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Advanced Accounting by Debra Jeter and Paul Chaney
Chapter 15: Partnerships: Formation, Operation, and
Ownership Changes
Slides Authored by Hannah Wong, Ph.D.Rutgers University
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Partnership
Definition An association of two or more persons
to carry on as co-owners of a business for profit
Attributes an agreement the business operates for profit members of the firm must be co-
owners
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General Partnership
All partners are general partners
Mutual agency
Right to dispose of a partnership interest
Unlimited liability
Limited or uncertain life
Tax implications: partnership income is allocated to partners who are taxed on their individual tax returns (form 1040)
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Limited Partnership
At least one general partner and one limited partner
General partner: manage the firm unlimited liability
Limited partner: invest capital only limited liability
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Joint Venture
An agreement by two or more parties to accomplish a limited purpose for their mutual benefit, often to earn a profit.
Each joint venturer participates directly or indirectly in the management of the resources
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Partnership Agreement
name of the firm, identity of the partners nature, purpose and scope of business date of organization length of operating time location of business allocation of profit and loss salaries and withdrawals of assets by
partners rights, duties and obligations of each partner contractual authority of each partner
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Partnership Agreement
procedure for admitting a new partner plan on withdrawal or death of a partner procedures for arbitration of disputes fiscal period identification and valuation of initial asset
investments situations for dissolution of partnership accounting practices whether an audit is to be performed
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Financial Statement Presentation
Difference between partnership and corporation reporting: changes in partners’ equity during the
year should be disclosed partners’ salary allowances is not an
expense no income tax expense interest on capital investment is not an
expense.
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Capital vs. Drawing Accounts
Capital Account – Reflects permanent investment of partner periodically updated for withdrawals.
Drawing Account – Used to record withdrawals during the year. Closed to capital account at end of year.
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Bonus Method
MV of asset investment = negotiated capital interest
Assets contributed by Wright$40,000
Assets contributed by Young$50,000
Fair value of assets
invested$90,000
Wright, capital $45,000
Young, capital $45,000
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Goodwill Method
MV of asset investment = negotiated capital interest
Assets contributed by Wright$40,000
Assets contributed by Young$50,000
$90,000
Fair value of assets
invested
Wright, capital $50,000
Young, capital $50,000
Goodwill of $10,000 is recorded
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Profit/Loss Allocation
Profit $20,000
Fixed Ratio
Adams $14,000
Brown$6,000
7:3
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Profit/Loss Allocation
Profit $20,000
Capital Balances
Adams $14,000
Brown$6,000
7:3Adams Capital $60,000 Brown Capital $40,000
3:2
= 3:2
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Profit/Loss Allocation
Steps:
(1) Allocate profit as interest on capital investment
(2) allocate the remaining income on another basis
Interest Allocation
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Profit/Loss Allocation
The following should be specified: the interest rate capital balance to be used how remaining profit should be allocated whether or not interest should be
allocated if profit < agreed interest allocation
Interest Allocation
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Profit/Loss Allocation
Profit $20,000
Interest Allocation
Adams $5,400
Brown$5,4001:1
Interest allocated = capital balance
x interest rate
7:3Adams $6,200
Brown $3,000
Unallocated profit
Interest allocation
Allocation of remaining profit
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Profit/Loss Allocation
Allocate profit as: fixed salary or provide for a bonus as a % of net income
The net income used in bonus calculation can be before allocation of income to partners after other allocations, but before the bonus after bonus, but before other allocations after bonus and all other allocations
Salary and Bonus Allocation
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Insufficient Income to Cover Allocation
If partnership income > interest and/or salary allocation
allocate the deficiency in the agreed ratio for allocating residual income
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Insufficient Income to Cover Allocation
Profit $11,000
Adams ($2,100)
Brown($2,100)1:1
7:3Adams$4,000
Brown $3,000
Deficiency in profit
Salary allocation
Adams$6,200
Brown $2,000
Interest allocation
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Salary and Interest
Partnerships pay salary and interest to effect an equitable distribution of income.
Pay interest on initial investment as a return on investment. Compensates each partner for use of assets.
Pay salaries to partners reflective of time dedicated to partnership.
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Admission of New Partner
A new partner can acquire an interest in a partnership by:
purchasing an interest from an existing partner New partner acquires the right to share
profits only no right to participate in management
unless granted by all remaining partners
investing assets
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Assignment of Partnership Interest
By Payment to Partners - Bonus Method
Adams, Capital 18,000
Brown, Capital 12,000
Call, Capital 30,000
To transfer capital from capital accounts of Adams and Brown to Call’s capital account.
Amounts = recorded capital x % interest acquired by Call
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Assignment of Partnership Interest
By Payment to Partners - Goodwill Method
Adams, Capital 18,000
Brown, Capital 12,000
Call, Capital 30,000
To transfer capital from capital accounts of Adams and Brown to Call’s capital account.
Goodwill 20,000
Adams, Capital 12,000
Brown, Capital 8,000
To record implied goodwill = Call’s payments / % interest acquired - recorded partnership net assets
= $36000 / 30% -$100,000
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Asset Investment
BV Acquired = Assets Invested
Cash 35,000
Call, Capital 35,000
To record Call’s 1/3 capital in the partnership= (existing net assets + assets invested by Call) x 1/3
= ($70,000 + $35,000) x 1/3= $35,000
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Asset Investment
BV Acquired < Assets Invested : Bonus Method
Cash 50,000
Call, Adams 6,000
Call, Brown 4,000
Call, Capital 40,000
To record Call’s 1/3 capital in the partnership= (existing net assets + assets invested by Call) x 1/3
= ($70,000 + $50,000) x 1/3
The excess is considered
a bonus to the
existing partners
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Asset Investment
BV Acquired < Assets Invested : Goodwill Method
Goodwill 30,000
Adams, Capital 18,000
Brown, Capital 12,000
Implied total net assets = Call’s payments / % interest acquired= $50000 / 30% = $150,000
goodwill for existing partners= implied net assets x % ownership - current capital accounts
= $150,000 x 2/3 - $70,000 = $30,000
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Asset Investment
BV Acquired < Assets Invested : Goodwill Method
Cash 50,000
Call, Capital 50,000
To record Call’s 1/3 capital in the partnership= (implied net assets) x 1/3 = $150,000x 1/3
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Payment to a Retiring Partner
Payment > BV: Bonus Method
Call, Adams 30,000
Call, Brown 6,000
Call, Capital 4,000
Liability to Adams 40,000
To record $40,000 agreed payment
to Adams
The excess is considered a bonus to the retiring partners; allocated
to existing partners by their profit and loss ratio
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Payment to a Retiring Partner
Payment > BV: Goodwill Method
Goodwill 20,000
Adams, Capital 10,000
Brown, Capital 6,000
Call, Capital 4,000
Implied goodwill = excess payment to Adams / % interest withdrawn
= $10000 / 50% = $200,000
The goodwill is allocated to partners by their profit and loss ratio
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Rational for Goodwill Method in Accounting for Partnership
Membership
Differences between historical cost and market value of assets
Presence of intangible assets
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Advanced Accounting by
Debra Jeter and Paul Chaney
Copyright © 2003 John Wiley & Sons, Inc. All rights reserved.Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.
