In simple terms
A friendly intro before the formal notes — no formulas yet.
Partnerships
9706 P2 — appropriation account, partner capital/current accounts, admission and retirement.
- 1
The Partnership Agreement is the primary document for profit distribution.
- 2
In the absence of an agreement, the Partnership Act 1890 dictates terms (e.g., equal profit share).
- 3
The Appropriation Account is a distribution statement, not an expense account.
- 4
Key adjustments include interest on capital, interest on drawings, and partners' salaries.
What this topic covers
The official Cambridge syllabus points this lesson works through.
- 1.5.3.1
How to prepare a statement of profit or loss, appropriation account and statement of financial position for a partnership from full or incomplete accounting records. The business may be a trading or a service business
- 1.5.3.2
Why partners may maintain separate capital accounts and current accounts
- 1.5.3.3
How to prepare partners' capital and current accounts
- 1.5.3.4
The contents of a partnership agreement
- 1.5.3.5
The advantages and disadvantages to partners of maintaining a partnership agreement
- 1.5.3.6
The provisions of the Partnership Act 1890 in respect of partners' salaries, division of profit or loss, interest on partners' loans, interest on capital and interest on drawings
Explore the concept
Use the live diagram and synced steps — play it or tap a step card to walk through.
At a glance — side by side
Compare key properties side by side — ideal for exam contrasts.
Comparison of Fixed Capital and Current Accounts
| Feature | Capital Account | Current Account |
|---|---|---|
| Purpose | To record the long-term, permanent capital invested by a partner. | To record day-to-day transactions, including profit share, drawings, salaries, and interest. |
| Volatility | Stable. It only changes with permanent capital injections or withdrawals. | Fluctuates annually with each year's profit distribution and drawings. |
| Typical Items Recorded | Opening capital balance, additional permanent capital, capital withdrawn permanently. | Drawings, interest on drawings, interest on capital, partner's salary, share of residual profit/loss. |
| Normal Balance | Always a credit balance. | Can have a credit balance (firm owes partner) or a debit balance (partner owes firm). |
Purpose
Capital Account
Current Account
Volatility
Capital Account
Current Account
Typical Items Recorded
Capital Account
Current Account
Normal Balance
Capital Account
Current Account
Full topic notes
Formal explanation with the rigour you need for the exam.
The Partnership Agreement and Appropriation Account
A partnership is governed by a Partnership Agreement (or Deed), a legal document outlining how the business will operate. This includes the profit-sharing ratio (PSR), interest on capital, interest on drawings, and any partner salaries. The Appropriation Account is prepared after the Statement of Profit or Loss to show how the net profit is distributed among partners. It begins with the net profit, then adjusts for salaries and interest on capital (reducing the distributable profit) and interest on drawings (increasing it). The final figure, the residual profit or loss, is then shared among the partners according to their PSR.
The double-entry for these appropriations is:
- Partner's Salary: Debit Appropriation Account, Credit Partner's Current Account.
- Interest on Capital: Debit Appropriation Account, Credit Partner's Current Account.
- Interest on Drawings: Debit Partner's Current Account, Credit Appropriation Account.
If no agreement exists, the Partnership Act 1890 applies, which states:
- Profits and losses are shared equally.
- No partner salaries are paid.
- No interest is paid on capital.
- No interest is charged on drawings.
- Partners receive 5% per annum interest on loans made to the firm.
The Partnership Agreement is the primary document for profit distribution.
In the absence of an agreement, the Partnership Act 1890 dictates terms (e.g., equal profit share).
The Appropriation Account is a distribution statement, not an expense account.
Key adjustments include interest on capital, interest on drawings, and partners' salaries.
The residual profit/loss is the final amount shared according to the profit-sharing ratio.
Remember that partners' salaries and interest on capital are appropriations of profit, not business expenses. They are debited in the Appropriation Account and credited to the partners' current accounts. They do not appear in the Statement of Profit or Loss.
Fixed Capital and Current Accounts
In a partnership using a fixed capital system, two accounts are maintained for each partner: a capital account and a current account. The Capital Account records the partner's long-term stake in the business. It remains 'fixed' and only changes if a partner makes a permanent capital contribution or withdrawal. All other transactions are recorded in the Current Account. This includes credits for the partner's share of profits, salary, and interest on capital. Debits are made for drawings taken during the year and any interest charged on those drawings. A credit balance on the current account means the partnership owes money to the partner, while a debit balance means the partner owes money to the partnership.
