Partnerships - Formation, Operations, and Changes in Ownership Interests

Partnerships Formation, Operations, and Changes in Ownership Interests
Chapter 15
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
15 - 1
Learning Objective 1
Comprehend the legal characteristics of partnerships.
15 - 2
Partnership Characteristics
It is an association of two or more persons who co-own a business for a profit. The legal life of a partnership terminates with the admission of a new partner, the withdrawal or death of a partner, voluntary dissolution by the partners, or involuntary dissolution such as bankruptcy proceedings.
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Articles of Partnership
A partnership may be formed by a simple oral agreement among two or more people to operate a business for profit.
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Articles of Partnership
The types of products and services to be provided
Each partners rights and responsibilities Each partners initial investment Additional investment conditions Asset drawing provisions
Profit and loss sharing formulas

Procedures for dissolving the partnership
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Partnership Financial Reporting

The accounting reports are designed to meet the needs of three user groups The partners Partnership creditors Internal Revenue Service
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Understand initial investment valuation and record keeping.
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Initial Investment in a Partnership

Ashley and Becker each invest $20,000 cash in a new partnership. Cash 20,000 Ashley, Capital 20,000 To record Ashleys original investment of cash Cash 20,000 Becker, Capital 20,000 To record Beckers original investment of cash
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Noncash Investments
C. Cola and R. Crown enter into a partnership.
C. Cola R. Crown Fair Value Fair Value
Cash $ Land (cost to C. Cola, $5,000) 10,000 Building (cost to C. Cola, $30,000) 40,000 Inventory (cost to R. Crown, $28,000) Total $50,000 $ 7,000 35,000 $42,000
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Noncash Investments
Land 10,000 Building 40,000 C. Cola, Capital 50,000 To record C. Colas original investment of land and building at fair value
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Noncash Investments
Cash 7,000 Inventory 35,000 R. Crown, Capital 42,000 To record R. Crowns original investment of cash and inventory items at fair value
Bonus or Goodwill on Initial Investment

The partnership agreement specifies equal capital interests.
C. Cola, Capital 4,000 R. Crown, Capital 4,000 To establish equal capital interests of $46,000 by recording a $4,000 bonus from C. Cola to R. Crown
Bonus or Goodwill on Initial Investment
Goodwill 8,000 R. Crown, Capital 8,000 To establish equal capital interests of $50,000 by recognizing R. Crowns investment of an $8,000 unidentifiable asset
Drawings
Regular withdrawals are called drawings, drawing allowances, or sometimes salary allowances. Debit Drawing and credit Cash.
At period end, credit Drawing and debit each partners Capital.
Loans and Advances

Loans and advances to the partnership and accrued interest are regarded as liabilities of the partnership. Loans and advances to partners are regarded as assets of the partnership.
Partnership Operations
Ratcliffe and Yancey are partners sharing profits in a 60:40 ratio, respectively.
Partnership Operations
Equity Accounts, 2003 Partnership net income 2003 Ratcliffe capital January 1, 2003 Ratcliffe additional investment 2003 Ratcliffe drawing 2003 Yancey capital January 1, 2003 Yancey drawing 2003 Yancey withdrawal 2003
$34,500 40,000 5,000 6,000 35,000 9,000 3,000
Format for a Statement of Partners Capital

Ratcliffe and Yancey Statement of Partners Capital For the Year Ended 12/31/2003 60% 40% Ratcliffe Yancey Total Capital balances 1/1/03 $40,000 $35,000 $75,000 Add: Additional investments 5,000 5,000 Deduct: Withdrawals 3,000 3,000 Deduct: Drawings 6,000 9,000 15,000 Net contributed capital 39,000 23,000 62,000 Add: Net income for 2003 20,700 13,800 34,500 Capital balances 12/31/03 $59,700 $36,800 $96,500
Closing Entries
December 31, 2003 Revenue and Expense Summary 34,500 Ratcliffe, Capital 20,700 Yancey, Capital 13,800 To divide net income for the year 60% to Ratcliffe and 40% to Yancey
Closing Entries
December 31, 2003 Ratcliffe, Capital 6,000 Yancey, Capital 9,000 Ratcliffe, Drawing 6,000 Yancey, Drawing 9,000 To close partner drawing accounts to capital accounts
Grasp the diverse nature of profit and loss sharing agreements and their computation.
Profit and Loss Sharing Agreements
Equal division of partnership income is required in the absence of a profit and loss sharing agreement.
Service Considerations in Profit and Loss Sharing Agreements

