Advanced Accounting

by Debra Jeter and Paul Chaney

Chapter 16: Partnerships:

Formation, Operation, and
Ownership Changes

Slides Authored by Hannah Wong, Ph.D.

Rutgers University
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Partnership
Definition
An

association of two or more persons

to carry on as co-owners of a
business for profit

Attributes
an

agreement

the

business operates for profit

members

of the firm must be co-

owners
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General Partnership
All partners are general partners
Mutual agency
Right to dispose of a partnership interest
Unlimited liability
Limited or uncertain life
Tax implications: partnership income is
allocated to partners who are taxed upon
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Limited Partnership
At least one general partner and one
limited partner
General partner:
manage

the firm

unlimited

Limited partner:
invest

capital only

liability
limited

liability

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Joint Venture
An agreement by two or more parties
to accomplish a limited purpose for
their mutual benefit, often to earn a
profit.
Each joint venturer participates
directly or indirectly in the
management of the resources

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Partnership Agreement
name

of the firm, identity of the partners

nature,
date

purpose and scope of business

of organization

length

of operating time

location

of business

allocation
salaries
rights,

of profit and loss

and withdrawals of assets by partners

duties and obligations of each partner

contractual

authority of each partner

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Partnership Agreement
procedure
plan

for admitting a new partner

on withdrawal or death of a partner

procedures
fiscal

for arbitration of disputes

period

identification

and valuation of initial asset

investments
situations

for dissolution of partnership

accounting
whether

practices

an audit is to be performed
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Capital Interest VS Profit Interest

Capital interest
a

partners claim
against the net assets
of the partnership

shown

by the balance
in the partners
capital account

Profit interest
a

partners claim
against income and
loss of the
partnership

determines

how the
partners capital
interest changes as
a result of
partnership
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operations

Accounting for a Partnership

Formation of Partnership
Cash

50,000
Bell, capital

50,000

Peters, capital
50,000

Monthly Withdrawal
Bell, drawing

1,000

Peters, drawing

1,000

Cash

1,000

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Accounting for a Partnership

Income Summary Closing Entry
Income summary

60,000

Bell, capital

30,000

Peters, capital
30,000

Drawing Accounts Closing Entry

Bell, capital
Peters, capital

12,000
12,000

Bell, drawing

12,000

Peters, drawing

12,000

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Bonus Method
MV of asset investment = negotiated capital interest
Assets
contributed
by Wright
$40,000

Assets
contributed
by Young
$50,000

Fair value of
assets
invested
$90,000

Wright, capital
$45,000

Young, capital
$45,000

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Goodwill Method
MV of asset investment = negotiated capital interest

Goodwill of $10,000 is recorded

Assets
contributed
by Wright
$40,000
Assets
contributed
by Young
$50,000

Fair value of
assets
invested

Wright, capital
$50,000

$90,000
Young, capital
$50,000

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Profit/Loss Allocation
Fixed Ratio

Profit $20,000

7:3

Adams
$14,000

Brown
$6,000

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Profit/Loss Allocation
Capital Balances
Adams Capital $60,000 7:3Brown Capital $40,000

= 3:2

Profit $20,000

3:2
Adams
$14,000

Brown
$6,000
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Profit/Loss Allocation
Interest
Allocation

Steps:

(1) Allocate profit as

interest on capital
investment
(2) allocate the remaining
income on another basis
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Profit/Loss Allocation
Interest
Allocation

The following should be specified:

the

interest rate

capital
how

balance to be used

remaining profit should be allocated

whether

or not interest should be

allocated if profit < agreed interest
allocation
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Profit/Loss Allocation
Interest
Allocation
Profit $20,000
Interest
allocation
Unallocated
profit

Adams
7:3
$6,200

Allocation of
remaining profit
Adams
$5,400

1:1

Brown
$5,400

Brown
$3,000
Interest allocated
= capital balance
x interest rate
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Profit/Loss Allocation
Salary and Bonus
Allocation
Allocate profit
as:
fixed

salary or
provide for a bonus as a % of net income

The net income used in bonus calculation can

be
before

allocation of income to partners

after

other allocations, but before the bonus

after

bonus, but before other allocations

after

bonus and all other allocations

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Insufficient Income to Cover Allocation

