What is partnership form of business?
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it "passes through" any profits or losses to its partners. Each partner includes his or her share of the partnership's income or loss on his or her tax return.
Advantages of forming a partnership
The following are often seen as being positive attributes of being in a partnership:
- Partners may possess complimentary skills, which can be very cost-effective. Partners may specialise and become more efficient in certain aspects of their creative business. One partner might be good at selling work and presenting to clients, while another is better at bookkeeping.
- Partners have access to a wider pool of knowledge, skills and contacts.
- Partnerships provide moral support and will allow for more creative brainstorms
Partnerships have access to large amount of capital and find it easier to expand as compared to sole proprietor. - Partnerships have better administration and financial systems in place than sole traders.
Disadvantages
- A partnership is for the long term, and expectations and situations can change, which can lead to dramatic split ups. You might spend more time with your business partner than with anybody else, so losing that very intimate and personal business relationship can lead to major problems when splitting up.
- You have to consult your partner and negotiate more as you cannot take decisions by yourself. So you need to be more flexible.
- You both are responsible for the business debts and errors of others. So if the business fails and incurs debts, and your partner doesn’t pay his or her share, you will still be required to pay. This is even the case if debts were incurred by your partner’s dishonesty or mismanagement without your knowledge.
- You have to share your profits and decide on how you value each other’s time and skills. What is more valuable to the company - a fantastic creative idea generator or somebody who can sell this idea to a customer? What happens if one person puts in 60 hours a week and the other one turns up late very regularly? What happens if one partner can put in less time due to personal circumstances, such as caring responsibilities or illness?
Partnership Deed/ Agreement
Before starting a partnership business, the partners need to come to a common understanding. A typical partnership agreement would include
- Capital - the amount of capital put in by each partner, which will include both money and equipment and other capital goods.
- The role and responsibilities of each partner.
- The apportionment of profits and losses. Is this equal (50/50) and if not how is this split and why?
- The amount of drawing allowed to each partner.
- The salary, if nay, to be paid to any partner.
- There interest, if any, to be allowed on capital and charged on drawing.
- What are the arrangements in case of dissolving the company, including the retirement, death or long-term illness of a partner.
- Management of the finances, bank account, signing of cheques and orders
- Hours of work and holidays allocated.
- Arrangement for arbitration in the event of disagreement.
Capital account
Each partner in the business has a Capital account. It carries the record of initial capital and any additional capital contributed by the partner. It is fixed and is not affected by any entry other than contribution of capital.
Current account
This account records the share of profits and losses and drawing of a partner. Credit balances in the Current Accounts at the end of the accounting year represents undrawn profits whereas debit balance indicates that the partner has overdrawn from his account and owes to the firm.
Profit and Loss Appropriation Account
This account is prepared to show the division of profit or loss among the partners
Balance Sheet
Balance Sheet of a Partnership firm carries the following information:
- Capital Account of all the partners
- Current Account of all the partners
Interest on Capital
Partners who contribute more capital than other partners are granted interest on capital. It is calculated on the capital at the beginning of the trading period. If the partner brings in additional capital, interest will be calculated for the period beginning from the date the capital is injected into the business.
Interest is deducted from the profit and the remaining profit is divided among the partners.
Interest on Drawings
Withdrawals made by partners from the firm are known as drawings. These drawings may be in cash or in form of goods. The firm charges interest on these drawings. The interest is calculated for the period beginning from the date of withdrawal to the end of the trading period.
Interest on drawing is debited to the Current Account of the partner who makes the drawings.
Loans from Partners
When a partner makes a cash loan separate from the capital, it is credited to the partner’s Capital Account. A separate Loan Account is created and credited with the loan amount. The amount received by the firm is debited to the Cash account.
Interest is payable to the partner who makes the loan. The interest amount is
- Credited to the partner’s Current Account.
- Loan Interest Account is debited as it is an expense for the firm.
Partners’ Salaries
Salaries paid to the partners is Credited to their respective Current Account
If Salary is paid in Cash, then Cash Book is credited instead of Partner’s Current Account, Debited to Partnership Salaries Account which is later on transferred to the Profit and Loss Appropriation Account.