ACCOUNTING
PRINCIPLES
SIXTH CANADIAN EDITION
Chapter 12
Accounting for Partnerships
Prepared by:
Debbie Musil
Kwantlen Polytechnic University
Accounting for Partnerships
• Partnership form of organization
– Characteristics
– Advantages and disadvantages
– Partnership agreement
• Basic partnership accounting
– Forming a partnership
– Dividing partnership profit or loss
– Partnership financial statements
• Admission and withdrawal of partners
• Liquidation of a partnership
– With or without a capital deficiency
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CHAPTER 12:
Accounting for Partnerships
STUDY OBJECTIVES:
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
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Characteristics of Partnerships
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Characteristics of Partnerships 2
• Association of individuals
– Usually based on a written agreement
– A legal and accounting entity, but not taxed
• Co-ownership of property
– Assets are jointly owned by partners
• Division of profit
– Partners determine how profit or loss is to be divided
– Otherwise shared equally
• Limited life
– Partnership ends when change in ownership
– New partnership can be formed to continue business
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Characteristics of Partnerships 3
• Mutual agency
– Each partner acts for (binds) the partnership
• Unlimited liability
– Each partner is liable for all partnership liabilities
– Special types of partnerships created to limit liability
• Limited partnership (LP)
• Limited liability partnership (LLP)
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Partnership Agreement
• Written contract between two or more
parties to form a partnership
• Contains basic information:
– Name and location of firm
– Purpose of the business
– Date of inception
• Specifies relationship of partners:
–
–
–
–
Names and capital contributions of partners
Rights and duties of partners
Basis for sharing profit or loss
Procedures for admission, withdrawal, death of
partner, resolving disputes, liquidation of
partnership
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Basic Partnership Accounting:
ASPE Versus IFRS
• Many partnerships are private and
therefore follow ASPE
• Limited Partnerships are often public
enterprises and therefore follow IFRS
• International partnerships must also
follow IFRS
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CHAPTER 12:
Accounting for Partnerships
STUDY OBJECTIVES:
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
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Basic Partnership Accounting:
Forming a Partnership
• Partner’s initial investment is recorded
at fair value of assets contributed
– As at date of transfer into partnership
• Values assigned are agreed to by all
partners
• After partnership formed, accounting
for transactions is similar to other
types of business organizations
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CHAPTER 12:
Accounting for Partnerships
STUDY OBJECTIVES:
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
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Basic Partnership Accounting:
Dividing Profit or Loss
• Partnership profit/loss is shared
equally
– Unless partnership agreement indicates
otherwise
• The same basis of division applies to
profit and losses
– Called the profit ratio or profit and loss
ratio
• Each partners’ share of profit or loss
is recognized through closing entries
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Partnership Accounting:
Closing Entries
•
Four closing entries for partnership:
1. Close revenue accounts to income summary
2. Close expense accounts to income summary
3. Close income summary to partners’ capital accounts
•
•
If profit:
Dr. Income summary (= total profit)
Cr. Each partner’s capital account (= their share)
If loss:
Dr. Each partner’s capital account (= their share of
loss)
Cr. Income summary (= total loss)
4. Close each partner’s drawings account to their
respective capital accounts
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Partnership Accounting:
Profit and Loss Ratios
• Typical ratios used to share profit or loss:
– Fixed ratio: a proportion (2:1), percentage
(67%) or fraction (2/3)
– A ratio based on capital balances at beginning
or end of year or on average capital balances
during the year
– Salaries to partners and the remainder in a
fixed ratio
– Interest on partners’ capital balances,
remainder in a fixed ratio
– Salaries to partners, interest on partners’ capital
balances, remainder in a fixed ratio
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Partnership Accounting:
Profit and Loss Ratios 2
• Salaries and interest:
– Are allocated first even if greater than profit or if
partnership incurred a loss for the year
– Are NOT expenses of the partnership – only
used to divide profit or loss among the partners
– Are NOT distributions of cash (or other assets)
– drawings by partners are distributions
• Partners are neither employees or
creditors
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CHAPTER 12:
Accounting for Partnerships
STUDY OBJECTIVES:
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
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Partnership Financial Statements:
Statement of Partners’ Equity
• The equity statement for a partnership is the
statement of partners' equity
• Explains changes in each partner’s capital account
and total partnership equity during the year
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Partnership Financial Statements:
Balance Sheet
