PARTNERSHIPS:

1
CHAPTER 21

• PARTNERSHIPS
• CHANGES IN OWNERSHIP

2
FOCUS OF CHAPTER 21

• Tangible Assets Having Values Different from Book
  Values
• Intangible Element Exists Recording Methods and
  Alternative Approaches
• Intangible Element Exists Specific Situations
• Legal Aspects of Changes in Ownership
• Tax Aspects of Changes in Ownership

3
Partners AdmissionPurchase of An Existing
Interest

• The purchase of an interest from one or more of a
  partnerships existing partners is a
• PERSONAL TRANSACTION between the incoming partner
  and the selling partner(s).
• The ONLY entry required on the partnerships
  books is to TRANSFER an amount
• From the selling partners Capital account.
• To the new partners Capital account.

4
Methods to Minimize Inequities

• The Three Methods
• The revaluing of assets/recording the goodwill
  method.
• The special profit-and-loss sharing provision
  method.
• The bonus method.
• Some methods can still result in inequities if
  events do not materialize as assumed.

1
2
3
5
Best Minimizing Inequities

• ONLY the SPECIAL PROFIT-AND-LOSS SHARING
  PROVISION METHOD will prevent an inequity to one
  or more of the partners in the event that
• The agreed-upon values of the assets are
  erroneous.
• The agreed-upon value of goodwill does not
  materialize.

6
The Bonus Method

• Major Advantages
• Does not result in a departure from GAAP.
• Minimizes bookkeeping tax return effort.
• Mechanics
• A portion of one or more partners capital
  balance is TRANSFERRED to one or more other
  partners.
• The hope is that the transferred amount will
  later be recouped via future profits.

7
The Bonus MethodWhen to Apply It

• The bonus method may be applied when

New Old
New Partnership Partners
Partners Asset Capital
Capital Investment
8
The Revaluing of Assets/Recording The Goodwill
Method

• Advantages
• Incoming partners ALWAYS get credited to their
  capital accounts the full value of their asset
  investment (sometimes important psychologically).
• Disadvantages
• Departs from GAAP.
• Complicates income tax preparation.

9
The Goodwill MethodWhen to Apply It

• The goodwill method is applied when

New Old
New Partnership gt Partners
Partners Asset Capital
Capital Investment
10
Legal AspectsJoining a Partnership

• A major risk of joining an existing partnership
  is the general practice of requiring the new
  partner to become jointly responsible for
• ALL pre-existing partnership liabilities.
• ALL pre-existing contingent liabilities.

11
Legal AspectsWithdrawing From a Partnership

• A partner that withdraws from a partnership is
  still responsible for the following items that
  exist at the time of the withdrawal
• ALL partnership obligations.
• ALL contingent liabilities.
• ONLY creditors can expressly release a partner
  from this responsibility.

12
Legal AspectsWithdrawing From a Partnership

• Disassociation A broad term that refers to when
  a partner is no longer associated with a
  partnership.
• Dissolution A narrow term that refers to when a
  (1) partnership is dissolved and (2) its affairs
  must be wound up. Thus the partnerships
  existence is terminated.

13
Review Question 1

• Newby contributes 36,000 cash for a 25
  interest in the new net assets of the
  partner-ship (that has existing equity of
  120,000). The old partners capital accounts
  are not to decrease. Newbys capital account is
  creditedA. 6,000B. 36,000C. 39,000
  D. 40,000 E. 51,000

14
Review Question 1With Answer

• Newby contributes 36,000 cash for a 25
  interest in the new net assets of the
  partner-ship (that has existing equity of
  120,000). The old partners capital accounts
  are not to decrease. Newbys capital account is
  creditedA. 6,000B. 36,000C. 39,000
  D. 40,000 (120,000/75 - 120,000)
  E. 51,000

15
Review Question 2

• Upon withdrawal from a partnership, Leavy
  received 7,000 cash in excess of his capital
  balance. Leavys share of profits and losses was
  20. Partnership land was undervalued 25,000.
  The partnership goodwill isA. 2,000
  B. 10,000C. 12,000 D. 35,000

16
Review Question 2With Answer

• Upon withdrawal from a partnership, Leavy
  received 7,000 cash in excess of his capital
  balance. Leavys share of profits and losses was
  20. Partnership land was undervalued 25,000.
  The partnership goodwill isA. 2,000 B.
  10,000 (5 x 7,000 - 20 x 25,000) C.
  12,000 D. 35,000

17
End of Chapter 21 (Appendix 21A follows)

• Time to Clear Things UpAny Questions?

18
Appendix 21A Income Tax Aspects
Appendix 21A

• Upon withdrawal from a partnership, the partner
  must determine whether there is again or loss
  for tax-reporting purposes.
• This determination is made by comparing
• The partners proceeds with
• The partners tax basis.

19
Appendix 21A Income Tax Aspects
Appendix 21A

• A partners proceeds are the sum of
• Cash received plus
• The partners share of existing liabilities for
  which he or she is relieved of responsibility.
• The share is determined by applying the
  partners profit-sharing percentage.

20
Review Question 21A-1
Appendix 21A

• Gale contributes 50,000 cash and a 24,000
  liability upon admission into a partnership that
  has existing liabilities of 60,000. Gales share
  of profits and losses is 25. What is Gales tax
  basis immediately after admission? A.
  32,000B. 41,000C. 47,000D. 50,000E.
  59,000

21
Review Question 21A-1With Answer
Appendix 21A

• Gale contributes 50,000 cash and a 24,000
  liability upon admission into a partnership that
  has existing liabilities of 60,000. Gales share
  of profits and losses is 25. What is Gales tax
  basis immediately after admission?
  A. 32,000B. 41,000C. 47,000 (50,000
  60,000/4 - 24,000 x 75)D. 50,000E. 59,
  000

22
Review Question 21A-2
Appendix 21A

• Upon withdrawal from a partnership (that has
  existing liabilities of 80,000), Gawner receives
  50,000 cash. Gawners share of profits and
  losses was 25. What is Gawners taxable gain or
  loss if his tax basis immediately before
  withdrawing was 66,000? A. 4,000B.
  14,000C. 16,000 D. 36,000

23
Review Question 21A-2With Answer
Appendix 21A

• Upon withdrawal from a partnership (that has
  existing liabilities of 80,000), Gawner receives
  50,000 cash. Gawners share of profits and
  losses was 25. What is Gawners taxable gain or
  loss if his tax basis immediately before
  withdrawing was 66,000? A. 4,000 (50,000
  80,000/4 - 66,000)B. 14,000C. 16,000
  D. 36,000