Accounting for IGCSE - Video 31 - Financial statements of Partnerships

Summary

This video from the IGCSE Accounting series on edx world covers partnership firms' accounting. It starts with the theory behind partnerships, including their meaning, advantages, disadvantages, and key accounting terms like profit sharing ratio and interest on capital. The importance of a partnership deed and the difference between floating and fixed capital accounts are discussed. The video then explains how to prepare financial statements for partnerships, focusing on the profit and loss appropriation account and partner's current account, using journal entries to understand the logic behind the formats.

Takeaways

• 📚 The video is part of an IGCSE accounting series focusing on partnership firms.
• 🤝 A partnership firm is a business organization consisting of two or more people sharing profits and losses.
• 💡 The advantages of partnerships include access to high capital, shared risks, and pooled knowledge and experience.
• ⚠️ Disadvantages include slow decision-making, shared responsibilities for other partners' actions, and divided profits.
• 📑 Key accounting terms for partnerships include profit sharing ratio, interest on capital, partners' salary, and interest on drawings.
• 📝 A partnership deed is a written agreement outlining terms and conditions of the partnership, and it's advisable to have one.
• 💼 The absence of a partnership deed leads to default provisions under partnership law, such as equal profit sharing and zero interest on capital.
• 💰 Two types of capital accounts are discussed: floating (changeable) and fixed (unchangeable unless capital is adjusted).
• 📈 The profit and loss appropriation account is prepared after the income statement to show how profits are distributed among partners.
• 🔄 Journal entries are used to understand and record transactions related to partners' capital and current accounts.
• 🏦 The final step in accounting for partnerships is balancing the current accounts, which can result in either a credit or debit balance.

Q & A

What is the main focus of today's video in the IGCSE Accounting series?

Today's video focuses on partnership firms, specifically how to do accounting for partnership firms and how to prepare their financial statements.

Why is it important to understand the theory behind partnership firms before diving into financial statements?

Understanding the theory and concepts behind partnership firms is crucial because it makes it easier to comprehend the impact on financial statements. It allows for long-term retention of knowledge and a deeper understanding of the topic.

What are the advantages and disadvantages of a partnership business?

Advantages include access to high capital, pooled knowledge and experience, and shared risks and responsibilities. Disadvantages include slow decision-making, being bound by the actions of other partners, and sharing profits among all partners.

What is meant by a partnership deed and why is it important?

A partnership deed is a written agreement between partners outlining the terms and conditions of the partnership. It is important because it helps prevent conflicts and clarifies the agreed-upon terms, such as profit sharing ratios, capital investment, and interest rates.

What happens if there is no partnership deed?

In the absence of a partnership deed, certain provisions of the partnership law will apply, such as equal profit sharing, zero interest on capital, no partner salary, and a fixed interest rate of five percent per annum on partners' loans.

What are the two types of capital accounts mentioned in the script?

The two types of capital accounts are floating capital account and fixed capital account. A floating capital account can change in value due to adjustment entries, while a fixed capital account remains unchanged unless there is a change in the capital invested by the partner.

How is the profit and loss appropriation account prepared after calculating the net profit in the income statement?

The profit and loss appropriation account is prepared by transferring the net profit from the income statement to the profit and loss appropriation account, which then details the distribution of the profit based on agreed terms and conditions among the partners.

What is the purpose of charging interest on drawings to partners?

Interest on drawings is charged to discourage partners from taking excessive amounts from the firm for personal use, ensuring sufficient liquidity in the business.

How are partner salaries handled in the accounting for partnership firms?

Partner salaries are given to working partners to encourage more working hours for the firm's growth. They are recorded as an expense that reduces the distributable profit and are credited to the partner's current account.

What is the final step in preparing the partner's current account after recording all entries?

The final step is to balance the current account, which may result in either a credit balance or a debit balance, depending on the transactions recorded throughout the year.

Why is it beneficial to understand the journal entries before memorizing the formats of the profit and loss appropriation account and the partner's current account?

Understanding the journal entries provides a logical basis for the transactions, making it easier to remember the formats of the accounts without having to memorize them directly. This approach simplifies the topic and aids in long-term retention of the information.

Outlines

00:00

📚 Introduction to Partnership Firms in Accounting

This paragraph introduces the topic of partnership firms in the context of IGCSE accounting. It emphasizes the importance of understanding the theory behind partnership firms to comprehend the impact on financial statements. The speaker advises viewers to watch previous videos for a comprehensive understanding. The video promises to cover the meaning, advantages, and disadvantages of partnerships, key accounting terms, the significance of a partnership deed, and the difference between floating and fixed capital accounts. The speaker also discusses the preparation of financial statements, including the profit and loss appropriation account and the balance sheet presentation of partners' capital and current accounts.

