Converting Capital Account to Loan

Former partner wishes to convert capital account

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A company had three partners with capital accounts of £10,000, £15,000 and £50,000.

The third partner left the partnership due to retirement two years ago, but chose to leave his capital account in the business for the short term. He left on good terms and didn't want thr business to suffer by stripping it's liquid assets.

He now wishes to withdraw £25,000 and leave £25,000 as an official loan to the business.

Am I right in thinking this would be entered as £50,000 drawings from his capital account. £25,000 would then be repaid and the company liabilities would increase by £25,000?

The balance sheet would balance. My only concern is that the drawings would look extremely high on the balance sheet as the capital account would decrease significantly.

A bank loan would be used to repay the £25,000. The business isn't very liquid at the moment due to clients struggling to pay. I presume this is okay.

Replies (12)

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Psycho
By Wilson Philips
09th Oct 2020 20:13

I’m sorry, but I didn’t get past

“ A company had three partners”

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By Lee11_1989
09th Oct 2020 20:27

I presume you meant partnership instead of company.

What you've said sounds right. I doubt the increased drawings will be a problem as long as the overall capital account balance is still positive. I've had partners withdraw the majority of their capital account in a single year to buy a new house or something.

With regards to the outstanding balance, I believe its quite common for partners to do this when leaving. This is because it can be very difficult to obtain finance against goodwill and other intangible assets.

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By johngroganjga
09th Oct 2020 21:40

The £25,000 repaid to him is drawings. The other £25,000 is not drawings but a reclassification from capital to loan.

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Replying to johngroganjga:
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By carnmores
09th Oct 2020 23:28

I agree but the point i am concerned about is what is the double entry on the day after he left the partnership and did any partnership agreement make any reference to this

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Replying to carnmores:
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By Paul Crowley
10th Oct 2020 12:13

I ignored the question on first reading.
Reasons
1 Use of the word company
2 When the partner left it became a loan at that time
3 the accounts from date of departure have been knowingly misleading which may have been used to support lending and credit arrangements.
To date the accounts suggest there are three partners available for redress when there were really only two

REALLY hope this is DIY and not an accountant, or even a half capable bookkeeper

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Replying to carnmores:
By johngroganjga
10th Oct 2020 14:27

The entry is obviously Dr partner’s capital account Cr loan from former partner. I don’t see what the partnership agreement has to do with it. It comes down to what the outgoing partner agreed with the continuing partners as to the repayment of his capital.

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Replying to johngroganjga:
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By Lee11_1989
10th Oct 2020 16:47

Agreed. The OP seems concerned with raising a red flag.

The opening capital account is £75k. With no knowledge of the business, say the profit is £50k and each of the remaining partners draw £25k each through the year. This would mean the capital accounts would show drawings of £100k, despite only a profit of £50k. The capital account would have a c/fwd balance of £25,000.

Personally, I don't suspect this would cause concern for HMRC as the partners are entitled to draw their capital. Not sure if anyone else agrees or disagrees.

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Replying to Lee11_1989:
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By Paul Crowley
10th Oct 2020 16:59

I suppose it depends on whether outgoing partner still considers that he is a partner.
If I left I would want my name removed and any money owed to me to be clearly shown as a loan.

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Replying to Paul Crowley:
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By Lee11_1989
10th Oct 2020 17:03

I agree that it should be listed as a loan. But surely it must be entered as drawings in order to remove the funds from the capital account? The only options on a SA tax return are: o/bal, capital introduced, drawings, b/fwd. So it must go in drawings, correct?

It'd then become a creditor on the other side of the balance sheet, which would make the balance sheet balance.

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Replying to Lee11_1989:
Psycho
By Wilson Philips
10th Oct 2020 17:16

Well, since putting it in drawings would be incorrect, you may as well go the whole hog and make the adjustment to the opening balance. As far as I know, HMRC do not cross-check opening and py closing balances. You could always leave some white space narrative.

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Replying to johngroganjga:
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By carnmores
12th Oct 2020 15:01

A masterpiece John
I don't see what the partnership agreement has to do with it
Followed by
It comes down to what the outgoing partner..

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By The Dullard
12th Oct 2020 15:23

What does the partnership agreement say? Like Paul and Nick, my expectation would be that it became a debt due to him when he retired from the partnership, unless the partnership agreement said something to the contrary.

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