Lecture 3

1. Partnerships – Part A Lecture 3

2. Partnerships - Definition 2 or more people carry on a business jointly with the intention of making a profit. Partners share responsibility for the conduct of the partnership business as well as the liability for partnership debts. Unlimited liability. Partners share any profits or losses. If a partner dies or retires the partnership is dissolved. Partnership does not have its own separate legal identity but it is seen as a separate accounting entitiy. Conduct of partnership is governed by Partnership Act 1892 (NSW)

3. Advantages Access to more capital Partners share workload and risk Partners can bring different skills Formation is simple and inexpensive Government control is not as strict as Companies Income tax is paid by the individuals Financial reports usually do not have be made public

4. Disadvantage Profits must be shared Unlimited liability for debts of the partnership. Partners can lose personal assets. Each partner binds the others in contracts with 3rd parties. Disputes often arise. Partnership is terminated on death or bankruptcy of a partner.

5. Types of Partners Active Partner- takes active role in management of business. Sleeping/Dormant/Silent Partner – contributes capital and shares the liability for partnership debts buts does not share in the management of the business. Limited Partner – contributes capital but has no further liability for partnership debts. They are not permitted to take an active role in conduct of the partnership. There must be at least one partner who has unlimited liability.

6. Partnership Agreement Important document outlining the rights, duties and liabilities of each partner. It should include the following information:- Partner’s rights and duties Arrangements for the mang’t of the partnership Amount of capital to be introduced Profit-sharing ratio of the partners Details of interest on drawings and interest on capital Details of any salary payable to partners. Procedures in event of dispute Procedures to follow in event of new partner introduced Procedure to follow if partner retires/dies.

7. Profit-sharing ratio Assumed to be equal if there is no agreement to the contrary!

8. Partnership Formation Each partner has a:- ‘capital’ account recording the funds/assets contributed to the business. ‘current’ account which records the profits/losses accumulating to that partner, any entitlements and charges, and any drawings.

9. Accounting entries for partnership formation See Illustrative Examples 1,2,3 pgs 122-126 Do Self Test Question 3A, 3B Do exercises 3.6, 3.8 pg 153 3.12 pg 155 Note when partners contribute assets/liabilities from an existing business they must be at their “fair values”. Read pg 124

10. Partnership Operations At end of the year, the profit/loss is distributed to the partners in accordance with the partnership agreement. This distribution process is referred to as “appropriation”. REVISION from Cert III – closing accounts to P&L account. The profit figure from the P&L account is transferred to the “P&L appropriation” account. This account is also used to record any partner entitlements or charges. The balance of the P&L Appropriation account is transferred according to the profit sharing ratio to the partners’ current accounts.

11. Partner Entitlements & Charges Entitlements: Interest on capital contributed Interest on loans to the partnership Partner’s salary Charges: Interest on drawings Interest on advances made to partners Read Pg 127-128

12. Accounting for interest on drawings and interest on capital See journal entries pg 129 Work through illustrative example 4 – pg 130-131 Do self test 3D pg 133

13. Accounting for Partner’s Salary Partner’s salary should be transferred to the Profit and Loss account so that it appears in the list of operating expenses in the Income Statement See journal entry pg 132

14. Accounting for Partner’s Loan If a partner loans money to the partnership, a Partner Loan Account is established. See journal entry pg 133 Do Self Test Question 3C pg 132 Do Exercises 3.17, 3.18,3.19, 3.20 pg 158 3.22 pg 160 NOTE: I have summarised the journal entries so far on file called “Summary of Partnership Operation Journals” which is on the wiki site.