Peter Marshall Bsc (Econ) BA MBIM is a Fellow of the Society of Business Teachers, and an experienced educator in business subjects. He is also a prolific author and his books have been translated and sold worldwide. He lives in London, UK.
It is now time to change perspective. We are no longer dealing with pieces of the accounting system, but with different types of accounts for different purposes, beginning with accounts for partnerships. Partnership accounts differ from sole proprietor accounts in two ways:
- a profit and loss appropriation account is needed and
- separate capital accounts are needed for each partner.
In every other way, they are the same.
What is a partnership?
Partnerships are business units owned jointly by more than one person. Such people may have joined in partnership for all kinds of reasons. Perhaps neither had enough capital on their own; perhaps they wished to obtain economies of scale by combining their capitals; perhaps they had matching skills or matching control of the factors of production (e.g. one owned land and buildings while the other had special skills). There are partnerships of solicitors, accountants, building contractors, agencies—in fact of almost any kind of business activity.
Each partner is responsible ‘jointly and severally’ for all the debts of the partnership. This means that if the business cannot pay its debts, the creditors can hold each and every partner personally responsible. More than that, if one partner has personal assets such as a house and savings, while the other partners have none, creditors can sue the partner who does have assets for all the debts of the partnership—not just for his ‘share’ of the debts.
There are endless types of financial arrangement in partnerships. For example profits may be shared in proportion to capital invested; or interest may be paid on capital before any residual net profit is shared equally, regardless of capital. Similarly, the partners may agree that interest will be charged on all individual drawings against capital. At the onset, they may decide that each working partner will receive a fixed salary. It is to take care of all such points that partnership accounts have these extra facilities.
Where there is no written partnership agreement, the Partnership Act 1890 (section 24) states that no interest is to be allowed on capital except where provided in excess of any agreement (in which case 5% would be allowed). No interest is to be charged on drawings; no partner will be entitled to a salary, and each will share the profits equally.
Advantages of partnerships over sole proprietorships:
- increased capital
- increased range of expertise
- sharing of responsibilities
- sharing of work
- sharing of risk.
- loss of independent control
- profits have to be shared
- debts, or even insolvency of one partner can negatively affect the other partners.