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Partners capital accounts
Last Updated On: 31-Oct-2021Posted On: 31-Oct-2021
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The purpose of this article is to assist candidates to develop their understanding of the topic of accounting for partnerships. As such, it covers all of the outcomes in Section H of the detailed Study Guide[/i] for FA2. It also provides underpinning knowledge for candidates studying FFA/FA but it is not intended to comprehensively cover the detailed Study Guides[/i] for those exams.
What is a partnership?
There are a number of ways in which a partnership may be defined, but there are four key elements.
Two or more individuals[/i]
A partnership includes at least two individuals (partners). In certain jurisdictions, there may be an upper limit to the number of partners but, as that is a legal point, it is not part of the FA2 syllabus.
Business arrangement[/i]
A partnership exists to carry on a business.
Profit motive[/i]
As it is a business, the partners seek to generate a profit.
Unincorporated business entity[/i]
A partnership is an unincorporated business entity. That means:
- the reporting entity (business entity) principle applies to a partnership, so for accounting purposes, the partnership is a separate entity from the partners;
- the partners have unlimited liability; and
- if the partnership is unable to pay its liabilities, the partners may be called upon to use their personal assets to settle unpaid liabilities of the partnership.
How is a partnership controlled?
It is good practice to set out the terms agreed by the partners in a partnership agreement. While this is not mandatory, it can reduce the possibility of expensive and acrimonious disputes in the future. As a formal agreement is not mandatory, there is no definitive list of what it should contain, but FA2 exams will not go beyond the following:
Share of residual profit[/i]
This is the amount of profit available to be shared between the partners in the profit and loss sharing ratio, after all other appropriations have been made. The profit and loss sharing ratio is sometimes simply called the ‘profit sharing ratio’ or ‘PSR’.
Therefore, candidates need to be aware that there is a distinction to be made between the profit for the year (income minus expenses), which is calculated in exactly the same way as for a sole trader and residual profit (the remaining profit after profit for the year has been adjusted by the appropriations in accordance with the partnership agreement).
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