PARTNERSHIP PROBLEMS DURING OPERATIONS 1. The importance of the partnership contract.— When men enter into partnership they are vitally in terested in the partnership agreement. In fact one of the greatest "bones of contention" is a vague, badly worded contract and probably nothing in their busi ness life will cause the partners more concern.
2. Interest allowed on capital, first illustration.— The attention of the reader has been called in a pre vious chapter to the importance of clearly providing in the partnership agreement for interest on partners' capital. This point may be further emphasized in the following illustration: Let us assume that the capital of a firm of three partners aggregated on January 1st, 1916, $6,000, of which amount X was credited with $1,000; Y, $2, 000; Z, $3,000. The partners share profits and losses in the same ratio as the capital ratio. The articles provide that interest shall be allowed on the capital at the rate of six per cent per annum. Let us as sume, in addition, that the profit-and-loss account, prior to the time when interest was charged on cap ital, disclosed the fact that the firm had neither made a profit nor sustained a loss, i.e., the expenses exactly equalled the income. Following the instructions in the partnership agreement, profit-and-loss account would be charged with $360 and the partners indi vidually would be credited with interest on their cap ital at six per cent. The disposition of the debit bal ance in the profit-and-loss account caused by the charge of interest would be on the basis of the capital ratio, viz., 1, 2 and 3, or $60 to X; $120 to Y; and $180 to Z. The following tabulation will more clearly set forth the status: From the foregoing it is evident that where the capital ratio and the profit-and-loss-sharing ratio are the same, no change results in the status of the indi vidual partner's accounts, inasmuch as each partner's capital account will be charged in the distribution of the profit-and-loss account with exactly the same amount with which it was previously credited in re spect of interest.
3. Interest allowed on capital, second illustration. —The result would be different if the profit-and-loss sharing ratio differed from that of the capital ratio.
Let us assume again that at January 1st, the total aggregate capital of the firm was $6,000, of which $1,000 was standing to the credit of X, and $2,000 and $3,000 to the credit of Y and Z, respec tively. The partnership agreement provides for the allowance of interest on the capital account at the rate of six per cent per annum. The agreement also provides that the profits and losses shall be shared eqUally. Assuming the same condition with respect to the profit-and-loss account as was assumed above, the following tabulation will clearly reveal the status of the partners at the end of the period: An inspection of this form will reveal the fact that this method of procedure results unfavorably for the partner having the smallest capital and benefits the partners having the greater capital.
4. Interest allowed on capital, third illustration.— Still another difference in result will be obtained if the capital ratio of all the partners is the same but the profit-and-loss-sharing ratio is different. If we assume the same aggregate capital of $6,000, and the same state of facts with reference to interest and the net result of the profit-and-loss account before the adjustment for interest, the following tabulation will disclose the effect of this method of procedure: As will be seen, this method operates to the detri ment of the partner whose share of the profits is the greatest and benefits the partner whose share is the least, because the latter will bear a smaller charge in respect to the interest than his fellow-partners.
5. Advantages of a fixed rate of interest on capital. —It is advisable to charge a fixed rate of inter est per annum in respect of capital employed in the business. This opinion is based on the assumption that the money if employed in safe investments would earn a fair rate of interest. Thus, profits from busi ness operations are distinguished from a fair rate of return on capital. Where the capital ratios are un equal it gives to those holding the larger proportion of capital an advantage prior to the division of the profits.