Learning Objectives

The number of partnerships in the United States has been estimated to be between 1.5 and 2.0 million, second only to sole proprietorships, which number in excess of 15 million businesses. In contrast, there are about 1 million corporations in the United States. Accountants are often called on to aid in the formation and operation of partnerships to ensure proper measurement and valuation of the partnership's transactions. This chapter focuses on the formation and operation of partnerships, including accounting for the addition of new partners and the retirement of a present partner. Chapter 16 presents the accounting for the termination and liquidation of partnerships.

Partnerships are a popular form of business because they are easy to form and they allow several individuals to combine their talents and skills in a particular business venture. In addition, partnerships provide a means of obtaining more equity capital than a single individual can obtain and allow the sharing of risks for rapidly growing businesses.

Accounting for partnerships requires recognition of several important factors. First, from an accounting viewpoint, the partnership is a separate business entity. The Internal Revenue Code, however, views the partnership form as a conduit only, not separable from the business interests of the individual partners. Therefore, several differences exist between tax and financial accounting for specific events, such as the value assigned to assets contributed in the formation of the partnership. This chapter presents the generally accepted accounting principles of partnership accounting. A brief discussion of the tax aspects of a partnership is presented in Appendix 15A to this chapter.

Second, although many partnerships account for their operations using accrual accounting, some partnerships use the cash basis or modified cash basis of accounting. These alternatives are allowed because the partnership records are maintained for the partners and must reflect their information needs. The partnership's financial statements are usually prepared only for the partners but occasionally for the partnership's creditors. Unlike publicly traded corporations, most partnerships are not required to have annual audits of their financial statements. Although many partnerships adhere to generally accepted accounting principles (GAAP), deviations from GAAP are found in practice. The specific needs of the partners should be the primary criteria for determining the accounting policies to be used for a specific partnership.