© The McGraw-Hill Companies, Inc., 2001

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14

C H A P T E R

Partnerships: Formation and

Operation

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PartnershipsCapital Accounts

PartnershipsCapital Accounts

The equity section of a partnership consists of capital balances for each partner.

Profits/losses each period are allocated to each partner’s capital account.

Withdrawals by partners reduce their capital accounts.

The equity section of a partnership consists of capital balances for each partner.

Profits/losses each period are allocated to each partner’s capital account.

Withdrawals by partners reduce their capital accounts.

© The McGraw-Hill Companies, Inc., 2001

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Articles of PartnershipArticles of Partnership

Partnerships can exist even in the absence of a written partnership agreement.

The Uniform Partnership Act establishes standards and rules for partnerships.

A written agreement will supercede the UPA standards.

Partnerships can exist even in the absence of a written partnership agreement.

The Uniform Partnership Act establishes standards and rules for partnerships.

A written agreement will supercede the UPA standards.

© The McGraw-Hill Companies, Inc., 2001

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Articles of PartnershipArticles of Partnership

Put it in writing!

Put it in writing!

Rights and responsibilities

of partners

Rights and responsibilities

of partners

Initial contribution to

be made by each partner

Initial contribution to

be made by each partner

Method for valuing

individual contributions

Method for valuing

individual contributions

Profit/loss sharing

percentages

Profit/loss sharing

percentages

Withdrawal limits

Withdrawal limits

Method for dispute

settlements

Method for dispute

settlements

Method for admitting

new partners

Method for admitting

new partners

© The McGraw-Hill Companies, Inc., 2001

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Accounting for Capital Contributions

Accounting for Capital Contributions

If the partners each contribute cash . . . . . . debit Cash. . . . credit individual Partner Capital accounts.

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Accounting for Capital Contributions

Accounting for Capital Contributions

If the partners each contribute cash and other assets . . .

. . . debit Cash & contributed assets for FMV. . . . credit individual Partner Capital accounts.

If the partners each contribute cash and other assets . . .

. . . debit Cash & contributed assets for FMV. . . . credit individual Partner Capital accounts.

© The McGraw-Hill Companies, Inc., 2001

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Accounting for Capital Contributions

Accounting for Capital Contributions

Intangible assets, such as expertise, require special consideration

Use either the Bonus Method or the Goodwill Method.

Intangible assets, such as expertise, require special consideration

Use either the Bonus Method or the Goodwill Method.

Record the tangible assets contributed.

Adjust the partner capital balances to reflect the relative value of the intangible asset.

Record the tangible assets contributed.

Adjust the partner capital balances to reflect the relative value of the intangible asset.

© The McGraw-Hill Companies, Inc., 2001

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Prepare the journal entry to set up the partnership.

Prepare the journal entry to set up the partnership.

Intangible ContributionsBonus Method

Intangible ContributionsBonus Method

On 2/15/98, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes $80,000 cash. Redd contributes

land valued at $40,000.

On 2/15/98, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes $80,000 cash. Redd contributes

land valued at $40,000.

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Intangible ContributionsBonus Method

Intangible ContributionsBonus Method

Total tangible assets for the partnership are $120,000. The partners have agreed to have equal capital

balances, based on the contributed assets. Even though Redd only contributed land worth $40,000,

essentially, Greene has given Redd a $20,000 bonus.

Total tangible assets for the partnership are $120,000. The partners have agreed to have equal capital

balances, based on the contributed assets. Even though Redd only contributed land worth $40,000,

essentially, Greene has given Redd a $20,000 bonus.

© The McGraw-Hill Companies, Inc., 2001

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Intangible ContributionsGoodwill Method

Intangible ContributionsGoodwill Method

Record the tangible assets contributed.

Record the contributed intangibleintangible asset as the difference between the contributed tangible assets and the implied value of the partnership.

Record the tangible assets contributed.

Record the contributed intangibleintangible asset as the difference between the contributed tangible assets and the implied value of the partnership.

© The McGraw-Hill Companies, Inc., 2001

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Prepare the journal entry to set up the partnership.

Prepare the journal entry to set up the partnership.

Intangible ContributionsGoodwill Method

Intangible ContributionsGoodwill Method

On 2/15/98, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes

$80,000 cash. Redd contributes land valued at $40,000, and brings years of experience to the new

business.

On 2/15/98, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes

$80,000 cash. Redd contributes land valued at $40,000, and brings years of experience to the new

business.

© The McGraw-Hill Companies, Inc., 2001

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Intangible ContributionsGoodwill Method

Intangible ContributionsGoodwill Method

On 2/15/98, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes

$80,000 cash. Redd contributes land valued at $40,000, and brings years of experience to the new

business.

On 2/15/98, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes

$80,000 cash. Redd contributes land valued at $40,000, and brings years of experience to the new

business.

÷

© The McGraw-Hill Companies, Inc., 2001

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Intangible ContributionsGoodwill Method

Intangible ContributionsGoodwill Method

Greene’s capital account is credited for the tangible contribution of $80,000.

