Chapter 10 Financial Statements

for Partnerships
 Agreement agreed in a partnership
Jack Lily Michelle
35 years old 25 years old 30 years old
Businessman; have already Fashion designer; gain two CPA for 10 years
invested 2 trading firms in HK and design competitions awards in
Macau Hong Kong
Saving $3 million Saving $30,000 Saving $1 million

Set up a boutique in TST Profit earned : $40,000

Capital contribution:
Profit/ sharing Salary: Lily $48,000 p.a.
Jack: $100,000
= $20,000 ： $10,000 ： $10,000
Michelle: $30,000
Drawings:
Lily: work full time in the Further capital contribution: Jack 1 Jan $40,000
boutique Jack: $20,000 Michelle 1 July $1,000
Profit/ loss sharing ratio Profit or loss sharing ratio:
= ２：１：１ 2:1:1
Partnership agreement

 In order to prevent conflicts, partners need to agree on

important issues before starting a business and put them
into a partnership agreement.

1 Capital contribution by each partner

 The partners should agree among themselves on the
amount of capital to be contributed by each partner, which
must be / is not necessarily equal.
Partnership agreement

2 Profit and loss sharing ratio

 This is the ratio in which partners share the profits or losses of a
partnership. It may be linked to the amount of capital contributed
or the workload borne by each partner.

3 Rate of interest on capital

 Interest may be allowed on partners’ capital as a maximum /
minimum return on their capital contributions. Given a fixed rate
of interest, a partner who has contributed more / less capital than
others will be entitled to more interest.
Encouragement / discouragement to partners
Increase / decrease of Capital of partners
Increase / decrease of net profit
Partnership agreement

4 Rate of interest on drawings

 Given a fixed rate of interest, a partner who has made more drawings than others
will be charged more / less interest in order to discourage partners from taking
resources out of the partnership.

Encouragement / discouragement to partners

Increase / decrease of Capital of partners
Increase / decrease of net profit
5 Salaries to partners
 If the profit and loss sharing ratio does not reflect the unequal workloads of
partners, salaries may be paid to partners who contribute more time and effort.
Encouragement / discouragement to partners
Increase / decrease of Capital
Increase / decrease of net profit
Partnership agreement

When there is no partnership agreement

If there is no agreement of any type (verbal or written),
the provisions of the Hong Kong Partnership Ordinance
(Chapter 38) apply.
 Profits and losses are shared equally
equally by all partners
 No interest on the capital contributed Salaries / bonus paid
 No remuneration for services for the partnership
 If a partner pays more into the partnership than the
agreed capital contribution, he is entitled to interest at
an annual rate of 8% on any such advance. Interest on loan
 No interest should be charged on drawings
Profit and loss appropriation account

 The balance in the profit and loss account represents

the net profit made or net loss incurred during that
period.
 However, it is not the net profit or loss that will be shared
by the partners. The net profit or net loss should be
shared by the partners before / after the following
appropriations:
 Interest on capital
 Interest on drawings
 Salaries to partners
 Profit and loss appropriation account

The balance of the profit and loss account

will first be transferred to an account called
the profit and loss appropriation account.

Or simply called ‘the appropriation account’ which

records all the appropriation adjustments required
for the accounting period.

Finally, the balance (i.e., net profit or net

loss after appropriations) in the profit and
loss appropriation account will be shared by
the partners according to the agreed profit
and loss sharing ratio.
Open a capital account for each partner

 For a partnership, a capital account is opened for

each partner to record the amount of capital
contributed, the profit or loss shared, the amount of
drawings made, as well as appropriations.
Fluctuating and fixed capital accounts

Recurrent items are recorded in an

additional account

Quite common
Fluctuating and fixed capital accounts

An example of a partnership Exhibit 10.1

Chan and Ng established a partnership on 1 January

2015. The profit and loss sharing ratio is 2 : 1. Other
information for the year ended 31 December 2015 is as
follows:
1 Amount contributed on 1 January 2015 by cheque:
Chan $400,000, Ng $300,000.
2 Rate of interest on capital: 5% per annum.
3 Rate of interest on drawings: 10% per annum.
4 Ng was entitled to an annual salary of $100,000.
5 Drawings on 1 July 2015: Chan $90,000, Ng
$60,000.
6 Net profit for the year amounted to $900,000.
 Fluctuating capital accounts

(i) Capital contributed Dr Bank / Cash / Other assets account

Cr Partners’ capital accounts
(ii) Drawings made Dr Partners’ drawings accounts
Cr Bank / Cash / Other assets /
Purchases account
(iii) Transfer of year-end Dr Partners’ capital accounts
balances of drawings Cr Partners’ drawings accounts
(iv) Interest on drawings Dr Partners’ capital accounts
Cr Profit and loss appropriation
account
 Fluctuating capital accounts

