IGCSE Partnership Accounts
In this lesson, we will learn how to calculate interest on capital, interest on drawings, interest on partners’ loans, and partners’ salaries. We will also learn how to record these items, along with additional capital and drawings, in the capital and current accounts. Finally, we will learn how to prepare the Appropriation Account.
Related Lessons:
Partnership Agreement
A Partnership Agreement is prepared for a partnership business to clearly outline how the partnership operates. This helps to prevent future disputes between partners.
The agreement outlines the followings:
- Contribution of capital by each partner
- Appropriation of profits / losses for each partner
- Drawings of assets for personal use
- Interest charged on drawings
- Interest payable on capital
- Partners’ salary
- Interest chargeable on loans from partners
Recording in the Capital Account
The Capital Account records the funds that each partner invests or withdraws from the business. Therefore, a separate Capital Account is prepared for each partner.
The Capital account is a Credit account.
As such, we credit the partner’s Capital account when recording the contribution of assets by the partner. On the other hand, we debit this account to record the withdrawal of funds by the partner.
Interest on Capital
Interest is charged on the capital contributed by the partners to compensate any partner who has contributed more capital than the other partners.
To calculate interest on capital,
Capital × Rate (% per annum) × Time (year)
As interest on capital increases a partner’s stake in the business, so it is recorded on the credit side of the Current Account.
At the same time, it reduces the profit available for distribution among all partners and is therefore recorded in the Appropriation account as a reduction of profit.
Interest on Drawings
Interest is charged on cash or goods withdrawn by partners for their own use. This is to discourage the withdrawal so that these assets are kept for business opportunities.
To calculate interest on drawings,
Drawings × Rate (% per annum) × Time (year)
As interest on drawings decreases a partner’s stake in the business, it is recorded on the debit side of the Current Account.
At the same time, it increases the profit available for distribution among all partners and is therefore recorded in the Appropriation account as an addition to profit.
Partner's Salary
Salary is paid to a partner who has contributed time and effort towards operating the business. Unlike salaries paid to employees, it is treated as an appropriation of profit rather than a business expense, as it represents the partner’s entitlement.
Therefore, it is recorded in the Appropriation account as a reduction of profit.
In the Current Account, only the salary due to the partner is recorded. As it increases the partner’s stake in the business, it is entered on the credit side of the Current Account.
Loan from Partner
A loan from the business partner is treated the same way as loans from external parties.
As such, it is only recorded in the Statement of financial position as a liability.
Interest on Partner's Loan
Interest is charged on the outstanding amount loaned to the business by the partner. This provides the partner with a return for the use of their funds.
To calculate interest on partner’s loan,
Loan × Rate (% per annum) × Time (year)
Only the interest owing is credited to the partner’s Current Account; any interest already paid is not recorded here.
As a loan from a partner is treated as a business liability, the interest on it is regarded as a business expense and is recorded in the Income Statement, not in the Appropriation Account.
Recording in the Appropriation Account
The Appropriation account is prepared to determine the final profit or loss available for distribution among all partners.
It records, for each partner, the interest on capital, interest on drawings, partners’ salaries, bonuses or commissions, and the share of profit or loss allocated to them.
Recording in the Current Account
While the Capital Account records the funds or assets each partner invests in or withdraws from the business, the Current Account records the additional amounts owed to or by each partner in relation to the partnership.
The Current account records:
- Drawings made by the partners
- Interest charged on the drawings
- Interest on capital
- Salary owed to the partner
- Interest on partner’s loan owing
- Profits or losses allocated to a partner
Transactions that increase a partner’s stake in the business are credited to the Current account, while those that decreases the stake is debited to the account.
At the end of the accounting year, a Debit balance in the Current Account represent Profit Overdrawn by the partner, and a Credit balance represent Profit Not Drawn by the partner.