangements.
The profits for each time period are then shared between the partners in
accordance with the agreement for that period.
CHANGES IN THE PARTNERSHIP AGREEMENT ON PROFIT-
SHARING

The DEF Partnership has three partners, D, E and F.

In the first half of year 1, to 30 June Year 1, Partner D and Partner F each
received an annual salary of Rs. 30,000.
Residual profits or losses are shared between D, E and F in the ratio [Link].
(There is no interest on capital.)
In the second half of the year, from 1 July to 31 December, Partner D’s salary
was increased to Rs. 40,000, and the partners altered the profit-sharing ratio to
[Link] for [Link]). The salary of Partner F was unchanged at Rs. 30,000 per year.
The profit for the year was Rs. 220,000 (arising evenly throughout the year).
CHANGES IN THE PARTNERSHIP AGREEMENT ON PROFIT-
SHARING
CHANGES IN THE PARTNERSHIP AGREEMENT ON PROFIT-
SHARING
PROFITS, DRAWINGS AND THE PARTNERS’ CURRENT ACCOUNTS
For each partner, the share of the annual profit is added to the partner’s current
account. Any drawings during the year are deducted.

Requirement:
Calculate the closing
balances of Capital
and Current
Accounts for each
partner at the end
of the period.
PROFITS, DRAWINGS AND THE PARTNERS’ CURRENT ACCOUNTS
PROFITS, DRAWINGS AND THE PARTNERS’ CURRENT ACCOUNTS
PROFITS, DRAWINGS AND THE PARTNERS’ CURRENT ACCOUNTS
CONCEPT OF GOODWILL

A partnership may change due to one of the following:

- Admission of a new partner to the firm.
- Death or retirement of a partner
- Amalgamation of a partnership with another business (maybe a sole
proprietor or another partnership.
The accounting problems are similar in each case (though amalgamation does
have an extra dimension which will be discussed later).
In each case the old partnership comes to an end and a new partnership is
formed. Usually the records of the old partnership continue as those of the
new partnership with adjustments to reflect the change of ownership.
The main objective of these adjustments is to establish the capital of each
partner in the old partnership. This is important in each of the above cases.
CONCEPT OF GOODWILL

However, the balance on the accounts is the partners’ share of the net assets of
the firm as recorded in the statement of financial position. The statement of
financial position is a list of assets and liabilities, not a statement of value.
The assets of the business will be stated at cost. This may be very different to
their value at the date of the change in partnership.
CONCEPT OF GOODWILL

Example:
A, B and C were in partnership sharing profits or losses equally.
The firm bought a plot of land in 2001 for Rs. 2,500,000.
A left the partnership on 30 June 2020.
The land was worth Rs. 4,000,000 at that date. (This is known as its fair value).
The land has risen in value by Rs. 1,500,000 but this is not reflected in the financial
statements. This means that A’s capital does not include his share of the gain but
clearly Rs. 500,000 of the gain belongs to him.
Somehow the extra amount must be accounted for so that A can benefit from this.

The firm’s net assets are not the same as the value of the firm and each partner
will be more concerned with this latter figure.
CONCEPT OF GOODWILL

Example:
A, B and C were in partnership sharing profits or losses equally.
A left the partnership on 30 June 2013.
At this date the net assets of the firm were Rs. 6,000,000. The value of the firm
was estimated at Rs. 9,000,000. (The difference of Rs. 3,000,000 is called
goodwill and this will be explained shortly).
A’s share of the net assets might be 2,000,000 but his share of the value of the
firm is Rs. 3,000,000.
Somehow the extra amount must be accounted for so that A can benefit from
this.
The firm’s net assets are not the same as the value of the firm and each
partner will be more concerned with this latter figure.
CONCEPT OF GOODWILL
Example:
A, B and C were in partnership sharing profits or losses equally.
A left the partnership on 30 June 2013.
At this date the net assets of the firm were Rs. 6,000,000. The value of the firm
was estimated at Rs. 9,000,000. (The difference of Rs. 3,000,000 is called goodwill
and this will be explained shortly).
A’s share of the net assets might be 2,000,000 but his share of the value of the
firm is Rs. 3,000,000.
Somehow the extra amount must be accounted for so that A can benefit from this.
The solution to the above problems is as follows:
- The net assets must be revalued so that the partners share in any adjustment;
- The difference between the value of the firm and the net assets of the firm
(goodwill) must be recognised.
CONCEPT OF GOODWILL
Goodwill:
Goodwill is the amount by which the value of a business exceeds the fair value of
its net assets (its assets less liabilities).
Goodwill is an intangible asset of a business, but normally it is not recognised as
an asset in the financial statements.
The value of a business is usually more than the net assets of the business
because it reflects the trading potential that the business, i.e. its ability to
generate profits in the future. All successful businesses have goodwill, which
means that buyers will be prepared to pay more to acquire the business than the
value of its net assets.
CONCEPT OF GOODWILL
Goodwill:
A firm has net assets of Rs. 1,000,000.
One of the assets held by the firm is a property at cost less accumulated
depreciation of Rs.400,000. This property has a market value of Rs.600,000 (Rs.
200,000 above its book value.
The firm is valued at Rs. 1,800,000.

