18–1 McQuaig Bille 1 College Accounting 10 th Edition McQuaig Bille Nobles © 2011 Cengage Learning PowerPoint presented by Douglas Cloud Professor Emeritus

18–1McQuaig Bille

11College Accounting10th Edition

McQuaig Bille Nobles

© 2011 Cengage Learning

PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

Chapter 18

Partnerships

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Types of PartnershipsTypes of Partnerships A general partnership (GP) is an association of two or

more people or firms to carry on, as co-owners, of a business for profit. The partners are called general partners.

A limited partnership (LP) is an organization with two or more people or firms with at least one general partner and one limited partner. A limited partner or partners have the largest share of invested capital, are not involved in the day-to-day operations, and usually cannot lose more than their capital contribution.

A limited liability partnership (LLP) is an organization similar to a limited partnership except that all partners may take an active role in the business of the partnership with only their invested capital at risk.

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Characteristics of a PartnershipsCharacteristics of a Partnerships

Co-ownership of partnership property• According to the co-ownership concept, each partner

owns half of each asset owned by the business. Limited Life

• A partnership may be ended by the death, bankruptcy, incapacity, or withdrawal of a partner.

• May also be ended by the expiration of a specified period of time or the completion of a project.

Mutual Agency• The mutual agency concept allows each partner to enter

into binding contracts in the name of the firm for the purchase or sale of goods or services within the normal scope of the firm’s business and based upon the provisions of the partnership agreement.

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Characteristics of a PartnershipsCharacteristics of a Partnerships Taxation

Federal income taxes are not levied against a partnership.

A partner has to file an individual income tax return .

Unlimited Liability General partners are personally liable for all

debts that are incurred by the partnership.

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Characteristics of PartnershipsCharacteristics of Partnerships

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Partnership AgreementsPartnership Agreements

A limited partnership and a limited liability partnership must be based upon a written contract, called a partnership agreement, with the following provisions: Effective date of the agreement Names and addresses of the partners Name, location, and nature of the business Type of partnership Management structure Duration of agreement Investment of each partner Procedure for sharing profits and losses Withdrawals to be allowed each partner Procedure for a partner’s exit from the business Provision for division of assets upon liquidation

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Recording Investments—Formation of a PartnershipRecording Investments—

Formation of a Partnership

Ron P. Duncan owns Duncan Accounting. Stephen A. James decides to join him and form a partnership. James invests $190,000 in cash into the partnership.

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Duncan Accounting has the following account balances:



Cash $183,300Accounts Receivable 18,000Allowance for Doubtful Accounts 200Equipment 16,000Accumulated Depreciation, Equipment 4,500Accounts Payable 8,400Notes Payable 1,600

The two men agree that $400 of Accounts Receivable is uncollectible.

17,600

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There is some doubt as to the collectibility of $500 of the remaining Accounts Receivable.

17,600 500

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An independent appraiser valued the equipment at $9,000.

9,000 0

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Additional InvestmentsAdditional Investments

On October 1, each partner’s invests an additional $7,000.

Additional InvestmentsAdditional InvestmentsAt the end of the year, before the books are closed, R. P. Duncan, Capital appears as follows:

At the end of the year, before the books are closed, S. A. James, Capital appears as follows:

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WithdrawalsWithdrawals

On March 17, Duncan withdrew $4,620 in cash from the partnership. On May 4, James withdrew cash from the partnership, $3,742.

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Closing Entries for a PartnershipClosing Entries for a Partnership

STEP 1. Close the revenue accounts into Income Summary.

STEP 2. Close the expense accounts into Income Summary.

STEP 3. Close Income Summary into each partner’s Capital account by each partner’s share of the net income or net loss.

STEP 4. Close each partner’s Drawing account into their respective Capital accounts.

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Division of Net Income or Net Loss


The share of net income (or net loss) allocated to each partner is know as his or her distributive share.

