Needles Powers Crosson Financial and Managerial Accounting 10e Accounting for Unincorporated Businesses A APPENDIX © human/iStockphoto ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Accounting for Sole Proprietorships (slide 1 of 2)  A sole proprietorship is a business owned by one person. –This business form can be a convenient way of separating business activities from personal activities. –However, legally, the proprietorship is the same economic unit as the individual. –The sole proprietor receives all the profits or losses and is liable for all the obligations of the business. –The life of a proprietorship ends when the owner wishes it to or at the owner’s death or incapacity. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Accounting for Sole Proprietorships (slide 2 of 2) –When someone invests in his or her own company, the amount of the investment is recorded in the person’s Capital account. –When a sole proprietor withdraws assets from the business for personal expenses, the withdrawal is recorded as a debit to the Withdrawals account. –Revenue and expense accounts are closed out to Income Summary, as in a corporation, but the Income Summary and Withdrawals accounts are closed to the Capital account instead of to Retained Earnings. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Accounting for Partnerships  A partnership, as defined by the Uniform Partnership Act, is an association of two or more persons to carry on as co-owners of a business for profit. –Partnerships are treated as separate entities, with their own accounting records and financial statements. –Legally, there is no economic separation between a partnership and its owners. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Characteristics of Partnerships (slide 1 of 3)  Voluntary association—A partnership is a voluntary association of individuals. Therefore, a partner is legally responsible for his or her partners’ actions within the scope of the business.  Partnership agreement—Although not required, it is good business practice to have a written partnership agreement that clearly states: –Name, location, and purpose of the business –Names of the partners and their respective duties –Investments of each partner –Method of distributing income and losses –Procedures for the admission and withdrawal of partners, the withdrawal of assets, and the liquidation of the business ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Characteristics of Partnerships (slide 2 of 3)  Limited life—A partnership has a limited life. It may be dissolved when: –a new partner is admitted –a partner withdraws, goes bankrupt, is incapacitated, retires, or dies –the terms of the partnership agreement are met, such as when the project for which the partnership was formed is completed  Mutual agency—Each partner is an agent of the partnership within the scope of the business. Because of this mutual agency, any partner can bind the partnership to a business agreement as long as he or she acts within the scope of the company’s normal operations. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Characteristics of Partnerships (slide 3 of 3)  Unlimited liability—Each partner has personal unlimited liability for all the debts of the partnership. If the assets of the business are not enough to pay all the debts of the business, creditors can seek payment from the personal assets of each partner.  Co-ownership of partnership property—When individuals invest property in a partnership, the property becomes an asset of the partnership and is owned jointly by the partners.  Participation in partnership income—Each partner has the right to share in the partnership’s income and the responsibility to share in its losses. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Advantages and Disadvantages of Partnerships  Advantages –Can be easy to form, change, and dissolve. –Facilitates the pooling of capital resources and individual talents. –Has no corporate tax burden. –Gives the partners a certain amount of freedom and flexibility.  Disadvantages –The life of a partnership is limited. –One partner can bind the partnership to a contract. –Partners have unlimited personal liability. –It is more difficult for a partnership to raise capital than it is for a corporation. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Accounting for Partners’ Equity  The owner’s equity in a partnership is called partners’ equity. –It is necessary to maintain separate Capital and Withdrawals accounts for each partner. –It is also necessary to divide the income and losses of the company among the partners. –In the partner’s equity section of the balance sheet, the balance of each partner’s Capital account is listed separately. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Distribution of Partnership Income  A partnership’s income can be distributed according to whatever method the partners specify in the partnership agreement. –If the agreement does not specify this, the partners share income equally. –Income in a partnership normally has three components:  Return to the partners for the use of their capital (called interest on partners’ capital)  Compensation for services the partners have rendered  Other income for any special contributions individual partners may make to the partnership or for risks they may take ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Stated Ratios  One method of distributing income is to give each partner a stated ratio of the total income. –If each partner is making an equal contribution to the firm, each can assume the same share of income. –An equal contribution does not necessarily mean an equal capital investment, because one partner may be devoting more time and another partner more capital. –If the partners contribute unequally to the firm, unequal stated ratios can be appropriate. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Salaries, Interest, and Stated Ratios  To make up for unequal contributions to a firm, a partnership agreement can allow for partners’ salaries, interest on partners’ capital balances, or both in the distribution of income. –Salaries and interest of this kind are not deducted as expenses before the partnership income is determined. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Dissolution of a Partnership  Dissolution of a partnership occurs whenever there is a change in the original association of partners. –When a partnership is dissolved, the partners lose their authority to continue the business as a going concern. –This does not mean that the business operation necessarily is ended or interrupted, but from a legal standpoint, the separate entity ceases to exist. –The dissolution may take place through the admission of a new partner, the withdrawal of a partner, or the death of a partner. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Admission of a New Partner  The admission of a new partner dissolves the old partnership because a new association has been formed. –Dissolving the old partnership and creating a new one requires the consent of all the original partners and the ratification of a new agreement. –An individual can be admitted to a partnership in one of two ways:  Purchasing an interest in the partnership from one or more of the original partners  Investing assets in the partnership ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Bonus to the Old Partners  A new investor is sometimes willing to pay more than the actual dollar interest he or she receives in the partnership.  The excess of the payment over the interest purchased is a bonus to the original partners. –The bonus must be distributed to the original partners according to the partnership agreement or, if the agreement does not cover the distribution of bonuses, in accordance with the method for distributing income and losses. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Bonus to the New Partner  A partnership might want a new partner for several reasons. –A partnership in financial trouble might need additional cash, or the partners might want to expand the firm’s markets and need more capital. –The partners might also know a person who would bring a unique talent to the firm. –Under these conditions, part of the original partners’ capital may be transferred to the new partner’s Capital account as a bonus. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Withdrawal of a Partner  Generally, a partner has the right to withdraw from a partnership in accord with legal requirements. –The partnership agreement should describe the procedures to be followed, including:  Whether an audit will be performed  How the assets will be reappraised  How a bonus will be determined  By what method the withdrawing partner will be paid –A partner can withdraw from a partnership by selling his or her interest or by withdrawing assets. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Death of a Partner  When a partner dies, the partnership is dissolved because the original association has changed. –Normally the books are closed, and financial statements are prepared to determine the capital balance of each partner on the date of death. –The remaining partners may purchase the deceased’s equity, sell it to outsiders, or deliver certain business assets to the estate of the deceased partner. –If the firm intends to continue, a new partnership must be formed. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Liquidation of a Partnership  The liquidation of a partnership is the process of selling enough assets to pay the partnership’s liabilities and distributing any remaining assets among the partners. –Liquidation is a form of dissolution. –As the assets of the business are sold, any gain or loss should be distributed according to the stated ratios. –As cash becomes available, it must be applied first to outside creditors, then to loans from partners, and finally to the partners’ capital balances. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.