UNIT
10
ACCOUNTING FOR
PARTNERSHIPS
ILLUSTRATION 10-1
PARTNERSHIP CHARACTERISTICS
Association of Individuals
Partnership Form
of Business
Organization
Mutual
Agency
Unlimited Liability
Co-ownership of
Property
Limited Life
PARTNERSHIP CHARACTERISTICS
Association of individuals. A partnership is a voluntary association of two or more
individuals that may be based on as simple an act as a handshake or preferably a written
agreement.
Division of income. The net income (loss) of a partnership is divided among the
partners according to their agreement.
Mutual agency. Each partner acts on behalf of the partnership when engaging in
partnership business. The act of any partner is binding on all other partners.
Co-ownership of property. Partnership assets are owned jointly by all the partners. If
the partnership is terminated, the assets do not legally return to the original contributor.
Limited life. A partnership does not have unlimited life. A partnership is ended any time through
the acceptance of a new partner into the firm or the withdrawal of a partner. Partnership
dissolution occurs whenever there is a change in the makeup of the partners, regardless of the
cause. Dissolution does not mean that the business ends. Operations can continue without
interruption through the formation of a new partnership.
Unlimited liability. Each partner is jointly and severally (individually) liable for all partnership
liabilities. Creditors’ claims attach first to partnership assets and then to the personal
resources of any partner, regardless of that partner’s equity in the partnership. Because each
partner is responsible for all the debts of the partnership, each partner is said to have unlimited liability.
ILLUSTRATION 10-2
ADVANTAGES AND DISADVANTAGES
OF A PARTNERSHIP
Advantages
Combining skills and resources of two or more individuals
Ease of formation
Freedom from governmental regulations and restrictions
Ease of decision making
Disadvantages
Mutual agency
Limited life
Unlimited liability
Disagreements
FORMING A PARTNERSHIP



Each partner’s initial investment in a partnership
should be recorded at the fair market value of the
assets at the date of their transfer to the partnership.
The values assigned must be agreed to by all of the
partners.
After the partnership has been formed, the accounting
is similar to accounting for transactions of any other
type of business organization.
Upon the formation of a partnership,
this personal computer should be
recorded at its FMV of $2,500
instead of net book value.
FORMING A PARTNERSHIP
Example
M. Gan and K. Sin start a partnership name Interactive Software with the following
assets stated at their fair market value.
Gan
Sin
Cash
$8,000
$9,000
Office Equipment
4,000
Accumulated Amortization
(2,000)
Accounts Receivable
4,000
Allowance for Doubtful Accounts
(1,000)
Journal Entry
Investment of Gan
Jan 2
Cash
Office Equipment
M. Gan, Capital
8,000
4,000
Investment of Sin
Jan 2
Cash
9,000
Accounts Receivable
4,000
Allowance for DA
K. Sin, Capital
12,000
1,000
12,000
DIVIDING NET INCOME
OR NET LOSS



Partnership net income or net loss is
shared equally unless the partnership
contract specifically indicates otherwise.
The same basis of division usually applies
to both net income and net loss, and is
called the income ratio or the profit and
loss ratio.
A partner’s share of net income or net loss is
recognized in the accounts through
closing entries.
CLOSING ENTRIES
Four closing entries are required for a partnership:
1. Debit each revenue account for its balance and credit
Income Summary for total revenues.
2. Debit Income Summary for total expenses and credit
each expense account for its balance.
3. Debit (credit) Income Summary for its balance and
credit (debit) each partner’s capital account for his
or her share of net income (net loss).
4. Debit each partner’s capital account for the balance
in that partner's drawing account and credit each
partner’s drawing account for the same amount.
CLOSING ENTRIES
Example
On Dec 31, Interactive Software had sales of $100,000 and operating expenses of
$68,000. The partners share profits and losses equally. Drawings for the year were Gan
$8,000 and Sin $6,000.
Dec 31
Dec 31
Dec 31
Dec 31
Sales
Income Summary
To close revenue
100,000
Income Summary
Operating Expenses
to close expenses
68,000
100,000
Income Summary (100,000-68,000)
32,000
M. Gan, Capital (32,000 x 50%)
K. Sin, Capital (32,000 x 50%)
to close net income to capital accounts
M. Gan, Capital
8,000
K. Sin, Capital
6,000
M. Gan, Drawings
K. Sin, Drawings
To close drawings to capital accounts
68,000
16,000
16,000
8,000
6,000
INCOME RATIOS
The partnership agreement should specify the basis for
sharing net income or net loss. The following are typical
of the ratios that may be used:
1. A fixed ratio, expressed as a proportion (2:1), a
percentage (67% and 33%), or a fraction (2/3 and 1/3).
2. A ratio based on either capital balances at the
beginning of the year or on average capital
balances during the year.
3. Salaries to partners and the remainder in a fixed
ratio.
4. Interest on partners’ capital balances and the
remainder in a fixed ratio.
5. Salaries to partners, interest on partners’ capital
balances, and the remainder in a fixed ratio.
INCOME STATEMENT WITH
DIVISION OF NET INCOME
Example 1
Sara King and Ray Lee are partners in the Kingslee Company. The
partnership agreement provides for 1) salary allowances of $8,400 for Sara and
$6,000 for Ray, 2) interest allowances of 10% on capital balances at the
beginning of the year, and 3) the remaining income to be split equally.
Beginning Capital balances were King $28,000 and Lee $24,000. The division
of the 2003 partnership income of $22,000 is as follows:
King
Total net income
Based on salary allowance
Based on interest allowance:
King - ($28,000 X 10%)
Lee - ($24,000 X 10%)
Total
Remaining income
Remainder shared equally
Division of net income
$8,400
Lee
Total
$6,000
$22,000
(14,400)
2,800
2,400
(5,200)
1,200
1,200
$12,400
$ 9,600
(2,400)
2,400
0
$22,000
PARTNER’S CAPITAL STATEMENT
KINGSLEE COMPANY
Statement of Partners’ Capital
For the Year Ended December 31, 2003
Capital, January 1
Add: Additional investment
Net income
Less: Drawings
Capital, December 31
Sara
King
$ 28,000
2,000
12,400
42,400
7,000
$ 35,400
Ray
Lee
$ 24,000
9,600
33,600
5,000
$ 28,600
Total
$52,000
2,000
22,000
76,000
12,000
$ 64,000
The equity statement for a partnership is called the statement of
partners' capital. It’s function is to explain the changes 1) in each
partner’s capital account and 2) in total partnership capital during
the year.
PARTNER’S EQUITY SECTION OF A
PARTNERSHIP BALANCE SHEET
KINGSLEE COMPANY
The statement of
Balance Sheet - partial
partners’ equity
December 31, 2003
is prepared from
Total liabilities (assumed amount)
$ 115,000
the income
Partners’ equity
Sara King, Capital
$ 35,400
statement and the
Ray Lee, Capital
28,600
partners’ capital
Total partners’ equity
64,000
and drawings
Total liabilities and partners’ equity
$ 179,000
accounts. The
balance sheet for
a partnership is the same as for a proprietorship except in the equity
section. The capital balances of the partners are shown in the balance
sheet.
INCOME STATEMENT WITH
DIVISION OF NET INCOME
Example 2
INCOME STATEMENT WITH
DIVISION OF NET INCOME
Example 2 cont.
Net Income of $100,000
INCOME STATEMENT WITH
DIVISION OF NET INCOME
Example 2 cont.
Net Income of $20,000