Chapter 18
Partnerships
1
College Accounting
10th Edition
McQuaig
McQuaig
Bille
Bille
Nobles
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
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© 2011 Cengage Learning
Types of Partnerships
 A general partnership (GP) is an association of two or
more people or firms to carry on, as co-owners, of a
business for profit. The partners are called general
partners.
 A limited partnership (LP) is an organization with two or
more people or firms with at least one general partner
and one limited partner. A limited partner or partners
have the largest share of invested capital, are not
involved in the day-to-day operations, and usually cannot
lose more than their capital contribution.
 A limited liability partnership (LLP) is an organization
similar to a limited partnership except that all partners
may take an active role in the business of the partnership
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with only their invested capital at risk.
Characteristics of a Partnerships
 Co-ownership of partnership property
• According to the co-ownership concept, each partner
owns half of each asset owned by the business.
 Limited Life
• A partnership may be ended by the death, bankruptcy,
incapacity, or withdrawal of a partner.
• May also be ended by the expiration of a specified
period of time or the completion of a project.
 Mutual Agency
• The mutual agency concept allows each partner to enter
into binding contracts in the name of the firm for the
purchase or sale of goods or services within the normal
scope of the firm’s business and based upon the
provisions of the partnership agreement.
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Characteristics of a Partnerships
 Taxation
 Federal income taxes are not levied against a
partnership.
 A partner has to file an individual income tax
return .
 Unlimited Liability
 General partners are personally liable for all
debts that are incurred by the partnership.
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Characteristics of Partnerships
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Partnership Agreements
A limited partnership and a limited liability partnership
must be based upon a written contract, called a
partnership agreement, with the following provisions:
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Effective date of the agreement
Names and addresses of the partners
Name, location, and nature of the business
Type of partnership
Management structure
Duration of agreement
Investment of each partner
Procedure for sharing profits and losses
Withdrawals to be allowed each partner
Procedure for a partner’s exit from the business
Provision for division of assets upon liquidation
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Recording Investments—
Formation of a Partnership
Ron P. Duncan owns Duncan Accounting. Stephen A.
James decides to join him and form a partnership. James
invests $190,000 in cash into the partnership.
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Recording Investments—
Formation of a Partnership
Duncan Accounting has the following account balances:
Cash
$183,300
Accounts Receivable
18,000
17,600
Allowance for Doubtful Accounts
200
Equipment
16,000
Accumulated Depreciation, Equipment
4,500
Accounts Payable
8,400
Notes Payable
1,600
The two men agree that $400 of Accounts Receivable
is uncollectible.
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Recording Investments—
Formation of a Partnership
Duncan Accounting has the following account balances:
Cash
$183,300
Accounts Receivable
18,000
17,600
Allowance for Doubtful Accounts
200
500
Equipment
16,000
Accumulated Depreciation, Equipment
4,500
Accounts Payable
8,400
Notes Payable
1,600
There is some doubt as to the collectibility of $500 of the
remaining Accounts Receivable.
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Recording Investments—
Formation of a Partnership
Duncan Accounting has the following account balances:
Cash
$183,300
Accounts Receivable
17,600
Allowance for Doubtful Accounts
500
9,000
Equipment
16,000
0
Accumulated Depreciation, Equipment
4,500
Accounts Payable
8,400
Notes Payable
1,600
An independent appraiser valued the equipment at
$9,000.
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Recording Investments—
Formation of a Partnership
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Additional Investments
On October 1, each partner’s invests an additional $7,000.
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Additional Investments
At the end of the year, before the books are closed, R. P.
Duncan, Capital appears as follows:
At the end of the year, before the books are closed, S. A.
James, Capital appears as follows:
Withdrawals
On March 17, Duncan withdrew $4,620 in cash from the
partnership. On May 4, James withdrew cash from the
partnership, $3,742.
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Closing Entries for a Partnership
STEP 1. Close the revenue accounts into
Income Summary.
STEP 2. Close the expense accounts into
Income Summary.
STEP 3. Close Income Summary into each
partner’s Capital account by each
partner’s share of the net income or
net loss.
STEP 4. Close each partner’s Drawing account
into their respective Capital accounts.
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Division of Net
Income or Net Loss
 The share of net income (or net loss) allocated to
each partner is know as his or her distributive
share.
