1. Accounting for partnerships

2. PARTNERSHIP FORM OF ENTITY
A partnership is defined as …
Is a contract whereby two or more persons bind themselves to contribute money, property or industry to a common fund with the intention of dividing the profits among themselves

3. Characteristics of partnerships

4. Characteristics of partnerships
1. Association of individuals
Voluntary association
May be based on handshake or written agreement
Partnership not a legal entity, so is not taxed
Individual partners pay tax on their share of profit

5. Characteristics of partnerships continued
2. Mutual agency
Each partner acts on behalf of the partnership when engaging in partnership business
Act of any partner is binding on all other partners
3. Limited life
May be ended voluntarily at any time through the acceptance of a new partner or withdrawal of a partner
May be ended by involuntarily by death of incapacity of a partner

6. Characteristics of partnerships continued
4. Unlimited liability
Each partner is personally and individually liable for all partnership liabilities
5. Co-ownership of property
Partnership assets are owned jointly by the partners
If partnership is dissolved, assets do not legally revert to original contributor
Partners have a claim on total assets equal to the balance in individual capital account
Partnership profit or loss is co-owned

7. Advantages and disadvantages of partnerships
Combining skills and resources of 2 or more individuals
Ease of formation
Not subject to as much government regulation as companies
Ease of decision making
No taxation on partnership profits
Disadvantages
Mutual agency
Limited life
Unlimited liability
Partners must be able to work together

8. Kinds of partner As to contribution As to liability
Capitalist partner contributes money or property
Industrial partner contributes skills, knowledge, industry or service
Capitalist-industrial partner contributes money or property and industry
As to liability
General partners have unlimited liability
Limited partners have limited liability

9. Kinds of partnership General Partnership Limited Partnership
Partners are all general partner
Limited Partnership
Composed of one or more general partner and one or more limited partner

10. Articles of Partnership
A written contract made by the partners specifying such details as …
Names and contributions of the partners
Rights and duties of partners
Basis for sharing net income or loss
Provision for withdrawals of assets
Procedures for settling disputes
Procedures for withdrawal or addition of a partner
Rights and duties of surviving partners in the event of a partner’s death

11. Review question 1
Which of the following is not a characteristic of a partnership?
Taxable entity
Co-ownership of property
Mutual agency
Limited life

12. Review question 2
Statement 1: A lawyer and doctor may formed a partnership as business partners to practice their profession.
Statement 2: A limited partner must pay first his personal creditors before paying the partnership creditors.
Only 1st is true
Only 2nd is true
Both true
Both false

13. BASIC PARTNERSHIP ACCOUNTING
Major accounting issues in relation to partnerships are
Forming a partnership
Dividing profit or loss
Preparing financial statements
Dissolution of partnership
Liquidation of partnership

14. Forming a partnership Initial investment
Rules to be observed:
The amount of contribution shall be based on the partner’s agreement. In the absence of any agreement, it shall be contributed equally.
Sample problem1:
A and B form a partnership with the total agreed capitalization of P150, 000 to be contributed in cash of 40% and 60% by A and B, respectively, through the issuance of their personal checks. The amount contributed and capital credited to be recorded per agreement would be:

15. Forming a partnership cont.
Sample problem2
A and B form a partnership with the total agreed capitalization of P150, 000 to be contributed in cash through the issuance of their personal checks. The amount contributed and capital credited to be recorded per agreement would be

16. Forming a partnership cont.
Valuation of partners’ contribution
If cash contribution – based on face value
If non cash – based on agreed value, in the absence of agreed value it shall be based on fair value.
*Fair value or fair market value – represents the estimated amount in which the seller and buyer would be willing to exchange value in an open market.
Once partnership has been formed
Accounting is similar to accounting for transactions of any other type of business organisation

17. Forming a partnership continued
Example 1
Carrying amount and fair value of assets invested
Carrying amt Fair value
A.Gibson T.Jones A.Gibson T.Jones
Cash P P P P
Office equipment
Accum. depreciation (2 000)
Accounts receivable
Allow. for doubtful debts (700) (1 000)
P P P P12 000

