Partnership Accounting Chapter Summary

CHAPTER
14
Partnership Accounting
LEARNING OBJECTIVES
When you have completed this chapter, you should
1. have a better understanding of accounting terminology.
2. understand the general characteristics of a partnership and the importance
of each one.
3. be able to calculate the division of profits, prepare the proper journal entries,
and prepare the financial statements for a partnership.
4. be able to calculate and prepare the journal entries for the sale of a partner-
ship interest, the withdrawal of a partner, and the addition of a partner.
5. be able to calculate and prepare the journal entries for a partnership that is
going out of business.
VO C A B U L A RY
account form a balance sheet that shows assets on the left-hand side and liabilities and
balance sheet owners equity on the right-hand side
deficit a deficiency in amount; i.e., in this chapter, a deficit balance in the capital
account is an abnormal, or a debit, balance
liquidation to settle the accounts and distribute the assets of a business
mutual agency the legal ability of a partner to bind the partnership to contracts within the
scope of the partnership
partnership a voluntary association of two or more legally competent persons who agree to
do business as co-owners for profit
profit-loss ratio the method chosen by partners for dividing the profits or losses; also called the
income and loss sharing ratio
realization the conversion of noncash assets to cash
unlimited liability each partner is personally liable for the business debts
Introduction
The three common types of business are the proprietorship, the corporation, and the
partnership. It is important to note that corporations, though fewer in number than
proprietorships or partnerships, transact at least 10 times the business of all other busi-
ness forms combined. There are advantages and disadvantages to each type of business
organization.
Partnership Accounting 377
Accounting for a partnership is similar to accounting for a proprietorship except

there is more than one owner.
General Partnership Characteristics

General partnerships and limited partnerships are recognized by Canadian law. In this
chapter, we will concentrate on general partnerships, which are governed by provincial
law and registration requirements, and which have certain characteristics. Following is a
discussion of each.
Voluntary Association
A partnership is a voluntary association of two or more legally competent persons (per-
sons who are of age and sound mental capacity) to carry on as co-owners a business for
profit. Because a partnership is based on agreement, no person can be a partner against
her or his will. Doctors, accountants, and lawyers frequently form partnerships, and this
form of business organization is common in small service and retail businesses.
Partnership Agreement
Two or more legally competent people may form a partnership. It is best if their agree-
ment is in writing, but it may be expressed verbally. The partnership contract is prepared
by a lawyer, though an acccountant may review it. The contract will stipulate, among
other things, how partnership income and losses are to be divided among the partners.
Taxation
A partnership is taxed like a proprietorship. In other words, the partners are taxed based
upon the partnerships net income, not on their withdrawals from the business.
Limited Life
A partnership is a business carried on by individuals and can not exist separate and apart
from those individuals. Should something happen to take away the ability of a partner
to contract (death, bankruptcy or lack of legal capacity), the partnership may be termi-
nated. Also, the life of a partnership may be limited by terms in the partnership contract,
or it may be terminated by any one of the partners at will.
Mutual Agency
Mutual agency is the legal ability of each partner, acting as an agent of the business, to
enter into and bind it to contracts within the scope of the partnership. For example,
Alyce, Ben, and Charlie are partners in an accounting firm. Ben may bind the partner-
ship by contracting to buy a computer for the business, even if the other two partners
know nothing of the purchase. They are bound to the contract because a computer is an
expected and necessary piece of equipment for an accounting firm. However, the firm
would not be bound if Ben should contract to buy land with the expectation that its
value would increase because this transaction is considered to be outside the purpose of
an accounting business.
Partners may agree to limit the power of one or more of the partners to negotiate con-
tracts for the business. Outsiders are bound by this agreement only if they are aware of it.
Unlimited Liability
Much like in a proprietorship, partners have unlimited liability for their business.
Unlimited liability means that each partner is personally liable for the debts of the
378 C H A P T E R f o u r t e e n
business. When a partnership business is unable to pay its debts, the creditors may sat-
isfy their claims from the personal assets of any of the partners. If any one partner can
not pay her or his share of the debt, creditors may make their claims against any of the
other partners.
Advantages and Disadvantages of a Partnership

A partnership has advantages over other forms of business. By combining the abilities
and capital of two or more persons, business potential may be greatly expanded. Also, a
partnership is much easier to form than a corporation because an agreement between
parties is all that is required. However, there are several disadvantageslimited life,
unlimited liability, and mutual agency are among these and pose potential legal prob-
lems that must be considered when forming any new partnership.
The Drawing Account

Partnership accounting is the same as accounting for a proprietorship except there are
separate capital and drawing accounts for each partner. The fundamental accounting
equation (Assets = Liabilities + Owners Equity) remains unchanged except that total
owners equity is the sum of the partners capital accounts. Similar to a proprietorship,
the partners (owners) do not receive salaries but withdraw assets from the business for
their personal needs. Generally, the rules for withdrawals are decided beforehand by the
partnership agreement. For example, assume that Partner Arnold withdraws $5,000
from a partnership firm of which he is a member. The journal entry to show this with-
drawal is as follows:
GENERAL JOURNAL Page

POST
DATE DESCRIPTION REF. DEBIT CREDIT
20XX
Jan. 15 Arnold, Drawing 5 0 0 0 00
Cash 5 0 0 0 00
To Record the Withdrawal of Cash
At the end of the accounting period, the drawing accounts of each partner are closed
to their individual capital accounts. Following is the journal entry to close the drawing
account of Partner Arnold to his capital account.

