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Partnership Agreement

Reasons for entering into a partnership include:

  1. One person may not have sufficient fund to meet the required capital.
  2. Persons with different expertise can complement each other.
  3. Partners belong to the same family.

Unlike limited partners, all the partners are equally responsible for the debts of the partnership. Each must pay their share of the debts, and if needed to, they have to pay using their private means. Limited partners’ debts are limited to the amount they contribute as capital. They are not required to pay more than their capital contribution to settle debts. Neither are they allowed to participate in the management of the business. Not all partners can be limited partners, at least one of them has to have unlimited liability.

Usually, a partnership agreement is drawn up to decide on the following:

  1. The sharing of profit or loss
  2. The interest rate on the capital
  3. The rate of interest on each partner’s drawing

1. The sharing of profit or loss. Here, the partners may agree to the share of profit or loss in proportion to the contribution of capital. For example, if the capital contributions are David: $30,000 and Goliath: $20,000 the share of profits would be three-fifths and two-fifths respectively. This is regardless of the amount of responsibility each of the partners shoulders. For example:

Year 1 2 3 4 5 Total

$ $ $ $ $ $
Net profit 12,500 13,000 12,800 13,200 13,500 65,000
Net profit shared:

David:   3/5 7,500 7,800 7,680 7,920 8,100 39,000
Goliath: 2/5 5,000 5,200 5,120 5,280 5,400 26,000

Above shows profits shared in the ratio of 3/5 and 2/5.

2. The interest rate on the capital contributed by each partner. If the partners had invested their capital elsewhere, they would have received a return. The partners’ share of 5% interest on capital is given priority before the equal share of profit. This is fair considering that they contribute unequal capital but do about the same amount of work. For example:

Years 1 2 3 4 5 Total

$ $ $ $ $ $
Net profit 12,500 13,000 12,800 13,200 13,500 65,000
Interest on capitals:

David 1,500 1,500 1,500 1,500 1,500 7,500
Goliath 1,000 1,000 1,000 1,000 1,000 5.000
Remainder of net profits shared:

David 5,000 5,250 5,150 5,350 5,500 26,250
Goliath 5,000 5,250 5,150 5,350 5,500 26,250

Above shows profits are shared equally.

3. The rate of interest on each partner’s drawing. Cash retained in the business is to the advantage of the business for purposes such as expansion, and benefiting discounts from bulk buying from suppliers. Interest on drawing is therefore imposed to discourage excessive withdrawal. It is charged from date of withdrawal to end of financial year. Assuming the financial year ends on 31 December, the following calculations are made for withdrawals.


Drawings Amount Interest Months Charged


1 April 480 5% 9 18
1 May 360 5% 8 12
1 July 640 5% 6 16
1 October 400 5% 3 5

Total 1,880



Drawings Amount Interest Months Charged


1 April 240 5% 9 9
1 July 200 5% 6
1 September
300 5% 4

Total 740


Drawings account
Separate drawings accounts may be opened for the partners especially if there are many withdrawals within a financial period. There may be an agreement on the limit to the total amount which each partner can withdraw. All drawings and interest on drawings are entered in the drawings accounts. At the financial year end, the drawings accounts are closed and their balances transferred to the respective current accounts, and if there are no current accounts to their respective capital accounts. The drawings account is a debit account and when transferred, reduces the balance in the current or capital account by the amount of the drawings.

Debit current/capital account
Credit drawings account

Loan from a partner
A loan from a partner to the partnership is treated in the same way as a loan from an external party. The loan is not entered in the partner’s account. It appears separately on the balance sheet as a long-term liability.

Debit cash/bank account
Credit loan account

Interest payable on the loan is an expense item and the postings are as follow:

Debit interest on loan account
Credit partner’s current account

This interest on loan account is closed at the end of the financial year and the balance is transferred to the profit and loss account.

Salary allowance
A salary payable to a partner is usually mutually agreed by the partners. It’s a form of compensation for the partner who has extra or special responsibility. This partner may also be the only one working full time in the partnership. The salary is deducted before the sharing of the balance of the profits.

Salaries and interest on capital are compulsory payments to the partners regardless of whether the partnership makes a profit or a loss. Net loss is allocated to the partners using the same basis as the net profit is distributed. If there is no agreement among the partners, profits and losses are shared equally by the partners without regard to how much each partner contributes to the capital of the partnership.

Last Updated (Saturday, 11 December 2010 11:35)