Partnerships: HAC001 FINAL

Partnership

Defined in the partnership act as the relo that 'subsists betw persons carrying on a business in common w a view profit'

3 attributes necessary for partnership to exist

1. Partnership agreement

2. Business operation w view to earn profit

3. Members are co-owners

Partnership Agreement

Contractual agreement betw legally competent people.

Must be agreement (verbal & written) betw 2 or more legally competent persons/ entities to carry on business)

Co-ownership involves:

->Right of each partner to share in profits of business

->Right to participate with other partners in management of business

->Right to own jointly w other partners the property of the business

Legal aspects of partnership

In legal terms, partnership ≠ sep legal entity, hence, not legally correct to talk of a partnership doing business

Partnership agreement includes

1. Name & identity of partners

2. Nature & duration of business

3. Location of business

4. How profits & losses are shared

5. How withdrawal of assets by partner is handled

6. Conduct of partnership affairs

7. Acc system & banking arrangement

8. Authority of each partner in contractual situations

9. Identification & valuation of initial asset contributions & specification of capital interest each partner is to achieve

10. Depr method used

11. How disputes among partners are resolved

12. How day-to-day operations are conducted

Partnership Act

Law that belongs to country designed by group of people governing formation and operation of partnerships.

Agreement vs act

AGREEMENT - Partners write it out (after develop & deciding, both sign)

ACT - Belongs to country designed by group of people.

In partnership act:

- Entitled to share equally capital & profits (& must contr equally toward losses)

- Liable for debts (to whole extent of personal property). Partners must contr to those debts in same proportions which they share profit

- Entitled to take part in management of business

- Not entitled (before ascertainment of profits), to interest on capital contr by them

- Not entitled to any remuneration for conduct business affairs of partnership

- No person may be intro as partner/expelled from partnership w/o consent of all existing partners

- If partner adv money to partnership beyond amount of their contr capital, partner is entitled to interest at rate specified in act

- Partnership records are to be kept at place of business & may be inspected by any partner any time.

Advantages of Partnership

Pooling of resources, easier & less costly, Less gov regulation, Flexibility (no board of directors), certain tax advantages

Characteristics/disadvantages of Partnerships

Mutual agency, Unlimited liability, Limited life, Consent required to transfer interest

Mutual agency

Every partner (normally) acts as an agent for partnership & for every other partner.

o Thus, partner can rep other partners & bind them to contract if acting within apparent scope of business.

Unlimited liability

Each partner is personally liable for obligations of partnership (in general partnership- the most common form)

Limited partnership

- exists when 1/more of partners have limited their liability for partnership debts to amount of assets they've contributed.

o (At least 1 partner must be general partner: unlimited liability)

o (Uncommon type of partnership)

Limited life

Partnership is dissolved/ends for many reasons

EX.

· Death of partner

· Bankruptcy of partnership/ind partner

· Admission of new partner/Retirement of old partner.

· Expiration of period specified in contract

· Judgement by court that partner is incapable of performing duties

Transf of partnership interest

partnership law recognises personal relo of partners & provides purch of partners interest doesn't have right to participate in management unless accepted & agreed to by all partners

Sep acc entity

Owners are tied to debts of business, but still sep acc entity bc acc affairs of partners must be sep from acc affairs of partnership

Financial reports for partnership

Acc & report det entirely by partners themselves & any fin reports are thus SPECIAL-PURPOSE REPORTS

2 methods of acc for equity

Method 1 - capital

Method 2 - retained earnings

Method 1

"Capital"

->Use of capital accs for each partner that records capital contr & withdrawn, AND partners periodic share of profits/losses

Method 2

Retained earnings

Use of capital accs w FIXED BALS for each partner reflect ONLY capital contr & withdrawn. (Partners share of profits/losses & drawings from profits recorded in sep retained earnings/current acc for each partner)

General Partner

Partner liable for all partnership obligations.

Acc for formation of partnership

Assets contr, Liabilities assumed, monetary amounts assigned to A&L, and capital interest each partner receives-> should be agreed on & specified in agreement, once agreed entries to record formation of partnership can be made

Fair Value

Defined in international acc standards as the P received to sell an asset/paid to transf liability in market (in orderly trans betw market participants at measurement date)

Carrying Amount

Value of an asset as recorded on books.

Owner of other business (sole trader- co owners), owners of own business before & decide to come tg & set up partnership

Special-Purpose Reports

Financial reports tailored by partners, not standardized.

Profit Distribution Account

Allocates profits/losses to partners' Capital accounts.

Closing Drawings Account

Drawings closed to Capital account at period end.

Profit or Loss Summary

Transfers to Profit Distribution account for allocation.

Accounting Procedures Similarity

Similar to sole trader accounting with added complexity.

Retained Earnings Account

Holds partners' share of profits after distributions.

Goodwill

Generated internally/purchased in exchange transaction. Term to descr unidentifiable assets in business. (NCA)

Purchased Goodwill

Goodwill acquired through an exchange transaction.

Only purchased goodwill should be recorded in accounts

Internally Generated Goodwill

Goodwill developed within the business, not recorded.

