CHAPTER Partnership Accounting - Pearson

1 14 CHAPTERP artnership AccountingLEARNING OBJECTIVESWhen you have completed this CHAPTER , you a better understanding of Accounting the general characteristics of a Partnership and the importanceof each able to calculate the division of profits, prepare the proper journal entries,and prepare the financial statements for a able to calculate and prepare the journal entries for the sale of a partner-ship interest, the withdrawal of a partner, and the addition of a able to calculate and prepare the journal entries for a Partnership that isgoing out of form a balance sheet that shows assets on the left-hand side and liabilities andbalance sheetowner s equity on the right-hand sidedeficita deficiency in amount.

2 , in this CHAPTER , a deficit balance in the capitalaccount is an abnormal, or a debit, balanceliquidationto settle the accounts and distribute the assets of a businessmutual agencythe legal ability of a partner to bind the Partnership to contracts within thescope of the partnershippartnershipa voluntary association of two or more legally competent persons who agree todo business as co-owners for profitprofit-loss ratiothe method chosen by partners for dividing the profits or losses; also called theincome and loss sharing ratiorealizationthe conversion of noncash assets to cashunlimited liabilityeach partner is personallyliable for the business debtsIntroductionThe three common types of business are the proprietorship, the corporation, and thepartnership.

3 It is important to note that corporations, though fewer in number thanproprietorships or partnerships, transact at least 10 times the business of all other busi-ness forms combined. There are advantages and disadvantages to each type of for a Partnership is similar to Accounting for a proprietorship exceptthere is more than one Partnership CharacteristicsGeneral partnerships and limited partnerships are recognized by Canadian law. In thischapter, we will concentrate on general partnerships, which are governed by provinciallaw and registration requirements, and which have certain characteristics.

4 Following is adiscussion of AssociationA partnershipis a voluntary association of two or more legally competent persons (per-sons who are of age and sound mental capacity) to carry on as co-owners a business forprofit. Because a Partnership is based on agreement, no person can be a partner againsther or his will. Doctors, accountants, and lawyers frequently form partnerships, and thisform of business organization is common in small service and retail AgreementTwo or more legally competent people may form a Partnership . It is best if their agree-ment is in writing, but it may be expressed verbally.

5 The Partnership contract is preparedby a lawyer, though an acccountant may review it. The contract will stipulate, amongother things, how Partnership income and losses are to be divided among the Partnership is taxed like a proprietorship. In other words, the partners are taxed basedupon the Partnership s net income, not on their withdrawals from the LifeA Partnership is a business carried on by individuals and can not exist separate and apartfrom those individuals. Should something happen to take away the ability of a partnerto contract (death, bankruptcy or lack of legal capacity), the Partnership may be termi-nated.

6 Also, the life of a Partnership may be limited by terms in the Partnership contract,or it may be terminated by any one of the partners at AgencyMutual agencyis the legal ability of each partner, acting as an agent of the business, toenter into and bind it to contracts within the scope of the Partnership . For example,Alyce, Ben, and Charlie are partners in an Accounting firm. Ben may bind the partner-ship by contracting to buy a computer for the business, even if the other two partnersknow nothing of the purchase. They are bound to the contract because a computer is anexpected and necessary piece of equipment for an Accounting firm.

7 However, the firmwould not be bound if Ben should contract to buy land with the expectation that itsvalue would increase because this transaction is considered to be outside the purpose ofan Accounting may agree to limit the power of one or more of the partners to negotiate con-tracts for the business. Outsiders are bound by this agreement only if they are aware of LiabilityMuch like in a proprietorship, partners have unlimited liability for their liabilitymeans that each partner is personally liable for the debts of thePartnership Accounting377business.

8 When a Partnership business is unable to pay its debts, the creditors may sat-isfy their claims from the personal assets of any of the partners. If any one partner cannot pay her or his share of the debt, creditors may make their claims against any of theother and Disadvantages of a PartnershipA Partnership has advantages over other forms of business. By combining the abilitiesand capital of two or more persons, business potential may be greatly expanded. Also, apartnership is much easier to form than a corporation because an agreement betweenparties is all that is required.

9 However, there are several disadvantages limited life,unlimited liability, and mutual agency are among these and pose potential legal prob-lems that must be considered when forming any new Drawing AccountPartnership Accounting is the same as Accounting for a proprietorship except there areseparate capital and drawing accounts for each partner. The fundamental accountingequation (Assets = Liabilities + Owner s Equity) remains unchanged except that totalowners equity is the sum of the partners capital accounts.

10 Similar to a proprietorship,the partners (owners) do not receive salaries but withdraw assets from the business fortheir personal needs. Generally, the rules for withdrawals are decided beforehand by thepartnership agreement. For example, assume that Partner Arnold withdraws $5,000from a Partnership firm of which he is a member. The journal entry to show this with-drawal is as follows:At the end of the Accounting period, the drawing accounts of each partner are closedto their individual capital accounts. Following is the journal entry to close the drawingaccount of Partner Arnold to his capital 15 Arnold, Drawing500000 Cash500000To Record the Withdrawal of CashGENERAL 31 Arnold, Capital500000 Arnold, Drawing500000To Record the Closing of Arnold s DrawingAccount to CapitalAccounting for a Partnership requires calculations be made for the division of prof-its and losses and the preparation of journal entries for the addition or withdrawal of apartner.