12

Accounting for Partnerships

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 Partnership

A partnership is a type of business structure

where two or more partners start an entity to
do business. For a partnership to exist, there
must always be two or more partners.

A Partnership is defined by the Partnership

Act, 1932, (the “Partnership Act”) as ‘the
relation between persons who have agreed to
share profits of the business carried on by all
or any of them acting for all’. This definition
gives three minimum requirements to
constitute a partnership:
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  there must be an agreement entered into
orally or in writing by the persons who
desire to form a partnership,
 the object of the agreement must be to
share the profits of business intended to
be carried on by the partnership, and
 the business must be carried on by all the
partners or by any of them acting for all of
them. The term ‘person’ is not defined by
the Partnership Act.

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 It is not compulsory to register your
partnership firm as there are no penalties for
non-registration. However, it is advisable
since the following rights are denied to an
unregistered firm:

 A partner cannot file a suit in any court

against the firm or other partners for the
enforcement of any right arising from a
contract or right conferred by the
Partnership Act

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  A right arising from a contract cannot be
enforced in any Court by or on behalf of
your firm against any third party
 Further, the firm or any of its partners
cannot claim a set off (i.e. mutual
adjustment of debts owned by the
disputant parties to one another) or other
proceedings in a dispute with a third party.

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 LIABILITY

 A partnership is considered as a separate

legal identity (i.e. separate from its
owners) in Bangladesh only if the
partnership is registered.
 All the partners of a partnership are liable
severally and jointly for the liability of the
partnership.
 The concept of Limited Liability
Partnership does not exist in Bangladesh.

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 Things to know in a partnership business

 1. Is this really a partnership, or just a

random arrangement?
 2. How many partners is too many?
 3. There is more than one form of
partnership.
 4. Declaring the partnership is optional.

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  5. "What is yours is also mine" doesn't
apply.
 6. In running a partnership, there are some
basic rules.
 7. Partners can use proxies for their
presence.
 8. Decisions need to be taken together.

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 Characteristics of Partnerships

ASSOCIATION OF INDIVIDUALS
 Legal entity.
 Accounting entity.
 Net income not taxed as a separate entity.

MUTUAL AGENCY
 Act of any partner is binding on all other partners, so long
as the act appears to be appropriate for the partnership.

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 Characteristics of Partnerships
LIMITED LIFE:
 Partnership has limited life. It may be ended voluntarily at
any time through the acceptance of a new partner or the
withdrawal of a partner.
 It may be ended involuntarily by the death or incapacity of
a partner.
 Dissolution does not mean the business ends. If the
continuing partners agree, operations can continue
without interruption of by forming a new partnership.

UNLIMITED LIABILITY
 Each partner is personally and individually liable for all
partnership liabilities.
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 Characteristics of Partnerships

CO-OWNERSHIP OF PROPERTY
 At the time of dissolution, Each partner has a claim on
total assets equal to the balance in his or her respective
capital account.
 This claim does not attach to specific assets that an
individual partner contributed to the firm.
 All net income or net loss is shared equally by the
partners, unless otherwise stated in the partnership
agreement.

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 Organizations with Partnerships Characteristics

Partnership is divided into Regular partnership (partners who

has little capital and business is not risky), Special
partnership (for risky business)

Special forms of business organizations are often used to

provide protection from unlimited liability.

Special partnership forms are:

 Limited Partnerships,
 Limited Liability Partnerships, and
Helpful Hint In an LLP, all
partners have limited
liability. There are no
general partners.

 Limited Liability Companies.

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 Organizations with Partnerships Characteristics

Regular Partnership

Major Advantages Major Disadvantages

 Simple and inexpensive  Owners (partners)
to create and operate. personally liable for
business debts.

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 Organizations with Partnerships Characteristics

“Ltd.,” or “LP”(limited partnership): Liabilities are limited and

unlimited for the partners. Unlimited liability partners are
regular partners.

Major Advantages
 Limited partners have limited
personal liability for business
debts as long as they do not
participate in management.
 General partners can raise cash
without involving outside
investors in management of
business.
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Major Disadvantages
 General partners
personally liable for
business debts.
 More expensive to
create than regular
partnership.
 Suitable for
companies that invest
in real estate.
 Organizations with Partnerships Characteristics
Limited Liability Partnership(LLP): It is designed to protect
innocent partners from malpractice or negligence claims
resulting from the act of another partner. Generally carry large
insurance policies as protection against malpractice suits.

