Answer to Question #110733 in Accounting for Lysandra

Question

Why is salaryof each partner included in the partnership agreement if it depend on the profit earned in the business?

Answer 1

A partnership is a form of business where two or more individuals combine their money and/or expertise together and start a business that they all own. Share in ownership, profits and losses from business is decided on the basis of factors like share of capital introduced, knowledge or expertise about business, assets introduced in business by partners etc.

 

Being a form of business, partnership is also started with the motive of profit earning so rewards and return to a Partner is the most crucial aspect for any partner in the partnership business. Whether the partner is investing in the partnership through money or serving with his skills/expertise, the return is expected by him. 

Partners may get following three rewards/returns in partnership business:

1. Remuneration or salary

2. Interest on Capital Introduced

3. Share of Profit

Meaning:

1. The term remuneration/salary may include bonus, commission and/or remuneration (by whatever name called) paid to a partner. This is normally payable to the partners who are actively contributing in the operations of the business. For compensating their work and efforts alike any other employee, the remuneration is payable to them.

2. Interest is paid to partners on the amount of the capital introduced by them whether by way of cash or any other mode.

3. The term share of Profit means the percentage of profit distributed among the partners as return from the partnership business with the capital introduced and efforts of the partners . Share of Profit can be distributed from remaining net profit after deduction of all the business expenses and is distributed among all the partners in their profit sharing ratio as per the partnership agreement.

All the above rewards/returns are specifically regulated by and subject to the clauses of Partnership agreement.

Why the salary is given to the partners?

Salary or remuneration in any form is normally given to the working partner of the partnership firm who is actively contributing in operations of the partnership business like other employees. A salary or remuneration is a guaranteed payment to a partner which can help to compensate the partner for his active participation in the business, especially when the business is operating at a loss or making limited profits. For a partner who is giving his full time to run the partnership business and have no other source of income, it may be unreasonable for him to rely on potential profits of business and he must be ensured for any guaranteed payment from that business.

The payment of salary or remuneration to partners against their significant contribution in business is treated as a business expense like other expenses of business so it is deducted from earned profits of business and are also beneficial for the business in reducing tax burden of the partnership firm .