Introduction to Partnership Accounting

Definition of Partnership and its Features

Sole proprietorship forms of business suffer from drawbacks like limited capital and lower access to resources. To overcome these difficulties, people prefer coming together and forming partnerships. Partnerships allow partners to share their resources collectively and expand their business. Let’s take a look at partnerships in detail. We will start by understanding the definition of the partnership first.

Definition of Partnership

The Indian Partnership Act, 1932 governs partnership forms of business in India. Section 4 of this Act defines a partnership as the relationship between partners who have agreed to share the firm’s profits carried on by all or any one of them acting for all.

A bare reading of this definition shows that a partnership requires partners who share their firm’s profits amongst each other. Further, the firm’s business must be carried on either by all of them together or by one of them acting on behalf of others. The members of such a business are individually called partners and collectively, a firm.

Definition of Partnership

Considering the definition of partnership we just learned, let us now take a look at some features of partnerships.

Features of Partnerships

A typical partnership form of business will always have the following basic features.

1. Agreement

The definition of the partnership itself makes it clear that there must exist an agreement between partners to work together and share profits amongst them. Partners may make such an agreement either orally or in writing. If it exists in written form, we refer to such an agreement as a partnership deed.

Such written or oral agreement between partners must ensure that they are clear on their status as partners of their firm. This includes details pertaining to their work as partners, the firm’s businesses, their profit and loss sharing ratio, etc.

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2. Business

The existence of a business is an essential feature of partnerships. There can be no formal partnership under the Partnership Act if the partners carry out charitable activities. Section 2 says that business includes any trade, profession or occupation. What is essential is that the firm must work with the intention of earning profits.

3. Profit sharing

A partnership does not exist unless partners share the profits of their firm. A person who works for the partnership business without having a share in its profits may be an employee, but not a partner. It is noteworthy to point out that the law only requires the sharing of profits amongst partners. Consequently, all partners need not share losses as well.

4. Principal-agency relationship

A partnership firm’s business may be conducted either by all partners together or by one partner acting on behalf of all others. We commonly refer to such a peculiar relationship between partners as the principle of agency.

This principle means that all partners are agents for each other. The decisions of one partner taken in the ordinary course of business will bind other partners as well. All partners are liable for acts of the firm individually and severally.

Now that we are clear with the definition of partnership and its peculiar features, let’s test what we have learned.

Solved Example for You

Question: Considering the features and definition of partnership, briefly explain how partnerships differ from other forms of business.

Answer: Partnerships differ from other forms of business like companies and sole proprietorships on the following grounds:

  • Partners are liable for each others’ actions. This does not always happen in companies where members can be individually responsible for their actions.
  • Partners have to share profits. Companies need not always share profits will their shareholders.
  • The partnership firm can be a legally-recognized entity, unlike sole proprietorships wherein the owner and business are treated alike.
  • The partnership firm must conduct some form of business. Companies, however, can exist for conducting purely charitable objectives as well.
  • Partners can be personally liable to the extent of their own assets for the firm’s liabilities. On the contrary, a company’s assets and liabilities are distinct from its shareholders and directors.
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