2. 8.4 Changes in Partnership Structure
• Circumstances whereby the profit-sharing arrangement
need to be altered to represent the new adjustment in
agreement between partners, and also the existing
assets (including goodwill) and liabilities need to be
revaluated:
(a) A change in profit-sharing arrangement among existing partners
(b) Admission of new partner
(c) Death or retirement of an existing partner.
This will ensure an equitable state of affairs among
partners.
It can be said that circumstances (b) & (c) will always
lead to (a).
BKAF3063 A141 2
3. Changes at the End of the Accounting Period
Retirement or Death of A Partner
The remaining balance in his current & capital ac will be paid to
him (or his heirs)
If the amount is paid in installments, the balance unpaid will be
recorded as loan to the business.
Assets need to be revalued to get the current value of the
partnership’s net assets. The profit or loss on revaluation of each
asset is credited or debited accordingly to the revaluation ac.
When all the assets have been revalued, the net profit or loss on
revaluation of these assets is transferred to the partners’ capital ac
according to their profit-sharing ratio or else transferred to the
partners’ current ac (if it is required by the partnership
agreement).
BKAF3063 A141 3
4. Changes at the End of the Accounting Period
Besides the revalued amount of tangible net assets, a partner who
retires or dies is also entitled for an intangible asset known as
goodwill. This is an excess amount of the value of the business as
a whole [the selling price of the business] and the total value of the
tangible net assets.
o A buyer is willing to pay more than the amount of the tangible net
assets ‘coz of the existence of the goodwill. Goodwill might have
existed due to various factors, such as good business location,
staff-customer relationship & ability to earn profits.
o For a change in partnership, goodwill will be calculated based on
estimates. The estimates may be based on 1 or a combination of
the following methods:
Method Based on Accounting Profit
o The value of goodwill is equal to the value of the average annual
net profit for a specified past number of years (often referred to as
x years’ purchase of the net profits).
BKAF3063 A141 4
5. Changes at the End of the Accounting Period
Illustration 2
On Ng’s retirement, goodwill was taken as equal to 2 years’
purchase of the average annual profit of the last 5 years:
RM
2009 70,500
2010 60,000
2011 110,000
2012 110,500
2013 140,000
Required:
Calculate the amount of goodwill.
Solution:
Avg. net profit = RM[70,500 + 60,000 + 110,000 + 110,500 + 140,000] / 5
= RM98,200
Goodwill = 2 x RM98,200 = RM196,400.
=========
BKAF3063 A141 5
6. Changes at the End of the Accounting Period
Method Based on Super Profits
o Super profits are the value of net profits after allowances have
been made for any salary to the partners & interests that would
have been earned if their capital had been invested elsewhere.
o The annual super profit is then multiplied by an agreed number to
arrive at the value of goodwill.
Illustration 3
The total salaries paid to Ajay, Bujal & Chan was RM30,000.
Their capital employed was RM550,000 & return on capital
employed was 20% per annum. Net profit for the year ended 31
Dec. 2013 was RM200,000. Goodwill was taken as equal to 4
years’ purchase of annual super profit on the retirement of Bujal.
Required:
Calculate the amount of goodwill.
BKAF3063 A141 6
7. Changes at the End of the Accounting Period
Solution:
Calculation of annual super profit:
RM RM
Annual net profit 200,000
Less: Salaries of partners 30,000
Interest on capital employed 110,000
[20% x 550,000] ----------- (140,000)
-------------
60,000
========
Goodwill = RM60,000 x 4
= RM240,000
=========
There are also other methods to estimate the value of goodwill
such as Multiple of the Annual Turnover & Capitalisation of the
Expected Profit at the current market rate of return.
BKAF3063 A141 7
8. Changes at the End of the Accounting Period
Accounting for Goodwill
o The value of goodwill calculated when a partnership changes will
be allocated to the partners before the change, based on the old
profit-sharing ratio.
o After the change, the amount of goodwill will be written back to the
new partners, based on the new profit-sharing ratio.
o This kind of accounting treatment effectively eliminates goodwill in
the books of the partnership business.
o The treatment to write off goodwill is based on the argument that
the value of goodwill is highly subjective ‘coz it is based on
estimates [the amount may not be reliable & should not be
recorded as an asset].
