partnershipnature of partnership •section 40 of the act states as follows, "the fact that a...

Partnership

Objectives

• Introduction and Regulatory Frame workDefinition NatureRelationship among partnersFormationPartnership accounts

Objectives

• Changes in partnership constitutionChanges In Profit And Loss Sharing Ratio

Revaluation Of Assets

Goodwill

The Admission Of A New Partner

Outgoing Partner (Death and Retirement)

Objectives

• Dissolution of partnershipMeaning of dissolutionLegal provisions for partnership dissolutionAccounting arrangement for dissolutionPiecemeal dissolution

Objectives

•Conversion of partnershipMeaning Reasons for conversionAccounting arrangements

•Amalgamation

Introduction and Regulatory Frame workLecture 4

Objective

• Definition

• Nature

• Relationship among partners

• Formation

• Partnership accounts

Definition and meaning of partnership

• Partnership is defined as the association of two or more individuals carrying on business jointly for the purpose of making profits

• The number of partners can range from two to twenty inclusive

• On a limited occasion, an individual could be the only partner of a partnership firm

• However, this situation can only exist for six months during which the remaining partner has to find other partners or liquidate the firm

• The main examples of partnerships can be found within the professional consultancy firms such as law and accountancy firms

Body not considered as partnership/Scope• Company registered under the companies Ordinance

• Company, body corporate, or unincorporated association form under any other enactment

• Body corporate formed in accordance with the law of any foreign country

• A joint venture without a firm name for one or more specific operations

Relationships not considered as partnership• Family ownership or co-ownership of property

• Remuneration of a servant or agent through the share of profit

• Joint venture

Nature of partnership • Any partnership duly registered under the Act (1962, Act 152)

qualifies to be called a firm

• The word "firm" is used under the Act to mean a body corporate formed by registration of a partnership in accordance with the Act

• Section 12 of the Act states that:

• "the firm shall be a body corporate under the firm name, distinct from the partners of whom it composed, and capable forthwith of exercising all the powers of a natural person of full capacity in so far as such powers can be exercised by a body corporate;

Nature of partnership• notwithstanding any changes in the constitution of the

partnership, the firm shall continue to exist as a corporate body until dissolved in accordance with section 51, 52 or 53 of this Act;

• notwithstanding that the firm is a body corporate, each partner therein shall be liable without limitation, for the debts and obligations of the firm …

Nature of partnership

• What the Act has done is to

create a firm capable of perpetual succession,

existence of which does not depend upon the changes in the composition of its members,

with all the rights and obligations of a body corporate different from those of its members

but the liability of whose members to the firm's liabilities are unlimited.

Nature of partnership

• Section 40 of the Act states as follows, "the fact that a partner has ceased to be a partner in the firm shall not affect the existence of the firm or the mutual rights and duties of the other partners“

• On the other hand, the Court may order the winding up of a firm if it carries on business for more than six months with fewer than two partners [Section 47(3)(b)]

Relationship between partnership• Section 34 of the Act states that the relationship between

partners is a fiduciary one and as such every partner acts as an agent of the firm for the purpose of the business of the firm. Every partner is expected to:

"render to every other partner full information of all things affecting the firm;

account to the firm of any benefit derived by him without the consent of the other partners from any transaction concerning the firm or from any use by him of the firm's property, name or business connection."

Relationship between partnership• In addition "if a partner, without the consent of the other

partners directly or indirectly carries on any business of the same nature as, and competing with, that of the firm, he shall account for, and pay over to the firm, all profits made by him in that business."

Relationship between partnership

• Section 16 states: "every partner in a firm shall be jointly and severally liable to the firm and the other partners for all debts and obligations of the firm incurred while he is a partner."

• If a firm is unable to meet all its maturing obligations out of its own assets, the partners must make good any balance up to the limit of their entire private possessions.

Formation/Registration of a partnership

• It is unlawful for any partnership to carry on business unless the firm is registered in accordance with the Act, 1962 (Act 152).

