$3,567.00

B.'S CAPITAL ACCOUNT.

parties concerned, and at the same time to comply with the law, is not an easy matter, and many an expensive litigation could have been avoided, if lawyers, who unfortunately in most cases drew up such articles of co-partnership, had had a knowledge of accounting. It often happens that, were an accountant to follow the articles of co-partnership, he would do just the thing partners do not want, not through fault of his, but because the party who drew up the agreement was ignorant of the effect it would produce on the books of the concern, if followed to the letter.

In one case, for instance, A., a practicing attorney of New York City, drew up a partnership agreement for the firm of B., C., and D., in which among other clauses was one which read as follows:

It is mutually agreed that if any of the partners fail to invest the agreed sum of $3,000, his account is to be charged with 6 per cent. interest per annum on that deficiency.

The partners continued in business for about nine months when they asked their bookkeeper to make up a Profit and Loss Statement. The latter was also given the agreement and told to use it as a guide. As the Ledger showed that C. had invested only $2,000 he prepared the Profit and Loss Account shown on the preceding page as well as a copy of the respective Capital Accounts.

To this C. objected, stating that "this is an equal partnership, and all profits or losses occurring in the business must go through the Profit and Loss Account proper, in which case I would share in the $45.00, and this was my understanding of the clause in the agreement." The other partners objected, adding that they failed to see what difference it would make, yet protesting vigorously against any change in the arrangement.

All this trouble could have been avoided if the attorney could have foreseen the ambiguity such a vague clause might cause. This trouble might have been prevented by adding to, or better by completing, the unfinished clause with a statement defining clearly a treatment of this point, i. e., whether the partner's account or the Profit and Loss Account was to be credited. It would then have been impossible for a misunderstanding to result. It is just such incomplete statements as these that cause troubles when the dissolution of a partnership is sought.

Another drawback, usually met in adjusting partnership

accounts, is that business men do not sufficiently provide for contingencies which may occur during the existence of the partnership, or at its dissolution. As the partnership agreement is to be used as a guide, not only for the partners themselves, but for accountants who may audit their books, the agreement should contain, not only important provisions, but minor ones also. In the absence of such provisions the law must be resorted to and, as already stated, this may result in a construction opposed to the intention of the partners. The intention of the partners at the formation of the agreement is to be the sole guide, even though the wording may not warrant it, provided, of course, that it is for the benefit of the whole concern.

Lord Justice Lindley in his work on Partnership and Companies says in regard to this:

In order to solve questions arising at an adjustment, regard must always be had to the terms of the partnership articles; but an express agreement with reference to the taking of accounts may be, and frequently is, only applicable to the case of a continuing partnership, and may not be intended to be observed on a final dissolution of the firm, or even on the retirement of one of its members * * * * * that which has been done for the purpose of sharing annual profits or losses is by no means necessarily a precedent to be followed when a Partnership Account has to be finally adjusted.

FORMATION OF PARTNERSHIPS.

The usual clauses in articles of co-partnership are as follows: (1) Name of firm.

(2) Place of business.

(3) Nature of business.

(4) Date of commencement and the duration of the partnership. (5) Capital to be invested.

(6) Provision in regard to interest on capital invested.

(7) Provision in regard to allocation of profit or loss.

(8) Provision in regard to withdrawals and how to treat them.
(9) Provision in regard to admitting a new partner and how to
adjust the affairs on admission; especially if the good will
is to be taken into consideration, which usually is the case.
(10) Provision for the correct keeping of records of all business
transactions, and the making of periodical balance sheets.
(11) Provision for procedure in case of dissolution.

In connection with the tenth clause, Dicksee, in his Auditing, says:

It should not only be provided that "proper accounts are to be kept," but that these should be kept upon some adequate system of double entry. They should be balanced at stated intervals and audited by a professional accountant, and provision made that after the audited accounts have been signed by the parties they are binding upon each individual partner, except where some manifest error has been discovered within a reasonable time -say, three months.

