Accounting for Partnerships



SOME ILLUSTRATIONS ON PARTNERSHIP:

Partnerships

A. Partnership--a partnership is an association of two more persons to carry

on as co-owners of a business for profit

B. Characteristics of a Partnership

1. Mutual Agency--the action of any partner is binding on all other

partners when the partner is engaging in partnership business

2. Limited Life--the partnership is dissolved whenever a new partner is

admitted to the partnership or an old partner withdraws from the

partnership

3. Unlimited Liability--each partner is personally liable for the

liabilities of the partnership if the partnership assets are

insufficient to settle the liabilities of the partnership

4. Co-ownership of Property--partnership assets are owned jointly by all

the partners

a. Separate Capital Accounts--separate capital and drawing accounts

are maintained for each partner to keep track of each partner’s

claim against the partnership’s assets

5. Taxation--the net income of the partnership is not taxed at the

partnership level, but is allocated to the partners and is included as

income on their individual tax returns

C. Partnership Agreement--a partnership agreement is the written agreement

between the partners stipulating how the partnership is to be operated,

including the distribution of net income to the partners

1. Lack of Partnership Agreement--if there is no partnership agreement,

net income is allocated equally to all the partners

D. Formation

1. Accounting Treatment--the assets and liabilities contributed to the

partnership should be recorded at their fair market value at the date

of formation of the partnership, and the partners' capital accounts are

credited for the recorded value of the net assets contributed by each

partner

2. Illustration--A, B, and C formed a partnership; A contributed inventory

with a fair market value of $100,000; B contributed equipment with a

fair market value of $180,000 and a building with a fair market value

of $600,000 and subject to a $480,000 mortgage; C contributed $100,000

in cash

Cash 100,000

Inventory 100,000

Equipment 180,000

Building 600,000

Mortgage Payable 480,000

A, Capital 100,000

B, Capital 300,000

(180,000 + 600,000 – 480,000)

C, Capital 100,000

B. Division of Profits--the objective of the partnership's profit-and-loss

sharing arrangement is to allocate the profit and loss of the partnership

among the partners in a way that reflects each partner's contribution to

the success of the firm

1. Allocation Methods--bases for the allocation of the profit and loss of

the partnership usually take one or a combination of the following

forms:

a. Fixed Ratios--profit and loss is allocated to the partners by

providing a fixed percentage of profit and loss to the individual

partners

b. Service Contributions--salary allowances are provided to the

partners to reward the individual partners for their different

service contributions to the operation of the partnership

c. Capital Investments--capital allowances, usually in the form of

interest on the capital balances of the individual partners, are

provided to the partners to reward the individual partners for

their different capital investments

2. Illustrations

a. A, B, and C are partners with profit-and-loss sharing ratios of

30%, 25%, and 45%, respectively, and capital balances of $50,000,

$100,000, and $350,000, respectively; the partnership agreement

provided for salaries of $20,000 for A, $25,000 for B, and $15,000

for C and 10% interest on the partners' capital balances; net

income was $140,000

_ A B C Total_

Salaries 20,000 25,000 15,000 60,000

Interest 5,000 10,000 35,000 50,000

Fixed Ratio _ 9,000 7,500 13,500 30,000

_34,000 42,500 63,500 140,000

Interest:

A = 10% x 50,000 = 5,000

B = 10% x 100,000 = 10,000

C = 10% x 350,000 = 35,000

Fixed Ratio:

A = 30% x (140,000 – (60,000 + 50,000)) = 9,000

B = 25% x 30,000 = 7,500

C = 45% x 30,000 = 13,500

b. A, B, and C are partners with profit-and-loss sharing ratios of

30%, 25%, and 45%, respectively, and capital balances of $50,000,

$100,000, and $350,000, respectively; the partnership agreement

provided for salaries of $20,000 for A, $25,000 for B, and $15,000

for C and 10% interest on the partners' capital balances; net

income was $100,000

_ A B C Total_

Salaries 20,000 25,000 15,000 60,000

Interest 5,000 10,000 35,000 50,000

Fixed Ratio ( 3,000) ( 2,500) ( 4,500) ( 10,000)