• Section 5(1) requires that "registration under this Act shall be effected in manner following, that is to say, there shall be sent or delivered to the Registrar for registration a copy of the partnership agreement and a statement in the prescribed form signed by all the partners containing the following particulars namely:

Formation of a partnership

the firm name of the partnership;

the general nature of the business;

the address of;

the principal place of business of the partnership; and

all other places in Ghana at which the business is carried on;

Partnership formationthe names and any other former names, residential

addresses and business occupations of the partners;

the date of commencement of the partnership, unless the partnership has commenced more than twelve months prior to the date of the statement;

Reasons for refusing partnership registration

• If the partnership is not registered in Ghana

• If any of the businesses carried on, or to be carried on by the firm is unlawful

• If the firm name is misleading or undesirable

• If any of the partners is an infant, or unsound mind, has been guilty of fraud or dishonesty or an undischarged bankrupt

• If the statement or agreement is incomplete, illegal or inaccurate

The partnership agreement

• The name and business of the firm

• Amount of capital and whether the capital is to earn interest

• Profit and loss sharing ratio

• Salary of partners

• Partners’ drawings (limit and interest)

• Capital account (fixed or fluctuation)

The partnership agreement

• The keeping of books and accounts.

• The date for the commencement of the partnership and its possible duration

• The method for the valuation of assets, especially goodwill in case -of an incoming or outgoing partner and dissolution of the partnership.

• How disputes shall be settled

Rules applying in the absence of agreement (section 35)

• All partners shall be entitled to share equally in the capital and profits of the firm and shall contribute equally towards the losses sustained

• The firm shall indemnify every partner in respect of payments made and personal liabilities incurred by him,

In the ordinary and proper conduct of the business of the firm; or

In or about anything necessarily done for the preservation of the property of the firm;


• A partner making for the purpose of the firm any actual payment or advance beyond the amount of capital which he has agreed to subscribe shall be entitled to interest at a rate of 5% p.a. from the date of payment or advance

• A partner shall not be entitled to payment of such interest before the ascertainment of the profit of the firm

Rules applying in the absence of agreement (section 35)• Every partner may take part in the management of the business of

the firm

• No partner shall be entitled to remuneration for acting in the firm’s business

• No person should be introduced as partner without his consent and the consent of all the existing partners;


• Any difference arising as to ordinary matters connected with the firm’s business may be decided by a majority of the partners, but no change may be made in the nature of the firm’s business without the consent of all the existing partners

• The partnership books and accounts shall be kept at the place of business of the firm or the principal place of business if there is more than one

Cessation of membership of a firm

• Death

• His becoming an alien enemy during time of war;

• An insolvency order being made against him under the provisions of the Insolvency Act 1962 (Act 153)

• If the other partners so elect in writing, a partner shall cease to be a partner in the firm if he suffers his interest in the partnership to be charged under section 20 of the Act for his separate debt.

• Retirement as defined in the partnership agreement

Advantages of partnership

• A partnership shares business risk between more than one person.

• Each partner can develop special skills upon which the other partners can rely.

• Greater resources will be available since more individuals will be contributing to the business.

Disadvantages of partnership

• There may be disputes in running the business

• Partners are jointly and severally liable for their partners. Thus if one partner is being sued in relation to the business, all partners share the responsibility and potential liability.

Keeping of Accounts (section 32)• Every firm shall cause to be kept proper account with respect to its

financial position

• Every firm shall, at intervals of not more than fifteen months be caused to prepare profit and loss account

• Disclosing the following:

All sums of money received and expended by or on behalf of the firm and the matters in respect of which the receipt and expenditure takes place

All sales and purchases by the firm of property, goods and services

The assets, liabilities of the firm and the interests and partners therein

Accounts of partnership

• Capital account

Separate capital account must be opened for each partner

The capital account records the amount of capital contributed by a particular partner to the firm in accordance with the partnership agreement

Preferably, this account should record only the increases or decreases in capital introduced into or withdrawn from the firm in accordance with the partnership agreement.


• Current account

In the situation where a fixed capital account is kept, a separate current account is opened for each partner

The current account is credited with a partner's share of profits, any salary and commission entitlements, Interest allowed on capital and loan accounts while it is debited with a partner's share of losses, drawings, interest charged on drawings all in accordance with the partnership agreement.


• Drawings Account

• Normally a separate drawings account is kept to record all drawings (both cash and goods) withdrawn from the firm by a partner the balance of which is transferred to the respective current accounts of the partners at the end of the accounting period.


• Drawings Account

• It is important to note that all drawings, either in form of cash, goods or other assets should be debited to either the drawings account in the first instance to be transferred in total to the current account or debited directly to the current account

• Under no circumstances should drawings be debited to the profit and loss accounts, as "drawings" does not represent a charge against profit.

