Priya Singh has landscaping equipment and a list of loyal customers. Luc Tremblay has a truck, some cash and a talent for design. Neither can grow the business alone, so they decide to join forces. The simplest way to do that is a partnership: an association of two or more persons who carry on a business together as co-owners, with a view to earning a profit. A partnership is quick and inexpensive to set up, but the partners take on serious personal risks, and the accounting must keep each partner's stake separate so everyone can see exactly who owns what. This lesson covers what makes a partnership different from the other forms of ownership, the two main types, and how to record the day the partnership opens.
What makes a partnership a partnership
- Association of individuals: a partnership is created by agreement between the partners. It is a separate accounting entity (its records are kept apart from each partner's personal affairs), but it is not a separate legal entity the way a corporation is, and it does not pay income tax itself. Each partner reports a share of partnership income on a personal tax return.
- Mutual agency: every partner acts as an agent of the partnership. Any partner can bind the partnership to a contract that is within the normal scope of the business, even if the other partners did not agree to it. If Tremblay orders $12,000 of interlocking stone for a client job, the partnership owes the supplier, whether or not Singh approved.
- Unlimited liability: each general partner is personally responsible for the debts of the partnership. If the business cannot pay, creditors can collect from a general partner's personal assets, and they can collect the full debt from any one partner, not just that partner's share.
- Limited life: the partnership ends whenever a partner is admitted, withdraws, dies or becomes unable to continue. The business itself often carries on, but legally a new partnership has been formed, which is why admissions and withdrawals need careful entries.
- Co-ownership of property: assets invested in the partnership belong to all the partners together. Once Tremblay contributes his truck, it is no longer his truck; it is partnership property. His claim is now a balance in his capital account, not a claim on the truck.
- Partnership agreement: a written contract (sometimes called the articles of co-partnership) that sets out each partner's name and investment, their duties, how income and losses will be shared, what happens when a partner joins or leaves, and how the business will be wound up. Without one, provincial partnership legislation fills the gaps, and it generally says partners share profits and losses equally.
General partnerships and limited partnerships
In a general partnership every partner is a general partner: each one shares in management, each one can bind the firm through mutual agency, and each one has unlimited liability. Provincial partnership legislation also allows a limited partnership (LP), which has two classes of partner. There must be at least one general partner, who manages the business and keeps unlimited liability. The limited partners are investors: their liability is limited to the amount they invested, and in exchange they generally cannot take part in managing the business. A limited partner who starts making management decisions risks being treated as a general partner and losing that protection. Limited partnerships are common when a project needs investors' money but only a few people will run it, such as a real estate development or a film production.
- Easy and inexpensive to form: an agreement and a provincial business name registration
- Combines the money, skills and contacts of several people
- Partners can make decisions quickly, without a board of directors
- No corporate income tax: income is taxed once, in the partners' hands
- Fewer government reporting requirements than a corporation
- Unlimited liability for general partners puts personal assets at risk
- Mutual agency: one partner's bad contract binds everyone
- Limited life: any change in partners ends the old partnership
- Hard to transfer ownership: a new partner needs the others' consent
- Raising large amounts of capital is harder than selling shares
Recording the formation of a partnership
When a partnership is formed, each partner's investment is recorded with a debit to each asset contributed, a credit to any liability the partnership agrees to take over, and a credit to that partner's own capital account for the difference (the net investment). Non-cash assets are recorded at their fair value on the date of investment, not at the cost or book value shown in the partner's personal records. Fair value is fair to everyone: Singh bought her equipment years ago for $32,000 and it now sits at a book value of $14,000 in her old records, but it would sell today for about $20,000. If the partnership recorded $14,000, Singh would be shortchanged; if it recorded $32,000, Tremblay would be. The partners agree on $20,000, so that is the cost to the new partnership. Any old accumulated amortization stays behind with the old records.
| Date | Account | Debit | Credit |
|---|---|---|---|
| Jan. 2, 2026 | Cash | $30,000 | |
| Equipment | $20,000 | ||
| P. Singh, Capital | $50,000 | ||
| To record P. Singh's investment at fair value | |||
| Jan. 2, 2026 | Cash | $5,000 | |
| Truck | $40,000 | ||
| Note Payable | $15,000 | ||
| L. Tremblay, Capital | $30,000 | ||
| To record L. Tremblay's investment and the note assumed |
Each partner also gets a separate drawings account. When a partner takes cash or other assets out for personal use during the year, the partner's drawings account is debited, exactly as it would be for a sole proprietor. For example, on Mar. 31, 2026 Singh withdraws $2,000: debit P. Singh, Drawings $2,000 and credit Cash $2,000. At year-end each drawings account is closed to that partner's own capital account. The ledger therefore has two equity accounts per partner, and a two-partner firm has four.