19-2 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.
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
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.
19-5 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:
19-6 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.
19-7 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
19-8 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.
19-9 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
19-10 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.
19-11 Capital Account Balances Net Income X partner’s share percentage: Net Income $100,000 Barret $100,000 x 65.517% = $65,517 Reed $100,000 x 34.483% = $34,483
19-12 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.
19-13 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
19-14 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
19-15 OLD ARMY Statement of Partners’ Equities Year Ended December 31, 2013 Barret Reed Total Capital Capital Capital Capital Balances, Jan. 1, 2013 0.00 0.00 0.00 Investment During Year 53,200.00 28,000.00 81,200.00 Net Income (Loss) for Year 6,308.00 (2,908.00) 3,400.00 Totals 59,508.00 25,092.00 84,600.00 Less Withdrawals During Year 30,000.00 22,800.00 52,800.00 Capital Balances, Dec. 31, 2013 29,508.00 2,292.00 31,800.00 Statement of Partners’ Equities Each partner’s salary is treated as a withdrawal on the statement
19-16 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.
19-17 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
19-18 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.
19-19 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
19-20 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
19-21 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.