Examkin

Question

Difficulty: MediumNature of Partnership and Provisions of Partnership Deed

Chukwu and Danjuma established a partnership business without drawing up a formal partnership deed. During the financial year, Chukwu advanced a loan of ₦200,000₦200,000 to the business beyond his agreed capital contribution. In accordance with the provisions of the Partnership Act 1890, how should the interest on Chukwu's loan be treated in the financial statements?

  1. Debited to the Profit and Loss Account at 5%5\% per annum as a charge against profitAnswer
  2. B
    Debited to the Profit and Loss Appropriation Account at 5%5\% per annum as an appropriation of profit
  3. C
    Omitted entirely from the financial statements because no interest is payable without a partnership deed
  4. D
    Debited to the Profit and Loss Account at 10%10\% per annum based on prevailing commercial bank rates

Answer

Debited to the Profit and Loss Account at 5%5\% per annum as a charge against profit
According to the Partnership Act 1890, in the absence of a partnership agreement, a partner is entitled to interest at 5%5\% per annum on any advance or loan made to the firm beyond capital. Because loan interest is a liability expense, it must be debited to the Profit and Loss Account as a charge against profit.

Step-by-Step Solution

1
Identify the governing rules for the partnership
Since no partnership deed was drawn up, the provisions of the Partnership Act 1890 apply automatically.
Statutory rules govern partnership operations in the absence of an express agreement.
2
Determine the statutory treatment of partner loans under the Partnership Act 1890
Any partner advancing money beyond their agreed capital contribution is entitled to interest at 5%5\% per annum on that advance.
Partner loans are liabilities of the firm, separate from equity capital.
3
Classify the accounting treatment of interest on partner loan
The interest is a financial expense (charge against profit) and must be debited to the Profit and Loss Account.
Charges against profit are deducted to arrive at net profit, unlike appropriations which distribute net profit.

Key Concept

Statutory default provisions of the Partnership Act 1890 regarding interest on partner loans
Rate this question

Topics

Nature of Partnership and Provisions of Partnership Deed

More questions from this topic