• Capital balances of each partner are shown
on the balance sheet in section called
partners’ equity:
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CHAPTER 12:
Accounting for Partnerships
STUDY OBJECTIVES:
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
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Admission of a Partner
• Causes the legal dissolution of the
existing partnership and the beginning
of a new partnership
• A new partner may be admitted either
by:
– Purchasing the interest of one or more
existing partners
– Investing assets in the partnership
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Admission of a Partner:
Purchase of a Partner’s Interest
• A personal transaction between one or
more existing partners and the new partner
– Consideration exchanged is personal property
of the partners involved and not property of the
partnership
• In the partnership, only the transfer of the
partnership interest is recorded:
– Existing partners’ equity is decreased by the
amount of equity given to the new partner
– New partner’s equity is increased by same
amount
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Admission of a Partner:
Investment of Assets in Partnership
• A transaction between the new partner and
the partnership:
– Partnership receives assets from new partner in
exchange for an interest in the partnership
• Both net assets and total partners’ equity of
the partnership will increase
• Complications occur when new partner’s
investment differs from the capital equity
acquired:
– The difference is considered a bonus either to
the existing (old) partners or to the new partner
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Admission of a Partner:
Bonus to Existing (Old) Partners
• Bonus to old partners may be
necessary:
– Fair value of partnership assets may be
greater than their carrying value
– Goodwill may exist that has not been
recorded
• Bonus to old partners occurs when:
– New partner’s investment > capital credit
on the date of admission to partnership
– Amount of bonus = difference
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Admission of a Partner:
Bonus to New Partner
• Bonus to new partner may be necessary:
– New partner has resources or attributes that the
partnership wants (cash, expertise)
– Carrying amount of partnership assets is
greater than their fair value
• Bonus to new partner occurs when:
– New partner’s investment < capital credit on the
date of admission to partnership
– Amount of bonus = difference
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Admission of a Partner:
Determining Amount of Bonus
1. Determine the total capital of partnership
= Capital of old partnership + new partner’s investment
2. Determine new partner’s capital credit
= Total capital determined above × new partner’s ownership
interest
3. Determine the amount of the bonus
= New partner’s investment ± new partner’s capital credit
• If investment > capital credit: bonus to new partner
• If investment < capital credit: bonus to old partners
4. Allocate the bonus to/from old partners
– Based on profit ratios of old partners
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Admission of a Partner:
Example Calculation of Bonus
• Old partners’ capital balance =
$120,000
Peart $72,000 and Sampson $48,000
• Old partners’ profit ratios:
Peart 60% and Sampson 40%
• Trent purchases 25% share:
Scenario 1: for $80,000
Scenario 2: for $20,000
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Admission of a Partner:
Bonus Calculation – Scenario 1
1. Total capital of new partnership:
$120,000 + $80,000 = $200,000
2. New partner’s capital credit:
$200,000 × 25% = $50,000
3. Amount of bonus to old partners:
$80,000 − $50,000 = $30,000
4. Allocation of bonus to old partners:
To Peart: $30,000 × 60% = $18,000
To Sampson: $30,000 × 40% = $12,000
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Admission of a Partner:
Bonus Calculation – Scenario 2
1. Total capital of new partnership:
$120,000 + $20,000 = $140,000
2. New partner’s capital credit:
$140,000 × 25% = $35,000
3. Amount of bonus to new partner:
$20,000 − $35,000 = $(15,000)
4. Allocate bonus from old partners:
From Peart: $15,000 × 60% = $9,000
From Sampson: $15,000 × 40% = $6,000
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CHAPTER 12:
Accounting for Partnerships
STUDY OBJECTIVES:
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
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Withdrawal of a Partner
• Voluntary withdrawal: Partner sells
their equity in the firm
• Involuntary withdrawal: Partner
reaches mandatory retirement age,
dies or is expelled
• Withdrawal may be accomplished by:
– Payment from remaining partners’
personal assets
– Payment from partnership assets
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Withdrawal of a Partner:
Payment from Partners’ Personal Assets
• A personal transaction between partners
– Payment is from remaining partners’ personal
assets
– Partnership assets are not involved and total
capital of partnership does not change
• In the partnership, only the transfer of the
partnership interest is recorded:
– Departing partner’s equity is eliminated
– Remaining partners’ equity increased by same
amount
– Amount is split between remaining parties on
same basis as they paid departing party
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Withdrawal of a Partner:
Payment from Partnership Assets
• A transaction between the withdrawing partner and
the partnership:
– Partnership pays assets in exchange for the withdrawing
partner’s interest in the partnership
• Both net assets and total partners’ equity of the
