2 PARTNERSHIP CHARACTERISTICS Voluntary associationPartnership AgreementLimited LifeMutual AgencyUnlimited LiabilityCo-ownership of Partnership propertyParticipation in partnership Income
3 Voluntary Association A voluntary association of individuals rather than a legal entity.A partner is responsible for his partner’s business actions under the law.A person must select a partner who shares his business objectives due to unlimited liability.←
4 Partnership Agreement Two or more competent people agree to be partners in some common business purpose.Partnership agreement does not have to be in written form.Good business practice calls for a written document providing details of partnership.
5 Partnership Agreement It should include name, location and purpose of business.Duties of partnersInvestments of each partner.Methods of distributing profits and losses←The admission or withdrawal of partners.Withdrawals of assets allowed for each partner.Procedure for dissolving or ending business.
6 LIMITED LIFE Partnership is dissolved when: A partner withdraws A partner goes bankruptA partner is incapacitatedA partner diesA new partner is admittedA partner retiresPartnership ends according to agreement.←
7 Participation in Partnership Income Partnership agreement should mention the method of distributing profit and losses to each partner.If an agreement doesn’t mention losses, they are distributed in the same way as profits.If agreement does not mention any method, then by law, they are shared equally.
8 ACCOUNTING FOR PARTNERS’ EQUITY separate Capital and Withdrawal accounts must be maintained for each partner.Balance of each partner’s capital is listed separately.Total Liabilities $28,000Partner’s Equity:Desmond, capital $25,000Frank, capital $34,000Total Partners’ Equity $59,000Total Liabilities & Equity $87,000
9 ACCOUNTING FOR PARTNERS’ EQUITY When assets other than cash are invested, partners must agree on their value.Value of non cash assets should be the fair market value on the date of transferring them to partnership.Value of assets must be entered into partnership agreement.
10 ACCOUNTING FOR PARTNERS’ EQUITY Jerry Adcock and Rose Villa agree to combine their capital and equipment into partnership for operating a jewelry store. Adcock will invest $28000 cash & $37000 of furniture and Villa will invest $40,000 cash & $20,000 equipment.What are the journal entries to record their initial investment??
11 ACCOUNTING FOR PARTNERS’ EQUITY July 1 Cash ,000Furniture ,000Adcock, Capital 65,000July 1 Cash ,000Equipment ,000Rose Villa, Capital 60,000
12 ACCOUNTING FOR PARTNERS’ EQUITY These values may differ from those carried on partners personal books.The equipment contributed by Villa was recorded on $12,000 in his personal book but at the time of investing it in business, market value increased. Then Villa’s investment must be recognized at the current market value of equipment.Partnership may also assume liabilities related to investments.
13 Distribution of Profit and losses Income of a partnership has three components:Return to partners for the use of capitalCompensation for services providedFurther economic income for taking up business risks.
14 Distribution of Profit and losses If partners contribute unequally, then income and losses should be shared according to:Stated ratioCapital Investment ratioSalaries to partners and interest on partners capital, with the remaining income shared according to stated ratio.
15 STATED RATIOEach partner must be given a stated ratio of the total income or losses.Adcock and Villa had a NI of $30,000 and agreement specified stated ratio of 60 and 40 respectively.June 30 Income Summary $30,000Adcock, capital $18,000Villa, capital $12,000
16 Capital Investment Ratio If invested capital produced the most income for the business, then income and losses may be distributed according to capital investment.Two ways to distribute income and losses:Ratio of capital balance at the beginning of yearOr to use average capital balance of each partner during the year.
17 Capital Investment Ratio Adcock and villa capital accounts balances at the beginning of the year were as following:Adcock; 65,000 Villa: 60,000NI = 140,000Capital Capital ratioAdcock /125,000 = %Villa 60,000/125,000 = %
18 Capital Investment Ratio Share of Income:Adcock: 140,000 x 52% = $72,800Villa: ,000 x 48% = $67,200June30 Income Summary ,000Adcock, Capital ,800Villa, Capital ,200
19 Capital Investment Ratio If partners believe their capital balances will change during year, then average capital balances should be used to distribute income and losses.Assume that Adcock withdrew 10,000 on Jan1,19x2 and Villa withdrew 10,000 on Nov1,19x1 and invested an additional 8,000 on Feb1,19x2. Income for the year was $140,000.
20 Average capital Balances PartnerDateCapital x BalanceMonths unchangedTotalAvg CapitalAdcock7/x1-12/x1x=390,0001/x2-6/x255,000 x330,00012720,000/1260,000Villa7/x1-10/x160, x=240,00011/x1-1/x250, x=150,0002/x2-6/x258, x=290,000680,000/1256,667
21 Average capital Balances Total Average Capital:Adcock = 60,000 + Villa = 56,667 = 116,667Average Capital balance ratio;Adcock = Adcock’s avg capital / Total avg capital= 60,000 / 116,667 = %Villa = Villa’s avg capital / Total avg capital= 56,667 / 116,667 = %
22 Distribution of Income: Adcock: 140,000 x 51.4% = 71,960Villa: 140,000 x 48.6% = 68,040Income Summary 140,000Adcock, Capital 71,960Villa, Capital 68,040
23 Salaries, Interest, and Stated Ratio Salaries and interest on capital are not expenses, rather it is distribution of income among partners. They are not deducted as expenses before the income is determined.Assume Adcock’s salary is $8000 and Villa’s salary is $7000. Any remaining income will be divided equally.
24 Salaries, and Stated Ratio AdcockVillaTotal IncomeTotal income for distribution140,000Distribution of salaries8000700015,000Remaining Income125,000Equal distribution of remaining income62,500-0-Income of Partners70,50069,500
25 Salaries, and Stated Ratio Income Summary 140,000Adcock, Capital 70,500Villa, Capital 69,500Salaries and interest must be allocated to partners even if income is not enough t cover these salaries and interest. Even in case of loss, these allocations must be made. The negative amount must be distributed among partners by stated ratio.
26 Salaries, Interest, and Stated Ratio AdcockVillaTotal IncomeTotal income for distribution140,000Distribution of salaries70,00060,000130,000Remaining Income10,000Distribution of Interest6,5006,00012,500(2,500)Equal distribution of negative income(1,250)2,500Income of Partners75,25064,750