1,800,000
1,200,000
600,000

Calculate the goodwill.

CONCEPT OF GOODWILL
Valuing Goodwill:
The method of arriving at total value of the firm might be based on a formula set
out in the partnership agreement.
Example:
The XYZ Partnership values has an agreed method to value the firm for purposes
of change in partnership as 10× the average annual profit for the last three years
for which financial statements are available.
Profit for the last three years has been as follows:
Year 3 Rs. 100,000
Year 2 Rs. 90,000
Year 1 Rs. 80,000
CONCEPT OF GOODWILL
The XYZ Partnership values has an agreed method to value the firm for purposes
of change in partnership as 10× the average annual profit for the last three years
for which financial statements are available.
Profit for the last three years has been as follows:
Year 3 Rs. 100,000
Year 2 Rs. 90,000
Year 1 Rs. 80,000

The average annual profit is: 100,000 + 90,000 + 80,000/3 = Rs. 90,000
The valuation of the firm is: 10  Rs. 90,000 = Rs. 900,000
CONCEPT OF GOODWILL
Valuing Goodwill:
Alternatively, a partnership agreement might specify a method for valuing
goodwill directly. One such method is measuring goodwill as a multiple of
average annual profits or a multiple of its average annual ‘excess’ profits.
Example:
The XYZ Partnership values its goodwill as two times the average of the annual
profits in excess of Rs. 60,000 each year for the last three years.
Profit for the last three years has been as follows:
Year 3 Rs. 100,000
Year 2 Rs. 90,000
Year 1 Rs. 80,000
CONCEPT OF GOODWILL
Example:
The XYZ Partnership values its goodwill as two times the average of the annual
profits in excess of Rs. 60,000 each year for the last three years.
Profit for the last three years has been as follows:
Year 3 Rs. 100,000
Year 2 Rs. 90,000
Year 1 Rs. 80,000
The profits in excess of Rs. 60,000 have been:
Rs. 40,000 + Rs. 30,000 + Rs. 20,000 = Rs. 90,000
The average annual excess profit is: Rs. 90,000/3 = Rs. 30,000
The valuation of goodwill is: 2 x Rs. 30,000 = Rs. 60,000
CLASS QUESTION 1 – HAMZA & DANIYAL FIRM

Hamza and Daniyal are in partnership. As per the partnership deed they share
profits and losses equally. Partners are allowed Interest on capital at the rate of
3% per annum. Interest on drawings is charged at the rate of 4% per annum. The
following balances were extracted from the books on 30th April 2015:
CLASS QUESTION 1 – HAMZA & DANIYAL FIRM
Additional information
The following information was available at 30 April 2015:
(1) Inventory was valued at Rs.13,650.
(2) Heat and light Rs.150 was accrued.
(3) Depreciation is to be charged on all non-current assets owned at the end of the
year as follows:
(i) Premises at the rate of 2% on cost per annum
(ii) Delivery vehicles at the rate of 20 % per annum using the diminishing (reducing)
balance method
(iii) Office Fixtures at the rate of 10% per annum using the straight line method.
(4) Advertising expenses prepaid were Rs.800
(5) The provision for doubtful debts is to be maintained at 4 %
(6) A cheque payment of Rs.550 made to a credit supplier on 15 April, had not been
CLASS QUESTION 1 – HAMZA & DANIYAL FIRM

