Chapter 13 Accounting for partnerships

PowerPoint presentation by Dr Anne Abraham University of Western Sydney 2009 John Wiley & Sons Australia, Ltd
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PARTNERSHIP FORM OF ENTITY

LO1

The Partnership Act regulates practice Each State has its own Act A partnership is defined as
an association between 2 or more persons carrying on a business in common with a view to making a profit

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Characteristics of partnerships
1. Association of individuals
Voluntary association May be based on handshake or written agreement Partnership not a legal entity, so is not taxed Individual partners pay tax on their share of profit

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Characteristics of partnerships
continued

2. Mutual agency
Each partner acts on behalf of the partnership when engaging in partnership business Act of any partner is binding on all other partners

3. Limited life
May be ended voluntarily at any time through the acceptance of anew partner or withdrawal of a partner May be ended by involuntarily by death of incapacity of a partner

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Characteristics of partnerships
continued

4. Unlimited liability
Each partner is personally and individually liable for all partnership liabilities

5. Co-ownership of property
Partnership assets are owned jointly by the partners If partnership is dissolved, assets do not legally revert to original contributor Partners have a claim on total assets equal to the balance in individual capital account Partnership profit or loss is co-owned

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PowerPoint presentation by Dr Anne Abraham, University of Western Sydney

Entities with partnership characteristics

In a limited partnership
one or more partners have unlimited liability, and one or more partners have limited liability for the debts of the firm

General partners have unlimited liability Limited partners have limited liability An incorporated limited partnership is a primarily used when engaged in high-risk venture capital projects

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Advantages and disadvantages of partnerships

Advantages Combining skills and resources of 2 of more individuals Ease of formation Not subject to as much government regulation as companies Ease of decision making No taxation on partnership profits

Disadvantages Mutual agency Limited life Unlimited liability Partners must be able to work together

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The partnership agreement

A written agreement specifying such details as
Names and contributions of the partners Rights and duties of partners Basis for sharing net income or loss Provision for withdrawals of assets Procedures for settling disputes Procedures for withdrawal or addition of a partner Rights and duties of surviving partners in the event of a partner s death

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LO1

Question 1
Which of the following is not a characteristic of a partnership? Taxable entity Co-ownership of property Mutual agency Limited life

A. B. C. D.

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BASIC PARTNERSHIP ACCOUNTING

Major accounting issues in relation to partnerships are
Forming a partnership Dividing profit or loss Preparing financial statements

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LO2

Forming a partnership
Recorded at the fair value of the assets at the date of their transfer to the partnership Values assigned must be agreed to by all of the partners

Initial investment

Once partnership has been formed

Accounting is similar to accounting for transactions of any other type of business organisation

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Forming a partnership continued

Example
Carrying amount and fair value of assets invested
Carrying amt Fair value A.Gibson T.Jones A.Gibson T.Jones Cash $ 8 000 $ 9 000 $ 8 000 $ 9 000 Office equipment 5 000 4 000 Accum. depreciation (2 000) Accounts receivable 4 000 4 000 Allow. for doubtful debts (700) (1 000) $11 000 $12 300 $12 000 $12 000

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Forming a partnership continued

Journal entries to record investments
Cash Office Equipment A. Gibson, Capital (To record investment of Gibson) Cash Accounts Receivable Allowance for Doubtful Debts T. Jones, Capital (To record investment of Jones) 8 000 4 000

12 000

9 000 4 000

1 000 12 000

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LO2

Question 2
In accounting for the formation of a partnership, each partner s initial investment is recorded at the carrying amount of assets invested the fair value of assets invested the historical cost of assets invested the book value of assets invested

A. B. C. D.

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LO3

Dividing profit or loss

Partnership profit or loss is shared equally unless the partnership contract indicates otherwise Profit-and-loss-ratio is used to identify basis for dividing profit and loss Partners share of net income or loss is recognised in the accounts through closing entries

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Dividing profit or loss continued

Closing entries:
1. DR each revenue account for its balance and CR Profit and Loss Summary for total revenue 2. DR Profit and Loss Summary for total expenses and CR each expense account for its balance 3. DR (CR) Profit and Loss Summary for its balance and CR (DR) each partner s capital account for their share of profit (loss) 4. DR each partner s capital account for the balance in that partner's drawing account and CR each partner s drawing account for the same amount

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Dividing profit or loss continued

Example
Partnership profit for year is $32 000 Partners share profit and loss equally

Profit and Loss Summary L. Cooke, Current ($32 000 x 50%) D. Kam, Current ($32 000 x 50%) (To transfer profit to partners current accounts)

