1. Partnerships: Formation and Operation14
C H A P T E R
Partnerships: Formation and Operation 1 1 1

2. Partnerships Capital Accounts
The equity section of a partnership consists of capital balances for each partner.
Profits/losses each period are allocated to each partner’s capital account.
Withdrawals by partners reduce their capital accounts.

3. Articles of Partnership
Partnerships can exist even in the absence of a written partnership agreement.
The Uniform Partnership Act establishes standards and rules for partnerships.
A written agreement will supercede the UPA standards.

4. Articles of Partnership
Method for admitting new partners
Method for dispute settlements
Profit/loss sharing percentages
Initial contribution to be made by each partner
Withdrawal limits
Put it in writing!
Method for valuing individual contributions
Rights and responsibilities of partners

5. Accounting for Capital Contributions
If the partners each contribute cash . . .
. . . debit Cash.
. . . credit individual Partner Capital accounts.

6. Accounting for Capital Contributions
If the partners each contribute cash and other assets . . .
. . . debit Cash & contributed assets for FMV.
. . . credit individual Partner Capital accounts.

7. Accounting for Capital Contributions
Intangible assets, such as expertise, require special consideration
Use either the Bonus Method or the Goodwill Method.
Record the tangible assets contributed.
Adjust the partner capital balances to reflect the relative value of the intangible asset.

8. Intangible Contributions Bonus Method
On 2/15/98, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes $80,000 cash. Redd contributes land valued at $40,000.
Prepare the journal entry to set up the partnership.

9. Intangible Contributions Bonus Method
Total tangible assets for the partnership are $120,000. The partners have agreed to have equal capital balances, based on the contributed assets. Even though Redd only contributed land worth $40,000, essentially, Greene has given Redd a $20,000 bonus.

10. Intangible Contributions Goodwill Method
Record the tangible assets contributed.
Record the contributed intangible asset as the difference between the contributed tangible assets and the implied value of the partnership.

11. Intangible Contributions Goodwill Method
On 2/15/98, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes $80,000 cash. Redd contributes land valued at $40,000, and brings years of experience to the new business.
Prepare the journal entry to set up the partnership.

12. Intangible Contributions Goodwill Method
On 2/15/98, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes $80,000 cash. Redd contributes land valued at $40,000, and brings years of experience to the new business. ÷

13. Intangible Contributions Goodwill Method
Greene’s capital account is credited for the tangible contribution of $80,000.
Redd’s capital account is credited for the tangible contribution of $40,000, plus the intangible contribution valued at $40,000.

14. Interest on beginning capital balances Allocated compensation
Allocation of Income
The allocation of income is not based on the relative capital balances.
It is a separately negotiated item.
Items to be allocated:
Remaining income
Interest on beginning capital balances
Bonuses
Allocated compensation

15. Allocation of Income Example
Lebo and Smith, a retail partnership, has beginning of period capital balances of $50,000 and $70,000 respectively. Net income for the period is $100,000.
Both partners are credited with 10% interest on their beginning capital balance. In addition, Lebo is credited with a bonus of $20,000 per the partnership agreement. They share income 40:60 (Lebo:Smith).
What are the ending capital balances for each partner?

16. Allocation of Income Example

17. Admission of a New Partner The Rights of a Partner
An individual partner’s ownership rights include:
The right to co-ownership of the partnership property.
The right to share in profits and losses as specified in the partnership agreement
The right to participate in the management of the partnership.
These two rights can be sold.
This right cannot be sold without the other partners’ approval.

18. Partnership Dissolution Admission of a New Partner
When the makeup of the partnership changes, the partnership is dissolved.
A new partnership is immediately formed.
New partner acquires partnership interest by:
Purchasing it from the other partners, or
Making a contribution to the partnership.

19. Admission of a New Partner Purchase of a Current Interest
A new partner can purchase partnership interest directly from the existing partners.
The cash goes to the partners, not to the partnership.
Two methods are available to account for the transfer of ownership.
Book Value Approach
Goodwill (Revaluation) Approach

20. Admission of a New Partner Purchase of a Current Interest
Book Value Example
Doe, Raye, and Mee have a partnership.
Using the Book Value Approach, prepare the entry assuming Flatt pays $60,000 directly to the other partners for a 20% partnership interest.

21. Admission of a New Partner Purchase of a Current Interest
Book Value Example
The cash goes to Doe, Raye, and Mee, NOT to the partnership.
Each partner gives up 20% of their existing capital.
Prepare the journal entry to admit Flatt to the partnership.

22. Admission of a New Partner Purchase of a Current Interest
Now, let’s take a look at the Goodwill Approach.

23. Admission of a New Partner Purchase of a Current Interest
Goodwill (Revaluation) Example
Doe, Raye, and Mee have a partnership.
Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 directly to the other partners for a 20% partnership interest.

24. Admission of a New Partner Purchase of a Current Interest
Goodwill (Revaluation) Example
The implied value of the partnership is $300,000
$60,000 ÷ 20% = $300,000
First, compute the Goodwill

25. Admission of a New Partner Purchase of a Current Interest
Goodwill (Revaluation) Example
Allocate the $160,000 of Goodwill to the existing partners, based on their income sharing %. (40:25:35)
Prepare the journal entry to allocate goodwill to Doe, Raye, & Mee.

26. Admission of a New Partner Purchase of a Current Interest
Goodwill (Revaluation) Example
The new balances for Doe, Raye, and Mee appear as follows:
Next, allocate 20% from each of the existing partners to Flatt.

27. Admission of a New Partner Purchase of a Current Interest
Revaluation Example
Note that Flatt’s balance, after allocation from the current partners, equals Flatt’s contribution of $60,000.

28. Admission of a New Partner Contribution to the Partnership
The new partner can gain partnership interest by contributing cash to the partnership.
Remember that the new cash will increase the partnership’s net assets.
Two methods are:
Bonus Approach
Goodwill Approach

29. Admission of a New Partner Contribution to the Partnership
Bonus Example
Doe, Raye, and Mee have a partnership.
Using the Bonus Approach, prepare the entry assuming Flatt pays $60,000 to the partnership for a 20% partnership interest.

30. Admission of a New Partner Contribution to the Partnership
Bonus Example
Net assets after the contribution are $200,000.
Flatt gets credit for 20% of net assets ($200,000 x 20%).
The remainder of the $60,000 contribution is allocated to the other partners.
Note that the $200,000 results from the net assets of the partnership of $140,000 + Flatt’s $60,000 contribution.
Prepare the journal entry.

31. Admission of a New Partner Contribution to the Partnership
Now, let’s take a look at the Goodwill Approach.

32. Admission of a New Partner Contribution to the Partnership
Goodwill Example
Doe, Raye, and Mee have a partnership.
Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 to the partnership for a 20% partnership interest.

33. Admission of a New Partner Contribution to the Partnership
Goodwill Example
Net assets after the contribution are $200,000.
Implied value of the partnership is $300,000.
$60,000 ÷ 20% = $300,000
Goodwill to be recorded is $100,000 (300, ,000)
Prepare the journal entry to allocate goodwill to Doe, Raye, & Mee.

34. Admission of a New Partner Contribution to the Partnership
Goodwill Example
After allocating the goodwill to the original partners, record Flatt’s cash contribution and credit Flatt’s capital account.
Prepare the journal entry to admit Flatt to the partnership.

35. End of Chapter 14
Accounting for my partners is easy. It’s accounting for their taste that I find difficult!