BKAF3063 A141 8
9. Changes at the End of the Accounting Period
o The required journal entries are:
[i] To record goodwill
Dr Goodwill Ac XX
Cr Partners’ Capital Ac XX
(‘old’ partners in the old profit-sharing ratio)
[ii] To write off goodwill
Dr Partners’ Capital Ac XX
(‘new’ partners in the new profit-sharing ratio)
Cr Goodwill Ac XX
BKAF3063 A141 9
10. Changes at the End of the Accounting Period
Admission of a New Partner
The admission of a new partner results in the legal dissolution of
the existing partnership and the beginning of a new one.
A new partner may be admitted either by:
1) Purchasing the interest of an existing partner or
2) Investing assets in a partnership.
The existing partners will want to ensure that they receive their full
entitlement (share of net assets & goodwill) up to the date of the
admission.
Similarly, the new partner will want to ensure that he does not
bear any losses which may have arisen before his admission.
To be fair to the existing & the new partners, net assets need to be
revalued & goodwill need to be calculated using similar accounting
techniques involved in the case of Retirement or Death of A
Partner.
BKAF3063 A141 10
11. Illustration 4
Aina, Bushro & Khaira have been in partnership business for 6
years,sharing profits & losses in a ratio of 3:4:3, respectively. However,
Bushro decided to retire on 31 Dec. 2013. The following is a summarised
statement of financial postion of the partnership as on 31 Dec. 2013
(before Bushro’s retirement):
RM RM RM
Non-current assets
Freehold premises 300,000
Motor vehicles 200,000
Current assets
Inventory 80,000
Debtors 90,000
Provision for doubtful debts (9,000) 81,000
Bank 329,000
410,000
Current liabilities
Creditors (70,000)
Net current assets 340,000
920,000
11
12. Illustration 4
BKAF3063 A141
RM RM RM
Capital accounts
Aina 200,000
Bushro 350,000
Khaira 250,000 800,000
Current accounts
Aina 30,000
Bushro 30,000
Khaira 60,000 120,000
920,000
12
13. Illustration 4
Upon retirement, it was agreed that Bushro should take over the
motor vehicles valued at RM170,000. The partnership settled
Bushro’s capital balance in cash & the balance in the current ac
remained as a loan to the partnership at an interest rate of 10%
per annum. The assets were revalued as follows:
RM
Freehold premises 450,000
Inventory 70,000
Debtors 75,000
On the date of Bushro’s retirement, Rania joined the partnership.
She contributed RM180,000 cash as capital & RM50,000 for her
share of the goodwill. The new profit-sharing ratio for Aina,
Rania & Khaira is 3:2:3, respectively.
For the purpose of Bushro’s retirement & Rania’s admission,
goodwill was taken as being equal to 2 years’ purchase of the
average annual profit of the last 5 years.
BKAF3063 A141 13
14. Illustration 4
The last 5 years’ profits were:
RM
2009 75,000
2010 60,000
2011 110,000
2012 115,000
2013 140,000
Required:
Prepare the following:
[a] The revaluation ac, the goodwill ac & the partners’ capital ac.
[b] The statement of financial position of the new partnership as
at 1 January 2014.
BKAF3063 A141 14
18. Aina, Khaira and Rania
Statement of Financial Position as at 1 Jan. 2014
RM RM
Non-current assets
Freehold premises [1] 450,000
Current assets
Inventory [2] 70,000
Debtors [2] 75,000
Bank [9] 257,400
402,400
Current liabilities
Creditors (70,000)
Net current assets 332,400
782,400
BKAF3063 A141 18
19. Aina, Khaira and Rania
Statement of Financial Position as at 1 Jan. 2014
RM RM
Capital accounts [8]
Aina 216,200
Khaira 266,200
Rania 180,000 662,400
Current accounts
Aina 30,000
Khaira 60,000 90,000
Non-current liabilities
Loan: Bushro 30,000
782,400
BKAF3063 A141 19
20. Explanatory Notes
[1] Profit on revaluation of freehold premises {450,000 – 300,000 =
150,000} is credited to the revaluation ac & debited to the freehold
premises ac.
[2] Losses on revaluation of motor vehicles {200,000 – 170,000 =
30,000}, inventory {80,000 – 70,000 = 10,000} & debtors {81,000 –
75,000 6,000} are debited to the revaluation ac & credited to the
relevant assets ac. Note that the taking of the motor vehicles by
the retiring partner is treated as a revaluation of assets.
