Partnerships Chapter 12 Copyright © 2007 Prentice-Hall. All rights reserved 1 Objective 1 Identify the characteristics of a partnership Copyright © 2007 Prentice-Hall. All rights reserved 2 Partnership • Association of two or more persons who co-own a business for a profit • Combines – Capital – Talent – Experience Copyright © 2007 Prentice-Hall. All rights reserved 3 Partnership Agreement • Contract between partners should specify 1. 2. 3. 4. 5. 6. 7. Name, location, and nature of business Name, investment, and duties of each partner How new partners are admitted How profits and losses are divided up Withdrawals of assets by the partners How to settle up with a withdrawing partner How to liquidate the partnership Copyright © 2007 Prentice-Hall. All rights reserved 4 Characteristics of a Partnership • • • • • • Limited life Mutual agency Unlimited liability Co-ownership of property No partnership income taxes Partners’ capital accounts Copyright © 2007 Prentice-Hall. All rights reserved 5 Types of Partnerships • General partnership – basic form • Limited partnership – two classes of partners Copyright © 2007 Prentice-Hall. All rights reserved 6 Limited Liability Company (LLC) • Its own form of business organization – Owners are called members – Limited liability – Members can participate in management – Can elect not to pay business income tax Copyright © 2007 Prentice-Hall. All rights reserved 7 S Corporations • Corporation taxed as a partnership – Limited liability of owners – No corporate income tax – Stockholders pay personal income tax on their share of income Copyright © 2007 Prentice-Hall. All rights reserved 8 Objective 2 Account for partner investments Copyright © 2007 Prentice-Hall. All rights reserved 9 The Partnership Start-Up • Record assets invested by partners at fair market values • Record liabilities assumed at fair market values • Each partner has his/her own capital and withdrawals account Copyright © 2007 Prentice-Hall. All rights reserved 10 Example GENERAL JOURNAL DATE DESCRIPTION REF Jun 1 Cash Inventory Computer Equipment Accounts Payable Lane, Capital DEBIT CREDIT 10,000 40,000 450,000 80,000 420,000 To record Lane’s Investment Jun 1 Cash Computer Software Reed, Capital 5,000 100,000 105,000 To record Reed’s Investment Copyright © 2007 Prentice-Hall. All rights reserved 11 Objective 3 Allocate profits and losses to the partners Copyright © 2007 Prentice-Hall. All rights reserved 12 Sharing Profits and Losses • Stated fraction for each partner • Based on percent of capital balances of the partners • Based on each partner’s service • Combination Copyright © 2007 Prentice-Hall. All rights reserved 13 Sharing Profits and Losses • If no partnership agreement, the law states earnings will be divided equally • If agreement specifies how to share profits, but not losses – losses are shared the same way as profits Copyright © 2007 Prentice-Hall. All rights reserved 14 E12-16 b Net income Cruz (2/3) x 60,000 Moore (1/3) x 60,000 $60,000 40,000 20,000 GENERAL JOURNAL DATE DESCRIPTION REF Income Summary Cruz, Capital Moore, Capital Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 60,000 40,000 20,000 15 When there is no written agreement, partners share profits losses equally. Netand loss Remember, a debit to Capital decreases it Cruz E12-16 a ($15,000) 10,000 5,000 Moore GENERAL JOURNAL DATE DESCRIPTION REF Cruz, Capital Moore, Capital Income Summary Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 10,000 5,000 15,000 16 E12-16 c Capital Bal. Service Remainder Total Hilton Lee $30,000 24,000 7,500 $61,500 $20,000 36,000 7,500 $63,500 Copyright © 2007 Prentice-Hall. All rights reserved Net income to be distributed $125,000 50,000 60,000 0 17 E12-16 c GENERAL JOURNAL DATE DESCRIPTION REF Dec 31 Income Summary Hilton, Capital Lee, Capital Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 125,000 61,500 63,500 18 Partner Drawings • Reduces capital • Debit