In’ most respects, partnership accounting is similar to that -in a sole proprietorship except there are more owners. As a result,’ a separate capital account and a separate drawing account are maintained for each partner. Partnerships, like sole proprietorships, recognize no salaries expense for services provided to the organization by the partners. Amounts paid to partners are recorded by debiting the partner’s drawing account. The statement of owner’s equityis replaced-by a statement of partners’ equity, which shows separately the changes in each partner’s capital account.” A typical statement of partners’ equity appears below:
Allocating Net Income Among the Partners
A special feature of a partnership is the need to allocate the firm’s net income among its partners. Allocating partnership net income means computing each partner’s share of total net income (or loss) and crediting this amount to the partner’s capital account.
This allocation of partnership income is simply a bookkeeping entry, made as the Income Summary account is closed into the various partners’ capital accounts. It does not involve any distributions of cash or other assets to the partners.
The amount that an individual partner withdraws during the year may differ substantially from the amount of partnership net income allocated to that partner.
All partners pay personal income taxes on the amount of partnership income allocated to them-not on the amount of assets withdrawn.
Partners have great freedom in deciding how to allocate the firm’s net income among themselves. In the absence of prior agreement; state laws generally provide for an equal split among the partners. But this seldom happens.
Partners usually agree well in advance how the firm’s net income will be allocated. ‘ Various features of partnership accounting, ‘including the allocation of net income, are llustrated in the Supplemental Topic section
The Importance of a Partnership Contract
Every partnership needs a carefully written partnership contract, prepared before the firm begins operation. This contract is an agreement among the partners as to their rights and responsibilities. It spells out the responsibilities of individual partners, how net income will be allocated, and the amounts of assets that partners are allowed to withdraw.
The balance, sheet of a partnership is more meaningful than that of a sole proprietorship. This ‘is because there are legal distinctions between partnership assets. which are jointly owned.and the personal assets of individual partners. Another reason is that personal responsibility for business debt s may not extend to all of the partners. Creditors should understand the distinctions among the types of partnerships. In a general partnership, all partners have unlimited personal liability for the’ debts of the business. This situation affords creditors the maximum degree of protection. In a limited partnership, only the general partners have personal liability for these obligations. In a limited liability partnership, liability for negligence or malpractice extends only to those partners directly involved.