Formation of Partnerships

One of the key advantages of the partnership form of business is that it is subject to less regulation than the corporate form. That is why setting up a partnership is much easier than starting up a corporation. All you need is two or more people willing to run a business together and share profits and losses.

Partnership agreement

Partnership agreement (also known as the partnership deed) is the agreement between the partners. It is ideally in written form and it documents the rights and responsibilities of the partners and addresses other matters to which the partners agree at the time of partnership formation.

The partners have to satisfy the relevant state's legal requirements related to formation of partnerships, obtain tax number for the business, obtain any required licenses (such in public accounting, etc.) and agree on the terms of the partnership with each other.

Accounting for partnership formation

Formation of a partnership involves investment by the partners in the partnership either in the form of cash or in the form of assets. When partners introduce cash or any other asset, cash or the other asset account is debited at the value agreed by the partners and the corresponding partner's capital account is credited by the same amount.

Example

JI Consultancy is a partnership established by Jazz and Indigo. The business is engaged in providing consultancy to telecommunication companies on revenue assurance. On 1 January 20X2, Jazz contributed contribute cash of $300,000 while Indigo introduced a vehicle with a written down value of $40,000 and fair value of $80,000, paid 2 years prepaid rent for office building of $70,000 and introduced technical equipment of $60,000 and marketable securities of $100,000. A firm of Indigo's friend did the furnishing work for $70,000 and JI Consulting agreed to pay off the loan in the first week of the partnership's formation.

Journalize the formation of the partnership.

Solution

The formation of partnership would involve recording the assets on the partners' balance sheet and creating corresponding capital accounts by the following journal entry:

Cash300,000
Marketable securities100,000
Prepaid70,000
Furniture and fittings70,000
Vehicles80,000
Equipment60,000
Sales70,000
Sales300,000
Sales310,000

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