A partner who devotes time to the partnership business while other partners work elsewhere may receive a salary allowance.
Salary allowances are also used to compensate for differences in the fair value of the talents of partners.
Salary Allowance in Profit Sharing Agreements

Bob, Gary, and Pete are partners. The partnership agreement provides that Bob and Gary receive salary allowances of $12,000 each, with the remaining income allocated equally. Partnership net income is $60,000 for 2003 and $12,000 for 2004.
Income Allocation Schedule: 2003

Bob Gary Pete
Net income $60,000 Salary allowances to Bob and Gary (24,000) $12,000 Remainder to divide 36,000 Divided equally (36,000) 12,000 Remainder to divide 0 Net income allocation $24,000
$12,000 12,000 $24,000 $12,000 $12,000

Bob Gary Pete
Net income $12,000 Salary allowances to Bob and Gary (24,000) $12,000 $12,000 Remainder to divide (12,000) Divided equally 12,000 (4,000) (4,000) Remainder to divide 0 Net income allocation $ 8,000 $ 8,000
$(4,000) $(4,000)
Journal Entries
December 31, 2003 Revenue and Expense Summary 60,000 Bob, Capital Gary, Capital Pete, Capital Partnership income allocation for 2003
24,000 24,000 12,000
Journal Entries
December 31, 2004 Revenue and Expense Summary 12,000 Pete, Capital 4,000 Bob, Capital Gary, Capital Partnership income allocation for 2004
8,000 8,000
Bonus and Salary Allowances

The partnership agreement provides that Bob receive a bonus of 10% of partnership net income. Bob and Gary receive salary allowances of $10,000 and $8,000, respectively, and the remaining income is allocated equally. Partnership net income is $60,000 for 2003 and $12,000 for 2004.

Bob Net income $60,000 Bonus to Bob (6,000) $ 6,000 Remainder to divide 54,000 Salary allowances to Bob and Gary (18,000) 10,000 Remainder to divide 36,000 Divided equally (36,000) 12,000 Remainder to divide 0 Net income allocation $28,000 Gary Pete
$ 8,000
12,000 $20,000 $12,000 $12,000

Bob Gary Pete Net income $12,000 Bonus to Bob (1,200) $ 1,200 Remainder to divide 10,800 Salary allowances to Bob and Gary (18,000) 10,000 $8,000 Remainder to divide (7,200) Divided equally 7,200 (2,400) (2,400) Remainder to divide 0 Net income allocation $ 8,800 $5,600
$(2,400) $(2,400)
Income Allocated in Relation to Partnership Capital

Ace Butch
Capital balances 1/1/2003 Investment April 1 Withdrawal July 1 Investment September 1 Withdrawal October 1 Investment December 28 Capital balances 12/31/2003
$20,000 2,000 3,000 $25,000
$20,000 (5,000) (4,000) 8,000 $19,000
Comparison of Capital Bases
Ace Butch Total
Beginning Capital Investment $20,000 20,000 $40,000
Ending Capital Investment $25,000 19,000 $44,000
Weighted Average Capital Investment $22,500 16,500 $39,000
Alternatives
Net income of $100,000 is divided on the basis of capital balances. Beginning Capital Balances Ace ($100,000 20/40) $ 50,000 Butch ($100,000 20/40) 50,000 Total income $100,000
Alternatives
Ending Capital Balances Ace ($100,000 25/44) $ 56,818.18 Butch ($100,000 19/44) 43,181.82 Total income $100,000.00 Average Capital Balances Ace ($100,000 22.5/39) $ 57,692.31 Butch ($100,000 16.5/39) 42,307.69 Total income $100,000.00
Interest Allowances on Partnership Capital

