When multiple people enter into business together, they often choose to form a partnership. Each member of the partnership invests financial, expertise or time resources to the success of the business. Together, the members agree to the terms of the partnership, which include working requirements or profit splits. When any transactions occur regarding the equity of one member of the partnership, the company records a journal entry.
Members’ equity refers to the net worth of the business and how it allocates to each partner. The equity equals the total assets of the business minus the total liabilities. Certain transactions impact the members’ equity, including additional investments, profits earned, losses incurred or withdrawals made by the partners. The equity component often receives the most scrutiny since it directly impacts each member’s ownership interest in the business.
The accountant creates a separate member equity account for each partner. The financial transactions for each partner remain separate in the accounting records. Whenever a financial transaction occurs that impacts an equity account, the accountant determines which members of the partnership experienced a change due to the transaction. She only records a journal entry to impact those accounts. These accounts classify as owner’s equity and appear on the balance sheet. Common entries in the members’ equity accounts include investment transactions and closing entries.
Investment transactions include initial investments made by new members of the partnership and additional investments made by current members. For initial investment transactions, the accountant first creates a member’s equity account in the new partner’s name. He then documents the dollar amount of the investment and creates a journal entry debiting cash for the amount of the investment and crediting the member’s equity account.
Net Profit or Loss
When the company experiences a net profit or a net loss, this amount needs to be allocated among the partnership members. The accountant refers to the partnership agreement to determine what percentage of the profit or loss each member receives. The accountant closes out all of the revenue and expense accounts to an account called income summary. If the company experienced a profit, this account maintains a credit balance. If the company experienced a loss, this account maintains a debit balance.
She then creates the journal entry to allocate the profit or loss to individual member equity accounts. If the company experienced a loss, she debits each member equity account for its portion of the loss and credits income summary. If the company experienced a profit, she credits each member equity account for its portion of the profit and debits income summary.
When a member withdraws money from the business, the accountant charges this withdrawal directly against that member’s equity account. The accountant debits the member’s equity account and credits cash for the amount withdrawn.