Fixed Capital Accounts hold the permanent, long-term investment.
Current Accounts are working accounts for annual appropriations and drawings.
Credits to the Current Account increase the amount owed to the partner (e.g., profit share, salary).
Debits to the Current Account decrease the amount owed to the partner (e.g., drawings, interest on drawings).
The final balance of the Current Account is shown in the Statement of Financial Position.
Admission of a New Partner: Goodwill & Revaluation
When a new partner is admitted, adjustments are made for goodwill and asset revaluation. Goodwill is the intangible value of a business's reputation. The Cambridge A-Level method requires a two-step process. First, the full value of goodwill is raised by debiting a Goodwill account and crediting the old partners' capital accounts in their old profit-sharing ratio. Immediately after, the goodwill is written off by crediting the Goodwill account and debiting the capital accounts of all partners (including the new one) in the new profit-sharing ratio.
Simultaneously, assets and liabilities are revalued to their current fair market value. A temporary 'Revaluation Account' is used. Increases in asset values are credited; decreases are debited. The net balance (profit or loss on revaluation) is shared only between the old partners in their old profit-sharing ratio and transferred to their capital accounts.
Goodwill compensates existing partners for the value of the reputation they have built.
Step 1 (Raise Goodwill): Dr Goodwill, Cr Old Partners' Capital Accounts (in old PSR).
Step 2 (Write-off Goodwill): Dr All Partners' Capital Accounts (in new PSR), Cr Goodwill.
Revaluation profit/loss is shared among the OLD partners in their OLD profit-sharing ratio.
Both goodwill and revaluation adjustments are made to the partners' Capital Accounts.
Retirement of a Partner
When a partner retires, their share in the business must be calculated and settled. This process mirrors an admission in several ways. First, assets and liabilities are revalued to their fair value, and any profit or loss is shared among all partners (including the retiring one) in the existing PSR. Second, goodwill is valued, and the retiring partner's share is credited to their capital account, while the remaining partners' capital accounts are debited in their new PSR (the ratio between themselves). Finally, the retiring partner's capital and current account balances are combined to find the total amount due. This amount may be paid immediately in cash, or, more commonly, transferred to a 'Loan from retiring partner' account. This loan becomes a non-current liability of the firm and accrues interest until it is repaid.
Revalue assets and liabilities; share profit/loss among all partners in the old PSR.
Calculate the retiring partner's share of goodwill and adjust capital accounts of all partners.
Combine the retiring partner's final capital and current account balances.
Settle the final amount in cash or transfer it to a loan account.
A loan from a retiring partner is a non-current liability for the continuing partnership.
Worked examples
See the formulas applied — reveal one step at a time, like the exam.
Net profit $48,000. Partners A and B share profits 3:2. Salaries: A $6,000, B $4,000. Interest on capital is 5% per annum: A's capital is $80,000, B's is $40,000. Prepare the Appropriation Account.
- 1
Appropriation Account for the year ended...
X and Y are partners sharing profits 3:2. Their capital balances are $60,000 and $40,000 respectively. They admit Z as a partner, with a new PSR of 5:3:2. Z introduces $30,000 capital. Goodwill is valued at $20,000. Premises are revalued up by $15,000 and Inventory is revalued down by $5,000. Calculate the closing capital balances.
- 1
1. Revaluation Account
- Profit on revaluation = Increase in Premises - Decrease in Inventory
- Profit = 5,000 =
How it all connects
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Glossary
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Quick check
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Revision flashcards
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Appropriation account order?
Net profit → salaries → interest on capital → residual profit share.
Key takeaways
Review these before you close the topic — retrieval beats re-reading.
- ✓
The Partnership Agreement is the primary document for profit distribution.
- ✓
In the absence of an agreement, the Partnership Act 1890 dictates terms (e.g., equal profit share).
- ✓
The Appropriation Account is a distribution statement, not an expense account.
- ✓
Key adjustments include interest on capital, interest on drawings, and partners' salaries.
- ✓
The residual profit/loss is the final amount shared according to the profit-sharing ratio.
Practice — then mark it
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