[3] Net profit on revaluation is transferred to the partners’ capital ac.
[4] Goodwill calculated on the retirement of Bushro is debited to the
goodwill ac & credited to the ‘old’ partners’ capital ac according to
the old profit-sharing ratio.
[5] To eliminate goodwill fr the partnership ac, the entries are debit
the ‘new’ partners’ capital ac & credit the goodwill ac according to
the new profit-sharing ratio.
BKAF3063 A141 20
21. Explanatory Notes
[6] Capital contribution by Rania is credited to her ac & debited to the
cash ac.
[7] On retirement, Bushro was paid RM30,160 in cash as part of her
capital contribution. The balance in her current ac was left as a
loan to the business.
[8] The balances carried down in the capital ac & current ac are
transferred to the statement of financial position at the end of the
accounting period.
[9] The cash balance is arrived at as follows:
RM
Balance b/d 329,000
Capital (Rania) 230,000
Capital (Bushro) (301,600)
257,400
=======
BKAF3063 A141 21
22. Changes During the Accounting Period
When the change in the partnership takes place during the actg.
period, it is necessary to apportion profits before the change and
those arising afterwards.
The profit appropriation ac needs to be prepared before & after the
change. Appropriation of profits before the change will be
recorded in the ‘pre’ column & after the change in the ‘post’
column as below:
Profit Appropriation Account
BKAF3063 A141 22
Pre Post Pre Post
Interest on Capital A XX XX Net profit XX XX
B XX XX
Remaining profit A XX XX
B XX XX
XX XX XX XX
23. Changes During the Accounting Period
In general, the net profit is assumed to be earned evenly
throughout the actg. period (unless otherwise stated). Hence, the
appropriation will be calculated based on a time basis.
It is important to note carefully the changes in the partnership
agreement as it will affect the amount calculated before & after the
change.
e.g. When a partner is admitted during the year & he makes a
drawing, interest on the drawing will only be charged in the profit
appropriation ac under the ‘post’ column.
A partnership agreement may provide for a minimum guaranteed
profit to 1 of the partners.
e.g. Partner A is guaranteed a minimum profit per annum of
RM5,000 & if his share is less, it will be borne by the other
partners.
BKAF3063 A141 23
24. 8.5 Dissolution of Partnership
• Legally, a partnership is dissolved when any partner
leaves (due to retirement or death) or a new partner is
admitted into the business.
• In Part V of the Partnership Act 1961, dissolution can
be in any of these forms:
S.34 – by expiration or notice (based on the partnership agreement)
S.35 - by bankruptcy, death or charge (the charge under the
partnership Act for a partner’s separate debt)
S.36 – by illegality of partnership
S.37 – by court (under 6 different cases: a partner is found lunatic or
permanently unsound mind, a partner is permanently incapable of
performing his part, a partner has been guilty of such conduct, a
breach of the partnership agreement, business can only be carried
on at a loss & other circumstances considered by the court as just
to be dissolved).
BKAF3063 A141 24
25. Dissolution of Partnership
• For actg. purposes, a partnership is dissolved when
the business is closed ‘coz all the partners are no
longer interested in carrying on the business or the
business is sold as a going concern to a limited
company.
o When a business ceased to exist, the partners are entitled to a
repayment of the capital contributed to set up the business.
o Repayment will only be made once all the assets are sold & all the
liabilities settled.
o In practice, realisation of assets may involve a considerable period
of time (referred to as piecemeal realisation), but this piecemeal
realisation is not allowed in Malaysia.
BKAF3063 A141 25
26. Dissolution of Partnership
• According to S. 46(a) of the Partnership Act 1961,
major sources to settle losses are profits, partners’
capital ac & partners’ assets (according to percentage
of gain).
• It is stated in S 46 (b): partnerships assets should be
allocated according to this rank order of payment:
amounts owed to creditors other than partners
amounts owed to partners other than for capital and gain
(money advanced to a partnership by a partner is a capital
contribution unless there is an evidence such as a promissory
note saying that the money was a loan)
amounts due to partners with respect to their capital interest
balances will be allocated accordingly by % partnership interest or
gains and losses
BKAF3063 A141 26
27. Dissolution of Partnership
Events taking place when a partnership business is
dissolved (at the date of the dissolution or within a
short period thereafter):
1. All non-cash assets are sold to a 3rd party or the partners & the
liabilities are settled. The related ac are closed & transferred to
the profit realisation ac.
