PARTNERSHIPS:

1
CHAPTER 20

• PARTNERSHIPS
• FORMATION AND OPERATION

2
FOCUS OF CHAPTER 20

• Types of Partnerships
• Major Features of the Partnership Form of
  Business
• Formation of a Partnership
• Methods to Share Profits and Losses
• Financial Reporting Issues
• Income Tax Aspects

3
Definition of a Partnership

• A partnership is an association of two or more
  persons who
• Are co-owners of a business.
• Share profits and losses in an agreed-upon
  manner.
• A person can be
• An individual.
• A corporation.
• Another partnership.

4
Types of Partnerships

• General Partnerships
• All partners have unlimited liability.
• Thus creditors can go after the personal assets
  of any or all of the partners.
• Since 1993, many accounting firms have abandoned
  this form of organization in favor of limited
  liability partnerships (LLPs).

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Types of Partnerships

• Limited Liability Partnerships (LLPs)
• A partners personal assets are at risk only for
• His or her OWN negligence and wrongdoing.
• The negligence and wrongdoing of those under his
  or her control.
• This form of organization has not been tested in
  the courts.

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Types of Partnerships

• Limited Partnerships
• Certain partners have limited liability to
  partnership creditors if the partnership is
  unable to pay its creditors.
• Usually the partners risk is limited to the
  partners capital invested.
• Thus personal assets are not at risk.
• At least 1 of the partners must be a general
  partner.

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Partnership Form of Organization Advantages
Disadvantages

• Advantages
• Ease of formation.
• Lack of formality.
• A closer sense of bonding among partners.
• Single taxation (see following slide).
• Disadvantages
• Unlimited liability (for general partnerships).
• Difficulty of disposing of interest.

8
Partnership Form of Organization Income Tax
Reporting

• Single Taxation of Partnership Earnings
• Partnerships only report their earningsthey are
  not taxed at the business entity level (as are
  corporations).
• Partnerships file IRS Form 1065, which shows the
  allocation of profits among partners.
• Partners report their share of profits on their
  individual IRS Form 1040 return.

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The Uniform Partnership Act (UPA)

• Each state has laws governing the conduct of
  partnerships.
• Most states have adopted the RUPA or a variation
  thereof. The RUPA covers
• Relations of partners to one another.
• Relations of partners to persons dealing with the
  partnership.
• Dissolution and winding up of the partnership.

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The Partnership Agreement

• The Partnership Agreement A written expression
  of what the partners have agreed to. Examples of
  areas addressed are
• Manner of sharing profits.
• Limitations on withdrawals.
• Rights of partners.
• Settling with withdrawing partners.
• Expulsion of partners.
• Conflicts of interest.

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General Matters

• SEPARATENESS The business of a partnership
  should always be accounted for separately from
  the partners personal transactions.
• GAAP Partnershipsunlike public corporationsdo
  not have to follow GAAP often they do not.
• FOCUS The accounting focus is achieving equity
  (fairness) among the partners.

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Partners Accounts

• Each partner can have
• A capital account.
• A drawing account (a contra capital
  accountclosed out at year-end).
• A loan account (loans usually earn interesta
  partnership expense).
• Partnerships do NOT use
• A retained earnings account.

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Recording the Capital Contributions

• Two Fundamental Principles for Achieving Equity
  among the Partners
• Current values should be used to value
• Noncash assets contributed to a partnership.
• Liabilities assumed by a partnership.

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Methods to Share Profits and Losses

• Partners can share profits and losses in any way
  they choose. Possible ways include
• Ratios.
• Salary allowances and ratios.
• Imputed interest on capital, salary allowances,
  and ratios.
• Capital balances only.
• Performance methods.

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Methods to Share Profits and Losses Order of
Priority Provision

• When an order of priority provision exists
• The exact sequence for sharing profits and
  losses specified in the partnership agreement
  must be followed.
• The next lower level method of sharing can be
  reached if and only if there is still unallocated
  profit remaining after dealing with the current
  level.