18. Forming a partnership continued
Journal entries to record investments
Cash
Office Equipment
A. Gibson, Capital (To record investment of Gibson)
Cash
Accounts Receivable
Allowance for Doubtful Debts
T. Jones, Capital (To record investment of Jones)

19. Forming a partnership continued
Example 2
C, D and E formed a partnership with agreed total capitalization of P30, 000 which should be contributed equally by C and D. Meanwhile, E was designated to manage the operation of the partnership as industrial partner with a share of 20% from partnership profits. C and D contribute the following assets:
Fair Value Agreed Value
Partner C Partner D Partner C Partner D
Cash P P
Land P
Office equipment
Supplies
Notes Payable
(assumed by the partners)
P P P P

20. Review question 3
In accounting for the formation of a partnership, each partner’s initial investment is recorded at …
the carrying amount of assets invested
the fair value of assets invested
the historical cost of assets invested
the book value of assets invested

21. Dividing profit or loss
Art of the New Civil Code provides that any stipulation that excludes one or more partners from any share in the profits or losses is null and void.
Art provides the following guidelines on how partnership profits and losses shall be distributed among the partners:

22. Dividing profit or loss
As to Capitalist Partner 1. Division of profits a. In accordance with agreement b. In the absence of an agreement, in accordance with capital contributions. 2. Division of losses b. If only the division of profits is agreed upon, the division of losses will be the same as the agreement on the division of profit c. In the absence of agreement, based on capital contribution

23. Dividing profit or loss
II. As to Industrial Partner 1. Division of profits a. In accordance with agreement b. In the absence of an agreement, industrial partner shall receive a just and equitable share of the profits. 2. Division of losses b. In the absence of agreement, industrial partner shall have no share in the losses

24. Dividing profit or loss continued
Closing entries:
1. DR each revenue account for its balance and CR Profit and Loss Summary for total revenue
2. DR Profit and Loss Summary for total expenses and CR each expense account for its balance
3. DR (CR) Profit and Loss Summary for its balance and CR (DR) each partner’s capital account for their share of profit (loss)
4. DR each partner’s capital account for the balance in that partner's drawing account and CR each partner’s drawing account for the same amount

25. Dividing profit or loss continued
Example
Partnership profit for year is P32 000
Partners share profit and loss equally
Profit and Loss Summary
L. Cooke, Capital (P x 50%)
D. Kam, Capital (P x 50%) (To transfer profit to partners’
current accounts)
L. Cooke, Capital
D. Kam, Capital
L. Cooke, Drawings
D. Kam, Drawings (To close drawings accounts to current accounts)
PowerPoint presentation by Dr Anne Abraham, University of Western Sydney

26. Dividing profit or loss continued
Example2:
Assume that Adam and Eve formed a partnership with original capital contributions of P60,000 and P30,000 respectively. The profit agreement is 60% and 40% respectively. During the year, the partnership generated an income of P100,000.
Give the closing entry for the above problem.
Assuming instead of profit, it was P100,000 loss.
Assuming no agreement was made, give the closing entry under assumption (a) and (b)

27. Dividing profit or loss continued
Profit-and-loss ratios
Typical profit-and loss ratios include:
1 A specified ratio
expressed as a proportion (6:4), a percentage (70% and 30%), or a fraction (2/3 and 1/3)
2 A ratio based on either:
capital balances at beginning of year or
ending capital balances

28. Dividing profit or loss continued
3 Interest on partners’ capital balances and the remainder on a agreed ratio
4 Salaries or Bonus allowed for partner’s services, the remainder to be divided in an agreed ratio
5 Multiple base of allocation
Salaries to partners, interest on partners’ capitals, and the remainder on a fixed ratio)

29. Dividing profit or loss continued
Sample Problem : Assume that Adam and Eve formed a partnership with original capital contributions of P60,000 and P30,000 respectively. General ledger for their capital accounts before closing entries are shown below:

30. Dividing profit or loss continued
During the year Net Income of P100,000 was earned by the partnership. They agreed that profit will be divided:
60% to Adam and 40% to Eve
Based on capital ratio: (a.) Beginning capital (b.) Ending capital
10% Interest on beginning capital and the balance will be distributed equally
Salary to Eve for P10,000 and the balance distributed 60% for Adam and 40% to Eve.
10% interest on ending capital, salary to Eve for 10,000, 10% bonus based on Net Income before salaries and interest for Adam. The balance will be divided equally.
10% interest on ending capital, salary to Eve for 10,000, 10% bonus based on Net Income after salaries and interest for Adam. The balance will be divided equally

31. Dividing profit or loss continued
insufficient income
As a rule. The prescribed allocation for salaries and/or interest should still be given in spite of the insufficiency of partnership’s net income to cover them. The earnings deficiency resulted for giving salaries and/or interest shall be allocated among the partners based on their profit and loss sharing.

32. Dividing profit or loss continued
Insufficient Income
Sample Problem:
M. Kings and S. Lee agree on
Salary allowances of P8400 to Kings and P6000 to Lee
Interest allowances of 10% on beginning capital balances
10% Bonus to S. Lee
Remainder shared equally
Beginning capital balances
Kings P and Lee P24 000
Profit for the year is P5,000

33. Dividing profit or loss continued
Division of profit
Kings Lee Running bal.
Net Profit to be distributed P 5,000
Salary allowance P 8,400 P 6, (9,400)
Interest allowance
Kings (P x 10%) , (12,200)
Lee (P x 10%) ,400 (14,600)
Balance: (50:50)
Kings (P14,600 x 50%) (7,300) (7,300)
Lee (P14,600 x 50%) (7,300)
Total division of profit P 3,900 P 1,100

34. Dividing profit or loss continued
Entry to record division of profit
Profit and Loss Summary
M. Kings, Capital
S. Lee, Capital (To close profit to partners’ capital accounts)

35. Review question 4
NBC reports net income of P If partners N, B, and C have an income ratio of 50%, 30%, and 20%, respectively, C’s share of net income is …
P30 000
P12 000
P18 000
P20 000

36. Review question 5
XYZ reports net loss of P X initial contributions amounting to P50,000, Y contributes P30,000 and Z contributes his time and service in the business. There is no agreement on how profit and loss will be distributed. How much is the share in the loss of each partner?
P37,500, 22,500, 0
P20,000, 20,000, 20,000
P30,000, 30,000, 0
P27,272, 16,364, 16,364

37. Partnership financial statements
Income statement
Identical to proprietorship except for division of profit
Statement of financial position
Identical to proprietorship except for owners’ equity section
Partnership statement of changes in equity
Used to explain the changes in each partner’s capital account and in total partnership equity during the year

38. Partnership financial statements
KINGSLEE Statement of Changes in Partners’ Equity For the year ended 31 December 2013 Max Kings Steven Lee Total . Capital, 1 January P 28,000 P 24,000 P 52,000 Add: Share on Profit 12,400 9,600 22,000 Total 40,400 33,600 74,000 Less: Drawings 7,000 5,000 12,000 Capital, 31 December P 33,400 p 28,600 P 62,000

39. Partnership financial statements
KINGSLEE Statement of Financial Position (partial) As at 31 December 2013 Total Liabilities(assumed amount) P 115,000 Owners’ Equity Max Kings, Capital P 33,400 Steven Lee, Capital 28,600 Total Owners’ Equity 62,000 TOTAL LIABILITIES AND OWNERS’ EQUITY P 177,000

40. Review question 5
Which of the following statements about the partnership financial statements is not true?
The capital balances of each partner are shown on the statement of financial position
Changes in each partner’s capital account is shown on statement of changes in equity
Each partner’s drawings is shown on the statement of financial position
Distribution of profit is shown in income statement

41. Partnership dissolution
The dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on of the business.
The change of partners in the partnership ends their original agreement, thus terminating the partnership.