The double entries will be the cash ac [if sold to 3rd parties] or the
partners’ capital ac [if taken over by any of the partners].
An alternative method for liabilities is not to transfer the amounts
immediately to the realisation ac, but instead, the amount owed is
settled & only the remainder is transferred to the realisation ac.
2. Any realisation expenses will be debited to the realisation ac &
credited to the cash ac.
BKAF3063 A141 27
28. Dissolution of Partnership
3. The net balance (i.e.profit or loss on realisation) is transferred to
the partners’ capital ac besed on their profit-sharing ratio.
4. Any remaining balances in the current ac are transferred to the
capital ac. The net balance in the capital ac will now represent
the amount payable to or from the partners. The final cash
balance is then distributed to the partners (debit capital ac &
credit cash ac). All the ac of the partnership are now closed.
5. It is possible that a partner might have a debit balance in his
capital ac… the partner needs to pay the business.
If the partner is not able to pay in full or in part due to certain
circumstances, his balance will be borne by the other partners,
based on their opening capital ratio… referred as the Garner vs.
Murray Rule [the partner must be in debt & must also be
insolvent]
BKAF3063 A141 28
29. Illustration 5
• Jim, Pat & Teh were partners in a partnership sharing profits & losses in
the ratio of 4:4;2. The statement of financial position as at 31 Dec. 2013
is as follows:
BKAF3063 A141 29
RM RM
Non-current assets
Land & building (cost) 1,360,000
Vehicles (cost) 300,000
Less: ACM (200,000) 100,000
Current assets
Inventories 40,000
Debtors 70,000
Bank 30,000
140,000
Current liabilities – Creditors (60,000)
Net current assets 80,000
1,540,000
30. Illustration 5
RM RM
Capital accounts:
Jim 500,000
Pat 350,000
Teh 160,000 1,010,000
Current accounts:
Jim 400,000
Pat 250,000
Teh (220,000) 430,000
Non-current liabilities
Loan: Pat 100,000
1,540,000
BKAF3063 A141 30
31. Illustration 5
• On the same day, the partners decided to dissolve the
partnership. Business assets & liabilities were disposed of or
settled as follows:
[i] Land & building were realised for RM1,460,000. Vehicles were
realised for RM85,000.
[ii] Jim took over the inventory at an agreed price of RM32,000.
[iii]Amount collected from debtors was RM58,000.
[iv]Trade creditors had agreed to receive RM58,500 as settlement.
Loan from Pat was paid in full.
[v] Dissolution expenses which amounted to RM5,000 was duly paid.
[vi]Teh was declared bankrupt & had only managed to contribute
RM40,000 to cover his capital ac’s deficit.
Required:
Prepare realisation ac, bank ac & partners’ capital ac.
BKAF3063 A141 31
32. Illustration 5 - Solution
Realisation Account
BKAF3063 A141 32
RM RM
Land & building [1] 1,360,000 Loan [2] 100,000
Vehicles [1] 100,000 Creditors [2] 60,000
Inventories [1] 40,000 Bank:
Debtors [1] 70,000 Land & building [3] 1,460,000
Bank: Dissolution
expenses
[5] 5,000 Vehicles [3] 85,000
Creditors [5] 58,500 Debtors [3] 58,000
Pat: Loan [6] 100,000 Jim: Inventories [4] 32,000
Profit on realisation:
Jim 24,600
Pat 24,600
Teh 12,300 61,500
1,795,000 1,795,000
33. Illustration 5 - Solution
Bank Account
BKAF3063 A141 33
RM RM
Balance b/d 30,000 Creditors [5] 58,500
Realisation: Realisation:
Land & building [3] 1,460,000 Dissolution
expenses
[5] 5,000
Vehicles [3] 85,000 Capital: Jim [10] 888,070
Debtors [3] 58,000 Pat [10] 721,430
Capital: Teh [9] 40,000
1,673,000 1,673,000
34. Illustration 5 - Solution
Capital Account
BKAF3063 A141 34
Jim Pat Teh Jim Pat Teh
RM RM RM RM RM RM
Current ac [8] 220,000 Balance b/d 500,000 350,000 160,000
Realisation: Current ac [8] 400,000 250,000 -
Inventory
taken-over
[4] 32,000 Realisation:
Teh [9] 4,530 3,170 Profit [7] 24,600 24,600 12,300
Bank [10] 888,070 721,430 Loan [6] 100,000
Bank [9] 40,0000
Jim [9] 4,530
Pat [9] 3,170
924,600 724,600 220,000 924,600 724,600 220,000
35. Explanatory Notes
[1] The asset balances are transferred to the realisation ac.
