Content Standard 13.1

Partnership Businesses

Perniagaan Perkongsian

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Explanation

A partnership business is a business owned and operated jointly by two to twenty persons (except professional partnerships, such as law or accounting firms, which may exceed this limit) who agree to carry on a business with the aim of earning profit and sharing it among themselves. Such a business is governed by the Partnership Act 1961. Each person involved is called a partner. A partnership exists when there is an agreement to share capital, management responsibilities, and the profits and losses of the business. Content Standard 13.1 introduces the basic concept of a partnership before students learn how to prepare partnership accounts such as the Profit and Loss Appropriation Account and the partners' Current Accounts.

One main purpose of forming a partnership is to raise more capital than a sole proprietorship can, because the capital is contributed by several partners. In addition, a partnership combines the different expertise and skills of the partners; for example, one partner may be an expert in marketing while another is skilled in finance. The workload and management responsibilities can also be shared so the business is easier to run. Risks and losses are borne together, not by one person alone. Business decisions can be made through discussion and mutual agreement, so they tend to be sounder. These factors make a partnership a suitable choice when a business wishes to grow but the owner is unable or unwilling to bear everything alone.

A partnership differs from a sole proprietorship in several clear ways. A sole proprietorship is owned by only one person while a partnership is owned by two to twenty persons. The capital of a sole proprietorship is limited to one owner's contribution but the capital of a partnership is larger because it is contributed by many partners. In a sole proprietorship all profit is enjoyed by the single owner and all losses are borne alone, whereas in a partnership profits and losses are divided according to an agreed ratio. Decisions in a sole proprietorship are made alone and quickly, while in a partnership decisions must be discussed together. Both forms of business have unlimited liability, meaning the owners' personal assets may be used to pay the business's debts. A partnership also maintains separate capital accounts and current accounts for each partner, which are not required in a sole proprietorship.

A Partnership Agreement (also known as a Partnership Deed) is a written document containing all the terms and conditions agreed upon by the partners. Although the law does not require the agreement to be in writing, a written agreement is strongly recommended to avoid future disputes. This agreement serves as the main reference when disagreements arise over profit sharing, interest on capital, partners' salaries and so on. If the partners do not make any agreement, or the agreement is silent on a matter, the default provisions of the Partnership Act 1961 apply.

The terms and conditions usually found in a Partnership Agreement include: the name and address of the business and of the partners; the amount of capital contributed by each partner; the profit and loss sharing ratio; the rate of interest on capital; the rate of interest on drawings; partners' salaries or allowances; and the rate of interest on partners' loans to the business. Where no agreement is made, the Partnership Act 1961 provides that profits and losses are divided equally, no interest is allowed on capital, no salary is paid to partners, and interest of 8% per year is allowed on loans given by a partner to the business. Understanding these terms is important because they form the basis for preparing the Profit and Loss Appropriation Account in the next topic.

Worked examples

Example 1: Formation of Maju Jaya Partnership

Mr Azman and Mr Bakri agreed to form a partnership called Maju Jaya Partnership on 1 January 2024. Mr Azman contributed RM50,000 in cash, deposited into the business bank account, while Mr Bakri contributed cash RM30,000 and a vehicle worth RM20,000.

Double entry to record Mr Azman's capital contribution: Debit Bank RM50,000; Credit Azman's Capital Account RM50,000.

Double entry to record Mr Bakri's capital contribution: Debit Bank RM30,000; Debit Vehicle RM20,000; Credit Bakri's Capital Account RM50,000.

The total partnership capital is therefore RM100,000 (Azman RM50,000 + Bakri RM50,000). Each partner has his own Capital Account showing his respective contribution.

Example 2: Terms in the Partnership Agreement

The Maju Jaya Partnership Agreement contains the following terms: the profit and loss sharing ratio of Azman and Bakri is 3:2; interest on capital 5% per year; interest on drawings 4% per year; a salary of RM12,000 per year for Mr Bakri because he manages daily operations; and interest of 6% per year on any partner's loan to the business.

Assume Bakri lends RM10,000 to the business on 1 January 2024. Interest on the loan for one year is RM10,000 x 6% = RM600. Double entry: Debit Profit and Loss Account (interest on loan) RM600; Credit Bakri's Current Account RM600. This is because interest on a loan is a business expense, not an appropriation of profit.

If this partnership had NO agreement, the default terms of the Partnership Act 1961 apply: profits and losses shared equally (1:1), no interest on capital, no salary for Bakri, and interest on partners' loans of 8% per year.

Example 3: Comparison of Sole Proprietorship and Partnership

Mrs Chan initially ran Indah Flower Shop as a sole proprietorship with capital of RM40,000. She later invited her sister, Mrs Ching, to become a partner with a capital contribution of RM40,000, making the total capital RM80,000.

As a sole proprietor, Mrs Chan enjoyed all the profit of RM24,000 a year alone but also bore all the risk. After becoming a partnership with a 1:1 ratio, the profit of RM24,000 is divided in two, that is RM12,000 each, but the capital is doubled and the risk is shared.

Double entry to record Mrs Ching's capital injection: Debit Bank RM40,000; Credit Ching's Capital Account RM40,000. This comparison shows that although each owner's share of profit decreases, the capital capacity and management of the business become stronger.

Practice

State the definition of a partnership business and give the minimum and maximum number of partners allowed under the Partnership Act 1961.

Answer: A partnership business is a business owned and operated jointly by two to twenty persons who agree to carry on a business with the aim of earning profit and sharing it among themselves, governed by the Partnership Act 1961. The minimum number of partners is two and the maximum is twenty (except professional partnerships such as legal and accounting firms which may exceed this limit).

Explain THREE purposes of forming a partnership.

Answer: Three purposes of forming a partnership are: (1) To pool a larger amount of capital because the capital is contributed by several partners rather than only one as in a sole proprietorship; (2) To combine the varied expertise and skills of the partners so the business is managed better, for example one skilled in marketing and another in finance; and (3) To share risks, losses and management responsibilities so the burden is not borne by one person alone.

Mr Daud and Mr Ekhbal form a partnership. Daud contributes cash RM60,000 and Ekhbal contributes cash RM25,000 and office equipment worth RM15,000. Record the double entries to show the capital contributions of both partners and state the total partnership capital.

Answer: Double entry for Daud: Debit Bank RM60,000; Credit Daud's Capital Account RM60,000. Double entry for Ekhbal: Debit Bank RM25,000; Debit Office Equipment RM15,000; Credit Ekhbal's Capital Account RM40,000. The total partnership capital is RM60,000 + RM40,000 = RM100,000.

A partnership does not have a written Partnership Agreement. State FOUR default provisions that apply under the Partnership Act 1961.

Answer: Four default provisions under the Partnership Act 1961 are: (1) Profits and losses are shared equally among the partners; (2) No interest is allowed on partners' capital; (3) No salary or allowance is paid to any partner; and (4) Interest of 8% per year is allowed on loans given by a partner to the business.

Exam tips

Key terms

Partnership: A business owned and operated jointly by 2 to 20 persons with the aim of earning profit, governed by the Partnership Act 1961.
Partner: An individual who contributes capital and agrees to carry on the partnership business and to share its profits and losses.
Partnership Agreement: A written document containing the terms and conditions agreed by the partners, such as the profit and loss sharing ratio, interest on capital and salaries.
Partnership Act 1961: The law governing partnerships that provides default provisions when no written agreement is made.

Source: DSKP KSSM Prinsip Perakaunan Tingkatan 5

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