(v) Interest on capital Dr Profit and loss appropriation account

Cr Partners’ capital accounts
(vi) Salaries to partners Dr Profit and loss appropriation account
Cr Partners’ capital accounts
(vii) Share of profit Dr Profit and loss appropriation account
Cr Partners’ capital accounts
Items such as interest on drawings, interest on capital, salaries to partners and
share of profit or loss are usually debited or credited to the partners’ capital (or
current) accounts instead of the cash or bank account. They seldom involve actual
payments to or receipts from the partners.
 Fluctuating capital accounts
Profit and Loss Appropriation Page: 7
$400,000 × 5%
2015 $
2015 $
Dec 31 Interest on capital — Dec 31 Profit and loss (net profit)
Capital: Chan 20,000 “ 31 Interest on drawings —
90,000
Capital: Chan

4,500
$90,000 × 10% × 1/2

Capital: Chan Page: 7

2015 $ 2015 $
Jul 1 Drawings 90,000 Jan 1 Bank
Dec 31 Profit and loss appropriation — Dec 31 Profit and loss appropriation —
400,000
Interest on drawings 4,500 Interest on capital

20,000
 Fluctuating capital accounts
Profit and Loss Appropriation Page: 7
2015 $
2015 $
$300,000 × 5%
Dec 31 Interest on capital — Dec 31 Profit and loss (net profit)
Capital: Chan 20,000 “ 31 Interest on drawings —
Capital: Ng 15,000 90,000
Capital: Chan
“ 31 Salary to partner — Capital: Ng 3,000
4,500
Capital: Ng 100,000
$60,000 × 10% × 1/2

Capital: Ng Page: 7
2015 $ 2015 $
Jul 1 Drawings Jan 1 Bank
Dec 31 Profit and loss appropriation — Dec 31 Profit and loss appropriation —
60,000 300,000
Interest on drawings 3,000 Interest on capital
Salary to partner
15,000
 Fluctuating capital accounts
Profit and Loss Appropriation Page: 7
2015 $ 2015 $
Dec 31 Interest on capital — Dec 31 Profit and loss (net profit)
Capital: Chan 20,000 “ 31 Interest on drawings —
Capital: Ng 15,000 90,000
Capital: Chan
“ 31 Salary to partner — Capital: Ng 3,000
4,500
Capital: Ng 100,000
“ 31 Share of profit —
Capital: Chan (2/3) 515,000

Capital: Chan Page: 7

2015 $ 2015 $
Jul 1 Drawings Jan 1 Bank
Dec 31 Profit and loss appropriation — Dec 31 Profit and loss appropriation —
90,000
Interest on drawings 4,500 400,000
Interest on capital
Share of profit
20,000
 Fluctuating capital accounts
Profit and Loss Appropriation Page: 7
2015 $ 2015 $
Dec 31 Interest on capital — Dec 31 Profit and loss (net profit)
Capital: Chan 20,000 “ 31 Interest on drawings —
Capital: Ng 15,000 90,000
Capital: Chan
“ 31 Salary to partner — Capital: 3,000
4,500
Capital: Ng 100,000
“ 31 Share of profit —
Capital: Chan (2/3) 515,000
Capital: Ng (1/3) 257,500
Capital: Ng Page: 7
2015 $ 2015 $
Jul 1 Drawings Jan 1 Bank
Dec 31 Profit and loss appropriation — Dec 31 Profit and loss appropriation —
60,000Interest on drawings 3,000 300,000
Interest on capital
Salary to partner
15,000
Share of profit
 Fluctuating capital accounts
Profit and Loss Appropriation Page: 7
2015 $
Dec 31 Interest on capital — Dec 31 Profit and loss (net profit)
Capital: Chan 20,000 “ 31 Interest on drawings —
Capital: Ng 15,000 90,000
Capital: Chan
“ 31 Salary to partner — Capital: Ng 3,000
4,500
Capital: Ng 100,000
“ 31 Share of profit —
Capital: Chan (2/3) 515,000
Capital: Ng (1/3) 257,500
907,500 907,500
 Fluctuating capital accounts

Capital: Chan Page: 7

2015 $ 2015 $
Jul 1 Drawings Jan 1 Bank
Dec 31 Profit and loss appropriation — Dec 31 Profit and loss appropriation —
90,000
Interest on drawings 4,500 400,000
Interest on capital
“ 31 Balance c/f Share of profit
840,500 20,000
935,000 935,000
515,000
2016
Jan 1 Balance b/f 840,500
 Fluctuating capital accounts

Capital: Ng Page: 7
2015 $ 2015 $
Jul 1 Drawings Jan 1 Bank
Dec 31 Profit and loss appropriation — Dec 31 Profit and loss appropriation —
60,000
Interest on drawings 3,000 300,000
Interest on capital
“ 31 Balance c/f Salary to partner
609,500 15,000
Share of profit
100,000
672,500 672,500
257,500
2016
Jan 1 Balance b/f 609,500
Ex10.2X


Not paid Paid
Points to note when preparing financial
Learning Tips
statements for a partnership
Capital vs. current accounts
1. Capital contributed and any gain/loss from revaluation are
recorded in the capital accounts.
2. Drawings and appropriation items such as interest on capital
and interest on drawings are recorded in the current accounts.