Required:
(a) Prepare the Statement of comprehensive income of Hamza and Daniyal for
the year ended 30th April 2015
(b) Prepare the appropriation account of Hamza and Daniyal for the year ended
30th April 2015.
(c) Prepare the current accounts of Hamza and Daniyal.
(d) Prepare the Statement of financial position of the Partnership at 30th April
2015.
CLASS QUESTION – DEE & EEE FIRM
Dee and Eee are in partnership. The profit sharing ratio between the partners is
3:2. Partners are allowed Interest on capital at the rate of 5% per annum. Eee is
entitled to a salary of Rs.6000 per annum. The following balances were extracted
from the books on 31st July 2015:
CLASS QUESTION – DEE & EEE FIRM
Additional information
The following information was available at 31 July 2015:
(1) Inventory was valued at Rs.34,100.
(2) Rent receivable of Rs.1500 was outstanding.
(3) Depreciation is to be charged on all non-current assets owned at the end of the year as
follows:
(i) Straight line method to be used for buildings which are held on a 25 year lease.
(ii) Vans at the rate of 30 % per annum using the diminishing (reducing) balance method
(iii) Equipment at the rate of 10% per annum using the straight line method.
(4) On 31st January 2015 the partners had agreed to allow Eee to increase his capital by
Rs.20,000. Eee paid a cheque into the partnership bank account on that date.
(5) Trade receivables of Rs.4,500 are irrecoverable. The provision for doubtful debts is to
be maintained at 4 %
(6) Other operating expenses prepaid Rs.1,800.
CLASS QUESTION – DEE & EEE FIRM
Required:
(a) Prepare the Statement of comprehensive income of Dee and Eee for the year
ended 31st July 2015
(b) Prepare the appropriation account of Dee and Eee for the year ended 31st July
2015.
(c) Prepare the current accounts of Dee and Eee.
(d) Prepare the Statement of financial position of Dee and Eee at 31st July 2015.
CLASS QUESTION – FAIZ, JALIB AND IQBAL FIRM
Faiz, Jalib and Iqbal are partners sharing profits and losses in the ratio [Link] in a
retail business. Interest on capital is allowed at the rate of 4% per annum
whereas interest on drawings is charged at the rate of 5% per annum on the
balances at 30 April 2015. The following balances were extracted from the books
on 30 April 2015:
CLASS QUESTION – FAIZ, JALIB AND IQBAL FIRM
Additional information:
The following information was available at 30 April 2015:
(1) Inventory was valued at Rs.28,100.
(2) The provision for doubtful debts is to be maintained at 5% of trade receivables
(3) Depreciation is to be charged as follows:
(i) Motor vehicles at the rate of 20% per annum using the diminishing (reducing)
balance method.
(ii) Fixtures and fittings at the rate of 10% per annum on cost, using the straight line
method
(4) General expenses, Rs.4,200, were prepaid.
(5) Rent Rs.2,500 was accrued.
(6) On 30 April 2015 the partners agreed to allow Iqbal to reduce his capital balance by
Rs.10,000. The sum was transferred to his current account on that date. The transfer
took place after calculating the interest on capital for the year.
CLASS QUESTION – FAIZ, JALIB AND IQBAL FIRM

Required:
(a) Prepare the Statement of comprehensive income of Faiz, Jalib and Iqbal for the
year ended 30 April 2015
(b) Prepare the appropriation account of Faiz, Jalib and Iqbal for the year ended 30
April 2015.
(c) Prepare the current accounts of Faiz, Jalib and Iqbal.
(d) Prepare the Statement of financial position of Faiz, Jalib and Iqbal at 30 April 2015.
ACCOUNTING FOR A CHANGE IN PARTNERSHIP

Accounting for a change in partnership

As previously stated, the old partnership comes to an end and a new partnership
begins but the records of the old partnership continue as those of the new
partnership with adjustments to reflect the change of ownership.
The adjustments aim to establish each partner’s share of the worth of the firm in
the old partnership. This is done by recognising goodwill and any revaluation
gains (or losses).
ACCOUNTING FOR A CHANGE IN PARTNERSHIP

Accounting for a change in partnership

As previously stated, the old partnership comes to an end and a new partnership
begins but the records of the old partnership continue as those of the new
partnership with adjustments to reflect the change of ownership.
The adjustments aim to establish each partner’s share of the worth of the firm in
the old partnership. This is done by recognising goodwill and any revaluation
gains (or losses).
Journal to recognise goodwill of old partnership.
ACCOUNTING FOR A CHANGE IN PARTNERSHIP

