Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter P 1

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2 Identify the characteristics and types of partnerships Account for partner investments Allocate profits and losses to the partners Account for the admission of a new partner Account for a partner’s withdrawal from the firm Account for the liquidation of a partnership Prepare partnership financial statements

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Identify the characteristics and types of partnerships 1 1 3

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. A partnership—a voluntary association Business with two or more owners Combines individual partners’ assets and liabilities (if any), talents and resources, and experience and knowledge Should have "Article of Partnership"—a contractual agreement that contains the rules of the partnership 4

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The articles of partnership should specify the following: 1.Name, location, and nature of the business 2.Name, capital investment, and duties of each partner 3.Procedures for admitting a new partner 4.Method of sharing profits and losses among the partners 5.Drawing of assets by the partners 6.Procedures for settling up with a partner who withdraws from the firm 7.Procedures for liquidating the partnership Selling the assets, paying the liabilities and giving any remaining cash to the partners 5

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Written agreements Limited life Mutual agency Unlimited liability Co-ownership of property No partnership income taxes Partners’ capital accounts 6

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 7

General partnership–basic form Each partner is co-owner With all the privileges and risks of ownership Limited partnership–two classes of partners One or more general partners assuming primary responsibilities Unlimited liability Last to receive share of profit and losses Get all excess profits after limited partners get their share of income Limited partners Limited liability Limited profits and losses 8

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Neither a partnership nor a corporation Owners are called members Must file articles of organization with the state Must include LLC in business name Not personally liable for the business’s debts Can elect NOT to be subject to income tax on the business Income taxed to the partners Can participate actively in management Accounting follows the pattern for a partnership 9

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. For tax purposes, treated similar to a partnership Less than 100 stockholders Subchapter S of the Internal Revenue Code Benefits of a corporation Limited liability of owners No corporate income tax Stockholders pay personal income tax on their share of income 10

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Account for partner investments

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Assets and liabilities invested by partners at fair market values Fair market value measures partner’s capital contribution to the business Each partner has a capital and withdrawal account 12

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 13 Bright’s Investment Cash, $10,000; inventory, $40,000; and accounts payable, $80,000 Computer equipment—cost, $80,000; accumulated depreciation, $20,000; current market value, $55,000 Gonzalez’s Investment Cash, $5,000, Computer software: cost, $20,000; market value, $18,000

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Assets and liabilities–presented and listed the same for a proprietorship and a partnership Difference–each partner has an equity account 14

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Robert Morris invests land in a partnership with Andy Phillips. Morris purchased the land in 2012 for $300,000. A real estate appraiser now values the land at $700,000. Morris wants $500,000 capital in the new partnership, but Phillips objects. Phillips believes that Morris’s capital investment should be measured by the book value of his land. Phillips and Morris seek your advice. 1.Which value of the land is appropriate for measuring Morris’s capital—book value or current market value? 2. Give the partnership’s journal entry to record Morris’s investment in the business 15 Market value measures a partner’s capital investment in a partnership because the business is buying the asset at its current market value. Land700,000 Morris, Capital700,000 To record Morris’ investment.

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Susan Knoll and Emerson Wyndon are forming a partnership to develop a theme park near Carlson City, Florida. Knoll invests cash of $3,000,000 and land valued at $11,000,000. When Knoll purchased the land in 2012, its cost was $9,000,000. The partnership will assume Knoll’s $4,000,000 note payable on the land. Wyndon invests cash of $5,000,000 and equipment worth $6,000, Journalize the partnership’s receipt of assets and liabilities from Knoll and from Wyndon. 16 Cash3,000,000 Land11,000,000 Note Payable 4,000,000 Knoll, Capital (3+11-4=10)10,000,000 To record Brown’s investment. Cash5,000,000 Equipment6,000,000 White, Capital (5+6)11,000,000 To record White’s investment.

