Partnerships CHAPTER 9 Electronic Presentations in Microsoft® PowerPoint®

Partnerships

CHAPTER CHAPTER 99

Electronic Presentations in Microsoft® PowerPoint®

1. Identify characteristics of partnerships.

2. Prepare entries when forming a partnership.

3. Allocate and record income and loss among partners.

4. Account for the admission and withdrawal of a partner.

5. Prepare entries for partnership liquidation.

Learning ObjectivesLearning Objectives

An unincorporated association of An unincorporated association of two or more persons to pursue a two or more persons to pursue a business for profit as co-owners.business for profit as co-owners.

PartnershipPartnership

Usually include the partners’: Usually include the partners’: 1. Names and contributions,

2. Rights and duties,

3. Sharing of income and losses,

4. Withdrawal provisions,

5. Dispute procedures,

6. Procedures for admission and withdrawal of new partners, and

7. Rights and duties of surviving partners in the event of a partner’s death.

Partnership AgreementPartnership Agreement

Limited lifeLimited life Taxation of partnersTaxation of partners Co-ownership of propertyCo-ownership of property Mutual agencyMutual agency Liability of partnersLiability of partners

Characteristics of PartnershipsCharacteristics of Partnerships

Partners’ liabilities depend upon the form Partners’ liabilities depend upon the form of partnership.of partnership.

Partnership forms:Partnership forms:1.1. General partnershipsGeneral partnerships

2.2. Limited partnershipsLimited partnerships

3.3. Limited liability partnershipsLimited liability partnerships

Liability of PartnersLiability of Partners

General PartnershipsGeneral Partnerships

Each partner has unlimited liability for the Each partner has unlimited liability for the partnership’s debts.partnership’s debts.


Limited PartnershipsLimited Partnerships At least one general partner who At least one general partner who

assumes management duties and assumes management duties and unlimited liability for the debts of the unlimited liability for the debts of the partnership.partnership.

Other partners may be limited partners Other partners may be limited partners who have no personal liability beyond the who have no personal liability beyond the amounts they invested in the partnership.amounts they invested in the partnership.


Limited Liability PartnershipsLimited Liability Partnerships Protects innocent partners from Protects innocent partners from

malpractice or negligence of other malpractice or negligence of other partners.partners.

All partners are responsible for other All partners are responsible for other partnership debts.partnership debts.


Separate capital account and withdrawal Separate capital account and withdrawal account for each partner.account for each partner.

Partnership income or loss is allocated to Partnership income or loss is allocated to partners based on partnership agreement.partners based on partnership agreement.

Partners can invest assets Partners can invest assets and liabilities and liabilities in the partnership.in the partnership.

Assets invested are recorded at fair market Assets invested are recorded at fair market value.value.

Partnership AccountingPartnership Accounting

Illustration: Formation of a partnership

Jackson and Thompson create a partnership. Jackson invests $20,000 cash and Thompson invests $20,000 cash and equipment with a fair market value of $10,000.

The entries to record these investments are:

Cash 20,000Jackson, capital 20,000

Cash 20,000Equipment 10,000

Thompson, capital 30,000

The partnership income or loss may be The partnership income or loss may be allocated based on:allocated based on:

Fractional basisFractional basis Ratio of capital investmentsRatio of capital investments Salaries, interest allowance, and a fixed Salaries, interest allowance, and a fixed

ratioratio

Dividing Income or LossDividing Income or Loss

Illustration: Income and loss sharing based on a fractional basis.

Jackson and Thompson agree to share income and losses on a 2:1 ratio. The income for the year is $90,000.

The entry to close the income summary account is : Income summary 90,000 Jackson, capital 60,000 Thompson, capital 30,000

2/3 x 90,000 = 60,0001/3 x 90,000 = 30,000

Income and loss sharing based on ratio of capital investments.

Jackson and Thompson agree to share income and losses on the basis of their beginning capital investments. Assume partnership income for the year is $90,000, and Jackson and Thompson’s beginning-of-year capital balances are $20,000 and $30,000 respectively.