Salaries to partners
Staff salaries and partners’ salaries should be separately recorded
in the partnership books.
1. Staff salaries are treated as an operating expense of the
partnership.
2. Partners’ salaries are treated as appropriation items after
net profit has been determined.
Points to note when preparing financial
Learning Tips
statements for a partnership
Loans from partners
A partner may sometimes make a loan to the partnership. When this
happens:
1. The partner becomes a creditor of the partnership.
2. The liability is shown separately in the statement of financial
position. Whether it is classified as a current or non-current liability
depends on when the loan has to be repaid.
Interest on loans from partners
Interest on a loan from a partner is treated as an operating expense
of the partnership and not as an appropriation item.
1. When interest is actually paid to the partner, the amount is
credited to the cash or bank account.
2. When interest is not yet paid to the partner, the interest
amount is credited to the partner’s current account.
 Fixed capital accounts (with current accounts)

(i) Capital contributed Dr Bank / Cash / Other assets account

Cr Partners’ capital accounts
(ii) Drawings made Dr Partners’ drawings accounts
Cr Bank / Cash / Other assets /
Purchases account
(iii) Transfer of year-end Dr Partners’ capital accounts
balances of drawings Cr Partners’ drawings accounts
(iv) Interest on drawings Dr Partners’ capital accounts
Cr Profit and loss appropriation
account
 Fixed capital accounts (with current accounts)

(v) Interest on capital Dr Profit and loss appropriation account

Cr Partners’ current accounts
(vi) Salaries to partners Dr Profit and loss appropriation account
Cr Partners’ current accounts
(vii) Share of profit Dr Profit and loss appropriation account
Cr Partners’ current accounts
Fixed capital accounts (with current accounts)

 With the exception of capital contributions, all items

affecting the capital balance of a partner are recorded in
his current account.
 The balance in the capital account shows only the
amount of capital that the partner brings in.
 The balance in the current account represents that
partner’s undrawn profits (represented by a credit
balance) or overdrawn profits (represented by a debit
balance).
 Fixed capital accounts (with current accounts)
Profit and Loss Appropriation Page: 9
2015 $ 2015
Dec 31 Interest on capital — Dec 31 Profit and loss (net profit)
Current: Chan 20,000 $ “ 31 Interest on drawings —
90,000
Current: Chan

$400,000 × 5% 4,500
$90,000 × 10% × 1/2

Current: Chan Page: 9

2015 $ 2015
Jul 1 Drawings Dec 31 Profit and loss appropriation —
Dec 31 Profit and loss appropriation — $ Interest on capital
90,000
Interest on drawings 4,500
20,000
 Fixed capital accounts (with current accounts)
Profit and Loss Appropriation Page: 9
2015 $ 2015
$300,000 × 5%
Dec 31 Interest on capital — Dec 31 Profit and loss (net profit)
Current: Chan 20,000 $ “ 31 Interest on drawings —
Current: Ng 15,000 90,000
Current: Chan
“ 31 Salary to partner — Current: Ng 3,000
4,500
Current: Ng 100,000
$60,000 × 10% × 1/2

Current: Ng Page: 9
2015 $ 2015
Jul 1 Drawings Dec 31 Profit and loss appropriation —
$
Dec 31 Profit and loss appropriation — Interest on capital
60,000
Interest on drawings 3,000 Salary to partner
15,000
100,000
 Fixed capital accounts (with current accounts)
Profit and Loss Appropriation Page: 9
2015 $ 2015
Dec 31 Interest on capital — Dec 31 Profit and loss (net profit)
Current: Chan 20,000 $ “ 31 Interest on drawings —
Current: Ng 15,000 90,000
Current: Chan
“ 31 Salary to partner — Current: Ng 3,000
4,500
Current: Ng 100,000
“ 31 Share of profit —
Current: Chan (2/3) 515,000

