B301 Unit 11 Partnerships and Joint Ventures
- In HK, the law is found in the Partnership Ordinances which is based on the UK Partnership Act of 1890.
- Definition: the relationship which subsists between persons carrying on a business with a view to profit.
- "Persons" includes any body corporate, executors, administrators and legal representatives. A limited company can also be one of the partners in a partnership.
- If a partnership agreement exists, the terms and conditions stated in the agreement normally supersede the law.
- In the absence of an agreement, the provisions of the Partnership Ordinance apply.
Some rules in the Ordinance
- A partnership is usually described as a firm, e.g. PricewaterhouseCoopers is an accounting firm.
- The existence is usually determined by looking at the partners share in the profits or losses of the business.
- Most of the time, any one of the partners has the power to bind the firm.
- Every partner is jointly and severally liable if one partner, acting on behalf of the firm, causes loss or injury to a third party.
- Unless specified, all the partners should have an equal share in the firm's capital, profits and losses and no partner should receive a salary.
- If partner advances an amount to the firm, he may receive interest at 8% (instead of 5% in UK).
- Partnership Agreement
- the partnership's name and nature of business
- the amount of capital each partner should contribute
- how the partnership's profit should be shared
- Limited partnership
- Although a partnership cannot have limited liability, some partnerships allow one or more of the partners to limit their liability up to the amount of the registered capital.
- However, there must be a minimum of one general partner who will bear the unlimited liability.
- The purpose is to invite partners who have the resources to invest in the partnership without being actively involved in the firm.
- Capital, current and drawings accounts
- Capital account: maintained as a 'fixed' account because each partner is entitled to repayment of his or her capital when he or she retires or leaves the partnership.
- Current account: useful for recording the wide range of items (a partner's drawings, interest payments on the capital contributed, and shares of profits taken on a periodic basis.) Servings as a control account for the other accounts which in turn record the operating activities of each partner.
- Drawings & profits: not shown separately on the B/S but are included in the current accounts.
- Appropriation of profit
- Used to appropriate the partnership's profits or losses among partners.
- A partnership may need to pay salaries to particular partners who have spent time and effort in the business, or interest on drawings is charged to particular partners who have drawn cash during the year.
- Unless specified otherwise in the partnership agreement, the apportionment of profit is divided in accordance with the stipulations set out in the Partnership Ordinance.
- Goodwill and valuation of goodwill
|
Methods |
Goodwill is |
Remarks |
|
Average profit |
x times the average profit of the last y year |
weighted average profits can be used (more weighting will be allocated to recent profits); simple but cannot always reflect accurately the potential future profits of a business. |
|
Average revenue |
average revenue (sales) replaces average profit |
weighted average revenues can be uses; simple but cannot always reflect accurately the potential future revenue of a business. |
|
Future profits |
NPV of the future cash flows value of the business - the value of the assets less liabilities |
the value of business = (estimate annual profit - partners' salaries) / rate of return requires; requires the estimation of future annual profits that can never be accurate at the time of calculation |
|
Super profits |
(estimate annual profit - charge for interest on capital employed and partner's salaries) / rate of return required |
i.e. super profits / rate of return required; requires the estimation of future annual profits that can never be accurate at the time of calculation |
- Treatment of goodwill on the admission of a new partner
- Goodwill will be recognised as an asset - based on 'old' profits sharing ratio.
- When goodwill is not recognised as assets, either
- by adjusting the capital accounts of each existing partner - based on the difference between 'old' and 'new sharing ratio, or
- by making a cash payment to the existing partners for goodwill - ditto, no accounting entries required.
- Reason
- By expiration or notice, i.e. when a partnership is formed for a fixed term and the term expires
- By bankruptcy, death, or change of any partner
- By illegality of partnership
- Dissolution by court
- The rule in Garner vs. Murray
- A well-known UK case provides an important precedent for a deficiency exists in a partner's capital account on dissolution of a partnership.
- When a partner does not have sufficient cash to cover the deficiency in his or her capital account on dissolution, the other partners should bear the deficiency in accordance with the "last agreed capital" ratios, and not the profit sharing ratios.
