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Partnership accounting focuses on the business form that includes two or more principle owners within a business. The accounting process starts with calculating the value each partner has in the business. Income distribution is calculated using these percentages, unless the partnership agreement dictates something different. All partners have a specific ownership share in the assets, liabilities, and capital of the company. Each partner will have a withdrawal account he or she can use to take money legally out of the firm under partnership accounting.
An example of partnership accounting starts with Bill, Frank, and Suzie contributing $50,000 US Dollars (USD), $30,000 USD, and $20,000 USD respectively to their partnership. Classic partnership accounting rules dictate ownership percentage of 50 percent, 30 percent, and 20 percent for Bill, Frank, and Suzie. All future income distributions will fall under these percentages and be added to each partner's capital account in the firm. This income split allows each partner to maintain his or her ownership percentage in the firm as it grows.
Each partner's capital account represents a credit on the partnership's general ledger. To allocate income of $60,000 USD, an accountant will debit the income account and distribute $30,000 USD to Bill's capital account, $18,000 USD to Frank's, and $12,000 USD to Suzie's. This increases each partner's value while keeping the initial ownership percentage the same. Partners can typically withdraw money from their capital account, but cannot reduce the initial capital balance; this would change the ownership percentages.
Partners may receive a paycheck for their contributions, similar to working as an employee in another firm. The paycheck will reduce the amount of income distributed to each partner. If each partner agrees to the same wage each month for services provided, the income at the end of each month will be lower. For example, if each partner agrees to a $4,000 USD monthly salary, the income allocation from the previous example will fall from $60,000 USD to $48,000 USD. The income distribution will then follow the standard allocation method.
When a partner decides to leave the firm, the partnership will typically dissolve unless the initial agreement provides for a partner withdrawal. During the partnership accounting withdrawal process, the firm must revalue all assets and liabilities relating to the firm. The partner leaving the company will then receive his or her ownership percentage of the net assets in the firm. Accountants will add this figure to the partner's capital account and then pay the partner this amount when he or she leaves the firm.
@Monika - That's a good question! When people enter into business partnerships, there is usually an astronomical amount of paperwork involved. Some of this paperwork is usually an agreement as to how a dispute will be resolved.
I think mediation is usually the agreed upon method. I think this is good, because I know sometimes business partnerships don't dissolve for the best of reasons. It seems like things could get a little heated and it would be a good idea for a third party to mediate any disputes!
Partnership accounting sounds very reasonable. Each partner reaps an equal percentage of the profits to what they originally contributed.
It sounds like it could get a little bit complicated if one person wanted out of the partnership. What if the person leaving doesn't agree with the appraisal of how much the business is worth?
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