How to Account for a Partnership
The accounting for a partnership is essentially the same as is used for a sole proprietorship, except that there are more owners. In essence, a separate account tracks each partner's investment, distributions, and share of gains and losses.
Overview of the Partnership Structure
A partnership is a type of business organizational structure where the owners have unlimited personal liability for the business. The owners share in the profits [and losses] generated by the business. There may also be limited partners in the business who do not engage in day-to-day decision making, and whose losses are limited to the amount of their investments in it; in this case, a general partner runs the business on a day-to-day basis.
Partnerships are a common form of organizational structure in businesses that are oriented toward personal services, such as law firms, auditors, and landscaping.
Accounting for a Partnership
There are several distinct transactions associated with a partnership that are not found in other types of business organization. These transactions are noted below.
Contribution of Funds
When a partner invests funds in a partnership, the transaction involves a debit to the cash account and a credit to a separate capital account. A capital account records the balance of the investments from and distributions to a partner. To avoid the commingling of information, it is customary to have a separate capital account for each partner.
Contribution of Other than Funds
When a partner invests some other asset in a partnership, the transaction involves a debit to whatever asset account most closely reflects the nature of the contribution, and a credit to the partner's capital account. The valuation assigned to this transaction is the market value of the contributed asset.
Distribution of Funds
Distributions to partners may be extracted directly from their capital accounts, or they may first be recorded in a drawing account, which is a temporary account whose balance is later shifted into the capital account. The net effect is the same, whether a drawing account is used or not.
Withdrawal of Funds
When a partner extracts funds from a business, it involves a credit to the cash account and a debit to the partner's capital account.
Withdrawal of Assets
When a partner extracts assets other than cash from a business, it involves a credit to the account in which the asset was recorded, and a debit to the partner's capital account.
Allocation of Profit or Loss
When a partnership closes its books for an accounting period, the net profit or loss for the period is summarized in a temporary equity account called the income summary account. This profit or loss is then allocated to the capital accounts of each partner based on their proportional ownership interests in the business. For example, if there is a profit in the income summary account, then the allocation is a debit to the income summary account and a credit to each capital account. Conversely, if there is a loss in the income summary account, then the allocation is a credit to the income summary account and a debit to each capital account.
Tax Reporting
In the United States, a partnership must issue a Schedule K-1 to each of its partners at the end of its tax year. This schedule contains the amount of profit or loss allocated to each partner, and which the partners use in their reporting of personal income earned.
Rina Dhillon
Practice Questions
- A partnership capital account is opened for each partner to:
a. | keep track of the partners’ share of profits | |
b. | keep track of the partners’ original and subsequent contributions | |
c. | keep track of the partners’ drawings from the partnership | |
d. | all of the options given |
2. If two sole proprietors come together to form a partnership, with each contributing assets and liabilities from their previous businesses, these are brought into the partnership at:
a. | value as recorded in the books of the original businesses | |
b. | current market value | |
c. | discounted cash flow value | |
d. | independent valuation of non-cash assets and liabilities |
3. If A and B form a partnership, the investment in the partnership will be recorded with:
a. | credits to each partner’s capital account | |
b. | debit to cash | |
c. | credit to contributed capital | |
d. | debits to any liabilities brought into the partnership |
4. E&R Partnership agrees to share profits 40 per cent to E and 60 per cent to R. How will losses be shared?
a. | 40% E, 60% R | |
b. | By E&R initial capital contribution | |
c. | 50% E, 50% R | |
d. | Losses are not shared in partnerships |
5. XYZ partnership shares profits and losses in a 5:4:3 ratio respectively. This means:
a. | partner X receives 1/5 of the profits | |
b. | partner Y receives 1/4 of the profits | |
c. | partner Z receives 1/3 of the profits | |
d. | partner X receives 5/12 of the profits |
6. When Peter joined with partner Mary, Peter contributed a printing press with a current market value of $75000, accounts receivable of $25000. The partnership also agrees to take over his $10000 of accounts payable. The amount credited to Peter’s capital account would be:
a. | $75000 | |
b. | $90000 | |
c. | $100000 | |
d. | $110000 |
7. Procter and Gamble are partners. They have agreed to share profits based on a formula where the first $100 000 is based on service and Procter is to receive $60 000 and Gamble $40 000. The next $100 000 is based on capital contributed where Procter invested $350 000 and Gamble $150 000. Any remaining profits are shared equally.