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20XX
Jan. 31 Arnold, Capital 5 0 0 0 00
Arnold, Drawing 5 0 0 0 00
To Record the Closing of Arnolds Drawing
Account to Capital
Accounting for a partnership requires calculations be made for the division of prof-
its and losses and the preparation of journal entries for the addition or withdrawal of a
partner. In addition, special problems must be solved when a partnership is going out of
business. Each of these will be discussed in the following paragraphs.
Dividing the Net Income

Remember that partners are owners of the business, not employees, and as such, may
divide their net income as they choose. The partnership contract, however, must state
how the net income or loss is to be divided. If there is no contract, the law states that
profits and losses will be divided equally. The method chosen by the partners for divid-
ing the profits or losses is called the profit-loss ratio. This chapter will discuss a num-
ber of methods that may be used. Profits and losses:
1. may be divided equally
2. may be distributed on a fractional basis
3. may be distributed based on amounts invested
4. may be distributed using a fixed ratio
5. may be distributed using a salary allowance with any remaining profits divided
equally or using a ratio
Dividing Net Income Equally

Partners may divide profits equally. For example, M. Saar, J. Loretto, and S. Abdullah are
partners. Saar invested $50,000 in cash and other assets, Loretto invested $30,000 cash,
and Abdullah invested $40,000 cash in their accounting firm. The following balance
sheet was prepared on December 31 before adjusting and closing entries for the year had
been prepared.
Saar, Loretto, and Abdullah, Accountants

Balance Sheet
December 31, 20XX
Assets
Cash $ 8 0 0 0 0 00
Other Assets 5 0 0 0 0 00
Total Assets $ 1 3 0 0 0 0 00
Liabilities
Accounts Payable $ 1 0 0 0 0 00
Owners Equity
Saar, Capital 5 0 0 0 0 00
Loretto, Capital 3 0 0 0 0 00
Abdullah, Capital 4 0 0 0 0 00 1 2 0 0 0 0 00
Total Liabilities and Owners Equity $ 1 3 0 0 0 0 00
Revenues were $96,000 and expenses were $60,000, leaving $36,000 net income to be
distributed to the three partners capital accounts. Once the amount to be allocated is deter-
mined, a closing entry crediting the capital accounts is required. If net income is to be
divided equally, the Income Summary account is closed to the capital accounts as follows:

POST
20XX
Dec. 31 Income Summary 3 6 0 0 0 00
Abdullah, Capital 1 2 0 0 0 00
To Close Income Summary to Capital
Dividing Net Income Based on Amounts Invested

The partners may agree to divide net income using a fraction determined by using the
amounts of the original capital investment. The following shows the steps involved in
this calculation:
1. Determine the amounts originally invested.
Saar $ 50,000
Loretto 30,000
Abdullah 40,000
Total $120,000
2. Determine fractions. (The denominator is the total amount invested, $120,000,

and each partners individual investment becomes the numerator.)
Profits to be Total
Ratio Divided Allocated
50,000 5
Saar = $36,000 = $15,000
120,000 12
30,000 3
Loretto = 36,000 = 9,000
120,000 12
40,000 4
Abdullah = 36,000 = 12,000
120,000 12
Total to be allocated $36,000
The general journal entry to close the Income Summary to the capital accounts is as
follows:

POST
20XX
Loretto, Capital 9 0 0 0 00
To Record the Closing of the Income
Summary to Capital
Dividing Net Income Using a Fixed Ratio

In the partnership agreement, the contract may specify a fixed ratio to be used to divide
the profits or losses. For example, Saar, Loretto, and Abdullah decide to use a ratio of
3:2:1, respectively. To use this ratio, convert the ratio into a fraction and multiply it by
the net income or loss of the period. The steps for using the ratio to divide the profit are
as follows:
1. Determine the fraction from the ratio. Add: 3 + 2 + 1 = 6. Thus, 6 becomes the
denominator of the fraction. The numerators are the numbers in the ratio.
Saar 3/6 or 1/2
Loretto 2/6 or 1/3
Abdullah 1/6
2. Calculate the distribution amounts.
Profits to be Total
Fraction Divided Allocated
Saar 1/2 $36,000 = $18,000

Loretto 1/3 $36,000 = 12,000
Abdullah 1/6 $36,000 = 6,000
Total $36,000
follows:

POST
20XX
Abdullah, Capital 6 0 0 0 00
Summary to Capital
Dividing Net Income by Paying Interest on

Investments and Salary Allowances
Another common way to divide profits is to pay interest on the original capital invest-
ments, give a salary allowance, and divide any remainder equally or according to a fixed
ratio. The following example assumes 5 percent (.05) interest on the original invest-
ment, salary allowances of $10,000 to each partner, and any remainder to be divided
equally. The following shows the calculations made to determine the distribution.
Share to Share to Share to

Saar Loretto Abdullah Total
Total Amount to Be Divided $36,000

Allocated as Interest:
Saar (5% $50,000) $ 2,500
Loretto (5% $30,000) $ 1,500
Abdullah (5% $40,000) $ 2,000
Total Interest 6,000
Balance $30,000
Salary Allowances 10,000 10,000 10,000 30,000
Totals to Each $12,500 $11,500 $12,000 0
There is no remainder to be divided in this instance. The following is the journal

entry to close the Income Summary to the capital accounts.

POST
20XX
Summary to Capital
Now assume the same facts except that Saar will receive $10,000 salary allowance, Loretto
will receive $8,000, and Abdullah will receive $9,000. The remainder, if any, will be divid-
ed equally. The calculation to determine the distribution would then be as follows:


5% Interest $ 2,500 $ 1,500 $ 2,000 6,000
Balance $30,000
Salary Allowance 10,000 8,000 9,000 27,000
Balance 3,000
Remainder Divided by 3 1,000 1,000 1,000 3,000
Totals $13,500 $10,500 $12,000 0
follows:

POST
20XX
Summary to Capital
The methods illustrated thus far are used for calculating the proper allocation of profits
to the partners. The use of the salary allowance method does not require the partners to
withdraw a certain amount as salary. The salary allowances are used solely for calculat-
ing the distribution of net income. The closing of the Income Summary account to the
capital accounts of the partners is the end result of the method used to share profits or
losses.
Partnership Financial Statements

The financial statements of a partnership business are similar to those of a proprietor-
ship. The income statement, statement of changes in partners equity and the balance
sheet follow. Assume that each partner has withdrawn $8,000 during the year.