The entry to close the income summary account is :Income summary 90,000

Jackson, capital 36,000Thompson, capital 54,000

20,000/50,000 x 90,000 = 36,00030,000/50,000 x 90,000 = 54,000

Income and loss sharing based on salaries, interest allowance, and a fixed ratio

Jackson and Thompson agree to share income or losses as follows:

1. Annual salary allowances of $30,000 for Jackson and $10,000 for Thompson.

2. Interest allowances of 10% of beginning-of-year capital balance.

3. Remainder to be shared equally.

Assume partnership income for the year is $90,000 and Jackson and Thompson’s beginning-of-year capital balances are $80,000 and $70,000 respectively.

Income Allocation:Jackson Thompson Balance

Income to be allocated 90,000$ Salary allowance 30,000$ 10,000$ (40,000) Interest allowance 8,000 7,000 (15,000) 10% x 80,000 = 8,000 10% x 70,000 = 7,000Remainder 35,000

shared equally 17,500 17,500 (35,000) -

Allocation to partners 55,500$ 34,500$ 90,000$


Income to be allocated 90,000$ Salary allowance 30,000$ 10,000$ (40,000) Interest allowance 8,000 7,000 (15,000) 10% x 80,000 = 8,000 10% x 70,000 = 7,000Remainder 35,000

shared equally 17,500 17,500 (35,000) -

Allocation to partners 55,500$ 34,500$ 90,000$

The entry to close the income summary account is :

Income summary 90,000 Jackson, capital 55,500 Thompson, capital 34,500

Income and loss sharing based on salaries, interest allowance, and a fixed ratio

Assume the same income and loss sharing agreement as before and that there is a net loss of $10,000 for the year.


Income to be allocated (10,000)$ Salary allowance 30,000$ 10,000$ (40,000) Interest allowance 8,000 7,000 (15,000) 10% x 80,000 = 8,000 10% x 70,000 = 7,000Remainder (65,000)

shared equally (32,500) (32,500) 65,000 -

Allocation to partners 5,500$ (15,500)$ (10,000)$


Income to be allocated (10,000)$ Salary allowance 30,000$ 10,000$ (40,000) Interest allowance 8,000 7,000 (15,000) 10% x 80,000 = 8,000 10% x 70,000 = 7,000Remainder (65,000)

shared equally (32,500) (32,500) 65,000 -

Allocation to partners 5,500$ (15,500)$ (10,000)$

The entry to close the income summary account is :

Thompson, capital 15,500 Income summary 10,000 Jackson, capital 5,500

Mini-QuizMini-Quiz

R, H, and D formed a partnership with R R, H, and D formed a partnership with R contributing $60,000, H contributing $50,000, and contributing $60,000, H contributing $50,000, and D contributing $40,000. Their partnership D contributing $40,000. Their partnership agreement called for the earnings division to be agreement called for the earnings division to be based on the ratio of capital investments. If the based on the ratio of capital investments. If the partnership had earnings of $74,000 for its first partnership had earnings of $74,000 for its first year of operation, what amount of earnings year of operation, what amount of earnings (rounded) would be credited to D's capital (rounded) would be credited to D's capital account? account?

The amount credited would be $19,733.

40,000/(60,000+50,000+40,000) x $74,000 = $19,733

New partners may be admitted to the partnership New partners may be admitted to the partnership by either :by either :

1.1. Purchasing a partnership interest.Purchasing a partnership interest.

oror

2.2. Investing assets in the partnership.Investing assets in the partnership.

Admission and Withdrawal of a Admission and Withdrawal of a PartnerPartner

Personal transaction between one or more Personal transaction between one or more current partners and the new partner.current partners and the new partner.

New partner must be accepted by current New partner must be accepted by current partners.partners.

New income-and-loss sharing agreement is New income-and-loss sharing agreement is prepared. prepared.

Purchase of Partnership InterestPurchase of Partnership Interest

Illustration: Purchase of Partnership Interest

Jackson and Thompson continues to operate for several years. Jackson’s beginning of the year capital balance is $100,000. Jackson sells one half of his partnership interest to Harris for $60,000.