05:01

🤝 Understanding Partnership Deed and Capital Accounts

The second paragraph delves into the concept of a partnership deed, which is a written agreement outlining the terms and conditions of the partnership. It highlights the importance of having a written agreement to avoid future conflicts. The paragraph also discusses the contents of a partnership deed, such as profit-sharing ratios, capital investment, and interest rates. The speaker clarifies the implications of not having a partnership deed, such as default profit-sharing ratios and zero interest on capital. Additionally, the paragraph differentiates between floating and fixed capital accounts, explaining how transactions are recorded in each and the implications for financial reporting.

10:02

📈 Journal Entries and Financial Statements for Partnerships

This paragraph focuses on the preparation of financial statements for partnership firms, starting with journal entries. The speaker explains the process of transferring net profit from the income statement to the profit and loss appropriation account. It details how to account for interest on drawings, interest on capital, and partner salaries, emphasizing the impact of these entries on distributable profits. The paragraph also covers the calculation of residual profit and its distribution among partners according to the agreed ratio. The speaker advises understanding the logic behind journal entries to simplify the memorization of financial statement formats.

15:04

💼 Finalizing Partner's Current Account and Drawings

The final paragraph discusses the process of recording partner drawings and balancing the current account. It explains that drawings are recorded on the debit side of the partner's current account, similar to a sole trader's capital account. The paragraph concludes with advice on studying the topic efficiently, noting that understanding the terms and logic behind partnership accounting can lead to high marks in exams. The speaker encourages viewers to like and share the video and looks forward to the next video in the series.

Keywords

💡Partnership Firm

A partnership firm is a form of business organization where two or more people come together to start and run a business, sharing the profits and losses. It is a central theme of the video, as the script discusses how to account for such firms. The video script mentions that the minimum number of people should be two, and the maximum is usually stipulated by law.

💡Financial Statements

Financial statements are records that show the financial activities and performance of a business. In the context of the video, the script focuses on how to prepare these statements specifically for partnership firms, which is crucial for understanding their financial health.

💡Profit and Loss Appropriation Account

The profit and loss appropriation account is prepared after the income statement and before the balance sheet in a partnership firm. It shows how the profit earned during the year will be distributed among the partners based on agreed terms. The video script explains that this account is crucial for understanding profit distribution in partnerships.

💡Partnership Deed

A partnership deed is a written agreement between partners that outlines the terms and conditions of their partnership. The video script emphasizes its importance and contents, such as profit-sharing ratios and interest on capital. It also discusses the implications of not having a partnership deed.

💡Floating Capital Account

A floating capital account is one where the capital can change in value due to various transactions during the year. The video script contrasts this with a fixed capital account and explains that all transactions related to a partner, except capital transactions, are recorded in this account.

💡Fixed Capital Account

A fixed capital account does not change due to adjustment entries related to a partner. The script explains that for capital-related transactions, entries are made in the capital account, but other transactions are recorded in a separate current account.

💡Interest on Capital

Interest on capital is compensation given by the firm to a partner for the capital invested in the firm. The video script mentions that this encourages partners to invest more capital and is an important accounting term related to partnership firms.

💡Interest on Drawings

Interest on drawings is charged by the firm to a partner based on the amount withdrawn for personal use. The script explains that this is done to discourage excessive withdrawals and ensure sufficient liquidity in the business.

💡Partner's Salary

A partner's salary is given to working partners to encourage more working hours and contribution to the firm. The video script discusses how this is recorded in the financial statements and its impact on distributable profits.

💡Capital and Current Accounts

Capital and current accounts are used to record transactions related to partners in a partnership firm. The video script explains that capital accounts record capital transactions, while current accounts record other transactions, with the balance indicating the partner's position with the firm.

💡Distributable Profits

Distributable profits refer to the profits available for distribution to partners after all expenses, including interest on capital and partners' salaries, have been accounted for. The video script details how these profits are calculated and shared among partners as per their agreed ratio.

Highlights

Introduction to the IGCSE Accounting series focusing on partnership firms.

Explanation of the importance of understanding the theory behind partnership firms for financial statement preparation.

Definition and characteristics of a partnership business organization.

Advantages of partnership firms such as access to high capital and shared risks.

Disadvantages of partnership firms including slow decision-making and shared liabilities.

Key accounting terms related to partnership firms like profit sharing ratio and interest on capital.

The significance of a partnership deed and its contents.

Consequences of not having a partnership deed and the default provisions of partnership law.

