(107)-LIMITED LIABILITY

Limited Liability

Limited liability means that the maximum amount that an owner stands to lose in the event that the company becomes insolvent and cannot pay off its debits is his share of capital in the business.

Unlimited liability means that if the business runs up debts that it is unable to pay, the proprietors will become personally liable for the unpaid debts, and would be required, if necessary, to sell their private possessions in order to repay them.

Sole traders are generally fairly small concerns. The amount of capital involved may be modest, and the proprietor usually participates in managing the business. His or her liability for the debts of the business is unlimited.

Limited companies offer limited liability to their owners.

Thus limited liability is a major advantage of turning a business into a limited company. However, in practice, banks will normally seek personal guarantees from shareholders of a small owner managed company before making loans or granting an overdraft facility, and so the advantage of limited liability is lost.

(106)-ACCOUNTING FOR LIMITED COMPANIES INTRODUCTIONS

Accounting For Limited Companies Introduction

The accounting rules and conventions for recording the business transactions of limited companies and then preparing their final accounts are much the same as for sole trader. For example, companies will have a cash book, sales day book, purchase day book, journal, sales ledger, purchase ledger and nominal ledger. They will also prepare a profit and loss account annually and a balance sheet at the end of the accounting year.

They are, however, some differences in the accounts of limited companies, of which the following are perhaps the most significant.

• The legislation governing the activities of limited companies is very extensive. Among other things, the company’s acts define certain minimum accounting records which must be maintained by companies. They specify that the annual accounts of the company must be field with the registrar of companies and so available for public inspection. They contain detailed requirements on the minimum information which must be disclosed in a company’s accounts.
• The owners of a company may be very numerous. Their capital is shown differently from that of a sole trader; and similarly the appropriation account of a company is different.

(105)-SUMMARY ABOUT PARTNERSHIP ACCOUNTING

Summary about Partnership Accounting

Accounting for a partnership is for the most part the same as accounting for a sole trader except in the following respects.

• The initial capital put into the business by each partner is shown by means of a capital account for each partner.
• Each partner also has a current account and drawings account.
• The net profit of the partnership is appropriated by the partners according to some previously agreed ratio.
• Partners may be charged interest on their drawings, and may receive interest on capital. If a partner makes a loan to the business, he will receive interest on it the normal way.
• Partnerships may be terminated either by closing down the business entirely or by disposing of the business as a going concern to a limited company.

(104)-APPROPRIATION OF NET PROFITS IN PARTNERSHIPS

Appropriation of Net Profits in Partnerships

The net profit of a partnership is shared out between them according to the terms of their agreement. This sharing out is shown in a profit and loss appropriation account, which follows on from the profit and loss account itself.

The accounting entries are:

• Profit and loss account with net profit c/d – Debit
  Profit and loss appropriation account with net profit b/d – Credit
• Profit and loss appropriation account – Debit
  The current accounts of each partner – Credit
  With an individual share of profits for each partner

The way in which profit is shared out depends on the terms of the partnership agreement. The steps to take are as follows.

• Step 1. Establish how much the net profit is.
• Step 2. Appropriate interest on capital and salaries first. Both of these items are an appropriation of profit and are not expenses in the profit and loss account.
• Step 3. If partners agree to pay interest on their drawings during the year
  Current account – Debit
  Appropriation of profit account – Credit
• Step 4. Residual profits, the difference between net profits plus any interest charged on drawings and appropriations for interest on capital and salaries is the residual profit. This is shared out between partners in the profit sharing ratio.
• Step 5. Each partner’s share of profits is credited to his current account.
• Step 6. The balance on each partner’s drawings account is debited to his current account.
  In Practice each partner’s capital account will occupy a separate ledger account, as will his current account.

(103)-ACCOUNTING ADJUSTMENTS FOR LOANS BY PARTNERS

Accounting Adjustments for Loans by Partners

In addition, it is sometimes the case that an existing or previous partner will make a loan to the partnership in which case he becomes a creditor of the partnership. On the balance sheet, such a loan is not include as partners’ funds, but is shown separately as a long-term liability. This is the case whether or not the loan creditor is also an existing partner.

However, interest on such loans will be credited to the partner’s current account if he is an existing partner. This is administratively more convenient, especially when the partner does not particularly want to be paid the loan interest in cash immediately it becomes due. Remember:

• Interest on loans from a partner is accounted for as an expense in the profit and loss account, and not as an appropriation of profit, even though the interest is added to the current account of the partners.
• If there is no interest rate specified, the partnership act provides for to be paid at 5% per annul on loans by partners.

(102)-CAPITAL AND CURRENT ACCOUNTS IN PARTNERSHIPS

Capital Account and Current Account in Partnership

Capital account

The balance for the capital account will always be a brought forward credit entry in the partnership accounts, because the capital contributed by proprietors is a liability of the business.
When a partnership is formed, each partner puts in some capital to the business. These initial capital contributions are recorded in a series of capital accounts, one for each partner. Partners do not have to put in the same amount.

In addition to capital account, each partner normally has:

• A current account.
• A drawing account.

Current account

A current account is used to record the profits retained in the business by the partner.
The main differences between the capital and current account in accounting for partnerships are as follows.

• The balance on the capital account remains static from year to year.
• The current is continually fluctuating up and down, as the partnership makes profits which are shared out between the partners, and as each partner takes out drawings.
• A further difference is that when the partnership agreement provides for interest on capital, partners receive interest on the balance in their capital account, but not on the balance in their current account.

Drawing account

The drawings accounts serve exactly the same purpose as the drawings account for a sole trader. Each partner’s drawings are recorded in a separate account. At the end of an accounting period, each partner’s drawings are cleared to his current account.

Current account – Debit
Drawings account – Credit

The partnership balance sheet will therefore consist of:

• The capital accounts of each partner.
• The current accounts of each partner, net of drawings.

(101)-DIFFERENCE BETWEEN PARTNERSHIP ACCOUNTS AND SOLE TRADER ACCOUNTS

Difference between Partnership Accounts and Sloe Trader Accounts

Partnership accounts are identical in many respects to the accounts of sole traders.

• The assets of a partnership are like the assets of any other business, and are accounted for in the same way. The assets side of a partnership balance sheet is no different from what has been shown in earlier posts.
• The net profit of a partnership is calculated in the same way as the net profit of a sole trader. The only minor difference is that if a partner makes a loan to the business as distinct from capital contribution then interest on the loan will be an expense in the profit and loss account, in the same way as interest on any other loan from a person or organization who is not a partner.