_22,000 32,500 45,500 100,000

Interest:

A = 10% x 50,000 = 5,000

B = 10% x 100,000 = 10,000

C = 10% x 350,000 = 35,000

Fixed Ratio:

A = 30% x (100,000 – (60,000 + 50,000)) = (3,000)

B = 25% x (10,000) = (2,500)

C = 45% x (10,000) = (4,500)

C. Changes in Ownership--since a change in ownership creates a new

partnership, the assets and liabilities of the old partnership should be

revalued to reflect fair market value at the date of change in ownership

1. Investment in the Partnership--the new partner gains admission to the

partnership by investing assets directly into the partnership

a. Accounting Treatment--the assets and liabilities invested in the

partnership should be recorded at their fair market value at the

date of investment in the partnership, and the new partner's

capital account is credited for his capital interest multiplied by

the recorded value of the net assets of the partnership after the

investment of the new partner with the difference, if any, between

the recorded value of the net assets invested by the new partner

and the amount recorded in his capital account (bonus payment)

allocated to the old partners on the basis of their profit-and-loss

sharing ratios before the investment of the new partner

b. Illustrations

1) A and B are partners with profit-and-loss sharing ratios of

25% and 75%, respectively, and capital balances of $130,000

and $70,000, respectively; C invested $50,000 in cash for a

20% capital interest in the partnership

C = 20% x (130,000 + 70,000 + C)

C = 50,000

Cash 50,000

C, Capital 50,000

(50% x (200,000 + 50,000))

2) A and B are partners with profit-and-loss sharing ratios of

25% and 75%, respectively, and capital balances of $130,000

and $70,000, respectively; C invested $60,000 in cash for a

20% capital interest in the partnership; C agreed that the

partnership had goodwill of $40,000

C = 20% x (130,000 + 70,000 + 40,000 + C)

C = 60,000

Cash 60,000

C, Capital 52,000

(20% x (200,000 + 60,000))

A, Capital 2,000

(25% x (60,000 - 52,000))

B, Capital 6,000

(75% x 8,000)

3) A and B are partners with profit-and-loss sharing ratios of

25% and 75%, respectively, and capital balances of $130,000

and $70,000, respectively; C invested $30,000 in cash for a

20% capital interest in the partnership; A and B agreed that C

had goodwill of $20,000

C + 20,000 = 20% x (200,000 + C + 20,000)

C = 30,000

Cash 30,000

A, Capital 4,000

(25% x (30,000 – 46,000))

B, Capital 12,000

(75% x (16,000))

C, Capital 46,000

(20% x (200,000 + 30,000))

2. Purchase of an Interest--the new partner gains admission to the

partnership by transferring assets directly to one or more of the old

partners

a. Accounting Treatment--the new partner's capital account is credited

for his capital interest multiplied by the recorded value of the

net assets of the partnership, and the old partners' capital

accounts are debited for the new partner’s capital interest

multiplied by the old partners’ capital account balance

b. Illustrations

1) A and B are partners with profit-and-loss sharing ratios of

25% and 75%, respectively, and capital balances of $130,000

and $70,000, respectively; C purchased a 20% capital interest

in the partnership by purchasing 20% of A’s capital balance for

for $26,000 and 20% of B’s capital interest for $14,000

C = 20% x 200,000

C = 40,000

A, Capital 26,000

(20% x 130,000)

B, Capital 14,000

(20% x 70,000)

C, Capital 40,000

(20% x 200,000)

2) A and B are partners with profit-and-loss sharing ratios of

25% and 75%, respectively, and capital balances of $130,000

and $70,000, respectively; C purchased a 20% capital interest

in the partnership by purchasing 20% of A’s capital balance for

for $28,000 and 20% of B’s capital interest for $20,000; C

agreed that the partnership had goodwill of $40,000

C = 20% x (200,000 + 40,000)

