IntroductionA partnership is a legal form of business ownership that occurs when at least two and at most twenty people come together with the intention of making profits. Each partner contributes capital, labor, and skills to the business with the aim of making profits and sharing them in a particular proportion. Partnerships have various advantages over other forms of business ownerships. For instance, they are relatively easy to create in comparison to corporations, they can be quickly expanded by admitting new partners, and they allow the partners to maintain personal contact with their customers and clients, just like in sole proprietorships (Hattingh & Vallabh, 2006, p. 55). Additionally, partnerships make it possible for the different partners to combine their various skills and competencies and to pool their resources for the mutual benefit of the business (Hattingh & Vallabh, 2006, p. 55). The different elements of accounting for partnership businesses are discussed in the present essay. They include accounting for partnership formations, the distribution of profits or losses, and ownership changes due to the admission of a new partner.
Accounting for Partnership Formation
There are several ways through which a partnership comes into existence. They include situations whereby each partner contributes cash only, where each partner contributes and assets or liabilities, and where partners provide assets or liabilities from existing businesses (Freeman & Freeman, 2009, p. 122). Different entries are made into the partnership’s journal under each of the above methods of partnership formation. For instance, in the case that each of the partners contributes cash only and assuming that there are only two partners A and B where each provides $1000; the following entry will be passed in the partnership’s journal.
Distribution of Profits or Losses
Partners share profits and losses according to the provisions of their partnership agreements. However, in the case that the partnership agreement does not state the basis sharing profits and losses among the partners, the law dictates that profits and losses must be shared equally. Partners may agree to share their profits and losses based on a stated fraction, capital contributions, and capital contributions and service. The following part elaborates the various methods of sharing profits and losses in partnerships.
When partners agree to share profits and losses based on a stated fraction, they indicate a particular portion of the total profits and losses that each of them will share. For instance, each partner in a two-partner firm may share a half of the profits or losses, or one may agree to share a third while the other shares two-thirds of the profits and losses. Partners may also share profits and losses based on their capital contributions to the business. The share that each partner gets in such a case is based on the proportion of his or her capital to the total capital of the enterprise (Freeman & Freeman, 2009, p. 126). They may also agree to share profits and losses based on capital contributions and service, particularly when one or some of the partners put in more work than others to the business, regardless of his or her capital contribution. In such a case, the partners decide the proportion of profits and losses that will be shared based on capital contributions and the percentage to be shared based on service to the business. For instance, they may decide that half of the income and losses will be shared based on capital contribution while the remaining half is divided based on service.
Ownership Changes in a Partnership
The existence of a partnership enterprise depends on the contractual agreement between the partners. The admission of a new partner or the withdrawal of an existing one results in the legal dissolution of the old partnership and the formation of a new one (Fischer, Taylor & Cheng, 2008, p. 456). As such, the business may continue even with changes in its ownership structure.
A new partner may be admitted through the acquisition of a portion of the interests of the existing partners or investment of additional capital into the business. The accounting treatment in the case that a new partner buys the interest of an existing partner involves the transfer of capital from the old partner to the new partner. The personal transactions between the old and the new partners are not part of the partnership and are not recorded in its books (Fischer, Taylor & Cheng, 2008, p. 457). For instance, assuming that A and B are partners and that B decides to sell his whole stake of $1000 at $1200 to C, the following accounting entry will be made in the books of the partnership.
Accounting for partnerships depends on various elements. For instance, the accounting entries made during the formation of partnerships depends on the various forms of contributions made by the partners. Accounting for the distribution of profits and losses depends on the method agreed upon by the partners in the partnership agreement. Lastly, accounting for the admission of a new partner depends on the admission method used.
- Fischer, P., Taylor, W., & Cheng, R. (2008). Fundamentals of Advanced Accounting. Mason, OH: Thomson/South-Western.
- Freeman, S., & Freeman, J. (2009). Financial Accounting: A Practical Approach (3rd ed.). Frenchs Forest: NSW: Pearson Higher Education AU.
- Hattingh, A., & Vallabh, P. (2006). Accounting. Cape Town: Maskew Miller Longman.