Redd’s capital account is credited for the tangible contribution of $40,000, plus the intangible

contribution valued at $40,000.

Greene’s capital account is credited for the tangible contribution of $80,000.

Redd’s capital account is credited for the tangible contribution of $40,000, plus the intangible

contribution valued at $40,000.

© The McGraw-Hill Companies, Inc., 2001

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Allocation of IncomeAllocation of Income

The allocation of income is not based on the relative capital balances. It is a separately negotiated

item. Items to be allocated:

Allocated compensation

Allocated compensation

BonusesBonuses

Remaining income

Remaining income

Interest on beginning

capital balances

Interest on beginning

capital balances

© The McGraw-Hill Companies, Inc., 2001

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Allocation of IncomeExample

Allocation of IncomeExample

Lebo and Smith, a retail partnership, has beginning of period capital balances of $50,000 and $70,000

respectively. Net income for the period is $100,000.

Both partners are credited with 10% interest on their beginning capital balance. In addition, Lebo is

credited with a bonus of $20,000 per the partnership agreement. They share income 40:60

(Lebo:Smith).

What are the ending capital balances for each partner?

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Allocation of IncomeExample

Allocation of IncomeExample

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These two rights can be

sold.

These two rights can be

sold.

This right cannot be sold

without the other partners’

approval.

This right cannot be sold

without the other partners’

approval.

Admission of a New PartnerThe Rights of a Partner

Admission of a New PartnerThe Rights of a Partner

An individual partner’s ownership rights include:

The right to co-ownership of the partnership property.

The right to share in profits and losses as specified in the partnership agreement

The right to participate in the management of the partnership.

An individual partner’s ownership rights include:

The right to co-ownership of the partnership property.

The right to share in profits and losses as specified in the partnership agreement

The right to participate in the management of the partnership.

© The McGraw-Hill Companies, Inc., 2001

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Partnership DissolutionAdmission of a New Partner

Partnership DissolutionAdmission of a New Partner

When the makeup of the partnership changes, the partnership is dissolved.

A new partnership is immediately formed.

New partner acquires partnership interest by: Purchasing it from the other

partners, or Making a contribution to the

partnership.

When the makeup of the partnership changes, the partnership is dissolved.

A new partnership is immediately formed.

New partner acquires partnership interest by: Purchasing it from the other

partners, or Making a contribution to the

partnership.

© The McGraw-Hill Companies, Inc., 2001

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Admission of a New PartnerPurchase of a Current InterestAdmission of a New Partner

Purchase of a Current Interest

A new partner can purchase partnership interest directly from the existing partners. The cash goes to the

partners, not to the partnership.

Two methods are available to account for the transfer of ownership. Book Value Approach Goodwill (Revaluation)

Approach

A new partner can purchase partnership interest directly from the existing partners. The cash goes to the

partners, not to the partnership.

Two methods are available to account for the transfer of ownership. Book Value Approach Goodwill (Revaluation)

Approach

© The McGraw-Hill Companies, Inc., 2001

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Book Value Example Doe, Raye, and Mee have a partnership.

Using the Book Value Approach, prepare the entry assuming Flatt pays $60,000 directly to the other partners for a 20% partnership interest.

Admission of a New PartnerPurchase of a Current InterestAdmission of a New Partner

Purchase of a Current Interest

© The McGraw-Hill Companies, Inc., 2001

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Admission of a New PartnerPurchase of a Current InterestAdmission of a New Partner

Purchase of a Current Interest

Book Value Example The cash goes to Doe,

Raye, and Mee, NOT to the partnership.

Each partner gives up 20% of their existing capital.

Book Value Example The cash goes to Doe,

Raye, and Mee, NOT to the partnership.

Each partner gives up 20% of their existing capital.

Prepare the journal entry to admit Flatt to the partnership.

Prepare the journal entry to admit Flatt to the partnership.

© The McGraw-Hill Companies, Inc., 2001

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Now, let’s take a look at the Goodwill

Approach.

Admission of a New PartnerPurchase of a Current InterestAdmission of a New Partner

Purchase of a Current Interest

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Goodwill (Revaluation) Example Doe, Raye, and Mee have a partnership.

Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 directly to the other partners for a 20% partnership interest.

Goodwill (Revaluation) Example Doe, Raye, and Mee have a partnership.

Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 directly to the other partners for a 20% partnership interest.

Admission of a New PartnerPurchase of a Current InterestAdmission of a New Partner

Purchase of a Current Interest

© The McGraw-Hill Companies, Inc., 2001

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Admission of a New PartnerPurchase of a Current InterestAdmission of a New Partner

Purchase of a Current Interest

Goodwill (Revaluation) Example The implied value of the partnership is $300,000

$60,000 ÷ 20% = $300,000 First, compute the Goodwill

Goodwill (Revaluation) Example The implied value of the partnership is $300,000

$60,000 ÷ 20% = $300,000 First, compute the Goodwill

© The McGraw-Hill Companies, Inc., 2001

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Admission of a New PartnerPurchase of a Current InterestAdmission of a New Partner

Purchase of a Current Interest

Prepare the journal entry to allocate goodwill to Doe, Raye,

& Mee.

