1. Partnerships – Formation, Operations, and Changes in Ownership Interests
Chapter 15

2. characteristics of partnerships.
Learning Objective 1
Comprehend the legal
characteristics of partnerships.

3. Partnership Characteristics
It is an association of two or more persons
who co-own a business for a profit.
The legal life of a partnership terminates
with the admission of a new partner, the
withdrawal or death of a partner, voluntary
dissolution by the partners, or involuntary
dissolution such as bankruptcy proceedings.

4. Articles of Partnership
A partnership may be formed by a simple
oral agreement among two or more
people to operate a business for profit.

5. Articles of Partnership
Such agreements should specify:
The types of products and services to be provided
Each partner’s rights and responsibilities
Each partner’s initial investment
Additional investment conditions
Asset drawing provisions
Profit and loss sharing formulas
Procedures for dissolving the partnership

6. Partnership Financial Reporting
The accounting reports are designed to
meet the needs of three user groups…
The partners
Partnership creditors
Internal Revenue Service

7. Understand initial investment valuation and record keeping.
Learning Objective 2
Understand initial investment
valuation and record keeping.

8. Initial Investment in a Partnership
Ashley and Becker each invest $20,000
cash in a new partnership.
Cash ,000
Ashley, Capital ,000
To record Ashley’s original investment of cash
Cash ,000
Becker, Capital ,000
To record Becker’s original investment of cash

9. C. Cola and R. Crown enter into a partnership.
Noncash Investments
C. Cola and R. Crown enter into a partnership.
C. Cola R. Crown
Fair Value Fair Value
Cash $ — $ 7,000
Land (cost to C. Cola, $5,000) , —
Building (cost to C. Cola, $30,000) 40, —
Inventory (cost to R. Crown, $28,000) — 35,000
Total $50,000 $42,000

10. Noncash Investments Land 10,000 Building 40,000
C. Cola, Capital ,000
To record C. Cola’s original investment
of land and building at fair value

11. Noncash Investments Cash 7,000 Inventory 35,000
R. Crown, Capital ,000
To record R. Crown’s original investment
of cash and inventory items at fair value

12. Bonus or Goodwill on Initial Investment
The partnership agreement specifies
equal capital interests.
Bonus Approach
C. Cola, Capital ,000
R. Crown, Capital ,000
To establish equal capital interests of $46,000 by
recording a $4,000 bonus from C. Cola to R. Crown

13. Bonus or Goodwill on Initial Investment
Goodwill approach
Goodwill ,000
R. Crown, Capital ,000
To establish equal capital interests of $50,000
by recognizing R. Crown’s investment
of an $8,000 unidentifiable asset

14. Drawings Regular withdrawals are called drawings, drawing allowances,
or sometimes salary allowances.
Debit Drawing and credit Cash.
At period end, credit Drawing
and debit each partner’s Capital.

15. Loans and Advances Loans and advances to the partnership
and accrued interest are regarded as
liabilities of the partnership.
Loans and advances to partners are
regarded as assets of the partnership.

16. Partnership Operations
Ratcliffe and Yancey are partners sharing
profits in a 60:40 ratio, respectively.

17. Partnership Operations
Equity Accounts, 2003
Partnership net income $34,500
Ratcliffe capital January 1, ,000
Ratcliffe additional investment ,000
Ratcliffe drawing ,000
Yancey capital January 1, ,000
Yancey drawing ,000
Yancey withdrawal ,000

18. Format for a Statement of Partners’ Capital
Ratcliffe and Yancey Statement of Partners’ Capital For the Year Ended 12/31/2003
60% 40%
Ratcliffe Yancey Total
Capital balances 1/1/03 $40,000 $35,000 $75,000
Add: Additional investments 5, — 5,000
Deduct: Withdrawals — – 3,000 – 3,000
Deduct: Drawings – 6,000 – 9,000 –15,000
Net contributed capital , , ,000
Add: Net income for , , ,500
Capital balances 12/31/03 $59,700 $36,800 $96,500

19. Closing Entries December 31, 2003 Revenue and Expense Summary 34,500
Ratcliffe, Capital ,700
Yancey, Capital ,800
To divide net income for the year 60% to Ratcliffe
and 40% to Yancey

20. Closing Entries December 31, 2003 Ratcliffe, Capital 6,000
Yancey, Capital ,000
Ratcliffe, Drawing ,000
Yancey, Drawing ,000
To close partner drawing accounts to capital accounts

21. Grasp the diverse nature of profit and loss sharing agreements
Learning Objective 3
Grasp the diverse nature of profit
and loss sharing agreements
and their computation.

22. Profit and Loss Sharing Agreements
Equal division of partnership income is required in
the absence of a profit and loss sharing agreement.

23. Service Considerations in Profit and Loss Sharing Agreements
A partner who devotes time to the partnership
business while other partners work elsewhere
may receive a salary allowance.
Salary allowances are also used to
compensate for differences in the fair
value of the talents of partners.

24. Salary Allowance in Profit Sharing Agreements
Bob, Gary, and Pete are partners.
The partnership agreement provides that
Bob and Gary receive salary allowances
of $12,000 each, with the remaining
income allocated equally.
Partnership net income is $60,000 for 2003
and $12,000 for 2004.