32 000

16 000 16 000

L. Cooke, Current 8 000 D. Kam, Current 6 000 L. Cooke, Drawings D. Kam, Drawings (To close drawings accounts to current PowerPoint presentation by Dr Anne accounts) Abraham, University of Western Sydney

8 000 6 000
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Dividing profit or loss continued

Profit-and-loss ratios Typical profit-and loss ratios include: 1 A fixed ratio
expressed as a proportion (6:4), a percentage (70% and 30%), or a fraction (2/3 and 1/3)

2 A ratio based on either:

capital balances at beginning of year or average capital balances during year

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Dividing profit or loss continued

3 Salaries to partners and the remainder on a fixed ratio 4 Interest on partners capital balances and the remainder on a fixed ratio 5 Salaries to partners, interest on partners capitals, and the remainder on a fixed ratio

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Dividing profit or loss continued

Salaries, interest and remainder on a fixed ratio Example
M. Kings and S. Lee agree on
Salary allowances of $8400 to Kings and $6000 to Lee Interest allowances of 10% on beginning capital balances Remainder shared equally

Beginning capital balances

Kings $28 000 and Lee $24 000

Profit for year is $22 000

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Dividing profit or loss continued

Division of profit
Salary allowance Interest allowance Kings ($28 000 x 10%) Lee ($24 000 x 10%) Total interest allowance Total salaries and interest Remaining profit ($22 000 - $19 600 = $2400) Kings ($2400 x 50%) Lee ($2400 x 50%) Total remainder Total division of profit Kings Lee Total $ 8 400 $6 000 $14 400

2 800
11 200 1 200

2 400

5 200 8 400 19 600

2 400 $12 400 $9 600 $22 000

22

1 200

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Dividing profit or loss continued

Entry to record division of profit
Profit and Loss Summary M. Kings, Current S. Lee, Current (To close profit to partners current accounts) 22 000 12 400 9 600

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LO3

Question 3
NBC reports net income of $60 000. If partners N, B, and C have an income ratio of 50%, 30%, and 20%, respectively, C s share of net income is $30 000 $12 000 $18 000 $20 000

A. B. C. D.

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Partnership financial statements

LO4

Income statement
Identical to proprietorship except for division of profit

Statement of financial position

Identical to proprietorship except for owners equity section

Partnership statement of changes in equity

Used to explain the changes in each partners capital or current account and in total partnership equity during the year

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LO4

Question 4
Which of the following statements about the partnership financial statements is not true? The capital balances of each partner are shown on the statement of financial position Changes in each partner s current account is shown on statement of changes in equity Each partners drawings is shown on the statement of financial position Distribution of profit is shown in income statement

A. B. C.

D.

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LO5

ADMISSION OF A PARTNER

The admission of a new partner results in legal dissolution of the existing partnership and the beginning of a new one To recognise economic effects it is necessary only to open a capital account for each new partner A new partner may be admitted either by:
Purchasing the interest of an existing partner or Investing assets in a partnership

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ADMISSION OF A PARTNER
continued

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Purchase of a partners interest

The admission of a partner by purchase of an interest in the firm is a personal transaction between one or more existing partners and the new partner Price paid is negotiated and determined by the individuals involved The price may be equal to or different from the capital equity acquired

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Purchase of a partners interest

continued

Any money or other consideration exchanged is the personal property of the participants and not the property of the partnership Example
Cox agrees to pay $10 000 cash to Adler and Barker for 1/3 of their interest in the Adler-Barker partnership At the time of admission of Cox, each partner has a $30 000 capital balance

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Purchase of a partners interest

continued Entry to record admission of Cox
Each partner will give up $10 000 (1/3 x $30 000)

C. Adler, Capital 10 000 D. Barker, Capital 10 000 L. Cox, Capital 20 000 (To record admission of Cox by purchase)

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Purchase of a partners interest

continued Ledger balances after purchase of partners interest

C. Adler, Capital 10 000 30 000 Bal. 20 000 L. Cox, Capital 20 000

D. Barker, Capital 10 000 30 000 Bal. 20 000 Net Assets 60 000

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Investment of assets in a partnership

When a partner is admitted by investment, both the total net assets and the total partnership capital change When the new partner s investment differs from the capital equity acquired, the difference is considered a bonus either to:
1. The existing (old) partners or 2. The new partner

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Investment of assets in a partnership

continued

Example
Cox invests $30 000 cash in the Adler-Barker partnership for a 1/3 capital balance Journal entry to record admission
Cash 30 000 L. Cox, Capital 30 000 (To record admission of Cox by investment)

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Investment of assets in a partnership

continued Ledger balances after investment of assets
C. Adler, Capital 30 000 D. Barker, Capital 30 000

L. Cox, Capital 30 000

Bal.

