INTRODUCTION TO PARTNERSHIP FINAL ACCOUNTS

1.0 INTRODUCTION

The law governing partnership, which is guided by the partnership Act of 1890, in Nigeria defined partnership as “the relation which subsists between persons carrying on a business in common with the view of profit”. The number of persons, termed partners, who may form a partnership, is limited to 20 except (a) in the case of: (i) Solicitors; (ii) Accountants; (iii) Members of a recognized Stock Exchange, and (b) in the case of banking business where the limit is ten (10) except that the number may go up to 20 if each partner has bound of trade authorization.

This Unit discusses types of partners that could be found in partnership arrangements, partnership deeds, liabilities of partners, and advantages of partnership, types of partnership and partnership accounts to be maintained by a serious partnership business.

2.0 OBJECTIVES

At the end of this unit, you should be able to:

1. appreciate types of partners and partnership 
2. understand the likely contents of the partnership deeds 
3. appreciate the liabilities that attributable to partners in a partnership business 
4. understand the advantages of partnership over sole proprietorship business 
5. learn about the types of accounts to be kept by a partnership business. 

3.0 MAIN CONTENT

3.1 Partnership Final Accounts

3.1.1 Kind of Partners

3.1.1.1 Ordinary (or Active) Partner

This is a partner who has capital in the business and takes part in conducting the affairs of the business.

3.1.1.2 Sleeping (or Dormant) Partners

This is a partner who has capital in the firm (business). Such a Partner is responsible for the debts of the firm as if he were an ordinary partner. His name may or may not appear in the firm’s name.

3.1.1.3 Nominal (Apparent or Quasi) Partner

This is a person who whilst not a partner in a partnership business, lends his name to the business. Such a person is said to be holding out as a partner and is therefore liable as a partner for credit given to the firm, on the assumption that he was actually a member of the firm.

SELF ASSESSMENT EXERCISE 1

1.  How is a partner in a partnership business? 
2. Discuss any two types of partners. 

3.2 Partnership Deeds/Article of Association

When a partnership is to be formed, it is usual to draw up a legal document termed the deeds of partnership; although a partnership might be carried out by verbal agreement.

Partnership deeds/Article of Association should contain clauses relation to:

1. The firm’s name 
2. The nature of the business. 
3. The address (es) with which the business will be transacted. 
4. The amount of capital to be contributed by each member and interest thereon (if any). 
5.  The sharing formula for the profit or loss of the partnership. 
6. The commencement and duration of the partnership. 
7.  Partner (s) salaries or remuneration, if any. 
8.  Loan by partner(s) to the firm and interest thereon. 
9.  Drawing and interest thereon. 
10. The keeping of proper books, preparation of final accounts and periodic audits. 
11. The adjustment and repayment of capital to a retiring partner. 
12. Arbitration, in order that any partnership’s dispute may be settled without litigation (going to law). 

Section 24 of the partnership Act (1890) provides that in the absence of agreement by the partners to the contrary:

1.  Partners are to share profit and loss equally and contribute equal amount of capital. 
2.  No interest is payable in respect of capital before the ascertainment of profit and no interest is to be charged on drawings. 
3.  5% is to be paid to a partner who puts more money than the subscribed capital. The payment will be on the excess. 
4.  Any partner may take part in the management of the business. But no partner is entitled to salary for his services. 
5.  No partner may be introduced into the partnership without the consent of all the existing partners. 
6.  The partnership books are to be kept at the place of business and every partner should have access to them. 

SELF ASSESSMENT EXERCISE 2

1. Discuss any 5 issues to be covered in a partnership agreement. 2. Highlight any 3 provisions of partnership act. 

3.3 Liability of Partners

The partners are liable for all the debts of the firm. In the event of partner’s capital not enough to save him or her, he or she has to go for his or her personal belongings. The only exception to this is where there is the provision for limited partnership and unlimited partnership. However, in coming partner is not liable to the debts of the firm but retiring partner is liable to the extent of the debts of the firm before his retirement.

3.4 Advantages of Partnership

3.4.1 Large Capital

Sole traders may combine resources together to form a partnership if the amount of capital required for the running of the type of business in mind cannot be provided by one person. Persons looking for immediate and large profits might find it impossible because of lack of large capital. To achieve their business goal; therefore, they have to bring together their capitals so as to make the large and immediate profit which they will share among themselves.

3.4.2 Experience and Ability

The experience and ability required for the progress of a business and the achievement of its goal available with one of more investors should combined with the health, vitality and wealth available with other investor(s) so as to establish a very successful partnership business. A typical example is where an old man forms partnership with a young man so that the old man’s wealth of experience could be combined with the young man’s health and strength for a successful partnership business.

3.4.3 Share of Ownership

Many people just prefer to share the care of ownership rather than bear all the burdens themselves. Such people will therefore decide to form a partnership instead of operating a sole proprietorship.

