1. Accounting Principles Second Canadian Edition Prepared by: Carole Bowman, Sheridan College Revised by: Carolyn Doering, Huron Heights SS Weygandt · Kieso · Kimmel · Trenholm

2. ACCOUNTING FOR PARTNERSHIPS CHAPTER 13

3. ILLUSTRATION 13-1 PARTNERSHIP CHARACTERISTICS Unlimited Liability Partnership Form of Business Organization Association of Individuals Mutual Agency Co-ownership of Property Limited Life

4. ORGANIZATIONS WITH PARTNERSHIP CHARACTERISTICS General Partnerships – all partners have unlimited liability Limited Partnerships – one or more partners have limited liability up to the amount of capital they contributed (they have less compensation and influence on the business) Limited Liability Partnerships – professionals such as lawyers, doctors or accountants are not allowed to incorporate; this helps protect innocent partners (LLP)

5. ILLUSTRATION 13-2 ADVANTAGES AND DISADVANTAGES OF A PARTNERSHIP

6. PARTNERSHIP AGREEMENT A written contract should include: Name and location of the business Purpose of the business Date of inception Names and capital contributions for each partner Rights and duties of partners Basis for sharing net income or net loss Provisions for withdrawal of assets Procedures for submitting disputes to arbitration Procedures for the withdrawal, or addition, of a partner Right and duties of surviving partners in event of a partner’s death

7. FORMING A PARTNERSHIP Each partner’s initial investment in a partnership should be recorded at the fair market value of the assets at the date of their transfer to the partnership. The values assigned must be agreed to by all of the partners. After the partnership has been formed, the accounting is similar to accounting for transactions of any other type of business organization. Upon the formation of a partnership, this personal computer should be recorded at its FMV of $2,500 instead of net book value. Amount of amortization in previous business is not recorded for the new business.

8. DIVIDING NET INCOME OR NET LOSS Partnership net income or net loss is shared equally unless the partnership contract specifically indicates otherwise. The same basis of division usually applies to both net income and net loss, and is called the income ratio or the profit and loss ratio. A partner’s share of net income or net loss is recognized in the accounts through closing entries.

9. CLOSING ENTRIES Four closing entries are required for a partnership: 1. Debit each revenue account for its balance and credit Income Summary for total revenues. 2. Debit Income Summary for total expenses and credit each expense account for its balance. 3. Debit (credit) Income Summary for its balance and credit (debit) each partner’s capital account for his or her share of net income (net loss). 4. Debit each partner’s capital account for the balance in that partner's drawing account and credit each partner’s drawing account for the same amount.

10. INCOME RATIOS The partnership agreement should specify the basis for sharing net income or net loss. The following are typical of the ratios that may be used: 1. A fixed ratio, expressed as a proportion (2:1), a percentage (67% and 33%), or a fraction (2/3 and 1/3). 2. A ratio based on either capital balances at the beginning of the year or on average capital balances during the year. 3. Salaries to partners and the remainder in a fixed ratio. 4. Interest on partners’ capital balances and the remainder in a fixed ratio. 5. Salaries to partners, interest on partners’ capital balances, and the remainder in a fixed ratio.

11. ILLUSTRATION 13-4 INCOME STATEMENT WITH DIVISION OF NET INCOME Sara King and Ray Lee are partners in the Kingslee Company. The partnership agreement provides for 1) salary allowances of $8,400 for Sara and $6,000 for Ray, 2) interest allowances of 10% on capital balances at the beginning of the year, and 3) the remaining income to be split equally. Beginning Capital balances were King $28,000 and Lee $24,000. The division of the 2003 partnership income of $22,000 is as follows: King Lee Total Total net income $22,000 Based on salary allowance Based on interest allowance: King - ($28,000 X 10%) Lee - ($24,000 X 10%) Total Remaining income Remainder shared equally Division of net income $8,400 $6,000(14,400) 2,800 2,400 (5,200) 1,200 1,200 (2,400) $12,400 $ 9,600$22,000

12. ILLUSTRATION 13-5 INCOME STATEMENT WITH DIVISION OF NET LOSS Sara King and Ray Lee are partners in the Kingslee Company. The partnership is the same as stated in the previous example, except this time they have a net loss of $18,000. In this case, the salary and interest allowances create a deficiency of $37,600 ($18,000 + $19,600). This deficiency is divided equally among the partners King Lee Total Salary allowance Interest allowance: King - ($28,000 X 10%) Lee - ($24,000 X 10%) Total Remaining deficiency (18,000) – 19,600 = 37,600 Division of net loss $8,400 $6,000$14,400 2,800 2,400 5,200 19,600 (18,800) (18,800)(37,600) ($7,600) ($ 10,400)($18,000)

13. ILLUSTRATION 13-6 PARTNER’S CAPITAL STATEMENT The equity statement for a partnership is called the statement of partners' capital. It’s function is to explain the changes 1) in each partner’s capital account and 2) in total partnership capital during the year.

14. The statement of partners’ equity is prepared from the income statement and the partners’ capital and drawings accounts. The balance sheet for a partnership is the same as for a proprietorship except in the equity section. The capital balances of the partners are shown in the balance sheet. ILLUSTRATION 13-7 PARTNER’S EQUITY SECTION OF A PARTNERSHIP BALANCE SHEET ILLUSTRATION 13-7 PARTNER’S EQUITY SECTION OF A PARTNERSHIP BALANCE SHEET

15. ADMISSION OF A PARTNER The admission of a new partner results in the legal dissolution of the existing partnership and the beginning of a new partnership. To recognize economic effects, it is necessary only to open a capital account for each new partner. A new partner may be admitted either by: 1. Purchasing the interest of one or more existing partners, or 2. Investing assets in the partnership.

