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19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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Presentation on theme: "19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a."— Presentation transcript:

1 19-1

2 Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a partnership. 2.State the important provisions that should be included in every partnership agreement. 3.Account for the formation of a partnership. McGraw-Hill© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

3 19-3 Advantages of a Partnership Each partner is taxed individually on his or her share of the partnership’s income. It pools the skills, abilities, and financial resources of two or more individuals. It is easy and inexpensive to form. A partnership does not pay income tax. Explain the major advantages and disadvantages of a partnership Objective 1

4 19-4 Disadvantages of a Partnership Each partner has unlimited liability. The partnership is a mutual agency. The business lacks continuity. It has a limited life. Ownership rights are not freely transferable.

5 19-5 A partnership agreement is a legal contract forming a partnership and specifying certain details of the operation. ANSWER: QUESTION: What is a partnership agreement? Explain the important provisions which should be included in a partnership agreement Objective 2

6 19-6 Names of the partners. Name, location, and nature of the business. Starting date of the agreement. Life of the partnership. Rights and duties of each partner. Every partnership agreement should contain:

7 19-7 Amount of capital to be contributed by each partner Every partnership agreement should contain: Drawings (withdrawals) by the partners. Fiscal year and accounting method. Method of allocating income or loss to the partners. Procedures to be followed if the partnership is dissolved or the business is liquidated.

8 19-8 Memorandum entry to record formation of partnership. Investment of assets and liabilities by partners. Setting up partners’ capital accounts. Setting up partners’ drawing accounts. Subsequent investments and permanent withdrawals. Account for the formation of a partnership. Objective 3

9 19-9 Memorandum Entry to Record Formation of Partnership 20-- Jan. 1 On this date a partnership was formed between Ellen Barret and Jerry Reed to carry on a retail clothing business under the name of Old Army, according to the terms of the partnership agreement effective this date.

10 Jan. 1Accounts Receivable 20, Merchandise Inventory 105, Store Equipment 3, Allow. for Doubtful Accts. 1, Notes Payable—Bank 39, Accounts Payable 34, Interest Payable Ellen Barret, Capital 53, Investment of Ellen Barret Assets that are transferred to a partnership should be appraised and recorded at the agreed-upon fair market value at the time of transfer. Investments of Assets and Liabilities by a Sole Proprietor

11 19-11 Investment of Cash by Partner New Partner Given Credit for Amount Invested Jan. 1 Cash 28, Jerry Reed, Capital 28, Investment of cash by Reed

12 19-12 Drawing Accounts  Any withdrawal by a partner, whether it is cash or some other asset, is a return of equity to that partner.  The partner’s drawing account balance reduces that partner’s equity.

13 Accounting for Partnerships Section 2: Allocating Income or Loss Chapter 19 Section Objectives 4.Compute and record the division of net income or net loss between partners in accordance with the partnership agreement. 5. Prepare a statement of partners’ equities. McGraw-Hill/Irwin© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

14 19-14 Allocating Partnership Income or Loss In step 3 the business determines the distributive share for each partner. Step 1.Close revenue to Income Summary. Step 2.Close expenses to Income Summary. Step 3.Close Income Summary to the partners’ capital accounts. Step 4.Close each partner’s drawing account to the partner’s capital account. Compute and record the division of net income or net loss between partners in accordance with the partnership agreement Objective 4

15 19-15 Allocation of Partnership Income or Loss Based on the partnership agreement. Allocated equally to each partner if the partnership agreement is “silent.” Income distribution does not mean cash distribution.

16 19-16 Agreed Upon Ratio Step 1:Add the figures given in the ratio. Barret 3 + Reed 2 Example: Barret and Reed agreed that net income should be split in a 3:2 ratio to Barret and Reed, respectively. Step 2:Express each figure as a fraction of the total. Barret’s share 3/5 Reed’s share 2/5 Step 3: Convert each fraction into a percentage. Barret’s share 3/5 = 60% Reed’s share 2/5 = 40% = Total 5

17 19-17 Net Income X partner’s share percentage: Agreed Upon Ratio 20-- Dec. 31 Income Summary 100, Ellen Barret, Capital 60, Jerry Reed, Capital 40, Net Income = $100,000 Barret’s share ($100,000 x 60% = $60,000) Reed’s share ($100,000 x 40% = $40,000)

18 19-18 Capital Account Balances Step 1:Add the capital account balances. Barret $53,200 Reed + 28,000 Total = $81,200 Step 2:Express each balance as a fraction and convert it to a percentage. Barret $53,200/$81,200 = % Reed $28,000/$81,200 = %

19 19-19 Capital Account Balances Net Income X partner’s share percentage: Net Income $100,000 Barret $100,000 x % = $65,517 Reed $100,000 x % = $34,483

20 19-20 Salary and Interest Allowances Allowances for partners’ salaries and interest on their investments can be included in the allocation of net income or loss. Allowances are debited to the Income Summary account and credited to the partners’ capital accounts. The remaining net income or loss is then allocated in the proper ratio.

21 19-21 Salary allowances are intended to reward the partners for the time they spend in the business and for the expertise and talents they bring to it. Salary Allowances Salary allowances are withdrawals. Salary allowances do not represent salary expense.

22 Dec. 31 Income Summary 52, Ellen Barret, Capital 30, Jerry Reed, Capital 22, Net Income is $112,800. Salary Allowances Salary allowances for Barret $30,000 and Reed is $22,800.

