Lecture Principles of financial accouting - Chapter 12: Accounting for partnerships

Chapter 12

Accounting for Partnerships

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw­Hill/Irwin

        Copyright © 2011 by The McGraw­Hill Companies, Inc. All rights reserved.


12 ­ 2

C 1

Partnership Form of Organization
Voluntary
Voluntary
Association
Association

Partnership
Partnership
Agreement
Agreement

Limited

Limited
Life
Life

Taxation
Taxation

Mutual
Mutual
Agency
Agency

CoCoOwnership
Ownership
of
of Property
Property

Unlimited
Unlimited
Liability
Liability


12 ­ 3

C 1

Organizations with Partnership
Characteristics

Limited
Limited
Partnerships
Partnerships
(LP)
(LP)

•• General
General partners
partners
assume
assume management
management
duties
duties and
and unlimited
unlimited
liability
liability for
for partnership
partnership
debts.
debts.
•• Limited
Limited partners
partners
have
have no
no personal
personal

liability
liability beyond
beyond
invested
invested amounts.
amounts.

Limited
Limited
Liability
Liability
Partnerships
Partnerships
(LLP)
(LLP)
•• Protects
Protects innocent
innocent
partners
partners from
from
malpractice
malpractice or
or
negligence
negligence claims.
claims.
•• Most
Most states
states hold

hold all
all
partners
partners personally
personally
liable
liable for
for partnership
partnership
debts.
debts.

Limited
Limited
Liability
Liability
Corporations
Corporations
(LLC)
(LLC)

•• Owners
Owners have
have same
same
limited
limited liability
liability feature
feature
as

as owners
owners of
of aa
corporation.
corporation.
•• A
A limited
limited liability
liability
corporation
corporation typically
typically
has
has aa limited
limited life.
life.


12 ­ 4

C 1

Choosing a Business Form

Many
Many factors
factors should
should be
be considered
considered when

when
choosing
choosing the
the proper
proper business
business form.
form.


12 ­ 5

P 1

Organizing a Partnership
Partners can invest both assets and liabilities in
the partnership.
Assets and liabilities are recorded at an agreedupon value, normally fair market value.
Asset contributions increase the partner’s capital
account.
Withdrawals from the partnership decrease the
partner’s capital account.


12 ­ 6

P 1

Organizing a Partnership
In
In accounting

accounting for
for partnerships:
partnerships:
1.
1.Partners
Partners’’ withdrawals
withdrawals are
are debited
debited to
to their
their own
own separate
separate
withdrawals
withdrawals account.
account.
2.
2.Partners
Partners’’ capital
capital accounts
accounts are
are credited
credited (or
(or debited)
debited) for
for
their
their shares
shares of
of net

net income
income (or
(or net
net loss)
loss) when
when closing
closing the
the
accounts
accounts at
at the
the end
end of
of the
the period.
period.
3.
3.Each
Each partner
partner’s
’s withdrawal
withdrawal account
account is
is closed
closed to
to that
that
partner’s
partner’s capital
capital account.

account. Separate
Separate capital
capital and
and withdrawals
withdrawals
accounts
accounts are
are kept
kept for
for each
each partner.
partner.


12 ­ 7

P 1

Organizing a Partnership
On 1/11, Kayla Zayn and Hector Perez organize a
partnership called BOARDS. Zayn’s initial investment
is $7,000 cash, $33,000 in boarding facilities, and a
note payable for $10,000 on the boarding facilities.
Perez’s initial investment is $10,000 cash.
Jan 11

Cash
Boarding Facilities
Notes Payable
K. Zayn, Capital

7,000
33,000
10,000
30,000

To record Zayn's initial investment.

Jan 11

Cash

10,000
H. Perez, Capital

To record Perez's initial investment.

10,000


12 ­ 8

P 2

Dividing Income or Loss
Partners are not employees of the partnership but are its
owners. This means there are no salaries reported as
expense on the income statement. Profits or losses of the
partnership are divided on some agreed upon ratio.

