After examining all the relevant factors, Dale and Ciara decide to create their landscaping partnership. After much discussion, they agree on the name Acorn Lawn & Hardscapes. The first step is to formally document the actual partnership agreement. While a handshake would work, it is far more sensible to document it in case of disagreement. Show
Creation of a PartnershipIdeally, the agreement to form a partnership should be in the form of a written contract. This partnership agreement details the partners’ roles, the way profits and losses are shared, and the contributions each partner makes to the partnership. It also should contain basic information such as the business’s name, its location, its purpose or mission, the names of the partners, and the date of inception. Even more importantly, it should outline the following information. There is no legal requirement for a written partnership agreement. In fact, individuals can end up in court after forming a partnership agreement by accident with no written documentation. It is strongly suggested that any business relationship has a written agreement. A properly drafted agreement will often contain the following details:
The partners should also consider the following items:
Once the partnership agreement is complete, there are other steps to take to create the business as a legal entity.
Ethical ConsiderationsEthical Obligations to PartnersRecall that each partner is jointly and severally liable for all the debts of the partnership, meaning each partner is personally liable for these obligations. As a result, in most business settings and jurisdictions, the actions of any partner are attributed to the partnership and each of its partners, whether the actions were approved by all partners or not. For example, if partner A signs a loan agreement on behalf of the partnership and the partnership defaults on the loan, partner B can be personally liable for the loan, even though this partner had no role in signing the initial agreement. Due to this unlimited liability, whether there is a written partnership agreement or not, partners have an ethical duty to act in the best interests of the partnership and of each of their partners. This is generally called a fiduciary duty. A fiduciary is someone who has a legal and/or ethical obligation to act in the best interest of others in order to maintain a relationship of trust and confidence. What this means in practice is that partners are to avoid actual and potential conflicts of interests, and there is to be no self-dealing. Partners are expected to put the partnership’s interest ahead of their own. Formation of the PartnershipEach partner’s initial contribution is recorded on the partnership’s books. These contributions are recorded at the fair value of the asset at the date of transfer. All partners must agree to the valuation being recorded. As an example, let’s go back to Dale and Ciara. On January 1, 2019 they combined their resources into a general partnership named Acorn Lawn & Hardscapes. They agree to a 50:50 split of income and losses. As stated earlier, Ciara will invest cash and Dale has real assets to contribute to the partnership. Dale’s contributed assets include lawn equipment that he bought or created based on his specific needs. The equipment had a book value (determined in the process of filing Dale’s past individual income taxes) of $5,600 and a fair market value (the current price at which it would sell) of $6,400. He also contributed accounts receivable from his business with a book value of $2,000. However, he expects to collect only $1,600 of it, so he is contributing accounts receivable with a market value of $1,600. Since Ciara contributed cash of $8,000 and no other assets, her contribution has a book value and a fair market value of $8,000 (Figure 15.2). Note this point about the formation of a partnership when its assets’ fair market value differs from their book value: it wouldn’t make sense to base the value of the capital contribution of assets (or liabilities) on their book value. To see why, consider the equipment and accounts receivable contributions made by Dale. The equipment had a book value of $5,600 and a fair value of $6,400. Why should Dale get credit for a contribution of only the $5,600 book value when he could have sold the equipment for $6,400 and contributed $6,400 in cash, instead of the equipment with a fair value of $6,400? The same principle applies to Dale’s Accounts Receivable but in the opposite direction. Dale is contributing Accounts Receivable with a book value of $2,000, but since the partnership expects to collect only $1,600, that is the amount of capital contribution credit he will receive.
Figure 15.2 Assets Invested by Partners at Book Value and Fair Value. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license) The journal entries would be as follows: When used fixed assets are contributed, depreciation is calculated based on their fair value and the partnership’s estimate of their useful life. Fixed assets are contributed at their fair value, not the book value on the partner’s individual books before the formation of the partnership. (In our examples, assume all the partners were sole proprietors before the formation of the partnership.) Likewise, if the partnership were to assume liabilities from one of the partners, the liability would be recorded at the current value. And, as demonstrated above, any non-cash assets contributed to the partnership should be valued at their current values. At what value will contributions of a partner recorded in the partnership books?The assets contributed by the partners should be recorded on the partnership books at their fair market value. Thus, the asset's market value represents its worth, which is part of the individual's contribution to the business.
What are contributions to a partnership?In business law, contribution may refer to a capital contribution, which is money or assets given to a business or partnership by one of the owners or partners. The capital contribution increases the owner or partner's equity interest in the entity.
What is capital contributions of the partners at the commencement of the partnership?Capital contributions of the partners at the commencement of the partnership. A method of dividing profits which uses as basis the amount of capital invested and the time during which such capital are actually used by the business.
What type of account is partner contributions?The partnership capital account is an equity account in the accounting records of a partnership. It contains the following types of transactions: Initial and subsequent contributions by partners to the partnership, in the form of either cash or the market value of other types of assets.
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