Accounting for Partnerships

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Accounting Principles Second Canadian Edition
Weygandt Kieso Kimmel Trenholm
Prepared by Carole Bowman, Sheridan College
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CHAPTER
13
ACCOUNTING FOR PARTNERSHIPS
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Chapter 13 Accounting For Partnerships

• What is a Partnership?

A partnership is an agreement in which two or
more people combine resources in a business with
a view to making a profit.
Terms of the PartnershipIn order to establish
the terms of the partnership and to protect
yourself in the event of a disagreement or
dissolution of a partnership, a partnership
agreement should be drawn up.
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Advantages and Disadvantages

• Advantages of Partnership
• Ease of formation Low start-up costs
  Additional sources of investment capital
  Possible tax advantages Limited regulation
  Broader management base
• Disadvantages of Partnership
• Unlimited liability Divided authority
  Difficulty in raising additional capital Hard
  to find suitable partners Possible development
  of conflict between partners

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Limited vs. General

• Most partnerships that are formed are general
  partnerships.
• In a general partnership, the owners share the
  management of a business, and each partner is
  personally liable for all debts and obligations
  incurred
• A limited partnership involves limited partners
  who combine only capital. They are not as
  involved in managing the business and cannot be
  liable for more than the amount of capital they
  have contributed. This is known as limited
  liability.

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Transactions

• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

• Each partners initial investment in a
  partnership should be recorded at the fair market
  value of the assets at the date of their transfer
  to the partnership.
• The values assigned must be agreed to by all of
  the partners.

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Example

• Bert and Ernie begin a partnership. Bert invests
  12,000 and Ernie invests 5,000 plus a computer
  valued at 800.
• The Entry to establish this business is
• Cash 17,000
• Computer 800
• Bert, Capital 12,000
• Ernie, Capital 5,800

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

The partnership agreement should outline how
income or loss is divided among partners. This is
known as the income ratio. If there is no
partnership agreement, or it is not covered in
the partnership agreement, then all profits or
losses are shared equally.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

• The following are typical of the ratios that may
  be used
• 1. A fixed ratio, expressed as a proportion
  (21), a percentage (67 and 33), or a fraction
  (2/3 and 1/3).
• 2. A ratio based on either capital balances at
  the beginning of the year or on average capital
  balances during the year.
• 3. Salaries to partners and the remainder in a
  fixed ratio.
• 4. Interest on partners capital balances and the
  remainder in a fixed ratio.
• 5. Salaries to partners, interest on partners
  capital balances, and the remainder in a fixed
  ratio.

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Example 1
The partnership of Adams, Harris and Downs
divides income on an equal basis, they have
earned a net income of 75,000. The entries would
be Income Summary (or Revenue) 75 000  J.
Adams, Capital   25 000  K. Harris,
Capital   25 000  T. Downs, Capital  25
000
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Example 2
Jenny Adams and Kendall Harris have a
partnership. Jenny has a capital balance of 60
000 and Harris has a capital balance of 80 000.
Their partnership agreement states that they are
to be given a salary of 7 000 each, an interest
allowance of 5 on their capital balance and the
remainder to be allocated at 40 for Adams and
60 for Harris. The business earned 24000 during
the past year.

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Example 2

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

• The admission of a new partner results in the
  legal dissolution of the existing partnership and
  the beginning of a new partnership.
• A new partner may be admitted either by
• 1. Purchasing the interest of one or more
  existing partners, or
• 2. Investing assets in the partnership.

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

I. Purchase of a Partners Interest

• The admission of a partner by purchase of an
  interest in the firm is a personal transaction
  between one or more existing partners and the new
  partner.
• The price paid is negotiated and determined by
  the individuals involved it may be equal to or
  different from the capital equity acquired.
• Any money exchanged is the personal property
  of the participants and not the property of the
  partnership.