Three frequently used methods to divide
income or loss are allocation on:
1. Stated ratios.
2. Capital balances.
3. Services, capital and stated ratios.


12 ­ 9

P 2

Allocation on Stated Ratios
In the partnership agreement, Zayn is to receive
2/3 and Perez 1/3 of partnership income or loss. If
the partnership income is $60,000, we will allocate
the income to partners as follows:

$60,000 × 2/3 = $40,000


12 ­ 10

P 2

Allocation on Capital Balances
In
In their
their partnership
partnership agreement,
agreement, Zayn

Zayn and
and Perez
Perez agree
agree
to
to allocate
allocate profits
profits and
and losses
losses on
on the
the basis
basis of
of their
their
beginning
beginning capital
capital balances.
balances.
Balance
K. Zayn, Capital $ 30,000
H. Perez, Capital
10,000
Totals
$ 40,000

Ratio
75%
25%
100%

Dec 31 Income Summary
K. Zayn, Capital
H. Perez, Capital

Income
$ 60,000
60,000

Allocation
$ 45,000
15,000
$ 60,000

60,000

To allocate income to partner's capital.

45,000
15,000


12 ­ 11

P 2

Allocation on Services, Capital,
and Stated Ratios
Zayn and Perez have a partnership agreement
with the following conditions:

1.Zayn receives a $36,000 annual salary
allowance and Perez receives an allowance of
$24,000.
2.Each partner is allowed an annual interest
allowance of 10% on their beginning capital
balance.
3.Any remaining balance of income or loss is
allocated equally.
Net income is $70,000.


12 ­ 12

P 2

Allocation on Services, Capital,
and Stated Ratios

Net income
Salaries
Interest
Equal allocation
Income to each partner

Income Allocation
Zayn
Perez
Remainder
$
70,000

$
36,000
$
24,000
10,000
3,000
1,000
6,000
3,000
3,000
42,000
28,000

$30,000
$30,000 ×× 10%
10% == $3,000
$3,000

$6,000
$6,000 ×× ½
½ == $3,000
$3,000


12 ­ 13

P 2

Allocation on Services, Capital, and Stated
Ratios

Now let’s assume that net income is only $50,000.
Net income
Salaries
Interest
Equal allocation
Income to each partner

Income Allocation
Zayn
Perez
Remainder
$
50,000
$
36,000
$
24,000
(10,000)
3,000
1,000
(14,000)
(7,000)
3,000
(7,000)
3,000
(20,000)
42,000
32,000
28,000
18,000

($14,000)
($14,000) ×× ½
½ == ($7,000)


12 ­ 14

P 2

Partnership Financial Statements
During 2009, Zayn withdrew $20,000 cash from the partnership and
Perez withdrew $12,000. Net income for the year is $70,000.
BOARDS
Statement of Partners' Equity
For the Year Ended December 31, 2011
Zayn
Perez
Total
Beginning capital balances
$
$
$
Investments by owners
30,000
10,000
40,000
Net income
Salary allowances
$ 36,000

$ 24,000
Interest allowances
3,000
1,000
Balance allocated
3,000
3,000
Total net income
42,000
28,000
70,000
Less partners' withdrawals
(20,000)
(12,000)
(32,000)
Ending capital balances
$ 52,000
$ 26,000 $
78,000


12 ­ 15

P 3

Admission and Withdrawal of Partners




When the makeup of the partnership changes,
the existing partnership is dissolved.
A new partnership may be immediately
formed.
New partner acquires partnership interest by:
1. Purchasing it from the other partners, or
2. Investing assets in the partnership.


12 ­ 16

P 3

Purchase of Partnership Interest


A new partner can purchase
partnership interest directly from
the existing partners.
The cash goes to the partners, not
to the partnership.



To become a partner, the new
partner must be accepted by the
current partners.


