prepare income statements, appropriation accounts and statements of financial position

Cambridge IGCSE Accounting 0452 – Topic 5.2: Partnerships

Lesson Objective

By the end of this lesson you will be able to prepare:

• The Partnership Income Statement
• The Partnership Appropriation Account (in the exact order required by the syllabus)
• The Partnership Statement of Financial Position, showing the updated capital balances for each partner

1. Advantages & Disadvantages of Forming a Partnership

2. The Partnership Agreement – Why It Matters & What It Usually Contains

The partnership agreement is the written contract that governs the relationship between partners. It is the reference point for every item that appears in the appropriation account.

• Capital contributions – amount each partner invests at the start.
• Profit‑sharing ratio – the agreed proportion for dividing profit (or loss).
• Interest on capital – rate and whether it is payable.
• Partner salaries/commissions – if any.
• Interest on drawings – rate and whether it is charged; the interest may be added to capital or deducted from drawings (both treatments are accepted by the syllabus).
• Rules for admission, retirement, death or dissolution – these topics are not examined in this syllabus.

3. Key Concepts (quick reference)

• Partnership – an agreement between two or more persons to carry on a business and share profits (or losses).
• Profit‑sharing ratio – the proportion in which partners divide the net profit after all appropriations.
• Appropriation account – shows how the net profit is allocated (interest on capital, salaries, interest on drawings, profit share, retained profit).
• Statement of financial position – a snapshot of assets, liabilities and partners’ capital at a specific date.

4. Preparing the Partnership Income Statement

The income statement is prepared exactly as for a sole trader: it records only business‑related revenue and expenses. Items that relate specifically to partners (interest on capital, partner salaries, interest on drawings) must **not** be included here; they belong in the appropriation account.

What belongs in the Income Statement?

• Sales / service revenue
• Cost of goods sold (COGS)
• Operating expenses such as rent, utilities, non‑partner salaries, depreciation, advertising, etc.

Income Statement Template

5. Preparing the Partnership Appropriation Account

Purpose: to allocate the net profit (or loss) in accordance with the partnership agreement **before** the capital balances are updated.

Exact order of items (as required by the syllabus)

1. Interest on capital (if agreed)
2. Partner salary or commission (if agreed)
3. Interest on drawings (if agreed – deducted before profit sharing)
4. Profit available for sharing
5. Share of profit according to the profit‑sharing ratio
6. Retained profit (or loss) – any amount not distributed to partners

Appropriation Account Template

6. Updating Capital Balances

Closing capital for each partner is calculated using the figures from the appropriation account:

Closing Capital = Opening Capital
                 + Interest on Capital
                 + Salary / Commission
                 + Share of Profit
                 – Drawings
                 + Interest on Drawings (if the interest is **added to capital**; otherwise treat it as a reduction of drawings)

7. Preparing the Partnership Statement of Financial Position

The statement of financial position shows the partnership’s financial position at the end of the period. The capital section must display **post‑appropriation (closing) capital balances**.

Statement of Financial Position Template

8. Worked Example (Year ended 31 December 2025)

Three partners – A, B and C – operate a trading business. The following information is given:

• Sales: $250,000
• Cost of goods sold: $150,000
• Rent: $12,000
• Salaries (non‑partner): $30,000
• Depreciation: $8,000
• Interest on capital: 5 % (A $40,000, B $30,000, C $30,000)
• Partner salaries: A $15,000, B $10,000 (C receives none)
• Drawings: A $20,000, B $15,000, C $10,000 (interest on drawings 3 % charged to each)
• Profit‑sharing ratio: A : B : C = 3 : 2 : 1
• Opening capital balances: A $80,000, B $60,000, C $40,000

Step 1 – Income Statement

Sales                         250,000
Cost of Goods Sold            150,000
------------------------------
Gross Profit                  100,000
Operating expenses:
   Rent          12,000
   Salaries      30,000
   Depreciation   8,000
------------------------------
Total operating expenses       50,000
------------------------------
Net profit before appropriation 50,000

Step 2 – Appropriation Account (order follows the syllabus)

Step 3 – Updated Capital Balances

A: 80,000 + 2,000 + 15,000 + 9,325 – 20,000 + 600 = 86,925
B: 60,000 + 1,500 + 10,000 + 6,217 – 15,000 + 450 = 63,167
C: 40,000 + 1,500 + 0      + 3,108 – 10,000 + 300 = 35,908

These figures are the **closing capital balances** that will appear in the statement of financial position.

Step 4 – Statement of Financial Position (excerpt)

9. Common Errors to Avoid

• Including partner‑related items (interest on capital, partner salaries, interest on drawings) in the income statement.
• Applying the profit‑sharing ratio **before** deducting interest on capital, salaries and interest on drawings.
• Forgetting that interest on drawings can be either added to capital or deducted from drawings – treat it consistently with the partnership agreement.
• Not updating the capital balances after completing the appropriation account.
• Failing to ensure that total assets equal total liabilities + capital in the statement of financial position.

10. What Is NOT Covered in This Syllabus Section

• Admission of a new partner or retirement of an existing partner.
• Dissolution, winding‑up, or the distribution of assets on termination.
• Changes to the profit‑sharing ratio during the accounting period.
• Taxation of partnership income (examined separately).

11. Summary Checklist

1. Income Statement – record only business revenue & expenses; calculate the net profit before appropriation.
2. Appropriation Account – use the exact order required:
   1. Interest on capital
   2. Partner salary/commission
   3. Interest on drawings (deducted if stipulated)
   4. Profit available for sharing
   5. Allocate profit according to the agreed ratio
   6. Record any retained profit or loss
3. Closing Capital – apply the formula shown in Section 6, using the figures from the appropriation account.
4. Statement of Financial Position – list assets, liabilities and the **closing** partners’ capital balances; verify that total assets = total liabilities + capital.