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Susan Knoll and Emerson Wyndon are forming a partnership to develop a theme park near Carlson City, Florida. Knoll invests cash of $3,000,000 and land valued at $11,000,000. When Knoll purchased the land in 2012, its cost was $9,000,000. The partnership will assume Knoll’s $4,000,000 note payable on the land. Wyndon invests cash of $5,000,000 and equipment worth $6,000, Compute the partnership’s total assets, total liabilities, and total owners’ equity immediately after organizing. 17 Total assets: $3,000,000 + $11,000,000 + $5,000,000 + $6,000,000 = $25,000,000 Total liabilities:= $ 4,000,000 Total owners’ equity: $10,000,000 + $11,000,000 ( $3M+11M-4M ) ($5M+6M) = $21,000,000

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Allocate profits and losses to the partners

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Partners can agree to any profit-and-loss-sharing method they desire Typical arrangements Fraction basis: 50/50, 60/40, 25/75 Three partners: 40/30/30 or 4:3:3 or 4/10, 3/10, 3/10 Based upon investment amounts Based upon service contribution Based upon some combination of fractions, investments and service If no agreement, shared equally among partners: 50/50, 33.3/33.3/33.3, or 25/25/25/25, etc. 19

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Fraction based Profits and losses are shared using the same fraction amounts The Income summary account has a credit balance of $60,000 Or the partnership had a net loss of $15,000 20

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Partners have agreed to share profits as follows: 1.The first allocations are based on 10% of partner capital balances. 2.The next $40,000 is allocated based on service, with Bright getting $16,000 and Gonzalez $24, Any remaining profit is allocated equally. Net income for the first year is $60,000 21

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Journal entry to follow profit/loss sharing calculations: The 4 th closing entry would close out any drawing accounts 22

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. What happens if this same income sharing agreement were in place, but Bright & Gonzalez incurred total net loss of $15,000? 23

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Journal entry to follow loss sharing calculations: The 4 th closing entry would close out any drawing accounts 24

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Withdraw cash or assets based upon the partnership agreement Recorded as contra equity account Assume that Sheena Bright and Martin Gonzalez each made withdrawals of $3,000 Drawing accounts are closed at the end of the year 25

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Farrah and Davidson had beginning capital balances of $25,000 and $20,000, respectively. The two partners fail to agree on a profit-and-loss-sharing ratio. For the first month (June 2012), the partnership lost $6, How much of this loss goes to Farrah? How much goes to Davidson? Farrah: $6,000 x ½ = $3,000 Davisdson: $6,000 x ½ = $3, The partners withdrew no assets during June. What is each partner’s capital balance at June 30? Prepare a T- account for each partner’s capital. 26 Farrah, Capital 3,00025,000 Bal.22,000 Davidson, Capital 3,00020,000 Bal.17,000

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Bagwell, McWilliams, and Briand have capital balances of $24,000, $36,000, and $60,000, respectively. The partners share profits and losses as follows: a.The first $50,000 is divided based on the partners’ capital balances. b.The next $50,000 is based on service, shared equally by Bagwell and Briand. c.The remainder is divided equally. Compute each partner’s share of the $112,000 net income for the year. 27

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. BagwellMcWilliamsBriandTotal Total net income$112,000 Sharing of first $50,000 of net income based on capital balances: Bagwell 24/120 X $50,000$10,000 McWilliams 36/120 X $50,000$15,000 Briand 60/120 X $50,000$25,000 Total50,000 Net income remaining for allocation $62,000 Sharing of next $50,000 based on service: Bagwell ($50,000 × ½)25,000 Briand ($50,000 × ½)25,000 Total50,000 Net income remaining for allocation$12,000 Remainder shared equally: Bagwell ($12,000 × 1/3)4,000 McWilliams ($12,000 × 1/3)4,000 Briand ($12,000 × 1/3)4,000 Total 12,000 Net income remaining for allocation $ -0- Net income allocated to the partners$39,000$19,000$54,000$112,000 28

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Account for the admission of a new partner

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Admitting a new partner or partners—dissolves the old partnership Any change to the partner mix—the old partnership ceases to exist New partnership begins with partner changes Changes can arise from: Death or retirement of partner(s) Admitting a new partner(s) Purchase of a partner’s share 30

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Partnership make-up will change when a new partner buys an existing partner’s interest Change must be approved by all partners Equity is transferred from retiring partner to new partner: Debit retiring partner’s capital Credit new partner’s capital Partnership assets not affected 31

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. With approval, Bright sells partnership share to Barry Holt for $50,000 Balance sheet at date of transfer Journal entry to record transfer Cash is exchanged between Bright and Holt 32

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. New partner invests assets into the business in exchange for share of the business Investment alternatives: Investing in the partnership at book value—no bonus to any partner Investing in the partnership—bonus to the old partners Investing in the partnership—bonus to the new partner Bonus—an increase in the capital account from the investment transaction 33

