What you'll learn
Partnership accounts form a crucial component of financial statement preparation at IGCSE level. This guide covers the preparation of appropriation accounts, capital and current accounts, and the accounting treatment of partner transactions including profit distribution, interest on capital and drawings, partner salaries, and changes in partnership composition.
Key terms and definitions
Partnership — a business owned by two or more persons (up to 20 in most cases) who share profits, losses and management responsibilities according to a partnership agreement.
Partnership Agreement — a legal document (also called a deed of partnership) that specifies how profits are shared, interest rates on capital and drawings, partner salaries, and other terms governing the partnership.
Appropriation Account — a financial statement showing how net profit is divided among partners after accounting for interest on capital, interest on drawings, and partner salaries.
Capital Account — a fixed account recording each partner's initial and additional capital contributions, showing permanent investment in the partnership.
Current Account — a fluctuating account recording each partner's share of profits, drawings, interest on capital, interest on drawings, and salaries.
Interest on Capital — a reward paid to partners based on their capital invested in the business, calculated as a percentage of their capital balance.
Interest on Drawings — a charge made against partners for withdrawing money from the business, calculated on the amount and timing of drawings.
Drawings — money or goods taken out of the business by partners for personal use, reducing their stake in the partnership.
Core concepts
Formation and characteristics of partnerships
Partnerships arise when sole traders combine resources or when individuals start a business together. Key characteristics include:
- Shared ownership between 2-20 partners (ordinary partnerships)
- Unlimited liability for debts (each partner personally liable)
- Shared decision-making and management
- No separate legal identity from the owners
- Governed by the Partnership Act 1890 in the UK (unless a partnership agreement states otherwise)
Default provisions under the Partnership Act when no agreement exists:
- Profits and losses shared equally
- No interest on capital
- No interest on drawings
- No partner salaries
- Interest at 5% per annum on partner loans to the business
Partnership accounts differ from sole trader accounts primarily in how profits are distributed and how owners' equity is recorded.
The Appropriation Account
The Appropriation Account shows the distribution of net profit among partners. It follows the Income Statement and begins with net profit for the year.
Structure of the Appropriation Account:
- Start with net profit from the Income Statement
- Add interest on drawings (reduces partners' share)
- Deduct interest on capital (partners' entitlement)
- Deduct partner salaries
- Remaining profit shared in the profit-sharing ratio
Format:
Profit and Loss Appropriation Account for year ended 31 December 20XX
£ £
Net profit for the year 45,000
Add: Interest on drawings
Partner A 200
Partner B 150 350
45,350
Less: Interest on capital
Partner A 2,000
Partner B 1,500 3,500
Less: Salaries
Partner A 8,000
Partner B - 8,000
33,850
Share of remaining profit (in ratio 3:2):
Partner A (3/5) 20,310
Partner B (2/5) 13,540 33,850
Capital and Current Accounts
Partnerships maintain two accounts per partner to record their financial interest:
Capital Accounts record:
- Initial capital introduced
- Additional capital contributed
- Capital withdrawn (permanent reductions)
- Goodwill adjustments on admission/retirement
- Revaluation of assets
Capital accounts normally maintain fixed balances unless structural changes occur.
Current Accounts record:
- Share of profits (credit)
- Drawings (debit)
- Interest on capital (credit)
- Interest on drawings (debit)
- Partner salaries (credit)
Current accounts fluctuate throughout the year. A credit balance represents amounts owed to the partner; a debit balance (sometimes allowed) represents amounts owed by the partner to the business.