Difference between floating and fixed capital accounts.

How to prepare the profit and loss appropriation account after the income statement.

Explanation of adjustment entries for partner-related transactions.

Presentation of partner's capital and current accounts in the balance sheet.

Offer for theory notes and practice questions for purchase to enhance learning.

Detailed walkthrough of journal entries for profit distribution and partner's current account adjustments.

Process of calculating and recording interest on drawings and its impact on distributable profits.

Explanation of how interest on capital is calculated and recorded.

Procedure for handling partner salary payments and its effect on the profit and loss appropriation account.

Final steps in preparing the profit and loss appropriation account and the partner's current account.

Emphasis on the importance of understanding the logic behind journal entries for effective learning.

Encouragement for viewers to like and share the video for more content.

Transcripts

hey welcome to this channel edx world

and do another video in the igcse

accounting

series if you're watching this video i

presume you've already watched the other

videos in the playlist

if not if you've still not checked out

the other videos in the igcse accounting

playlist i suggest you do

go and check it out a major part of the

syllabus has already been covered

so today's video will be on partnership

firms how to do

accounting for partnership firms how to

prepare the financial statements of

partnership firms so in this video first

we start

with the theory involved behind

partnership firms

when we understand the theory and the

concepts properly it'll be easy for us

to understand the impact on the

financial statements

i could tell you to directly go and just

remember the format of the financial

statements but that will not help you

for a very long time you will forget but

once you understand the basic concepts

the basic terms

and why the financial statements are

prepared the way

they are prepared you will definitely be

able to remember it for long and you

will

enjoy learning the topic so we start

with understanding the meaning

advantages and disadvantages of

partnership businesses some important

accounting terms related to partnership

firms the importance of partnership need

the meaning and importance of

partnership deed

the the two type of capital accounts

floating capital account and fixed

capital account

understand the meaning of that then we

see how to prepare the profit and loss

appropriation account

which is prepared after the income

statement and before the balance sheet

and we also see the adjustment entries

for partner related transactions

in the profit and loss appropriation and

the partners capital and current

accounts

and finally we end this video by seeing

how do we present the partners capital

and current accounts in the balance

sheet if you want access to theory notes

for this chapter you want access to

questions practice questions for this

chapter you can consider buying our

online course

for just 99 i'll give you access until

june 2021

so what do you mean what do you mean a

partnership a partnership is a form of

business organization where

two or more people have come up to start

a business

run a business together share the

profits and losses of the business

minimum number of people should be two

maximum is usually stipulated by the law

of that country there will be usually a

maximum number of people

stipulated or stated that this can be

the maximum number of people in the

partnership firm

advantages and disadvantages pretty

obvious

but why have i mentioned it here because

they do ask this as a theory question in

the exam

so i thought i'll just mention it to you

but it's you can just read it and also

understand

so in a partnership you'll obviously

have access to high capital

compared to a sold trader because of

more than one person being

an owner of the business then multiple

people can come together pool their

knowledge and experience and run the

business

successfully the risks and

responsibilities of the business are

shared by

multiple people which is obviously

better compared to a sole trader

where the entire risk is shared or taken

up by

a single person coming to disadvantages

there are certain disadvantages

of partnership firm decision making is

slow obviously partners may have to

first consult each other before taking

any major decisions

which slows down the decision making

process important decisions

if taken at on urgent basis then only

might yield the necessary

results now partners are bound by action

of other partners

one partner cannot state that i have not

taken this decision in the firm

and then not responsible for the related

liabilities you cannot do that you are

bound by actions of all other partners

also

and yes if the partnership firm is very

profitable the profits are high

those profits are shared by all the

partners a single person does not enjoy

them and hence the profits are divided

now some important accounting terms

which are peculiar to the partnership

business

profit sharing ratio this is the

mutually agreed ratio between the

partners pre-decided

they decide that in this ratio they will

share all the future profits and losses

of the business

interest on capital now interest on

capital is what the firm compensates to

the partner for the capital invested

in the firm now why is interest on

capital given to the partner so that you

encourage

partners to invest more and more capital

else if a part one partner invests

lesser capital than the other partner

partners

those are investing higher capital in

the business will be unfair to them

and hence we compensate the partners by

giving them

interest on capital as a percentage of

the capital invested in the business

partners salary is given to working

partners hence

you encourage partners to contribute

more and more working hours to the firm

so that the firm can grow

else it will be unfair to people or

partners who contribute more hours

in the firm than partners who don't

contribute those many hours but share

the

profits equally or in the pre-decided

ratio

other than that interest on drawings is

what the firm charges to the partner

based on whatever drawings have been

made by the partner from the firm now

