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Accounting for Partnerships
Businesses can be classified into various forms of ownership. In this text, I concern myself with partnerships. In so doing, I will discuss partnerships and the various advantages as well as disadvantages associated with this form of business ownership. Further, I will also highlight the Financial Accounting Standards (FAS) governing accounting for this form of business ownership from creation and operation to liquidation. Partnerships' tax consequences will also be discussed.
Partnerships: Advantages and Disadvantages
Just like any form of business ownership, partnerships also do have several advantages and disadvantages. A partnership according to Needles, Needles and Powers (2010) is "an association of two or more persons to carry on as co-owners of a business for profit." In that regard, a partnership is formed when two or more people come together with an aim of initiating a business activity. Individuals may be motivated to start a partnership form of business by a number of factors. These factors could include but they are not limited to the possession of complementary talents as well as skills.
One of the main advantages of a partnership as a form of business organization is access to more capital. Indeed, as Eisen (2000) points out, the formation of a partnership unlocks more capital for investment purposes. In this case, the reasoning is that two or more partners bring into the business their individual contributions whose sum is much greater than what any of the partners could have raised on his or her own. It is also important to note that the borrowing capacity of partners in this case is much greater. Thus unlike a sole proprietor form of ownership, a partnership can be able to exploit business opportunities that require a significant amount of capital.
Next, in comparison to some other forms of business ownership i.e. A corporation, a partnership also happens to be much easier to not only establish but also run. In Eisen's (2000) own words, a "partnership is more easily formed than a corporate form of business." The ease of establishment in this case has got to do with fewer legal bottlenecks or formalities involved in the formation or setup of the same. Further, it is also important to note that in comparison to corporations, the costs involved in setting up partnerships are minimal. There are also no specific legal requirements that require a partnership to publish its accounts. Thus the nature of a partnership's operations as well as its financial dealings can easily be kept secret. This is in comparison to a limited liability company where disclosure of volumes of financial information is mandatory.
Third, as I have pointed out elsewhere in this text, one of the main reasons as to why individuals come together to establish a partnership is the need to complement each others talents and skills. In the opinion of Eisen, partners bring into the organization various skills. For instance, in a hypothetical partnership, Partner A could be good in planning but lack negotiation skills. Such a critical deficiency can be neutralized by having on board a partner, Partner B, who possesses strong negotiation skills. Hence in a way, the diverse skills of partners in the case of a partnership can enhance the efficiency of a business entity.
A partnership form of business ownership also does have some disadvantages. To begin with, the life of a partnership according to Eisen (2000) may be limited. For instance, the death of a partner may trigger the end of a partnership. Further, the withdrawal of one partner may also cause the partnership to end.
Secondly, "partners have unlimited liability for the debts of the partnership" (Eisen, 2000). This is considered one of the most significant disadvantages of partnerships as a form of business ownership. In this case, partners classified as general partners are regarded liable for all the unsettled obligations or debts incurred/contracted by the business entity. Thus in comparison to corporations, some investors may view partnerships as being rather risky. This key disadvantage can even hinder the performance of the business especially when partners choose to play too safe in an attempt to avert a situation whereby they could lose their personal possessions were the partnership to become unable to settle its obligations.
Next, as Eisen (2000) points out, the ability to raise capital in the case of partnerships is largely limited. To begin with, there is a limit as to the number of individuals who can form a partnership. This key handicap effectively limits the amount of capital a partnership has access to. It is important to note that when it comes to a corporation, there is no limit as to the number of investors who should be onboard. With that in mind, a partnership can find itself unable to exploit large-scale business opportunities which require a huge capital outlay. This could impact negatively on the profit potential of a partnership.
Profit sharing is also viewed as a disadvantage of a partnership. This is however largely in comparison to a sole proprietor form of business ownership in which case the owner of the entity keeps all the profits the business rakes in. As Needles, Needles and Powers (2010) point out, in a partnership, "each partner has the right to share in the company's income…" This must however be done in accordance with the various provisions outlined in the partnership agreement.
In regard to the discussion above, it should be noted that although a partnership comes across as being better that a sole proprietorship on quite a number of fronts, it is still not the most preferred form of business ownership. Indeed, when it comes to popularity, a partnership in the opinion of Pride, Hughes and Kapoor (2011) remains "the least popular of the major forms of business ownership." However, it should be noted that the law makes it possible to offset some of the challenges associated with this form of business ownership. For instance, it is possible according to Pride, Hughes and Kapoor (2011) to limit the liability of some partners. This according to the authors can be made possible through the formation or establishment of what is referred to as a limited partnership.
Accounting for Partnerships
When it comes to the creation of a partnership, owners' equity according to Needles, Needles and Powers (2010) is referred to as partners' equity. The authors recommend that each partner should have separate Capital and Withdrawal accounts. This facilitates accounting for the equity of each partner. Each partner is expected to make his or her contributions in accordance with the provisions set in the partnership agreement. As I have pointed out elsewhere in this text, it is this agreement that also determines how profits as well as losses are to be shared in a partnership. According to Needles, Needles and Powers (2010), immediately they are transferred in the partnership, "noncash assets should be valued at their fair market value." The value of each partner's invested assets is credited to his or her capital account with the corresponding debit entry made in the proper account.
Regarding the operation of a partnership, the distribution of income and losses in this case according to Needles, Needles and Powers (2010) is done in accordance with the specific provisions of the partnership agreement. The major components of income identified by the authors here include salaries, interest on the capital of partners and other contributions regarded special depending on specific contributions of partners in their individual capacities etc. During the period the partnership continues in its operation, any partner may seek to either withdraw or retire from the partnership. In such a case, Warren, Reeve and Duchac (2011) point out that the interest of such a partner is sold either to the partnership or existing partners. In the latter case, the purchase of such an interest is done by any of the partners in an individual capacity. The death of a partner may also trigger some accounting adjustments. According to Warren, Reeve and Duchac (2011), closure of the partnership accounts should take place on the death of a partner. The current period's income (net) "should then be determined and divided among the partner's capital accounts" (Warren, Reeve and Duchac, 2011). Further, the authors in this case point out that an adjustment of asset accounts should take place to reflect current values with the resulting amount as a result of the said adjustment being divided among the partners' capital accounts. On division of the income and the reevaluation of assets, the capital account of the deceased partner is closed by debiting it with its balance and crediting the amount payable to the said partner's estate to a liability account (Warren, Reeve and Duchac, 2011).
When it comes to accounting for liquidation of partnerships, Warren, Reeve and Duchac (2011) are of the opinion that the prevailing theme in this case remains the sale of assets, payment of those to whom the partnership owes money i.e. creditors, and the distribution of what remains (cash and other assets) to the partners.…[continue]
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