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

I. Purchase of a Partners Interest
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

I. Purchase of a Partners Interest
Why did Jenny and Kendall's capital only go up
20 000 when Ted paid them 22 000 each? The
purchase is a personal transaction. The 2000
extra goes directly to Jenny and Kendall. Ted
paid the extra amount because he thinks that the
business will do well.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership
When a partner is admitted by investment, both
the total net assets and the total partnership
capital change. When the new partners investment
differs from the capital equity acquired, the
difference is considered a bonus either to 1)
the existing (old) partners or 2) the new partner.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
existing partners

• The procedure for determining the new partners
  capital credit and the bonus to the old partners
  is as follows
• 1. Determine the total capital of the new
  partnership by adding the new partners
  investment to the total capital of the old
  partnership.
• 2. Determine the new partners capital credit by
  multiplying the total capital of the new
  partnership by the new partners ownership
  interest.
• 3. Determine the amount of bonus by subtracting
  the new partners capital credit from the new
  partners investment.
• 4. Allocate the bonus to the old partners on the
  basis of their income ratios.

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
existing partners
Jenny Adams and Kendall Harris have a partnership
and each have 60 000 in their capital accounts.
The partnership has been in operation for three
years now and is very successful. Ted Downs wants
to become a partner of the business with a 20
ownership share. Ted is going to invest 40 000.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
existing partners
Step 1 - Calculate the total capital of the new
partnership. Add the capital of the existing
partners and the investment of the new partner.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
existing partners
Step 2 - Calculate the amount of capital of the
new partner. This is done by multiplying the
total capital of the new business by the percent
of ownership to which the new partner agreed. In
this example, Ted Downs agreed to a 20 ownership
share 160 000 X .20 32 000
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
existing partners
Step 3 - Calculate the amount of the bonus to be
allocated to the existing partners. This is done
by taking the investment of the new partner and
subtracting the amount of capital to be allocated
as calculated in step 2. 40 000 - 32 000 8000
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
existing partners
Step 4 - Record the entry to admit the new
partner, allocating the bonuses to the existing
partners based on their income ratios. In this
case, Jenny and Kendall agreed to divide all
income or losses equally, therefore each of their
capital accounts will increase 4000 (8000 total
bonus divided in half).
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
existing partners
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
new partners
Jenny Adams and Kendall Harris have a partnership
and each have 60 000 in their capital accounts.
The partnership has been in operation for three
years now, and Jenny and Kendall have decided to
expand the manufacturing unit of the business.
They approached Ted Downs because he is currently
running the manufacturing section of another
company. Ted is excited about becoming a partner,
but is hesitant about leaving his current,
well-paying job. Jenny and Kendall offer Ted a
one-third share of the partnership if Ted agrees
to invest 30 000. Ted agrees.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
new partners
Step 1 - Calculate the total capital of the new
partnership. Add the capital of the existing
partners and the investment of the new partner.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
new partners
Step 2 - Calculate the amount of capital of the
new partner. This is done by multiplying the
total capital of the new business by the percent
of ownership to which the new partner agreed. In
this example, Ted Downs agreed to a one-third
ownership share 150 000 X 1/3 50 000
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
new partners
Step 3 - Calculate the amount of the bonus to be
allocated to the new partner. This is done by
taking the capital of the new partner as
calculated in step 2, and subtracting the amount
invested. 50 000 - 30 000 20 000
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
new partners
Step 4 - Record the entry to admit the new
partner, allocating the bonus to the new partner,
and decreasing the existing partner's capital
accounts based on their income ratios. In this
case, Jenny and Kendall agreed to divide all
income or losses equally therefore, each of
their capital accounts will decrease 10 000 (20
000 total bonus divided in half).
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

II. Investing assets in the partnership Bonus to
new partners
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

• A partner may withdraw from a partnership
  voluntarily by selling his or her equity in the
  firm or involuntarily by dying.
• The withdrawal of a partner may be accomplished
  by
• 1. payment from remaining partners personal
  assets or
• 2. payment from partnership assets.

