chapter 15 firma

15 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Partnerships – Formation,

Operations, and Changes in

Ownership Interests

Chapter 15


Learning Objective 1

Comprehend the legal

characteristics of partnerships.


Partnership Characteristics

It is an association of two or more persons

who co-own a business for a profit.

The legal life of a partnership terminates

with the admission of a new partner, the

withdrawal or death of a partner, voluntary

dissolution by the partners, or involuntary

dissolution such as bankruptcy proceedings.


Articles of Partnership

A partnership may be formed by a simple

oral agreement among two or more

people to operate a business for profit.


Articles of Partnership

The types of products and services to be provided

Each partner’s rights and responsibilities

Each partner’s initial investment

Additional investment conditions

Asset drawing provisions

Profit and loss sharing formulas

Procedures for dissolving the partnership


Partnership Financial Reporting

The accounting reports are designed to

meet the needs of three user groups…

The partners

Partnership creditors

Internal Revenue Service



Understand initial investment

valuation and record keeping.


Initial Investment in a Partnership

Ashley and Becker each invest $20,000

cash in a new partnership.

Cash 20,000

Ashley, Capital 20,000

To record Ashley’s original investment of cash

Cash 20,000

Becker, Capital 20,000

To record Becker’s original investment of cash


Noncash Investments

C. Cola R. CrownFair Value Fair Value

Cash $ — $ 7,000

Land (cost to C. Cola, $5,000) 10,000 —

Building (cost to C. Cola, $30,000) 40,000 —

Inventory (cost to R. Crown, $28,000) — 35,000

Total $50,000 $42,000

C. Cola and R. Crown enter into a partnership.


Noncash Investments

Land 10,000

Building 40,000

C. Cola, Capital 50,000

To record C. Cola’s original investment

of land and building at fair value


Noncash Investments

Cash 7,000

Inventory 35,000

R. Crown, Capital 42,000

To record R. Crown’s original investment

of cash and inventory items at fair value


Bonus or Goodwill

on Initial Investment

The partnership agreement specifies

equal capital interests.

C. Cola, Capital 4,000


To establish equal capital interests of $46,000 by

recording a $4,000 bonus from C. Cola to R. Crown


Bonus or Goodwill

on Initial Investment

Goodwill 8,000


To establish equal capital interests of $50,000

by recognizing R. Crown’s investment

of an $8,000 unidentifiable asset


Drawings

Regular withdrawals are called

drawings, drawing allowances,

or sometimes salary allowances.

Debit Drawing and credit Cash.

At period end, credit Drawing

and debit each partner’s Capital.


Loans and Advances

Loans and advances to the partnership

and accrued interest are regarded as

liabilities of the partnership.

Loans and advances to partners are

regarded as assets of the partnership.


Partnership Operations

Ratcliffe and Yancey are partners sharing

profits in a 60:40 ratio, respectively.


Partnership Operations

Partnership net income 2003 $34,500

Ratcliffe capital January 1, 2003 40,000

Ratcliffe additional investment 2003 5,000

Ratcliffe drawing 2003 6,000

Yancey capital January 1, 2003 35,000

Yancey drawing 2003 9,000

Yancey withdrawal 2003 3,000

Equity Accounts, 2003


Format for a Statement

of Partners’ Capital

Ratcliffe and Yancey Statement of Partners’ CapitalFor the Year Ended 12/31/2003

60% 40%Ratcliffe Yancey Total

Capital balances 1/1/03 $40,000 $35,000 $75,000

Add: Additional investments 5,000 — 5,000Deduct: Withdrawals — – 3,000 – 3,000

Deduct: Drawings – 6,000 – 9,000 –15,000Net contributed capital 39,000 23,000 62,000

Add: Net income for 2003 20,700 13,800 34,500Capital balances 12/31/03 $59,700 $36,800 $96,500


Closing Entries

December 31, 2003

Revenue and Expense Summary 34,500

Ratcliffe, Capital 20,700

Yancey, Capital 13,800

To divide net income for the year 60% to Ratcliffe

and 40% to Yancey


Closing Entries

December 31, 2003

Ratcliffe, Capital 6,000

Yancey, Capital 9,000

Ratcliffe, Drawing 6,000

Yancey, Drawing 9,000

To close partner drawing accounts to capital accounts



Grasp the diverse nature of profit

and loss sharing agreements

and their computation.


Profit and Loss Sharing

Agreements

Equal division of partnership income is required in

the absence of a profit and loss sharing agreement.


Service Considerations in

Profit and Loss Sharing Agreements

A partner who devotes time to the partnership

business while other partners work elsewhere

may receive a salary allowance.

Salary allowances are also used to

compensate for differences in the fair

value of the talents of partners.


Salary Allowance in Profit

Sharing Agreements

Bob, Gary, and Pete are partners.

The partnership agreement provides that

Bob and Gary receive salary allowances

of $12,000 each, with the remaining

income allocated equally.