3.4.4 Family Relationship

By virtue of being members of same family, some sole traders prefer coming together and carrying on business activities as a family unit rather than operating differently. This will strengthen the family relationship whereas separately operating the business may lead to competition or opposition between members of the family.

3.4.5 Continuity

The continuity and enhancement of the business is more secured than in the case of single proprietorship.

SELF ASSESSMENT EXERCISE 3

1.  Describe the liabilities of retiring and incoming partners. 
2.  Discuss any three advantages of a partnership business over a sole proprietorship business. 

3.5 Types of Partnership

There are basically two (2) types of partnership: Limited and Unlimited.

 3.5.1 Unlimited partnership

This is the partnership in which the partners are liable to all the debts of the business up to the extent of their personal properties. This is when the partnership is indebted or insolvent. The partners here must pay the debt even if it means selling their personal belongings like cars, houses, lands, etc in order to raise money for that purpose.

3.5.2 Limited Partnership

This is the partnership in which some partners have a limited liability and other(s) unlimited liability. Those with limited liability are liable only to the extent of the amount of capital they invested into the business if the business witnesses a failure. This means that they loss only what they already invested into the business as nobody will force them to contribute any further amount for the purpose of repaying the debt of the partnership.

The unlimited partners, on the other hand, are liable to all the debts of the partnership up to the extent of their personal belongings when the business becomes insolvent. A limited partner is registered under the provisions of the limited partnership Act (1907) and he may not take part in the management of the partnership business. There must be at least one general (unlimited) partner in a limited partnership.

SELF ASSESSMENT EXERCISE 4

1.  What are the characteristics of unlimited partnership? 
2.  How limited is a limited partnership? 

3.6 Partnership Accounts

3.6.1 Capital Account

This is the account that records the partners’ capital contribution to the business. There are as many capital accounts as there are partners. There are two (2) ways of keeping the capital account: (1) fixed capital account and (2) fluctuating capital account. The first method is the most acceptable one where the capital account is left intact and current account introduced in which fluctuations in the gains and obligations of partners in the business will be recorded. The dimension of the account is like that of other accounts.

3.6.2 Drawing Account

This is the account in which the drawings made by the partners are recorded. It normally has a debit balance unlike Capital Account that has a credit balance.

3.6.3 Current Account

This is the account in which the current earnings and drawings of partner’s are recorded, leaving capital account fixed. On the right of it (credit side) are recorded (1) interest on capital, (2) partners salary, (3) share of profit, and (4) interest on loan. On the left of it (debit side) are recorded (1) drawings, (2) interest on drawing, and (3) share of loss.

3.6.4 Salary Account

This is the account that records the salaries paid to active partners for their management and control of the partnership business and of course their concentration for the day-day running of the affairs of the business, sacrificing other activities that can equally fetch them money. This is credited to the current account and debited to the profit and loss appropriation account.

3.6.5 Interest on Capital

Interest is sometimes charged on capital if the work to be done by each partner is of equal value but the capital contributed is unequal. Also, if profit is to be shared equally, interest on capital has to be paid to compensate higher capital contributors.
This interest is paid out of the net profit for the year as part of appropriation. It is, therefore, treated as a deduction prior to the calculation of the “super profit” and its distribution to the partners according to the profit/loss sharing ratio. The rate of the interest is a matter for agreement between the partners. But, theoretically, it should be equal to the return which the partners would have received had they invested the capital elsewhere.

3.6.6 Interest on Drawing

Interest is sometime charged on drawings to deter the partners from taking out cash and other resources unnecessary. The interest is calculated from the date of withdrawal to the end of the financial year. The amount charged helps swell the profit divisible among the partners. It is obviously in the best interest of the firm if cash is withdrawn by the partners in accordance with the two (2) basic principles of (a) as little as possible, and (b) as late as possible. The more cash that is left in the firm, the more expansion can be financed.

SELF ASSESSMENT EXERCISE 5

1. Differentiate between current account and capital account in a partnership business. 
2.  Differentiate between interest on capital and interest on drawing. 

4.0 CONCLUSION

Partnership business is one of the three forms of businesses in any country of the world. It is more popular among professionals and vocational men and women. A partnership business is a source of income and not a unit of income, and so its profit is not taxable until it is shared amongst the partners. The accounts of a partnership business are similar to those of sole proprietorship and companies, in theory and practice, but there are specialized accounts that are normally kept by partnership businesses. This Unit highlights all the fundamental issues students should know about partnership accounting.

5.0 SUMMARY

The Unit has introduced partnership business, the type of book keeping system to be put in place and the way to prepare final accounts of partnership businesses. Types of partnership and types of partners were made very clear, as well as liabilities of partnership and advantages of partnership business over sole proprietorship business. The Unit is a good introduction to the concept of partnership and its expected accounting system.