CHAPTER 21

PARTNERSHIPS:CHANGES IN OWNERSHIP

FOCUS OF CHAPTER 21• Tangible Assets Having Values Different

from Book Values• Intangible Element Exists: Recording

Methods and Alternative Approaches• Intangible Element Exists: Specific

Situations• Legal Aspects of Changes in Ownership• Tax Aspects of Changes in Ownership

Partner’s Admission:Purchase of An Existing Interest

• The purchase of an interest from one or more of a partnership’s existing partners is a:– PERSONAL TRANSACTION between the

incoming partner and the selling partner(s).

• The ONLY entry required on the partnership’s books is to TRANSFER an amount:– From the selling partner’s Capital account.– To the new partner’s Capital account.

Methods to Minimize Inequities

• The Three Methods:– The revaluing of assets/recording the

goodwill method.– The special profit-and-loss sharing

provision method.– The bonus method.

• Some methods can still result in inequities if events do not materialize as assumed.

#1#2#3

Best Minimizing Inequities• ONLY the SPECIAL PROFIT-AND-LOSS

SHARING PROVISION METHOD will prevent an inequity to one or more of the partners in the event that:– The agreed-upon values of the assets

are erroneous.– The agreed-upon value of goodwill

does not materialize.

The Bonus Method• Major Advantages:

– Does not result in a departure from GAAP.

– Minimizes bookkeeping & tax return effort.• Mechanics:

– A portion of one or more partner’s capital balance is TRANSFERRED to one or more other partners.• The hope is that the transferred amount

will later be recouped via future profits.

The Bonus Method:When to Apply It

• The bonus method may be applied when:

New Old New Partnership = Partner’s + Partner’s Asset Capital Capital Investment

The Revaluing of Assets/Recording The Goodwill Method

• Advantages:– Incoming partners ALWAYS get

credited to their capital accounts the full value of their asset investment (sometimes important psychologically).

• Disadvantages:– Departs from GAAP.– Complicates income tax preparation.

The Goodwill Method:When to Apply It

• The goodwill method is applied when:

New Old New Partnership > Partners’ + Partner’s Asset Capital Capital Investment

Legal Aspects:Joining a Partnership

• A major risk of joining an existing partnership is the general practice of requiring the new partner to become jointly responsible for:– ALL pre-existing partnership

liabilities.– ALL pre-existing contingent liabilities.

Legal Aspects:Withdrawing From a Partnership

• A partner that withdraws from a partnership is still responsible for the following items that exist at the time of the withdrawal:– ALL partnership obligations.– ALL contingent liabilities.

• ONLY creditors can expressly release a partner from this responsibility.

Legal Aspects:Withdrawing From a Partnership

• Disassociation: A broad term that refers to when a partner is no longer associated with a partnership.

• Dissolution: A narrow term that refers to when a (1) partnership is dissolved and (2) its affairs must be wound up. Thus the partnership’s existence is terminated.

Review Question #1Newby contributes $36,000 cash for a 25% interest in the new net assets of the partner-ship (that has existing equity of $120,000). The old partners capital accounts are not to decrease. Newby’s capital account is credited:A. $6,000B. $36,000C. $39,000 D. $40,000 E. $51,000

Review Question #1With Answer

Newby contributes $36,000 cash for a 25% interest in the new net assets of the partner-ship (that has existing equity of $120,000). The old partners capital accounts are not to decrease. Newby’s capital account is credited:A. $6,000B. $36,000C. $39,000 D. $40,000 ([$120,000/75%] - $120,000) E. $51,000

Review Question #2Upon withdrawal from a partnership, Leavy received $7,000 cash in excess of his capital balance. Leavy’s share of profits and losses was 20%. Partnership land was undervalued $25,000. The partnership goodwill is:A. $2,000 B. $10,000C. $12,000 D. $35,000

Review Question #2With Answer

Upon withdrawal from a partnership, Leavy received $7,000 cash in excess of his capital balance. Leavy’s share of profits and losses was 20%. Partnership land was undervalued $25,000. The partnership goodwill is:A. $2,000 B. $10,000 (5 x [$7,000 - {20% x $25,000}]) C. $12,000 D. $35,000

End of Chapter 21 (Appendix 21A follows)

Time to Clear Things Up—Any Questions?

Appendix 21A: Income Tax Aspects

• Upon withdrawal from a partnership, the partner must determine whether there is again or loss for tax-reporting purposes.

• This determination is made by comparing:– The partner’s proceeds with– The partner’s tax basis.

Appendix 21A

Appendix 21A: Income Tax Aspects

• A partner’s proceeds are the sum of:– Cash received plus– The partner’s share of existing

liabilities for which he or she is relieved of responsibility.• The share is determined by applying

the partner’s profit-sharing percentage.

Appendix 21A

Review Question #21A-1Gale contributes $50,000 cash and a $24,000 liability upon admission into a partnership that has existing liabilities of $60,000. Gale’s share of profits and losses is 25%. What is Gale’s tax basis immediately after admission? A. $32,000B. $41,000C. $47,000D. $50,000E. $59,000

Appendix 21A

Review Question #21A-1With Answer

Gale contributes $50,000 cash and a $24,000 liability upon admission into a partnership that has existing liabilities of $60,000. Gale’s share of profits and losses is 25%. What is Gale’s tax basis immediately after admission? A. $32,000B. $41,000C. $47,000 ($50,000 + [$60,000/4] - [$24,000 x

75%])D. $50,000E. $59,000

Appendix 21A

Review Question #21A-2Upon withdrawal from a partnership (that has existing liabilities of $80,000), Gawner receives $50,000 cash. Gawner’s share of profits and losses was 25%. What is Gawner’s taxable gain or loss if his tax basis immediately before withdrawing was $66,000? A. $4,000B. $14,000C. $16,000 D. $36,000

Appendix 21A

Review Question #21A-2With Answer

Upon withdrawal from a partnership (that has existing liabilities of $80,000), Gawner receives $50,000 cash. Gawner’s share of profits and losses was 25%. What is Gawner’s taxable gain or loss if his tax basis immediately before withdrawing was $66,000? A. $4,000 ($50,000 + [$80,000/4] - $66,000)B. $14,000C. $16,000 D. $36,000

Appendix 21A