 Four methods for sharing earnings:
1. Division of income based on fractional shares
2. Division of income based on the ratio of capital
investments
3. Division of income based on salary allowance
4. Division of income based on interest allowance
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Division of Net
Income or Net Loss
EXAMPLE 1 Net Income
D. R. Durr, Capital
D. R. Durr, Drawing
N. A. Jacob, Capital
N. A. Jacob, Drawing
$248,000
300,000
120,000
75,000
20,000
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Division of Net
Income or Net Loss
 Assume that the partnership agreement
stipulates that profits and losses are to be divided
three-fourths to Durr and one-fourth to Jacob, or
a 3-to-1 ratio.
 We turn the ratio into a fraction by making the
partner’s share the numerator and the total shares
the denominator, thus ¾ and ¼.
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Division of Income Based
on Fractional Shares
In Example 1, the net income is $248,000. Durr is
allocated ¾ and Jacob ¼, as follows:
Durr: $248,000 x ¾ = $186,000
Jacob: $248,000 x ¼ = $ 62,000
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Division of Income Based
on Fractional Shares
STEP 3. Close Income Summary to the Capital accounts.
STEP 4. Close drawing accounts into the capital accounts.
Division of Income Based
on Fractional Shares
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Division of Income Based
on Fractional Shares
Net Loss
$ (4,000)
D. R. Durr, Capital
300,000
D. R. Durr, Drawing
120,000
N. A. Jacob, Capital
75,000
N. A. Jacob, Drawing
20,000
The net loss is $4,000. Durr’s portion is ¾ and Jacob’s
portion is ¼. The loss is divided as follows:
Durr: $(4,000) x ¾ =
$(3,000)
Jacob: $(4,000) x ¼ =
$(1,000)
EXAMPLE 2
Division of Income Based
on Fractional Shares
STEP 3: Closing entries.
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Division of Income Based
on Fractional Shares
STEP 4: Closing the drawing accounts provides the same
result as shown in Example 1.
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Division of Net Income or Net Loss
Based on Ratio of Capital Investments
EXAMPLE 1
Assume that the partnership agreement
stipulates that profits and losses are to be
divided according to the ratio of their
investments at the beginning of the year.
Net Income
D. R. Durr, Capital
D. R. Durr, Drawing
N. A. Jacob, Capital
N. A. Jacob, Drawing
$248,000
300,000
120,000
75,000
20,000
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Division of Net Income or Net Loss
Based on Ratio of Capital Investments
In Example 1, the net income is $248,000. Durr is
allocated $300,000/$375,000, while Jacob is allocated
$75,000/$375,000. We can now calculate their
respective shares as follows:
Durr: $300,000/$375,000 (or 80%) = $198,400
Jacob: $75,000/$375,000 (or 20%) = $ 49,600
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Closing Entries
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Division of Net Income or Net Loss
Based on Ratio of Capital Investments
EXAMPLE 2
Net Loss
D. R. Durr, Capital
D. R. Durr, Drawing
N. A. Jacob, Capital
N. A. Jacob, Drawing
$
(4,000)
300,000
120,000
75,000
20,000
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Division of Net Income or Net Loss
Based on Ratio of Capital Investments
In Example 2, the net loss is $4,000. Durr’s portion
is 80 percent and Jacob’s portion is 20 percent. The
loss is divided as follows:
Durr: $(4,000) x 0.80 =
Jacob: $(4,000) x 0.20 =
$(3,200)
$ (800)
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Division of Net Income or Net Loss
Based on Ratio of Capital Investments
STEP 3: Closing entries.
STEP 4: Closing the drawing accounts provides the same
result as shown in Example 1.