Four methods for sharing earnings:

1. Division of income based on fractional shares

2. Division of income based on the ratio of capital investments

3. Division of income based on salary allowance

4. Division of income based on interest allowance

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EXAMPLE 1 Net Income $248,000D. R. Durr, Capital 300,000D. R. Durr, Drawing 120,000N. A. Jacob, Capital 75,000N. A. Jacob, Drawing 20,000

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Assume that the partnership agreement stipulates that profits and losses are to be divided three-fourths to Durr and one-fourth to Jacob, or a 3-to-1 ratio.

We turn the ratio into a fraction by making the partner’s share the numerator and the total shares the denominator, thus ¾ and ¼.

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Division of Income Based on Fractional Shares


In Example 1, the net income is $248,000. Durr is allocated ¾ and Jacob ¼, as follows:

Durr: $248,000 x ¾ = $186,000

Jacob: $248,000 x ¼ = $ 62,000



STEP 3. Close Income Summary to the Capital accounts.

STEP 4. Close drawing accounts into the capital accounts.

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EXAMPLE 2 Net Loss $ (4,000)D. R. Durr, Capital 300,000D. R. Durr, Drawing 120,000N. A. Jacob, Capital 75,000N. A. Jacob, Drawing 20,000



The net loss is $4,000. Durr’s portion is ¾ and Jacob’s portion is ¼. The loss is divided as follows:

Durr: $(4,000) x ¾ = $(3,000)Jacob: $(4,000) x ¼ = $(1,000)

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STEP 3: Closing entries.

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STEP 4: Closing the drawing accounts provides the same result as shown in Example 1.

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Assume that the partnership agreement stipulates that profits and losses are to be divided according to the ratio of their investments at the beginning of the year.

Division of Net Income or Net Loss Based on Ratio of Capital Investments


EXAMPLE 1

Net Income $248,000D. R. Durr, Capital 300,000D. R. Durr, Drawing 120,000N. A. Jacob, Capital 75,000N. A. Jacob, Drawing 20,000

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In Example 1, the net income is $248,000. Durr is allocated $300,000/$375,000, while Jacob is allocated $75,000/$375,000. We can now calculate their respective shares as follows:

Durr: $300,000/$375,000 (or 80%) = $198,400

Jacob: $75,000/$375,000 (or 20%) = $ 49,600

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Closing EntriesClosing Entries

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EXAMPLE 2

Net Loss $ (4,000)D. R. Durr, Capital 300,000D. R. Durr, Drawing 120,000N. A. Jacob, Capital 75,000N. A. Jacob, Drawing 20,000



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In Example 2, the net loss is $4,000. Durr’s portion is 80 percent and Jacob’s portion is 20 percent. The loss is divided as follows:

Durr: $(4,000) x 0.80 = $(3,200)

Jacob: $(4,000) x 0.20 = $ (800)

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Division of Net Income or Net Loss Based on Ratio of Capital InvestmentsSTEP 3: Closing entries.

STEP 4: Closing the drawing accounts provides the same result as shown in Example 1.

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When there is a net income of $248,000, the Division of Net Income Section of the incomes statement is as follows:

Division of Income Based on Salary Allowance

Division of Income Based on Salary Allowance

EXAMPLE 1

Net income $248,000Less amount allocated to salaries ($60,000 + $40,000) (100,000)Remainder $148,000

Remainder ÷ 2 = = $74,000$148,000

2

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Closing EntriesClosing Entries

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Division of Loss Based on Salary Allowance


EXAMPLE 2

Net loss $ (4,000)Less amount allocated to salaries ($60,000 + $40,000) (100,000)Remainder $(104,000)

Remainder ÷ 2 = = $(52,000)$104,000

2

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In addition to their salary allowances of $60,000 and $40,000, the partners at Durr & Jacob are allowed a 6 percent interest on their Capital balances at the beginning of the fiscal year, calculated as follows:

Division of Income Based on Interest Allowance


Interest allowance for Durr $300,000 x 0.06 = $18,000Interest allowance for Jacob $75,000 x 0.06 = $ 4,500

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The accountant calculates the remainder in the following way:

Net income $248,000Less:

Amount allocated as salaries ($60,000 + $40,000) $(100,000)Amount allocated as interest ($18,000 + $4,500) (22,500) (122,500)

Remainder $125,500Remainder ÷ 2 $ 62,750



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Division of Loss Based on Interest Allowance


EXAMPLE 2 The partnership has a loss of $4,000.