Accounting for a change in partnership

The goodwill figure is not usually retained in the accounts after the change in the
partnership. It is removed as follows:
ACCOUNTING FOR A CHANGE IN PARTNERSHIP

Accounting for a change in partnership

The goodwill figure is not usually retained in the accounts after the change in the
partnership. It is removed as follows:
CHANGE IN PARTNERSHIP - ADMITTING A NEW PARTNER
Admitting a new partner
When a new partner is admitted to a partnership the following steps are
required when accounting for this admission:

Steps:
1. Measure goodwill of the old partnership (this figure will usually be given to
you)
2. Recognise goodwill sharing the credit entry to the partners of the old
partnership in the old profit sharing ratio.
3. Remove the goodwill in the books of the new partnership sharing the debit
entry to the partners of the new partnership in the new profit sharing ratio.
4. Account for capital introduced by the new partner
CHANGE IN PARTNERSHIP - ADMITTING A NEW PARTNER –
Question 1

R and S are in partnership sharing profits or losses equally.

R has Rs. 80,000 of capital and S has contributed Rs. 60,000 of capital.
T is to be admitted to the partnership and will introduce capital of Rs. 50,000.
Profits or losses are to be shared in the new partnership in the ratio of 2: 2: 1.
The goodwill of the partnership at the date of admission is agreed to be Rs. 30,000.
Steps:
1. Measure goodwill of the old partnership (this figure will usually be given to you)
2. Recognise goodwill sharing the credit entry to the partners of the old partnership in
the old profit sharing ratio.
3. Remove the goodwill in the books of the new partnership sharing the debit entry to
the partners of the new partnership in the new profit sharing ratio.
4. Account for capital introduced by the new partner
CHANGE IN PARTNERSHIP - ADMITTING A NEW PARTNER –
Question 1
R and S are in partnership sharing profits or losses equally.
R has Rs. 80,000 of capital and S has contributed Rs. 60,000 of capital.
T is to be admitted to the partnership and will introduce capital of Rs. 50,000.
Profits or losses are to be shared in the new partnership in the ratio of 2: 2: 1.
The goodwill of the partnership at the date of admission is agreed to be Rs. 30,000.
CHANGE IN PARTNERSHIP - ADMITTING A NEW PARTNER –
Question 1
R and S are in partnership sharing profits or losses equally.
R has Rs. 80,000 of capital and S has contributed Rs. 60,000 of capital.
T is to be admitted to the partnership and will introduce capital of Rs. 50,000.
Profits or losses are to be shared in the new partnership in the ratio of 2: 2: 1.
The goodwill of the partnership at the date of admission is agreed to be Rs. 30,000.
CHANGE IN PARTNERSHIP - ADMITTING A NEW PARTNER –
Question 1
R and S are in partnership sharing profits or losses equally.
R has Rs. 80,000 of capital and S has contributed Rs. 60,000 of capital.
T is to be admitted to the partnership and will introduce capital of Rs. 50,000.
Profits or losses are to be shared in the new partnership in the ratio of 2: 2: 1.
The goodwill of the partnership at the date of admission is agreed to be Rs. 30,000.
CHANGE IN PARTNERSHIP - ADMITTING A NEW PARTNER –
Question 2

Practice question:
P and Q are in partnership sharing profits or losses in the ratio of 2:1. P has
contributed Rs. 600,000 of capital and Q has contributed Rs. 500,000 of capital.
They are about to admit a new partner, M, to the partnership and M has agreed to pay
the partnership Rs. 400,000 of capital.
After the admission of M profits or losses will be shared between P, Q and M in the
ratio of [Link].
The goodwill of the partnership at the date of admission is estimated to be Rs.
150,000.
Write up the capital accounts of the partners to show the admission of M to the
partnership.
CHANGE IN PARTNERSHIP - ADMITTING A NEW PARTNER –
Question 2

Practice question:
P and Q are in partnership sharing profits or losses in the ratio of 2:1. P has
contributed Rs. 600,000 of capital and Q has contributed Rs. 500,000 of capital.
They are about to admit a new partner, M, to the partnership and M has agreed to pay
the partnership Rs. 400,000 of capital.
After the admission of M profits or losses will be shared between P, Q and M in the
ratio of [Link].
The goodwill of the partnership at the date of admission is estimated to be Rs.
150,000.
Write up the capital accounts of the partners to show the admission of M to the
partnership.
Answer : P: 640,000 Q: 490,000 R: 370,000
CHANGE IN PARTNERSHIP - RETIREMENT OR DEATH OF A
PARTNER

