Partnership Agreement & Partnership Act 1890 (Cambridge (CIE) A Level Accounting): Revision Note

Partnership agreement & Partnership Act 1890

What is a partnership agreement?

• A partnership agreement is a document that sets out the terms of how the partnership should operate

• Its purpose is to help partners avoid disagreements in the future

• If there is no partnership agreement, then the Partnership Act 1890 applies

What is contained in the partnership agreement?

• The agreement contains information about:

  • The amount of capital each partner is to invest

  • Whether the partners are entitled to interest on their capital 

    • And if so, the percentage to be paid

    • Interest on capital is given to reward partners for investing their money into the business

  • Whether salaries are paid to each partner

    • And the amount to be paid

  • Whether partners are entitled to drawings

    • And if so, the limit on the amount each partner can withdraw from the business

  • Whether interest is charged on partners' drawings

    • And if so, the percentage to be charged

    • Interest on drawings is charged to discourage partners from withdrawing money from the business

  • Whether the partners are entitled to interest when they loan their own money to the business

    • And if so, the percentage to be paid

    • Interest on loans is given to reward partners for loaning their money to the business

  • The distribution of profits and losses to be shared between partners

What are the provisions of the Partnership Act 1890?

• The main financial provisions are:

  • Profits and losses are shared equally

  • No interest is charged on drawings

  • No interest is allowed on capital

  • Partners are allowed interest of 5% on partners' loans

  • Partners are not entitled to a salary

Why might a partner provide a loan to the business instead of increasing their capital investment?

• A partner might provide a loan to the business because the loan is repayable

• The partner is then guaranteed a return from the repayments each year

  • The partner also receives interest

• The partner might not want to invest more capital in order to avoid:

  • having to alter the partnership agreement

  • having capital tied up in the business

What are the advantages of maintaining a partnership agreement?

• A partnership agreement allows the partners to set their own agreed terms

  • Division of profits and losses

    • If one partner invests significantly more capital than the other(s), then it would be unfair to share the profits and losses equally

  • Partners' salaries

    • Salaries can be given to partners who work more hours or have more responsibilities

  • Interest on capital

    • Interest can be included to reward partners who invest more money into the business

• A partnership agreement protects the business's cash flow

  • Charging interest on drawings can deter a partner from making excessive drawings

• A partnership agreement can help prevent disputes and clarify roles

  • The agreement sets out clear terms

What are the disadvantages of maintaining a partnership agreement?

• Maintaining a partnership agreement incurs legal costs

• It takes time to prepare and maintain a partnership agreement

• The partnership agreement needs to be updated whenever agreed changes are made