1. Partnerships CHAPTER 9 Electronic Presentations in Microsoft® PowerPoint®

2. 1. 1. Identify characteristics of partnerships. 2. 2. Prepare entries when forming a partnership. 3. 3. Allocate and record income and loss among partners. 4. 4. Account for the admission and withdrawal of a partner. 5. 5. Prepare entries for partnership liquidation. Learning Objectives

3. An unincorporated association of two or more persons to pursue a business for profit as co-owners. An unincorporated association of two or more persons to pursue a business for profit as co-owners. Partnership

4. Usually include the partners’: Usually include the partners’: 1. 1. Names and contributions, 2. 2. Rights and duties, 3. 3. Sharing of income and losses, 4. 4. Withdrawal provisions, 5. 5. Dispute procedures, 6. 6. Procedures for admission and withdrawal of new partners, and 7. 7. Rights and duties of surviving partners in the event of a partner’s death. Partnership Agreement

5.  Limited life  Taxation of partners  Co-ownership of property  Mutual agency  Liability of partners Characteristics of Partnerships

6. Partners’ liabilities depend upon the form of partnership. Partners’ liabilities depend upon the form of partnership. Partnership forms: 1. General partnerships 2. Limited partnerships 3. Limited liability partnerships Liability of Partners

7. General Partnerships General Partnerships Each partner has unlimited liability for the partnership’s debts. Liability of Partners

8. Limited Partnerships  At least one general partner who assumes management duties and unlimited liability for the debts of the partnership.  Other partners may be limited partners who have no personal liability beyond the amounts they invested in the partnership. Liability of Partners

9. Limited Liability Partnerships  Protects innocent partners from malpractice or negligence of other partners.  All partners are responsible for other partnership debts. Liability of Partners

10.  Separate capital account and withdrawal account for each partner.  Partnership income or loss is allocated to partners based on partnership agreement.  Partners can invest assets and liabilities in the partnership.  Assets invested are recorded at fair market value. Partnership Accounting

11. Illustration: Formation of a partnership Jackson and Thompson create a partnership. Jackson invests $20,000 cash and Thompson invests $20,000 cash and equipment with a fair market value of $10,000. The entries to record these investments are: Cash 20,000 Jackson, capital 20,000 Cash 20,000 Equipment 10,000 Thompson, capital 30,000

12. The partnership income or loss may be allocated based on: The partnership income or loss may be allocated based on:  Fractional basis  Ratio of capital investments  Salaries, interest allowance, and a fixed ratio Dividing Income or Loss

13. Illustration: Income and loss sharing based on a fractional basis. Jackson and Thompson agree to share income and losses on a 2:1 ratio. The income for the year is $90,000. The entry to close the income summary account is : Income summary 90,000 Jackson, capital 60,000 Thompson, capital 30,000 2/3 x 90,000 = 60,000 1/3 x 90,000 = 30,000

14. Income and loss sharing based on ratio of capital investments. Jackson and Thompson agree to share income and losses on the basis of their beginning capital investments. Assume partnership income for the year is $90,000, and Jackson and Thompson’s beginning- of-year capital balances are $20,000 and $30,000 respectively. The entry to close the income summary account is : Income summary 90,000 Jackson, capital 36,000 Thompson, capital 54,000 20,000/50,000 x 90,000 = 36,000 30,000/50,000 x 90,000 = 54,000

15. Income and loss sharing based on salaries, interest allowance, and a fixed ratio Jackson and Thompson agree to share income or losses as follows: 1.Annual salary allowances of $30,000 for Jackson and $10,000 for Thompson. 2.Interest allowances of 10% of beginning-of-year capital balance. 3.Remainder to be shared equally. Assume partnership income for the year is $90,000 and Jackson and Thompson’s beginning-of-year capital balances are $80,000 and $70,000 respectively.

16. The entry to close the income summary account is : Income summary 90,000 Jackson, capital 55,500 Thompson, capital34,500

17. Income and loss sharing based on salaries, interest allowance, and a fixed ratio Assume the same income and loss sharing agreement as before and that there is a net loss of $10,000 for the year.