Income Statement
For Year Ended December 31, 20XX
Professional Revenue $ 9 6 0 0 0 00
Operating Expenses 6 0 0 0 0 00
Net Income $ 3 6 0 0 0 00
Allocation of Net Income to the Partners:

Saar
Interest at 5% (.05 $50,000) $ 2 5 0 0 00
Salary Allowance 1 0 0 0 0 00
1/3 of Remaining Net Income 1 0 0 0 00
Total $ 1 3 5 0 0 00
Loretto
Interest at 5% (.05 $30,000) $ 1 5 0 0 00
Salary Allowance 8 0 0 0 00
Total $ 1 0 5 0 0 00
Abdullah
Interest at 5% (.05 $40,000) $ 2 0 0 0 00
Salary Allowance 9 0 0 0 00
Total $ 1 2 0 0 0 00
Net Income Allowed $ 3 6 0 0 0 00

Statement of Changes in Partners Equity
For Year Ended December 31, 20XX
Capital, January 1 50000 00 30000 00 40000 00 120000 00
Add: Additional Invest. 0 00 0 00 0 00 0 00
Add: Net Income 13500 00 10500 00 12000 00 36000 00
Subtotals 63500 00 40500 00 52000 00 156000 00
Deduct: Withdrawals 8000 00 8000 00 8000 00 24000 00
Capital, December 31 55500 00 32500 00 44000 00 132000 00

Balance Sheet
December 31, 20XX
Assets
Cash $ 9 2 0 0 0 00
Total Assets $ 1 4 2 0 0 0 00
Liabilities
Accounts Payable $ 1 0 0 0 0 00
Owners Equity
Saar, Capital $5 5 5 0 0 00
Total Liabilities and Owners Equity $ 1 4 2 0 0 0 00
Accounting for a Deficit When Distributing Net Income

In the event the method used for distribution of net income results in a deficit amount
(negative) after interest and salary allowances, the deficit must be subtracted in the calcu-
lation rather than added. Assume for the partnership of Saar, Loretto, and Abdullah that
the method for distributing net income or loss is to calculate interest at 5 percent of the
original investment, give salary allowances of $10,000, $8,000, and $9,000, respectively, and
divide any remainder equally. The following example will show the use of this method
when profits are $24,000. The calculation to determine the distribution is as follows:


5% Interest $ 2,500 $ 1,500 $ 2,000 6,000
Balance $18,000
Salary Allowance 10,000 8,000 9,000 27,000
Deficit Balance $(9,000)
Deficit Distributed (3,000) (3,000) (3,000) 9,000
Totals $ 9,500 $ 6,500 $ 8,000 0
The general journal entry to close the Income Summary to the capital accounts will
debit income summary for $24,000 and credit the individual capital accounts.
Distributing a Net Loss

The above examples cover only net income. Should a loss occur, the procedure for dis-
tributing the loss to the partners capital accounts is the same as distributing net income
unless the partners agree otherwise. Losses will reduce both assets and capital. Assuming
that the partners share profits and losses equally, and assuming a $36,000 loss, the clos-
ing entry debits the individual partners capital accounts $12,000 each and credits
Income Summary for $36,000.
The Account Form Balance Sheet

An account form balance sheet shows the assets on the left-hand side and liabilities and
owners equity on the right-hand side. The account form balance sheet will be used in
this chapter to demonstrate changes in the balance sheet as they occur from the with-
drawal of a partner, the addition of a partner, or a partnership going out of business. The
report form balance sheet has been used in previous chapters. Following are illustrations
of various possibilities for changes in the composition of the partnership.
Withdrawing or Adding a New Partner

A partnership is based on a contractual agreement among individuals and ends when a
partner withdraws from the firm or a new partner is added. The business, however, may
continue with a new partnership agreement. A partner may withdraw by selling his or
her interest or equity in cash or other assets. If all the partners agree, a new partner may
join the firm either by buying the interest of a present partner, by contributing addi-
tional assets equal to the equity he or she is acquiring, or by investing either more or less
than the equity he or she will receive.
The partnership agreement should outline the procedure governing a partner who
wishes to withdraw from the business. Withdrawal may occur when a partner wants to
retire or does not wish to continue under the present business arrangements. For exam-
ple, assume that Abdullah, with an equity of $40,000, wants to retire. The partnership
contract provides that an audit be performed which includes having all assets appraised
to determine market value. In addition, a determination must be made of all liabilities
of the partnership. Should the audit reveal that assets and liabilities are different than
reflected on the books of the partnership, adjustments are made to the record to deter-
mine the true equities of the partners. Once this is accomplished, the contract may pro-
vide that assets be distributed to the retiring partner if it does not jeopardize the future
profitability of the remaining partners.
Sale of Partnership Interest for More Than Partners

Equity
Assume that M. Saar wants to sell his interest to B. Knight. The balance sheet before this
sale is as follows:

Balance Sheet
December 31, 20XX
Assets Liabilities and Owners Equity
Liabilities
Cash $ 5 0 0 0 0 00 Accounts Payable $ 1 0 0 0 0 00
Owners Equity
Saar, Capital $ 5 0 0 0 0 00
Total Liabilities and
Total Assets $ 1 3 0 0 0 0 00 Owners Equity $ 1 3 0 0 0 0 00
Knight has agreed to pay Saar $60,000 for his equity in the business. Loretto and
Abdullah agree to accept Knight as a partner. The general journal entry to record the
transfer is as follows:
GENERAL JOURNAL PAGE

POST
20XX
Aug. 31 Saar, Capital 5 0 0 0 0 00
Knight, Capital 5 0 0 0 0 00
To Record the Transfer of Saars Equity
in the Partnership to Knight
After this entry, the old partnership is ended and a new partnership is formed. The only
change in the balance sheet will be the substitution of Knight for Saar. After the new
partnership is formed, a new contract is written.
Two points should be noted. First, the $60,000 Knight paid Saar was a personal
transaction between the two and does not affect the partnership records. The $50,000
equity of Saar is transferred to Knight with the approval of the other two partners.
Remember, the business entity concept requires that personal transactions be kept sep-
arate from business transactions. The second point to note is that Loretto and Abdullah
must agree to have Knight as a partner since a partnership is based on agreement of all
parties.
Partner Admitted with Investment Same as Equity