42. ADMISSION OF A PARTNER
The admission of a new partner results in legal dissolution of the existing partnership and the beginning of a new one
To recognise economic effects it is necessary only to open a capital account for each new partner
A new partner may be admitted either by:
Purchasing the interest of an existing partner or
Investing assets in a partnership

43. ADMISSION OF A PARTNER continued
PowerPoint presentation by Dr Anne Abraham, University of Western Sydney

44. Purchase of a partner’s interest
The admission of a partner by purchase of an interest in the firm is a personal transaction between one or more existing partners and the new partner
Price paid is negotiated and determined by the individuals involved
The price may be equal to or different from the capital equity acquired
Any money or other consideration exchanged is the personal property of the participants and not the property of the partnership

45. Purchase of a partner’s interest continued
Example
Cox agrees to pay P cash to Adler and Barker each for 1/3 of their interest in the Adler-Barker partnership
At the time of admission of Cox, each partner has a P capital balance

46. Purchase of a partner’s interest continued
Entry to record admission of Cox
Each partner will give up P (1/3 x P30 000)
C. Adler, Capital
D. Barker, Capital
L. Cox, Capital
(To record admission of Cox by purchase)

47. Purchase of a partner’s interest continued
Ledger balances after purchase of partners’ interest
Total partnership capital before and after admission of Cox is P60,000
C. Adler, Capital
Bal
D. Barker, Capital
Bal
L. Cox, Capital
20 000

48. Purchase of a partner’s interest continued
Sample Problem2: The capital balances and agreed profit and loss distribution of Eric and Vincent partnership prior to dissolution are as follows: Partners Capital Balances P&L Ratio Vincent 250,000 25% Eric 750,000 75% Lally wants to buy 50% of the interest of Eric to give her interest of 37.5% in the partnership’s asset and in the partnership’s profit and loss.

49. Purchase of a partner’s interest continued
Sample Problem2 cont’d... Case 1: Purchase at Book Value: Assume that Lally paid P375,000 directly to Eric. Case 2: Purchase Lesser than Book Value: Assume that Lally paid P350,000 directly to Eric. Case 3: Purchase More than Book Value: Assume that Lally paid P400,000 directly to Eric. What is the journal entry for the admission and what is the new profit and loss ratio of new partnership?

50. Purchase of a partner’s interest continued
Entry to record admission of Lally under case1,2 and 3
Eric will give up 50% of his share (50% x 750,000)
Note:
Gain or loss in the purchase of interest transaction is a personal gain or loss of the partner/s involved.
Total capital before and after admission of Lally is P1,000,000
New P&L ratio after admission of Lally: Vincent-25%, Eric-37.5%, Lally-37.5%
Eric, Capital
Lally, Capital
(To record admission of Lally by purchase)

51. Purchase of a partner’s interest continued
Sample Problem3: The capital balances and agreed profit and loss distribution of Pat and Sponge partnership prior to dissolution are as follows: Partners Capital Balances P&L Ratio Pat 150,000 30% Sponge 350,000 70% Mr. Crab wants to buy 20% of the interest in the partnership’s asset and profit by paying directly to each of the existing partners.

52. Purchase of a partner’s interest continued
Sample Problem3 cont’d... Case 1: Purchase at Book Value: Assume that Mr. Crab paid P100,000 directly to the partners. Case 2: Purchase Lesser than Book Value: Assume that Mr. Crab paid P60,000 directly to the partners. Case 3: Purchase More than Book Value: Assume that Mr. Crab paid P150,000 directly to the partners. What is the journal entry for the admission and what is the new profit and loss ratio of new partnership?

