Chapter 15
PARTNERSHIPS -- FORMATION, OPERATIONS
Comprehensive Chapter Outline
NATURE OF PARTNERSHIP ORGANIZATION
A
Partnership is defined as an association of two or more persons to carry on as coowners of a business for profit.
B
Characteristics
C
D
1
Limited life - the legal life of a partnership terminates with the admission of a
new partner, withdrawal or death of an old partner, voluntary dissolution by the
partners, or involuntary dissolution.
2
Mutual agency - each partner is assumed to be an agent for the partnership with
the power to bind all the other partners by his/her actions on behalf of the
partnership.
3
Unlimited liability - each partner is liable for all partnership debts.
Articles of partnership (the partnership agreement) should be written (but oral
agreements may be legal and binding)
1
The agreement should specify the types of products and services to be provided
and other details of the business, rights and responsibilities of partners, initial
investments, provisions for additional investments , asset drawing provisions,
profit and loss sharing formulas, and procedures for dissolving the partnership.
2
Profits and losses are divided equally if there is no specific partnership
agreement.
Partnerships do not pay federal income taxes, but the IRS requires filing of a financial
information return.
INVESTMENTS AND DISINVESTMENTS (Illustration 15-1)
A
Initial investments
1
All property brought into the partnership or acquired by the partnership is
partnership property.
2
Initial investment is recorded in the partners’ capital accounts at its fair value at
the time of transfer to the partnership.
3
Unidentifiable assets in initial investment:
a
b
Bonus approach - the unidentifiable asset is not recorded on the
partnership books and the capital accounts are adjusted to meet the
conditions of the partnership agreement
Goodwill approach - the unidentifiable asset is measured and recorded by
reference to the total partnership capital implied by the other partners’
investment divided by the other partners’ interest
B
Additional investments - The same valuation rules apply for additional investments as
apply for initial investments.
C
Withdrawals are large and irregular disinvestments charged directly to partners’ capital
accounts.
D
Drawings, drawing allowances, and salary allowances are:
E
1
Regular amounts that are withdrawn in anticipation of profits and charged to
individual partner drawings accounts.
2
Closed to the capital accounts at the end of each accounting period, before
preparation of the partnership balance sheet.
Loans and advances
1
Loans made to the partnership by a partner earn interest and are considered
liabilities of the partnership.
2
Loans made to a partner by the partnership are partnership assets
PARTNERSHIP OPERATIONS
A
Financial statements of a partnership include a balance sheet, an income statement, a
statement of partnership capital, and a statement of cash flows.
B
Profit and loss sharing agreements provide for the division of profits.
1
Salaries and bonuses to partners and interest on capital accounts are not
expenses and do not affect the measurement of partnership income.
2
The order of the partnership agreement is followed regardless of the income or
loss experienced by the partnership.
3
Losses are divided the same as profits if there is no specific agreement for
losses.
4
Capital to be considered in profit and loss sharing agreements may be beginning,
ending, or average capital balances. Average capital means weighted average
unless otherwise specified in the partnership agreement.