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Existing Partners Using Personal Funds to Buy Out
Partner
If a partner is leaving, the remaining partners
may choose to buy him/her out with their personal
money. As is the case when a new partner buys an
existing partner's ownership share, this is a
personal transaction between the partners, and
the only change on the books of the business will
be a change in the capital accounts.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Existing Partners Using Personal Funds to Buy Out
Partner
Example Jenny Adams, Kendall Harris and Ted
Downs have a partnership with 80 000, 110 000,
and 55 000 in their capital accounts,
respectively. Jenny has worked hard over the
years and wants to retire. Kendall and Ted offer
Jenny 44 000 each (88 000 total) for a 50
share of her capital. Jenny accepts. The entry
would be
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Payment from Assets Bonus to Withdrawing Partner
Jenny Adams, Kendall Harris, and Ted Downs have a
partnership with 134 000, 144 000 and 140 000
respectively in their capital accounts. They have
an income ratio of 432. The partnership has
been in operation for fifteen years now and is
very successful. Ted Downs wants to retire and he
leaving the business on friendly terms. He
receives a cash payout of 160 000 on Nov. 1.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Payment from Assets Bonus to Withdrawing Partner
Step 1- Calculate the amount of the bonus to be
allocated to the outgoing partner. This is done
by taking the amount of the payout and
subtracting the balance in the capital
account. 160 000 - 140 000 20 000
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Payment from Assets Bonus to Withdrawing Partner
Step 2- Record the entry of the outgoing partner,
allocating the bonus to the existing partners
based on their income ratios. In this case, the
bonus of 20 000 is divided as follows Jenny
Adams 20 000 X 4/7 11 428.57 Kendall Harris
20 000 X 3/7 8 571.43
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Payment from Assets Bonus to Withdrawing Partner
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Payment from Assets Bonus to Remaining Partners
Jenny Adams, Kendall Harris, and Ted Downs have a
partnership with 134 000, 144 000 and 140 000
respectively in their capital accounts. They have
an income ratio of 432. Ted Downs wants to
retire and he leaving the business because it has
been struggling. He receives a cash payout of
105 000 on Nov. 1.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Payment from Assets Bonus to Remaining Partners
Step 1- Calculate the amount of the bonus to be
allocated to the remaining partners. This is done
by taking the balance in the capital account and
subtracting the amount of the payout. 140 000 -
105 000 35 000
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Payment from Assets Bonus to Remaining Partners
Step 2- Record the entry of the outgoing partner,
allocating the bonus to the existing partners
based on their income ratios. In this case, the
bonus of 35000 is divided as follows Jenny
Adams 35 000 X 4/7 20 000 Kendall
Harris 35 000 X 3/7 15 000
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Payment from Assets Bonus to Remaining Partners
As you can see above, the result of allocating a
bonus to the existing partners is an increase in
the capital accounts of the existing partners.
This is because Ted was paid less than the
balance in his capital account.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

The liquidation of a partnership terminates the
business.

• To liquidate a partnership, follow these steps
• 1. Sell noncash assets for cash and recognize any
  gain or loss on realization.
• 2. Allocate any gain or loss on realization to
  the partners based on their income ratios.
• 3. Pay partnership liabilities in cash.
• 4. Distribute remaining cash to partners based
  on their capital balances.

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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Capital Shortfall
It is possible for a partner to have a negative
(debit) balance in their Capital account when all
of the liquidation transactions are completed.
This could happen if a partner starts the
process with a low capital balance due to a
series of losses, selling assets below book
value, or a lot of drawings. If this happens,
the partner(s) with the debit balance owes the
businesses the amount of the shortfall.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

Capital Shortfall
If this happens, the partner(s) with the debit
balance owes the businesses the amount of the
shortfall. In order for the other partners to
collect their equity, the partner pays cash to
the business and then the remaining partners can
collect the full amount owing. If the shortfall
is not paid, or cannot be paid, the remaining
partners write off the amount that is owed, based
on the income sharing ratio, by debiting their
capital accounts and crediting the capital of the
partner with a debit balance to bring it to a
zero balance.
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• Establishing a Partnership
• Dividing Net Income (Loss)
• Adding a New Partner
• Withdrawal of a Partner
• Dissolution of the Partnership
• Equity Section of a Balance Sheet for a
  Partnership

The main difference between the equity section of
a partnership and the equity section of a sole
proprietorship is that the equity position of all
owners must be shown. The partners' equity
section of a balance sheet would look like this