Assume that Knight is to invest $40,000 in cash to receive a one-fourth interest in the
partnership. The following shows the equity of the present owners:
Saar $ 50,000
Loretto 30,000
Abdullah 40,000
Total $120,000
After Knights investment of $40,000, the total equity is $160,000. One-fourth of

$160,000 is $40,000, the equity of the new partner. The journal entry to illustrate the
addition of Knight under this assumption is as follows:

POST
20XX
Aug. 31 Cash 4 0 0 0 0 00
To Record the Addition of Knight as a
Partner with a One-Fourth Interest
After the entry is posted, the assets and equities of the new partnership will appear as
follows:

Balance Sheet
December 31, 20XX
Liabilities
Owners Equity
Knight, Capital 4 0 0 0 0 00 1 6 0 0 0 0 00
Withdrawal of a Partner
Assume that Abdullah wants to retire and will accept cash equal to her equity. Assume
further that assets and liabilities are the same as presented on the balance sheet on page
386 and that the withdrawal of cash by Abdullah will not jeopardize the firms cash posi-
tion. The general journal entry to record the withdrawal of Abdullah is as follows.

POST
20XX
Aug. 31 Abdullah, Capital 4 0 0 0 0 00
Cash 4 0 0 0 0 00
To Record the Withdrawal of Rose who
Receives Cash Equal to Her Equity
Sometimes when a partner retires, the remaining partners may not wish to give an
amount equal to the retiring partners equity. The retiring partner may then agree to
take an amount less than the value of his or her capital account. If this is the situation,
the profit-loss sharing ratio is used to adjust the capital accounts of the remaining part-
ners. Assume that the profits and losses are to be divided equally, and Abdullah agrees to
take $30,000 in cash for her $40,000 equity. The entry to show the withdrawal of
Abdullah for $30,000 cash is as follows:

POST
20XX
Cash 3 0 0 0 0 00
Saar, Capital 5 0 0 0 00
To Record the Withdrawal of Abdullah who
Receives Cash Less Than Her Equity
Bonus to Old Partners

A new partner may be expected to invest more assets than the equity he or she is to
receive. This might occur because the equities of the present partners may not reflect the
true worth of an already successful business. If this is the case, the partnership is worth
more than the records indicate. For example, assume that the present equities are the
same as previously indicated and that Knight is to invest cash of $36,000 for a one-fifth
interest. The amount to be credited to Knights capital account for a 1/5 interest is deter-
mined as follows:
Equities of the present partners $120,000
Investment of the new partner 36,000
Total equities of the new partnership 156,000
Equity of Knight (1/5 $156,000 = $31,200) $ 31,200
Providing the present partners share equally, the bonus of $4,800 (the difference
between the cash given, $36,000, and the equity received, $31,200) will be divided by 3
and the capital accounts of the present partners will each be increased by $1,600. The
following is the journal entry to admit Knight as one-fifth partner.

POST
20XX
Aug. 31 Cash 3 6 0 0 0 00
To Record the Addition of Knight as
Partner with a One-Fifth Interest
After the entry is posted, the assets, liabilities, and owners equity are as follows:

Balance Sheet
December 31, 20XX
Liabilities
Owners Equity
Knight, Capital 3 1 2 0 0 00 1 5 6 0 0 0 00
Bonus to New Partner

A bonus may be given to a new partner when the new partner is given more equity than
his or her current capital balance. Assume that Knight invests $20,000 for a one-fourth
interest. The equity given to Knight in this case is greater than his equity. Thus Saar,
Loretto, and Abdullah, who share net income and losses equally, must give up an equal-
portion of their equity to Knight as determined below.
Equities of the present partners $120,000
Add investment of new partner 20,000
Total equities of the new partnership 140,000
Equity of Knight (1/4 $140,000 = $35,000) $ 35,000
There is $15,000 difference between the $20,000 cash investment of Knight and total
equity of $35,000 he received. The $15,000 is a bonus to Knight. However, the difference
must be shared by the present partners as a reduction in their capital accounts. The
reduction in the capital accounts is $5,000 each. The entry to record the addition of
Knight under these circumstances is as follows.

POST
20XX
Aug. 31 Cash 2 0 0 0 0 00
To Record the Addition of Knight as a
Partner with a One-Fourth Interest
After the entry is posted, the assets, liabilities, and owners equity appear as follows.

Balance Sheet
December 31, 20XX
Liabilities
Owners Equity
Saar, Capital $ 4 5 0 0 0 00
Knight, Capital 3 5 0 0 0 00 1 4 0 0 0 0 00
This type of situation might occur when a new partner has a special talent or busi-
ness skill that will increase the profitability of the firm. However, there are times when a
bonus is not recorded at all. Rather, goodwill is recorded and the old partners capital
accounts are increased. This method is seldom used; the bonus method is the preferred
method.
In the event the two remaining partners are eager to see Abdullah retire, they may abe
willing to give more than Abdullahs equity. Assume that they agree to give Abdullah
$40,000 in cash and a note payable for $10,000 for her $40,000 equity. The entry to
record this situation is as follows:

POST
20XX
Cash 4 0 0 0 0 00
Notes Payable 1 0 0 0 0 00
To Record the Withdrawal of Abdullah
Who Receives Cash and a Note Payable
for Her Equity
The remaining partners share the additional equity given to Abdullah as a loss to them-
selves. Many other variations similar to these can be used. However, whatever method is
used, assets must equal liabilities and owners equity at all times.
Going Out of BusinessLiquidation