Drawing and credit Cash • At period end, close drawing to capital Copyright © 2007 Prentice-Hall. All rights reserved 19 Objective 4 Account for the admission of a new partner Copyright © 2007 Prentice-Hall. All rights reserved 20 Purchasing a Partner’s Interest • Equity is transferred from retiring partner to new partner – Debit retiring partner’s capital – Credit new partner’s capital • Partnership assets are not affected Copyright © 2007 Prentice-Hall. All rights reserved 21 Purchasing A Partner’s Interest Fisher, Capital Garcia, Capital Total $170,000 110,000 $280,000 GENERAL JOURNAL DATE DESCRIPTION REF Fisher, Capital Holt, Capital DEBIT CREDIT 170,000 170,000 Notice, this is an agreement between two individuals. No new assets are acquired by the partnership Copyright © 2007 Prentice-Hall. All rights reserved 22 Purchasing A Partner’s Interest Balances: Holt, Capital Garcia, Capital Total Copyright © 2007 Prentice-Hall. All rights reserved $170,000 110,000 $280,000 23 Investing in the Partnership • New partner contributes assets to the partnership in exchange for a share of the business Copyright © 2007 Prentice-Hall. All rights reserved 24 Investing in the Partnership at Book Value • New partner invests assets equal to his/her interest in the new partnership – Debit assets – Credit new partner’s capital Copyright © 2007 Prentice-Hall. All rights reserved 25 Investing in Partnership at Book Value Ingel, Capital Jay, Capital Total before admitting Kaska investment Total after admitting $70,000 90,000 $160,000 80,000 $240,000 1/3 interest = $80,000 Copyright © 2007 Prentice-Hall. All rights reserved 26 Investing in Partnership at Book Value GENERAL JOURNAL DATE DESCRIPTION REF Other Assets Kaska, Capital Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 80,000 80,000 27 Investing in Partnership at Book Value Balances Ingel, Capital Jay, Capital Kaska, Capital Copyright © 2007 Prentice-Hall. All rights reserved $70,000 90,000 80,000 $240,000 28 Investing in the Partnership Bonus to the Old Partners • New partner invests assets greater than his/her equity in the new partnership • Bonus increases old partner’s capital in profit-and-loss sharing ratio – Debit assets – Credit new partner’s capital for his/her share – Credit each old partners’ capital for his/her share of the bonus Copyright © 2007 Prentice-Hall. All rights reserved 29 Investing in Partnership Bonus to Existing Fry contributed $90,000. The credit to her Partners capital account is $60,000. The extra $30,000 is considered a bonus to the existing Capital $70,000 partners Kaga, Opper, Capital Total before admitting Fry investment Total after admitting 80,000 $150,000 90,000 $240,000 ¼ interest = $60,000 Bonus of $30,000 paid to existing partners Copyright © 2007 Prentice-Hall. All rights reserved 30 Investing in Partnership Bonus to Existing Partners Distribution of bonus: Kaga, Capital (30,000 x 1/2) Opper, Capital (30,000 x 1/2) Copyright © 2007 Prentice-Hall. All rights reserved $15,000 15,000 31 Investing in Partnership Bonus to Existing Partners GENERAL JOURNAL DATE DESCRIPTION REF Cash Fry, Capital Kaga, Capital Opper, Capital Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 90,000 60,000 15,000 15,000 32 Investing in Partnership Bonus to Existing Partners Balances: Kaga, Capital Opper, Capital Fry, Capital Copyright © 2007 Prentice-Hall. All rights reserved $85,000 95,000 60,000 $240,000 33 Investing in the Partnership Bonus to New Partners • New partner invests assets less than his/her equity in the new partnership • Bonus decreases old partner’s capital in profit-and-loss sharing ratio – Debit assets – Debit each old partners’ capital for his/her share of the bonus to the new partner – Credit new partner’s capital for his/her share Copyright © 2007 Prentice-Hall. All rights reserved 34 Investing in the Partnership Jones contributed $100,000. The credit to Bonus to New Partners his capital account is $160,000. The extra $60,000 is considered a bonus to the new Page, Capital partners and will be donated by the$230,000 other Franco,partners Capital 150,000 Total before admitting Jones investment Total after admitting $380,000 100,000 $480,000 1/3 interest = $160,000 Bonus of $60,000 paid to new partner Copyright © 2007 Prentice-Hall. All rights reserved 35 Investing in the Partnership Bonus to New Partners Distribution of bonus: Page, Capital (60,000 x 2/3) Franco, Capital (60,000 x 1/2) Copyright © 2007 Prentice-Hall. All rights reserved $40,000 20,000 36 Investing in the Partnership Bonus to New Partners GENERAL JOURNAL DATE DESCRIPTION REF Cash Page, Capital Franco, Capital Jones, Capital Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 100,000 40,000 20,000 160,000 37 Investing in the Partnership Bonus to New Partners Balances: Page, Capital Franco, Capital Jones, Capital Copyright © 2007 Prentice-Hall. All rights reserved $190,000 130,000 160,000 $480,000 38 Objective 5 Account for a partner’s withdrawal from the firm Copyright © 2007 Prentice-Hall. All rights reserved 39 Withdrawal of a Partner • Assets may be revalued • Any gain or loss is allocated among the partners based on their profit- and-loss ratios Copyright © 2007 Prentice-Hall. All rights reserved 40 Partner Sells Interest to Existing Partner • Transfer equity from the withdrawing partner to the purchaser • No assets flows through the partnership • Debit withdrawing partner’s capital • Credit purchaser’s capital Copyright © 2007 Prentice-Hall. All rights reserved 41 Withdrawal at Book Value • Partner takes assets with value equal to his capital account (equal to book value) • Debit withdrawing partner’s capital • Credit assets taken Copyright © 2007 Prentice-Hall. All rights reserved 42 Withdrawal at Less Than Book Value • Remaining partners share the difference (bonus) based on their profit-and losssharing ratio. • Debit withdrawing partner’s capital • Credit assets and remaining partners’ capital based on agreed upon ratios Copyright © 2007 Prentice-Hall. All rights reserved 43 Withdrawal at More Than Book Value • Bonus to the withdrawing partner reduces the remaining partners’ capital balances based on their profit-and-loss ratio • Debit withdrawing partner’s capital • Debit remaining partners’ capital • Credit assets Copyright © 2007 Prentice-Hall. All rights reserved 44 Example Distribute gain on land to partners based on profit-loss ratio Green (50,000 x 1/4) $12,500 Henry (50,000 x 1/2) 25,000 Jackson (50,000 x 1/4) 12,500 Copyright © 2007 Prentice-Hall. All rights reserved 45 Example GENERAL JOURNAL DATE DESCRIPTION REF Jul 31 Land Green, Capital Henry, Capital Jackson, Capital Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 50,000 12,500 25,000 12,500 46 Example Distribute loss on inventory to partners based on profit-loss ratio Green (6,000 x 1/4) $1,500 Henry (6,000 x 1/2) 3,000 Jackson (6,000 x 1/4) 1,500 Copyright © 2007 Prentice-Hall. All rights reserved 47 Example GENERAL JOURNAL DATE DESCRIPTION REF Jul 31 Green, Capital Henry, Capital Jackson, Capital Inventory Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 1,500 3,000 1,500 6,000 48 Example Green, Capital 50,000 12,500 1,500 61,000 Henry, Capital Jackson, Capital 40,000 20,000 25,000 12,500 3,000 1,500 62,000 31,000 Jackson is getting $40,000 cash so he receives a bonus of $9,000 ($40,000 - $31,000) Copyright © 2007 Prentice-Hall. All rights reserved 49 Example Distribute bonus to withdrawing partner based on profit-loss ratio Green (9,000 x 1/2) $4,500 Henry (9,000 x 1/2) 4,500 Copyright © 2007 Prentice-Hall. All rights reserved 50 Example GENERAL JOURNAL DATE DESCRIPTION REF Jul 31 Green, Capital Henry, Capital Jackson, Capital Cash Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 4,500 4,500 31,000 40,000 51 Objective 6 Account for the liquidation of a partnership Copyright © 2007 Prentice-Hall. All rights reserved 52 Death of