Two Partners, One Salary, No Agreement
Asha and Ben formed a partnership on 1 January. They signed no partnership agreement. Asha introduced capital of $60,000 and works full time in the business. Ben introduced $30,000 and works two days a week. During the year the partnership made a profit of $84,000 before any appropriations. Drawings were Asha $28,000 and Ben $12,000.
At the year end Ben argues that, because he put in half of Asha's capital and the profit should be split equally, he is owed $42,000 less his drawings. Asha argues she should receive a salary of $30,000 for full-time work before any split, and that profits should be shared in the capital ratio 2:1.
A loan of $20,000 that Asha made to the partnership in July has also not been dealt with.
1. State how the profit should be appropriated in the absence of a partnership agreement, and calculate each partner's share.
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Under the Partnership Act, where there is no agreement:
- Profits and losses are shared equally.
- No salaries are allowed to partners.
- No interest on capital is allowed.
- Interest on loans by partners is allowed at 5% per year.
So Asha's claimed $30,000 salary and the 2:1 capital ratio do not apply. Ben's equal-split instinct is correct on the profit share, but he has ignored the loan interest.
Appropriation:
| $ | |
|---|---|
| Profit before appropriations | 84,000 |
| Less interest on Asha's loan: $20,000 × 5% × 6/12 | (500) |
| Profit available for sharing | 83,500 |
| Asha (1/2) | 41,750 |
| Ben (1/2) | 41,750 |
Interest on the loan is an expense of the partnership, not an appropriation, so it is deducted before the split. Asha receives $500 interest plus $41,750 = $42,250; Ben receives $41,750.
2. Prepare the partners' current accounts and explain the effect of drawings on each partner's capital.
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Current accounts
| Asha $ | Ben $ | |
|---|---|---|
| Share of profit | 41,750 | 41,750 |
| Loan interest | 500 | - |
| Less drawings | (28,000) | (12,000) |
| Balance c/d | 14,250 Cr | 29,750 Cr |
Both balances are credit - the partners are owed these amounts by the partnership.
Drawings do not reduce capital in a properly kept partnership; they are recorded in the current account and offset against the profit share. Capital accounts remain at the amounts introduced ($60,000 and $30,000) unless the partners agree a permanent withdrawal of capital. This keeps the capital ratio intact for any future interest-on-capital or profit-sharing agreement and shows clearly how much each partner has taken out of the business.
3. Advise the partners on two terms they should include in a written partnership agreement, justifying each by reference to this dispute.
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Profit-sharing ratio. An equal split ignores Asha's greater capital and greater time commitment. A written ratio (e.g. 2:1, or one reflecting salaries plus a residual split) would remove the ambiguity Ben exploited and reward Asha's $60,000 stake.
Partners' salaries and interest on capital. Asha works full time; without an agreed salary the Act gives her nothing for it. A salary clause (say $30,000 to Asha) plus interest on capital at, say, 5% would compensate both for time and for capital employed, and would have prevented Ben's claim that the equal split was fair.
A third useful term would be a clause on partners' loans - fixing the rate and whether the loan is repayable on demand - since the $20,000 loan was left to the default 5%.