Partners may determine that it is no longer possible to continue in business. This may
occur if the partners have unsettled disputes or the business is no longer profitable and
liquidation becomes necessary. Liquidation is the total process of going out of business,
or the legal process of converting assets to cash, paying all creditors, and making final
distribution of cash to the partners. This legal process also means that each partner is
liable to pay the creditors whether or not there is sufficient cash remaining. Although
many different circumstances occur in liquidation, only two are discussed here. In each
case, there are four steps to be followed.
1. Convert all noncash assets to cash and record the gain or loss on liquidation.
2. Distribute the gains or losses to the partners capital accounts according to the
profit-loss ratio.
3. Pay the liabilities.
4. Distribute the remaining cash according to the equities (capital balances) of the
partners.
A temporary account called Loss or Gain from Liquidation is opened to assemble the
gains or losses that may occur when selling the assets. It is credited for a gain and debited
for a loss. The conversion of noncash assets to cash is called realization. Partners will nor-
mally share losses and gains from liquidation using their income and loss sharing ratio.
Assets Sold for a Gain

The liquidation of a partnership may be illustrated using the following information.
Saar, Loretto, and Abdullah, the partners in the accounting firm in previous illustrations,
have had a bitter dispute over business policies. They decide to dissolve the partnership.
To illustrate a liquidation where assets are sold for a gain, assume the following balance
sheet before liquidation.

Balance Sheet
December 31, 20XX
Liabilities
Other Assets 1 0 0 0 0 0 00
Owners Equity
Saar, Capital $ 5 0 0 0 0 00
Assume that the other assets are sold for $109,000 and the partners share profits and
losses equally. The four steps necessary upon liquidation are shown as journal entries.

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20XX
Dec. 31 Cash 1 0 9 0 0 0 00
Loss or Gain on Realization 9 0 0 0 00
To Record the Sale of Other Assets
2. Distribute gains or losses to the partners capital accounts according to the profit-
loss ratio.

POST
20XX
Dec. 31 Loss or Gain on Realization 9 0 0 0 00
To Record the Closing of the Loss or Gain
on Realization Account to the Partners
Capital Accounts
After posting these two entries, the balance sheet appears as follows.

Balance Sheet
December 31, 20XX
Liabilities
Cash $ 1 3 9 0 0 0 00 Accounts Payable $ 1 0 0 0 0 00
Owners Equity
Saar, Capital $ 5 3 0 0 0 00

POST
20XX
Dec. 31 Accounts Payable 1 0 0 0 0 00
Cash 1 0 0 0 0 00
To Record Payment to the Creditors
4. Distribute the remaining cash according to the equities of the partners.

POST
20XX
Dec. 31 Saar, Capital 5 3 0 0 0 00
Cash 1 2 9 0 0 0 00
To Record the Closing of the Partnership
Books
Once the above entries are posted, every account in the partnership records will have a
zero balance, signifying the termination of this business.
It is important to remember that cash remaining after liquidation is distributed to
partners according to their capital balances while gains and losses from liquidation are
allocated according to the income and loss sharing ratio.
Assets Sold for a Loss

Many times a business cannot sell its other assets at the amount carried in the records.
Assets will deteriorate with age and therefore are not as marketable as when they were
new. Assume that other assets are listed on the balance sheet at $100,000 and that they
are sold for $91,000. This is a $9,000 loss to the partners and will result in reducing both
their assets and capital accounts. Each of the four steps are presented as journal entries
as follows.

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20XX
Dec. 31 Cash 9 1 0 0 0 00
To Record the Sale of Other Assets
profit-loss ratio.

POST
20XX
Dec. 31 Saar, Capital 3 0 0 0 00
To Record the Closing of the Loss to
Partners Capital Accounts

POST
20XX
Cash 1 0 0 0 0 00
To Record the Payment of the Creditors
After the above entries are posted, the T-accounts will appear as follows:
Cash Other Assets Accounts Payable

30,000 10,000 100,000 100,000 10,000 10,000
91,000
111,000
Saar, Capital Loretto, Capital Abdullah, Capital

3,000 50,000 3,000 30,000 3,000 40,000
47,000 27,000 37,000
Loss or Gain
on Realization
9,000 9,000
There is $111,000 left in the Cash account, and the total remaining capital account bal-
ances equal $111,000. In step four, the amount of cash to be distributed to each partner
is determined by the balance in each partners capital account.


POST
20XX
Cash 1 1 1 0 0 0 00
Books
After this entry is posted, all the accounts have a zero balance and the partnership is ter-
minated.
A problem may occur if one partners share of the loss is greater than the balance of
his or her capital account. If this is the case, the partner must cover the deficit by paying
cash into the partnership. In this situation, a deficit is a debit balance in a partners cap-
ital account. This could occur from liquidation losses, losses from previous periods, or
withdrawals before liquidation. For example, assume the partners Saar, Loretto, and
Abdullah share profits and losses in a 2:2:1 ratio. If the other assets are shown at
$100,000 on the balance sheet and sold for $20,000, a loss of $80,000 must be distrib-
uted. The four steps, presented as journal entries, will illustrate this problem and are as
follows.
1. Convert all assets to cash.

POST
20XX
Dec. 31 Cash 2 0 0 0 0 00
Loss or Gain on Realization 8 0 0 0 0 00
To Record the Sale of the Other Assets
profit-loss ratio.

POST
20XX
Dec. 31 Saar, Capital * 3 2 0 0 0 00
Loss or Gain on Realization 8 0 0 0 0 00
To Record the Closing of the Loss to the
Partners Capital Accounts on a 2:2:1 Ratio
*Calculation of division of loss:

Saar 2/5 $80,000 = $32,000
Bagwell 2/5 $80,000 = 32,000
Abdullah 1/5 $80,000 = 16,000
3. Pay the creditors.

POST
20XX
Cash 1 0 0 0 0 00
To Record the Payment of the Creditors
After the above entries are posted, the T accounts will appear as follows:
Cash Other Assets Accounts Payable

30,000 10,000 100,000 100,000 10,000 10,000
20,000
40,000
Saar, Capital Loretto, Capital Abdullah, Capital

32,000 50,000 32,000 30,000 16,000 40,000
18,000 2,000 24,000
Loss or Gain
on Realization
80,000 80,000
Loretto has a debit balance of $2,000 in his capital account and is liable to the partner-
ship for his deficit. If Loretto has sufficient personal assets and contributes $2,000 to the
firm to cover his debit balance, step four can be completed as follows:
a. Payment of cash by Loretto.

