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Do your accounts reflect the ownership of the property accurately?

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It is becoming increasingly common that only a few of the partners within a partnership will own a share of the practice property.  Therefore, if not all the partners have a share in the property, it is important that the accounts clearly reflect who does own it.  Otherwise it can cause financial implications for the partnership as a whole.

We were approached by a GP whose partnership split on 31st March 2004.  He has a lot of money left in the practice and is concerned as to how he will be paid this money due to the fact that the practice bank account is overdrawn. The only assets the practice has are the fixtures and fittings which have a very small value and the property.  He does not own a share of the property, as this is owned by only three of the five partners in the practice.

The first problem was that, looking at the partnership accounts, it was not clear who actually owned the property.  The reason for this was that as profits had been shared in profit sharing ratios with no prior allocations, both the non property owning partners had actually received a share of cost rent income and had also been charged with a share of mortgage interest even though they did not own the property. Because of this, it could be argued that they did, in fact, also own a share of the property.

Practices who own their property will receive either cost rent or notional rent income.  This income is used towards paying the cost of the mortgage on the property.  It is normal accounting practice to allocate this income between the property owning partners together with the related mortgage interest.  Even if all partners in the practice own the property, they may own it in different shares to their profit sharing ratios so it should be prior allocated before the balance of profits is split in the profit sharing ratios.  

Another problem for this practice was that the accounts do not separately identify each partner's capital that related to their investment in the property and the capital which related to their investment in the working capital of the practice.

If a practice owns their surgery premises and the property is included in the accounts with the related mortgage, there should be separate capital accounts which show each partner investment in the net equity of the property.  This also clarifies which partners own the property and their share of it.

Each partner's investment in the working capital is normally shown as a "current account", this would be a partner's share of profits less drawings.  Current account values are increased by profits earned and decreased by drawings.  A partner is only entitled to draw their share of profits from the practice. A partner's current account balance would increase if their drawings were less than their profits or decrease if their drawings were more than their profits.

If a partner left, they would be entitled to their current account balance, if this was overdrawn then they would have to repay this to the practice as this means they have taken more money from the practice than they are entitled to. A partner would only be entitled to their capital account balance if they sold their share of the property.

The implication for this practice of not separating out the capital which relates to the net equity, means that the practice could not identify the partners' profits which had not been drawn out. Therefore they would not know if any partner had actually taken more drawings than their share of profits.  

For this GP's partnership, once the net equity had been separated out from the balances on the capital accounts, it showed that two of the property owning partners had actually taken more drawings from the practice than they were entitled to. These partners owed the practice nearly £20,000 each which had accumulated over several years of overdrawing.  As the practice had dissolved, these partners would need to repay this money into the practice so that the other partners, who had left money in the practice would be able to be repaid what was owed to them.

One of the reason's why the partners' current accounts showed that they had taken more drawings than profits was due to the non property owing partners receiving a share of cost rent income which they were not entitled to. The allocation of profit had not followed the intentions of the partners. This income should have only been allocated to the property owing partners. If all partners agreed they could put an adjustment through the dissolution accounts to correctly amend this. However as all the previous accounts had been signed and agreed by all partners, the non property owing partners could argue that the accounts be left as they are.

It is important to ensure that your accounts correctly reflect the ownership of the property and to ensure profits have been correctly allocated.  If for this practice, the net equity had been shown separately, this practice would have been able to clearly identify each partner's profits which had not yet been drawn and could ensure that no partner drew more than they were entitled to.  This would avoid the problem of asking leaving partners to repay money back to the practice, which could be large sums of money.

September 2004