Chapter 14 Partnerships

1. Chapter 14Partnerships Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

2. Types • Partnerships – an unincorporated association of 2 or more persons to pursue a business for profit as co-owners. • Generally 2 types: • General partnerships: involves a partnerships agreement, limited life, taxation in the hands of the owners, co-ownership of property, mutual agency, unlimited liability • Limited Partnerships: Where the partnership is subject to limited legal liability. At least one partner must be a general partner (unlimited liability). The limited partners have liability limited to their investment Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

3. Characteristics of Partnerships • Partnership Agreement – a written contract that defines the partnership relationship. • Limited Life – the partnership is limited by death, bankruptcy, or can be limited by some event that prevents a partner from fulfilling on the partnership commitment • Taxation – The partnership itself is not taxed. Instead, income is allocated to the partners and then taxed in their hands on withdrawal • Co-ownership of Property – Assets are co-owned by partners. Assets brought by one partner to the partnership are then shared by all partners Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

4. Characteristics of Partnerships • Mutual Agency – In a general partnership, each partner is a fully authorized agent of the partnership. • Any partner can commit or bind the partnership to a contract • Unlimited Liability – Partners are liable for creditors claims on partnership assets and must cover those claims with personal assets. Creditors can seek the personal assets of any and all partners to satisfy their claims • Limited Partnerships – You can have limited partnerships where one partner must bear the “unlimited-ness” but others only have restricted duties and control • Limited Liability Partnerships – where each individual partner is not liable for the debt of the others, but is still personally liable for their own Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

5. Basic Partnership Accounting • Very similar to the accounting for a sole proprietorship except: • There is an individual capital account for each partner • There is an individual withdrawals account for each partner • Income and loss is allocated to the partners according to the partnership agreement • Partners generally get paid by withdrawals, not by salary • 3 general ways of dividing income or loss: • Allocated on stated fractional basis • Allocated on ratio of capital investment • Allocated using salary, interest allowance and a fixed ratio Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

6. When income exceeds allowance • Examine Exh 14.4 • In this case the partnership has earned more than the combined allowance of the partners • First, salary is portioned out based on the Partnership Agreement (Exh 14.3) • Next, the interest allowance is portioned out, again, based on the Agreement • Finally, The balance is portioned out • Note that these are allowances and not payments. • The partners themselves can now decide how much payment they wish to receive, keeping in mind the tax implications Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD

7. When Allowances Exceed Income • Exh 14.6 illustrates when the firm has not earned enough to cover allowances • Again, first, salary allowances are calculated • Next, interest allowances are calculated • Finally, these are balanced against net income and the “loss” is allocated to the partners’ allowances. This results in a reduction in apportioned net income to their individual capital accounts • Exh 14.7 shows the same type of calculations for a net loss. In this case the resulting negative numbers are just bigger. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD