LO1 – Describe the characteristics of a proprietorship.
A proprietorship is a business owned by one person. It is not a separate legal entity, which means that the business and the owner are considered to be the same. The profits of a proprietorship are reported on the owner’s personal income tax return. A proprietorship has unlimited liability. If the business cannot pay its debts, the owner would be responsible even if the business’s debts were greater than the owner’s personal resources. A proprietorship has limited life. It ceases to exist upon the proprietor’s death, for instance.
LO2 – Describe how the financial statements of a proprietorship are different from those of a corporation.
A proprietorship’s income statement does not show items like salaries paid to the proprietor or income taxes expense, since the business and owner are the same legal entity. A proprietorship’s statement of equity and balance sheet do not distinguish between share capital and retained earnings. All contributions, withdrawals, and net income or losses are recorded in the Proprietor’s Capital account.
LO3 – Describe the characteristics of a partnership.
A partnership is a business owned by more than one person. Like a proprietorship, a partnership is not a separate legal entity. It also has unlimited liability and a limited life. The partnership ceases when a partner joins or leaves the firm, or upon the death of a partner. Unlike a proprietorship, partners are subject to mutual agency. Each partner is an authorized agent of the partnership. A partner can commit the partnership to a contract. The closing entries for a partnership are the same as those for a proprietorship except there is more than one capital account and more than one withdrawals account. The closing of the income summary to each partner’s capital account is based on the allocation of net income, which should be detailed in the partnership agreement.
LO4 – Account for a partnership’s profits and losses and prepare astatement of partner’s capital.
Profits and losses are allocated according to a formula. This is usually specified in the partnership agreement. The formula may consider three factors: a return to each partner for the amount of capital invested in the partnership, a payment to each partner for services rendered, and a further division of any remaining profit (or loss) according to a specified profit and loss sharing ratio. Individual revenue and expense accounts are closed to the Income Summary general ledger account at the end of each fiscal year. The Income Summary is then closed directly to each partner’s capital account in the general ledger at the fiscal year-end.
LO5 – Account for the admission or withdrawal or partners from a partnership.
The admission of a new partner results in the creation of a new partnership. New partners can be admitted either by purchasing an existing partner’s interest or by contributing assets to the partnership. A bonus may be paid to the new partner, or by the new partner to existing partners. The withdrawal of a partner can be accounted for as a sale to a new partner, as a sale to one or more of the existing partners, or through a payment of partnership assets to the withdrawing partner.
LO6 – Account for the liquidation of a partnership.
The liquidation of a partnership results in a termination of the partnership business. Its assets are sold, debts are paid, and any remaining cash or unsold assets are distributed to the partners in settlement of their capital balances.
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