19-1. accounting for partnerships section 1: forming a partnership chapter 19 section objectives...
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19-1
Accounting for Partnerships
Accounting for Partnerships
Section 1: Forming a
Partnership
Chapter
19
Section Objectives1. Explain the major advantages and disadvantages
of a partnership.
2. State the important provisions that should be included in every partnership agreement.
3. Account for the formation of a partnership.
McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.
19-3
Advantages of a Partnership
Each partner is taxed individually on his or her share of the partnership’s income.
It pools the skills, abilities, and financial resources of two or more individuals.
It is easy and inexpensive to form.
A partnership does not pay income tax.
Explain the major advantages and disadvantages of a partnership
Objective 1
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Disadvantages of a Partnership
Each partner has unlimited liability.
The partnership is a mutual agency.
The business lacks continuity. It has a limited life.
Ownership rights are not freely transferable.
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A partnership agreement is a legal contract forming a partnership and specifying certain details of the operation.
ANSWER:
QUESTION:
What is a partnership agreement?
Explain the important provisions which should be included in a partnership agreement
Objective 2
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Names of the partners. Name, location, and nature of the business. Starting date of the agreement. Life of the partnership. Rights and duties of each partner.
Every partnership agreement should contain:
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Amount of capital to be contributed by each partner
Every partnership agreement should contain:
Drawings (withdrawals) by the partners. Fiscal year and accounting method. Method of allocating income or loss to the
partners. Procedures to be followed if the partnership is
dissolved or the business is liquidated.
19-8
Memorandum entry to record formation of partnership.
Investment of assets and liabilities by partners.
Setting up partners’ capital accounts.
Setting up partners’ drawing accounts.
Subsequent investments and permanent withdrawals.
Account for the formation of a partnership.
Objective 3
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Memorandum Entry to Record Formation of Partnership
20--
Jan. 1 On this date a partnership was formed between Ellen Barret
and Jerry Reed to carry on a retail clothing business under
the name of Old Army, according to the terms of the partnership agreement effective this date.
19-10
20-- Jan. 1 Accounts Receivable 20,500.00 Merchandise Inventory 105,200.00 Store Equipment 3,000.00 Allow. for Doubtful Accts. 1,200.00 Notes Payable—Bank 39,100.00 Accounts Payable 34,700.00 Interest Payable 500.00 Ellen Barret, Capital 53,200.00 Investment of Ellen Barret
Assets that are transferred to a partnership should be appraised and recorded at the agreed-upon fair market value at the time of transfer.
Investments of Assets and Liabilities by a Sole Proprietor
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Investment of Cash by Partner
New Partner Given Credit for Amount Invested
Jan. 1 Cash 28,000.00
Jerry Reed, Capital 28,000.00
Investment of cash by Reed
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Drawing AccountsDrawing Accounts
Any withdrawal by a partner, whether it is cash or some other asset, is a return of equity to that partner.
The partner’s drawing account balance reduces that partner’s equity.
Accounting for Partnerships
Accounting for Partnerships
Section 2: Allocating
Income or Loss
Chapter
19
Section Objectives
4. Compute and record the division of net income or net loss between partners in accordance with the partnership agreement.
5. Prepare a statement of partners’ equities.
McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc. All rights reserved.
19-14
Allocating Partnership Income or Loss
In step 3 the business determines the distributive share for each partner.
Step 1. Close revenue to Income Summary.
Step 2. Close expenses to Income Summary.
Step 3. Close Income Summary to the partners’ capital accounts.
Step 4. Close each partner’s drawing account to the partner’s capital account.
Compute and record the division of net income or net loss between partners in accordance with the partnership agreement
Objective 4
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Allocation of Partnership Income or Loss
Based on the partnership agreement.
Allocated equally to each partner if the partnership agreement is “silent.”
Income distribution does not mean cash distribution.
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Agreed Upon Ratio
Step 1: Add the figures given in the ratio.
Barret 3 + Reed 2
Example: Barret and Reed agreed that net income should be split in a 3:2 ratio to Barret and Reed, respectively.
