Partnerships

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter P

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Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.2

Identify the characteristics and types ofpartnerships

Account for partner investments

Allocate profits and losses to the partners

Account for the admission of a new partner

Account for a partner’s withdrawal from the firm

Account for the liquidation of a partnership

Prepare partnership financial statements


Identify the characteristics and types ofpartnerships

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A partnership—a voluntary associationBusiness with two or more ownersCombines individual partners’ assets and liabilities (if any), talents and resources, and experience and knowledgeShould have "Article of Partnership"—a contractual agreement that contains the rules of the partnership

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The articles of partnership should specify the following:1. Name, location, and nature of the business2. Name, capital investment, and duties of each partner3. Procedures for admitting a new partner4. Method of sharing profits and losses among the

partners5. Drawing of assets by the partners6. Procedures for settling up with a partner who

withdraws from the firm7. Procedures for liquidating the partnership

1. Selling the assets, paying the liabilities and giving any remaining cash to the partners

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Written agreementsLimited lifeMutual agencyUnlimited liabilityCo-ownership of propertyNo partnership income taxesPartners’ capital accounts

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General partnership–basic formEach partner is co-ownerWith all the privileges and risks of ownership

Limited partnership–two classes of partnersOne or more general partners assuming primary responsibilities

Unlimited liabilityLast to receive share of profit and lossesGet all excess profits after limited partners get their share of income

Limited partnersLimited liabilityLimited profits and losses8


Neither a partnership nor a corporationOwners are called members

Must file articles of organization with the stateMust include LLC in business nameNot personally liable for the business’s debtsCan elect NOT to be subject to income tax on the business

Income taxed to the partners

Can participate actively in managementAccounting follows the pattern for a partnership

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For tax purposes, treated similar to a partnership

Less than 100 stockholdersSubchapter S of the Internal Revenue CodeBenefits of a corporationLimited liability of ownersNo corporate income taxStockholders pay personal income tax on their share of income

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Account for partner investments

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Assets and liabilities invested by partners at fair market valuesFair market value measures partner’s capital contribution to the businessEach partner has a capital and withdrawal account

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Bright’s InvestmentCash, $10,000; inventory, $40,000; and accounts payable, $80,000Computer equipment—cost, $80,000; accumulated depreciation, $20,000; current market value, $55,000Gonzalez’s InvestmentCash, $5,000, Computer software: cost, $20,000; market value, $18,000


Assets and liabilities–presented and listed the same for a proprietorship and a partnershipDifference–each partner has an equity account

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Robert Morris invests land in a partnership with Andy Phillips. Morris purchased the land in 2012 for $300,000. A real estate appraiser now values the land at $700,000. Morris wants $500,000 capital in the new partnership, but Phillips objects. Phillips believes that Morris’s capital investment should be measured by the book value of his land. Phillips and Morris seek your advice.1.Which value of the land is appropriate for measuring Morris’s capital—book value or current market value?

2. Give the partnership’s journal entry to record Morris’s investment in the business

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Market value measures a partner’s capital investment in a partnership because the business is buying the asset at its current market value.

Land 700,000Morris, Capital 700,000

To record Morris’ investment.


Susan Knoll and Emerson Wyndon are forming a partnership to develop a theme park near Carlson City, Florida. Knoll invests cash of $3,000,000 and land valued at $11,000,000. When Knoll purchased the land in 2012, its cost was $9,000,000. The partnership will assume Knoll’s $4,000,000 note payable on the land. Wyndon invests cash of $5,000,000 and equipment worth $6,000,000.

1. Journalize the partnership’s receipt of assets and liabilities from Knoll and from Wyndon.

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Cash 3,000,000Land 11,000,000

Note Payable 4,000,000Knoll, Capital 10,000,000

To record Brown’s investment.

Cash 5,000,000Equipment 6,000,000

White, Capital 11,000,000To record White’s investment.


Susan Knoll and Emerson Wyndon are forming a partnership to develop a theme park near Carlson City, Florida. Knoll invests cash of $3,000,000 and land valued at $11,000,000. When Knoll purchased the land in 2012, its cost was $9,000,000. The partnership will assume Knoll’s $4,000,000 note payable on the land. Wyndon invests cash of $5,000,000 and equipment worth $6,000,000.

