Partnerships – Formation, Operations, and Changes in Ownership Interests Chapter 15

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.



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.



Articles of Partnership

A partnership may be formed by a simple oral agreement among two or more people to operate a business for profit.



Articles of Partnership

The types of products and services to be provided

Each partner’s rights and responsibilities

Each partner’s initial investment

Additional investment conditions

Asset drawing provisions

Profit and loss sharing formulas

Procedures for dissolving the partnership



Partnership Financial Reporting

The accounting reports are designed to meet the needs of three user groups…

The partners

Partnership creditors

Internal Revenue Service




Understand initial investment valuation and record keeping.



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 Ashley’s original investment of cash

Cash 20,000

Becker, Capital 20,000

To record Becker’s original investment of cash



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)

Building (cost to C. Cola, $30,000)

Inventory (cost to R. Crown, $28,000)

Total

$ — $ 7,000

10,000 —

40,000

—

—

35,000

$50,000 $42,000



Noncash Investments

Land 10,000

Building 40,000

C. Cola, Capital 50,000

To record C. Cola’s original investment of land and building at fair value



Noncash Investments

Cash 7,000

Inventory 35,000

R. Crown, Capital 42,000

To record R. Crown’s 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

R. Crown, Capital

4,000

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

R. Crown, Capital

8,000

8,000

To establish equal capital interests of $50,000 by recognizing R. Crown’s 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 partner’s 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

Add: Additional investments

$40,000 $35,000 $75,000

5,000

—

5,000

Deduct: Withdrawals

— – 3,000 – 3,000

Deduct: Drawings

– 6,000 – 9,000 –15,000

Net contributed capital

Add: Net income for 2003

39,000

20,700

23,000

13,800

62,000

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

Yancey, Capital

20,700

13,800

To divide net income for the year 60% to Ratcliffe and 40% to Yancey



Closing Entries

December 31, 2003

Ratcliffe, Capital

Yancey, Capital

Ratcliffe, Drawing

Yancey, Drawing

6,000

9,000

6,000

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

Salary allowances

$60,000 to Bob and Gary (24,000) $12,000 $12,000

Remainder to divide 36,000

Divided equally (36,000) 12,000 12,000 $12,000

Remainder to divide

Net income allocation

0

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




Bob Gary Pete

Net income

Salary allowances

$12,000 to Bob and Gary (24,000) $12,000 $12,000

Remainder to divide (12,000)

Divided equally 12,000 (4,000) (4,000) $(4,000)

Remainder to divide


0

$ 8,000 $ 8,000 $(4,000)



Journal Entries

December 31, 2003


Bob, Capital

Gary, Capital

Pete, Capital

Partnership income allocation for 2003

24,000

24,000

12,000



Journal Entries

December 31, 2004


Pete, Capital

Bob, Capital

4,000

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 Gary Pete

Net income $60,000

Bonus to Bob (6,000) $ 6,000


Salary allowances to Bob and Gary (18,000) 10,000 $ 8,000


Divided equally

Remainder to divide


(36,000) 12,000 12,000 $12,000

0

$28,000 $20,000 $12,000




Bob Gary Pete

Net income $12,000

Bonus to Bob (1,200) $ 1,200


Salary allowances to Bob and Gary (18,000) 10,000 $8,000

Remainder to divide (7,200)

Divided equally

Remainder to divide


7,200 (2,400) (2,400) $(2,400)

0

$ 8,800 $5,600 $(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

$20,000 $20,000

2,000

—

—

3,000

—

(5,000)

—

(4,000)

—

8,000

Capital balances 12/31/2003 $25,000 $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)

Butch ($100,000

×

20/40)

$ 50,000

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 partner’s share upon retirement or death.



Dissolution of a Continuing Partnership

Through Death or Retirement

Profit and

Capital Percentage Loss

Balances of Capital Percentage

Bonnie

Clyde

Dillinger

$ 70,000

50,000

80,000

35%

25

40

Total capital $200,000 100%

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 80,000

Bonnie, Capital

Clyde, Capital

Cash

8,000

4,000

Dillinger, Capital 80,000

Goodwill 12,000

Cash

92,000

92,000



Reevaluation of Total

Partnership Capital

Goodwill (other assets) 30,000

Bonnie, Capital

Clyde, Capital

Dillinger, Capital

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

72,000

20,000

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 Chapter 15

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