Advanced financial accounting by baker chapter 15

15
Partnerships:
Formation,
Operation, and
Changes
in Membership

McGraw-Hill/Irwin

© 2009 The McGraw-Hill Companies, Inc. All rights reserved.


Overview
•

Accounting for partnerships requires
recognition of several important factors
–

From an accounting viewpoint, the partnership is a separate
business entity

–

Accrual accounting, cash basis accounting, or modified cash
basis of accounting are allowed

15-2


Nature of Partnership Entity

•

Legal regulation
–

Each state regulates the partnerships that are formed in it

–

Each state tends to begin with a model act and then modifies
it to fit that state’s business culture and history

–

Most states have now adopted the Uniform Partnership Act of
1997 (UPA 1997) as the model act

15-3


Nature of Partnership Entity
•

Definition of a partnership
–

Section 202 of the UPA 1997 states that, “. . . the association
of two or more persons to carry on as co-owners of a business
for profit forms a partnership . . .”

15-4


Nature of Partnership Entity
•

Definition of a partnership
–
–

–

Association of two or more persons – The “persons”
may be individuals, corporations or other partnerships
To carry on as co-owners – Each partner has the
apparent authority, unless restricted by the partnership
agreement, to act as an agent of the partnership for
transactions in the ordinary course of business
Business for profit – The partnership must attempt to
make a profit; therefore, not-for-profit entities, such as
fraternal groups, may not organize as partnerships

15-5


Nature of Partnership Entity
•

Formation of a partnership
–

Easy to form

–

The agreement to form a partnership may be informal or
formal

–

Each partner must agree to the formation agreement, and
partners are strongly advised to have a formal written
agreement to avoid potential problems later

15-6


Nature of Partnership Entity
•

Other major characteristics
–

Partnership agreement: The UPA 1997 is used by the courts
when there is no partnership agreement

–

Partnership as a separate entity: The entity concept means
that a partnership can sue or be sued and that partnership

property belongs to the partnership and not to any individual
partner

15-7


Nature of Partnership Entity
•

Other major characteristics
–

Partner is an agent of the partnership: The agency relationship
among the partners is very important

–

Statement of partnership authority: Describes the partnership
and identifies the specific authority of partners to transact

15-8


Nature of Partnership Entity
•

Other major characteristics
–

Partner’s liability is joint and several: All partners are liable

jointly and severally for all obligations of the partnership unless
otherwise provided by law

–

Partner’s rights and duties: Each partner is to have a capital
account presenting the amount of that partner’s contributions
to the partnership, net of any liabilities, and the partner’s share
of the partnership profits or losses, less any distributions

15-9


Nature of Partnership Entity
•

Other major characteristics
–

Partner’s transferable interest in the partnership: A partner is
not a co-owner of any partnership property

–

Partner’s dissociation: A partner’s dissociation means that the
partner can no longer act on behalf of the partnership

15-10

Nature of Partnership Entity
•

Types of limited partnerships
–

Limited Partnerships (LP)

•
•

•

There is at least one general partner and one or
more limited partners
The general partner is personally liable for the
obligations of the partnership and has
management responsibility
Limited partners are liable only to the extent of
their capital contribution but do not have any
management authority

15-11


Nature of Partnership Entity
•

Types of limited partnerships
–

Limited Liability Partnerships (LLP)

•
•
•

One in which each partner has some degree of
liability shield
There are no general or limited partners
Each partner has the rights and duties of a
general partner, but limited legal liability

15-12


Nature of Partnership Entity
•

Types of limited partnerships
–

Limited Liability Limited Partnership (LLLP)

•

•

Each partner is liable only for the business
obligations of the partnership, and not for acts of

malpractice by the other partners in the normal
course of the partnership’s business
General partners, even though responsible for
management of the partnership, have no
personal liability for partnership obligations

15-13


Nature of Partnership Entity
•

Accounting and financial reporting
requirements for partnerships
–

For internal reporting needs, non-GAAP accounting methods
may be used and financial reports may be in a format different
from those required under GAAP

–

To issue general-purpose financial statements for external
users, generally accepted accounting principles should be
used

15-14


Accounting for the Formation of a

Partnership
•

At the formation of a partnership:
–

Assign a proper value to the noncash assets and liabilities
contributed

–

Distinguish between capital contributions and loans made to
the partnership by individual partners

–

Distinguish between tangible assets owned by the partnership
and those specific assets that are owned by individual
partners but are used by the partnership

15-15


Accounting for the Formation of a
Partnership
•

•

FASB Statement No. 157: Contributed

assets should be valued at their fair values,
which may require appraisals or other
valuation techniques
Liabilities assumed by the partnership
should be valued at the present value of the
remaining cash flows

15-16


Accounting for the Formation of a
Partnership
•

•

The individual partners must agree to the
percentage of equity that each will have in
the net assets of the partnership
Generally, the capital balance is determined
by the proportionate share of each partner’s
capital contribution

15-17


Accounting for Operations of a
Partnership
•

Partners’ accounts
–

Capital accounts

•

•

Used to record the initial investment of a partner,
any subsequent capital contributions, profit or
loss distributions, and any withdrawals of capital
by the partner
Deficiencies are usually eliminated by additional
capital contributions

15-18


Accounting for Operations of a
Partnership
•

Partners’ accounts
–

Drawing accounts

•
•

–

Used to record periodic withdrawals and is then
closed to the partner’s capital account at the end
of the period
Noncash drawings are valued at their market
values at the date of the withdrawal

Loan accounts

•
•

A loan from a partner is shown as a payable on
the partnership’s books
Unless all partners agree otherwise, the
partnership is obligated to pay interest on the
loan
15-19


Allocating Profit or Loss to Partners
•

•
•

Profit or loss is allocated to the partners at
the end of each period in accordance with
the partnership agreement

If no agreement exists, all partners are to
share profits and losses equally (UPA 1997)
Profit distribution plans
–

Preselected ratio

–

Interest on capital balances

–

Salaries to partners

–

Bonuses to partners
15-20


Allocating Profit or Loss to Partners
•

•

The profit or loss distribution is recorded
with a closing entry at the end of each
period
The revenue and expenses are closed into

an income summary account or directly into
the partners’ capital accounts

15-21


Allocating Profit or Loss to Partners
•

Multiple bases of profit allocation
–

A combination of several allocation procedures:

Example: (AB Partnership)
•
•
•
•

Interest of 15 percent on weighted-average capital balances.
Salaries of $2,000 for A and $5,000 for B.
A bonus of 10 percent to be paid to B on partnership income exceeding
$5,000 before subtracting the bonus, partners’ salaries, and interest on
capital balances.
– Agreement should have a provision to specify the allocation
Any residual to be allocated in the ratio of 60 percent to A and 40 percent
process in a deficiency situation
to B.

15-22


Partnership Financial Statements
•

In addition to the three basic financial
statements, a statement of partners’ capital
is prepared to present the changes in the
partners’ capital accounts for the period

15-23


Changes in Membership
•

New partners are often a source of
additional capital or business expertise
–

Admission of a new partner is subject to the unanimous
approval of the present partners

–

Public announcements are typically made

–

A new partner is not personally liable for any partnership
obligation incurred prior to admission

15-24


Changes in Membership
•

Retirement or withdrawal of a partner from a
partnership is a dissociation of that partner
–

This does not necessarily mean a dissolution and winding up
of the partnership

–

The partnership may purchase the dissociated partner’s
interest at a buyout price

–

Partners who simply wish to leave may be liable to the
partnership for damages caused by a wrongful dissociation

15-25