Partnerships

1. Partnerships

2. Partnerships- Definition • A partnership exists when two or more persons carry on a business jointly with the intention of making a profit. • Partnerships are formed in a variety of businesses, ranging from the small family enterprise to large professional practices such as accountants and solicitors. • Partners share the responsibility for the conduct of the partnership business as well as the liability for partnership debts. • Partners also share any profits or losses made by the partnership business. Freeman (120)

3. Points to note • The accounting procedures used by partnerships are similar to those of single ownership businesses, except that the records are normally more extensive. • The main difference in accounting for partnerships is in the treatment of partners equity and the distribution of profit. • A partnership does not have its own separate legal identity. However, a partnership is seen as a separate accounting entity. • The conduct of partnerships is governed by the Partnership Act 1892 (NSW).

4. Advantages • By having more than one owner: more capital is available to the business partners can share the workload and risks associated with the business, and partners can bring to the partnership different skills. • When compared with companies, partnership formation is simple and inexpensive. Government control is not as strict as for some other forms of business organisation, for example companies. • By entering into a partnership with the owner of a similar business, competition can be eliminated. • Income tax is paid by the individual partners not the partnership. • Partnerships do not need to publish their financial reports. Freeman(120)

5. Disadvantages • The profits of the business must be shared between the partners. • Each member of the partnership normally has unlimited liability for debts of the partnership business. That is, each partner can lose all personal assets to pay for the debts of the partnership. • In accordance with the Partnership Act, each partner binds the others in contracts with third parties. • There is a possibility that disputes will arise between partners in relation to the operation of the partnership, their rights and responsibilities. • Unless the partnership agreement provides otherwise, the partnership is terminated on the death or bankruptcy of a partner. • Partners have no separate legal capacity to enter into contracts. Freeman(121)

6. Types Active Partner • An active partner shares in the profit and losses of the business and takes an active role in the management of the business. Sleeping or dormant partner • A sleeping or dormant partner contributes capital and shares the liability for partnership debts, but does not share in the management of the business. Limited partner • A limited partner contributes capital to the partnership but has no further liability for partnership debts. That is, the liability of partners is limited to their contribution of capital. They are not permitted to take an active role in the conduct of the partnership. There must be at least one partner who has unlimited liability to outsiders. The most common form of partnership is one where the partners are active and each partner is personally liable for any partnership debts

7. Partnership Agreement In order to ensure the partners understand their obligations to each other, a partnership agreement should be drawn up. Although the agreement may be verbal it is best to have it in writing to minimise disputes later. This agreement should set out the rights, duties and liabilities of each partner including: • the date of formation of the partnership • the duration of the partnership if applicable • the name and address of each partner • the nature of the partnership business • partners rights and duties • arrangements for the management of the partnership • the amount of capital to be introduced the profit-sharing ratio of the partners • details of interest on drawings and interest on capital • details of any salary payable to partners • procedures in the event of a dispute procedures to be followed if a new partner is introduced, and • procedures to be followed if a partner retires. Note that the profit-sharing ratio is assumed to be equal if there is no agreement to the contrary. Freeman (121)

8. Formation Complete the journals for commencement and purchase of existing business Each partner contributes cash only • Illustrative example 1 p 122 Each partner contributes cash and/or other assets/liabilities • Illustrative example 2 p 122-123 Balance Sheet on Completion • Self test Q 3A p 123 Partners contribute assets/liabilities from an existing business • Agree value of assets and liabilities (AASB 3) • Illustrative example 3 p 124-127 • Self Test Q 3B p 127(note: includes purchase of existing business from a third party)

9. Operation – Freeman (128) Prepare journals and ledgers for the following: Partners’ salaries May be treated as operating expenses or in the profit and loss appropriation account if paid as part of the profit-sharing agreement Partners’ advances/ loans Advances are treated as an asset of the partnership. Loans are treated as liabilities of the partnership. Interest on loans and advances Interest on advances is receivable by the partnership and is treated as income to the business and is credited to the profit and loss account Interest on capital and drawings Partners may be entitles to receive interest on capital (if provided for in the partnership agreement). This may be done to adjust for differing capital contributions. It is an appropriation transfer from profit and loss to profit and loss appropriation and should be adjusted before the distribution of profit. Interest on drawings may be charged in the same way as interest on capital Refer Freeman (127-129) Illustrative example 4 p 130-131 Homework for Friday 1/6/2012: Self test 3C p 132 Q3.7p153 and 3.16 p157, Portfolio Question 3.15p156

10. Profit and Loss appropriation account • Partner’s salary p132 • Self-Test Q 3D p133 • Partner’s loan p133 • Q3.18, 3.20, 3.21, 3.22 p158-160 • portfolio exercises 3.23 p161, 3.27p164

11. 3.22 p160

12. Admission of a new partner • Reasons for admission

14. Admission of a new partner (cont.) • Adjustment of profit-sharing ratios – Illustrative example 5 p134, 6 p135, 7 p136 and Self-Test Q 3E • Revaluation of existing assets/liabilities – Illustrative Example 8 p137-139 • Balance sheet • After formation - Illustrative Example 8 p139, Self Test Q3F and 3G p139-141 • Acquisition of existing business/ merger of existing businesses Q3.39 p176

15. Q3.34 p 174

16. Classwork • Self test questions: 3F p139-140, 3G p140-141 • Homework – portfolio exercises 3.39 p176, 3.40 p176-7 • Read Chapter 4