15 - 1 ©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e,...

15 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Partnerships – Formation,Operations, and Changes in

Ownership Interests

Chapter 15


Learning Objective 1

Comprehend the legal

characteristics of partnerships.


Partnership Characteristics

It is an association of two or more personswho co-own a business for a profit.

The legal life of a partnership terminateswith the admission of a new partner, the

withdrawal or death of a partner, voluntarydissolution by the partners, or involuntary

dissolution such as bankruptcy proceedings.


Articles of Partnership

A partnership may be formed by a simpleoral agreement among two or more

people to operate a business for profit.


Articles of Partnership

The types of products and services to be provided

Each partner’s rights and responsibilities

Each partner’s initial investment

Additional investment conditions

Asset drawing provisions

Profit and loss sharing formulas

Procedures for dissolving the partnership


Partnership Financial Reporting

The accounting reports are designed tomeet the needs of three user groups…

The partners

Partnership creditors

Internal Revenue Service



Understand initial investment

valuation and record keeping.


Initial Investment in a Partnership

Ashley and Becker each invest $20,000cash in a new partnership.

Cash 20,000Ashley, Capital 20,000

To record Ashley’s original investment of cash

Cash 20,000Becker, Capital 20,000

To record Becker’s original investment of cash


Noncash Investments

C. Cola R. CrownFair Value Fair Value

Cash $ — $ 7,000Land (cost to C. Cola, $5,000) 10,000 —Building (cost to C. Cola, $30,000) 40,000 —Inventory (cost to R. Crown, $28,000) — 35,000

Total $50,000 $42,000

C. Cola and R. Crown enter into a partnership.


Noncash Investments

Land 10,000Building 40,000

C. Cola, Capital 50,000To record C. Cola’s original investmentof land and building at fair value


Noncash Investments

Cash 7,000Inventory 35,000

R. Crown, Capital 42,000To record R. Crown’s original investmentof cash and inventory items at fair value


Bonus or Goodwillon Initial Investment

The partnership agreement specifiesequal capital interests.

C. Cola, Capital 4,000R. Crown, Capital 4,000

To establish equal capital interests of $46,000 byrecording a $4,000 bonus from C. Cola to R. Crown


Bonus or Goodwillon Initial Investment

Goodwill 8,000R. Crown, Capital 8,000

To establish equal capital interests of $50,000by recognizing R. Crown’s investmentof an $8,000 unidentifiable asset


Drawings

Regular withdrawals are calleddrawings, drawing allowances,

or sometimes salary allowances.

Debit Drawing and credit Cash.

At period end, credit Drawingand debit each partner’s Capital.


Loans and Advances

Loans and advances to the partnershipand accrued interest are regarded as

liabilities of the partnership.

Loans and advances to partners areregarded as assets of the partnership.


Partnership Operations

Ratcliffe and Yancey are partners sharingprofits in a 60:40 ratio, respectively.


Partnership Operations

Partnership net income 2003 $34,500Ratcliffe capital January 1, 2003 40,000Ratcliffe additional investment 2003 5,000Ratcliffe drawing 2003 6,000Yancey capital January 1, 2003 35,000Yancey drawing 2003 9,000Yancey withdrawal 2003 3,000

Equity Accounts, 2003


Format for a Statementof Partners’ Capital

Ratcliffe and Yancey Statement of Partners’ CapitalFor the Year Ended 12/31/2003

60% 40%Ratcliffe Yancey Total

Capital balances 1/1/03 $40,000 $35,000 $75,000Add: Additional investments 5,000 — 5,000Deduct: Withdrawals — – 3,000 – 3,000Deduct: Drawings – 6,000 – 9,000 –15,000 Net contributed capital 39,000 23,000 62,000Add: Net income for 2003 20,700 13,800 34,500 Capital balances 12/31/03 $59,700 $36,800 $96,500


Closing Entries

December 31, 2003Revenue and Expense Summary 34,500

Ratcliffe, Capital 20,700Yancey, Capital 13,800

To divide net income for the year 60% to Ratcliffeand 40% to Yancey


Closing Entries

December 31, 2003Ratcliffe, Capital 6,000Yancey, Capital 9,000

Ratcliffe, Drawing 6,000Yancey, Drawing 9,000

To close partner drawing accounts to capital accounts



Grasp the diverse nature of profit

and loss sharing agreements

and their computation.


Profit and Loss SharingAgreements

Equal division of partnership income is required inthe absence of a profit and loss sharing agreement.


Service Considerations inProfit and Loss Sharing

Agreements

A partner who devotes time to the partnershipbusiness while other partners work elsewhere

may receive a salary allowance.

Salary allowances are also used tocompensate for differences in the fair

value of the talents of partners.


Salary Allowance in ProfitSharing Agreements

Bob, Gary, and Pete are partners.

The partnership agreement provides thatBob and Gary receive salary allowances

of $12,000 each, with the remainingincome allocated equally.

Partnership net income is $60,000 for 2003and $12,000 for 2004.