Format of Capital Accounts:
Partner A Partner B Partner A Partner B
£ £ £ £
Balance c/d 30,000 20,000 Balance b/d 30,000 20,000
------ ------ ------ ------
30,000 20,000 30,000 20,000
Format of Current Accounts:
Partner A Partner B Partner A Partner B
£ £ £ £
Drawings 12,000 9,000 Balance b/d 2,500 1,800
Interest on Interest on
drawings 200 150 capital 2,000 1,500
Balance c/d 12,610 7,690 Salary 8,000 -
Share of profit 20,310 13,540
------ ------ ------ ------
24,810 16,840 24,810 16,840
Balance b/d 12,610 7,690
Calculating interest on capital and drawings
Interest on capital rewards partners for leaving money invested in the business. Calculate using:
Interest = Capital balance × Rate × Time period
For fixed capital accounts, use the balance throughout the year. If capital changes during the year, calculate interest for the appropriate period.
Example: Partner with £40,000 capital, 5% interest per annum = £40,000 × 5% = £2,000
Interest on drawings discourages partners from withdrawing excessive amounts. Three calculation methods:
- Exact method: Calculate interest on each withdrawal from the date drawn to year-end
- Average method: Assume all drawings occurred at the middle of the year; charge interest for 6 months
- Total drawings method: Use when drawings occur uniformly; multiply total drawings by half the annual rate
Example (Average method): Annual drawings £12,000, interest rate 4% per annum Interest = £12,000 × 4% × 6/12 = £240
Admission of a new partner
When a new partner joins, existing partners may require compensation for sharing future profits. This involves recognizing goodwill — the value of the business's reputation and existing customer relationships.
Two methods for dealing with goodwill:
Method 1: Goodwill account created and maintained
- Create a Goodwill account (debit)
- Credit existing partners' capital accounts in old profit-sharing ratio
- After admission, debit all partners (including new) in new profit-sharing ratio
- Credit Goodwill account to remove it
Method 2: Goodwill not recorded (adjustment to capital accounts)
- Debit new partner's capital account
- Credit existing partners' capital accounts in old profit-sharing ratio
- No Goodwill account appears in Statement of Financial Position
Revaluation of assets often accompanies partner admission:
- Create a Revaluation Account
- Debit: decreases in asset values, increases in liabilities
- Credit: increases in asset values, decreases in liabilities
- Transfer profit/loss to existing partners' capital accounts in old ratio
Statement of Financial Position presentation
In a partnership Statement of Financial Position, the Financed by section shows:
Financed by: Partner A Partner B Total
£ £ £
Capital accounts 30,000 20,000 50,000
Current accounts 12,610 7,690 20,300
------ ------ ------
Total partners' equity 42,610 27,690 70,300
If a current account has a debit balance, show it in brackets (deducted from that partner's total).
Non-current and current liabilities follow below partners' equity.
Worked examples
Example 1: Preparing an Appropriation Account
Question: Ahmed and Bianca are in partnership sharing profits 3:2. Their partnership agreement provides for:
- Interest on capital at 6% per annum
- Ahmed receives a salary of £15,000
- Interest on drawings at 4% per annum
At 31 December 2023:
- Ahmed's capital: £50,000; Bianca's capital: £30,000
- Net profit for the year: £68,400
- Drawings: Ahmed £18,000; Bianca £12,000
- Interest on drawings: Ahmed £360; Bianca £240
Required: Prepare the Profit and Loss Appropriation Account for the year ended 31 December 2023.
Solution:
Profit and Loss Appropriation Account for year ended 31 December 2023
£ £
Net profit for the year 68,400
Add: Interest on drawings
Ahmed 360
Bianca 240 600
69,000
Less: Interest on capital
Ahmed (£50,000 × 6%) 3,000
Bianca (£30,000 × 6%) 1,800 4,800
Less: Salary
Ahmed 15,000
Bianca - 15,000
49,200
Share of remaining profit (ratio 3:2):
Ahmed (3/5 × £49,200) 29,520
Bianca (2/5 × £49,200) 19,680 49,200
Example 2: Current Accounts
Question: Using the information from Example 1, prepare the partners' Current Accounts for the year ended 31 December 2023. Opening balances: Ahmed £4,200 credit; Bianca £1,850 credit.