Why is only purchased goodwill recorded

Bc purchased goodwill can be measured reliably on the basis of the amount paid for it, whereas internally generated goodwill is not usually capable of reliable measurement (recorded as NCA)

Examples of goodwill

Customer loyalty, brand repetition, efficient operations, location, market share

Allocation of profits & losses

Partners may agree to any method, details should be in agreement

(If no agreement reached, comply w act- profits & losses divided equally regardless of amount inv)

Partners should consider 3 distinct elements that make up profits

1. A return for the PERSONAL SERVICES performed by partners

(If 1 partner's more actively involved in management)

2. A return on CAPITAL provided by partners

(If partners capital investments are not equal - stm to recognise these diff should be incl in agreement)

3. A return for BUSINESS RISKS assumed by partners

3 profit & loss sharing agreements

1. Fixed ratio

2. Ratio based on cap bals

3. Fixed ratio est by partners after allowing for interest on capital contr & salaries to partners for services rendered to partnership

Fixed Ratio

Profits allocated based on specific ratio (one of simplest profit/loss agreements) (appropriate method if partners contr can be stated in terms of fixed %)

Formula for fixed ratio

Ratio/Total ratio x Profit

Capital Balances Ratio

Equitable allocation when invested capitl is most important (than time/effort)

Agreement should specify whether ratio is to be calc from og inv/beg of yr bals/eoy bals/ avg (bc capital bals change during period)

Formula for capital bals

Capital/total capital x profit

Ratio after allowing interest & salaries

Sometimes partners contr diff amounts of money/work. (unless agreement says otherwise), partners aren't legally entitled to rec compensation for services/interest on cap inv. If goal is to fairly div profits, agreement should incl rudes for interest/salary allocation before residual profit

First GJ entry to record profit of period

DR profit & loss sum, CR profit distr (Transfer of partnership profit to profit distr acc)

Residual profit

Amount left after deducting interest & salary from eoy profit

Difference betw method 1 & 2

1 - uses term retained profit swhen distr profit to partners

2 - uses capital when recording profit allocation

What must a partnership do if they don't have an agreement

Comply with partnership act

If Jim, Anita and miller (capital bals of 100,000, 50,000 & 70,000), agree to share profit of 50,500 in ratio of 5:2:3, how much will they get

jim: 25,250

anita: 10,100

miller: 15,150

If Jim, Anita and miller (capital bals of 100,000, 50,000 & 70,000), agree to share profit of 50,500 in ratio of 5:2:3. what would be the GJ entry to record distr of profit to partners under method 2 (fixed ratio)

DR profit distr 50,5000

CR jim, retained profits 25,250

CR anita, retained profits 10,100

CR miller, retained profits 15,150

(Distribution of profit to partners)

Mere and mirah form partnership 1 june 2023. mere: cash at bank 10,000 & loan 2,500.

mirah: cash at bank 500, debtors 1,400, equip 10,000, creditors 1,000, capital 20,000

record GJ entries

DR cash at bank 10,000

CR loan 2,500

CR mere, capital 7,500

(assets & liabilites contr by mere to partnership) DR 10,000 CR 10,000

DR cash at bank 500

DR debtors 1,400

DR equip 10,000

DR goodwill 9,100

CR creditors 1,000

CR capital 20,000

(assets & liabilities contr by mirah to partnership) DR 21,000 CR 21,000

If Jim, Anita and miller (capital bals of 100,000, 50,000 & 70,000), agree to share profit of 50,500 in ratio of 5:2:3. if they share profit according to act, how much will they get?

jim 16,833.33

anita 16,833.33

miller 16,833.33

Interest Calculation

Formula: Capital × Interest Rate.

Statement of Changes in Equity

Shows changes in partners' equity over time.

if two partners have interest agreement of allowed 8% on cap bals, with A: cap bal 150,000 & B: cap bal 90,000 and eoy profit 80,000, how much interest will they receive

A: 12,000

B: 7,200

If Jim, Anita and miller (capital bals of 100,000, 50,000 & 70,000), agree to share profit of 50,500 agree to share profit accord to beg cap bals, how much will they get?

jim 22,955

anita 11,477

miller 16,068

Disadvantage both partnerships & sole traders share

Unlimited liability

Advantage partnership has over sole trader

Pooling of both capital resources & multiple skills

True or false, a partnership business has a limited life span and unlimited debts

true

True or false, transfer of partnership interest means that capital interest of individual partners can be sold/disposed of legally if approved by all partners

False

True or false, mutual agency means that partners can act on behalf of other partners. a partner can rep other partner and bind them to contract if acting within scope of business

True

True or false, partnership agreement is important doc that should contain vital matters such as partners' identities, duration of business, nature of business, partners' personal matters, provision of profits and losses & others

False

How much residual profit will partner A and B if partner A has cap bal 150,000 B has 90,000, agreed to share eoy profit 80,000 according to:

1. allowed interest 8% on cap bals

2.A receives salary 22,000, B receives 15,000

3. Residual profit shared equally

A: 11,900

B: 11,900