Partnership net income is $60,000 for 2003

and $12,000 for 2004.


Income Allocation Schedule: 2003

Bob Gary Pete

Net income $60,000

Salary allowances

to Bob and Gary (24,000) $12,000 $12,000

Remainder to divide 36,000

Divided equally (36,000) 12,000 12,000 $12,000

Remainder to divide 0

Net income allocation $24,000 $24,000 $12,000



Bob Gary Pete

Net income $12,000

Salary allowances

to Bob and Gary (24,000) $12,000 $12,000

Remainder to divide (12,000)

Divided equally 12,000 (4,000) (4,000) $(4,000)


Net income allocation $ 8,000 $ 8,000 $(4,000)


Journal Entries

December 31, 2003


Bob, Capital 24,000

Gary, Capital 24,000

Pete, Capital 12,000

Partnership income allocation for 2003


Journal Entries

December 31, 2004


Pete, Capital 4,000

Bob, Capital 8,000

Gary, Capital 8,000

Partnership income allocation for 2004


Bonus and Salary Allowances

The partnership agreement provides that Bob

receive a bonus of 10% of partnership net income.

Partnership net income is $60,000

for 2003 and $12,000 for 2004.

Bob and Gary receive salary allowances

of $10,000 and $8,000, respectively, and

the remaining income is allocated equally.



Bob Gary Pete

Net income $60,000

Bonus to Bob (6,000) $ 6,000


Salary allowances

to Bob and Gary (18,000) 10,000 $ 8,000


Divided equally (36,000) 12,000 12,000 $12,000


Net income allocation $28,000 $20,000 $12,000



Bob Gary Pete

Net income $12,000

Bonus to Bob (1,200) $ 1,200


Salary allowances

to Bob and Gary (18,000) 10,000 $8,000

Remainder to divide (7,200)

Divided equally 7,200 (2,400) (2,400) $(2,400)


Net income allocation $ 8,800 $5,600 $(2,400)


Income Allocated in Relation

to Partnership Capital

Capital balances 1/1/2003 $20,000 $20,000

Investment April 1 2,000 —

Withdrawal July 1 — (5,000)

Investment September 1 3,000 —

Withdrawal October 1 — (4,000)

Investment December 28 — 8,000

Capital balances 12/31/2003 $25,000 $19,000

Ace Butch


Comparison of Capital Bases

WeightedBeginning Ending AverageCapital Capital Capital

Investment Investment Investment

Ace $20,000 $25,000 $22,500

Butch 20,000 19,000 16,500

Total $40,000 $44,000 $39,000


Alternatives

Beginning Capital Balances

Ace ($100,000 × 20/40) $ 50,000

Butch ($100,000 × 20/40) 50,000

Total income $100,000

Net income of $100,000 is divided

on the basis of capital balances.


Alternatives

Ending Capital Balances

Ace ($100,000 × 25/44) $ 56,818.18

Butch ($100,000 × 19/44) 43,181.82

Total income $100,000.00

Average Capital Balances

Ace ($100,000 × 22.5/39) $ 57,692.31

Butch ($100,000 × 16.5/39) 42,307.69

Total income $100,000.00


Interest Allowances

on Partnership Capital

An agreement may provide for interest

allowances on partnership capital in

order to encourage capital investments,

as well as salary allowances.

Remaining profits are then divided

equally or in any other ratio specified

in the profit sharing agreement.



Value new partners’ investment

in an existing partnership.


Changes in Partnership Interest

The existing legal partnership entity is

dissolved when a new partner is admitted

or an existing partner retires or dies.


Changes in Partnership Interest

Assignment of an interest to a third party

Admission of a new partner

Purchase of an interest from existing partners

Investing in an existing partnership



Value partner’s share upon

retirement or death.


Dissolution of a Continuing Partnership

Through Death or Retirement

Profit and Capital Percentage LossBalances of Capital Percentage

Bonnie $ 70,000 35% 40%

Clyde 50,000 25 20

Dillinger 80,000 40 40

Total capital $200,000 100% 100%


Dissolution of a Continuing Partnership

Through Death or Retirement

Dillinger decides to retire.

The partners agree that the business is

undervalued on the partnership books

and that Dillinger will be paid $92,000.


Bonus to Retiring Partner

Dillinger, Capital 80,000

Bonnie, Capital 8,000

Clyde, Capital 4,000

Cash 92,000


Goodwill 12,000

Cash 92,000


Reevaluation of Total

Partnership Capital

Goodwill (other assets) 30,000





Payment to Retiring Partner

Less than Capital Balance

Suppose that Dillinger is paid $72,000

in final settlement of his capital interest.


Overvalued Assets Written Down




Net assets 20,000


Cash 72,000


Bonus to Continuing Partners




Cash 72,000



Understand limited liability

partnership characteristics.


Limited Partnerships

The limited partnership consists

of at least one general partner

and one or more limited partners.

The limited partner is excluded from

the management of the business.


End of Chapter 15

chapter 15 firma

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