12 ­ 17

P 3

Purchase of Partnership Interest
On January 4th, Hector Perez sells one-half of his
partnership interest to Tyrell Rasheed for $18,000. Perez
gives up a $13,000 recorded interest in the partnership.

Capital balances before new partner
Allocation to new partner
Capital balances after new partner

Zayn
Perez
Rasheed
Total
$ 52,000 $ 26,000 $
$ 78,000
(13,000)
13,000
$ 52,000 $ 13,000 $ 13,000 $ 78,000


12 ­ 18

P 3

Investing Assets in a Partnership
The new partner can gain
partnership interest by

contributing assets to the
partnership.
 The new assets will increase
the partnership’s net assets.
 After admission, both assets
and equity will increase.



12 ­ 19

P 3

Investing Assets in a Partnership
On January 4th, Tyrell Rasheed is admitted to the
partnership with a payment of $22,000 cash.

Capital balances before new partner
Allocation to new partner
Capital balances after new partner

Zayn
Perez
Rasheed
Total
$ 52,000 $ 26,000 $
$ 78,000
22,000
22,000
$ 52,000 $ 26,000 $ 22,000 $ 100,000

12 ­ 20

P 3

Bonus to Old or New Partners
Bonus to Old
Partners

When
When the
the current
current value
value of
of aa
partnership
partnership is
is greater
greater than
than the
the
recorded
recorded amounts
amounts of
of equity,
equity, the
the old
old
partners

partners usually
usually require
require aa new
new partner
partner
to
to pay
pay aa bonus
bonus when
when joining.
joining.

Bonus to New
Partners

The
The partnership
partnership may
may grant
grant aa bonus
bonus to
to
aa new
new partner
partner if
if the
the business
business is
is in
in

need
need of
of cash
cash or
or if
if the
the new
new partner
partner has
has
exceptional
exceptional talents.
talents.


12 ­ 21

P 3

Bonus to Old Partners
On January 4th, Zayn and Perez agree to accept Rasheed
as a partner upon his investment of $42,000 cash in the
partnership. Rasheed is to receive a 25% ownership interest
in the new partnership. Any bonus is attributable to the
existing partners and is shared equally.
Equity of Zayn and Perez
Investment by Rasheed
Total partnership equity
Rasheed's ownership percent
Rasheed's equity balance

$ 78,000
42,000
120,000
25%
$ 30,000


12 ­ 22

P 3

Bonus to Old Partners
On January 4th, Zayn and Perez agree to accept Rasheed
as a partner upon his investment of $42,000 cash in the
partnership. Rasheed is to receive a 25% ownership interest
in the new partnership. Any bonus is attributable to the
existing partners and is shared equally.

$42,000
$42,000 -- $30,000
$30,000 == $12,000
$12,000 ×× ½
½ == $6,000
$6,000


12 ­ 23

P 3

Bonus to New Partner
On January 4thth, Zayn and Perez agree to accept
Rasheed as a partner upon his investment of $18,000
cash in the partnership. Rasheed is to receive a 25%
ownership interest in the new partnership. Any bonus is
attributable to Rasheed’s excellent business skills.
Equity of Zayn and Perez
Investment by Rasheed
Total partnership equity
Rasheed's ownership percent
Rasheed's equity balance

$ 78,000
18,000
96,000
25%
$ 24,000


12 ­ 24

P 3

Bonus to New Partner
On January 4thth, Zayn and Perez agree to accept
Rasheed as a partner upon his investment of $18,000
cash in the partnership. Rasheed is to receive a 25%
ownership interest in the new partnership. Any bonus is
attributable to Rasheed’s excellent business skills.

$18,000
$18,000 -- $24,000
$24,000 == ($6,000)
($6,000) ×× ½
½ == ($3,000)
($3,000)


12 ­ 25

P 3

Withdrawal of a Partner
A partner can withdraw
in two ways:
The partner can sell his/her
partnership interest to
another person.
 The partnership can
distribute cash and/or other
assets to the withdrawing
partner.