[2] The liabilities balances are transferred to the realisation ac.
Assets & liabilities ac are now closed.
[3] When cash is received on the disposal of the assets, the
realisation ac is credited & the cash ac is debited.
[4] Inventory taken over by Jim is debited to his capital ac & credited
to the realisation ac.
[5] Dissolution expenses & payments to creditors are debited to the
realisation ac & credited to the cash ac.
[6] Loan from Pat is debited to the realisation ac & credited to his
capital ac.
[7] The final profit on realisation is transferred to the capital ac.
[8] The current ac balances are transferred to the capital ac.
[9] Teh’s capital ac balance is a debit {220,000 – 172,300 = 47,700} &
he could only pay the business RM40,000. The remaining
RM7,700 was paid by Jim & Pat.
BKAF3063 A141 35
36. Explanatory Notes
The amount paid by Jim & Pat was computed as below:
Jim: 7,700 x {500,000 / (500,000 + 350,000)} = RM4,530.
Pat: 7700 x {350,000 / 850,000} = RM3,170.
The journal entries are:
Dr Capital ac - Jim 4,530
- Pat 3,170
Cr Capital ac - Teh 7,700
[10] The balance is the cash ac is finally paid to Jim & Pat. All the
partnership ac are now closed.
In relation to actg. for partnership, there is also a
complex actg for amalgamation & sale of partnership to
a limited co. which will not be covered in this course.
BKAF3063 A141 36
37. 8.6 Musharakah (Partnership)
Definition of Shirkah
The word “syarikat” or co. is the plural form of an
Arabic word for shirkah. In Islamic commercial law,
partnership is known as shirkah that simply means
sharing.
2 kinds of shirkah:
i. Shirkat-ul-milk
Joint ownership of 2 or more persons in a particular property.
It is a co-ownership of an asset.
ii. Shirkat-ul-’aqd
A partnership affected by a mutual contract; also known as
joint commercial enterprise…sharing the capital & profit as in
the conventional partnership organisation.
BKAF3063 A141 37
39. Shirkat-ul-’aqd – Based on Type of Capital
i. Shirkat-ul-amwal (wealth @ finance partnership)
All partners invest some monetary capital into a commercial
enterprise.
The most common form of partnership in the business world.
Also known as Musharakah.
[Note the diff. between the wider scope of Shirkah as compared
to Musharakah]
ii. Shirkat-ul-a’mal (work)
All partners jointly undertake to render some services to their
customers & the fee charged is distributed among them
according to an agreed ratio.
iii. Shirkat-ul-wujooh (creditworthiness)
No monetary investment, but partners purchase commodities on
credit & sell them at cash price.
BKAF3063 A141 39
40. Shirkat-ul-’aqd – Based on Legal Form
Legal Form of Commercial Partnership
BKAF3063 A141 40
Inan Mufawadah Mudharabah
o Capital & mgt from all
partners
o Capital & mgt from all
partners
o Capital from 1 party,
mgt from another
party
o No complete equality
required
o Complete equality
required
o-
o Limited liability o Unlimited liability o-
o Profit according to
capital ratio or
agreed ratio
o Profit & loss shared
equally
o Profit shared
according to agreed
ratio
o Loss according to
capital ratio
o Loss borne by capital
provider
41. Basic Rules of Musharakah
Musharakah is a form of investment contract by
partners in a business venture.
Neither the return nor the capital should be
guaranteed.
Any profit or loss will be shared by the partners
depending on the outcome of the business
performance.
1. Distribution of profit
The profit-sharing ratio must be agreed upon at the time of
affecting the contract. If no such ratio has been determined, the
contract is not valid in Shari’ah.