Step 2: Express each figure as a fraction of the total.
Barret’s share 3/5 Reed’s share 2/5
Step 3: Convert each fraction into a percentage.
Barret’s share 3/5 = 60% Reed’s share 2/5 = 40%
= Total 5
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Net Income X partner’s share percentage:
Agreed Upon Ratio
20--
Dec. 31 Income Summary 100,000.00 Ellen Barret, Capital 60,000.00
Jerry Reed, Capital 40,000.00
Net Income = $100,000 Barret’s share ($100,000 x 60% = $60,000) Reed’s share ($100,000 x 40% = $40,000)
19-18
Capital Account Balances
Step 1: Add the capital account balances.
Barret $53,200
Reed + 28,000
Total = $81,200
Step 2: Express each balance as a fraction and convert it to a percentage.
Barret $53,200/$81,200 = 65.517%
Reed $28,000/$81,200 = 34.483%
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Capital Account Balances
Net Income X partner’s share percentage: Net Income $100,000
Barret $100,000 x 65.517% = $65,517
Reed $100,000 x 34.483% = $34,483
19-20
Salary and Interest Allowances
Allowances for partners’ salaries and interest on
their investments can be included in the allocation of net income or loss.
Allowances are debited to the Income Summary account and credited to the partners’ capital accounts.
The remaining net income or loss is then allocated in the proper ratio.
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Salary allowances are intended to reward the partners for the time they spend in the business and for the expertise and talents they bring to it.
Salary Allowances
Salary allowances are withdrawals.
Salary allowances do not represent salary expense.
19-22
20--
Dec. 31 Income Summary 52,800.00 Ellen Barret, Capital 30,000.00
Jerry Reed, Capital 22,800.00
Net Income is $112,800.
Salary Allowances
Salary allowances for Barret $30,000 and Reed is $22,800.
19-23
20--
Dec. 31 Income Summary 60,000.00 Ellen Barret, Capital 36,000.00
Jerry Reed, Capital 24,000.00
Salary AllowancesNet Income $112,800
Less: Salary Allowances – 52,800
Using the agreed upon ratio, the amount of net income after salary allowances is allocated 60% to Barret and 40% to Reed.
Balance in Income Summary = $ 60,000
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Net Loss
Net Loss 30,000
Their capital accounts are debited (decreased).
Income Summary
Distributed between Ross and Wright.
Dec. 31Sal. All. 52,800
Dec. 31Int. All. 6,496
Bal. $89,296
Assume net loss = $30,000 Record the salary allowances of $30,000 for Barret and $22,800
for Reed. Record the interest allowances of $4,256 to Barret and $2,240
to Reed.
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Partnership Financial Statements
Income Statement Same as that for a sole
proprietorship.
One exception—on the bottom of the statement, the division of net income is shown between the partners.
Balance Sheet Same as that for a sole
proprietorship.
One exception—there exists a separate capital account for each of the partners in Partner’s Equity section.
Prepare a statement of partners’ equities
Objective 5
19-26
OLD ARMY Statement of Partners’ Equities Year Ended December 31, 2010
Barret Reed Total Capital Capital Capital
Capital Balances, Jan. 1, 2010 0.00 0.00 0.00
Investment During Year 53,200.00 28,000.00 81,200.00
Net Income (Loss) for Year 6,308.00 (2,908.00) 3,400.00
Totals 59,508.00 25,092.00 84,600.00
Less Withdrawals During Year 30,000.00 22,800.00 52,800.00
Capital Balances, Dec. 31, 2010 29,508.00 2,292.00 31,800.00
Statement of Partners’ Equities
Each partner’s salary is treated as a withdrawal on the statement.
Accounting for Partnerships
Accounting for Partnerships
Section 3: Partnership
Changes
Chapter
19
Section Objectives6. Account for the revaluation of assets and
liabilities prior to the dissolution of a partnership.7. Account for the sale of a partnership interest.8. Account for the investment of a new partner in an
existing partnership. 9. Account for the withdrawal of a partner from a
partnership.McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.