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. New partner invests assets equal to his/her interest in the new partnership Equity interest calculated on the total equity assumed after the admission Profit/loss sharing is agreed upon separately 34 Partnership capital before Kaska is admitted ($48,100 + $53,900)$102,000 Kaska’s investment in the partnership (Land)51,000 Partnership capital after Kaska is admitted$153,000 Kaska’s capital in the new partnership ($153,000 1/3)$ 51,000

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Successful partnership interest worth more than the percentage of assumed ownership New partner invests assets greater than his/her equity in the new partnership Bonus increases old partner’s capital according to the sharing agreement already in place Profit/loss sharing agreed upon separately 35

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 36 Assume Bright and Gonzalez admit Nancy Fye to a ¼ interest in exchange for $98,000 Fry invested in partnership at a price ($98,000) above the book value of her 1/4 interest ($50,000) Partnership capital before Fry is admitted ($48,100 + $53,900)$102,000 Fry’s investment in the partnership98,000 Partnership capital after Fry is admitted$200,000 Fry’s capital in the new partnership ($200,000 x 1/4)$ 50,000 Bonus to the old partners ($98,000 - $50,000)$ 48,000

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. New partner more valuable and offered a partnership share greater than assets exchanged Excess share is a bonus to the new partner Bonus decreases old partner’s capital in relation to profit-and-loss sharing ratio Profit/loss sharing agreed upon separately Assume Fry gives Bright and Gonzalez $98,000 but instead, gets a 60% interest in the new partnership 37

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The computation of Fry’s 60% equity in the new partnership: Original partners’ equity reduced 38 Partnership capital before Fry is admitted ($48,100 + $53,900)$102,000 Fry’s investment in the partnership98,000 Partnership capital after Fry is admitted$200,000 Fry’s capital in the new partnership ($200,000 x 60%)$ 120,000 Bonus to the new partner ($120, ,000 )$ 22,000

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Persimmon has $75,000 capital and Hawk has $45,000 capital in the Persimmon & Hawk partnership. Persimmon and Hawk share profits and losses equally. Judy Pound invests cash of $40,000 to acquire a 1/4 interest in the new partnership. 1.Calculate Pound’s capital in the new partnership. 2.Journalize the partnership’s receipt of the $40,000 from Pound. 39 Partnership capital before Pound is admitted ($75,000 + $45,000)$120,000 Pound’s investment in the partnership 40,000 Partnership capital after Pound is admitted$160,000 Pound’s capital in the partnership—same as her investment; no bonus ($160,000 × 1/4)$ 40,000 Cash40,000 Pound, Capital40,000 To admit Pound as a partner.

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Account for a partner’s withdrawal from the firm

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Partner leaves the business due to retirement, death or dispute with existing partners Withdrawing partner may receive cash or other assets Partnership agreement should specify how settlements are valued Often specifies an appraisal to determine current market value Changes in market value requires partners share the changes according to profit-and-loss-sharing ratio Three scenarios: Withdrawal at book value Withdrawal at less than book value Withdrawal at greater than book value 41

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Bright, Gonzalez, and Fry balance sheet after Fry admitted to the partnership Independent appraiser revalues the inventory at $70,000 and the computer equipment at $45,200 Journal entry required to bring the partnership to current market value 42

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Partnership agreement allocates 1/6 to Bright, 2/6 (or 1/3) to Gonzalez, and 3/6 (or 1/2) to Fry Journal entry: 43

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Bright, Gonzalez, and Fry capital accounts are updated Bright is withdrawing from the partnership 44

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Partner takes assets with value equal to his capital account (equal to book value) If Bright withdraws by receiving cash for her book value, the entry will be as follows: Bright’s capital account is closed 45

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Withdrawing partner eager to depart and will take less than his/her full equity interest Remaining partners share the difference (bonus) based on their profit-and-loss-sharing ratio Bright withdraws from the business and agrees to receive cash of $10,000 and the new partnership’s $20,000 note payable 46

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Withdrawing partner receives assets worth more than the book value of their equity interest Bonus reduces the remaining partners’ capital balances based on their profit-and-loss ratio Bright is given cash of $20,000 and a note payable of $20,000 47

