A partnership is legal business structure consisting of an association of two or more people who contribute money, property, or services to operate as co-owners of a business. When discussing partnerships as a form of business ownership, the term person can refer to individuals, corporations, or even other partnerships. However, in this chapter, all the partners are individuals. Show
Think It ThroughChoosing a PartnerIn some ways, a partnership is like a marriage; choosing a partner requires a great deal of thought. How do you know whether you and your potential partner or partners will be a good fit? A strong partnership agreement is one way to help settle future disagreements. But before you get that far, it is really important to take a hard look at future partners. How do they deal with stressful situations? What skills and assets do they possess that you do not, and vice versa? What work ethic do they exemplify? Do they procrastinate? Are they planners? Do they get along with others? Do the two of you work well with each other? All these questions and many more should be explored before choosing business partners. While you cannot predict the future or see all possible issues, doing your due diligence will help. What other questions can you think of that would help you decide whether someone will be a good business partner for you? Characteristics of a PartnershipJust like a corporation, a partnership is a legal entity. It can own property and can be held legally liable for its actions. It is a separate entity from its owners, the partners. Partnerships have several distinct characteristics that set them apart from other entity types. The most common characteristics of a partnership are the following:
IFRS ConnectionPartnerships and IFRSYou’ve learned how partnerships are formed, and you will soon learn how partnership capital and income can be allocated and what happens to the capital structure when a partner is added or subtracted. But how does a partnership account for normal day-to-day business transactions? Partnership organizations can be very small, very large, or any size in between. What type of accounting rules do partnerships use to record their daily business activities? Partnerships can choose among various forms of accounting. The options broadly include using a cash basis, a tax basis, and a full accrual basis to track transactions. When choosing to use the full accrual basis of accounting, partnerships apply U.S. GAAP rules in their accounting processes. But you may be surprised to learn that some non-publicly traded partnerships in the United States can use IFRS, or a simpler form of IFRS known as IFRS for Small and Medium Sized Entities (SMEs). In 2008, the AICPA designated IFRS and IFRS for SMEs as acceptable sets of generally accepted accounting principles. However, it is up to each State Board of Accountancy to determine whether that state will allow the use of IFRS or IFRS for SMEs by non-public entities incorporated in that state. Despite the use of size descriptors in the title, qualifying as a small- or medium-sized entity has nothing to do with size. A SME is any entity that publishes general purpose financial statements for public use but does not have public accountability. In other words, the entity is not publicly traded. In addition, the entity, even if it is a partnership, cannot act as a fiduciary; for example, it cannot be a bank or insurance company and use SME rules. Why might a partnership want to use IFRS for SMEs? First, IFRS for SMEs contains fewer and simpler standards. IFRS for SMEs is only about 300 pages in length, whereas regular IFRS is over 2,500 pages long and U.S. GAAP is over 25,000 pages. Second, IFRS for SMEs is modified only every three years, whereas U.S. GAAP and IFRS are modified more frequently. This means entities using IFRS for SMEs don’t have to adjust their accounting systems and reporting to new standards as frequently. Finally, if a partnership transacts business with international businesses or hopes to attract international partners, seek capital from international sources, or be bought out by an international company, having its financial statements in IFRS form can make these transactions easier. Advantages of Organizing as a PartnershipWhen it comes to choosing a legal structure or form for your business, the most common options are sole proprietorships, partnerships, and different forms of corporations, each with advantages and disadvantages. Partnerships have several advantages over other forms of business entities, as follows:
Your TurnAll in the FamilyFamily partnerships are frequently utilized to allow family members to pool resources for investment purposes and to transfer assets in a tax-efficient manner. In what ways can you imagine using a family partnership? Solution Cash can be combined to purchase income-producing properties or other investments without having to sell assets, thus keeping costly investments all in the family. Through a family partnership, it becomes possible for those in high net worth tax brackets to transfer assets and wealth to younger generations in a way that reduces potential estate and gift taxes. For example, a family partnership can be formed by a grandparent who owns an apartment building. Children and grandchildren can be partners to share in profits of the building. As they earn the income from the building while living, this can be a very tax efficient way to transfer wealth. Disadvantages of Organizing as a PartnershipWhile partnerships carry some clear advantages, there are also several disadvantages to consider. For example, due to unlimited liability, each partner in a general partnership is equally and personally liable for all the debts of the partnership. Following are some of the disadvantages of the partnership form of business organization:
Concepts In PracticeSports Memorabilia StoreFarah and David decide to form a sports memorabilia retail partnership. They have known each other since business graduate school and have always worked well together on various projects. The business is doing well but cash flow is very tight. Farah takes several calls from vendors asking for payment. He believed David had been paying the bills. When he asks about this, David admits to embezzling from the partnership. What liability does Farah face as a result of the theft? Table 15.1 summarizes some of the main advantages and disadvantages of the partnership form of business organization. Advantages and Disadvantages of Forming a Partnership
Table 15.1 Types of PartnershipsA general partnership is an association in which each partner is personally liable to the partnership’s creditors if the partnership has insufficient assets to pay its creditors. These partners are often referred to as general partners. A limited partnership (LP) is an association in which at least one partner is a general partner but the remaining partners can be limited partners, which means they are liable only for their own investment in the firm if the partnership cannot pay its creditors. Thus, their personal assets are not at risk. Finally, the third type is a limited liability partnership (LLP), which provides all partners with limited personal liability against another partner’s obligations. Limited liability is a form of legal liability in which a partner’s obligation to creditors is limited to his or her capital contributions to the firm. These types of partnerships include “LLP” or partnership in their names and are usually formed by professional groups such as lawyers and accountants. Each partner is at risk however, for his or her own negligence and wrongdoing as well as the negligence and wrongdoing of those who are under the partners’ control or direction. Table 15.2 summarizes the advantages and disadvantages of different types of partnerships. Advantages and Disadvantages of Types of Partnerships
Table 15.2
Link to LearningArthur Andersen was one of the “Big 5” accounting firms until it was implicated in the Enron scandal. Arthur Andersen had been formed as an LLP. Read this CNN Money article about the Arthur Andersen case to see how courts can hold partners liable. Dissolution of a PartnershipDissolution occurs when a partner withdraws (due to illness or any other reason), a partner dies, a new partner is admitted, or the business declares bankruptcy. Whenever there is a change in partners for any reason, the partnership must be dissolved and a new agreement must be reached. This does not preclude the partnership from continuing business operations; it only changes the document underlying the business. In some cases, the new partnership may also require the revaluation of partnerships assets and, possibly, their sale. Ideally, the partnership agreement has been written to address dissolution. What is an advantage of a partnership over a corporation?Advantages of a partnership include that: two heads (or more) are better than one. your business is easy to establish and start-up costs are low. more capital is available for the business. you'll have greater borrowing capacity.
What is one major advantage of a partnership compared to a corporation?Limited liability is a major advantage of a partnership as compared to a corporation.
What is an advantage of a partnership over a corporation quizlet?The Advantages include, easy and inexpensive to create, the partners have complete control, they can combine ideas, secure more capital. The disadvantages include different interests, one partner dies the partnership is over. Define what a corporation is.
What are advantages and disadvantages of partnership business?Comparison Table for Advantages and Disadvantages of Partnership. |