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Review Question 1

• Dee and Jay created a partnership (DJ) on
  12/31/05 (sharing profits 50-50). Dee contributed
  equipment from her sole proprietorship having a
  carrying value of 5,000 and a fair value of
  9,000. In 2006, DJ had profits of 88,000 and
  borrowed 20,000 from a bank. In 2006, Dee
  withdrew 30,000 cash. Dees Y/E capital balance
  is A. 13,000 B. 19,000 C. 23,000 D.
  43,000

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Review Question 1With Answer

• Dee and Jay created a partnership (DJ) on
  12/31/05 (sharing profits 50-50). Dee contributed
  equipment from her sole proprietorship having a
  carrying value of 5,000 and a fair value of
  9,000. In 2006, DJ had profits of 88,000 and
  borrowed 20,000 from a bank. In 2006, Dee
  withdrew 30,000 cash. Dees Y/E capital balance
  is A. 13,000 B. 19,000 C. 23,000 (9,000
  88,000/2 - 30,000)D. 43,000

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End of Chapter 20(Appendix 20A follows)

• Time to Clear Things UpAny Questions?

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Appendix 20A Income Taxes
Appendix 20A

• A partnership interest is a capital assetit is
  the equivalent of owning shares of common stock
  in a corporation.
• Individuals keep track of their cost basis of
  shares owned in corporations.

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Appendix 20A Income Taxes
Appendix 20A

• Tax Basis A partners cost basis in the
  partnershipcommonly referred to merely as
  basis.
• Each partner keeps track of his or her own tax
  basis.
• Tracking is needed to determine thetaxable gain
  or loss to be reported onthe disposal of the
  partnership interest.

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Appendix 20A Income Taxes
Appendix 20A

• Items That Increase Tax Basis
• Profits.
• Capital contributions.
• An increase in partnership liabilities (shared in
  the profit and loss sharing ratio).
• Items That Decrease Tax Basis
• Losses.
• Capital withdrawals (distributions).
• A decrease in partnership liabilities.

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Appendix 20A Income Taxes
Appendix 20A

• What is the most important thing to ignore for
  tax reporting purposes?ANSWER A partners
  general ledger capital
  balanceit is totally
  irrelevant.

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Review Question 20A-1
Appendix 20A

• Dee and Jay created a partnership (DJ) on
  12/31/06 (sharing profits 50-50). Dee contributed
  equipment from her sole proprietorship having (1)
  a carrying value of 5,000, (2) a tax basis of
  6,000, and (3) a fair value of 9,000. Dees tax
  basis in DJ isA. 5,000 B. 6,000 C. 7,000
  D. 8,000 E. 9,000

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Review Question 20A-1With Answer

• Dee and Jay created a partnership (DJ) on
  12/31/06 (sharing profits 50-50). Dee contributed
  equipment from her sole proprietorship having (1)
  a carrying value of 5,000, (2) a tax basis of
  6,000, and (3) a fair value of 9,000. Dees tax
  basis in DJ isA. 5,000 B. 6,000 C. 7,000
  D. 8,000 E. 9,000

Appendix 20A
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Review Question 20A-2
Appendix 20A

• Use the information in the preceding question,
  but also assume that (1) Dee contributed a 2,000
  liability to DJ and (2) DJ borrowed 4,000 from
  a bank on 12/31/06? What is Dees tax basis in
  DJ?A. 5,000 B. 6,000 C. 7,000 D. 8,000
  E. 9,000

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Review Question 20A-2With Answer
Appendix 20A

• Use the information in the preceding question,
  but also assume that (1) Dee contributed a 2,000
  liability to DJ and (2) DJ borrowed 4,000 from
  a bank on 12/31/06? What is Dees tax basis in
  DJ?A. 5,000 B. 6,000 C. 7,000 (6,000 -
  2,000 x 50 4,000 x 50) D. 8,000
  E. 9,000