The entry to record the admission of Harris is:

Jackson, capital 50,000Harris, capital 50,000

50% x $100,000

Instead of purchasing the equity of an existing Instead of purchasing the equity of an existing partner, an individual may gain equity by partner, an individual may gain equity by investing assets. investing assets.

The amount invested may or may not equal the The amount invested may or may not equal the share of equity obtained.share of equity obtained.

1.1. Investment equal to share of equityInvestment equal to share of equity

2.2. Investment greater than share of equity Investment greater than share of equity (bonus to old partners)(bonus to old partners)

3.3. Investment less than share of equity (bonus to Investment less than share of equity (bonus to new partner)new partner)

Investing Assets in a PartnershipInvesting Assets in a Partnership

When the value of the partnership is approximately When the value of the partnership is approximately equal to the equity recorded on the accounting equal to the equity recorded on the accounting records, a new partner receives a proportionate records, a new partner receives a proportionate share of equity equal to his investment.share of equity equal to his investment.

Investment Equals Share of EquityInvestment Equals Share of Equity

Illustration: Investment Equals Share of Equity

Jackson and Thompson accept Harris as a partner with his investment of $40,000 for 20%* equity. The partnership had total equity of $160,000 (Jackson $90,000 and Thompson $70,000) before his investment.

The entry to record this investment is:Cash 40,000

Harris, capital 40,000

Note: Harris does not necessarily have a right to 20% of income.

*20% = 40,000 / (160,000 + 40,000)

When the current market value of the partnership When the current market value of the partnership is greater than the book value, a new partner is greater than the book value, a new partner usually pays a bonus for the privilege of joiningusually pays a bonus for the privilege of joining

Investment is Greater Than Share of Investment is Greater Than Share of EquityEquity

Illustration: Investment is Greater Than Share of Equity

Jackson and Thompson accept Harris as a partner with his investment of $60,000 for 20% equity. The partnership had total equity of $160,000 (Jackson $90,000 and Thompson $70,000) before his investment.

Equities of existing partners $160,000

Investment of new partner 60,000

Total partnership equity $220,000

Equity of Harris (20% x $220,000) $44,000


The $16,000 difference between the amount invested by Harris ($60,000) and his equity ($44,000) represents a bonus to the old partners.

Assume that this bonus is allocated to the existing partners in their income/loss ratio of 50:50.

The entry to record this investment is:

Cash 60,000Harris, capital 44,000Jackson, capital 8,000

Thompson, capital 8,000 ($16,000 x 50%)

When existing partners are anxious to bring a When existing partners are anxious to bring a new partner into the firm, the old partners may new partner into the firm, the old partners may be willing to give the new partner a larger be willing to give the new partner a larger equity in the business than the amount of his equity in the business than the amount of his investment.investment.

The bonus given to the new partner is The bonus given to the new partner is allocated to the original partners (reducing allocated to the original partners (reducing their equity balances) based on their income-their equity balances) based on their income-and-loss-sharing ratio as per their agreement.and-loss-sharing ratio as per their agreement.

Investment is Less Than Share of Investment is Less Than Share of EquityEquity

Illustration: Investment is Less Than Share of Equity

Jackson and Thompson accept Harris as a partner with his investment of $10,000 for 20% equity. The partnership had total equity of $160,000 (Jackson $90,000 and Thompson $70,000) before his investment.

Equities of existing partners $160,000

Investment of new partner 10,000

Total partnership equity $170,000

Equity of Harris (20% x $170,000) $34,000


The $24,000 difference between the amount invested by Harris ($10,000) and his equity ($34,000) represents a bonus to Harris.

Assume that this bonus is allocated to the existing partners in their income/loss ratio of 50:50.

The entry to record this investment is: Cash 10,000 Jackson, capital 12,000 Thompson, capital 12,000

Harris, capital 34,000 ($24,000 x 50%)

A partner may withdraw from the A partner may withdraw from the partnership by: partnership by:

1.1. Selling his or her interest to another Selling his or her interest to another person.person.

oror

2.2. Receiving assets from the partnership in Receiving assets from the partnership in settlement for his or her equity interest.settlement for his or her equity interest.

