What is a parntership? How does it change financial statements prepared?
In business, a partnership refers to the coming together of two or more persons to conduct a business. Normally, there is a maximum number of partners with exceptions made in cases like accounting practices and legal practices. A partnership is usually formed to take advantage of the combining of skills and resources. The objective is normally to make a profit, and this profit is shared out in some agreed way among partners. Losses too are borne by the partners.
As essential element in the formation of a partnership is the Partnership Agreement. This is a legal agreement (which ideally should be written) which contains items such as the following:
- the capital to be contributed by each partner
- how profits are to be divided
- any interest to be paid on capital contributions
- any interest to be paid by the partners on monies withdrawn
- salaries to be paid to partners
- arrangements for admission of new partners
- arrangements to dissolve the partnership, and procedures on the retirement/death of a partner.
In the absence of a partnership agreement, in the UK and Ireland, the Partnership Act 1890 applies (see here).
In terms of preparing financial statements, there are some differences. First, any adjustments to profit are made in a profit and loss appropriation account – which is in effect an addendum to the income statement/profit and loss a/c. For example, any interest due to or to be paid by partners, salaries etc are made here. The resulting adjusted profit is then shared among the partners as agreed. In the statement of financial position (balance sheet), each partner will have their own separate capital account. Some partnerships used a combination of capital and current accounts. The former shows only the fixed capital contributions, the latter shows profits, drawings, interest, salaries etc. This approach is probably better as the any negative balances on the current account will signify that perhaps a partner is taking out more from the business than they should.