Current: Chan Page: 9

2015 $ 2015
Jul 1 Drawings Dec 31 Profit and loss appropriation —
Dec 31 Profit and loss appropriation — $ Interest on capital
90,000
Interest on drawings 4,500 Share of profit
20,000
515,000
 Fixed capital accounts (with current accounts)
Profit and Loss Appropriation Page: 9
2015 $ 2015
Dec 31 Interest on capital — Dec 31 Profit and loss (net profit)
Current: Chan 20,000 $ “ 31 Interest on drawings —
Current: Ng 15,000 90,000
Current: Chan
“ 31 Salary to partner — Current: Ng 3,000
4,500
Current: Ng 100,000
“ 31 Share of profit —
Current: Chan (2/3) 515,000
Current: Ng (1/3) 257,500
Current: Ng Page: 9
2015 $ 2015
Jul 1 Drawings Dec 31 Profit and loss appropriation —
Dec 31 Profit and loss appropriation — $ Interest on capital
60,000
Interest on drawings 3,000 Salary to partner
15,000
Share of profit
100,000
257,500
 Fixed capital accounts (with current accounts)
Profit and Loss Appropriation Page: 9
2015 $ 2015
Dec 31 Interest on capital — Dec 31 Profit and loss (net profit)
Current: Chan 20,000 $ “ 31 Interest on drawings —
Current: Ng 15,000 90,000
Current: Chan
“ 31 Salary to partner — Current: Ng 3,000
4,500
Current: Ng 100,000
“ 31 Share of profit —
Current: Chan (2/3) 515,000
Current: Ng (1/3) 257,500
907,500 907,500
 Fixed capital accounts (with current accounts)

Capital: Chan Page: 9

2015 $ 2015
Dec 31 Balance c/f Jan 1 Bank 400,000
400,000 400,000 $ 400,000
2016
Jan 1 Balance b/f 400,000
Current: Chan Page: 9
2015 $ 2015
Jul 1 Drawings Dec 31 Profit and loss appropriation —
Dec 31 Profit and loss appropriation — $ Interest on capital
90,000
Interest on drawings 4,500 Share of profit
“ 31 Balance c/f 20,000
440,500 535,000 515,000
535,000
2016
Jan 1 Balance b/f 440,500
 Fixed capital accounts (with current accounts)
Capital: Ng Page: 9
2015 $ 2015
Dec 31 Balance c/f Jan 1 Bank 300,000
300,000 300,000 $ 300,000
2016
Jan 1 Balance b/f 300,000

Current: Ng Page: 9
2015 $ 2015
Jul 1 Drawings Dec 31 Profit and loss appropriation —
Dec 31 Profit and loss appropriation — $ Interest on capital
60,000
Interest on drawings 3,000 Salary to partner
“ 31 Balance c/f 309,500 15,000
Share of profit
100,000
372,500 372,500
257,500
2016
Jan 1 Balance b/f 309,500
Fluctuating and fixed capital accounts

When we combine the balances of the fixed capital

accounts and current accounts:
Chan: $400,000 + $440,500 = $840,500
Ng: $300,000 + $309,500 = $609,500
we find that the total balances are actually the same as
those in the fluctuating capital accounts
Chan: $840,500
Ng: $609,500
Capital and current accounts in columnar form
Capital and current account balance

Current account balances

When a partnership is profitable and the partners have
not made excessive drawings, credit balances will be
brought forward in the current accounts.
However, it is possible to have debit balances in the
current accounts. This situation will arise if a partner has
overdrawn his current account.
In other words, the drawings have exceeded the balance
accumulated from the share of profit and other
appropriation items.
Capital and current account balance

Capital account balances

Credit balances will normally be brought forward in the
capital accounts. However, if a partnership has made a
substantial loss and/or a partner has made excessive
drawings, his capital balance (or the combined balance of
capital and current accounts) will be positive / negative.
In this case, the partner is said to have a capital
deficiency. He is indebted to the partnership and is
required to repay the amount owed.
Capital and current account balance

Capital account balances

Income statement of a partnership

 Unlike the income statement of a sole proprietorship, an appropriation

section appears in the income statement of a partnership immediately
after the item ‘net profit’.

Appropriation section
Income statement of a partnership

 Unlike the income statement of a sole proprietorship, an appropriation

section appears in the income statement of a partnership immediately
after the item ‘net profit’.
The interest on drawings was an addition to
the net profit to be shared. It should be
distinguished from the operating income.
Income statement of a partnership

 Unlike the income statement of a sole proprietorship, an appropriation

section appears in the income statement of a partnership immediately
after the item ‘net profit’.

The interest on capital and the partner’s

salary were deducted from the net profit to be
shared. They should be distinguish from the
operating expenses.
 Practice
Homework more

1. Ex 10.1

1. Ex10.3

Finish the two exercises and check the

answers with red ball pen.