a Partner • Dissolves partnership • Settlement with the deceased partner’s estate - based on partnership agreement • Or, a remaining partner may buy the deceased partner’s equity Copyright © 2007 Prentice-Hall. All rights reserved 53 Liquidation of a Partnership • Adjust and close books • Sell the noncash assets, allocate gains and losses to the partners based on their profit-and-loss-sharing ratio • Pay all the liabilities • Distribute the remaining cash based on the partners’ capital balances Copyright © 2007 Prentice-Hall. All rights reserved 54 E12-24 Sell off the noncash assets Noncash Dodd, Gage, Hamm, Assets Liabilitie Capital Capital Capital Cash s $6,000 $126,000 $77,000 $12,000 $37,000 $6,000 140,000 (126,000) GENERAL JOURNAL DATE DESCRIPTION REF Cash Noncash Assets Gain on Sale of Assets Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 140,000 126,000 14,000 55 Distribute gain based on profit and loss ratio E12-24 Distribute Gain on Sale of Assets: Dodd ($14,000 x 20%) Gage ($14,000 x 30%) Hamm ($14,000 x 50%) $2,800 4,200 7,000 GENERAL JOURNAL DATE DESCRIPTION REF Gain on Sale of Assets Dodd, Capital Gage, Capital Hamm, Capital Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 14,000 2,800 4,200 7,000 56 Pay off the liabilities E12-24 Noncash Dodd, Gage, Hamm, Assets Liabilitie Capital Capital Capital Cash s $6,000 $126,000 $77,000 $12,000 $37,000 $6,000 140,000 (126,000) 2,800 4,200 7,000 $146,000 0 $77,000 $14,800 $41,200 $13,000 GENERAL JOURNAL DATE DESCRIPTION REF Liabilities Cash DEBIT CREDIT 77,000 77,000 Copyright © 2007 Prentice-Hall. All rights reserved 57 Distribute the cash to the partners and close out their accounts as well E12-24 Noncash Dodd, Gage, Hamm, Assets Liabilitie Capital Capital Capital Cash s $6,000 $126,000 $77,000 $12,000 $37,000 $6,000 140,000 (126,000) 2,800 4,200 7,000 $146,000 0 (77,000) $69,000 $77,000 $14,800 $41,200 $13,000 (77,000) 0 0 $14,800 $41,200 $13,000 $69,000 Copyright © 2007 Prentice-Hall. All rights reserved 58 E12-24 GENERAL JOURNAL DATE DESCRIPTION REF Dodd, Capital Gage, Capital Hamm, Capital Cash Copyright © 2007 Prentice-Hall. All rights reserved DEBIT CREDIT 14,800 41,200 13,000 69,000 59 E12-24 Noncash Dodd, Gage, Hamm, Assets Liabilitie Capital Capital Capital Cash s $6,000 $126,000 $77,000 $12,000 $37,000 $6,000 140,000 (126,000) 2,800 4,200 7,000 $146,000 0 (77,000) $69,000 $77,000 $14,800 $41,200 $13,000 (77,000) 0 0 $14,800 $41,200 $13,000 (69,000) 0 (14,800) (41,200) (13,000) 0 0 0 Copyright © 2007 Prentice-Hall. All rights reserved 0 0 60 E12-22 1. Cash Ray, capital Scott, capital Van, capital $80,000 $33,000 28,000 19,000 80,000 Each partner receives cash equal to his capital balance because cash equals total partnership capital Copyright © 2007 Prentice-Hall. All rights reserved 61 E12-22 2. Cash Ray, capital Scott, capital Van, capital Loss $50,000 $33,000 28,000 19,000 80,000 $30,000 Each partner gets $10,000 ($30,000 / 3) less than his capital balance Copyright © 2007 Prentice-Hall. All rights reserved 62 E12-22 2. Ray Scott Van $23,000 18,000 9,000 $50,000 Copyright © 2007 Prentice-Hall. All rights reserved 63 Objective 7 Prepare partnership financial statements Copyright © 2007 Prentice-Hall. All rights reserved 64 Financial Statements • Much like those of a proprietorship • Income statement - section showing division of net income to the partners • Balance sheet - capital of each partner in owners’ equity section • Statement of Owners’ Equity shows changes to each partner’s capital account Copyright © 2007 Prentice-Hall. All rights reserved 65 S12-13 Bush and Carter Income Statement Year Ended September 30, 2007 Service revenue Total expenses Net income Allocation of net income: To Bush ($60,000 .60) To Carter ($60,000 .40) $145,000 85,000 $60,000 $36,000 24,000 Copyright © 2007 Prentice-Hall. All rights reserved $60,000 66 End of Chapter 12 Copyright © 2007 Prentice-Hall. All rights reserved 67