If profits before distributions were $400 000 how much will Gamble receive?
a. | $200 000 | |
b. | $170 000 | |
c. | $160 000 | |
d. | $120 000 |
8. All of the following are reasons that a company may buy back shares, except:
a. | if it needs the shares for its employees’ share bonus program | |
b. | if it desires to make an investment in its own shares | |
c. | to buy out the ownership of shareholders | |
d. | to increase the reported amount of earnings per share |
9. When a company declares a cash dividend:
a. | cash decreases | |
b. | liabilities decrease | |
c. | equity decreases | |
d. | no entry is necessary |
10. The shareholders’ equity section of the 30 June 2022 balance sheet for Shah Interiors before its recent share dividend:
Ordinary shares, 100 000 shares | $600000 | |
Retained earnings | 725000 | |
Total shareholders’ equity | $1 325000 | |
Shah declared a 10% share dividend when the market price per share was $8.00. After the share dividend, the components of Shah’s shareholders’ equity section were:
a. | Ordinary shares $600000; Retained earnings $725000 | |
b. | Ordinary shares $650000; Retained earnings $805000 | |
c. | Ordinary shares $710000; Retained earnings $805000 | |
d. | Ordinary shares $680000; Retained earnings $645000 |
11. On 15 July 2022, Tech Systems Limited paid a cash dividend that had been declared prior to the end of its 30 June 2022 financial year. The entry to pay the dividends includes a debit to:
a. | cash and a credit to dividends payable | |
b. | dividends payable and a credit to cash | |
c. | retained earnings and a credit to dividends payable | |
d. | dividends payable and a credit to retained earnings |
12. A liability for cash dividends is created at the:
a. | end of each financial year | |
b. | date of declaration | |
c. | date of record | |
d. | date of payment |
13. In which of the following organisation forms is the owners’ legal responsibility for the debt of the business limited to the amount they invested in the business?
a. | Sole proprietorship | |
b. | Company | |
c. | Partnership | |
d. | Cooperative |
14. Dhillon Company issues 1000 shares. $10 per share is payable on application and $6 per share on allotment. When the application money is received, cash trust is debited, and the credit is made to:
a. | issued shares | |
b. | application | |
c. | Ordinary share capital | |
d. | retained earnings |
15. When a company issues a share dividend:
a. | cash decreases | |
b. | equity remains the same | |
c. | equity decreases | |
d. | retained earnings increases |
16. The number of shares issued is important because it determines the amount of _______ that will be paid.
a. | cash | |
b. | retained earnings | |
c. | dividends | |
d. | profit |
17. The financial statements of a partnership are different from that of a sole trader because of:
a. | more government regulation | |
b. | accounting for inventory at the lower of cost and net realisable value. | |
c. | more complex business transactions | |
d. | separate capital accounts for each partner. |
18. Which of the following statements is true regarding a company’s buy-back of shares?
a. | The cost of re-purchased shares is a reduction in shareholders’ equity | |
b. | Dividends must still be paid on re-purchased shares because they are still issued | |
c. | Re-purchased shares are reported as an asset because it is considered an investment in the company’s own shares | |
d. | Re-purchased shares are still entitled to a vote at annual general meetings |
19. Which of the following is not characteristic of a company?
a. | Companies are organised as a separate legal taxable entity | |
b. | Ownership is divided into share | |
c. | Companies are usually able to obtain large amounts of resources by issuing shares | |
d. | A company’s resources are limited to their individual shareholders’ resources |
20. Issued shares represent the:
a. | number of previously issued shares that have been repurchased by the company | |
b. | number of shares that the company will distribute to owners | |
c. | number of shares that are currently held by shareholders | |
d. | maximum number of shares that can be sold by the company |
Solutions: [1] d; [2] b; [3] a; [4] c; [5] d; [6] b; [7] b; [8] b; [9] c; [10] d; [11] b; [12] b; [13] b; [14] b; [15] b; [16] c; [17] d; [18] a; [19] d; [20] c