Solution:
Current Accounts
Ahmed Bianca Ahmed Bianca
£ £ £ £
Drawings 18,000 12,000 Balance b/d 4,200 1,850
Interest on Interest on
drawings 360 240 capital 3,000 1,800
Balance c/d 33,360 11,250 Salary 15,000 -
Share of profit 29,520 19,680
------ ------ ------ ------
51,720 23,490 51,720 23,490
Balance b/d 33,360 11,250
Example 3: Admission of a partner with goodwill
Question: Chan and Daley are partners sharing profits equally. Their capital account balances on 1 January 2024 are Chan £60,000 and Daley £40,000. On this date, they admit Emma as a partner. The new profit-sharing ratio will be 2:2:1 (Chan:Daley:Emma). Goodwill is valued at £25,000 but will not remain in the books. Emma introduces £30,000 as capital.
Required: Prepare the partners' Capital Accounts showing the admission of Emma.
Solution:
Capital Accounts
Chan Daley Emma Chan Daley Emma
£ £ £ £ £ £
Goodwill 10,000 10,000 5,000 Balance b/d 60,000 40,000
written off Goodwill 12,500 12,500
(old ratio)
Balance c/d 62,500 42,500 25,000 Bank 30,000
------ ------ ------ ------ ------ ------
72,500 52,500 30,000 72,500 52,500 30,000
Balance b/d 62,500 42,500 25,000
Workings:
- Goodwill credited to Chan and Daley in old ratio 1:1 = £12,500 each
- Goodwill debited to all partners in new ratio 2:2:1 = £10,000, £10,000, £5,000
Common mistakes and how to avoid them
Confusing capital and current accounts — Remember: capital accounts record permanent investment; current accounts record profit shares, drawings, and related adjustments. Keep capital fixed unless specifically told otherwise.
Incorrect profit-sharing calculations — Always convert ratios to fractions. A 3:2 ratio means Partner A receives 3/5 (not 3/2) and Partner B receives 2/5. Check your fractions sum to 1.
Forgetting to add interest on drawings before deducting appropriations — Interest on drawings is income to the business and increases the amount available for distribution. Add it to net profit first.
Mishandling goodwill adjustments — When goodwill is not retained, remember to credit old partners in the old ratio, then debit all partners (including new ones) in the new ratio. The new partner effectively compensates existing partners through their capital contribution.
Wrong treatment of partner salaries — Salaries are appropriations of profit, not expenses. They appear in the Appropriation Account, never in the Income Statement.
Arithmetic errors in current accounts — Always check that debits equal credits for each partner's current account. A common error is omitting the opening balance or transposing debit and credit entries.
Exam technique for "Financial Statements: Partnership Accounts"
Command words matter — "Prepare" requires a full formal statement with headings and proper format (typically 4-6 marks); "Calculate" requires only the numerical answer with workings (typically 2-3 marks); "State" requires a brief written explanation without calculations (1-2 marks).
Show full workings — Even if the final answer is wrong, you earn method marks for correct process. For profit shares, write out "3/5 × £45,000 = £27,000" rather than just stating £27,000.
Label accounts clearly — Write "Profit and Loss Appropriation Account for year ended [date]" as a heading. Use partner names as column headings. Examiners cannot award presentation marks if formats are unclear.
Use ledger account format correctly — Capital and current accounts use T-account format with debit entries on the left, credit entries on the right. Remember "balance c/d" goes on the side that makes both sides equal, and "balance b/d" appears on the opposite side in the next period.
Quick revision summary
Partnership accounts record transactions for businesses owned by 2-20 partners. The Appropriation Account distributes net profit after adjusting for interest on drawings (added), interest on capital, and salaries (both deducted). Partners maintain two accounts: fixed Capital Accounts recording permanent investment and fluctuating Current Accounts recording profit shares, drawings, interest, and salaries. When new partners join, goodwill represents compensation for existing partners. Calculate interest on capital by multiplying capital balances by the agreed rate; calculate interest on drawings using exact, average, or total drawings methods.