Major Advantages Major Disadvantages

 Mostly of interest to partners
in old-line professions such
as law, medicine, and
accounting.
 Owners (partners) are not
personally liable for the
malpractice of other
partners.
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 Partners remain
personally liable for many
types of obligations owed
to business creditors,
lenders, and landlords.
 Often limited to a short list
of professions.
 Organizations with Partnerships Characteristics

Limited Liability Companies (LLC): A hybrid form of

business organization with certain features like a
corporation and others like a limited partnership

Major Advantages
Major Disadvantages
 Owners have limited
personal liability for  More expensive to create
business debts even if than regular partnership.
they participate in
management.

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 Accounting Across the Organization
Limited Liability Companies Gain in Popularity
The proprietorship form of business organization is still the
most popular, followed by the corporate form. But whenever a
group of individual wants to form a partnership, the limited
liability company is usually the popular choice. One other form
of business organization is a corporation. A corporation has
many of the characteristics of a partnership—especially taxation
as a partnership—but it is losing its popularity. The reason: It
involves more paperwork and expense than a limited liability
company, which in most cases offers similar advantages.

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 Advantages and Disadvantages of Partnerships

Advantages
• Combining skills and resources of two or more individuals
• Ease of formation
• Freedom from governmental regulations and restrictions
• Ease of decision-making

Disadvantages
• Mutual agency
• Limited life
• Unlimited liability

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 Partnership Agreement: Ideally, the agreement of two or
more individuals to form a partnership should be
expressed in a written contract, called the partnership
agreement/deed/articles of co partnership
It Should specify relationships among the partners:
1. Names and capital contributions of partners.
2. Rights and duties of partners.
3. Basis for sharing net income or net loss.
4. Provision for withdrawals of assets.
5. Procedures for submitting disputes to arbitration.
6. Procedures for the withdrawal or addition of a partner.
7. Rights and duties of surviving partners in the event of a
partner’s death.
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 Explain how to account for net income or net loss
of a partnership.

Dividing Net Income or Net Loss

Partners equally share net income or net loss unless the
partnership contract indicates otherwise.

CLOSING ENTRIES:
 Close all Revenue and Expense accounts to Income
Summary.

 Close Income Summary to each partner’s Capital account for

his or her share of net income or loss.

 Close each partners Drawing account to his or her respective

Capital account.
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 Dividing Net Income or Net Loss

INCOME RATIOS
Partnership agreement should specify the basis for sharing
net income or net loss. Typical income ratios:
 Fixed ratio.
 Ratio based on capital balances.
 Salaries to partners and remainder on a fixed ratio.
 Interest on partners’ capital balances and the remainder
on a fixed ratio.
 Salaries to partners, interest on partners’ capital, and the
remainder on a fixed ratio.
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 Explain how to account for the liquidation of a
partnership.

Ends both the legal and economic life of the entity.

To liquidate, it is necessary to:

1. Sell noncash assets for cash and recognize a gain or loss

on realization.

2. Allocate gain/loss on realization to the partners based on

their income ratios.

3. Pay partnership liabilities in cash.

4. Distribute remaining cash to partners on the basis of their

capital balances.

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 Prepare journal entries when a partner is either admitted or
withdraws.

Admission of a Partner
 Results in the legal dissolution of the existing partnership
and the beginning of a new one.

 New partner may be admitted either by

► purchasing the interest of one or more existing partners
or

► investing assets in the partnership.

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 Investment of Assets in a Partnership

BONUS TO OLD PARTNERS

Results when the new partner’s investment in the firm is
greater than the capital credit on the date of admittance.
 Bonus results in an increase in the capital balances of the
old partners.

 Partnership allocates the bonus to them on the basis of

their income ratios before the admission of the new
partner.

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 Investment of Assets in a Partnership

BONUS TO NEW PARTNER

Results when the new partner’s investment in the firm is less
than his or her capital credit.
 Bonus results in an decrease in the capital balances of the
old partners.

 Decrease for each partner is based on the income ratios

before the admission of the new partner.

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 Payment from Partnership Assets APPENDIX

BONUS TO RETIRING PARTNER

A partnership may pay a bonus to a retiring partner when:

1. The fair value of partnership assets is more than their book value,

2. There is unrecorded goodwill resulting from the partnership’s

superior earnings record, or

3. The remaining partners are eager to remove the partner from the
firm.

The partnership deducts the bonus from the remaining partners’

capital balances on the basis of their income ratios at the time of
the withdrawal.

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 Withdrawal of a Partner

 A partner may withdraw from a partnership voluntarily,

by selling his or her equity in the firm.

 Or, he or she may withdraw involuntarily, by reaching

mandatory retirement age or by dying.

 The withdrawal of a partner, like the admission of a

partner, legally dissolves the partnership.

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 Death of a Partner APPENDIX

Dissolves the partnership.

Partnership agreements usually contain a provision for the
surviving partners to continue operations.

Surviving partners may

 agree to purchase the deceased partner’s equity from their
personal assets.

 use partnership assets to settle with the deceased

partner’s estate.

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