Net Assets 60 000 30 000 90 000

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Investment of assets in a partnership

continued

Bonus to old partners Results when new partners investment in the firm is greater than the capital credit on the date of admittance Example
Boyd and Chan with total capital of $120 000 agree to admit Dante to the partnership Dante acquires a 25% ownership interest by making a cash investment of $80 000 Current profit sharing ratio is Boyd 60% and Chan 40%
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Investment of assets in a partnership

continued

Steps in determining bonus

1 Determine the total capital of the new partnership
New partner s investment + capital of the old partnership $120 000 + $80 000 = $200 000

2 Determine the new partner s capital credit

Multiply the total capital of the new partnership by the new partner s ownership interest $200 000 x 25% = $50 000

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Investment of assets in a partnership

continued 3 Determine the amount of bonus
Subtract the new partner s capital credit from the new partner s investment $80 000 - $50 000 = $30 000

4 Allocate the bonus to the old partners on the basis of their income ratios
Boyd: $30 000 x 60% = $18 000 Chan: $30 000 x 40% = $12 000

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Investment of assets in a partnership

continued Entry to record admission of Dante
Cash 80 000 S. Boyd, Capital 18 000 T. Chan, Capital 12 000 L. Dante, Capital 50 000 (To record admission of Dante and bonus to old partners)

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Investment of assets in a partnership

continued

Bonus to new partner Results when the new partner s investment is less than his or her capital credit in the firm Capital balances of the old partners are decreased based on their income ratios before the admission of the new partner

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Investment of assets in a partnership

continued

Example
Dante invests $20 000 cash for 25% ownership Calculation of bonus by 4 steps
1. Total capital of Boyd-Chan partnership Investment by new partner, Dante Total capital of new partnership 2. Gunns capital credit (25% x $140 000) 3. Bonus to Dante ($35 000 - $20 000) 4. Allocation of bonus to old partners: Boyd ($15 000 x 60%) $9000 Chan ($15 000 x 40%) $6000
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$120 000 20 000 $140 000 $ 35 000 $ 15 000

$ 15 000
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Investment of assets in a partnership

continued Entry to record admission of Dante
Cash 20 000 S. Boyd, Capital 9 000 T. Chan, Capital 6 000 L. Dante, Capital 35 000 (To record admission of Dante and bonus)

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LO5

Question 5
Yen purchases 50% of Baht s capital interest in the Euro-Baht Partnership for $12 000. If the capital balance of Euro and Baht are $20 000 and $36 000 respectively, Yens capital balance following the purchase is $12 000 $28 000 $10 000 $18 000

A. B. C. D.

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LO6

WITHDRAWAL OF A PARTNER
Voluntarily selling his or her equity Involuntarily by reaching mandatory retirement age or by dying

A partner may withdraw

Withdrawal of a partner may be accomplished by

Payment from remaining partners personal assets, or Payment from partnership assets

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WITHDRAWAL OF A PARTNER
continued

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Payment for partners personal assets

The withdrawal of a partner when payment made from partners personal assets is the direct opposite of admitting a new partner who purchases a partner s interest It is a personal transaction between the partners

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Payment for partners personal assets continued

Example
Marshall, Nguyen and Opal have capital balances of $25 000, $15 000 and $10 000, respectively Marshall and Nguyen agree to buy out Opals interest Each of them agrees to pay Opal $8000 in exchange for one-half of Opals total interest of $10 000

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Payment for partners personal assets continued

Entry to record the withdrawal
J. Opal, Capital 10 000 A. Marshall, Capital M. Nguyen, Capital (To record purchase of Opals interest) 5 000 5 000

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Payment for partners personal assets continued

Ledger balances after payment from partners personal assets
A. Marshall, Capital 25 000 5 000 Bal. 30 000
J. Opal, Capital 10 000 10 000 Bal. 0

M. Nguyen, Capital 15 000 5 000 Bal. 20 000

Net Assets 50 000

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Payment from partnership assets

Using partnership assets to pay for a withdrawing partner s interest decreases both total assets and total partnership capital In accounting for a withdrawal by payment from partnership assets:
Asset revaluations should not be recorded, and Any difference between the amount paid and the withdrawing partner s capital balance should be considered a bonus to the retiring partner or a bonus to the remaining partners

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Payment from partnership assets

continued

Many partnerships require amount paid to be based on fair value of assets Differences are
Recorded by an adjusting entry Allocated to all partners on the basis of their profit-andloss ratios

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Payment from partnership assets

continued

Example
Williams is retiring from partnership Partners share profit and losses equally Statement of financial position shows:
Cash $ 22 000 Inventory 30 000 Equipment 25 000 Less Accum. Depn 5 000 20 000 Land 59 000 Total Assets $131 000 Total Liabilities Wu, Capital White, Capital Williams, Capital $ 55 000 36 000 25 000 15 000
.

