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15 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Partnerships – Formation,Operations, and Changes in
Ownership Interests
Chapter 15
15 - 2©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 1
Comprehend the legal
characteristics of partnerships.
15 - 3©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Partnership Characteristics
It is an association of two or more personswho co-own a business for a profit.
The legal life of a partnership terminateswith the admission of a new partner, the
withdrawal or death of a partner, voluntarydissolution by the partners, or involuntary
dissolution such as bankruptcy proceedings.
15 - 4©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Articles of Partnership
A partnership may be formed by a simpleoral agreement among two or more
people to operate a business for profit.
15 - 5©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Articles of Partnership
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
15 - 6©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Partnership Financial Reporting
The accounting reports are designed tomeet the needs of three user groups…
The partners
Partnership creditors
Internal Revenue Service
15 - 7©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 2
Understand initial investment
valuation and record keeping.
15 - 8©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Initial Investment in a Partnership
Ashley and Becker each invest $20,000cash in a new partnership.
Cash 20,000Ashley, Capital 20,000
To record Ashley’s original investment of cash
Cash 20,000Becker, Capital 20,000
To record Becker’s original investment of cash
15 - 9©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Noncash Investments
C. Cola R. CrownFair Value Fair Value
Cash $ — $ 7,000Land (cost to C. Cola, $5,000) 10,000 —Building (cost to C. Cola, $30,000) 40,000 —Inventory (cost to R. Crown, $28,000) — 35,000
Total $50,000 $42,000
C. Cola and R. Crown enter into a partnership.
15 - 10©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Noncash Investments
Land 10,000Building 40,000
C. Cola, Capital 50,000To record C. Cola’s original investmentof land and building at fair value
15 - 11©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Noncash Investments
Cash 7,000Inventory 35,000
R. Crown, Capital 42,000To record R. Crown’s original investmentof cash and inventory items at fair value
15 - 12©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Bonus or Goodwillon Initial Investment
The partnership agreement specifiesequal capital interests.
C. Cola, Capital 4,000R. Crown, Capital 4,000
To establish equal capital interests of $46,000 byrecording a $4,000 bonus from C. Cola to R. Crown
15 - 13©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Bonus or Goodwillon Initial Investment
Goodwill 8,000R. Crown, Capital 8,000
To establish equal capital interests of $50,000by recognizing R. Crown’s investmentof an $8,000 unidentifiable asset
15 - 14©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Drawings
Regular withdrawals are calleddrawings, drawing allowances,
or sometimes salary allowances.
Debit Drawing and credit Cash.
At period end, credit Drawingand debit each partner’s Capital.
15 - 15©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Loans and Advances
Loans and advances to the partnershipand accrued interest are regarded as
liabilities of the partnership.
Loans and advances to partners areregarded as assets of the partnership.
15 - 16©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Partnership Operations
Ratcliffe and Yancey are partners sharingprofits in a 60:40 ratio, respectively.
15 - 17©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Partnership Operations
Partnership net income 2003 $34,500Ratcliffe capital January 1, 2003 40,000Ratcliffe additional investment 2003 5,000Ratcliffe drawing 2003 6,000Yancey capital January 1, 2003 35,000Yancey drawing 2003 9,000Yancey withdrawal 2003 3,000
Equity Accounts, 2003
15 - 18©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Format for a Statementof Partners’ Capital
Ratcliffe and Yancey Statement of Partners’ CapitalFor the Year Ended 12/31/2003
60% 40%Ratcliffe Yancey Total
Capital balances 1/1/03 $40,000 $35,000 $75,000Add: Additional investments 5,000 — 5,000Deduct: Withdrawals — – 3,000 – 3,000Deduct: Drawings – 6,000 – 9,000 –15,000 Net contributed capital 39,000 23,000 62,000Add: Net income for 2003 20,700 13,800 34,500 Capital balances 12/31/03 $59,700 $36,800 $96,500
15 - 19©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Closing Entries
December 31, 2003Revenue and Expense Summary 34,500
Ratcliffe, Capital 20,700Yancey, Capital 13,800
To divide net income for the year 60% to Ratcliffeand 40% to Yancey
15 - 20©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Closing Entries
December 31, 2003Ratcliffe, Capital 6,000Yancey, Capital 9,000
Ratcliffe, Drawing 6,000Yancey, Drawing 9,000
To close partner drawing accounts to capital accounts
15 - 21©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 3
Grasp the diverse nature of profit
and loss sharing agreements
and their computation.
15 - 22©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Profit and Loss SharingAgreements
Equal division of partnership income is required inthe absence of a profit and loss sharing agreement.
15 - 23©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Service Considerations inProfit and Loss Sharing
Agreements
A partner who devotes time to the partnershipbusiness while other partners work elsewhere
may receive a salary allowance.
Salary allowances are also used tocompensate for differences in the fair
value of the talents of partners.
15 - 24©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Salary Allowance in ProfitSharing Agreements
Bob, Gary, and Pete are partners.
The partnership agreement provides thatBob and Gary receive salary allowances
of $12,000 each, with the remainingincome allocated equally.
Partnership net income is $60,000 for 2003and $12,000 for 2004.