Income Allocation Schedule: 2003

Bob Gary PeteNet income $60,000Salary allowances

to Bob and Gary (24,000) $12,000 $12,000Remainder to divide 36,000Divided equally (36,000) 12,000 12,000 $12,000Remainder to divide 0 Net income allocation $24,000 $24,000 $12,000



Bob Gary PeteNet income $12,000Salary allowances

to Bob and Gary (24,000) $12,000 $12,000Remainder to divide (12,000)Divided equally 12,000 (4,000) (4,000) $(4,000)Remainder to divide 0 Net income allocation $ 8,000 $ 8,000 $(4,000)


Journal Entries

December 31, 2003Revenue and Expense Summary 60,000

Bob, Capital 24,000Gary, Capital 24,000Pete, Capital 12,000

Partnership income allocation for 2003


Journal Entries

December 31, 2004Revenue and Expense Summary 12,000Pete, Capital 4,000

Bob, Capital 8,000Gary, Capital 8,000

Partnership income allocation for 2004


Bonus and Salary Allowances

The partnership agreement provides that Bobreceive a bonus of 10% of partnership net income.

Partnership net income is $60,000for 2003 and $12,000 for 2004.

Bob and Gary receive salary allowancesof $10,000 and $8,000, respectively, and

the remaining income is allocated equally.



Bob Gary PeteNet income $60,000Bonus to Bob (6,000) $ 6,000Remainder to divide 54,000Salary allowances

to Bob and Gary (18,000) 10,000 $ 8,000Remainder to divide 36,000Divided equally (36,000) 12,000 12,000 $12,000Remainder to divide 0 Net income allocation $28,000 $20,000 $12,000



Bob Gary PeteNet income $12,000Bonus to Bob (1,200) $ 1,200Remainder to divide 10,800Salary allowances

to Bob and Gary (18,000) 10,000 $8,000Remainder to divide (7,200)Divided equally 7,200 (2,400) (2,400) $(2,400)Remainder to divide 0 Net income allocation $ 8,800 $5,600 $(2,400)


Income Allocated in Relationto Partnership Capital

Capital balances 1/1/2003 $20,000 $20,000Investment April 1 2,000 —Withdrawal July 1 — (5,000)Investment September 1 3,000 —Withdrawal October 1 — (4,000)Investment December 28 — 8,000Capital balances 12/31/2003 $25,000 $19,000

Ace Butch


Comparison of Capital Bases

Weighted Beginning Ending Average

Capital Capital Capital Investment Investment Investment

Ace $20,000 $25,000 $22,500Butch 20,000 19,000 16,500Total $40,000 $44,000 $39,000


Alternatives

Beginning Capital BalancesAce ($100,000 × 20/40) $ 50,000Butch ($100,000 × 20/40) 50,000

Total income $100,000

Net income of $100,000 is dividedon the basis of capital balances.


Alternatives

Ending Capital BalancesAce ($100,000 × 25/44) $ 56,818.18Butch ($100,000 × 19/44) 43,181.82

Total income $100,000.00

Average Capital BalancesAce ($100,000 × 22.5/39) $ 57,692.31Butch ($100,000 × 16.5/39) 42,307.69

Total income $100,000.00


Interest Allowanceson Partnership Capital

An agreement may provide for interestallowances on partnership capital in

order to encourage capital investments,as well as salary allowances.

Remaining profits are then dividedequally or in any other ratio specified

in the profit sharing agreement.



Value new partners’ investment

in an existing partnership.


Changes in Partnership Interest

The existing legal partnership entity isdissolved when a new partner is admitted

or an existing partner retires or dies.


Changes in Partnership Interest

Assignment of an interest to a third party

Admission of a new partner

Purchase of an interest from existing partners

Investing in an existing partnership



Value partner’s share upon

retirement or death.


Dissolution of a Continuing Partnership

Through Death or Retirement Profit and

Capital Percentage LossBalances of Capital Percentage

Bonnie $ 70,000 35% 40%Clyde 50,000 25 20Dillinger 80,000 40 40 Total capital $200,000 100% 100%


Dissolution of a Continuing Partnership

Through Death or Retirement

Dillinger decides to retire.

The partners agree that the business isundervalued on the partnership books

and that Dillinger will be paid $92,000.


Bonus to Retiring Partner

Dillinger, Capital 80,000Bonnie, Capital 8,000Clyde, Capital 4,000

Cash 92,000

Dillinger, Capital 80,000Goodwill 12,000

Cash 92,000


Reevaluation of TotalPartnership Capital

Goodwill (other assets) 30,000Bonnie, Capital 12,000Clyde, Capital 6,000Dillinger, Capital 12,000


Payment to Retiring PartnerLess than Capital Balance

Suppose that Dillinger is paid $72,000in final settlement of his capital interest.


Overvalued Assets Written Down

Bonnie, Capital 8,000Clyde, Capital 4,000Dillinger, Capital 8,000

Net assets 20,000

Dillinger, Capital 72,000Cash 72,000


Bonus to Continuing Partners

Dillinger, Capital 80,000Bonnie, Capital 5,333Clyde, Capital 2,667Cash 72,000



Understand limited liability

partnership characteristics.


Limited Partnerships

The limited partnership consistsof at least one general partner

and one or more limited partners.

The limited partner is excluded fromthe management of the business.


End of Chapter 15

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