Prepare the journal entry to allocate goodwill to Doe, Raye,

& Mee.

Goodwill (Revaluation) ExampleAllocate the $160,000 of Goodwill to the existing

partners, based on their income sharing %. (40:25:35)

Goodwill (Revaluation) ExampleAllocate the $160,000 of Goodwill to the existing

partners, based on their income sharing %. (40:25:35)

© The McGraw-Hill Companies, Inc., 2001

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Admission of a New PartnerPurchase of a Current InterestAdmission of a New Partner

Purchase of a Current Interest

Goodwill (Revaluation) ExampleThe new balances for Doe, Raye, and Mee appear as

follows:

Next, allocate 20% from each of the existing partners to Flatt.

Goodwill (Revaluation) ExampleThe new balances for Doe, Raye, and Mee appear as

follows:

Next, allocate 20% from each of the existing partners to Flatt.

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Admission of a New PartnerPurchase of a Current InterestAdmission of a New Partner

Purchase of a Current Interest

Revaluation ExampleNote that Flatt’s balance,

after allocation from the current partners,

equals Flatt’s contribution of

$60,000.

Revaluation ExampleNote that Flatt’s balance,

after allocation from the current partners,

equals Flatt’s contribution of

$60,000.

© The McGraw-Hill Companies, Inc., 2001

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Admission of a New PartnerContribution to the PartnershipAdmission of a New Partner

Contribution to the Partnership

The new partner can gain partnership interest by contributing cash to the partnership.

Remember that the new cash will increase the partnership’s net assets.

Two methods are: Bonus Approach Goodwill Approach

The new partner can gain partnership interest by contributing cash to the partnership.

Remember that the new cash will increase the partnership’s net assets.

Two methods are: Bonus Approach Goodwill Approach

© The McGraw-Hill Companies, Inc., 2001

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Bonus Example Doe, Raye, and Mee have a partnership.

Using the Bonus Approach, prepare the entry assuming Flatt pays $60,000 to the partnership for a 20% partnership interest.

Admission of a New PartnerContribution to the PartnershipAdmission of a New Partner

Contribution to the Partnership

© The McGraw-Hill Companies, Inc., 2001

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Bonus Example Net assets after the contribution are $200,000. Flatt gets credit for 20% of net assets ($200,000 x 20%). The remainder of the $60,000 contribution is allocated to the

other partners.

Bonus Example Net assets after the contribution are $200,000. Flatt gets credit for 20% of net assets ($200,000 x 20%). The remainder of the $60,000 contribution is allocated to the

other partners.

Note that the $200,000 results from the net

assets of the partnership of $140,000 + Flatt’s $60,000 contribution.

Note that the $200,000 results from the net

assets of the partnership of $140,000 + Flatt’s $60,000 contribution.

Prepare the journal entry.

Admission of a New PartnerContribution to the PartnershipAdmission of a New Partner

Contribution to the Partnership

© The McGraw-Hill Companies, Inc., 2001

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Now, let’s take a look at the Goodwill

Approach.

Admission of a New PartnerContribution to the PartnershipAdmission of a New Partner

Contribution to the Partnership

© The McGraw-Hill Companies, Inc., 2001

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Goodwill Example Doe, Raye, and Mee have a partnership.

Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 to the partnership for a 20% partnership interest.

Goodwill Example Doe, Raye, and Mee have a partnership.

Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 to the partnership for a 20% partnership interest.

Admission of a New PartnerContribution to the PartnershipAdmission of a New Partner

Contribution to the Partnership

© The McGraw-Hill Companies, Inc., 2001

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Admission of a New PartnerContribution to the PartnershipAdmission of a New Partner

Contribution to the Partnership

Goodwill Example Net assets after the contribution are $200,000. Implied value of the partnership is $300,000.

$60,000 ÷ 20% = $300,000 Goodwill to be recorded is $100,000 (300,000 - 200,000)

Goodwill Example Net assets after the contribution are $200,000. Implied value of the partnership is $300,000.

$60,000 ÷ 20% = $300,000 Goodwill to be recorded is $100,000 (300,000 - 200,000)

Prepare the journal entry to allocate goodwill to Doe, Raye,

& Mee.

Prepare the journal entry to allocate goodwill to Doe, Raye,

& Mee.

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Admission of a New PartnerContribution to the PartnershipAdmission of a New Partner

Contribution to the Partnership

Goodwill Example

After allocating the goodwill to the original partners, record Flatt’s cash contribution and credit Flatt’s

capital account.

Prepare the journal entry to admit Flatt to the partnership.

Prepare the journal entry to admit Flatt to the partnership.

© The McGraw-Hill Companies, Inc., 2001

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Accounting for my partners is

easy. It’s accounting for

their taste that I find difficult!

End of Chapter 14End of Chapter 14