Accounts of partnership• A credit balance on the current account indicates the

amount of undrawn profits

• A debit balance indicates that a partner has overdrawn on his account.

• Usually to avoid such a situation from arising, the partnership agreement will indicate that an interest at an agreed rate shall be charged on all overdrawn current accounts.

• Partners’ loan account

Financial statement of partnership

• Manufacturing Account

• The trading, Profit and loss account

• Appropriation account

• Partners current account

• Capital account

• Balance sheet

ACTIVITY 1Taylor and Clarke share profits in the ratio: Taylor, three-fifths; Clarke, two-fifths.They are entitled to 5% interest on capital.Taylor invested £20,000 capital and Clarke invested £60,000 capital.Clarke receives a salary of £15,000.Taylor is to be charged £500 interest on drawings and Clarke £1,000.Net profits amounted to £50,000.Drawing of £15,000 and £26,000 for Taylor and Clarke respectively

Try this

Black, Brown and Cook are partners. They share profits and losses in

the ratios of 2/9, 1/3 and 4/9 respectively. For the year ended 31 July

20X2, their capital accounts remained fixed at the following amounts:

£

Black 60,000

Brown 40,000

Cook 20,000

They have agreed to give each other 6 per cent interest per annum

on their capital accounts. In addition to the above, partnership

salaries of £30,000 for Brown and £18,000 for Cook are to be

charged. The net profit of the partnership, before taking any of the

above into account was £111,000. Black and Brown withdrew £4,000

and £5,000 worth of goods respectively during the period. The firm

charges 10% interest on drawings. You are required to draw up the

appropriation account of the partnership for the year ended 31 July20X2.

Homework

•41.9 of Frank wood

•Thank You

•Any Question?

Changes in partnership constitutionLecture five

Objective

• Changes in partnership constitution

• Changes In Profit And Loss Sharing Ratio

• Revaluation Of Assets

• Goodwill

• The Admission Of A New Partner

• Outgoing Partner (Death and Retirement)

Changes in partnership constitution

Changes in the constitution of partnership• There is a change in the constitution whenever there is:

Admission of a new partner

Retirement of a partner

Death of a partner

• There may also be a constructive change whereby the original partners remain the same but there is a change in the agreed profit and loss sharing ratios

Reasons for Change in Profit and Loss Ratio

• A partner may now not work as much as in the past, possibly because of old age or ill-health.

• A partner’s skills and ability may have changed, perhaps after attending a course or following an illness.

• A partner may now be doing much more for the business than in the past.

Changes in the constitution of partnership• Section 12(2) states that ‘notwithstanding any changes in the

constitution of the partnership, the firm shall continue to exist as a corporate body until dissolved in accordance with section 51, 52 or 53 of this Act’

• Section 39(1) state as follows: “A partner shall cease to be a partner in the firm in the event of,

• Death;

• His becoming an alien enemy during time of war;

• An insolvency order being made against him under the provisions of the Insolvency Act 1962 (Act 153)

Changes in the constitution of partnership• Section 17 states as follows:

“A person who is admitted as a partner into an existing firm shall not thereby become liable to the creditors of the firm for anything done before he becomes a partner

A partner who retires from a firm shall not thereby cease to be liable for the debts or obligations of the firm incurred before his retirement

Changes in the constitution of partnership

A retiring partner may be discharged from any existing liabilityby an agreement to that effect between himself and the firm and the creditor and this agreement may be either express, or inferred as a fact from the course of dealing between the creditor and the firm as newly constituted

Where a person deals with a firm after the retirement of any partner whom he knew to be a partner in the firm, he shall be entitled to treat the retired partner as still being a partner until he has notice of the retirement and the retired partner shall be liable accordingly.


If any such person had dealings with the firm prior to the retirement he shall not be deemed to have notice of the retirement unless he has actual knowledge thereof, but an advertisement in a daily newspaper circulating in the district in which is situated the principal place of business of the firm shall be notice to persons who have not had dealings with the firm prior to the retirement.


The estate of a partner who dies or has an insolvency order madeagainst him under the Insolvency Act, 1962 (Act 153) or subject asprovided by subsections (4) and (5) of this section, a partner whoretires, shall not be liable for any debts or obligations of the firmcontracted or incurred after the date of the death, insolvency order,or retirement respectively”.

Summary of accounting arrangements for a change in constitution• Any change in the constitution of a partnership by way

of admission, retirement, death etc. results in a change in the profit and loss sharing ratio.