- If the deficiency situation is specified clearly in the partnership agreement, the dispute could be avoided.
- Piecemeal realization and interim distributions
- Withdrawal of the partners' interest on a gradual basis.
- Example 11.1 Piecemeal
realization
John and Peter have been in partnership sharing profits and losses in the ratio of 1:1. The partnership was dissolved on 31 December 2001 and the balance sheet at that date is as follows:
$
Assets 100,000
Creditors 30,000
70,000
Capital accounts
John 40,000
Peter 30,000
70,000
On 1 January 2002, some of the assets were sold for $40,000. All creditors were
paid and the cost of dissolution, $5,000, was paid.
On 1 June 2002, the remaining assets were sold for $45,000.
By piecemeal realization:
On 1 January 2002, it is assumed that all remaining assets would be valueless.
Money available for distribution would be $5,000 after settling creditors and
cost of dissolution (i.e. $40,000 - $30,000 - $5,000) and the loss on
dissolution would be assumed to be $65,000 (i.e. $70,000 - $5,000). The
distribution would be as follows:
First distribution:
John Peter
$ $
Capital balance before distribution 40,000 30,000
Share of dissolution loss ($65,000/2) (32,500)
(32,500)
7,500 (2,500)
Peter's deficiency borne by other partner
(2,500) 2,500
Cash paid to John 5,000 0
The deficiency of a partner account would be borne by other partners in
accordance with the rule in Garner vs. Murray. All remaining cash on 1January
2002 would be distributed to John.
Second & final distribution:
On 1 June 2002, the remaining assets were sold for $45,000. In other words,
total assets (together with that sold on 1 Jan. 2002) were sold for $85,000
(i.e. $45,000 + $40,000). Total cash available for distribution would be
$50,000(i.e. $85,000 - $30,000 - $5,000) and the loss on dissolution would be
$20,000 (i.e. $70,000-$50,000),
which was shared equally by John and Peter.
John Peter
$
$
Capital balance before dissolution 40,000 30,000
Share of dissolution loss ($20,000/2) (10,000)
(10,000)
30,000 20,000
Cash received at first distribution 5,000 0
Cash paid at second distribution 25,000
20,000
Total cash
received by partners:
First distribution 5,000
0
Second distribution 25,000 20,000
30,000 20,000
- A partnership formed by 2 or more persons who decide to enter into a business venture, usually for a limited time and a specific purpose.
- Governed by the Partnership Ordinance.
- E.g. City One, Shatin is a JV developed by Cheung Kong (#001), Henderson (#012), Sun Hung Kai (#016)&New World(#017).
- Types of JV
|
Types of joint
venture |
Nature |
Accounting
records |
|
Jointly controlled operations |
2 or more venturers use their assets and other resources for a jointly controlled operation, e.g. a civil engineering project. |
Separate accounting records may not be required. Venturers record in their own accounting records. Profits are shared among ventures. |
|
Jointly controlled assets |
2 or more venturers jointly control and own one or more assets for economic benefits, e.g. forming a joint venture to bid on a piece of land. |
Separate accounting records may or my not be required. Ditto Ditto |
|
Jointly controlled entities |
2 or more venturers are involved in the establishment of a corporation, partnership or other entity for economic benefits, e.g. establishing a business in foreign country in conjunction with the government agency in that country. |
Separate accounting records are maintained as a separate entity. Venturers record in their own accounting records. |
- Accounting methods:
o To keep a separate set of books
|
|
Expenses incurred by venturers / for
joint venture |
Income received by venturers / for
joint venture |
|
Joint venture’s books |
Dr. Expense accounts Cr. Capital accounts of venturers |
Dr. Capital accounts of venturers Cr. Income account |
|
Individual venturer's books |
Dr. JV account Cr. Expenses accounts / Bank account |
Dr. Bank account Cr. JV account |
o A separate set of books is not opened.
§ A Memorandum joint venture account is used for determining the profit and sharing of it among venturers.
§ Each partner will also open a joint venture account in his books, and debit expenses and credit revenue to it in respect of his participation.