2. Compute the partnership’s total assets, total liabilities, and total owners’ equity immediately after organizing.

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Total assets:$3,000,000 + $11,000,000 + $5,000,000 + $6,000,000

= $25,000,000

Total liabilities: = $ 4,000,000Total owners’ equity:

$10,000,000 + $11,000,000 (or $21,000,000 − $4,000,000)

= $21,000,000


Allocate profits and losses to the partners

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Partners can agree to any profit-and-loss-sharing method they desireTypical arrangements

Fraction basis: 50/50, 60/40, 25/75Three partners: 40/30/30 or 4:3:3 or 4/10, 3/10, 3/10Based upon investment amountsBased upon service contributionBased upon some combination of fractions, investments and service

If no agreement, shared equally among partners: 50/50, 33.3/33.3/33.3, or 25/25/25/25, etc.

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Fraction basedProfits and losses are shared using the same fraction amounts

The Income summary account has a credit balance of $60,000

Or the partnership had a net loss of $15,000

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Partners have agreed to share profits as follows:1. The first allocations are based on 10% of partner capital balances.2. The next $40,000 is allocated based on service, with Bright

getting $16,000 and Gonzalez $24,000.3. Any remaining profit is allocated equally.

Net income for the first year is $60,000

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Journal entry to follow profit/loss sharing calculations:

The 4th closing entry would close out any drawing accounts

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What happens if this same income sharing agreement were in place, but Bright & Gonzalez incurred total net loss of $15,000?

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Journal entry to follow loss sharing calculations:

The 4th closing entry would close out any drawing accounts

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Withdraw cash or assets based upon the partnership agreementRecorded as contra equity accountAssume that Sheena Bright and Martin Gonzalez each made withdrawals of $3,000

Drawing accounts are closed at the end of the year

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Farrah and Davidson had beginning capital balances of $25,000 and $20,000, respectively. The two partners fail to agree on a profit-and-loss-sharing ratio. For the first month (June 2012), the partnership lost $6,000.1.How much of this loss goes to Farrah? How much goes to Davidson?

Farrah: $6,000 x ½ = $3,000Davisdson: $6,000 x ½ = $3,000

2. The partners withdrew no assets during June. What is each partner’s capital balance at June 30? Prepare a T-account for each partner’s capital.

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Farrah, Capital3,000 25,000

Bal. 22,000

Davidson, Capital3,000 20,000

Bal. 17,000


Bagwell, McWilliams, and Briand have capital balances of $24,000, $36,000, and $60,000, respectively. The partners share profits and losses as follows:

a.The first $50,000 is divided based on the partners’ capital balances.b.The next $50,000 is based on service, shared equally by Bagwell and Briand.c.The remainder is divided equally.

Compute each partner’s share of the $112,000 net income for the year.

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Bagwell McWilliams Briand TotalTotal net income $112,000Sharing of first $50,000 of net incomebased on capital balances: Bagwell 24/120 X $50,000 $10,000 McWilliams 36/120 X $50,000 $15,000 Briand 60/120 X $50,000 $25,000

Total 50,000Net income remaining for allocation $62,000Sharing of next $50,000 based on service: Bagwell ($50,000 × ½) 25,000 Briand ($50,000 × ½) 25,000

Total 50,000Net income remaining for allocation $12,000Remainder shared equally: Bagwell ($12,000 × 1/3) 4,000 McWilliams ($12,000 × 1/3) 4,000 Briand ($12,000 × 1/3) 4,000

Total 12,000Net income remaining for allocation $ -0- Net income allocated to the partners $39,000 $19,000 $54,000 $112,000

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Account for the admission of a new partner

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Admitting a new partner or partners—dissolves the old partnershipAny change to the partner mix—the old partnership ceases to existNew partnership begins with partner changesChanges can arise from:

Death or retirement of partner(s)Admitting a new partner(s)Purchase of a partner’s share

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Partnership make-up will change when a new partner buys an existing partner’s interestChange must be approved by all partnersEquity is transferred from retiring partner to new partner:

Debit retiring partner’s capitalCredit new partner’s capital

Partnership assets not affected

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With approval, Bright sells partnership share to Barry Holt for $50,000Balance sheet at date of transfer

Journal entry to record transfer

Cash is exchanged between Bright and Holt32


New partner invests assets into the business in exchange for share of the businessInvestment alternatives:

Investing in the partnership at book value—no bonus to any partnerInvesting in the partnership—bonus to the old partnersInvesting in the partnership—bonus to the new partner

