Appendix D – Accounting for Partnerships
APP D-1
Appendix D
Accounting for Partnerships
Related Assignment Materials
Student Learning Objectives
Questions
Quick
Studies*
Exercises*
Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Identify characteristics of
partnerships and similar
organizations.
1, 2, 3, 4, 5,
7, 8, 9
D-1
D-1, D-2
CIP, ED
Analytical objectives:
Al. Compute partner return on
equity and use it to evaluate
partnership performance.
D-8
D-12
Procedural objectives:
P1. Prepare entries for partnership
formation.
D-4
TTN
P2. Allocate and record income and
loss among partners.
6, 7, 9
D-2, D-3
D-3, D-4,
D-5, D-6
D-1, D-2,
D-3
EC, TTN,
TIA
P3. Account for the admission and
withdrawal of partners.
12
D-5, D-6
D-7, D-8,
D-9
D-4
P4. Prepare entries for partnership
liquidation.
10, 11
D-7
D-10, D-11
D-5
*See additional information on next page that pertains to these quick studies, exercises and
problems.
Appendix D – Accounting for Partnerships
*Assignment materials that can be completed by students using:
Appendix D – Accounting for Partnerships
APP D-3
Appendix Outline
Notes
I. Partnership Form of Organization—An unincorporated association
of two or more people to pursue a business for profit as co-owners.
A. Characteristics of Partnerships
1. Voluntary Association between partners.
2. Partnership Agreement—partnership contract normally
includes details of partners’ (1) names and contributions, (2)
right and duties, (3) sharing of income and losses, (4)
withdrawal arrangement, (5) dispute procedures, (6) admission
and withdrawal of partners, and (7) rights and duties in the
event a partner dies. This agreement should be in writing but is
binding even if only expressed orally.
3. Limited Life—death, bankruptcy, or expiration of the contract
period automatically ends a partnership.
4. Taxation—partnerships are not subject to tax on income—
partners report their share of income on their personal income
tax return.
5. Mutual agency—each partner is an agent of the partnership
and can enter into and bind the partnership to any contract
within the normal scope of its business.
6. Unlimited liability—each general partner is responsible for
payment of all the debts of the partnership if the other partners
are unable to pay their share.
7. Co-Ownership of Property—assets are owned jointly by all
partners but claims on partnership assets are based on their
capital account and the partnership contract.
B. Organizations with Partnership Characteristics
1. Limited Partnership (L.P. or Ltd.) has two classes of partners,
general and limited. General partners assume unlimited
liability for the debts of the partnership. The limited partners
assume no personal liability beyond their invested amounts and
cannot take an active role in managing the company.
2. Limited liability partnership (L.L.P.) is designed to protect
innocent partners from malpractice or negligence claims
resulting from the acts of another partner. Generally, all
partners are personally liable for other partnership debts.
3. S Corporation has 75 or fewer stockholders, is treated as a
partnership for income tax purposes but otherwise is accounted
for as a “C” corporation.
4. Limited Liability Company (L.L.C. or L.C) owners are called
members, are protected with the limited liability feature as
owners of corporations and can assume an active management
role. L.L.C.’s have a limited life and are typically classified as
a partnership for tax purposes.
Appendix D – Accounting for Partnerships
APP D-4
Appendix Outline
Notes
C. Choosing a Business Form
Factors to be considered include: taxes, liability risk, tax and fiscal
year-end, ownership structure, estate planning, business risks, and
earnings and property distributions.
II. Basic Partnership Accounting—same as accounting for a
proprietorship except for transactions directly affecting partners’
equity. Use separate capital and withdrawal accounts for each partner.
A. Organizing a Partnership
Each partner’s investment is recorded at an agreed upon value,
normally the fair market value of the assets and liabilities at their
date of contribution.
B. Dividing Income or Loss
1. Any agreed upon method of dividing income or loss is
allowed. If there is no agreement, the net income or loss is
divided equally.
2. Common methods of dividing partnership earnings use:
a. Allocation on stated ratios—partners must agree on the
fractional share each receives.
b. Allocation on capital balances—based on the ratio of each
partner’s relative capital balance.
c. Allocation on service, capital, and stated ratios—salary
and interest allowances, and a fixed ratio are specified.
i. When income exceeds allowances, the remainder is
allocated to individual partners using a fixed ratio and
added to their individual planned allowance.
ii. When allowances exceed the income, the negative
amount or shortage is allocated using the ratio and
applied against each partner’s total allowance.
3. Salaries to partners and interest on partners’ investments are
not partnership expenses; they are allocations of net income.
4. Partners may agree to salary and interest allowances to reward
unequal contributions of services or capital.
C. Partnership Financial Statements
Similar to those of other organizations except:
1. The statement of partners’ equity shows changes for each
partner’s capital account, including the allocation of income.
2. The equity section of the balance sheet generally lists a
separate capital account for each partner.
Appendix D – Accounting for Partnerships
APP D-5
Appendix Outline
Notes
III. Admission and Withdrawal of Partners
A. Admission of a Partner
1. Purchase of Partnership Interest
a. The purchase is a personal transaction between one or
more current partners and the new partner.
b. Purchaser does not become a partner until accepted by the
current partners.
c. Involves a reallocation of current partners’ capital to
reflect the transaction.