An agreement may provide for interest allowances on partnership capital in order to encourage capital investments, as well as salary allowances.
Remaining profits are then divided equally or in any other ratio specified in the profit sharing agreement.
Value new partners investment in an existing partnership.
Changes in Partnership Interest
The existing legal partnership entity is dissolved when a new partner is admitted or an existing partner retires or dies.
Changes in Partnership Interest

Assignment of an interest to a third party
Admission of a new partner Purchase of an interest from existing partners
Investing in an existing partnership

Value partners share upon retirement or death.
Dissolution of a Continuing Partnership Through Death or Retirement

Capital Balances
Bonnie Clyde Dillinger Total capital $ 70,000 50,000 80,000 $200,000 Profit and Percentage Loss of Capital Percentage 35% 25 40 100% 40% 20 40 100%
Dissolution of a Continuing Partnership Through Death or Retirement

Dillinger decides to retire.
The partners agree that the business is undervalued on the partnership books and that Dillinger will be paid $92,000.
Bonus to Retiring Partner

Dillinger, Capital Bonnie, Capital Clyde, Capital Cash 80,000 8,000 4,000 92,000
Dillinger, Capital Goodwill Cash
80,000 12,000
92,000
Reevaluation of Total Partnership Capital
Goodwill (other assets) Bonnie, Capital Clyde, Capital Dillinger, Capital
30,000
12,000 6,000 12,000
Payment to Retiring Partner Less than Capital Balance

Suppose that Dillinger is paid $72,000 in final settlement of his capital interest.
Overvalued Assets Written Down

Bonnie, Capital Clyde, Capital Dillinger, Capital Net assets Dillinger, Capital Cash 8,000 4,000 8,000 20,000 72,000
72,000
Bonus to Continuing Partners
Dillinger, Capital Bonnie, Capital Clyde, Capital Cash
80,000 5,333 2,667 72,000
Understand limited liability partnership characteristics.
Limited Partnerships
The limited partnership consists of at least one general partner and one or more limited partners.
The limited partner is excluded from the management of the business.
End of Chapter 15

Partnerships - Formation, Operations, and Changes in Ownership Interests

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Partnerships - Formation, Operations, and Changes in Ownership Interests

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Partnerships Formation, Operations, and Changes in Ownership Interests

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Comprehend the legal characteristics of partnerships.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Profit and loss sharing formulas

Partnership Financial Reporting

Understand initial investment valuation and record keeping.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Initial Investment in a Partnership

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 15 - 10

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 15 - 11

Bonus or Goodwill on Initial Investment

Bonus or Goodwill on Initial Investment

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Loans and Advances

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$34,500 40,000 5,000 6,000 35,000 9,000 3,000

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Format for a Statement of Partners Capital

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2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 15 - 20

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 15 - 21

Profit and Loss Sharing Agreements

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Service Considerations in Profit and Loss Sharing Agreements

Salary Allowance in Profit Sharing Agreements

Income Allocation Schedule: 2003

$12,000 12,000 $24,000 $12,000 $12,000

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Income Allocation Schedule: 2004

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24,000 24,000 12,000

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Bonus and Salary Allowances

Income Allocation Schedule: 2003

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Income Allocation Schedule: 2004

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Income Allocated in Relation to Partnership Capital

$20,000 2,000 3,000 $25,000

$20,000 (5,000) (4,000) 8,000 $19,000

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Comparison of Capital Bases

Ace Butch Total

Beginning Capital Investment $20,000 20,000 $40,000

Ending Capital Investment $25,000 19,000 $44,000

Weighted Average Capital Investment $22,500 16,500 $39,000

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Interest Allowances on Partnership Capital

Value new partners investment in an existing partnership.

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Changes in Partnership Interest

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Changes in Partnership Interest

Investing in an existing partnership

Value partners share upon retirement or death.

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