Understanding Basic Accounting for a Partnership

Understanding Basic Accounting for a Partnership

Accounting for a partnership business follows similar fundamentals to accounting for a sole proprietorship. However, when crunching the numbers, there are a few significant differences that are important to be aware of.

A partnership is different from a sole proprietor because it is made up of various sole proprietors. A partnership between multiple sole proprietors requires incorporation of the company as a whole. Compared to corporations, partnerships are simpler to establish because all that is required is a written agreement between the partners.

Let’s examine partnership business accounting in more detail:

When conducting accounting for partnerships, there are three different approaches. The techniques will be applied to assess each individual’s contributions to and stake in the business when new entities are added to a partnership or when previous partners depart.

1. Exact Technique

The exact method aims to give the capital interest that one of the partners owns an exact book value. A partner who invests more will have great assets to their name because this depends on who owns what.

2. Bonus Technique

The investments of a new partner under the bonus method may or may not be equal to the book value of that partner’s capital investments. The difference is given to the former partners as a bonus if the capital investments’ book value is higher. The bonus will go to the new partner if the book value is lower than the value of the capital investments made.

3. Good Will Approach

It is recorded as an intangible asset called “goodwill” when a new partner makes an investment that is less than the item’s book value. The goodwill is the discrepancy between the partnership’s net assets’ book value and their market value. This difference is a result of a variety of factors, including the partnership’s location, customer base, expertise, and marketing position.

Some of other aspects of company’s accounting include: 

  • Company Accounting

Accounting for a partnership is similar to accounting for a sole proprietor, with the exception of the number of equity accounts held by the partners. Each partner has a separate withdrawal account as well as a separate capital account for investments and their respective shares of net income or loss. To keep track of the money taken out of the company for personal use, a withdrawal account is used. During the closing process, the net gain or loss is added to the capital accounts. During the closing process, the withdrawal account is also closed to the capital account.

  • Contributions of assets to partnerships

The partnership determines the net realisable or fair market value of the assets when a partnership is created or a partner is added and contributes assets other than cash. The partnership assesses the collectibility of the accounts receivable and records them at their net realisable value if, for instance, the Walking Partners company adds a partner who contributes equipment and accounts receivable from an existing business. The partnership would not inherit an existing valuation reserve account, also known as an allowance for doubtful accounts because it would create its own reserve account. The partnership does not take on any existing accumulated depreciation accounts either. In order to begin depreciating the equipment over the course of its useful life to the partnership, the partnership establishes and records it at its current fair market value.

  • Income distributions

The allocation of net income or loss to the partners should be specified in the partnership agreement. If there is no written agreement, each partner receives an equal share of the net income or loss. Since partners are the business’s owners, they do not receive salaries. However, each partner is allowed to withdraw funds up to the amount of their capital account balance. In some partnership agreements, partners’ salaries or salary benefits as well as interest on investments are mentioned.

These are components of the formula for dividing net income; they are not costs incurred by the company. The elements of the formula for dividing net income or loss are frequently used by partners to estimate how much cash they will take out of the company throughout the year in anticipation of their share of net income. Regardless of how much money the partners actually take out of the partnership during the year, if the partnership uses the accrual basis of accounting, the partners must pay federal income taxes on their share of net income.

After net income has been distributed among the partners, closing entries are used to transfer the money to each partner’s capital accounts. Assume, for instance, that The Pro Accountants, a partnership, earned $60,000 and that their agreement calls for an equal distribution of all profits. A total of $20,000 ($60,000 x 3) would be distributed among the three partners.

The Pro Accountants and Tax Consultants finance professionals are well-versed in partnership taxes and accounting. Learn more and find a new accountant today to get your partnership accounting back on track.