Business Associations
Chapter 3 Handout
Example 1
Partnership agreement provides for equal profits and losses
Where a PS is formed, each partner’s capital account is credited for his/her initial investment and
the appropriate asset account is debited. If non-cash assets are invested, these assets should be
listed at an agreed amount.
Initial contributions:
1. Smith
2. Jones
3. Williams
$5K (truck)
$10K to buy inventory/lease store
$0.00 agrees to manage
During year:
$3K profits
1. Smith
2. Jones
3. Williams
contributes cash register for $400
w/draws $500 for personal reasons
managed
Interest at end of year:
1. Smith
$6,400.00
2. Jones
$10, 500
3. Williams
$1,000.00
--------------------------------------------------------------------------------------------------------------------Example 2
Partnership agreement provides for equal profits and losses
Morrison is a proprietor in a small merchandising business. He decides to form a partnership with
Kathy in which Kathy will become an equal partner and share profits and losses equally.
Morrison contributes his sole proprietorship business to the partnership as follows:
Sole Proprietorship:
Morrison
Cash
Accounts Receivable
Merchandise Inventory
Equipment
$10,000
$5,000
$20,000
$15,000
Allowance for doubtful accounts
Notes Payable
$1,000
$9,000
Morrison, Capital
$40,000
If Kathy is to contribute cash to the new partnership, recordation of initial investments would
look like this:
(A) Cash
Accounts Receivable
Merchandise Inventory
Equipment
$10,000
$5,000
$20,000
$15,000
1
Allowance for doubtful accounts
Notes Payable
$1,000
$9,000
Morrison, Capital
$40,000
(B) Cash
$40,000
Kathy Capital
$40,000
--------------------------------------------------------------------------------------------------------------------Fixed or capital basis
Profits and losses are divided equally in a fixed ration based on capital
contributions
Example 3
Perez and Roth have capital balances of 30k and 20k respectively. The net income for the 1st year of
operations was 15k. If the partners have decided to share on an equal basis, the journal entry for the
allocation of the net income will be:
Expense and Income Summary:
15k
Perez, Capital
Roth, Capital
$7,500
$7,500
If, however, capital investment is to be the determining factor, the entry will run as follows:
Expense and Income Summary:
15k
Perez, Capital
[
30k
[60% x 15k]
[30k plus 20k]
$9k
Roth, Capital
[
20k
]
[40%x 15k]
[30k plus 20k]
Interest basis
$6k
Under the interest method, each partner is paid interest on his or her capital investment,
and the remaining net income is divided in a fixed ratio. Thus, a partner’s share depends
partially on his or her capital investment.
Example 4
Assume each partner is to receive 6% on his or her capital balance, the remaining net income to be shared
equally. The entry would be:
Expense and Income Summary:
Perez, Capital
Roth, Capital
15k
$7,800
$7,200
The computation being:
Interest on investment
Balance
Perez
1,800 (30kx.06)
6,000
Salary basis
2
Roth
1,200 (20kx.06)
6,000
Total
3,000
12,000
15,000
The partners may agree to give recognition to contribution in the form of services, while the remaining net
income may be divided equally or in a fixed ration. These “salaries” are treated as “withdrawels” and are
not charged as an expense of the business.
Example 5
Assume that the PS of Perez and Roth agree that a yearly salary allowance of $4k will be given to Perez
and $3k to Roth, the balance to be divided equally. The entry would be:
Expense and Income Summary:
Perez, Capital
Roth, Capital
15k
$8,000
$7,000
The computation being:
Salary
Balance
Perez
4,000
4,000
8,000
Roth
3,000
4,000
7,000
Total
7,000
8,000
15,000
Salary plus interest basis
Under the salary plus interest basis, services rendered to the business and capital
contribution jointly determine the income division. Each partner gets a salary, and, at the
same time, interest on capital. If any balance remains, it is divided in an agreed ratio.
Example 6
Perez and Roth decide to allow a credit of 6% interest on capital balances, respective
salalries of 4k and 3k, and equal division of any remainder. The entry would be:
Expense and Income Summary:
Perez, Capital
Roth, Capital
15k
$8,300
$6,700
The computation being:
Interest
Salary
Balance
Perez
$1,800
$4,000
Roth
$1,200
$3,000
Total
$3,000
$7,000
$5,800
$2,500
8,300
$4,200
$2,500
6,700
$10,000
$5,000
15,000
Dividing a negative balance
If the income of the business does not exceed the total of the allowances to the partners,
the balance remaining is negative and is divided among the partners equally as though it
were a loss.
Example 7
3
Perez and Roth decide to allow a credit of 6% on capital balances, respective salaries of
$8k and$6k respectively, and equal division of the remainder. The entry would be:
Expense and Income Summary:
Perez, Capital
Roth, Capital
15k
$8,800
$6,200
The computation being:
Interest
Salary
Balance
Perez
$1,800
$8,000
Roth
$1,200
$6,000
Total
$3,000
$14,000
$9,800
-$1,000
8,800
$7,200
-$1,000
6,200
$17,000
-$2,000
15,000
If in the partnership of Perez and Roth a $15k loss has occurred (all profits and losses are
to be shared equally), the entry to record the loss would be:
Perez, Capital
Roth, Capital
Expense and Income Summary:
$7,500
$7,500
15k
4