• Immediately before the change occurs, all the assets and liabilities including goodwill should be revalued

• and any revaluation profit or loss credited or debited to the partners’ capital accounts in accordance with the existing profit and loss sharing ratio.

Revaluation of assets

Revaluation of Assets

• Assets may be revalued to reflect their true values as part of the process to admit a new partner

• If the asset is revalued higher than the book value the entries are as follows:

Debit the Asset Account and

credit the Revaluation Account


• The credit balance on the Revaluation Account represents revaluation surplus

• This is credited to the old Partners’ Capital Accounts according to old profit sharing ratio

• If the asset is revalued lower than the book value, the entries are as follows:

Debit the Revaluation Account

credit the Asset Account.


• The debit balance on the revaluation account represents revaluation deficit

• This is debited to the old Partners’ Capital Accounts according to old loss sharing ratio


• The new firm (after admission of the new partner) may decide to maintain the assets in the books as revalued

• On the contrary, the new firm (after admission of the new partner), may decide to revert the valuation of the assets to their book values prior to the admission of the new partner


• If the revaluation resulted in a revaluation surplus, the reversal is effected by debiting the new partner’s capital (according to new profit/loss sharing ratio) and crediting the Asset Account

• If the revaluation resulted in revaluation deficit, the reversal is effected by debiting the Asset Account and crediting the new partner’s Capital Accounts (according to new profit/loss sharing ratio)

Assets GH¢ GH¢

Premises (at cost) 65,000

Equipment (at cost less depreciation) 15,000

80,000

Stock 20,000

Debtors 12,000

Bank 8,000 40,000

120,000

Financed by:

Capitals: W 70,000

Y 50,000

120,000

The following is the balance sheet as at 31 December 2005 of W and Y, who shared

profits and losses in the ratios: W two-thirds; Y one-third. From 1 January 2006 the

profit and loss sharing ratio is to be altered to W one-half; Y one-half.

Balance Sheet as at 31 December 2005

The assets were revalued on 1 January 2006 to be:

Premises GH¢90,000; Equipment GH¢11,000. Other

assets values were unchanged.

Account for the revaluation in the partnership books

Goodwill

Goodwill Definition and Meaning

• Goodwill refers to the advantages and benefits arising from good name, reputation and trade connections that a firm possesses

• It may also be defined as the difference between the purchase price and the value of tangible separable assets of the firm

• IFRS 3 defines Goodwill as “the excess of the cost of the business combination over the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities”

Goodwill Definition and Meaning

• Whenever a new partner is admitted, goodwill is valued and shared among the exiting partners

• In certain situations, the incoming partner is asked to contribute his or her part of the goodwill in the form of premium

Characteristics of goodwill

• It is an intangible asset

• The valuation of goodwill is very subjective

• It is impracticable of realization separately from the business as a whole. That is, you cannot sell goodwill separately without selling the business

• Its value has no predictable relationship to any cost incurred

• The value of goodwill may fluctuate widely according to internal and external circumstances over a relatively short period

Types of goodwill

• Purchased Goodwill

• Purchased goodwill can be defined as the difference between the purchase price of an entity and the fair value of the aggregate tangible separable assets of the entity

• Purchased goodwill will be recognized within the accounts of the firm

• Purchased goodwill has a limited life

Types of goodwill• Non-purchased goodwill

• This is internally generated goodwill. Usually this is not recorded in the books and does not appear in the balance sheet because of its volatile nature and uncertainty as to its true value.

• IAS 38 states clearly that ‘internally generated goodwill (or “self-generated goodwill”) shall not be recognized as an asset.

• Goodwill is recognized for the purpose of inter-partner capital adjustments

Goodwill

• Non-purchased goodwill

• Whenever a change occurs in a partnership, it is necessary to record the goodwill internally, prior to making the change and normally it is then written off once the change has occurred.

Goodwill

• Whenever a business is sold, and goodwill is realized, it is enjoyed by the owners of the firm

• In the same vein, if a change is made in partnership such as retirement or admission of a new partner, the old partners should enjoy the value of the goodwill they have created for the firm

Factors giving rise to goodwill

• Reputation of the firm and its products or services

• The location of the firm and its premises

• Reputation of the individuals making up the firm

• Expertise of the employees of the firm

Factors giving rise to a goodwill

• Possession of patent and copyright.