Retirement or death of a partner

When a partner leaves a partnership the following steps are required when
accounting for his leaving:
Steps:
1. Measure goodwill of the old partnership (this figure will usually be given to
you)
2. Recognise goodwill sharing the credit entry to the partners of the old
partnership in the old profit sharing ratio.
3. Remove the goodwill in the books of the new partnership sharing the debit
entry to the partners of the new partnership in the new profit sharing ratio.
4. Account for capital taken
CHANGE IN PARTNERSHIP - RETIREMENT OR DEATH OF A
PARTNER

Retirement or death of a partner

P, Q and R are in partnership sharing profits or losses equally.
P has Rs. 80,000 of capital and Q has Rs. 60,000 of capital and R has Rs. 75,000 of capital.
R is to retire. He will be paid cash in the amount of Rs.50,000 and he will leave the rest as
a loan to the company.
Profits or losses are to be shared equally in the new partnership.
The goodwill of the partnership at the date of retirement is agreed to be Rs. 60,000.
Steps:
1. Measure goodwill of the old partnership (this figure will usually be given to you)
2. Recognise goodwill sharing the credit entry to the partners of the old partnership in
the old profit sharing ratio.
3. Remove the goodwill in the books of the new partnership sharing the debit entry to
the partners of the new partnership in the new profit sharing ratio.
4. Account for capital taken
CHANGE IN PARTNERSHIP - RETIREMENT OR DEATH OF A
PARTNER

Retirement or death of a partner

CHANGE IN PARTNERSHIP - RETIREMENT OR DEATH OF A
PARTNER

Retirement or death of a partner

CHANGE IN PARTNERSHIP - RETIREMENT OR DEATH OF A
PARTNER

Retirement or death of a partner

CHANGE IN PARTNERSHIP - RETIREMENT OR DEATH OF A
PARTNER

Retirement or death of a partner

Practice question:
J, K and L are partners sharing profits or losses and losses equally.
Capital account balances at 31 December 2013 are Rs.320,000, Rs.210,000 and
Rs.120,000.
K is to retire, leaving the amounts due to her as a loan to the partnership.
The land and buildings were revalued by Rs. 1,800,000 and goodwill was valued
at Rs. 900,000.
After the change the profit share is revised to 3:1 and goodwill is not to be
recorded in the books.
Show how the retirement of K should be shown in the capital accounts.
CHANGE IN PARTNERSHIP - RETIREMENT OR DEATH OF A
PARTNER

Retirement or death of a partner

Practice question:
J, K and L are partners sharing profits or losses and losses equally.
Capital account balances at 31 December 2013 are Rs.320,000, Rs.210,000 and
Rs.120,000.
K is to retire, leaving the amounts due to her as a loan to the partnership.
The land and buildings were revalued by Rs. 1,800,000 and goodwill was valued
at Rs. 900,000.
After the change the profit share is revised to 3:1 and goodwill is not to be
recorded in the books.
Show how the retirement of K should be shown in the capital accounts.
Answer: J – 545,000, K – 0 and L – 795,000
AMALGAMATION OF PARTNERSHIPS

