Characteristics of a Business Partnership
A partnership is a voluntary association between the partners that is based on a contract. The life of a partnership is limited by agreement or by the death of incapacity of a partner. Normally, each partner can act as an agent of the others partners and commit the partnership to any contract within the apparent scope of its business. All partners in a general partnership are personally liable for all the debts of the partnership. Limited partnerships include one or more general partners plus one or more (limited) partners whose liabilities are limited to the amounts of their investments in the partnership. The risk of becoming a partner results in part from the fact that partnership characteristics include mutual agency and unlimited liability.
The initial investment of partnership assets is recorded by debiting the assets contributed at the fair market value and crediting the partners’ capital accounts. A partnership’s profits or losses are allocated to the partners according to the terms of the partnership agreement. The agreement may specify that each partner will receive a given fraction, or that the allocation of profits and losses will reflect salary allowances and/or interest allowances. When salary/ or interest allowances are granted, the residual profit or loss usually is allocated equally or on a stated fractional basis.
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When a new partner buys a partnership interest directly from one or more of the existing partners, the amount of cash paid from one partner to another does not affect the total recorded equity of the partnership. The recorded equity of the selling partner (s) is simply transferred to the capital account of the new partner. Alternatively, a new partner may purchase an equity interest in the partnership by investing additional asset in the partnership. When this occurs, part of the new partner’s investment may be credited as a bonus to the capital accounts of the existing partners. Also, to gain the participation of the new partner, the existing partners may give the new partner a bonus whereby portions of the existing partner’s capital balances are transferred to the new partner’s capital account.
When a partnership is liquidated, losses and gains from selling the partnership assets are allocated to the partners according to the partnership profit – and – loss – sharing ratio. If a partner’s capital account has a deficit balance that the partner cannot pay, the others partners must share the deficit in their relative profit and loss sharing ratio.