Question

Nitty and Gritty are considering the formation of a partnership to operate a crafts and hobbies store. They have come to you to obtain information about the basic elements of a partnership agreement. These agreements usually specify an income and loss–sharing ratio. They also may provide for additional income and loss–sharing features such as salaries, bonuses, interest allowances on invested capital.

Required:

Discuss why a partnership agreement may need features in addition to the income and loss–sharing ratio. Discuss the arguments in favor of recording salary and bonus allowances to partners as expenses included in computing net income. What ethical issues may arise in a partnership agreement?

Answer 1

Followings are the basic elements of a partnership agreement;

1. What will be the main purpose of partnership firm? So objects & mission of the firm should be clearly defined in advance.

2. Details about percentage of ownership. Partnership agreement should include details about the share of each partner in the partnership firm because without this detail we can not know about the share of each partnership in the firm.

3. Ratio of allocation of profits or losses. Detail of profit or loss sharing should be disclosed in the partnership firm because it will help in distribution of profits or losses amongst partners of the firm.

4. Who can bind partnership firm. So detail about such partner must be disclosed in the partnership agreement because if such detail is not given in the agreement then there will be a confussion between partners.

5. Detail about distribution of authority should be given in the partnership agreement because it is better to define authority of each partners in advance so that they all can know about their authority.

6. Detail about the compenstions also should be disclosed in the partnership agreement because if a partner or some partners do additional work in the firm then they must be given additional remuneration or rewards. Hence we can say that all details related to compensation must be disclosed in the agreement.

7. Procee of dispute dissolution should also be disclosed in the agreement because it will help in quick solution of partners’ issues. Who will be middleman in handelling the issues between partners also should be disclosed in the partnership’s agreement.

8. What will happen if a partner dies? So details about this condition must be disclosed in the agreement.

9. What will be the process of entering new members in the partnership firm, it also should be disclosed.

Yes, it is true that salaries & bonus paid to the partners must be recorded as expenses while computing net income of the firm. As we know that compensation are offered to the partners for their additional efforts made in the firm hence these are treated as expenses and not recorded as the distribution of income. Expenses are those items which have been incurred to operate a firm or to earn some revenues hence compensation given to the patners is also an expense.

Followings ethical issues can arise in case of partnership agreement;

1. Each partners can have different management style hence it will lead to clash of ideology between partners. Hence we can say that after including all relevant & important factors in the agreement we can not handle such issues.

2. Personal habits of the members of the firm also lead to some ethical issues in the firm also.

3. Distribution of power & authority on the basis of invested amount also lead to some issues because we know that every partner can have different talent but due to low financial investment that partner does not have sufficient power & authority in the firm.

4. There may be a misbalance between personal and professional relationship. As we are aware that in most of the firms relatives & close friends are included as partners so in such cases personal relationship take edge over professional relationship.

5. There may be disparities in the skills or roles of the members of the firms.

6. There may be difference in the commitment level of the partners which can lead to various ethical problems.