Withdrawal of a PartnerWithdrawal of a Partner

The withdrawing partner’s account is The withdrawing partner’s account is debited and the new partner’s account is debited and the new partner’s account is credited.credited.

Withdrawing partner, capital xxxWithdrawing partner, capital xxx

New partner, capital xxxNew partner, capital xxx

Withdrawal of a Partner-Sale of Withdrawal of a Partner-Sale of Interest to Another PersonInterest to Another Person

Three possibilities:Three possibilities:1.1. No bonus.No bonus.

2.2. Bonus to remaining partners.Bonus to remaining partners.

3.3. Bonus to withdrawing partner.Bonus to withdrawing partner.

Withdrawal of a Partner-Withdrawal of a Partner-Partnership assets exchanged for equity interestPartnership assets exchanged for equity interest

No BonusNo Bonus

The withdrawing partner receives assets The withdrawing partner receives assets equal to the balance of their capital equal to the balance of their capital account.account.


Illustration: No Bonus

Assume that Harris withdraws and receives $55,000 cash from the partnership. His capital balance is also $55,000.

The entry to record the withdrawal of Harris is:

Harris, capital 55,000 Cash 55,000

Bonus to Remaining PartnersBonus to Remaining Partners The withdrawing partner receives assets The withdrawing partner receives assets lessless than the balance of their capital than the balance of their capital account.account.

Possible reasons:Possible reasons:1.1. Withdrawing partner may want out of Withdrawing partner may want out of

the partnership.the partnership.2.2. Assets may be overvalued.Assets may be overvalued.


Illustration: Bonus to Remaining Partners

Assume that Harris withdraws and receives $40,000 cash from the partnership. His capital balance is $55,000.

Assume that this bonus is allocated to the remaining partners in their income/loss ratio of 50:50.

The entry to record the withdrawal of Harris is:

Harris, capital 55,000 Jackson, capital 7,500 Thompson, capital 7,500

Cash 40,000 ($55,000 - $40,000) x 50% =$7,500

Bonus to Withdrawing PartnerBonus to Withdrawing Partner The withdrawing partner receives assets The withdrawing partner receives assets

greatergreater than the balance of their capital than the balance of their capital account.account.

Possible reasons:Possible reasons:1.1. Remaining partners may want a partner out Remaining partners may want a partner out

of the partnership.of the partnership.2.2. Recorded equity of the partnership may be Recorded equity of the partnership may be

understated.understated.


Illustration: Bonus to Withdrawing Partner

Assume that Harris withdraws and receives $65,000 cash from the partnership. His capital balance is $55,000.

Assume that this bonus is allocated to the remaining partners in their income/loss ratio of 50:50.

The entry to record the withdrawal of Harris is: Harris, capital 55,000 Jackson, capital 5,000 Thompson, capital 5,000

Cash 65,000 ($55,000 $65,000) x 50% = -$5,000

Steps involved in liquidation:

1.Non-cash assets are sold for cash and a gain or loss on liquidation is recorded.

2.The gain or loss is allocated to partners using their income-and-loss ratio.

3.Liabilities are paid.

4.The remaining cash is distributed to partners based on their capital balances.

Liquidation of a PartnershipLiquidation of a Partnership

No Capital Deficiency

All partners have credit balances in their capital accounts before the final distribution of cash.

Capital Deficiency

At least one partner has a debit balance in his or her capital account before the final distribution of cash.

Liquidation of a Partnership-Liquidation of a Partnership-Possible ScenariosPossible Scenarios

Illustration: No Capital Deficiency

Accum. Accounts Jackson Thompson HarrisTransaction Events: Cash Building Amort. Land Payable Capital Capital CapitalBalances prior to liquidation 40,000$ 80,000$ (20,000)$ 60,000$ 20,000$ 60,000$ 50,000$ 30,000$

Assume the company is closing down and all losses or gains are shared equally between the partners.

