Partnership is a legal business relationship between two or more people who agree to do business for the purposes of earning profit. It is considered as the most appealing option in setting up a new small scale business and growing it with the passage of time. In this business relationship, all the partners share profits and losses in an agreed ratio while assign the decision making powers to the partners who are more competent and experienced than the rest (Needles, Powers, & Crosson, 2011).
The creation, operations, and liquidation processes of a partnership firm are quite different than those of a sole proprietorship or a joint stock corporation. Therefore, it has its own advantages and disadvantages that must be kept in mind while partners choose to engage together and share profits and liabilities.
The following sections discuss all the major aspects of a business partnership; including advantages and disadvantages, creation, operation, and liquidation of partnership business, and the tax consequences for partners. The discussion has been made in the light of Financial Accounting Standards (FAS) that govern the partnership businesses.
Advantages and Disadvantages of Partnership
Every type of business setup has some benefits and pitfalls that must be balanced in order to achieve the desired financial results and operational targets. Partnership also has some advantages and disadvantages that are seen by the partners and the stakeholders of their partnership business from their own perspectives. These are now discussed below in detail:
1. Advantages of partnership:
a. Easy Formation and Availability of Finance:
The biggest benefit of a partnership is its easy formation process. Unlike a joint stock company, a partnership business can be set up with only a few legal formalities and documentation. The governing rules and regulations for a partnership business are also less strict than those for a joint stock company. Secondly, partnership business does not face any difficulty in obtaining finance for the business as the capital is readily available for its proper functioning and growth (Clifford & Warner, 2008). When partners join hands to run a partnership firm, they agree to share their financial capital and keep investing in the business in a view to boost up its day-to-day operations. It also means that a greater number of partners make a stronger partnership business. Moreover, new partners can also be added in the firm in order to get more finance to meet the requirements of the business. The liability of the partners is totally unlimited in the partnership business. It helps them in obtaining finance from the banks and financial institutions without any difficulty (Emerson, 2009).
b. Partners with Diverse Skills and Competencies:
Another advantage of a partnership business is the availability of partners who have diverse expertise and skills. This thing helps in the better management, leadership, and decision making for the business. Other partners may also choose to take the services of experienced and competent partners in place of their share in the losses or liabilities of the business. Decisions are made more effectively when all the partners present their point-of-views on business matters and reach final decisions on which all of them are agree. In this way, the partnership is able to sell its products or services in a more effective and tactful way (Needles, Powers, & Crosson, 2011).
c. Fewer Burdens of Financial Losses:
As the partnership is formed as an agreement between the partners to share losses whenever they happen, the burden of these losses is divided among all the partners at agreed proportions. It means partnership has an edge over sole proprietorship where the owner has to bear the full losses from his business himself. The financial losses in a partnership business are borne by the partners according to the shares or stakes held by each partner (Li & Wolfstetter, 2010).
d. Easy Termination of Partnership:
The termination of a partnership business is also as easy as its formation. There are no complex or lengthy legal requirements that partners have to meet in order to terminate their partnership. A partner can leave the firm any time and take his share upon calculation and deduction of any withheld liabilities on his side. Lastly, partners are not obliged for any superannuation contribution or workers' compensation insurance on their profits or drawings. It is because partners are not the employees of their partnership firm; they are the owners (Rese, 2006).
2. Disadvantages of Partnership:
a. Unlimited Liability and the Risk of Implied Authority:
In addition to the aforementioned advantages, partnership has some pitfalls which create troubles and complexities for the partners and the people directly or indirectly associated with their partnership firm. Some benefits can also turn into disadvantages if partners do not make effective decisions and manage their business in critical circumstances (Emerson, 2009). The biggest disadvantage or pitfall of a partnership business is the unlimited liability of partners. Upon termination of the business, they have to pay all the due liabilities from their share in the business as well as from their personal assets (Needles, Powers, & Crosson, 2011).
Moreover, each of the partners is individually as well as collectively responsible for all the right and wrong deeds of the other partners. An irresponsible and dishonest partner may perform a fraudulent activity on behalf of the other partners which can make them personally liable to pay for its losses. The unlimited liability characteristic of partnership discourages the new entrepreneurs to get engage in this type of business (Clifford & Warner, 2008).
b. Disagreements and Conflicts among Partners:
Another big disadvantage of partnership business is the risk of disagreements and conflicts between the partners. When partners have to make decisions on day-to-day business affairs, each of them presents his own point-of-views. Disagreements arise when every partner wishes that all others get agree to what he believes (Li & Wolfstetter, 2010). When the situation becomes serious, the disagreeing partners may leave their relationship in the business and take away their share. This thing badly hampers the operational setup, profits, and the growth of the partnership business. Ultimately, partners may also decide to dissolve the business (Warren, Reeve, & Duchac, 2012).
c. The Instability of Partnership Business:
A partnership is the most unstable form of business. It is because the term of business relationship between partners is highly uncertain. If the firm is run by a small number of partners; the death, insanity, or insolvency of one or more partners put all the burdens and the management functions of the business on the existing partners. If these partners are unable to continue the business with a more limited capital and resources, they have to dissolve it and terminate their partnership (Rese, 2006).
d. Lack of Stakeholders' Confidence:
It is not legally mandatory for a partnership business to maintain its accounts and publish them to the general public. Therefore, partners can make any changes in the financial results and other important aspects of their business without giving any notice to their stakeholders (Rese, 2006). This thing creates a sense of suspicion on the professional integrity and honesty of the partners that they are misrepresenting their business affairs to the general public. It shakes the stakeholders' confidence on the partners which is eventually a bad sign for the business (Clifford & Warner, 2008).
5. Uneven efforts by some partners:
Some partners do not take their duties and responsibilities seriously and show little or no interest in developing the business of the firm. When profits are distributed, they consider themselves as the most deserving partners among the rest. These types of partners are never welcomed in any firm due to their uneven efforts and interest for the business. While forming a partnership business, partners cannot know who among them is a responsible partner and who is non-serious. This is a common disadvantage of partnership due to which people hesitate to enter new partners in their business (Needles, Powers, & Crosson, 2011).
Financial Accounting Standards for Creation, Operation and Liquidation of Partnerships
Formation of Partnership Business:
To establish a partnership firm, partners have to get it registered so as to operate it in a legal and lawful way. The name with which the partners are intending to start their partnership business must be recorded with the Registrar of partnership firms. Once the name of the firm is registered, the partners can start doing business legally (Warren, Reeve, & Duchac, 2012). To register a partnership firm, partners have to submit an application to the Registrar and get Certification from him. In the registration application, they have to give the name and place of the firm, the names, dates of joining, and addresses of all the partners, and duration of the firm, if applicable. The Registrar makes his own examination and verification of the particular supplied in the application and issues a Certificate of Registration to the partners.
Registration of a partnership business is not compulsory for partners; however, there are certain benefits that can be realized from a registered firm. For example, partners get…