15 - 25©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Income Allocation Schedule: 2003
Bob Gary PeteNet income $60,000Salary allowances
to Bob and Gary (24,000) $12,000 $12,000Remainder to divide 36,000Divided equally (36,000) 12,000 12,000 $12,000Remainder to divide 0 Net income allocation $24,000 $24,000 $12,000
15 - 26©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Income Allocation Schedule: 2004
Bob Gary PeteNet income $12,000Salary allowances
to Bob and Gary (24,000) $12,000 $12,000Remainder to divide (12,000)Divided equally 12,000 (4,000) (4,000) $(4,000)Remainder to divide 0 Net income allocation $ 8,000 $ 8,000 $(4,000)
15 - 27©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Journal Entries
December 31, 2003Revenue and Expense Summary 60,000
Bob, Capital 24,000Gary, Capital 24,000Pete, Capital 12,000
Partnership income allocation for 2003
15 - 28©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Journal Entries
December 31, 2004Revenue and Expense Summary 12,000Pete, Capital 4,000
Bob, Capital 8,000Gary, Capital 8,000
Partnership income allocation for 2004
15 - 29©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Bonus and Salary Allowances
The partnership agreement provides that Bobreceive a bonus of 10% of partnership net income.
Partnership net income is $60,000for 2003 and $12,000 for 2004.
Bob and Gary receive salary allowancesof $10,000 and $8,000, respectively, and
the remaining income is allocated equally.
15 - 30©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Income Allocation Schedule: 2003
Bob Gary PeteNet income $60,000Bonus to Bob (6,000) $ 6,000Remainder to divide 54,000Salary allowances
to Bob and Gary (18,000) 10,000 $ 8,000Remainder to divide 36,000Divided equally (36,000) 12,000 12,000 $12,000Remainder to divide 0 Net income allocation $28,000 $20,000 $12,000
15 - 31©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Income Allocation Schedule: 2004
Bob Gary PeteNet income $12,000Bonus to Bob (1,200) $ 1,200Remainder to divide 10,800Salary allowances
to Bob and Gary (18,000) 10,000 $8,000Remainder to divide (7,200)Divided equally 7,200 (2,400) (2,400) $(2,400)Remainder to divide 0 Net income allocation $ 8,800 $5,600 $(2,400)
15 - 32©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Income Allocated in Relationto Partnership Capital
Capital balances 1/1/2003 $20,000 $20,000Investment April 1 2,000 —Withdrawal July 1 — (5,000)Investment September 1 3,000 —Withdrawal October 1 — (4,000)Investment December 28 — 8,000Capital balances 12/31/2003 $25,000 $19,000
Ace Butch
15 - 33©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Comparison of Capital Bases
Weighted Beginning Ending Average
Capital Capital Capital Investment Investment Investment
Ace $20,000 $25,000 $22,500Butch 20,000 19,000 16,500Total $40,000 $44,000 $39,000
15 - 34©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Alternatives
Beginning Capital BalancesAce ($100,000 × 20/40) $ 50,000Butch ($100,000 × 20/40) 50,000
Total income $100,000
Net income of $100,000 is dividedon the basis of capital balances.
15 - 35©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Alternatives
Ending Capital BalancesAce ($100,000 × 25/44) $ 56,818.18Butch ($100,000 × 19/44) 43,181.82
Total income $100,000.00
Average Capital BalancesAce ($100,000 × 22.5/39) $ 57,692.31Butch ($100,000 × 16.5/39) 42,307.69
Total income $100,000.00
15 - 36©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Interest Allowanceson Partnership Capital
An agreement may provide for interestallowances on partnership capital in
order to encourage capital investments,as well as salary allowances.
Remaining profits are then dividedequally or in any other ratio specified
in the profit sharing agreement.
15 - 37©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 4
Value new partners’ investment
in an existing partnership.
15 - 38©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Changes in Partnership Interest
The existing legal partnership entity isdissolved when a new partner is admitted
or an existing partner retires or dies.
15 - 39©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
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
15 - 40©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 5
Value partner’s share upon
retirement or death.
15 - 41©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Dissolution of a Continuing Partnership
Through Death or Retirement Profit and
Capital Percentage LossBalances of Capital Percentage
Bonnie $ 70,000 35% 40%Clyde 50,000 25 20Dillinger 80,000 40 40 Total capital $200,000 100% 100%
15 - 42©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Dissolution of a Continuing Partnership
Through Death or Retirement
Dillinger decides to retire.
The partners agree that the business isundervalued on the partnership books
and that Dillinger will be paid $92,000.
15 - 43©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Bonus to Retiring Partner
Dillinger, Capital 80,000Bonnie, Capital 8,000Clyde, Capital 4,000
Cash 92,000
Dillinger, Capital 80,000Goodwill 12,000
Cash 92,000
15 - 44©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Reevaluation of TotalPartnership Capital
Goodwill (other assets) 30,000Bonnie, Capital 12,000Clyde, Capital 6,000Dillinger, Capital 12,000
15 - 45©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Payment to Retiring PartnerLess than Capital Balance
Suppose that Dillinger is paid $72,000in final settlement of his capital interest.
15 - 46©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Overvalued Assets Written Down
Bonnie, Capital 8,000Clyde, Capital 4,000Dillinger, Capital 8,000
Net assets 20,000
Dillinger, Capital 72,000Cash 72,000
15 - 47©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Bonus to Continuing Partners
Dillinger, Capital 80,000Bonnie, Capital 5,333Clyde, Capital 2,667Cash 72,000
15 - 48©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 6
Understand limited liability
partnership characteristics.
15 - 49©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Limited Partnerships
The limited partnership consistsof at least one general partner
and one or more limited partners.
The limited partner is excluded fromthe management of the business.
15 - 50©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
End of Chapter 15
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