The account balances immediately prior to liquidation are:


Step 1:Sell Non-Cash AssetsThe entry to record the sale is: Cash 144,000 Accumulated Amortization 20,000 Building 80,000 Land 60,000

Gain on Liquidation 24,000

Step 2:Allocate the Gain or Loss to the Partners’ Capital Accounts

The entry to allocate the gain is:

Gain on Liquidation 24,000 Jackson, Capital 8,000 Thompson, Capital 8,000 Harris, Capital 8,000 $24,000/3


Accum. Accounts Jackson Thompson HarrisTransaction Events: Cash Building Amort. Land Payable Capital Capital CapitalBalances prior to liquidation 40,000$ 80,000$ (20,000)$ 60,000$ 20,000$ 60,000$ 50,000$ 30,000$ Sell noncash assets and allocate gain on liquidation 144,000 (80,000) 20,000 (60,000) 8,000 8,000 8,000 Balance 184,000 - - - 20,000 68,000 58,000 38,000

Balances after liquidation and allocation of the gain


Accum. Accounts Jackson Thompson HarrisTransaction Events: Cash Building Amort. Land Payable Capital Capital CapitalBalances prior to liquidation 40,000$ 80,000$ (20,000)$ 60,000$ 20,000$ 60,000$ 50,000$ 30,000$ Sell noncash assets and allocate gain on liquidation 144,000 (80,000) 20,000 (60,000) 8,000 8,000 8,000 Balance 184,000 - - - 20,000 68,000 58,000 38,000 Pay the liabilities (20,000) (20,000) Balance 164,000 68,000 58,000 38,000

Step 3:Pay the Liabilities

The entry to record this is:

Accounts Payable 20,000 Cash 20,000


Accum. Accounts Jackson Thompson HarrisTransaction Events: Cash Building Amort. Land Payable Capital Capital CapitalBalances prior to liquidation 40,000$ 80,000$ (20,000)$ 60,000$ 20,000$ 60,000$ 50,000$ 30,000$ Sell noncash assets and allocate gain on liquidation 144,000 (80,000) 20,000 (60,000) 8,000 8,000 8,000 Balance 184,000 - - - 20,000 68,000 58,000 38,000 Pay the liabilities (20,000) (20,000) Balance 164,000 68,000 58,000 38,000 Distribute cash (164,000) (68,000) (58,000) (38,000) Balance - - - - - - - -

Step 4: Distribute the remaining cash to the partners

The entry to record this is: Jackson, Capital 68,000 Thompson, Capital 58,000 Harris, Capital 38,000 Cash 164,000

Situations may arise when one or more partners has a debit balance in his or her capital account before the final distribution of cash. This is referred to as a Capital Deficiency.

The partner(s) with the deficiency either:

1. Can and do pay the deficiency with personal funds.

2. Cannot pay the deficiency. The other partners absorb the deficiency.

Liquidation of a Partnership-Liquidation of a Partnership-Possible ScenariosPossible Scenarios

ReviewReview

Discuss the options for the allocation of income Discuss the options for the allocation of income and loss among partners. and loss among partners.

In the absence of a partnership agreement, In the absence of a partnership agreement, income and losses are shared equally by the income and losses are shared equally by the partners. A partnership agreement should partners. A partnership agreement should specify how to allocate partnership income or specify how to allocate partnership income or loss among partners. Allocation can be made loss among partners. Allocation can be made based on a fractional share of ownership, salary based on a fractional share of ownership, salary allowances, or interest allowances. allowances, or interest allowances.

ReviewReview

Explain the steps involved in the liquidation of a partnership.

Four steps are involved in the liquidation process.

1. Noncash assets are sold for cash and a gain or loss on liquidation is recorded.

2. Gains or losses are allocated to the partners' capital accounts based on the partnership agreement or in equal shares.

3. Liabilities of the partnership are paid.

4. The remaining cash is distributed to the partners based on the amounts in their capital accounts.

End of ChapterEnd of Chapter

Partnerships CHAPTER 9 Electronic Presentations in Microsoft® PowerPoint®

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