POST
20XX
Dec. 31 Cash 2 0 0 0 00
To Record the Cash Contribution of Loretto
to Cover His Liability
b. Distribute remaining cash.

POST
20XX
Cash 4 2 0 0 0 00
Books
After posting these two entries, all the accounts have a zero balance and the partnership
is terminated. However, if Loretto has no personal assets and cannot pay his debt,
because of unlimited liability Saar and Abdullah must share this additional loss accord-
ing to their portion of the profit-loss ratio, without Loretto, which is 2:1. The journal
entries for step four under these circumstances are as follows.
a. Distribute the $2,000 loss.

POST
20XX
Dec. 31 Saar, Capital * 1 3 3 3 00
Abdullah, Capital 6 6 7 00
To Record Lorettos Liability as a Loss to
the Remaining Partners
*Calculation of division of loss:

Saar 2/3 $2,000 = $1,333
Abdullah 1/3 $2,000 = 667
b. Distribute the remaining cash.

POST
20XX
Cash 4 0 0 0 0 00
Books
After posting of the above entries, all the accounts have a zero balance and the partner-
ship is terminated.
Even though the partner with the deficit cannot pay at the present time, the liability
is not eliminated. If the deficit partner becomes able to pay at some time in the future,
he or she must do so.
Summary
A partnership is a voluntary association of two or more legally competent persons to
carry on as co-owners a business for profit. It is best if they have a written partnership
agreement, but their contract may be a verbal one. Partnerships are characterized by
limited life, which means that the partnership cannot exist separate from the individual
partners, thus it may end when one partner becomes unable, through death, bankrupt-
cy or lack of legal capacity, to contract. Partners, through mutual agency, have the legal
ability to enter into contracts within the scope of the partnership. Such contracts are
binding on the other partners. Unlimited liability, which also characterizes partnerships,
refers to the fact that each partner is personally liable for the debts of the business.
Though there are many advantages to forming a partnership, limited life, unlimited lia-
bility, and mutual agency are disadvantages that should be considered before forming a
new partnership.
Partnership accounting is the same as proprietorship accounting, except that each
partner has his or her own drawing account. Partners are owners of the business and do
not receive salaries; rather, their drawing accounts are debited when cash is taken for per-
sonal use and income taxes are based on their share of the net income of the business.
Partners will decide upon a profit-loss ratio which will be used to determine how
profits and losses are to be allocated. Profits and losses may be distributed: (1) equally;
(2) on a fractional basis; (3) based on amounts invested; or (4) using a fixed ratio.
Should there be a loss, it will be distributed to the partners capital accounts the same
way as a net income unless there is an agreement to the contrary.
A new partnership may be created when a new individual buys the interest of one of
the existing partners, or if an additional person is admitted as a partner. In such a case,
the old partnership is dissolved. In addition to adding a new partner, an existing partner
may wish to withdraw from the partnership. In such a case, the value of all assets and
liabilities of the partnership must be determined by an audit.
Partners may decide, because, for example, of unsettled disputes or lack of prof-
itability, to liquidate. When this occurs: (1) all noncash assets must be converted to cash
(called realization) and the gain or loss on liquidation recorded; (2) gains or losses must
be distributed to the partners capital accounts according to their profit-loss ratio; (3)
liabilities must be paid; and (4) any remaining cash must be distributed to the partners
according to their capital balances. Partners normally share gains and losses from liqui-
dation according to their profit-loss sharing ratio.
Vocabulary Review
Here is a list of the words and terms for this chapter:
account form balance sheet partnership
deficit profit-loss ratio
liquidation realization
mutual agency unlimited liability
Fill in the blank with the correct word or term from the list.
1. The total process of going out of business is __________.
2. A/an __________ is an association of two or more competent persons who agree
to do business as co-owners for profit.
3. The ability of each partner, acting as an agent of the business, to enter into and
bind it to contracts within the apparent scope of the business is __________.
4. __________ is the conversion of noncash assets to cash.
5. The method used by the partners to divide profits or losses in the __________.
6. A/an __________ is an abnormal balance in a capital account.
7. The principle that each partner is personally liable for the debts of the business is
called __________.
8. __________ shows the three major categoriesassets, liabilities, and owners
equityin a horizontal manner.
Match the words and terms on the left with the definitions on the right.
9. account form balance sheet a. the method used by the partners to divide
10. deficit profits or losses
11. liquidation b. each partner is personally liable for the debts
of the business
12. mutual agency
c. an association of two or more competent
13. partnership
persons who agree to do business as
14. profit-loss ratio co-owners for profit
15. realization d. an abnormal balance in a capital account
16. unlimited liability e. the conversion of noncash assets to cash
f. the total proces of going out of business
g. the ability of each partner, acting as an agent
of the business, to enter into and bind it to
contracts within the apparent scope of the
partnership
h. the format of a balance sheet that shows the
assets, liabilities, and owners equity in a
horizontal manner
Exercises
EXERCISE 14.1
Morton and Long plan to enter into a law partnership, investing $30,000 and $20,000,
respectively. They have agreed on everything but how to divide the profits. Calculate
each partners share of the profit under each of the following independent assumptions.
a. If the first years net income is $50,000 and they cannot agree, how should the
profits be divided?
b. If the partners agree to share net income according to their investment ratio, how
should the $50,000 be divided?
c. If the owners agree to share net income by granting 10 percent interest on their
original investments, giving salary allowances of $10,000 each, and dividing the
remainder equally, how should the $50,000 be divided?
EXERCISE 14.2
Assume Morton and Long from Exercise 14.1 use method c to divide profits and net
income is $20,000. How should the income be divided?
EXERCISE 14.3
After a number of years, Long, from Exercise 14.1, decided to go with a large law firm
and wishes to sell his interest to Brown. Longs equity at this time is $35,000. Morton
agrees to take Brown as a partner, and Long sells his interest to Brown for $40,000.
Prepare the general journal entry on December 31, 20XX to record the sale of Longs
interest to Brown.
EXERCISE 14.4
Smith, White, and Saint are partners owning the Book Nook. The equities of the part-
ners are $60,000, $50,000, and $40,000, respectively. They share profits and losses equal-
ly. White wishes to retire on May 31, 20XX. Prepare the general journal entries to record
Whites retirement under each independent assumption.
a. White is paid $50,000 in partnership cash.
b. White is paid $40,000 in partnership cash.
c. White is paid $55,000 in partnership cash.
EXERCISE 14.5
Hall and Mason share profits and losses equally and have capital balances of $60,000 and
$40,000, respectively. Taylor is to be admitted on January 2, 20XX, and is to receive a
one-third interest in the firm. Prepare the general journal entries to record the addition
of Taylor as a partner under the following unrelated circumstances.
a. Taylor invests $50,000.
b. Taylor invests $62,000.
c. Taylor invests $47,000.
EXERCISE 14.6
Martin, Pearson, and Henderson are partners sharing profits and losses in a 2:1:1 ratio.
Their capital balances are $30,000, $25,000, and $20,000, respectively. Because of an eco-
nomic turndown, they have decided to liquidate. After all assets are sold and the credi-
tors paid, $43,000 cash remains in the business chequing account.
a. Determine the amount of their losses by using the accounting equation.
b. Using the profit-loss ratio, determine the amount of loss to be distributed to each
partner, and determine their new capital balances.
c. Determine the amount of cash each partner will receive in the final distribution.
EXERCISE 14.7
Baker, Marshall, and Perryman share profits and losses equally and begin their business
with investments of $20,000, $15,000, and $8,000, respectively. They have been unprof-
itable in their business venture and decide they must liquidate. After all the assets are
sold and all debts paid, $16,000 cash remains in the business chequing account.
a. Determine the amount of their losses by using the accounting equation.
b. Using the profit-loss ratio, determine the amount of loss allocated to each partner,
and determine their new capital balances.
c. Calculate the amount of cash, if any, each partner will receive under the different
assumptions below.
(1) Perryman has personal assets and pays the amount she owes to the
partnership.
(2) Perryman has no personal assets and does not pay the amount she owes to the
partnership.
Problems
PROBLEM 14.1
Jones, Brady, and Bell formed a partnership making investments of $40,000, $60,000,
and $80,000, respectively. They believe the net income from their business for the first
year will be $81,000. They are considering several alternative methods for sharing this
expected profit, which are: (1) divide the profits equally; (2) divide the profits according
to their investment ratio; (3) divide the profits by giving an interest allowance of 10 per-
cent on original investments, granting $10,000 salary allowance to each partner, and
dividing any remainder equally. Round to the nearest dollar where required.
Instructions
a. Prepare a schedule showing distribution of net income under methods 1, 2, and 3.
It should have the following headings.
Share to Share to Share to Total
Plan Calculations Jones Brady Bell Allocated
b. Using method 3 above, prepare a partial income statement showing the allocation
of net income to the partners (see income statement on page 384 for example).
c. Journalize the closing of the Income Summary account on December 31, 20XX
using the information from b above.
PROBLEM 14.2
Abner, Black, and Cobb share profits and losses equally and have capital balances of
$60,000, $50,000, and $50,000, respectively. Cobb wishes to sell his interest and leave the
business on July 31 of this year. Cobb is to sell his interest to Williams with the approval
of Abner and Black.
Instructions
Prepare the general journal entries, without explanations, to record the following
independent assumptions.
a. Cobb sells his interest to Williams for $50,000.
b. Cobb sells his interest to Williams for $40,000.
c. Cobb decides to stay in the partnership but sell one-half of his interest to Williams
for $30,000. (Hint: What is the value of half of Cobbs capital account?)
d. If Williams is admitted as a new partner, must a new partnership agreement be
written? Why?
PROBLEM 14.3
Coleman and Simmons are partners and own the ABC Gift Shop. They formed their
partnership on January 2, 20XX, with investments of $50,000 and $25,000. Simmons
invested an additional $5,000 on July 7. They share profits giving 10 percent interest
allowance on beginning investments and dividing the remainder on a 2:1 ratio.
Following is their trial balance before closing.
Coleman and Simmons