25. Income Allocation Schedule: 2003
Bob Gary Pete
Net income $60,000
Salary allowances
to Bob and Gary (24,000) $12,000 $12,000
Remainder to divide 36,000
Divided equally (36,000) 12, ,000 $12,000
Remainder to divide
Net income allocation $24,000 $24,000 $12,000

26. Income Allocation Schedule: 2004
Bob Gary Pete
Net income $12,000
Salary allowances
to Bob and Gary (24,000) $12,000 $12,000
Remainder to divide (12,000)
Divided equally 12, (4,000) (4,000) $(4,000)
Remainder to divide
Net income allocation $ 8,000 $ 8,000 $(4,000)

27. Journal Entries December 31, 2003 Revenue and Expense Summary 60,000
Bob, Capital ,000
Gary, Capital ,000
Pete, Capital ,000
Partnership income allocation for 2003

28. Journal Entries December 31, 2004 Revenue and Expense Summary 12,000
Pete, Capital ,000
Bob, Capital ,000
Gary, Capital ,000
Partnership income allocation for 2004

29. Bonus and Salary Allowances
The partnership agreement provides that Bob
receive a bonus of 10% of partnership net income.
Bob and Gary receive salary allowances
of $10,000 and $8,000, respectively, and
the remaining income is allocated equally.
Partnership net income is $60,000
for 2003 and $12,000 for 2004.

30. Income Allocation Schedule: 2003
Bob Gary Pete
Net income $60,000
Bonus to Bob (6,000) $ 6,000
Remainder to divide 54,000
Salary allowances
to Bob and Gary (18,000) 10,000 $ 8,000
Remainder to divide 36,000
Divided equally (36,000) 12, ,000 $12,000
Remainder to divide
Net income allocation $28,000 $20,000 $12,000

31. Income Allocation Schedule: 2004
Bob Gary Pete
Net income $12,000
Bonus to Bob (1,200) $ 1,200
Remainder to divide 10,800
Salary allowances
to Bob and Gary (18,000) 10,000 $8,000
Remainder to divide (7,200)
Divided equally ,200 (2,400) (2,400) $(2,400)
Remainder to divide
Net income allocation $ 8,800 $5,600 $(2,400)

32. Income Allocated in Relation to Partnership Capital
Capital balances 1/1/2003 $20,000 $20,000
Investment April , —
Withdrawal July — (5,000)
Investment September , —
Withdrawal October — (4,000)
Investment December — ,000
Capital balances 12/31/2003 $25,000 $19,000
Ace Butch

33. Comparison of Capital Bases
Weighted
Beginning Ending Average
Capital Capital Capital
Investment Investment Investment
Ace $20,000 $25,000 $22,500
Butch 20, , ,500
Total $40,000 $44,000 $39,000

34. Alternatives Net income of $100,000 is divided
on the basis of capital balances.
Beginning Capital Balances
Ace ($100,000 × 20/40) $ 50,000
Butch ($100,000 × 20/40) ,000
Total income $100,000

35. Alternatives Ending Capital Balances
Ace ($100,000 × 25/44) $ 56,818.18
Butch ($100,000 × 19/44) ,181.82
Total income $100,000.00
Average Capital Balances
Ace ($100,000 × 22.5/39) $ 57,692.31
Butch ($100,000 × 16.5/39) ,307.69
Total income $100,000.00

36. Interest Allowances on Partnership Capital
An agreement may provide for interest
allowances on partnership capital in
order to encourage capital investments,
as well as salary allowances.
Remaining profits are then divided
equally or in any other ratio specified
in the profit sharing agreement.

37. Value new partners’ investment in an existing partnership.
Learning Objective 4
Value new partners’ investment
in an existing partnership.

38. Changes in Partnership Interest
The existing legal partnership entity is
dissolved when a new partner is admitted
or an existing partner retires or dies.

39. Changes in Partnership Interest
Assignment of an interest to a third party
Admission of a new partner
Purchase of an interest from existing partners
Investing in an existing partnership

40. Value partner’s share upon
Learning Objective 5
Value partner’s share upon
retirement or death.

41. Dissolution of a Continuing Partnership Through Death or Retirement
Profit and
Capital Percentage Loss
Balances of Capital Percentage
Bonnie $ 70, % 40%
Clyde ,
Dillinger ,
Total capital $200, % 100%

42. Dissolution of a Continuing Partnership Through Death or Retirement
Dillinger decides to retire.
The partners agree that the business is
undervalued on the partnership books
and that Dillinger will be paid $92,000.

43. Bonus to Retiring Partner
Dillinger, Capital 80,000
Bonnie, Capital 8,000
Clyde, Capital 4,000
Cash ,000
Dillinger, Capital 80,000
Goodwill ,000
Cash ,000

44. Reevaluation of Total Partnership Capital
Goodwill (other assets) 30,000
Bonnie, Capital ,000
Clyde, Capital ,000
Dillinger, Capital ,000

45. Payment to Retiring Partner Less than Capital Balance
Suppose that Dillinger is paid $72,000
in final settlement of his capital interest.

46. Overvalued Assets Written Down
Bonnie, Capital ,000
Clyde, Capital ,000
Dillinger, Capital 8,000
Net assets ,000
Dillinger, Capital 72,000
Cash ,000

47. Bonus to Continuing Partners
Dillinger, Capital 80,000
Bonnie, Capital ,333
Clyde, Capital ,667
Cash ,000

48. Understand limited liability partnership characteristics.
Learning Objective 6
Understand limited liability
partnership characteristics.

49. Limited Partnerships The limited partnership consists
of at least one general partner
and one or more limited partners.
The limited partner is excluded from
the management of the business.

50. End of Chapter 15