this is done to discourage the partners

to take as less as possible

amount from the firm for personal use

this ensures that there is enough

liquidity in the business as if interest

on drawing is not there

partners would try to withdraw whatever

they want to withdraw from the firm but

this will affect the liquidity of the

entire firm

what do you mean by partnership deed now

partnership deed is a written agreement

between the partners that states the

terms and conditions that have been

agreed to

when they entered into the partnership

it is not legally required to have a

written partnership date partners could

start the business

by just orally agreeing to the terms and

conditions but when they have a written

agreement

that agreement is known as a partnership

deed and it is advisable to have a

written

agreement which we'll see later why

what are the usual contents of a

partnership deed the

basic terms and conditions that have

been agreed to like the profit sharing

ratio

capital that will be invested by the

partners the basic details of the

business

like the name of the business decided

location

the activity that they're going to in

getting get involved into

and interest on capital the rate of

interest and capital that they've

decided rate of interest and drawings

that they've decided

partners salary that they have decided

to give to the working partners

and so on the various terms and

conditions will be listed in the

partnership team

now what happens when partnership deed

is not present when the

when there's an absence of written

partnership deed so in this case when

they're

when there are conflicts between the

partners there are certain provisions of

the partnership law that will apply

if there is no partnership deed for

example

let's say there's a conflict between the

partners regarding the profit sharing

ratio and they don't have a written

partnership deed

so in that case it will be decided that

the partners will be sharing profits and

losses equally because that's what

mentioned in the law

so if you really want to share profits

and losses in a certain ratio and

make sure there's no conflicts in future

always have a written partnership deed

so in the same way interest on capital

if there's an

conflict regarding interest and capital

between the partners what will be

decided is

zero interest on capital zero rate of

interest on capital because that is what

is mentioned

in the law interest on drawings again

there will be zero rate of interest on

drawings in absence of a partnership

deed

no partner will be entitled to any

salary if there is no written

partnership deed

now interest on partners loan the loan

that is given by the partner to the firm

the firm will have to pay the partner

interest at the rate of

five percent per annum as

interest okay now this is very important

here students get confused

they either mix with interest on loan

with interest on capital or they write

interest on loan is also zero so make

sure you remember

interest on partners loan is five

percent per annum if there is no

partnership deed

if you you can use a different rate you

can use four percent six percent but

make sure you have a written partnership

deed and make sure you mention this

interest on loan rate

in that deed

now there are two type of capital

accounts the one is the floating capital

account floating

the name suggests that it can change and

other is the fixed capital account

meaning the capital account cannot

change in value

unless there is a change in the capital

invested by the partner

so when there's a floating capital

account whatever are the adjustment

entries happening during the year

related to the partner you can put all

of those entries in the capital account

because that's a floating capital

account you can allow the capital

account to change

for example drawings you if you start

putting up drawings in the capital

account

the opening and closing balances of the

capital account won't be same

but it's okay because it's a floating

capital account so in a floating capital

account

all transactions related to the partner

are recorded in the

in one single capital account but when

you have a fixed capital account

capital account cannot change because of

these adjustment entries hence we open a

separate current account

to record all the other adjustment

entries related to the partner

all transactions between the partner and

the firm other than the capital

transactions are recorded in the

current account for our syllabus we

always follow a fixed capital account

so if it's a capital related transaction

you will have to pass the entry in

capital account

but all other adjustment entries will

always be in the current account

but there is no in real life there is no

restrictions as such

partners can follow floating capital as

well remember for your syllabus you have

to follow fixed capital

but you should know the meaning of both

floating and fixed capital from

theoretical questions point of view now

having understood all of this

now let us see how do we prepare the

profit and loss appropriation account

and the partners current account which

are the two main statements or two main

accounts

that you will be expected to prepare in

the exam now what is the profit loss

appropriation account profit or

propagation account

is what is prepared after you calculate

the net profit in the income statement

term appropriation means distribution so

this account tells you how will the

profit earned

during the year will be distributed

between the partners

based on the terms and conditions

they've agreed on and current account

will be maintained for each partner

wherein we will see how do we record

each

adjustment entry so now i will not be

directly giving you the format of the

profit loss appropriation and current

account and tell you to remember it

i will i will start with the journal

entries because when you understand the

journal entries

you don't have to go and remember the

appropriation and the current account

format

journal entries are very logical you

understand the logic behind them the

topic becomes very simple

so let's see each journal entry and

understand how are they reflected in the

two statements or two accounts

our current account will always begin

with balance brought down the balance

brought down in a current account can