Net loss $ (4,000)Less:

Amount allocated as salaries ($60,000 + $40,000) $(100,000)Amount allocated as interest ($18,000 + $4,500) (22,500) (122,500)

Remainder $(126,500)Remainder ÷ 2 $ (63,250)

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Statement of Partners’ EquityStatement of

Partners’ Equity

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Sale of a Partnership InterestSale of a Partnership Interest

At the end of a given year, N. A. Jacob has a Capital balance of $163,520 and decides to sell his interest to K. R. Gott for $182,000.

Partner Withdraws Book Value of His or Her Equity After RevaluationPartner Withdraws Book Value of

His or Her Equity After Revaluation

J. W. Navarro is retiring from the partnership of Turner, Navarro, and Teague, LP. The partnership agreement stipulates that net income and net loss shall be shared on an equal basis. It also provides for revaluation of assets in the event that a partner retires.At this point, an accountant (usually someone from outside the firm) examines the books and the firm’s assets are appraised. The review and appraisal indicate that Merchandise Inventory is undervalued by $9,600, that Allowance for Doubtful Accounts should be increased by $300, and that Equipment is overvalued by $2,100.



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J. W. Navarro is issued a check equal to her equity in the firm.

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Partner Withdraws More Than Book Value of His or Her Equity

Partner Withdraws More Than Book Value of His or Her Equity

When Navarro announced that she was going to retire, Turner and Teague agreed to pay her $99,400 for her interest in the partnership.

The partners share profits and losses equally, so the excess of $1,000 ($99,400 – $98,400) is deducted equally from the remaining partners’ Capital accounts.

Partner Withdraws Less Than Book Value of His or Her Equity

Partner Withdraws Less Than Book Value of His or Her Equity

Navarro is willing to withdraw if she gets just $94,200 cash out of the business. The difference of $4,200 ($98,400 – $94,200) represents a bonus to the remaining partners. Assuming they split profits and losses equally, each remaining partner’s Capital increases by $2,100.

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Death of a PartnerDeath of a Partner

The death of a partner automatically ends the partnership.

The partner’s estate is entitled to receive the amount of his or her equity.

Partnership agreements usually provide for an examination and revaluation of the assets at this time.

To insure that there is enough cash, partners and partnerships often carry life insurance policies.

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Liquidation of a PartnershipLiquidation of a Partnership

A liquidation means an end, not only of the partnership, but of the business itself.

STEP 1. Sale of the assets, using the Loss or Gain from Realization account.

STEP 2. Allocation of the loss or gain.

STEP 3. Payment of the liabilities.

STEP 4. Distribution of the remaining cash to the partners, in accordance with the balances of their Capital accounts.

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Assets Sold at a ProfitAssets Sold at a Profit

The firm sells its merchandise inventory for $46,000 and the other assets for $70,000.

At the time of liquidation Merchandise Inventory has a balance of $40,000 and the other assets are listed at $60,000.

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Assets Sold at a Loss: Partners’ Capital Account Sufficient to Absorb Loss

Assets Sold at a Loss: Partners’ Capital Account Sufficient to Absorb Loss

The firm sells its merchandise inventory for $36,000 and the other assets for $52,000.

At the time of liquidation Merchandise Inventory has a balance of $40,000 and the other assets are listed at $60,000.

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Assets Sold at a LossAssets Sold at a Loss

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Assets Are Sold at a Loss: Partners’ Capital Account Sufficient to Absorb Loss

Assets Are Sold at a Loss: Partners’ Capital Account Sufficient to Absorb Loss

Documents

18–1 McQuaig Bille 1 College Accounting 10 th Edition McQuaig Bille Nobles © 2011 Cengage Learning PowerPoint presented by Douglas Cloud Professor Emeritus