C = 48,000

A, Capital 26,000

(20% x 130,000)

B, Capital 14,000

(20% x 70,000)

C, Capital 40,000

(20% x 200,000)

3) A and B are partners with profit-and-loss sharing ratios of

25% and 75%, respectively, and capital balances of $130,000

and $70,000, respectively; C purchased a 20% capital interest

in the partnership by purchasing 20% of A’s capital balance for

for $23,500 and 20% of B’s capital interest for $6,500; A and

B agreed that C had goodwill of $12,500

C + 12,500 = 20% x (200,000 + 12,500)

C = 30,000

A, Capital 26,000

(20% x 130,000)

B, Capital 14,000

(20% x 70,000)

C, Capital 40,000

(20% x 200,000)

3. Withdrawl of a Partner--the old partner leaves the partnership by

withdrawing assets from the partnership to liquidate his capital

interest

a. Accounting Treatment--the retiring partner's capital account is

zeroed out with the difference, if any, between the assets

withdrawn by the retiring partner and his capital balance (bonus

payment) allocated to the remaining partners on the basis of their

relative profit-and-loss sharing ratios before the withdrawl of the

retiring partner

b. Illustrations

1) A, B, and C are partners with profit-and-loss sharing ratios

of 20%, 60%, and 20%, respectively, and capital balances of

$135,000, $70,000, and $55,000, respectively; C withdrew

$55,000 in cash from the partnership to liquidate his capital

interest in the partnership

C, Capital 55,000

Cash 55,000

2) A, B, and C are partners with profit-and-loss sharing ratios

of 20%, 60%, and 20%, respectively, and capital balances of

$135,000, $70,000, and $55,000, respectively; C withdrew

$65,000 in cash from the partnership to liquidate his capital

interest in the partnership; A, B, and C agreed that the

partnership had goodwill of $50,000

C = 55,000 + 20% x 50,000

C = 65,000

C, Capital 55,000

A, Capital 2,500

(20% / 80% x (55,000 - 65,000))

B, Capital 7,500

(60% / 80% x 10,000)

Cash 65,000

D. Liquidation--the sale of the partnership assets, payment of the

partnership's liabilities, and the distribution of any remaining assets to

the partners

1. Accounting Treatment

a. Realization of Assets--any gains or losses realized from the sale

of partnership assets are allocated to the partners using their

profit-and-loss sharing ratios

b. Distribution of Realization Proceeds--the claims against the assets

of the partnership are satisfied in the following order:

1) Creditors--amounts owed to partnership creditors are paid first

2) Partners--amounts owed to partners for their capital balances

to the extent of credit balances in their capital accounts

a) Capital Deficiency--a debit balance in a partner's capital

account represents a claim of the partnership against that

partner

1) Cash Contribution--if a partner with a debit balance in

his capital account contributes cash to the partnership

to make up his capital deficiency, the debit balance in

his capital account is reduced for the amount of cash

contributed

2) No Contribution--if a partner with a debit balance in

his capital account does not contribute cash to the

partnership to make up his capital deficiency or

contributes insufficient cash to the partnership to

make up his capital deficiency, the debit balance in

his capital deficiency is allocated to the other

partners in their relative profit-and-loss sharing

ratios

2. Illustrations

a. A, B, and C are partners with profit-and-loss sharing ratios of

20%, 60%, and 20%, respectively; the partnership balance sheet

consisted of cash of $20,000, noncash assets of $270,000,

liabilities of $40,000, and capital balances of $140,000 for A,

$60,000 for B, and $50,000 for C; the partnership was liquidated by

selling the noncash assets for $310,000; the partners have

sufficient cash to make up any capital deficiencies

Noncash A B C

_ Cash_ _Assets Liab. Capital Capital Capital

20,000 270,000 40,000 140,000 60,000 50,000

310,000 (270,000) _ _ 8,000 _24,000 _ 8,000

330,000 _ --- _ 40,000 148,000 84,000 58,000

( 40,000) (_40,000) _ _ _ _ _ _

290,000 _ --- _ 148,000 84,000 58,000

(290,000) (148,000) ( 84,000) ( 58,000)

