Chapter 8

Partnerships: formation,
operation and reporting

©2020 John Wiley & Sons Australia Ltd

 Learning objectives

After studying this presentation you should be able to:

8.1define a partnership and the major attributes of a
partnership
8.2state the advantages and main characteristics of
the partnership structure of a business
8.3explain the purpose of a partnership agreement
and describe its typical content
8.4describe the special features applicable to
accounting for partnerships
 Learning objectives

8.5explain the accounting entries for the formation

of a partnership
 Partnership defined

• Partnership Act:
– The relationship that ‘subsists between persons
carrying on a business in common with a view to
profit’.
• Three attributes are necessary:
– Must be an agreement (verbal or written) between
two or more legally competent persons.
– The business must be operated with a view to
earning a profit.
– Members must be co‐owners of the business.
 Advantages and characteristics of a
partnership

• The advantages of a partnership over other forms:

– It permits the pooling of both capital resources
and the multiple skills of the individual partners.
– It is easier and less costly to establish than a
company.
– It is not subject to as much government regulation
and supervision as companies.
 Advantages and characteristics of a
partnership

• The advantages of a partnership over other forms:

– Partners may be able to operate with more
flexibility because they are not subject to the
control of a board of directors or to external
shareholders.
– There may be certain tax advantages.
 Advantages and characteristics of a
partnership

• Characteristics of a partnership:
– Prospective owners of a business should consider
the tax and legal aspects of the various structural
forms of business carefully before selecting the
one that meets their organisational objectives and
personal goals.
– The partnership form may turn out to be
unattractive because of one or more of the
following characteristics.
 Advantages and characteristics of a
partnership

• Characteristics of a partnership:
– Mutual agency:
• Each partner acts as agent for the partnership
and for every other partner.
• This is known as mutual agency.
– Unlimited liability:
• Each partner is personally liable for the
obligations of the partnership.
• This is termed unlimited liability.
 Advantages and characteristics of a
partnership

• Characteristics of a partnership:
– Limited life:
• A partnership is dissolved for a number of
reasons.
– Including the death of a partner, the
bankruptcy of the partnership or an
individual partner.
 Advantages and characteristics of a
partnership

• Characteristics of a partnership:
– Transfer of partnership interest:
• A capital interest in a partnership is a personal
asset of the individual partner that can be sold
or disposed of legally.
 Partnership agreement

• A partnership is a voluntary association based on the

contractual agreement between legally competent
people.
• The contract between the parties is called the
partnership agreement.
 Partnership agreement

• The partnership agreement should be as explicit as

possible and typically should include these
important points:
– Partnership name and identity of the partners.
– Nature and duration of the business.
– Location of the place of business.
– How profits and losses are to be shared.
– Authority of each partner in contractual
situations.
 Partnership agreement

• The partnership agreement should be as explicit as

possible and typically should include these
important points:
– How the withdrawal of assets by a partner is to be
handled.
– Conduct of the partnership affairs.
– How day‐to‐day operations are to be conducted.
 Accounting for a partnership

• Most partnerships are not reporting entities and

hence do not have to comply with accounting
standards.
• A major difference is accounting for the partners’
equity.
 Accounting for a partnership

• In an ownership, interests are generally not equal

because:
– the Capital investment and drawings of each
partner vary over time.
– the profit or loss reported each accounting period
is distributed to the partners in accordance with
the partnership agreement.
 Accounting for a partnership

• Method 1: Capital accounts that include profits and

losses.
– The Capital account of each partner is credited
when assets are invested in the partnership by
that partner.
– Drawings account is debited to record the
withdrawal of assets or the payment of personal
expenses by an individual partner from
partnership assets.
 Accounting for a partnership

• Method 1: Capital accounts that include profits and

losses.
– Drawings account of each partner is typically
closed to his or her Capital account.
 Accounting for a partnership

• Method 2: Fixed Capital accounts.

– The Capital account of each partner is credited
when assets are invested in the partnership by that
person.
– Drawings account is debited only for withdrawals
of assets or the payment of personal expenses by
the partner out of his or her share of profits or
expected profits.
– The Drawings account of each partner is closed to
the Retained Earnings account for each partner.
 Accounting for the formation of a
partnership

• The capital interest each partner is to receive should

be agreed on and specified in the partnership
agreement.
• The agreement is made, entries to record the
formation of a partnership can be made.
• Fair value is the price that would be received to sell
an asset or paid to transfer a liability in an orderly
transaction between market participants at
measurement date, after deducting all the costs of
that transfer.
 Accounting for the formation of a
partnership

• Assuming that the partners agree to have capital

balances equal to the fair value of net assets
contributed and that GST is not applicable journal
entries to record the initial investment are:
 Summary

• The major attributes of a partnership.

• The advantages and main characteristics of the
partnership structure of business.
• The purpose of a partnership agreement and
describe its typical contents.
• The special features applicable to accounting for
partnerships.
 Concepts of Capital

• Financial capital
– Capital is synonymous with the net assets (equity) of the entity
– Profit exists only after the entity has maintained its capital,
measured as the dollar value (or purchasing power) of equity
at the beginning of the period

• Physical capital
– Capital is viewed as the operating capability of the entity’s
assets
– Profit exists only after the entity has set aside enough capital
to maintain the operating capability of its assets