Accounting for Partnerships

1
Accounting for Partnerships
Chapter
12
2
Partnership Form of Organization
Voluntary Association
Limited Life
Partnership Agreement
Taxation
Unlimited Liability
Mutual Agency
Co-Ownership of Property
3
Organizations with Partnership Characteristics
4
Choosing a Business Form
Many factors should be considered when choosing
the proper business form.
5
Organizing a Partnership
Partners can invest both assets and liabilities
in the partnership.
Assets and liabilities are recorded at an
agreed-upon value, normally fair market value.
Asset contributions increase the partners
capital account.
Withdrawals from the partnership decrease the
partners capital account.
6
Organizing a Partnership

• On 2/15/05, Smith and Jones form a partnership.
  Smith contributes 80,000 cash. Jones
  contributes land valued at 40,000.

7
Dividing Income or Loss
Partners are not employees of the partnership but
are its owners. This means there are no salaries
reported as expense on the income statement.
Profits or losses of the partnership are divided
on some agreed upon ratio.

• Three frequently used methods to divide income or
  loss are allocation on
• Stated ratios.
• Capital balances.
• Services, capital and stated ratios.

8
Allocation on Stated Ratios
Smith and Jones agree to divide profits or losses
¾ for Smith and ¼ for Jones. For 2005, the
partnership reported net income of 60,000.
9
Allocation on Capital Balances
Smiths capital balance, before division of
profits or losses is 80,000 and Joness capital
balance is 40,000. The partnership agreement
calls for income or loss to be allocated based on
the relative capital balances. Net income for
2005 is 60,000.
10
Allocation on Capital Balances
Smiths capital balance, before division of
profits or losses is 80,000 and Joness capital
balance is 40,000. The partnership agreement
calls for income or loss to be allocated based on
the relative capital balances. Net income for
2005 is 60,000.
11
Allocation on Services, Capital, and Stated Ratios

• Smith and Jones have a partnership agreement with
  the following conditions
• Smith receives 15,000 and Jones receives 10,000
  as annual salaries.
• Each partner is allowed an annual interest
  allowance of 5 on the beginning-of-year capital
  balance.
• Any remaining balance of income or loss is
  allocated equally.
• Net income for 2005 is 60,000.

12
Allocation on Services, Capital, and Stated Ratios
13
Partnership Financial Statements
Assume that during 2005, Smith withdrew 5,000
cash from the partnership and Jones withdrew
1,000.
14
Allocation on Services, Capital, and Stated Ratios

• Smith and Jones have a partnership agreement with
  the following conditions
• Smith receives 15,000 and Jones receives 10,000
  as annual salaries.
• Each partner is allowed an annual interest
  allowance of 5 on the beginning-of-year capital
  balance.
• Any remaining balance of income or loss is
  allocated equally.
• Net income for 2005 is 30,000.

15
Allocation on Services, Capital, and Stated Ratios
16
Admission and Withdrawal of Partners

• When the makeup of the partnership changes, the
  partnership is dissolved.
• A new partnership may be immediately formed.
• New partner acquires partnership interest by
• Purchasing it from the other partners, or
• Investing assets in the partnership.

17
Admission of a Partner
Purchase of Partnership Interest

• A new partner can purchase partnership interest
  directly from the existing partners.
• The cash goes to the partners, not to the
  partnership.
• To become a partner, the new partner must be
  accepted by the current partners.

18
Purchase of Partnership Interest

• On January 2, 2006, Jones agrees to sell Johnson
  10,000 of her partnership interest for 25,000
  cash. Smith agrees with this arrangement.

19
Investing Assets in a Partnership

• The new partner can gain partnership interest by
  contributing assets to the partnership.
• The new assets will increase the partnerships
  net assets.
• After admission, both assets and equity will
  increase.

20
Investing Assets in a Partnership

• On January 2, 2006, Smith and Jones agree to
  accept Johnson as a partner upon his investment
  of 30,000 cash in the partnership.

21
Bonus to Old or New Partners
22
Bonus to Old Partners

• On January 2, 2006, Smith and Jones agree to
  accept Johnson as a partner upon his investment
  of 60,000 cash in the partnership. Johnson is to
  receive a 20 ownership interest in the new
  partnership. Any bonus is attributable to the
  existing partners and is shared equally.

23
Bonus to Old Partners

• On January 2, 2006, Smith and Jones agree to
  accept Johnson as a partner upon his investment
  of 60,000 cash in the partnership. Johnson is to
  receive a 20 ownership interest in the new
  partnership. Any bonus is attributable to the
  existing partners and is shared equally.

24
Bonus to New Partner

• On January 2, 2006, Smith and Jones agree to
  accept Johnson as a partner upon his investment
  of 60,000 cash in the partnership. Johnson is to
  receive a 30 ownership interest in the new
  partnership. Any bonus is attributable to the new
  partner and is shared equally by the existing
  partners.

25
Bonus to New Partner

• On January 2, 2006, Smith and Jones agree to
  accept Johnson as a partner upon his investment
  of 60,000 cash in the partnership. Johnson is to
  receive a 30 ownership interest in the new
  partnership. Any bonus is attributable to the new
  partner and is shared equally by the existing
  partners.

26
Withdrawal of a Partner

• A partner can withdraw in two ways
• The partner can sell his/her partnership interest
  to another person.
• The partnership can distribute cash and/or other
  assets to the withdrawing partner.

27
Withdrawal of a Partner
Jones has a capital balance of 65,500. She
decides to withdraw from the partnership of
Smith, Jones, and Johnson for 50,000 cash. Any
bonus is attributable to the remaining partners
and is divided equally.
28
Liquidation of a Partnership

• When a partnership is dissolved, four steps are
  required
• Noncash assets are sold for cash and a gain or
  loss on liquidations is recorded.
• Gain or loss on liquidation is allocated to
  partners using their income-and-loss ratio.
• Liabilities are paid or settled.
• Any remaining cash is distributed to partners
  based on their capital balances.

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No Capital Deficiency
No capital deficiency means that all partners
have a zero or credit balance in their capital
accounts.
Smith, Jones, and Johnson agree to dissolve their
partnership. They sell all of their assets for
a net gain of 10,000. Profits and losses are
shared as follows Smith, ½ Jones, ¼ and
Johnson, ¼.
30
Capital Deficiency
Capital deficiency means that at least one
partner has a debit balance in his/her capital
account. A partner with a deficit must, if
possible, cover the deficit by paying cash into
the partnership.
Smith, Jones, and Johnson agree to dissolve their
partnership. They sell all of their assets for
a net loss of 10,000. Profits and losses are
shared as follows Smith, ½ Jones, ¼ and
Johnson, ¼.
31
Capital Deficiency
Any partners unpaid deficiency is absorbed by
the remaining partners with credit balances in
accordance with the partnership agreement.
32
Partner Return on Equity
33
End of Chapter 12