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. John, Susan, and Carl each have a $200,000 capital balance. They share profits and losses as follows: 1:2:1 to John, Susan, and Carl, respectively. Suppose Carl is withdrawing from the business, and the partners agree that no appraisal of assets is needed. 1.Journalize the withdrawal of Carl if the partnership agrees to pay Carl $200,000 cash. 2. Journalize the withdrawal of Carl if the partnership agrees to pay Carl $140,000 cash. 48 Carl, Capital200,000 Cash200,000 Carl, Capital200,000 Cash140,000 John, capital20,000 Susan, capital40,000

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Account for the liquidation of a partnership

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Liquidation–shuts down the firm by selling its assets and paying its liabilities Dissolves the partnership Adjust and close the books to establish final profits or losses Liquidation involves three steps: Sell the assets and distribute gains/losses to the partners’ capital accounts Pay all partnership liabilities Distribute remaining cash to the partners based on their capital balances Key–all accounts of the company are closed 50

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Assume the following balances after adjusting and closing During liquidation, three scenarios: Assets are sold at a gain Assets are sold at a loss Assets are sold at a book value 51

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Akers, Bloch, and Crane sell the noncash assets for $150,000 Partnership realizes a gain of $60,000 52

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Partnership then pays off its liabilities: If cash balance is less than the liabilities, the partners contribute cash to cover them If cash balance is greater than the liabilities, the remaining cash is paid to partners 53

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. If sale of assets results in a loss, the partners accounts debited Liabilities are paid Partners divide the remaining cash Accounting follows the same pattern illustrated for selling assets for a gain 54

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The Kelly & Lena partnership has the following balances on June 30, 2012: Kelly and Lena share profits 2:3. 1. Journalize the sale of the noncash assets for $25,000, the payment of the liabilities, and the payment to the partners. 55

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 1. Journalize the sale of the noncash assets for $25,000, the payment of the liabilities, and the payment to the partners. 56 Cash25,000 Kelly, capital2,000 Lena, capital3,000 Noncash assets30,000 To sell assets at a loss. Liabilities20,000 Cash20,000 To pay liabilities. Kelly, capital6,000 Lena, capital4,000 Cash10,000 To pay cash in liquidation.

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prepare partnership financial statements

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Similar to those of a proprietorship, with the following differences Income statement–has a section showing division of net income to the partners Balance sheet–has a capital account for each partner in owners’ equity section 58

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The partnership agreement contains the rules under which the partnership will operate. A partnership has limited life and mutual agency, is taxed only at the individual level, has unlimited liability, and maintains separate capital accounts for each partner. A partnership can be a general partnership or an LLP (or LLC). Some small owner groups may also choose to be an S corporation, which is taxed like a partnership but has the protection of the separate corporate entity (limited liability). 59

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. When a partnership is started, each partner contributes assets and liabilities at their current market values. The partnership balance sheet is similar to other balance sheets you’ve learned about—the main difference is that there are separate capital accounts for each partner. The partnership agreement should specify how the partners will share profits and losses. If the agreement is silent, the partners share profits and losses equally. If the agreement has multiple steps, all steps must be applied each time the partnership allocates profits or losses. Each partner has a separate drawing account. That account is closed to the partner’s capital account during the closing process. 60

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. There are many ways a new partner may be admitted to an existing partnership. The new partner can purchase the book equity directly from an existing partner. The new partner can also contribute cash or other assets to the partnership and receive a certain amount of the new partnership’s capital (value). The difference between what the new partner contributes and the value the new partner receives in capital is either a bonus to the existing partners or a bonus to the new partner. 61

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The treatment of a partner withdrawal is similar to the treatment of admitting a new partner. First, the partners can agree to a revaluation. Then, the withdrawing partner can be withdrawn at an amount either exactly equal to his or her capital balance or another amount, higher or lower than his or her capital balance. If the withdrawing partner is given an amount different than his or her capital balance, a bonus to either the remaining partners or to the withdrawing partner occurs. 62

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. To liquidate a partnership, first the partnership must perform the normal end-of-period closing of revenues, expenses, income summary, and drawing accounts. Then, the partnership sells its assets. Any gain or loss on the sale of the assets is allocated to the partners based on their profit-and-loss-sharing ratio from the partnership agreement. Next, the partnership pays off any liabilities it has. Last, if cash remains, the partners’ capital balances are paid. When a partnership is completely liquidated, all account balances are zero. 63

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The key difference in a partnership income statement and other types of company income statements is that the allocation of net income/loss is shown on the face of the statement. The key difference in the partnership balance sheet from other balance sheets is the individual capital accounts for each partner are listed in the equity section. 64

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 65

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 66 Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.