Bonus—an increase in the capital account from the investment transaction

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New partner invests assets equal to his/her interest in the new partnershipEquity interest calculated on the total equity assumed after the admission

Profit/loss sharing is agreed upon separately34

Partnership capital before Kaska is admitted ($48,100 + $53,900)

$102,000

Kaska’s investment in the partnership (Land) 51,000

Partnership capital after Kaska is admitted $153,000

Kaska’s capital in the new partnership ($153,000 1/3) $ 51,000


Successful partnership interest worth more than the percentage of assumed ownershipNew partner invests assets greater than his/her equity in the new partnershipBonus increases old partner’s capital according to the sharing agreement already in placeProfit/loss sharing agreed upon separately

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Assume Bright and Gonzalez admit Nancy Fye to a ¼ interest in exchange for $98,000

Fry invested in partnership at a price ($98,000) above the book value of her 1/4 interest ($50,000)

Partnership capital before Fry is admitted ($48,100 + $53,900) $102,000

Fry’s investment in the partnership 98,000

Partnership capital after Fry is admitted $200,000

Fry’s capital in the new partnership ($200,000 x 1/4) $ 50,000

Bonus to the old partners ($98,000 - $50,000) $ 48,000


New partner more valuable and offered a partnership share greater than assets exchangedExcess share is a bonus to the new partnerBonus decreases old partner’s capital in relation to profit-and-loss sharing ratioProfit/loss sharing agreed upon separatelyAssume Fry gives Bright and Gonzalez $98,000 but instead, gets a 60% interest in the new partnership

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The computation of Fry’s 60% equity in the new partnership:

Original partners’ equity reduced

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Partnership capital before Fry is admitted ($48,100 + $53,900) $102,000

Fry’s investment in the partnership 98,000

Partnership capital after Fry is admitted $200,000

Fry’s capital in the new partnership ($200,000 x 60%) $ 120,000

Bonus to the new partner ($120,000 - 98,000 ) $ 22,000


Persimmon has $75,000 capital and Hawk has $45,000 capital in the Persimmon & Hawk partnership. Persimmon and Hawk share profits and losses equally. Judy Pound invests cash of $40,000 to acquire a 1/4 interest in the new partnership.1.Calculate Pound’s capital in the new partnership.

2.Journalize the partnership’s receipt of the $40,000 from Pound.

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Partnership capital before Pound is admitted ($75,000 + $45,000) $120,000Pound’s investment in the partnership 40,000Partnership capital after Pound is admitted $160,000Pound’s capital in the partnership—same as her

investment; no bonus ($160,000 × 1/4) $ 40,000

Cash 40,000Pound, Capital 40,000

To admit Pound as a partner.


Account for a partner’s withdrawal from the firm

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Partner leaves the business due to retirement, death or dispute with existing partnersWithdrawing partner may receive cash or other assetsPartnership agreement should specify how settlements are valued

Often specifies an appraisal to determine current market valueChanges in market value requires partners share the changes according to profit-and-loss-sharing ratio

Three scenarios:Withdrawal at book valueWithdrawal at less than book valueWithdrawal at greater than book value

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Bright, Gonzalez, and Fry balance sheet after Fry admitted to the partnership

Independent appraiser revalues the inventory at $70,000 and the computer equipment at $45,200Journal entry required to bring the partnership to current market value

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Partnership agreement allocates 1/6 to Bright, 2/6 (or 1/3) to Gonzalez, and 3/6 (or 1/2) to FryJournal entry:

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Bright, Gonzalez, and Fry capital accounts are updated

Bright is withdrawing from the partnership

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Partner takes assets with value equal to his capital account (equal to book value)If Bright withdraws by receiving cash for her book value, the entry will be as follows:

Bright’s capital account is closed

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Withdrawing partner eager to depart and will take less than his/her full equity interest Remaining partners share the difference (bonus) based on their profit-and-loss-sharing ratioBright withdraws from the business and agrees to receive cash of $10,000 and the new partnership’s $20,000 note payable

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Withdrawing partner receives assets worth more than the book value of their equity interestBonus reduces the remaining partners’ capital balances based on their profit-and-loss ratioBright is given cash of $20,000 and a note payable of $20,000

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John, Susan, and Carl each have a $200,000 capital balance. They share profits and losses as follows: 1:2:1 to John, Susan, and Carl, respectively. Suppose Carl is withdrawing from the business, and the partners agree that no appraisal of assets is needed. 1.Journalize the withdrawal of Carl if the partnership agrees to pay Carl $200,000 cash.

