Chapter Ten
I.
1.
2.
3.
4.
5.
Accounts for Partnership and Distribution of Net Income
Learning Objectives
After completing this session, students should be able to
understand the nature of a partnership;
appraise the advantages and disadvantages of a partnership;
understand the differences between a limited and a general partnership;
prepare the balance sheet, income statement, and statement of partners’ capital of
a partnership;
understand different methods of dividing partnership net income among the
partners
II. Lecture notes
1. Three common forms of business organization found in the American economy
are: the single proprietorship, the partnership, and the corporation.
2. Differences between a single proprietorship and a partnership:
(1) In a single proprietorship
- a capital account and a drawing account are maintained in the ledger to show
the equity of the owner.
- the capital account is credited with the amount invested by the owner and
with the net income earned by the business.
- The capital account is debited when net losses are incurred.
- Withdrawals by the owner are debited to a drawing account, which is closed
into the capital account at the end of the accounting period.
(2) In a partnership
- the same procedures are followed, except that separate capital and drawing
accounts are maintained for each partner.
3. Principal characteristics of a partnership
(1) ease of formation;
(2) limited life.
- A partnership is dissolved whenever there is a change in partners.
(3) mutual agency
- Each partner has the right to bind the partnership to a contract.
(4) unlimited liability.
- Each partner may be personally liable for all the debts of the partnership.
(5) co-ownership of partnership property and profits.
4. Advantages of the partnership
(1)
(2)
(3)
(4)
It brings together sufficient capital to carry on a business;
It combines special skills of the several partners.
It offers freedom and flexibility of action.
It may result in income tax advantages to the partners.
5. Disadvantages of the partnership
(1) A partnership may be terminated upon death or withdrawal of a partner.
(2) Each partner is personally responsible for partnership debts.
(3) The partnership is bound by the acts of any partner as long as these acts are within
the scope of normal operations.
(4) The partnership is less effective than a corporation for raising large amounts of
capital.
6. Limited partnership vs. general partnership
(1) Limited partnership is a special form of organization which has limited partners as
well as one or more general partners.
(2) The general partners have unlimited liability and mutual agency.
(3) The limited partners are basically investors rather than partners in the traditional
sense.
- They have the right to participate in profits, but their liability for losses is
limited to the amount of their investment.
- They usually do not participate in management.
(4) Limited partnerships are widely used in ventures designed to provide investors
with tax shelters, such as real estate syndications.
7. Establishment of partnership accounts and preparing financial statements for a
partnership
(1)
(2)
(3)
(4)
Establish accounts (refer to the examples on the textbook)
Accounting procedures for a partnership
The balance sheet and income statement of a partnership
Statement of partners’ capital
- shows the changes in the partners’ capital accounts during a fiscal period.
- Additional investments made by the partners and their shares of net income
are added, and withdrawals are deducted from their beginning capital
balances in arriving at their ending capital balances.
8. Distribution of net income of partnership
(1) Factors that partners might consider in arriving at a plan to divide net income
- Amount of time each partner devotes to the business;
- Amount of capital invested by each partner;
- Other contributions by each partner to the success of the firm.
(2) Methods of dividing net income among partners
- If the profit-and loss-sharing agreement provides for salary and interest
allowances, any residual profit or loss must be divided in some ratio.
- These provisions are followed even if the net income for the year is less than
the total of the salary and interest allowances.
- The excess of the salary and interest allowances over the net income is
charged to the partners in the agreed residual profit-and loss-sharing ratio.
- Salary and interest allowances to partners are merely a step toward
distributing net income. Such allowances are not expenses to be deducted
from revenue in arriving at net income.
(3) Income tax considerations
- Partnerships are not required to pay income taxes.
- However, each partner must pay personal income tax on his or her share of
partnership net income, regardless of the amount of withdrawals.