Partnership agreements

Partnership agreements are legal documents that outline the terms and conditions agreed upon by individuals
or entities entering into a partnership. The contents of a partnership agreement may vary depending on the
nature of the partnership and the specific needs of the parties involved.

Contents of partnership agreements

The written agreement can contain as much, or as little, as the partners want. The law does not say what it
must contain. The usual accounting contents are:

1. The capital to be contributed by each partner.

2. The ratio in which profits (or losses) are to be shared.
3. The rate of interest, if any, to be paid on capital before the profits are shared.
4. The rate of interest, if any, to be charged on partners’ drawings.
5. Salaries to be paid to partners.
6. Arrangements for the admission of new partners.
7. Procedures to be carried out when a partner retires or dies.

Capital contributions

Detail each partner's contributions to the partnership, which may include financial investments, property,
equipment, intellectual property, or other assets.

Partners need not contribute equal amounts of capital. What matters is how much capital each partner agrees
to contribute. It is not unusual for partners to increase the amount of capital they have invested in the
partnership.

Profit (or loss) sharing ratios

Specify the percentage of ownership that each partner holds in the partnership. This determines each
partner's share of profits and losses.

Profits in a partnership are not always shared in the same ratio as the capital contributed by each partner.
While the capital contribution is one factor that may influence the allocation of profits, the partnership
agreement typically governs how profits are shared among the partners. This agreement can outline various

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methods for allocating profits, and it's not uncommon for partners to agree to a different profit-sharing
arrangement than the ratio of their capital contributions.

Interest on capital

Interest on capital is a form of compensation paid by a partnership to its partners for the use of their invested
capital within the business. It is similar to interest paid on a loan, but instead of borrowing funds externally,
the partnership compensates partners for their investment in the business.

Interest on capital is treated as an expense for the partnership and is deducted from the partnership's profits
before calculating the distribution of remaining profits to the partners. In the partnership's financial
statements, interest on capital may be included as a separate line item under expenses or deducted from the
partnership's net income.

If the work to be done by each partner is of equal value but the capital contributed is unequal, it is reasonable
to pay interest on the partners’ capitals out of partnership profits. This interest is treated as a deduction prior
to the calculation of profits and their distribution among the partners according to the profit-sharing ratio.

The rate of interest is a matter of agreement between the partners, but it should equal the return which they
would have received if they had invested the capital elsewhere.

Interest on drawings

Partners may periodically withdraw funds from the partnership for personal use. These withdrawals are
known as drawings.

Interest on drawings is a concept in partnership accounting that involves charging partners interest on any
withdrawals they make from the partnership for personal use. This interest charge is meant to compensate
the partnership for the opportunity cost of using its funds and to encourage partners to limit their withdrawals
to reasonable levels.

It is obviously in the best interests of the firm if cash is withdrawn from the firm by the partners in accordance
with the two basic principles of: (a) as little as possible, and (b) as late as possible.

The more cash that is left in the firm the more expansion can be financed, the greater the economies of
having ample cash to take advantage of bargains and of not missing cash discounts because cash is not
available and so on.

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To deter the partners from taking out cash unnecessarily the concept can be used of charging the partners
interest on each withdrawal, calculated from the date of withdrawal to the end of the financial year. The
amount charged to them helps to swell the profits divisible between the partners. The rate of interest should
be sufficient to achieve this without being too harsh.

Partnership salaries

One partner may have more responsibility or tasks than the others. As a reward for this, rather than change
the profit and loss sharing ratio, the partner may have a partnership salary which is deducted before sharing
the balance of profits.

Performance-related payments to partners

Partners may agree that commission or performance-related bonuses be payable to some or all the partners
linked to their individual performance. As with salaries, these would be deducted before sharing the balance
of profits.

Partnership appropriation account

In a partnership, an appropriation account is used to track how profits or losses are allocated among the
partners. It helps in ensuring transparency and fairness in distributing the partnership's income or losses
according to the terms agreed upon in the partnership agreement.

How a partnership appropriation account works:

o Allocation of Profits and Losses: The partnership agreement specifies how profits or losses are to be
divided among the partners. This may be based on each partner's ownership percentage, their
capital contributions, or other agreed-upon criteria.
o Initial Entries: At the end of the accounting period, the partnership's profits or losses are determined
through the preparation of an income statement. These profits or losses are then transferred to the
appropriation account.
o Appropriation Entries: Once the profits or losses are transferred to the appropriation account, they
are allocated among the partners according to the terms outlined in the partnership agreement. This
may involve specific allocations for salaries, interest on capital, bonuses, or any other agreed-upon
distributions.

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 o Distribution to Partners: After the allocation has been made, the appropriated profits or losses are
distributed to the individual partners' capital accounts. Each partner's capital account is adjusted to
reflect their share of the partnership's profits or losses for the period.
o Closing Entries: At the end of the accounting period, any remaining balances in the appropriation
account are closed out to the partners' capital accounts or retained earnings, depending on the
partnership's agreement and accounting practices.

It's important to note that the specifics of a partnership appropriation account can vary depending on the
partnership agreement and accounting principles followed. Partnerships may also have additional
appropriation accounts for specific purposes or activities, such as reserves for future investments or
distributions.

Illustration One

Tony and Claudio have been in partnership for one year sharing profits and losses in the ratio of Tony 3/5,
Claudio 2/5. They are entitled to 5 per cent per annum interest on capitals, Tony having Tzs 20,000,000
capital and Claudio Tzs 60,000,000. Claudio is to have a salary of Tzs 15,000,000. They charge interest on
drawings; Tony being charged Tzs 500,000 and Claudio Tzs 1,000,000. The net profit, before any
distributions to the partners, amounted to Tzs 50,000,000 for the year ended 31 December 2023.

Illustration Two

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 2023, their capital accounts remained fixed at the following amounts:

Tzs
Black 60,000,000
Brown 40,000,000
Cook 20,000,000

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 Tzs 30,000,000 for Brown and Tzs 18,000,000 for Cook are
to be charged.

The net profit of the partnership, before taking any of the above into account was Tzs 111,000,000.

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Required:

Draw up the profit and loss appropriation account of the partnership for the year ended 31 July 2023.

Illustration Three

Draw up a profit and loss appropriation account for the year ended 31 March 2023 and balance sheet extracts
at that date, from the following:

(i) Net profits Tzs 111,100,000.

(ii) Interest to be charged on capitals: Blair Tzs 3,000,000; Short Tzs 2,000,000; Steel Tzs
1,500,000.
(iii) Interest to be charged on drawings: Blair Tzs 400,000; Short Tzs 300,000; Steel Tzs 200,000.
(iv) Salaries to be credited: Short Tzs 20,000,000; Steel Tzs 25,000,000.
(v) Profits to be shared: Blair 70%; Short 20%; Steel 10%.
(vi) Current accounts: balances b/d Blair Tzs 18,600,000; Short Tzs Tzs 9,460,000; Steel Tzs
8,200,000.
(vii) Capital accounts: balances b/d Blair Tzs 100,000,000; Short Tzs 50,000,000; Howe Tzs
25,000,000.
(viii) Drawings: Blair Tzs 39,000,000; Short Tzs 27,100,000; Steel Tzs 16,800,000.