This article provides a brief introduction to partnerships and some of the basic calculations that would be needed to attempt the relevant questions in the FA2 exam. For a more detailed guide on partnerships and how they might be assessed, please see the article ‘Accounting for partnerships.’
A partnership is where two or more individuals are in business together with a view to making and sharing the profits. The partnership will usually set up an agreement which states the terms for each partner such as any salary they are entitled to, if interest will be payable for capital invested and what the profit or loss sharing ratio is (often called the ‘profit sharing ratio’ or ‘PSR’). However, before we get to deal with this, we need to know the net profit for the period – this is calculated exactly the same as for a sole trader. You need to be careful with partners’ salaries – these are not an expense to be deducted from the profits; instead they are an appropriation of profit.
Once we have found the net profit, or have been given it in the question, we then need to share this out among the partners per the terms of the partnership agreement. The easiest way is to set up an appropriation statement and then allocate the profits as follows:
- Allocate any salaries
- Allocate any interest on capital
- Allocate the remaining profit in the PSR
This remaining profit may be referred to as the residual profit – therefore if a question asks for a partner’s share of the residual profit, it is asking for the share of the remaining profit after all other appropriations.
Let’s consider an example where Alan and Betty are in partnership, both having invested $20,000, with a partnership agreement that states:
- Alan gets a salary of $6,000,
- interest on capital is 5% per year, and
- the residual profit is allocated 60:40.
If the total profit for the period is $22,400 then the appropriation would be as follows: