Lecture Accounting principles (7th Edition): Chapter 13 – Weygandt, Kieso, Kimmel

Accounting Principles, 7th Edition
Weygandt • Kieso • Kimmel

Chapter 13

Accounting for
Partnerships
Prepared by Naomi Karolinski
Monroe Community College
 and
Marianne Bradford
Bryant College

 

 

John Wiley & Sons, Inc. © 2005


CHAPTER 13

ACCOUNTING
FOR PARTNERSHIPS

 

After studying this chapter, you should be 
able to:
1 Identify the characteristics of the 
partnership form of business organization.

2 Explain the accounting entries for the 
formation of a partnership.
3 Identify the basis for dividing net income or 
net loss.
4 Describe the form and content of 
partnership financial statements.
5 Explain the effects of the entries to record 
liquidation of a partnership.
 


PARTNERSHIP FORM OF ORGANIZATION
STUDY OBJECTIVE 1

• Uniform Partnership Act 

– basic rules for the formation and operation 
of partnerships in more than 90 percent of 
the states
– defines a partnership
• an association of two or more
  persons to carry on as 
  co­owners of a business for
  a profit.

 

 

CHARACTERISTICS OF
PARTNERSHIPS
Principal characteristics of a partnership 
1 Association of individuals
2 Mutual agency
3 Limited life
4 Unlimited liability
5 Co­ownership of property

 

 


PARTNERSHIP
CHARACTERISTICS

 

 


MUTUAL AGENCY
• Mutual agency 
– each partner acts on behalf of the partnership 
when engaging in partnership business 
– act of any partner is binding on all other 
partners
• (true even when partners act beyond the scope of 
their authority, so long as the act appears to be 

appropriate for the partnership)

 

 


ASSOCIATION OF
INDIVIDUALS
• Association of individuals 
– may be based on as simple an act as a handshake, it is 
preferable to state the agreement in writing

• A partnership 
– legal entity for certain purposes (i.e., property can be owned in 
the name of the partnership)
– accounting entity for financial reporting purposes

• Net income of a partnership
– not taxed as a separate entity
– each partner’s share of income is taxable at personal tax rates

 

 


LIMITED LIFE
• Partnerships 
– have a limited life

– dissolution 
•  whenever a partner withdraws or a new partner is 
admitted

– ends involuntarily 
• by death or incapacity of a partner

– may end voluntarily 
• through acceptance of a new partner or withdrawal of a 
partner

 

 


UNLIMITED LIABILITY
• Unlimited liability
–  each partner is personally and individually 
liable for all partnership liabilities.
– creditors’ claims attach first to partnership 
assets
– if insufficient assets
•  claims then attach to the personal resources of any 
partner, irrespective of that partner’s capital equity in 
the company

 

 

CO-OWNERSHIP OF PROPERTY
• Partnership Assets 
– assets invested in the partnership are owned jointly 
by all the partners

• Partnership Income or Loss 
– co­owned; if the partnership contract does not 
specify to the contrary, net income or net loss is 
shared equally by the partners

 

 


ADVANTAGES AND DISADVANTAGES OF
A PARTNERSHIP

 

 


THE PARTNERSHIP AGREEMENT
Partnership agreement (Articles of co­partnership) 
– written contract 
1 Names and capital contributions of the partners.

2 Rights and duties of partners.
3 Basis for sharing net income or net loss.
4 Provision for withdrawals of assets.
5 Procedures for submitting disputes to arbitration.
6 Procedures for the withdrawal or addition of a partner.
7 Rights and duties of surviving partners in the event of a partner’s 
death.

 

 


Which of the following is not a
characteristic of a partnership:
a. Taxable entity.
b. Co-ownership of property.
c. Mutual agency.
d. Limited Life.
 

 


Which of the following is not a
characteristic of a partnership:
a. Taxable entity.
b. Co-ownership of property.
c. Mutual agency.
d. Limited Life.

 

 


FORMING A PARTNERSHIP
STUDY OBJECTIVE 2

• Initial investment 

– recorded at the fair market value of the assets 
at the date of their transfer to the partnership
– values assigned must be agreed to by all of the 
partners

•  Once partnership has been formed

– accounting is similar to accounting for 
transactions of any other type of business 
organization

Computer recorded at its FMV of $2,500
instead of book value, which after
depreciation may be much lower.
 
 


BOOK AND MARKET VALUE
OF ASSETS INVESTED

A. Rolfe and T. Shea combine their proprietorships to start a
partnership. They have the following assets prior to the
formation of the partnership:

Cash
Office equipment
Accumulated depreciation
Accounts receivable
Allowance for doubtful accounts

 

 

Book Value
Market Value
A. Rolfe
T. Shea
A. Rolfe
T. Shea
$ 8,000 $ 9,000 $ 8,000 $ 9,000
5,000
4,000
( 2,000)
4,000
4,000
( 700)
( 1,000)
$ 11,000 $ 12,300 $ 12,000 $ 12,000

RECORDING INVESTMENTS
IN A PARTNERSHIP
Entries to record the investments are:

 

 


DIVIDING NET INCOME
OR NET LOSS
• Partnership net income or net loss 
– shared equally unless the partnership 
contract indicates otherwise
– is called the income ratio or the profit and 
loss ratio
– partner’s share of net income or net loss  is 
recognized in the accounts through closing 
entries
 

 


CLOSING ENTRIES

 

4 closing entries are required for a partnership:
1) Debit each revenue account for its balance and 
 
credit Income Summary for total revenues.
2) Debit Income Summary for total expenses and 
credit each expense account for its balance.
3) Debit (credit) Income Summary for its balance and 
credit (debit) each partner’s capital account for his 
or her share of net income (net loss).
4) Debit each partner’s capital account for the 
balance in that partner's drawing account and   
credit each partner’s drawing account for the 
same               amount.
 

 
 
 
 
 
 


CLOSING ENTRIES
The first 2 entries are the same as a 
proprietorship, while the last 2 entries are 
different because:
1) there are 2 or more owners’
       capital and drawing accounts
2)   it is necessary to divide net

       income or loss among the                     
partners.
 

 


CLOSING NET INCOME AND
DRAWING ACCOUNTS
The AB Company has net income of $32,000 for 2005. The partners, L. Arbor and
D. Barnett, share net income and net loss equally, and drawings for the year were
Arbor $8,000 and Barnett $6,000. The last two closing entries are:

 

 


PARTNERS’ CAPITAL AND DRAWING
ACCOUNTS AFTER CLOSING
Beginning capital balance is $47,000 for Arbor and    
                                               $36,000 for Barnett,
the capital and
drawing accounts
will show the
following after
posting the closing
entries:
 

 


INCOME RATIOS
STUDY OBJECTIVE 3
The partnership agreement should specify the basis for sharing 
net income or net loss. Typical income ratios:
1 A fixed ratio
–

expressed as a proportion (6:4), a percentage (70% and 30%), 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 on a fixed ratio.
4 Interest on partners’ capital balances and the remainder  on a 
  fixed ratio
5 Salaries to partners, interest on partners’ capitals, and the       
     remainder on a fixed ratio
 
 


TYPICAL INCOME-SHARING RATIOS
Salaries, Interest and the Remainder on a Fixed Ratio

Sara King and Ray Lee agree to

A. Salary Allowance of $8,400 to King, $6,000 to 
Lee
B. Interest of 10% on Capital Balances
C. Remainder Equally

 

 


TYPICAL INCOME-SHARING RATIOS
Salaries, Interest and the Remainder on a Fixed Ratio

Capital balances - January 1, 2005
Sara King – $28,000
Ray Lee – $24,000