Trial Balance
December 31, 20XX
Cash $ 1 9 0 0 0 00
Accounts Receivable 5 0 0 0 00
Merchandise Inventory 6 0 0 0 0 00
Equipment 2 0 0 0 0 00
Accumulated Amortization: Equipment $ 1 0 0 0 0 00
Accounts Payable 1 0 0 0 0 00
Coleman, Drawing 1 0 0 0 0 00
Simmons, Drawing 1 0 0 0 0 00
Coleman, Capital 5 0 0 0 0 00
Simmons, Capital 3 0 0 0 0 00
Sales 1 0 0 0 0 0 00
Operating Expenses 7 6 0 0 0 00
$ 2 0 0 0 0 0 00 $ 2 0 0 0 0 0 00
a. Prepare the general journal entries, without explanations, to record the closing of
all the nominal accounts (revenue and expense) using the Income Summary
account.
b. Prepare a schedule showing the distribution of net income to the partners. It
should have the following headings.
Share to Share to Total
Calculations Coleman Simmons Allocated
c. Prepare the general journal entries to record the closing of the Income Summary
account to the capital accounts, and close the drawing accounts to the capital
accounts.
d. Prepare the partnership income statement showing the allocation of net income.
e. Prepare the statement of owners equity.
f. Prepare a balance sheet.
PROBLEM 14.4
Arnold, Cole, and Yamaguchi are partners, owning Pizza Plus and sharing profits and
losses in a 3:2:1 ratio. The balance sheet, presented in account form format for this busi-
ness, is as follows.
Arnold, Cole, and Yamaguchi