• Interpersonal relationship of the personnel of the firm

• Possession of monopoly (franchise) with respect to the sale of goods in an area

Instances where the valuation of goodwill is necessary

• On the admission of a new partner

• Upon the death or retirement of a partner

• On the dissolution of the firm

• When there is a change in the profit and loss sharing ratio

• Upon the revaluation of a business

• On the purchase of a business

• On the amalgamation of the firm

Methods of valuing goodwill

• Simple Average of annual profits method

• Weighted Average of net profit method

• Super profit method i.e. a number of years purchase of the super profit of the firm

• Revaluation method

• Plain bargaining

Methods of valuing goodwill• Simple Average of annual profits method

Goodwill is valued as the average net profit of a given number of years

The average annual profit is multiplied by a factor, say ‘X’ to give goodwill

Thus we talk of ‘X’ years purchase of the average profits for a given number of years


• Simple Average of annual profits method

• Illustration

Tyre and Tube are in partnership sharing profits and losses equally. The net profits for the last five years are as follows; ¢56 000, ¢74 000, ¢87 000, ¢90 000 and ¢101 000. Goodwill is to be valued at 21/2 years purchase of the average profit for the last five years.

• Calculate the value of goodwill

Solution

Total net profits = (56,000+74,000+87,000+90,000+101,000)

= ¢408 000

Average profit = 408,000/5 = ¢81 600

Goodwill at 21/2 years purchase =2.5 ×81 600 = ¢204 000


• Weighted Average of net profit method

Under this approach the net profits for a given period of time are weighted

The total weighted profit is then divided by the total weights

The average weighted figure may then be multiplied by a number of years purchase (or a factor)

• Illustration

• Hand and Leg are equal partners. Their reported net profits for the past five years are as follows


• GH¢

• 2003 25,000

• 2004 35,000

• 2005 40,000

• 2006 50,000

• 2007 60,000

• Using the weighted average profit method, calculate the value of goodwill if goodwill is agreed at 3 years purchase of the weighted profit.

Suggested Solution

Profits weight weighted

profit

2007 60,000 5 300,000

2006 50,000 4 200,000

2005 40,000` 3 120,000

2004 35,000 2 70,000

2003 25,000 1 25,000

15 715,000

Weighted average profit = ൗ715,00015= 47,667

Goodwill = 47,667 x 3 = 143,000


• Super Profits Method

• Super profit is the excess of the maintainable profit of a firm over the normal profits that would have been made if the capital was invested elsewhere and any salary that the proprietor could have earned if he should be employed elsewhere.



• Illustration

A firm invested ¢100m in a business. Interest to be earned in a similar venture if the firm had invested the ¢100m there is ¢25m. The annual salary of the partners if employed is estimated at ¢30m. The average annual profit of the firm is ¢78m.

What is the value of the goodwill?

Solution

¢m ¢m

Annual profits 78

Interest on capital 25

Annual salary 30

55

Goodwill

23

Note: Goodwill can also be valued as a number of years

purchase of super profit.



• TRY THIS

Mr. Cash, a mechanic operates a garage from which he earns annual income of ¢50m. Cash invested ¢120m in the project. If these funds were invested somewhere with similar business risk, Cash was sure to receive a return of 20% annually. Cash will also receive a salary of ¢10m a year if he was working for somebody else. Calculate the value of goodwill, if it is considered to be 5-years purchase of super profit

Solution

¢m ¢m

Annual Income

50

Less: Return on Capital (0.2*120m) 24

Salary

10 34

Super Profit

16

Goodwill = super profit × number of years purchased

Methods of treating goodwill

• A) Maintaining goodwill in the books

• Retain goodwill at cost unless there is a permanent fall in value (impairment). Thus goodwill will be recorded as a permanent non-current asset (IFRS 3)

• Write off goodwill over a useful life. Thus the value of the goodwill is amortized, over a period, to the profit and loss account. (IAS 38)

Methods of treating goodwill

• B) When goodwill is not maintained in the booksMemorandum revaluation method

oPass goodwill through the books and write off immediately

Purchase and sale method (inter-partner capital adjustment) oAscertain partners’ share of goodwill before and after the change.

Compare the two to determine a gain or loss to be credited or debited to the partners account. Goodwill account is not opened.

Premium method oshared by the old partners in their old profit and loss sharing ratio

according to what each partner has given up to let the new partner in. goodwill gained either pass through the books or not depending the policy of the firm.

partnershipnature of partnership •section 40 of the act states as follows, "the fact that a...

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