18. The entry to close the income summary account is : Thompson, capital 15,500 Income summary 10,000 Jackson, capital 5,500

19. Mini-Quiz R, H, and D formed a partnership with R contributing $60,000, H contributing $50,000, and D contributing $40,000. Their partnership agreement called for the earnings division to be based on the ratio of capital investments. If the partnership had earnings of $74,000 for its first year of operation, what amount of earnings (rounded) would be credited to D's capital account? R, H, and D formed a partnership with R contributing $60,000, H contributing $50,000, and D contributing $40,000. Their partnership agreement called for the earnings division to be based on the ratio of capital investments. If the partnership had earnings of $74,000 for its first year of operation, what amount of earnings (rounded) would be credited to D's capital account? The amount credited would be $19,733. 40,000/(60,000+50,000+40,000) x $74,000 = $19,733

20. New partners may be admitted to the partnership by either : New partners may be admitted to the partnership by either : 1. Purchasing a partnership interest. or or 2. Investing assets in the partnership. Admission and Withdrawal of a Partner

21.  Personal transaction between one or more current partners and the new partner.  New partner must be accepted by current partners.  New income-and-loss sharing agreement is prepared. Purchase of Partnership Interest

22. Illustration: Purchase of Partnership Interest Jackson and Thompson continues to operate for several years. Jackson’s beginning of the year capital balance is $100,000. Jackson sells one half of his partnership interest to Harris for $60,000. The entry to record the admission of Harris is: Jackson, capital 50,000 Harris, capital 50,000 50% x $100,000

23.  Instead of purchasing the equity of an existing partner, an individual may gain equity by investing assets.  The amount invested may or may not equal the share of equity obtained. 1. Investment equal to share of equity 2. Investment greater than share of equity (bonus to old partners) 3. Investment less than share of equity (bonus to new partner) Investing Assets in a Partnership

24. When the value of the partnership is approximately equal to the equity recorded on the accounting records, a new partner receives a proportionate share of equity equal to his investment. When the value of the partnership is approximately equal to the equity recorded on the accounting records, a new partner receives a proportionate share of equity equal to his investment. Investment Equals Share of Equity

25. Illustration: Investment Equals Share of Equity Jackson and Thompson accept Harris as a partner with his investment of $40,000 for 20%* equity. The partnership had total equity of $160,000 (Jackson $90,000 and Thompson $70,000) before his investment. The entry to record this investment is: Cash 40,000 Harris, capital 40,000 Note: Harris does not necessarily have a right to 20% of income. *20% = 40,000 / (160,000 + 40,000)

26. When the current market value of the partnership is greater than the book value, a new partner usually pays a bonus for the privilege of joining When the current market value of the partnership is greater than the book value, a new partner usually pays a bonus for the privilege of joining Investment is Greater Than Share of Equity

27. Illustration: Investment is Greater Than Share of Equity Jackson and Thompson accept Harris as a partner with his investment of $60,000 for 20% equity. The partnership had total equity of $160,000 (Jackson $90,000 and Thompson $70,000) before his investment. Equities of existing partners$160,000 Investment of new partner 60,000 Total partnership equity$220,000 Equity of Harris (20% x $220,000) $44,000

28. Illustration: Investment is Greater Than Share of Equity The $16,000 difference between the amount invested by Harris ($60,000) and his equity ($44,000) represents a bonus to the old partners. Assume that this bonus is allocated to the existing partners in their income/loss ratio of 50:50. The entry to record this investment is: Cash 60,000 Harris, capital 44,000 Jackson, capital 8,000 Thompson, capital 8,000 ($16,000 x 50%)

29.  When existing partners are anxious to bring a new partner into the firm, the old partners may be willing to give the new partner a larger equity in the business than the amount of his investment.  The bonus given to the new partner is allocated to the original partners (reducing their equity balances) based on their income- and-loss-sharing ratio as per their agreement. Investment is Less Than Share of Equity

30. Illustration: Investment is Less Than Share of Equity Jackson and Thompson accept Harris as a partner with his investment of $10,000 for 20% equity. The partnership had total equity of $160,000 (Jackson $90,000 and Thompson $70,000) before his investment. Equities of existing partners$160,000 Investment of new partner 10,000 Total partnership equity$170,000 Equity of Harris (20% x $170,000) $34,000

31. Illustration: Investment is Greater Than Share of Equity The $24,000 difference between the amount invested by Harris ($10,000) and his equity ($34,000) represents a bonus to Harris. Assume that this bonus is allocated to the existing partners in their income/loss ratio of 50:50. The entry to record this investment is: Cash 10,000 Jackson, capital 12,000 Thompson, capital 12,000 Harris, capital 34,000 ($24,000 x 50%)

32. A partner may withdraw from the partnership by: A partner may withdraw from the partnership by: 1. Selling his or her interest to another person. or or 2. Receiving assets from the partnership in settlement for his or her equity interest. Withdrawal of a Partner

33. The withdrawing partner’s account is debited and the new partner’s account is credited. The withdrawing partner’s account is debited and the new partner’s account is credited. Withdrawing partner, capital xxx New partner, capital xxx New partner, capital xxx Withdrawal of a Partner-Sale of Interest to Another Person

34. Three possibilities: Three possibilities: 1. No bonus. 2. Bonus to remaining partners. 3. Bonus to withdrawing partner. Withdrawal of a Partner- Partnership assets exchanged for equity interest

