0. Advanced Accounting by Debra Jeter and Paul Chaney
Chapter 15: Partnerships: Formation, Operation, and Ownership Changes
Slides Authored by Hannah Wong, Ph.D.
Rutgers University

1. Partnership Definition Attributes
An association of two or more persons to carry on as co-owners of a business for profit
Attributes
an agreement
the business operates for profit
members of the firm must be co-owners
obj 1

2. General Partnership All partners are general partners Mutual agency
Right to dispose of a partnership interest
Unlimited liability
Limited or uncertain life
Tax implications: partnership income is allocated to partners who are taxed on their individual tax returns (form 1040)
obj 1

3. Limited Partnership
At least one general partner and one limited partner
General partner:
manage the firm
unlimited liability
Limited partner:
invest capital only
limited liability
obj 1

4. Joint Venture
An agreement by two or more parties to accomplish a limited purpose for their mutual benefit, often to earn a profit.
Each joint venturer participates directly or indirectly in the management of the resources
obj 1

5. Partnership Agreement
name of the firm, identity of the partners
nature, purpose and scope of business
date of organization
length of operating time
location of business
allocation of profit and loss
salaries and withdrawals of assets by partners
rights, duties and obligations of each partner
contractual authority of each partner
obj 2

6. Partnership Agreement
procedure for admitting a new partner
plan on withdrawal or death of a partner
procedures for arbitration of disputes
fiscal period
identification and valuation of initial asset investments
situations for dissolution of partnership
accounting practices
whether an audit is to be performed
obj 2

7. Financial Statement Presentation
Difference between partnership and corporation reporting:
changes in partners’ equity during the year should be disclosed
partners’ salary allowances is not an expense
no income tax expense
interest on capital investment is not an expense.
obj 3

8. Capital vs. Drawing Accounts
Capital Account – Reflects permanent investment of partner periodically updated for withdrawals.
Drawing Account – Used to record withdrawals during the year. Closed to capital account at end of year.
obj 4

9. Fair value of assets invested
Bonus Method
MV of asset investment = negotiated capital interest
Assets
contributed
by Wright
$40,000
Wright, capital
$45,000
Fair value of assets invested
$90,000
Assets
contributed
by Young
$50,000
Young, capital
$45,000
obj 5

10. Goodwill Method MV of asset investment = negotiated capital interest
Goodwill of $10,000 is recorded
Wright, capital
$50,000
Assets
contributed
by Wright
$40,000
$90,000
Fair value of assets invested
Assets
contributed
by Young
$50,000
Young, capital
$50,000
obj 5

11. Profit/Loss Allocation
Fixed Ratio
Profit $20,000
7:3
Adams
$14,000
Brown
$6,000
obj 6

12. Profit/Loss Allocation
Capital Balances
7:3
Adams Capital $60,000
Brown Capital $40,000
= 3:2
Profit $20,000
3:2
Adams
$14,000
Brown
$6,000
obj 6

13. Profit/Loss Allocation
Interest Allocation
Steps:
(1) Allocate profit as interest on capital investment
(2) allocate the remaining income on another basis
obj 6

14. Profit/Loss Allocation
Interest Allocation
The following should be specified:
the interest rate
capital balance to be used
how remaining profit should be allocated
whether or not interest should be allocated if profit < agreed interest allocation
obj 6

15. Profit/Loss Allocation
Interest Allocation
Profit $20,000
Interest allocation
Unallocated
profit
Adams
$6,200
7:3
Brown
$3,000
Allocation of remaining profit
Interest allocated = capital balance x interest rate
Brown
$5,400
Adams
$5,400
1:1
obj 6

16. Profit/Loss Allocation
Salary and Bonus Allocation
Allocate profit as:
fixed salary or
provide for a bonus as a % of net income
The net income used in bonus calculation can be
before allocation of income to partners
after other allocations, but before the bonus
after bonus, but before other allocations
after bonus and all other allocations
obj 6