2. Journalize the withdrawal of Carl if the partnership agrees to pay Carl $140,000 cash.

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Carl, Capital 200,000

Cash 200,000

Carl, Capital 200,000

Cash 140,000

John, capital 20,000

Susan, capital 40,000


Account for the liquidation of a partnership

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Liquidation–shuts down the firm by selling its assets and paying its liabilities

Dissolves the partnershipAdjust and close the books to establish final profits or losses

Liquidation involves three steps:Sell the assets and distribute gains/losses to the partners’ capital accountsPay all partnership liabilitiesDistribute remaining cash to the partners based on their capital balances

Key–all accounts of the company are closed 50


Assume the following balances after adjusting and closing

During liquidation, three scenarios:Assets are sold at a gainAssets are sold at a lossAssets are sold at a book value

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Akers, Bloch, and Crane sell the noncash assets for $150,000

Partnership realizes a gain of $60,000

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Partnership then pays off its liabilities:

If cash balance is less than the liabilities, the partners contribute cash to cover themIf cash balance is greater than the liabilities, the remaining cash is paid to partners

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If sale of assets results in a loss, the partners accounts debited Liabilities are paidPartners divide the remaining cashAccounting follows the same pattern illustrated for selling assets for a gain

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The Kelly & Lena partnership has the following balances on June 30, 2012:

Kelly and Lena share profits 2:3.1. Journalize the sale of the noncash assets for $25,000, the payment of the liabilities, and the payment to the partners.

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1. Journalize the sale of the noncash assets for $25,000, the payment of the liabilities, and the payment to the partners.

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Cash 25,000Kelly, capital 2,000Lena, capital 3,000

Noncash assets 30,000To sell assets at a loss.

Liabilities 20,000Cash 20,000

To pay liabilities.

Kelly, capital 6,000Lena, capital 4,000

Cash 10,000To pay cash in liquidation.


Prepare partnership financial statements

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Similar to those of a proprietorship, with the following differences

Income statement–has a section showing division of net income to the partners

Balance sheet–has a capital account for each partner in owners’ equity section

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The partnership agreement contains the rules under which the partnership will operate. A partnership has limited life and mutual agency, is taxed only at the individual level, has unlimited liability, and maintains separate capital accounts for each partner. A partnership can be a general partnership or an LLP (or LLC). Some small owner groups may also choose to be an S corporation, which is taxed like a partnership but has the protection of the separate corporate entity (limited liability).

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When a partnership is started, each partner contributes assets and liabilities at their current market values. The partnership balance sheet is similar to other balance sheets you’ve learned about—the main difference is that there are separate capital accounts for each partner.The partnership agreement should specify how the partners will share profits and losses. If the agreement is silent, the partners share profits and losses equally. If the agreement has multiple steps, all steps must be applied each time the partnership allocates profits or losses. Each partner has a separate drawing account. That account is closed to the partner’s capital account during the closing process.60


There are many ways a new partner may be admitted to an existing partnership. The new partner can purchase the book equity directly from an existing partner. The new partner can also contribute cash or other assets to the partnership and receive a certain amount of the new partnership’s capital (value). The difference between what the new partner contributes and the value the new partner receives in capital is either a bonus to the existing partners or a bonus to the new partner.

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The treatment of a partner withdrawal is similar to the treatment of admitting a new partner. First, the partners can agree to a revaluation. Then, the withdrawing partner can be withdrawn at an amount either exactly equal to his or her capital balance or another amount, higher or lower than his or her capital balance. If the withdrawing partner is given an amount different than his or her capital balance, a bonus to either the remaining partners or to the withdrawing partner occurs.

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To liquidate a partnership, first the partnership must perform the normal end-of-period closing of revenues, expenses, income summary, and drawing accounts. Then, the partnership sells its assets. Any gain or loss on the sale of the assets is allocated to the partners based on their profit-and-loss-sharing ratio from the partnership agreement. Next, the partnership pays off any liabilities it has. Last, if cash remains, the partners’ capital balances are paid. When a partnership is completely liquidated, all account balances are zero.

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The key difference in a partnership income statement and other types of company income statements is that the allocation of net income/loss is shown on the face of the statement. The key difference in the partnership balance sheet from other balance sheets is the individual capital accounts for each partner are listed in the equity section.

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