Introduction to Partnerships
A partnership is a business formed by 2 to 20 people. Unlike a sole trader, partnerships require a Partnership Agreement to decide how profits and losses will be shared.
Key Terms in Partnership Agreements
- Profit Sharing Ratio: How the final profit is divided (e.g., 2:1).
- Interest on Capital: Reward for partners who invest more money.
- Interest on Drawings: A "penalty" charged to discourage partners from taking too much cash out of the business.
- Partner Salaries: Paid to partners who manage the daily operations.
1. The Appropriation Account
After calculating the Profit for the Year in the Income Statement, we use an Appropriation Account to show how that profit is distributed among partners.
2. Capital vs. Current Accounts
In a partnership, we usually keep two accounts for each partner:
| Account Type | What is recorded here? |
|---|---|
| Capital Account | Only the permanent investment made by the partner. |
| Current Account | Day-to-day items: Salaries, Interest, Drawings, and Share of Profit. |
If There Is No Partnership Agreement
If partners do not create a partnership agreement, the following rules normally apply:
- Profits are shared equally
- No interest on capital
- No partner salary
- No interest on drawings
Example of Profit Sharing
Total Profit
30,000
Partner A share (60%)
18,000
Partner B share (40%)
12,000
Quick Check
1. Which item appears on the Credit side of a Partner's Current Account?
View Correct Answer
Correct Answer: C. Partner salaries, interest on capital, and share of profit increase the partner's balance and are credited.