17. Insufficient Income to Cover Allocation
If partnership income > interest and/or salary allocation
allocate the deficiency in the agreed ratio for allocating residual income
obj 6

18. Insufficient Income to Cover Allocation
Profit $11,000
Salary allocation
Interest allocation
Deficiency
in profit
Adams
$4,000
Brown
$2,000
7:3
Adams
$6,200
Brown
$3,000
Brown
($2,100)
Adams
($2,100)
1:1
obj 6

19. Pay salaries to partners reflective of time dedicated to partnership.
Salary and Interest
Partnerships pay salary and interest to effect an equitable distribution of income.
Pay interest on initial investment as a return on investment. Compensates each partner for use of assets.
Pay salaries to partners reflective of time dedicated to partnership.
obj 7

20. Admission of New Partner
A new partner can acquire an interest in a partnership by:
purchasing an interest from an existing partner
New partner acquires the right to share profits only
no right to participate in management unless granted by all remaining partners
investing assets
obj 8

21. Assignment of Partnership Interest
By Payment to Partners - Bonus Method
Adams, Capital ,000
Brown, Capital 12,000
Call, Capital ,000
To transfer capital from capital accounts of Adams
and Brown to Call’s capital account.
Amounts = recorded capital x % interest acquired by Call
obj 8

22. Assignment of Partnership Interest
By Payment to Partners - Goodwill Method
Goodwill ,000
Adams, Capital ,000
Brown, Capital ,000
To record implied goodwill
= Call’s payments / % interest acquired - recorded partnership net assets
= $36000 / 30% -$100,000
Adams, Capital ,000
Brown, Capital 12,000
Call, Capital ,000
To transfer capital from capital accounts of Adams
and Brown to Call’s capital account.
obj 8

23. Asset Investment BV Acquired = Assets Invested
Cash ,000
Call, Capital ,000
To record Call’s 1/3 capital in the partnership
= (existing net assets + assets invested by Call) x 1/3
= ($70,000 + $35,000) x 1/3
= $35,000
obj 8

24. Asset Investment BV Acquired < Assets Invested : Bonus Method
Cash ,000
Call, Adams ,000
Call, Brown ,000
Call, Capital ,000
The excess is
considered
a bonus
to the
existing
partners
To record Call’s 1/3 capital in the partnership
= (existing net assets + assets invested by Call) x 1/3
= ($70,000 + $50,000) x 1/3
obj 8

25. Asset Investment BV Acquired < Assets Invested : Goodwill Method
Adams, Capital ,000
Brown, Capital ,000
Implied total net assets = Call’s payments / % interest acquired
= $50000 / 30% = $150,000
goodwill for existing partners
= implied net assets x % ownership - current capital accounts
= $150,000 x 2/3 - $70,000 = $30,000
obj 8

26. Asset Investment BV Acquired < Assets Invested : Goodwill Method
Cash ,000
Call, Capital ,000
To record Call’s 1/3 capital in the partnership
= (implied net assets) x 1/3 = $150,000x 1/3
obj 8

27. Payment to a Retiring Partner
Payment > BV: Bonus Method
Call, Adams ,000
Call, Brown ,000
Call, Capital ,000
Liability to Adams ,000
The excess is considered a bonus
to the retiring partners; allocated
to existing partners by their
profit and loss ratio
To record $40,000
agreed payment
to Adams
obj 8

28. Payment to a Retiring Partner
Payment > BV: Goodwill Method
Goodwill ,000
Adams, Capital ,000
Brown, Capital ,000
Call, Capital ,000
Implied goodwill
= excess payment to Adams / % interest withdrawn
= $10000 / 50% = $200,000
The goodwill is allocated to partners by their profit and loss ratio
obj 8

29. Rational for Goodwill Method in Accounting for Partnership Membership
Differences between historical cost and market value of assets
Presence of intangible assets
obj 9

30. Advanced Accounting by Debra Jeter and Paul Chaney
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