chapter 18

Question 1

partnership

Answer 1

two or more people carrying on a business together with a view of making a profit

Question 2

partnership agreement

Answer 2

an agreement, usually in writing, setting out the terms of the partnerships

Question 3

partnership act 1890

Answer 3

the rules that govern a partnership in the absence of a formal partnership agreement

Question 4

issues arising from partnerships

Answer 4

how much capital each person will bring to the partnership

the roles that will be carried out by each partner

how the profits will be be shared

how new partners will be admitted if the partnership expands

what happens when a partner leaves, retires or dies - or the whole partnership is dissolved

how decisions will be made and disputes resolved.

Question 5

why is a partnership agreement drawn up

Answer 5

to ensure that all partners know their rights and responsibilities and how the business will operate day to day. the agreement will be in writing, possibly by deed (a formal legal document), although verbal agreements are not unknown. advantage of having a partnership is that many disputes can be resolved without the need to involve the courts

Question 6

the provisions of partnership act 1890

Answer 6

all partners are entitled to contribute equally to the capital of the partnership
partners are not entitled to interest on the capital they have contributed
partners are not entitled to salaries
partners are not to be charges interest on their drawings
partners will share profits and losses equally
partnerships are entitled to interest at 5% per annum on loans they make to the partnership

Question 7

advantages of partnerships

Answer 7

The capital invested by the partners is often more than can be raised by a sole trader.

Partners are likely to have a wider range of knowledge, experience and expertise in running a business than a sole trader.

A partnership may be able to offer a greater range of services to its customers.

The business does not have to close down or be run by inexperienced staff in the absence of one of the partners; the other partner(s) will provide cover.

Losses are shared by all partners.

Question 8

disadvantages of partnerships

Answer 8

A partner doesn’t have the same freedom to act independently as a sole trader does-decisions may have to be agreed that may be a problem if the partners have different views on how the business should develop and operate.

Partners generally have ‘unlimited liability’, which means that they are personally responsible for making good on all losses and debts of the business-this can extend to their losing personal assets.

A partner may be legally liable for the acts of the other partner(s), even if those acts were committed without all of the partners’ knowledge.

Question 9

appropriation account

Answer 9

an account prepared after the statement of profit or loss that shows how the profit for the year is divided between each partner. it is a continuation of statement of profit or loss. it begins with the profit or loss for the year brought down from the statement of profit or loss

Question 10

appropriation

Answer 10

the sharing out of something-in this case, the profit made by the partnership

Question 11

how is the division of profit earned or loss incurred between partners be show in a partnership

Answer 11

it can be shown by preparing an appropriation account

Question 12

things that need to be considered before drawing up a partnership agreement

Answer 12

interest on partners’ drawings
partners’ salaries
interest on partners’ capital
share of the residual profit

Question 13

interest on partners’ drawings

Answer 13

a charge or fine imposed on partners, usually as a percentage of drawings, designed to deter partners from removing too much money from the business.

Question 14

partner’s salary

Answer 14

a share of the partnership profit for the year paid to one or more of the partners in addition to their normal share of the profit for the year.

Question 15

interest on capital

Answer 15

a share of the profit for the year usually based on a percentage of the amount of fixed capital each partner has contributed to the partnership. the rate of interest to be paid should be stated in the partnership agreement. interest on capital is payable even if the firm does not make profit

Question 16

capital account

Answer 16

an account that shows a partner’s (long-term) investment in the business.

Question 17

why may a partner receive a salary

Answer 17

A partner may carry out a large proportion of the day-to-day work and wish to be rewarded for it. Choosing to be paid a salary means that the partner’s work is recognised. It should be noted that this type of salary is an appropriation of profit and should not be confused with wages and salaries paid to employees, which is an expense in the statement of profit or loss Partners are not employees.

Question 18

why cant a partner want to receive a salary rather than a larger share of profit

Answer 18

the profit share could become the ‘loss share’. This would mean that the partner doing all of the work would be paying more if, through no fault of their own, a loss was made.

Question 19

what does interest on capital recognize

Answer 19

recognizes that if partners do not invest their capital in the partnership. their money could earn interest in some other form of investment.

Question 20

how is residual profit or loss shared

Answer 20

if there is profit after paying the partner’s salaries and interest on partners’ capital, it is shared between the partners in the proportions laid out in the partnership agreement. if there is a deficit then the profit shares become ‘loss shares’

Question 21

interest on partners’ loans to the firm

Answer 21

a partner may have loaned the business money- rather than investing it as capital- and may expect to be repaid at a particular point in time. in this case, the interest agreed should be regarded as a n expense in the statement of profit or loss. it is not an appropriation of profi

Question 22

current account

Answer 22

an account that shows a partner’s (short-term) investment in the business. it records shorter term changes to the owners’ capital including the appropriation of profit and drawings. interest on a loan from a partner may also be recorded in this account. any items that result in a partner’s current account balance increasing is recorded as a credit entry and any items that reduce the partner’s current account balance is recorded as a debit