Balance Sheet
June 30, 20XX
Cash $ 6 5 0 0 0 00 Liabilities
Delivery Truck #1 2500 0 00 Accounts Payable $ 3 0 0 0 00
Acc. Amort. Tr. #1 1000 0 00 1 5 0 0 0 00
Delivery Truck #2 3500 0 00 Owners Equity
Acc. Amort. Tr. #2 700 0 00 2 8 0 0 0 00 Arnold, Capital 6 0 0 0 0 00
Cole, Capital 3 0 0 0 0 00
Yamaguchi, Capital 1 5 0 0 0 00 1 0 5 0 0 0 00

Arnold wishes to withdraw from the firm. Cole and Yamaguchi agree.
Prepare the general journal entries, without explanations, to record the June 30 with-
drawal of Arnold under the following independent assumptions.
a. Arnold withdraws taking partnership cash of $60,000.
b. Arnold withdraws taking cash of $32,000 and truck #2 (debit Accumulated
Amortization and credit Truck).
c. Arnold withdraws taking cash of $51,000
d. Arnold withdraws taking cash of $25,000 and a $44,000 note given by the partner-
ship.
e. Arnold withdraws taking cash of $25,000, a $20,000 note, and truck #1.
PROBLEM 14.5
Garcia, Keller, and Henley are partners who share profits and losses in a 3:1:2 ratio. Their
capital account balances are $60,000, $25,000, and $35,000, respectively. Watts is to be
admitted to the firm on March 31, 20XX with a one-fourth interest.
Instructions
Prepare the general journal entries to record the following unrelated assumptions.
Omit explanations.
a. Watts is to be admitted by investing cash of $40,000.
b. Watts is to be admitted by investing cash of $30,000.
c. Watts is to be admitted by investing cash of $50,000.
PROBLEM 14.6
Bentley, Colby, and Musharaf plan to liquidate their partnership. They share profits and
losses on a 3:2:1 ratio. At the time of liquidation, the partnership balance sheet appears
as follows:
Bentley, Colby, and Musharaf

Balance Sheet
June 30, 20XX
Liabilities
Owners Equity
Bentley, Capital 4 8 0 0 0 00
Colby, Capital 3 6 0 0 0 00
Musharaf, Capital 2 4 0 0 0 00 1 0 8 0 0 0 00
Prepare the general journal entries, without explanations, to record (1) the sale of the
other assets; (2) the distribution of the loss or gain on realization; (3) the payment to
the creditors; and (4) the final distribution of cash. Each of the following are unrelated
assumptions.
a. The other assets are sold for $115,000.
b. The other assets are sold for $79,000.
c. The other assets are sold for $55,000.
PROBLEM 14.7
Irby, Jalisco, and Whitehorse are partners in a video rental business, sharing profits and
losses in a 2:1:1 ratio. Business has decreased due to the number of other rental stores in
their area. They decide it would be best to liquidate. Their December 31, 20XX balance
sheet information is as follows.
Balance Sheet Information
Cash $15,000
Video Inventory 75,000
Accounts Payable 25,000
Irby, Capital 25,000
Jalisco, Capital 20,000
Whitehorse, Capital 20,000
Instructions
Prepare the general journal entries, without explanations, to show: (1) the sale of the
noncash assets; (2) the distribution of the losses or gains; (3) the payment to the credi-
tors; and (4) the final distribution of cash under each of the following independent
assumptions.
a. The video inventory is sold for $63,000.
b. The video inventory is sold for $25,000
c. The video inventory is sold for $20,000 and the partner with the deficit can and
does pay from personal assets.
d. The same assumption as c above, except the partner with the deficit cannot pay.

Partnership Accounting Chapter Summary

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Partnership Accounting Chapter Summary

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CHAPTER

Accounting for a partnership is similar to accounting for a proprietorship except

General Partnership Characteristics

Advantages and Disadvantages of a Partnership

The Drawing Account

GENERAL JOURNAL Page

GENERAL JOURNAL Page

Dividing the Net Income

Dividing Net Income Equally

Saar, Loretto, and Abdullah, Accountants

GENERAL JOURNAL Page

Dividing Net Income Based on Amounts Invested

2. Determine fractions. (The denominator is the total amount invested, $120,000,

GENERAL JOURNAL Page

Dividing Net Income Using a Fixed Ratio

2. Calculate the distribution amounts.

Saar 1/2 $36,000 = $18,000

GENERAL JOURNAL Page

Dividing Net Income by Paying Interest on

Share to Share to Share to

Total Amount to Be Divided $36,000

There is no remainder to be divided in this instance. The following is the journal

GENERAL JOURNAL Page

Share to Share to Share to

Total Amount to Be Divided $36,000

GENERAL JOURNAL Page

Partnership Financial Statements

Saar, Loretto, and Abdullah, Accountants

Allocation of Net Income to the Partners:

Net Income Allowed $ 3 6 0 0 0 00

Saar, Loretto, and Abdullah, Accountants

Saar, Loretto, and Abdullah, Accountants

Accounting for a Deficit When Distributing Net Income

Share to Share to Share to

Total Amount to Be Divided $24,000

Distributing a Net Loss

The Account Form Balance Sheet

Withdrawing or Adding a New Partner

Sale of Partnership Interest for More Than Partners

Saar, Loretto, and Abdullah, Accountants

GENERAL JOURNAL PAGE

Partner Admitted with Investment Same as Equity

After Knights investment of $40,000, the total equity is $160,000. One-fourth of

GENERAL JOURNAL PAGE

Saar, Loretto, and Abdullah, Accountants

GENERAL JOURNAL PAGE

GENERAL JOURNAL Page

Bonus to Old Partners

GENERAL JOURNAL Page

Saar, Loretto, and Abdullah, Accountants

Bonus to New Partner

GENERAL JOURNAL Page

Saar, Loretto, and Abdullah, Accountants

GENERAL JOURNAL Page

Going Out of BusinessLiquidation

Assets Sold for a Gain

Saar, Loretto, and Abdullah, Accountants

GENERAL JOURNAL PAGE

GENERAL JOURNAL Page

Saar, Loretto, and Abdullah, Accountants

3. Pay the liabilities.

GENERAL JOURNAL PAGE