The fifth provision is probably the most important clause; it is a clause on account of defects in which many a business concern has been ruined and many a partnership dissolved before its time. The clause should state the proportions in which the capital is to be contributed, and the proportion in which it is to be shared at dissolution, or on the admission of a new partner. The fact that nothing is mentioned on this point is no prima facie evidence that the assets are to be divided according to investments; on the contrary, if nothing is stated, the assets-minus capital-will have to be divided equally among the partners, based on the principle that accretions of assets are the result of profits, which, according to the New York Statute, are the result of combined labor, combined skill, etc., of all partners alike.

The ninth clause deserves attention. If nothing is provided, the cash received from the incoming partner in respect of goodwill may be treated in various ways, and the view taken will make quite a difference when expressed on the books of the concern. To illustrate:

A. and B., who have been partners for five years, decide, in order to increase their business, to admit C. as an equal partner; the latter to invest a sum equal to 1/3 of their (A.'s and B.'s) capital as shown by the books, and, in addition, $2,000 in lieu of goodwill.

Nothing further being stated, this goodwill may be adjusted in one of the following ways:

Cash Dr.

To Goodwill Cr.

$2,000

For this sum received from C., in lieu of goodwill on being admitted to the firm as a partner.

$2,000

This entry would ultimately be adjusted by a charge to the Goodwill Account and a credit to the Profit and Loss Account. Or:

Cash Dr.

To A., Cr.

To B., Cr.

$2,000

$1,000

For the cash received from C., on being admitted as a partner.

1,000

In the latter case only the original partners share in the goodwill which C. paid in, and rightly so, while in the former case C. would ultimately also share in it; it is therefore of great importance to have a provision for the treatment of this goodwill. Dicksee in his Advanced Accounting suggests that in addition

to the clauses ordinarily found in articles of co-partnership the following be inserted:

(1) That the firm's accounts shall be periodically audited by a Chartered Accountant. It is desirable where practicable that the name of the accountant selected should be inserted in the partnership deed, as then a majority of the partners cannot change the auditor, although, of course, he can still be changed by the unanimous decision of all the partners.

(2) The accounts to be kept upon a proper system of Double Entry, to be approved by the auditor.

(3) All differences or disputes upon matters of account to be referred to the auditor, whose decision shall be binding upon all parties.

(4) Provision should be made for the charging of interest upon drawings in excess of the prescribed amount, and for allowing of interest upon any excess of the authorized drawings over the actual amount withdrawn.

(5) On the death or retirement of a partner it is necessary, under the general law, to take stock and to balance the books in order to ascertain the respective positions of the partners. To avoid trouble and inconvenience that this would cause, it is generally desirable to insert a clause providing that the share of the outgoing partner in the profits of the current broken period shall be computed upon the average of the three preceding years. A clause to this effect should, however, only be inserted when the profits do not fluctuate considerably, as otherwise serious injustice might be done by excluding the results of the broken period.

(6) The exact mode of paying out the outgoing partner should be provided, and, where practicable, this amount should be payable by instalments extending over such a period as not to seriously cripple the business; or, in the alternative, a policy of "survivorship insurance should be effected at the cost of the firm.'

PARTNERSHIP DISSOLUTION.

A partnership may be dissolved for one of the following

reasons:

(1) By the expiration of the time originally fixed for the continuation, or by the completion of the act for which the partnership was created. (2) By later agreement, annulling the first agreement by which the partnership was created.

(3) By the objects of the partnership becoming illegal or impossible. (4) By assignment of a partner's interest unless it be with the consent of all partners. (Partnership being a personal relation, only the parties that originally entered into that relation can continue, but they cannot assign any of their interests without the other partners' consent.) (5) By death of any one of the partners.

(6) Other occurrences, while not dissolving the firm, ipso facto, give the right to certain partners to dissolve, if they so desire. Such cases are: Insolvency or bankruptcy of one or more partners, insanity, etc.

In adjusting the accounts of partners, losses ought to be made good, first, out of profits of the firm, next, out of the capital of the firm, and finally, by the partners individually contributing the deficit according to their respective shares.