2. Investing Assets in a Partnership
a. The transaction is between the new partner and the
partnership. Invested assets become partnership property.
b. New partner’s equity recorded for assets invested may be
equal to, less than, or greater than the investment.
c. Bonuses to old partners are allocated based on their
income and loss sharing agreement. Occurs when current
value of partnership is greater than the recorded amounts
of equity so partners will require new partner to pay a
bonus for the privilege of joining.
d. Bonus to new partner when the new partner’s equity
differs from the investment. Occurs when new partner
needs additional cash or has exceptional talents.
B. Withdrawal of a Partner—two ways:
1. Withdrawing partner sells his or her interest to another person
who pays cash or other assets to the withdrawing partner.
2. Cash or other assets of the partnership can be distributed to the
withdrawing partner in settlement of his or her interest.
3. No Bonus if withdrawing partner takes cash or assets equal to
his/her equity balance.
4. Bonus to Remaining Partners when withdrawing partner is
willing to take less than the recorded value of his or her
equity, there is a bonus to remaining partner’s equity.
5. Bonus to Withdrawing Partner which means that the remaining
partners reduce their equity by the amount of the bonus given
to the withdrawing partner.
C. Death of a Partner
1. Dissolves a partnership.
2. Deceased partner’s estate is entitled to receive his or her
equity. Contract usually calls for closing of the books and
determining current value of assets and liabilities to update
equity.
3. Settlement of the deceased partner’s equity can involve selling
the equity to remaining partners or to an outsider, or it can
involve withdrawing assets.
Appendix D – Accounting for Partnerships
APP D-6
Appendix Outline
Notes
IV. Liquidation of a Partnership
A. Involves four steps:
1. Noncash assets are sold for cash and a gain or loss on
liquidation is recorded.
2. Allocate gain or loss from liquidation of the assets to partners
using their income-and-loss ratio.
3. Pay or settle all partner liabilities.
4. Distribute any remaining cash to partners based on their
capital account balances.
B. Allocating gains or losses on liquidation may result in:
1. No Capital Deficiency—all partners’ have a zero or credit
balance in their capital accounts equivalent to final
distribution of cash.
2. Capital deficiency—when at least one partner has a debit
balance in his/her capital account.
a. Partners Pays Deficiency: partners with a capital
deficiency, must, if possible, cover the deficit by paying
cash into the partnership.
b. Partner Cannot Pay Deficiency: when a partner is unable
to pay the deficiency, the remaining partners with credit
balances absorb the unpaid deficit according to their
income-and-loss ratio. Inability to cover deficiency does
not relieve partner of liability.
V. Global View – Partnership accounting according to U.S. GAAP is
similar, but not identical, to that under IFRS.
A. Both U.S. GAAP and IFRS include broad and similar guidance for
partnership accounting.
B. Different legal systems dictate different implications and
motivations for how a partnership is effectively setup.
C. Accounting for partnership admission, withdrawal, and liquidation
is similar worldwide. These procedures depend on the partnership
agreements constructed by all parties involved.
D. Different legal systems impact those agreements and their
implications to the parties.
VI. Decision Analysis—Partnership Return on Equity
A. The partnership return on equity ratio evaluates partnership
success compared with other opportunities.
B. It is calculated by dividing a partner’s share of net income by that
partner’s average partner equity.
Appendix D – Accounting for Partnerships
APP D-7
Appendix D Alternative Demonstration Problem #1
Sand, Mell, and Rand are partners who share incomes and losses in a
1:4:5 ratio. After lengthy disagreements among the partners and several
unprofitable periods, the partners decided to liquidate the partnership.
Before the liquidation, the partnership balance sheet showed Cash
$10,000, total “other assets”, $106,000; total liabilities, $88,000; Sand,
Capital, $1,200; Mell, Capital, $11,700; and Rand, Capital, $15,100. The
“other assets” were sold for $ 85,000.
Determine the following:
1. The gain (or loss) realized on the sale of the assets.
2. The balances in the partners’ capital accounts after the distribution
of this gain or loss to the capital accounts.
3. Assume that if any capital deficits exist, they are not made-up. How
much cash will each of the partners receive in the final liquidation?
Appendix D – Accounting for Partnerships
APP D-8
SOLUTION: Appendix D Alternative Demonstration Problem #1
1.
Proceeds from sale
$85,000
Cost of other assets
106,000
Loss on sale
21,000
2.
Sands
Mell
Rand
Capital account balance prior to
distribution of loss on sale of
assets
$1,200
$11,700
$15,100
Distribution of loss
(1/10 to Sands, 4/10 to Mell,
and 5/10 to Rand)
(2,100
)
(8,400
)
(10,500
)
Capital account balance after
distribution of loss on sale of
assets
$ (900
)
$ 3,300
$ 4,600
3.
Sands
Mell
Rand
Capital account balance after
distribution of loss on sale of
assets
$ (900
)
$3,300
$4,600
Distribution of deficit in Sands
account (4/9 to Mell, and
5/9 to Sands)
900
(400
)
(500
)
Amount of cash each partner
receives in final liquidation
none
$2,900
$4,100