If partnership income
> interest and/or
salary allocation

allocate the
deficiency in the
agreed ratio for
allocating residual
income
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Insufficient Income to Cover Allocation

Profit $11,000

Salary
allocation
Deficiency
in profit

Adams
($2,100)

Adams
$4,000

1:1

Interest
allocation

Brown7:3 Adams
$2,000
$6,200

Brown
$3,000

Brown
($2,100)
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Financial Statement Presentation

Difference between partnership and
corporation reporting:
changes

in partners equity during the

year should be disclosed

partners

salary allowances is not an

expense
no

income tax expense

interest

on capital investment is not an

expense.
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Admission of New Partner

A new partner can acquire an interest in a
partnership by:
purchasing an interest from an existing
partner
New

partner acquires the right to share

profits only

no

right to participate in management

unless granted by all remaining partners

investing assets
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Assignment of Partnership Interest

By Payment to Partners - Bonus Method
Adams, Capital

18,000

Brown, Capital

12,000

Call, Capital

30,000

To transfer capital from capital accounts of Adams

and Brown to Calls capital account.
Amounts = recorded capital x % interest acquired by Call

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Assignment of Partnership Interest

By Payment to Partners - Goodwill
Goodwill Method
20,000
Adams, Capital

12,000

Brown, Capital

8,000

To record implied goodwill

= Calls payments / % interest acquired - recorded partnership net assets
= $36000 / 30% -$100,000

Adams, Capital

18,000

Brown, Capital

12,000

Call, Capital

30,000

To transfer capital from capital accounts of Adams

and Brown to Calls capital account.

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Asset Investment
BV Acquired = Assets
Invested
Cash

35,000
Call, Capital

35,000

To record Calls 1/3 capital in the partnership

= (existing net assets + assets invested by Call) x 1/3
= ($70,000 + $35,000) x 1/3
= $35,000

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Asset Investment
BV Acquired < Assets Invested : Bonus
Method
Cash

50,000
Call, Adams

6,000

Call, Brown

4,000

Call, Capital

40,000

The excess is
To record Calls 1/3 capital in the partnership
considered
= (existing net assets + assets invested by Call) x 1/3
a bonus
= ($70,000 + $50,000) x 1/3
to the
existing
partners
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Asset Investment
BV Acquired < Assets Invested : Goodwill
Method

Goodwill

Adams, Capital
Brown, Capital

30,000

18,000
12,000

Implied total net assets = Calls payments / % interest acquired

= $50000 / 30% = $150,000

goodwill for existing partners

= implied net assets x % ownership - current capital accounts
= $150,000 x 2/3 - $70,000 = $30,000
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Asset Investment
BV Acquired < Assets Invested : Goodwill
Method
Cash

50,000

Call, Capital

50,000

To record Calls 1/3 capital in the partnership

= (implied net assets) x 1/3 = $150,000x 1/3

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Payment to a Retiring Partner

Payment > BV: Bonus
Method
Call, Adams
Call, Brown
Call, Capital
Liability to Adams

To record $40,000
agreed payment
to Adams

30,000
6,000
4,000
40,000

The excess is considered a bonus

to the retiring partners; allocated
to existing partners by their
profit and loss ratio
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Payment to a Retiring Partner

Payment > BV: Goodwill
Method
Goodwill
Adams, Capital

20,000
10,000

Brown, Capital
Call, Capital

6,000
4,000

Implied goodwill
= excess payment to Adams / % interest withdrawn
= $10000 / 50% = $200,000

The goodwill is allocated to partners by their profit and loss ratio

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Advanced Accounting
by
Debra Jeter and Paul Chaney
Copyright 2001 John Wiley & Sons, Inc. All rights reserved.
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