The ratio of profit for each partner must be determined in
proportion to the actual profit accrued to the business, & not in
proportion to the capital invested by him.
BKAF3063 A141 41
42. Basic Rules of Musharakah
• It is not allowed to fix a lump sum amount for any 1 of the
partners, or any rate of profit tied up with his investment. Hence
the following situations would not be allowed:
Ahmad put RM50,000 capital into a partnership with Alias. Ahmad
was promised that he would receive a return of RM5,000 every
year.
Karim started a partnership with Kassim & Kamal with a capital of
RM10,000 each. To attract a 4th partner into their business, they
promised to provide the new partner a 10% return from the
partners’ capital contribution every year regardless of the
performance of the partnership.
• Both situations are not allowed in islamic law ‘coz the return to the
partners does not take into ac the actual performance of the
partnership.
• In Islam, if we want to enjoy any return, then we should also bear
the responsibility if any losses arise.
BKAF3063 A141 42
43. Basic Rules of Musharakah
• That’s why only a profit-sharing ratio is fixed upfront. The
distribution of the profit must be based on actual profit of the
partnership every year.
ii. Sharing of Loss
All Muslim jurists are unanimous on the point that each partner
shall suffer the loss exactly according to the ratio of his
investment (i.e. capital ratio).
iii. Nature of Capital
Capital can be contributed either in cash or the form of
commodities (using market value).
IV. Management of Musharakah
Normal principle of Musharakah: every partner has a right to take
part in its mgt. & to work for it. If a sleeping partner exists &
accepted, he shall be entitled to the profit only to the extent of his
investment.
BKAF3063 A141 43
44. Basic Rules of Musharakah
v. Termination of Musharakah
• Every partner has a right to terminate after giving notice, hence
the musharakah will come to an end.
• If a partner died, the contract with him is terminated, but his heirs
will have the option either to draw the share of the deceased
from the business, or to continue with the contract of
musharakah.
• If any partners become insane or incapable of effecting
commercial transactions, the musharakah will be terminated.
• If 1 of the partners wants termination of the musharakah, while
the other partner or partners like to continue with the business,
this purpose can be achieved by mutual agreement. The
partners who want to run the business may purchase the share
of the partner who wants to terminate his partnership, ‘coz the
termination of musharakah with 1 partner does not imply its
termination between the other partners.
BKAF3063 A141 44
45. Musharakah vs Conventional Partnership
Conv. Partnership Musharakah
• in the absence of agreement, profit
& losses will be shared equally & no
salary paid to partners & no interest
on capital & no interest charges on
drawings.
• Apply
•Any loan from the partners, over &
above the capital amount, will earn
8% interest per annum.
• Violate the requirement of Islamic
law. Interest payment is not allowed,
hence any kind of loan to the
musharakah will only be guaranteed
a repayment of that amount, but not
any amount over & above the
principal sum. If a partner want to
enjoy any extra amount, over &
above the principal amount, he
should extend additional capital…no
guaranteed of a repayment, but he
may enjoy any profit arising from
therein & will have to bear any risk of
BKAF3063 A141 45
46. Musharakah vs Conventional Partnership
Conv. Partnership Musharakah
•The profit-sharing ratio is in
accordance with the agreement.
•The profit-sharing ratio must be
determined on the commencement
day to avoid any disagreement later
on.
•The amount of salary to be paid is in
accordance with the agreement.
• Apply. However, payment of salary
to an active partner is not a
requirement of the Islamic law. It is
up to the agreement of the partners.
• Can have fixed & predetermined
return if agreed by partners.
• Not allowed ‘coz the return on
investment will reflect the
performance of the business. The
partners will absorb both profit &
losses according to the actual
performance of the partnership.
BKAF3063 A141 46
47. References
Beams, F. A., et al. (2012). Advanced Accounting, 11th Edition.
Prentice Hall, USA.
Partnership Act 1961.
Roshayani, A., et al. (2009). Financial Accounting – An
Introduction, 3rd Edition. Mc Graw Hill Education, Kuala Lumpur.
Siti Manisah, N., et al. (2008). Partnership Accounting – Principles
and Paractice. Mc Graw Hill Education, Kuala Lumpur.
BKAF3063 A141 47