Amalgamation:
An amalgamation is where two or more partnerships combine
together to form a new partnership, or where a sole trader and a
partnership combine together.
There are strong similarities to the changes already covered with
revaluations made in the old books and the reversals made in the
new books.
You may have to construct the statement of financial position
immediately after the amalgamation. The added dimension to
this sort of question is that this involves merging the statements
of financial position of the two businesses that are amalgamating.
AMALGAMATION OF PARTNERSHIPS
Example: Amalgamation
A and B are partners sharing profits or losses equally. C and D are partners in another
firm. They also share profits equally.
The two firms are to amalgamate with A, B, C and D sharing profits or losses in the
ratio of 3: 3: 2: 2.
The statements of financial position of each business immediately prior to the
amalgamation and before any of the necessary amalgamation adjustments Were as
follows:
AMALGAMATION OF PARTNERSHIPS
Example: Amalgamation
The goodwill of AB & Co was agreed to be Rs. 100,000. AB & Co had non-current
assets which were to be revalued by Rs. 50,000.
The goodwill of CD & Co was agreed at 80,000. CD & Co also had non-current assets
which were to be revalued
by Rs. 50,000.
AMALGAMATION OF PARTNERSHIPS
Example: Amalgamation
Step 2: Recognise the adjustments in the books of each firm.
The capital accounts of each firm (this time in columnar form) would be as follows
after accounting for the above:
AMALGAMATION OF PARTNERSHIPS
Example: Amalgamation
After this the statements of financial position of each firm would look as follows and
can be amalgamated by adding each line together.
AMALGAMATION OF PARTNERSHIPS
Example: Amalgamation
The partners in the new firm have decided that the assets ledger will be carried
forward at their revalued amounts in the general ledger of the new firm but goodwill is
to be eliminated.
The total goodwill before elimination is Rs. 180,000. The necessary double entry is:
AMALGAMATION OF PARTNERSHIPS
Example: Amalgamation
The capital accounts of the new firm would be as follows after accounting for the
above:
AMALGAMATION OF PARTNERSHIPS
Example: Amalgamation
Step 4: Prepare the final statement of financial position as at the start of the new firm.
DISSOLUTION OF A PARTNERSHIP
Dissolution of a partnership:
A partnership might cease trading. When this happens the partners are said to dissolve
their partnership and liquidate the firm.
The following might then happen:
- Some assets of the firm are sold at a profit or loss which must be shared between the
partners in their profit sharing ratio.
- Other assets might be taken by the partner’s in part settlement of their capital.
- Liabilities are paid
- Finally, the balance on the capital owed to the partners is paid off using the
remaining assets of the business. Alternatively a partner might have to pay cash
into the business if there is a debit balance on his capital account.
DISSOLUTION OF A PARTNERSHIP
Realisation account:
A realisation account is used to calculate the profit /loss on disposal of assets.
All assets to be sold and those taken over by partners at agreed values are transferred
into the account at their carrying amounts (as debit balances). Note that for non-
current assets this will be cost less accumulated depreciation.
The account is credited with proceeds of sale and value of assets taken over by
partners. Any profit (loss) on the account is then transferred to partners’ capital in the
profit sharing ratio.
DISSOLUTION OF A PARTNERSHIP
Realisation account:
A realisation account is used to calculate the profit /loss on disposal of assets.
All assets to be sold and those taken over by partners at agreed values are transferred
into the account at their carrying amounts (as debit balances). Note that for non-
current assets this will be cost less accumulated depreciation.
The account is credited with proceeds of sale and value of assets taken over by
partners. Any profit (loss) on the account is then transferred to partners’ capital in the
profit sharing ratio.
DISSOLUTION OF A PARTNERSHIP
Detailed accounting entries to close off partnership books:
1. Close each partner’s current account by transferring the balances to their capital account.
This is to establish a single capital figure for each partner.
2. Transfer all assets (except cash) into the realisation account. Note that for noncurrent
assets this involves transferring in the cost of the assets and the accumulated depreciation.
3. Perform double entry to reflect the sale of any asset.
4. Perform double entry to reflect the transfer of any asset to a partner’s ownership at the
agreed value.
5. Strike a balance on the realisation account and transfer profit or loss to the partners in the
agreed profit sharing ratio.
6. Pay off any liabilities (if there is insufficient cash the partners will have to pay more into
the business first).
7. Use the remaining assets to pay the partners their capital.
DISSOLUTION OF A PARTNERSHIP
Dissolution:
A and B are partners sharing profits or losses equally. They decide to dissolve their
partnership. The statement of financial position of at this date is as:
DISSOLUTION OF A PARTNERSHIP
DISSOLUTION OF A PARTNERSHIP
DISSOLUTION OF A PARTNERSHIP
Example (continued): Dissolution
Further information:
1. The land and buildings are sold for Rs. 300,000.
2. The plant and equipment includes a car at a carrying amount of Rs. 30,000. B is to
take over this car at an agreed value of Rs. 35,000.
3. The rest of the plant and equipment was sold for Rs. 90,000.
4. The inventory was sold at a reduced price of Rs. 93,000 to ensure a quick sale.
5. All of the receivables were collected except for an amount of Rs. 5,000 owed by a
person who had become bankrupt.
6. Dissolution costs of Rs. 8,000 were paid.
DISSOLUTION OF A PARTNERSHIP
DISSOLUTION OF A PARTNERSHIP
DISSOLUTION OF A PARTNERSHIP
DISSOLUTION OF A PARTNERSHIP