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Division of Income Based
on Salary Allowance
EXAMPLE 1
When there is a net income of $248,000,
the Division of Net Income Section of the
incomes statement is as follows:
Net income
Less amount allocated to
salaries ($60,000 + $40,000)
Remainder
$148,000
Remainder ÷ 2 =
= $74,000
2
$248,000
(100,000)
$148,000
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Closing Entries
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Division of Loss Based on
Salary Allowance
EXAMPLE 2
Net loss
Less amount allocated to
salaries ($60,000 + $40,000)
Remainder
$104,000
Remainder ÷ 2 =
= $(52,000)
2
$ (4,000)
(100,000)
$(104,000)
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Division of Loss Based on
Salary Allowance
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Division of Loss Based on
Salary Allowance
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Division of Income Based
on Interest Allowance
In addition to their salary allowances of $60,000 and
$40,000, the partners at Durr & Jacob are allowed a 6
percent interest on their Capital balances at the
beginning of the fiscal year, calculated as follows:
Interest allowance for Durr
Interest allowance for Jacob
$300,000 x 0.06 = $18,000
$75,000 x 0.06 = $ 4,500
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Division of Income Based
on Interest Allowance
The accountant calculates the remainder in the
following way:
Net income
Less:
Amount allocated as salaries
($60,000 + $40,000)
Amount allocated as interest
($18,000 + $4,500)
Remainder
Remainder ÷ 2
$248,000
$(100,000)
(22,500) (122,500)
$125,500
$ 62,750
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Division of Income Based
on Interest Allowance
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Division of Loss Based on
Interest Allowance
EXAMPLE 2
The partnership has a loss of $4,000.
Net loss
Less:
Amount allocated as salaries
($60,000 + $40,000)
Amount allocated as interest
($18,000 + $4,500)
Remainder
Remainder ÷ 2
$
(4,000)
$(100,000)
(22,500)
(122,500)
$(126,500)
$ (63,250)
Division of Loss Based on
Interest Allowance
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Division of Loss Based on
Interest Allowance
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Statement of
Partners’ Equity
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Sale of a Partnership Interest
At the end of a given year, N. A. Jacob has a Capital
balance of $163,520 and decides to sell his interest to
K. R. Gott for $182,000.
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Partner Withdraws Book Value of
His or Her Equity After Revaluation
J. W. Navarro is retiring from the partnership of Turner,
Navarro, and Teague, LP. The partnership agreement
stipulates that net income and net loss shall be shared
on an equal basis. It also provides for revaluation of
assets in the event that a partner retires.
 At this point, an accountant (usually someone from
outside the firm) examines the books and the firm’s
assets are appraised.
 The review and appraisal indicate that Merchandise
Inventory is undervalued by $9,600, that Allowance
for Doubtful Accounts should be increased by
$300, and that Equipment is overvalued by $2,100.
Partner Withdraws Book Value of
His or Her Equity After Revaluation
Partner Withdraws Book Value of
His or Her Equity After Revaluation
J. W. Navarro is issued a check equal to her equity in the
firm.
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Partner Withdraws More Than Book
Value of His or Her Equity
 When Navarro announced that she was going to
retire, Turner and Teague agreed to pay her $99,400
for her interest in the partnership.
 The partners share profits and losses equally, so the
excess of $1,000 ($99,400 – $98,400) is deducted
equally from the remaining partners’ Capital accounts.
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Partner Withdraws Less Than Book
Value of His or Her Equity
Navarro is willing to withdraw if she gets just $94,200
cash out of the business. The difference of $4,200
($98,400 – $94,200) represents a bonus to the
remaining partners. Assuming they split profits and
losses equally, each remaining partner’s Capital
increases by $2,100.
Death of a Partner
 The death of a partner automatically ends the
partnership.
 The partner’s estate is entitled to receive the
amount of his or her equity.
 Partnership agreements usually provide for
an examination and revaluation of the assets
at this time.
 To insure that there is enough cash, partners
and partnerships often carry life insurance
policies.
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Liquidation of a Partnership
A liquidation means an end, not only of the partnership,
but of the business itself.
STEP 1.
Sale of the assets, using the Loss or Gain
from Realization account.
STEP 2.
Allocation of the loss or gain.
STEP 3.
Payment of the liabilities.
STEP 4.
Distribution of the remaining cash to the
partners, in accordance with the balances
of their Capital accounts.
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Assets Sold at a Profit
 The firm sells its merchandise inventory for $46,000
and the other assets for $70,000.
 At the time of liquidation Merchandise Inventory
has a balance of $40,000 and the other assets are
listed at $60,000.
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Assets Sold at a Profit
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Assets Sold at a Profit
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Assets Sold at a Profit
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Assets Sold at a Loss: Partners’ Capital
Account Sufficient to Absorb Loss
 The firm sells its merchandise inventory for $36,000
and the other assets for $52,000.
 At the time of liquidation Merchandise Inventory
has a balance of $40,000 and the other assets are
listed at $60,000.
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Assets Sold at a Loss
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Assets Sold at a Profit
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Assets Are Sold at a Loss: Partners’
Capital Account Sufficient to Absorb Loss
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