A partnership is a business organization that is formed by two or more individuals who agree to operate a business together. In a partnership, the assets of the business are owned jointly by the owners, who are called partners. The partners share the profit or loss of the partnership based on their agreement.
There are several characteristics of partnerships that have accounting implications. These include:
- Limited Life: A partnership has a limited lifespan and may be ended voluntarily at any time through the acceptance of a new partner or the withdrawal of a partner. It may also be ended involuntarily due to the death or incapacity of a partner. If the remaining partners agree, operations can continue without interruption by forming a new partnership.
- Unlimited Liability: Each partner is personally and individually liable for all partnership liabilities. Creditors have the right to pursue the personal assets of any partner to satisfy debts incurred by the partnership.
- Voluntary Association of Individuals: A partnership is a voluntary association of two or more individuals based on a legally binding contract. There are two types of partnerships: general partnerships and limited partnerships. In a general partnership, all partners have unlimited liability for the debts of the partnership. In a limited partnership, some partners have limited liability, while others are general partners with unlimited liability.
- Mutual Agency: Mutual agency means that each partner acts on behalf of the partnership when engaging in partnership business. The actions of any partner are binding on all other partners, even if the actions are beyond their scope of authority, as long as they appear to be appropriate for the partnership.
- Nontaxable Entity: The income of a partnership is not taxed as a separate entity. However, a partnership must file an information tax return showing the partnership's net income and each partner's share of net income. Each partner's share is taxable at personal tax rates, regardless of the amount of net income withdrawn from the business during the year.
- Co-ownership of Property: Partnership assets are co-owned by the partners and, if the partnership is terminated, the assets do not legally revert to the original contributor. Each partner has a claim on the total assets equal to the balance in their respective capital account, but this claim does not attach to specific assets that an individual partner may have contributed to the firm.