either be on the debit side

or credit side but in my capital account

balance brought down will always be on

the credit side

why in a current account can balance

brought down b on the debit side

maybe because a lot of drawings have

been have been done by the partner in

one of the previous years and hence

there's a debit balance

so our first journal entry that we study

is once we calculate the net profit in

the income statement we need to transfer

this

net profit from the income statement to

the profit and loss appropriation

account

we do this by debiting the income

statement and crediting the

profit and loss appropriation account

and hence using this

our first entry in the profit and loss

appropriation will be the net profit as

per the

income statement

going ahead

interest on drawings will be charged to

partners on based on whatever drawings

they've

made during the year and the rate of

interest of drawings you multiply the

rate by the amount of annual drawings

you get the interest on drawings amount

what is the journal entry now understand

that interest on drawings

is what is being charged by the firm to

the partner and hence this is an income

for the firm

it adds on to the distributable profits

of the

firm so any income is always credited

and you since you're going to charge the

partners you will have to debit the

partner's current account

so the journal entry that i have is

partners current account debit

interest on drawings credit now this

since partners current account is

debited this entry will be

transferred to the debit side of the

partner's current account

as interest on drawings now once

i record this entry the interest on

drawings account has to be transferred

to the

profit and loss appropriation account so

i debit the interest on drawings account

and credit the profit loss appropriation

account the effect of this is that

it will add on to the existing net

profit and increase the distributable

profits to the partners so

in my profit loss of operation i have

interest add interest on drawings

take a total of the interest on drawings

and add it with the net profit

calculated as for income statement

to arrive at the subtotal

so our next journal entry will be

regarding the

interest on capital interest on capital

is paid out by the

firm to the partner based on the capital

they've invested and the rate of

interest on capital agreed to

the journal entry would be interest on

capital debit partners current account

credit why because

interest on capital is being paid out by

the firm to the partner it's

an expense it reduces the distributable

profit so debit interest and capital

and credit partners current account this

will be recorded on the credit side of

partners

current account as interest on capital

eventually interest and capital account

is closed and transferred to the profit

and loss appropriation account

using this journal entry so in my profit

loss appropriation account i will have

this interest on capital reduced from my

distributable profit so i have

less interest on capital for the two

partners a and b in this case

i'll write the e interest and capital

for each partner in the innermost column

and take the total in the

middle column subtotal in the middle

column

in the same way salary partner salary is

also paid out

to the partners similar journal entry to

that

of interest on capital partners salary

debit

partners current account credit hence

this will be on the credit side of

partners current account

as partners salary partner salary will

be closed and transferred to the profit

and loss appropriation because that will

also reduce the distributable profits

to the partners and hence i have below

interest on capital less partners salary

if there since there are two partners

here again salary for both the partners

subtotal in the middle column

usually these are the adjustment entries

that you expected to learn in the exam

once i have done all of this i will then

take a total of the interest on capital

amount and the partner salary

i'll take the total of these two in the

final column reduce this from the

subtotal calculated above here to arrive

at the

final residual or distributable profit

this is the profit that will be

that is going to be shared by the

partners in the agreed ratio

now now when profit is there in the

profit and loss appropriation account as

a residual profit

i need to transfer this to the partner's

current account in the agreed ratio

so the journal entry would be profit and

loss appropriation debit

and partners current account credit so

i'll state here

saying that the profit will be shared by

the partners in the agreed ratio

and show the division and this will be

shown on the credit side of partners

current account because you're giving

out the profits

in the agreed ratio to the partners

apart from this partners would also

withdraw money or any kind of asset for

personal use during the year

when that happens what is the journal

entry for drawings drawings

debit cash credit or bank credit or

purchases credit depends what kind of

asset has been withdrawn for personal

use

eventually at the end of the year

partners drawings will have to be

transferred to the

individual partners current account and

hence on the debit side of partners

current account i have

partners drawings this is similar to

what we

we've already seen in the sole trader

capital account on the debit side we had

drawings

so same way partners current account

debit side partners drawings

now once we've recorded all these

entries in the current account the next

step is to

balance the current account if there's a

credit balance we call it as a

credit balance if there's a debit

balance debit side is more record that

as a debit balance

and hence we have balance carried down

could be on either of these sides

either debit side or credit side now

once you've understood the

terms important terms related to

partnership and understood the logic

behind these formats it's very simple to

remember it for the exam

make sure you study this topic well with

a very little effort put in for this

topic you can gain

good number of marks because the

questions usually for this topic

are for decent marks if you've enjoyed

the video

make sure you like the video and share

it with your friends i'll see you in the

next

video thank you