BAKER LEMBKE KING advanced financial accounting 8e chapter 015

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.
Any residual to be allocated in the ratio of 60 percent to A and 40 percent
to B.

– Agreement should have a provision to specify
the allocation process in a deficiency situation
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