_ --- _ _ --- _ _ --- _ _ --- _

Gain Allocation:

A = 20% x (310,000 – 270,000) = 8,000

B = 60% x 40,000 = 24,000

C = 20% x 40,000 = 8,000

b. A, B, and C are partners with profit-and-loss sharing ratios of

20%, 60%, and 20%, respectively; the partnership balance sheet

consisted of cash of $20,000, noncash assets of $270,000,

liabilities of $40,000, and capital balances of $140,000 for A,

$60,000 for B, and $50,000 for C; the partnership was liquidated by

selling the noncash assets for $220,000; the partners have

sufficient cash to make up any capital deficiencies

Noncash A B C

_ Cash_ _Assets Liab. Capital Capital Capital

20,000 270,000 40,000 140,000 60,000 50,000

220,000 (270,000) _ (_10,000) (_30,000) (_10,000)

240,000 _ --- _ 40,000 130,000 30,000 40,000

( 40,000) (_40,000) _ _ _ _ _ _

200,000 _ --- _ 130,000 30,000 40,000

(200,000) (130,000) ( 30,000) ( 40,000)

_ --- _ _ --- _ _ --- _ _ --- _

Loss Allocation:

A = 20% x (220,000 – 270,000) = (10,000)

B = 60% x (50,000) = (30,000)

C = 20% x (50,000) = (10,000)

c. A, B, and C are partners with profit-and-loss sharing ratios of

20%, 60%, and 20%, respectively; the partnership balance sheet

consisted of cash of $20,000, noncash assets of $270,000,

liabilities of $40,000, and capital balances of $140,000 for A,

$60,000 for B, and $50,000 for C; the partnership was liquidated by

selling the noncash assets for $160,000; the partners have

sufficient cash to make up any capital deficiencies

Noncash A B C

_ Cash_ _Assets Liab. Capital Capital Capital

20,000 270,000 40,000 140,000 60,000 50,000

160,000 (270,000) _ (_22,000) (_66,000) (_22,000)

180,000 _ --- _ 40,000 118,000 ( 6,000) 28,000

( 40,000) (_40,000) _ _ _ _ _ _

140,000 _ --- _ 118,000 ( 6,000) 28,000

_ 6,000 _ 6,000

146,000 _ --- _

(146,000) (118,000) ( 28,000)

_ --- _ _ --- _ _ --- _

Loss Allocation:

A = 20% x (160,000 – 270,000) = (22,000)

B = 60% x (110,000) = (66,000)

C = 20% x (110,000) = (22,000)

d. A, B, and C are partners with profit-and-loss sharing ratios of

20%, 60%, and 20%, respectively; the partnership balance sheet

consisted of cash of $20,000, noncash assets of $270,000,

liabilities of $40,000, and capital balances of $140,000 for A,

$60,000 for B, and $50,000 for C; the partnership was liquidated by

selling the noncash assets for $160,000; the partners are

personally insolvent

Noncash A B C

_ Cash_ _Assets Liab. Capital Capital Capital

20,000 270,000 40,000 140,000 60,000 50,000

160,000 (270,000) _ (_22,000) (_66,000) (_22,000)

180,000 _ --- _ 40,000 118,000 ( 6,000) 28,000

( 40,000) (_40,000) _ _ _ _ _ _

140,000 _ --- _ 118,000 ( 6,000) 28,000

_ ( 3,000) _ 6,000 ( 3,000)

140,000 115,000 _ --- _ 25,000

(140,000) (115,000) ( 25,000)

_ --- _ _ --- _ _ --- _

Loss Allocation:

A = 20% x (160,000 – 270,000) = (22,000)

B = 60% x (110,000) = (66,000)

C = 20% x (110,000) = (22,000)

B’s Deficit Allocation:

A = 20% / (20% + 20%) x (6,000) = (3,000)

C = 20% / 40% x (6,000) = (3,000)

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