Chapter 12
Appendix B: Partnerships
Review of Learning Objectives
LO1 Describe the characteristics of partnerships and related forms of business.
A partnership has several characteristics that distinguish it from the other forms of business. It is a voluntary association of two or more people who combine their talents and resources to carry on a business. The advantages of a partnership are that it is easy to form, change and dissolve; it facilitates the pooling of capital resources and individual talents; it has no corporate tax burden; and it gives the partners a certain amount of freedom and flexibility. Its disadvantages are that it has a limited life, one partner can bind the partnership to a contract (mutual agency), the partners have unlimited personal liability for the debts of the business, and it is more difficult for a partnership to raise large amounts of capital and transfer ownership than it is for a corporation. To maximize the advantages of a partnership and minimize the disadvantages, the partners must have a carefully planned partnership agreement that covers various contingencies. Important considerations affecting a partnership agreement are limited life, mutual agency, unlimited liability, co-ownership of property, participation in income or losses, and terms of dissolution and liquidation.
Various types of partnerships overcome some of the disadvantages of the basic form. They include limited partnerships, limited liability partnerships, joint ventures, S corporations, limited liability corporations, and special-purpose entities.
LO2 Record partners' investments of cash and other assets when a partnership is formed.
A partnership is formed when the partners contribute cash, other assets, or both to the business. The details are stated in the partnership agreement. Initial investments are recorded with a debit to Cash or other asset accounts and a credit to the investing partner's Capital account. Assets other than cash should be recorded at their fair market value on the date of transfer to the partnership. A partnership can also assume an investing partner's liabilities. When this occurs, the partner's Capital account is credited with the difference between the assets invested and the liabilities assumed.
LO3 Use stated ratios, capital balance ratios, and partners' salaries and interest to compute the income or losses that partners share.
Partners must share income and losses in accordance with the partnership agreement. If the agreement says nothing about the distribution of income and losses, the partners share them equally. Common methods used for distributing income and losses include stated ratios, capital balance ratios, and salaries and interest on capital investments. Each method tries to measure the individual partner's contribution to the business.
Stated ratios usually are based on the partners' relative contributions to the partnership. When capital balance ratios are used, income or losses are divided strictly on the basis of each partner's capital balance. The use of salaries and interest on capital investments takes into account both efforts (salary) and capital investment (interest) in dividing income or losses among the partners.
LO4 Record a person's admission to or withdrawal from a partnership.
A person can be admitted to a partnership by purchasing a partner's interest or by investing assets in the business. When a person purchases an interest from an original partner, the interest purchased is transferred from the Capital account of the selling partner to the Capital account of the new partner. When the new partner contributes assets to the partnership, it may be necessary to record a bonus shared or borne by the original partners or by the new partner.
A person can withdraw from a partnership by selling his or her interest in the business to the remaining partners or to a new partner or by withdrawing company assets. When assets are withdrawn, the amount can be equal to, less than, or greater than the partner's capital interest. When assets that have a value less than or greater than the partner's interest are withdrawn, a bonus is recognized and distributed among the remaining partners or to the departing partner.
LO5 Compute and record the distribution of assets to partners when they liquidate their partnership.
The liquidation of a partnership entails selling the assets necessary to pay the company's liabilities and distributing any remaining assets to the partners. Any gain or loss on the sale of the assets is shared by the partners according to their stated ratios. When a partner has a deficit balance in a Capital account, that partner must contribute personal assets equal to the deficit. When a partner does not have enough personal assets to cover a capital deficit, the deficit must be absorbed by the solvent partners according to their stated ratios.
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