53. Investment of assets in a partnership
When a partner is admitted by investment, both the total assets and the total partnership capital change
When the new partner’s investment differs from the capital equity acquired, the difference is considered a bonus either to:
1. The existing (old) partners or
2. The new partner

54. Investment of assets in a partnership continued
Example
Cox invests P cash in the Adler-Barker partnership for a 1/3 capital balance
Journal entry to record admission
Cash
L. Cox, Capital
(To record admission of Cox by investment)

55. Investment of assets in a partnership continued
Ledger balances after investment of assets
C. Adler, Capital
30 000
D. Barker, Capital
30 000
L. Cox, Capital
30 000
Total Partnership ‘s Capital
60 000
30 000
Bal

56. Investment of assets in a partnership continued
Bonus to old partners
Results when new partner’s investment in the firm is greater than the capital credit on the date of admittance
Sample Problem 1:
Boyd and Chan with total capital of P agree to admit Dante to the partnership
Dante acquires a 25% ownership interest by making a cash investment of P80 000
Current profit sharing ratio is Boyd 60% and Chan 40%

57. Investment of assets in a partnership continued
Steps in determining bonus
1 Determine the total contributed capital of the new partnership
New partner’s investment + capital of the old partnership
P P = P
2 Determine the new partner’s agreed capital
Multiply the total capital of the new partnership by the new partner’s ownership interest
P x 25% = P50 000

58. Investment of assets in a partnership continued
3 Determine the amount of bonus
Subtract the new partner’s capital credit from the new partner’s investment
P P = P30 000
4 Allocate the bonus to the old partners on the basis of their original income ratios
Boyd: P x 60% = P18 000
Chan: P x 40% = P12 000

59. Investment of assets in a partnership continued
Entry to record admission of Dante
Cash
S. Boyd, Capital
T. Chan, Capital
L. Dante, Capital
(To record admission of Dante and bonus to old partners)

60. Investment of assets in a partnership continued
Bonus to new partner
Results when the new partner’s investment is less than his or her capital credit in the firm
Capital balances of the old partners are decreased based on their income ratios before the admission of the new partner

61. Investment of assets in a partnership continued
Bonus to new partner
Sample Problem2:
Boyd and Chan with total capital of P agree to admit Dante to the partnership
Dante acquires a 25% ownership interest by investing cash of P20 000
Current profit sharing ratio is Boyd 60% and Chan 40%

62. Investment of assets in a partnership continued
Entry to record admission of Dante
Cash
S. Boyd, Capital
T. Chan, Capital
L. Dante, Capital
(To record admission of Dante and bonus)

63. Investment of assets in a partnership continued
Sample Problem 3: The capital balances and agreed profit and loss distribution ratio of the partners before admitting Judy are as follows: Judy admitted by investing cash of P200,000 for 30% interest in the partnership assets and profits
Job
John
Jun
Total
Capital Balances
120,000
240,000
600,000
Profit & Loss Ratio
20%
40%
100%

64. Investment of assets in a partnership continued
Sample Problem 3 cont’d… Required: 1.) Journalized admission of new partner Judy 2.) What is the new profit and loss sharing of the partners? 3.) Assume that Judy admitted by investing cash of P200,000 for 20% interest in the partnership.

65. Review question 6
Yen purchases 50% of Baht’s capital interest in the Euro-Baht Partnership for P If the capital balance of Euro and Baht are P and P respectively, Yen’s capital balance following the purchase is …
P12 000
P28 000
P10 000
P18 000

66. LIQUIDATION OF A PARTNERSHIP
The liquidation of a partnership terminates the business
In a liquidation, it is necessary to:
1 Sell noncash assets for cash and recognise a gain or loss on realisation
2 Allocate gain/loss on realisation to the partners based on their profit-and-loss ratios
3 Pay partnership liabilities in cash
4 Distribute remaining cash to partners on the basis of their capital balances

67. LIQUIDATION OF A PARTNERSHIP continued
Creditors must be paid before partners receive any cash distributions
Each step must be recorded by an accounting entry
No capital deficiency means that all partners have credit balances in their capital accounts
Capital deficiency means at least one partner’s account has a debit balance