Total liab. & equity $131 000

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Payment from partnership assets

continued Valuer assesses
inventory at $27 000 land at $74 000

Adjusting entries
Wu, Current ($3000 x 1/3) 1 000 White, Current ($3000 x 1/3) 1 000 Williams, Current ($3000 x 1/3) 1 000 Inventory (Revalue inventory & allocate loss to partners) Land 15 000 Wu, Current ($15 000 x 1/3) White, Current ($15 000 x 1/3) Williams, Current ($15 000 x 1/3) (Revalue land & allocate gain to partners)
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3 000 5 000 5 000 5 000

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Payment from partnership assets

continued

Statement of financial position after adjusting entries:

Cash $ 22 000 Inventory 27 000 Equipment 25 000 Less Accum. Depn 5 000 20 000 Land 74 000 Total Assets $143 000 Total Liabilities Wu, Capital White, Capital Williams, Capital $ 55 000 40 000 29 000 19 000
.

Total liab. & equity $143 000

Three accounting possibilities:

1 Withdrawal at carrying amount of the partners owners equity 2 Bonus to retiring partner 3 Bonus to remaining partners
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Payment from partnership assets

continued

1. Withdrawal of the carrying amount of the partners owners equity Example

Williams would be entitled to receive cash equal to balance of her capital account, which is $19 000
Williams, Capital 19 000 Cash 19 000 (Withdrawal of Williams from partnership)

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Payment from partnership assets

continued

2. Bonus to retiring partner May be paid where

There is unrecorded goodwill resulting from superior earnings record Remaining partners anxious to remove partner

Example
Williams retires and receives payment of $25 000 from the firm

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Payment from partnership assets

continued Process involves
Determining amount of bonus $25 000 - $19 000 = $6000 Allocating bonus to remaining partners on basis of profit-and-loss ratio Wu $6000 x = $3000 White $6000 x = $3000

Williams, Capital Wu, Capital White, Capital Cash (Withdrawal of and bonus to Williams)
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19 000 3 000 3 000

25 000

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Payment from partnership assets

continued

3. Bonus to remaining partners May occur when

Partnership has poor earnings record Partner is anxious to leave partnership

Example
Williams is paid on $16 000 for her $19 000 equity

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Payment from partnership assets

continued Process involves
Determining amount of bonus $19 000 - $16 000 = $3000 Allocating bonus to remaining partners on basis of profit-and-loss ratio Wu $3000 x = $1500 White $3000 x = $1500

Williams, Capital Wu, Capital White, Capital Cash (Withdrawal of Williams and bonus to remaining partners)
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15 000

1 500 1 500 16 000

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Death of a partner
Death of a partner dissolves the partnership Provision usually made for surviving partners to continue operations by purchasing deceased partner s equity from their personal assets To determine partner s equity at the date of death:
Determine profit or loss for year to date Close the books, and Prepare financial statements

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Death of a partner continued

The surviving partners will agree to either
purchase the deceased partner s equity from their personal assets, or use partnership assets to settle with the deceased partner s estate

In both instances, the entries to record the withdrawal of the partner are similar to those presented earlier

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LO6

Question 6
Capital balances in RMDP partnership are Rae $50 000, Mike $40 000, Dave $30 000 and Pete $20 000. Profit-&-loss sharing ratio is 4:3:2:1. Pete is going to leave partnership. Fair value increases land by $15 000. How will this increase affect Pete? CR to Petes capital account of $6000 CR to Petes capital account of $3750 CR to Petes capital account of $3000 CR to Petes capital account of $1500

A. B. C. D.

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LIQUIDATION OF A PARTNERSHIP
LO7

The liquidation of a partnership terminates the business In a liquidation, it is necessary to:

1 Sell noncash assets for cash and recognise a gain or loss on realisation 2 Allocate gain/loss on realisation to the partners based on their profit-and-loss ratios 3 Pay partnership liabilities in cash 4 Distribute remaining cash to partners on the basis of their capital balances

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LIQUIDATION OF A PARTNERSHIP
continued

Creditors must be paid before partners receive any cash distributions Each step must be recorded by an accounting entry No capital deficiency means that all partners have credit balances in their capital accounts Capital deficiency means at least one partner s account has a debit balance

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LO7

Question 7
Which of the following statements about the partnership liquidation is not true? Gain/loss on sale of non-current assets for cash must be recognised Partnership liabilities are paid in cash Gain/loss on realisation is allocated to partners equally A capital deficiency means at least one partner capital account has a debit balance
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A. B. C. D.

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