35. No Bonus No Bonus The withdrawing partner receives assets equal to the balance of their capital account. The withdrawing partner receives assets equal to the balance of their capital account. Withdrawal of a Partner- Partnership assets exchanged for equity interest

36. Illustration: No Bonus Assume that Harris withdraws and receives $55,000 cash from the partnership. His capital balance is also $55,000. The entry to record the withdrawal of Harris is: Harris, capital 55,000 Cash 55,000

37. Bonus to Remaining Partners The withdrawing partner receives assets less than the balance of their capital account. Possible reasons: 1. Withdrawing partner may want out of the partnership. 2. Assets may be overvalued. Withdrawal of a Partner- Partnership assets exchanged for equity interest

38. Illustration: Bonus to Remaining Partners Assume that Harris withdraws and receives $40,000 cash from the partnership. His capital balance is $55,000. Assume that this bonus is allocated to the remaining partners in their income/loss ratio of 50:50. The entry to record the withdrawal of Harris is: Harris, capital 55,000 Jackson, capital 7,500 Thompson, capital 7,500 Cash 40,000 ($55,000 - $40,000) x 50% =$7,500

39. Bonus to Withdrawing Partner Bonus to Withdrawing Partner The withdrawing partner receives assets greater than the balance of their capital account. The withdrawing partner receives assets greater than the balance of their capital account. Possible reasons: Possible reasons: 1. Remaining partners may want a partner out of the partnership. 2. Recorded equity of the partnership may be understated. Withdrawal of a Partner- Partnership assets exchanged for equity interest

40. Illustration: Bonus to Withdrawing Partner Assume that Harris withdraws and receives $65,000 cash from the partnership. His capital balance is $55,000. Assume that this bonus is allocated to the remaining partners in their income/loss ratio of 50:50. The entry to record the withdrawal of Harris is: Harris, capital 55,000 Jackson, capital 5,000 Thompson, capital 5,000 Cash 65,000 ($55,000 ­ $65,000) x 50% = -$5,000

41. Steps involved in liquidation: 1.Non-cash assets are sold for cash and a gain or loss on liquidation is recorded. 2.The gain or loss is allocated to partners using their income-and-loss ratio. 3.Liabilities are paid. 4.The remaining cash is distributed to partners based on their capital balances. Liquidation of a Partnership

42. No Capital Deficiency All partners have credit balances in their capital accounts before the final distribution of cash. Capital Deficiency At least one partner has a debit balance in his or her capital account before the final distribution of cash. Liquidation of a Partnership- Possible Scenarios

43. Illustration: No Capital Deficiency Assume the company is closing down and all losses or gains are shared equally between the partners. The account balances immediately prior to liquidation are:

44. Illustration: No Capital Deficiency Step 1:Sell Non-Cash Assets The entry to record the sale is: Cash 144,000 Accumulated Amortization 20,000 Building 80,000 Land 60,000 Gain on Liquidation 24,000 Step 2:Allocate the Gain or Loss to the Partners’ Capital Accounts The entry to allocate the gain is: Gain on Liquidation 24,000 Jackson, Capital8,000 Thompson, Capital8,000 Harris, Capital8,000 $24,000/3

45. Illustration: No Capital Deficiency Balances after liquidation and allocation of the gain

46. Illustration: No Capital Deficiency Step 3:Pay the Liabilities The entry to record this is: Accounts Payable 20,000 Cash 20,000

47. Illustration: No Capital Deficiency Step 4: Distribute the remaining cash to the partners The entry to record this is: Jackson, Capital68,000 Thompson, Capital58,000 Harris, Capital38,000 Cash164,000

48. Situations may arise when one or more partners has a debit balance in his or her capital account before the final distribution of cash. This is referred to as a Capital Deficiency. The partner(s) with the deficiency either: 1. Can and do pay the deficiency with personal funds. 2. Cannot pay the deficiency. The other partners absorb the deficiency. Liquidation of a Partnership- Possible Scenarios

49. Review Discuss the options for the allocation of income and loss among partners. Discuss the options for the allocation of income and loss among partners. In the absence of a partnership agreement, income and losses are shared equally by the partners. A partnership agreement should specify how to allocate partnership income or loss among partners. Allocation can be made based on a fractional share of ownership, salary allowances, or interest allowances. In the absence of a partnership agreement, income and losses are shared equally by the partners. A partnership agreement should specify how to allocate partnership income or loss among partners. Allocation can be made based on a fractional share of ownership, salary allowances, or interest allowances.

50. Review Explain the steps involved in the liquidation of a partnership. Four steps are involved in the liquidation process. 1. Noncash assets are sold for cash and a gain or loss on liquidation is recorded. 2. Gains or losses are allocated to the partners' capital accounts based on the partnership agreement or in equal shares. 3. Liabilities of the partnership are paid. 4. The remaining cash is distributed to the partners based on the amounts in their capital accounts.

51. End of Chapter