23 Dec. 31 Income Summary 60, Ellen Barret, Capital 36, Jerry Reed, Capital 24, Salary Allowances Net Income $112,800 Less: Salary Allowances – 52,800 Using the agreed upon ratio, the amount of net income after salary allowances is allocated 60% to Barret and 40% to Reed. Balance in Income Summary = $ 60,000

24 19-24 Net Loss Net Loss 30,000 Their capital accounts are debited (decreased). Income Summary Distributed between Ross and Wright. Dec. 31 Sal. All. 52,800 Dec. 31 Int. All. 6,496 Bal. $89,296 Assume net loss = $30,000 Record the salary allowances of $30,000 for Barret and $22,800 for Reed. Record the interest allowances of $4,256 to Barret and $2,240 to Reed.

25 19-25 Partnership Financial Statements Income Statement  Same as that for a sole proprietorship.  One exception—on the bottom of the statement, the division of net income is shown between the partners. Balance Sheet  Same as that for a sole proprietorship.  One exception—there exists a separate capital account for each of the partners in Partner’s Equity section. Prepare a statement of partners’ equities Objective 5

26 19-26 OLD ARMY Statement of Partners’ Equities Year Ended December 31, 2010 Barret Reed Total Capital Capital Capital Capital Balances, Jan. 1, Investment During Year 53, , , Net Income (Loss) for Year 6, (2,908.00) 3, Totals 59, , , Less Withdrawals During Year 30, , , Capital Balances, Dec. 31, , , , Statement of Partners’ Equities Each partner’s salary is treated as a withdrawal on the statement.

27 Accounting for Partnerships Section 3: Partnership Changes Chapter 19 Section Objectives 6.Account for the revaluation of assets and liabilities prior to the dissolution of a partnership. 7.Account for the sale of a partnership interest. 8.Account for the investment of a new partner in an existing partnership. 9.Account for the withdrawal of a partner from a partnership. McGraw-Hill© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

28 19-28 Dissolution Step 1 Accounting records are closed. Net income or net loss on the date of dissolution is recorded and transferred to the partners’ capital accounts. Step 2 Assets and liabilities are revalued at fair market value. Account for the revaluation of assets and liabilities prior to the dissolution of a partnership Objective 6

29 19-29 Asset Revaluation When transferred from one partnership to another, assets are revalued to their fair market value. The new value will not necessarily agree with the book value carried by the old firm. The revaluation of assets affects the balance sheet only.

30 19-30 An adjusting entry is prepared for the revalued items. GENERAL JOURNAL PAGE 4 DATE DESCRIPTION POST. DEBIT CREDIT REF April 1 Merchandise Inventory 9, Allow. for Doubtful Accounts 2, Tom Lee, Capital 2, Joan Wilner, Capital2, Nau Flores, Capital 1, To record revaluation of assets and allocation of gain to partners.

31 19-31 There are two ways a new partner may be admitted to the partnership: By purchasing all or part of the interest of an existing partner and paying that partner directly. By investing cash or other assets directly in the existing partnership. Admission of a New Partner Account for the sale of a partnership interest Objective 7

32 19-32 Account for the investment of a new partner in an existing partnership. Objective 8

33 19-33 New Partner Given Credit for Amount Invested 20-- April 1 Cash 51, Beth Rivera, Capital 51, To record investment of Rivera for one-fourth interest in partnership. New partner, Rivera, pays $51,500 for ¼ interest in partnership.

34 19-34 New Partner Given Credit for More Than Amount Invested After the cash investment is recorded, a bonus is given to the new partner by crediting the new partner’s capital account. This credit is offset by debits to the original partners’ capital accounts April 1 Tom Lee, Capital 1, Joan Wilner, Capital 1, Nau Flores, Capital Beth Rivera, Capital 4, To record bonus allowed new partner New partner paid $45,500 for one-fourth interest in partnership. (¼ of partnership capital = $50,000)

35 19-35 If a new partner is given credit for less than the amount invested, a bonus is allowed to the existing partners and is credited to their capital accounts in the former profit and loss ratio April 1 Beth Rivera, Capital 5, Tom Lee, Capital 2, Joan Wilner, Capital 2, Nau Flores, Capital 1, To record bonus to original partners. New Partner Given Credit for Less Than Amount Invested

36 19-36 When a partner withdraws, the payment given to the withdrawing partner may be more or less than the withdrawing partner’s capital balance. The difference in the cash payment and the withdrawing partner’s capital account is debited or credited to the remaining partners according to their profit-and-loss ratio. Account for the withdrawal of a partner from a partnership Objective 9

37 19-37 The revalued assets result in the following capital account balances: Lee $40,980 Wilner 61,180 Flores 52,340 Total $154,500 Withdrawal of Partner (Paid the balance of her capital account.) New Partner Given Credit for Amount Invested 20-- Mar. 31 Nau Flores, Capital 52, Cash 52, To record cash payment made to Flores on withdrawal from partnership.

38 19-38 Withdrawing Partner’s Capital Account If the amount paid is higher than the withdrawing partner’s capital account balance, the excess is debited to the capital accounts of the remaining partners according to their income and loss ratio. If the amount paid is less than the withdrawing partner’s capital account balance, the difference is credited to the remaining partners’ capital accounts based on their income and loss ratio.

39 19-39 The revalued assets result in the following capital account balances: Lee $40,980 Wilner 61,180 Flores 52,340 Total $154,500 Withdrawal of Partner (Paid more than the balance of her capital account.) New Partner Given Credit for Amount Invested 20-- Mar. 31 Nau Flores, Capital 52, Tom Lee, Capital 4, Joan Wilner, Capital 4, Cash 61,340 Flores receives a bonus of $61, ,340 = $9,000 The bonus comes out of the remaining partner’s capital accounts.

40 19-40 Thank You for using College Accounting, 12th Edition Price Haddock Farina


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