Partnerships are a legal form of business organisation where two or more partners come together to form a business. Partnership financial statements differ from financial statements of corporations or sole proprietorships--the other main forms of business organisation. Many sole proprietorships are organised as Limited Liability Companies, but for accounting and tax purposes they are proprietorships.
Typically professional firms such as law firms, accounting firms and architecture firms are organised as partnerships. Professional firms may have only two or three partners in the firm or there may be hundreds. Partnership firms typically have the words "& Co.." "& Associates" or "Ltd." at the end of their name to reflect their form of business. Corporations end their corporate name in "Inc." while Limited Liability Companies use "LLC."
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Determine how earnings will be allocated. The major difference between accounting for a partnership and accounting for other firms is that the earnings must be allocated to each partner. Earnings can be allocated based on a stated fractional basis, a ratio of capital investment or on salary and interest allowances. Fractional basis partnerships essentially state from the formation of the partnerships what percentage of earnings each partner will receive. When using a ratio of capital investment approach partners earn an income proportional to their percentage of capital contribution to the firm. Salary and interest allowances are a more sophisticated approach whereby partners earn a base salary and divide profits based on either a stated fractional basis or a ratio of capital investment or a combination of the two.
Begin the balance sheet as normal with cash and cash equivalents on the top followed by other assets and finally liabilities. All of the asset and liability entries on partnership statements are the same as other companies except for the owners' equity entries. These entries are allocated to each partner based on the capital investment and earnings allocation method that the firm uses.
Compile the changes in the owners' equity financial statement. At the end of the operating year the fractional ownership interest of each partner needs to be recalculated based on his distributions or capital contributions during the year. Corporations and sole proprietorship don't have this financial statement.
Tips and warnings
- Partnership tax returns are filed on a form 1065 (just as individuals file their taxes on a form 1040). This return is also due on April 15 but can be filed on extension and completely filed by October 15.
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