16. PROCEDURES IN ADDING PARTNERS Admission of Partner through: I. Purchase of a Partner’s Interest Partnership Assets 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. Partnership assets do not change. July 1D. Arbour, Capital10,000 D. Baker, Capital10,000 L. Carson, Capital20,000 To record admission of Carson by purchase.

17. PROCEDURES IN ADDING PARTNERS II. Investment of Assets in Partnership Hello Partnership Assets When a partner is admitted by investment, both the total net 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.

18. ADMISSION BY INVESTMENT Instead of purchasing the other partners’s interest, Carson invests $30,000 cash into the business. July 1Cash30,000 L. Carson, Capital30,000 To record admission of Carson by investment

19. BONUS TO OLD PARTNERS The procedure for determining the new partner’s capital credit and the bonus to the old partners is as follows: 1.Determine the total capital of the new partnership by adding the new partner’s investment to the total capital of the old partnership. 2.Determine the new partner’s capital credit by multiplying the total capital of the new partnership by the new partner’s ownership interest. 3.Determine the amount of bonus by subtracting the new partner’s capital credit from the new partner’s investment. 4.Allocate the bonus to the old partners on the basis of their income ratios. (see page 618 for example or the attached Word file) attached Word file

20. BONUS TO NEW PARTNER The procedure for determining the new partner’s capital credit and the bonus to the new partner is as follows: 1.Determine the total capital of the new partnership by adding the new partner’s investment to the total capital of the old partnership. 2.Determine the new partner’s capital credit by multiplying the total capital of the new partnership by the new partner’s ownership interest. 3.Determine the amount of bonus by subtracting the new partner’s investment from the new partner’s capital credit. 4.Allocate the bonus from the old partners on the basis of their income ratios. (see page 619 for example or the attached Word file)attached Word file

21. WITHDRAWAL OF A PARTNER A partner may withdraw from a partnership voluntarily by selling his or her equity in the firm or involuntarily by reaching a mandatory retirement age or by dying. The withdrawal of a partner may be accomplished by 1. payment from remaining partners’ personal assets or 2. payment from partnership assets.

22. PAYMENT FROM PARTNERS’ PERSONAL ASSETS The withdrawal of a partner when payment is made from partners’ personal assets is the direct opposite of admitting a new partner who purchases a partner’s interest. Withdrawal by payment from partners’ personal assets is a personal transaction between the partners. Bye Partnership Assets

23. PAYMENT FROM PARTNERSHIP ASSETS Both partnership net assets and total capital are decreased It is the reverse of admitting a partner through the investment of assets in the partnership Any difference between the amount paid and the withdrawing partner’s capital balance should be considered a bonus to the departing partner or a bonus to the remaining partners

24. BONUS TO RETIRING PARTNER A bonus may be paid to a retiring partner when: 1. the fair market value of partnership assets is greater than their book value, 2. there is unrecorded goodwill resulting from the partnership’s superior earnings record, or 3. the remaining partners are anxious to remove the partner from the firm. BONUS

25. BONUS TO RETIRING PARTNER con’t The bonus is deducted from the remaining partners’ capital balances on the basis of their income ratios at the time of the withdrawal. The procedure for determining the bonus to the retiring partner and the allocation of the bonus to the remaining partners is: 1.Determine the amount of the bonus by subtracting the retiring partner’s capital balance from the cash paid by the partnership. 2.Allocate the bonus to the remaining partners on the basis of their income ratios.

26. EXAMPLE (Bonus to Retiring Partner) Capital balances are F. Roman $50,000, D. Sand $30,000, and B. Terk $20,000. They share income in a ratio of 3:2:1. Terk retires on March 1 and receives a cash payment of $25,000. Bonus will be $25,000 - $20,000 = $5000 Based on ratio of remaining partners 3:2, bonus to Terk is allocated 3/5 to Roman and 2/5 to Sand March 1B. Terk, Capital$20,000 F. Roman, Capital 3,000 D. Sand, Captital 2,000 Cash25,000 To record withdrawl of, and bonus to Terk

27. BONUS TO REMAINING PARTNERS The retiring partner may pay a bonus to the remaining partners when: 1. recorded assets are overvalued, 2. the partnership has a poor earnings record, or 3. the partner is anxious to leave the partnership. BONUS

28. BONUS TO REMAINING PARTNERS con’t The bonus is added to the remaining partners’capital balances on the basis of their income ratios at thetime of the withdrawal. The procedure for determining the bonus to the remaining partners is: 1.Determine the amount of the bonus by subtracting the retiring partner’s capital balance from the cash paid by the partnership. 2.Allocate the bonus to the remaining partners on the basis of their income ratios.

29. LIQUIDATION OF A PARTNERSHIP The liquidation of a partnership terminates the business. To liquidate a partnership, follow these steps: 1. Sell noncash assets for cash and recognize any gain or loss on realization. 2. Allocate any gain or loss on realization to the partners based on their income ratios. 3. Pay partnership liabilities in cash. 4. Distribute remaining cash to partners based on their capital balances.

30. LIQUIDATION OF PARTNERSHIP No capital deficiency (credit balances in their capital accounts) (see page 625 for an example or the attached word file)attached word file Capital deficiency (debit balance) Partner with deficiency pays partnership or Partners with credit capital balances absorb deficiency in income sharing proportion (see page 626-627 for an example or the attached Word file) attached Word file

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