19-28
Dissolution
Step 1
Accounting records are closed.
Net income or net loss on the date of dissolution is recorded and transferred to the partners’ capital accounts.
Step 2
Assets and liabilities are revalued at fair market value.
Account for the revaluation of assets and liabilities prior to the dissolution of a partnership
Objective 6
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Asset Revaluation
When transferred from one partnership to another, assets are revalued to their fair market value.
The new value will not necessarily agree with the book value carried by the old firm.
The revaluation of assets affects the balance sheet only.
19-30
An adjusting entry is prepared for the revalued items.
GENERAL JOURNAL PAGE 4 DATE DESCRIPTION POST. DEBIT CREDIT REF.20--April 1 Merchandise Inventory 9,000.00
Allow. for Doubtful Accounts 2,300.00 Tom Lee, Capital 2,680.00 Joan Wilner, Capital 2,680.00 Nau Flores, Capital 1,340.00 To record revaluation of assets and allocation of
gain to partners.
19-31
There are two ways a new partner may be admitted to the partnership:
By purchasing all or part of the interest of an existing partner and paying that partner directly.
By investing cash or other assets directly in the existing partnership.
Admission of a New Partner
Account for the sale of a partnership interest
Objective 7
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Account for the investment of a new partner in an existing partnership.
Objective 8
19-33
New Partner Given Credit for Amount Invested
20--
April 1 Cash 51,500.00Beth Rivera, Capital 51,500.00
To record investment of Rivera for one-fourth interest in partnership.
New partner, Rivera, pays $51,500 for ¼ interest in partnership.
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New Partner Given Credit for More Than Amount Invested
After the cash investment is recorded, a bonus is given to the new partner by crediting the new partner’s capital account. This credit is offset by debits to the original partners’ capital accounts.
20--
April 1 Tom Lee, Capital 1,800.00 Joan Wilner, Capital 1,800.00 Nau Flores, Capital 900.00 Beth Rivera, Capital 4,500.00
To record bonus allowed new partner
New partner paid $45,500 for one-fourth interest in partnership. (¼ of partnership capital = $50,000)
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If a new partner is given credit for less than the amount invested, a bonus is allowed to the existing partners and is credited to their capital accounts in the former profit and loss ratio.
20--
April 1 Beth Rivera , Capital 5,500.00 Tom Lee, Capital 2,200.00
Joan Wilner, Capital 2,200.00 Nau Flores, Capital 1,100.00
To record bonus to original partners.
New Partner Given Credit for Less Than Amount Invested
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When a partner withdraws, the payment given to the withdrawing partner may be more or less than the withdrawing partner’s capital balance.
The difference in the cash payment and the withdrawing partner’s capital account is debited or credited to the remaining partners according to their profit-and-loss ratio.
Account for the withdrawal of a partner from a partnership
Objective 9
19-37
The revalued assets result in the following capital account balances:Lee $40,980 Wilner 61,180Flores 52,340 Total $154,500
Withdrawal of Partner(Paid the balance of her capital account.)
New Partner Given Credit for Amount Invested
20--
Mar. 31
Nau Flores, Capital 52,340.00Cash 52,340.00
To record cash payment made to Flores on withdrawal from partnership.
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Withdrawing Partner’s Capital Account
If the amount paid is higher than the withdrawing partner’s capital account balance, the excess is debited to the capital accounts of the remaining partners according to their income and loss ratio.
If the amount paid is less than the withdrawing partner’s capital account balance, the difference is credited to the remaining partners’ capital accounts based on their income and loss ratio.
19-39
The revalued assets result in the following capital account balances:Lee $40,980 Wilner 61,180Flores 52,340 Total $154,500
Withdrawal of Partner(Paid more than the balance of her capital account.)
New Partner Given Credit for Amount Invested
20--
Mar. 31
Nau Flores, Capital 52,340.00Tom Lee, Capital 4,500.00Joan Wilner, Capital 4,500.00 Cash 61,340
Flores receives a bonus of $61,340- 52,340 = $9,000
The bonus comes out of the remaining partner’s capital accounts.
19-40
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