partnership will decrease
• Complications occur when amount paid differs
from withdrawing partner’s capital balance:
– The difference is considered a bonus either to the
departing partner or to the remaining partners
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Withdrawal of a Partner:
Bonus to Withdrawing Partner
• Bonus to withdrawing partner may be
necessary:
– Fair value of partnership assets may be greater
than their carrying amount
– Goodwill may exist that has not been recorded
– Remaining partners wish to remove partner
from firm
• Bonus to withdrawing partner occurs when:
– Payment to departing partner > departing
partner’s capital balance on the date of
departure
– Amount of bonus = difference
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Withdrawal of a Partner:
Bonus to Remaining Partners
• Bonus to remaining partners may be
necessary:
– Recorded assets are overvalued
– Partnership has a poor earnings record
– Partner wishes to leave partnership
• Bonus to remaining partners occurs
when:
– Payment to departing partner <
departing partner’s capital balance on
departure date
– Amount of bonus = difference
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Withdrawal of a Partner:
Determining Amount of Bonus
1. Determine the amount of the bonus
= Payment from partnership to departing partner ±
departing partner’s capital balance
• If payment > capital balance: bonus to departing
partner
• If payment < capital balance: bonus to remaining
partners
2. Allocate payment of bonus to remaining
partners based on their profit ratios
– Amount allocated to each remaining partner =
bonus × profit ratio for each partner
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Withdrawal of a Partner:
Example Calculation of Bonus
• Partners’ capital balance:
Roman $50,000
Sand $30,000
Terk $20,000
• Partners’ profit ratio:
Roman, Sand, Terk: 3:2:1
• Terk retires and is paid:
Scenario 1: $25,000
Scenario 2: $16,000
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Withdrawal of a Partner:
Bonus Calculation
Scenario 1:
1. Amount of bonus:
$25,000 - $20,000 = $5,000
2. Allocate payment of bonus by remaining partners:
From Roman: $5,000 × 3/5 = $3,000
From Sand: $5,000 × 2/5 = $2,000
Scenario 2:
1. Amount of bonus:
$16,000 − $20,000 = $(4,000)
2. Allocate payment of bonus to remaining partners:
To Roman: $4,000 × 3/5 = $2,400
To Sand: $4,000 × 2/5 = $1,600
Copyright John Wiley & Sons Canada, Ltd.
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CHAPTER 12:
Accounting for Partnerships
STUDY OBJECTIVES:
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
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Liquidation of a Partnership
• Liquidation ends the business
• Steps in liquidating a partnership:
1. Sell non-cash assets for cash
2. Allocate any gain or loss from sale to
partners’ capital accounts based on profit
and loss ratios
3. Pay partnership liabilities
4. Distribute remaining cash to partners
based on their capital balances (not their
profit ratios)
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Liquidation of a Partnership:
No Capital Deficiency
• Capital deficiency: if one or more
partners’ capital account is in a debit
balance
• If no capital deficiency:
– Remaining cash after all assets sold and
liabilities paid is distributed to partners
– Distribution is based on partners’ capital
balances
• Since this is the final distribution to partners
all accounts will have zero balances
afterwards
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Liquidation of Partnership:
Capital Deficiency
• Capital deficiency may be caused by:
– Recurring losses
– Excessive drawings by one or more partners
– Losses from sale of assets during liquidation
• Partners having a capital deficiency
immediately before final distribution:
– May or may not be able to pay the deficiency
from personal funds
– This will affect the amount of funds available for
distribution to other partners
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Liquidation of Partnership:
Payment of Capital Deficiency
• Partnership has a legally enforceable
claim against partners with a capital
deficiency
• If partner repays deficiency to
partnership:
– Amount repaid is added to cash
available for distribution
– Total cash after repayment is distributed
to partners with credit balances in their
capital accounts
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Liquidation of Partnership:
Nonpayment of Deficiency
• If partner does not repay deficiency to
partnership:
– Amount of deficiency is considered a
loss
– Loss is allocated between partners with
credit balances based on their profit
ratios
– Allocation of loss will affect remaining
partners capital accounts
– Final distribution of remaining cash is to
partners with credit balances in capital
accounts
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Copyright
Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights
reserved. Reproduction or translation of this work beyond
that permitted by Access Copyright (the Canadian copyright
licensing agency) is unlawful. Requests for further
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Department, John Wiley & Sons Canada, Ltd. The purchaser
may make back-up copies for his or her own use only and
not for distribution or resale. The author and the publisher
assume no responsibility for errors, omissions, or damages
caused by the use of these files or programs or from the use
of the information contained herein.
Prepared by:
A. Davis, MSc, BComm, CA, CFE
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