As a business grows it may be necessary to involve additional people either to obtain access to more capital or to provide expertise. One way of introducing additional people is to form a partnership. A partnership is formed when two or more persons carry on a business for profit as co-owners.
Characteristics of a Partnership
There are numerous types of partnership, but generally, in the absence of a partnership agreement, a partnership has the following characteristics.
- The partnership is a separate legal and accounting entity.
- Each partner has unlimited liability.
- The acts of one partner binds the others.
- Each partner has a claim on the assets or the partnership.
- The partnership dissolves (but the business does not end) when a partner leaves or joins.
- Each partner has an equal share in the net income or loss or the partnership.
- The amount of capital contributed does not effect the share of net income each partner is entitled to.
The Partnership Agreement
A partnership agreement is usually drawn up between the partners to set out how the partnership will operate, this will include accounting matters such:
- The capital contributions of each partner.
- Ratio for sharing the net income or loss.
- Rate of interest to be received on capital and paid on drawings.
- Salaries to be paid to each partner.
- Provisions for the withdrawal and additions of assets.
Partnership Formation Accounting
When a partnership is formed each partner introduces capital. The capital introduction might be in cash form or non cash form such as equipment, machinery, buildings, or accounts receivable. If the capital is introduced in non cash form, it is always brought into the partnership at fair value.
Suppose for example, a partnership is formed between two people, partner A and partner B, typical partnership bookkeeping entries would be as follows:
Introduction of Cash into a Partnership
Partner A invests 10,000 by way of cash. The following double entry bookkeeping journal would be posted:
|Cash||10,000||Capital – Partner A||10,000|
Introduction of a Long Term (Fixed) Assets into a Partnership
Partner B introduces a piece of machinery whose fair value is 20,000 (non-cash assets are always accounted for at fair market value when introduced to the partnership). The following double entry bookkeeping journal would be posted:
|Long term assets – machinery||20,000|
|Capital – Partner B||20,000|
Introduction of Accounts Receivable into a Partnership
Partner A also introduces accounts receivable of 12,000, of which the partnership expects to be able to collect 10,000. In this case the gross value of the accounts receivable needs to be recorded (to reflect the total amount receivable from the customers), and the reduction to fair value is accounted for by changing the value on the allowance for doubtful debts account.
The bookkeeping entries of the partnership are as follows:
|Allowance for doubtful debts||2,000|
|Capital – Partner A||10,000|
At the end of these partnership formation accounting entries, the balance sheet of the of the partnership would be as follows:
|Fixed assets – machinery||20,000|
|Allowance for doubtful debts||-2,000|
|Capital – Partner A||20,000|
|Capital – Partner B||20,000|
In this partnership formation, the capital injected by each partner is 20,000 giving a ratio of 1:1 for capital introduced.
Further examples can be seen in our post of partnership journal entries.