Chapter 12
Accounting for Partnerships
Learning Objectives
1. Dene the partnership form of business, and identify its principal characteristics.
2. Record partners’ investments of cash and other assets when a partnership is formed.
3. Compute and record the income or losses that partners share, based on stated ratios,
capital balance ratios, and partners’ salaries and interest.
4. Record a person’s admission to or withdrawal from a partnership
5. Compute and record the distribution of assets to partners when they liquidate their
partnership.
6. Identify alternate forms of partnership-type entities.
Section 1: Concepts
Concept
Separate entity
Lecture Outline
I. A partnership is an association of two or more persons to carry on as co-owners of a
business for prot.
II. Partnerships are considered separate accounting entities but not separate legal
entities.
III. The partnership form of business has the following important characteristics:
A. A partnership is a voluntary association.
B. A partnership agreement should outline the following details:
1. Name, location, and purpose of the business
2. Names of the partners and their respective duties
3. Investments of each partner
4. Method of distributing income and losses
5. Procedures for the admission and withdrawal of partners, the withdrawal of
assets allowed each partner, and liquidation of the business
C. A partnership has limited life and may be dissolved when:
1. A new partner is admitted.
2. When a partner withdraws, goes bankrupt, is incapacitated, or dies
3. When the terms of the partnership agreement are met, if the partnership. was
formed for the completion of a specic project.
D. A partnership is a mutual agency
1. Any partner can bind the partnership to a business agreement as long as it is
within the scope of the business’s normal operations.
E. Each partner has personal unlimited liability for partnership debts.
F. Invested property becomes jointly owned.
G. Each partner has the right to share income and the responsibility to share
losses.
1. Income and losses do not have to be distributed in the same proportions.
2. If partnership agreement does not describe how losses are distributed, then
the losses are distributed the same way as income.
3. If partnership agreement does not describe income or loss distributions, the
partners share income and losses equally
IV. A partnership’s advantages include that it:
A. Is easy to form, change, and dissolve.
B. Facilitates pooling of capital and individual talents.
C. Has no corporate tax burden.
D. Allows 8exibility.
V. A partnership’s disadvantages include that it:
A. Has limited life.
B. Can bind an unwilling partner to a contract through mutual agency.
C. Gives unlimited personal liability to the partners.
D. Is more di9cult to raise capital and transfer ownership for a partnership than
for a corporation.
Summary
A partnership is an association of two or more persons to carry on as co-owners of
business for prot. Partnerships are treated as separate entities with their own accounting
records and nancial statements. However, there is no legal separation between the partner
and the partnership. A partnership is a voluntary association of individuals. The partnership
does not have to be in writing, but it is good business practice to put the agreement in
writing. Partnership agreements should clearly state:
Name, location, and purpose of the business
Names of the partners and their respective duties
Investments of each partner
Method of distributing income and losses
Procedures for the admission and withdrawal of partners, withdrawal of assets
allowed each partner, and liquidation of the business
Partnerships have a limited life in that the partnership may be dissolved upon admission,
withdrawal, bankruptcy, incapacity, or death of a partner. Under the concept of mutual
agency, each partner can act as an agent for the partnership, binding the partnership to
business agreements as long as they are in the scope of the business’s normal operations.
Each partner has personal unlimited liability for the debts of the partnership. When
individuals invest property in a partnership, the property becomes an asset of the
partnership and is owned jointly by the partners. Each partner has the right to share in the
income and the responsibility to share in the losses of the partnership as stated in the
partnership agreement. If the partnership agreement is silent regarding loss distributions,
then losses will be distributed in the same way as income. If the partnership agreement is
silent regarding income and losses, then income and losses are shared equally by the
partners.
Advantages of a partnership include that it:
Is easy to form, change, and dissolve
Facilitates pooling of capital and individual talents
Has no corporate tax burden
Allows 8exibility
Disadvantages of a partnership include that it:
Has limited life
Can bind an unwilling partner to a contract through mutual agency
Gives unlimited personal liability of the partners
Is more di9cult to raise capital and transfer ownership for a partnership than
for a corporation
Teaching Strategy
Students should be reminded that a partnership is a separate entity for accounting and
reporting purposes, but there is no legal separation between partner and partnership.
Review the characteristics of partnerships focusing on the details of a partnership
agreement, limited life, mutual agency, single level of taxation, and unlimited liability.
Emphasize that unlimited liability is often addressed by the formation of LLCs which will be
discussed in a later section of the chapter. Then walk through the advantages and
disadvantages of partnerships.
Explain that property invested in the partnership becomes an asset of the partnership,
owned jointly by all the partners. Each partner has the right to share in the company’s
income and the responsibility to share in its losses. For accounting purposes, however, the
partnership is treated as a separate entity with its own accounting records and nancial
statements.
Short Exercise 1 and Exercises 1A and 2A apply to this section.
Section 2: Accounting Applications
Accounting Applications
Record partners’ investments
Compute and record income and loss
Record a person’s admission to or withdrawal from a partnership
Compute and record distribution of assets to partners when a partnership is
liquidated
Lecture Outline
I. In accounting for partners’ equity, it is necessary to maintain separate Capital and
Withdrawals accounts for each partner.
A. When recording a partner’s investment:
1. Debit Cash for the amount of cash contributed.
2. Debit other asset accounts for the fair market value of any contributed assets.
3. Credit Partner, Capital for the total amount invested.
II. Income and losses may be distributed according to whatever method the partners
specify in the partnership agreement.
A. Income may be distributed based on stated ratios.
B. Income may be distributed according to capital balances with ratios based on:
1. Beginning capital balances.
2. Average capital balances.
C. Income may be distributed through a combination of salaries, Interest, and
stated ratios.
1. Partners may rst be paid a salary with the remainder of income (or loss)
distributed based on stated ratios.
2. Partners may rst be paid interest on their capital investments with the
remainder of income (or loss) distributed based on stated ratios.
3. Partners may rst be paid a salary, followed by a distribution for interest, with
the remainder (positive or negative) distributed based on stated ratios.
III. Dissolution of a partnership occurs when there is a change in the original association of
partners.
A. Admission of a new partner dissolves the old partnership.
1. When purchasing full interest from an original partner:
a. Actual amount paid is personal matter between individuals.
b. Ownership is transferred to new Capital account.
2. When purchasing partial interest from partners:
a. Original Capital accounts are decreased and new Capital account is
increased.
b. Asset accounts may need to be adjusted to current values with creation
of new entity.
3. When a new partner is admitted through an investment of assets, both assets
and equity increase.
4. When a new partner pays more than the value of the interest received, a
bonus is distributed to the old partners’ Capital accounts.
5. When a partner pays less than the value of the interest received, a bonus to
the new partner is transferred from old partners’ Capital accounts.
B. A partner may withdraw from a partnership in one of several ways.
1. When a partner withdrawals by selling his or her interest, it does not change
the partnership assets or the partners’ equity.
2. A partnership withdrawal may allow removal of assets equal to the
withdrawing partner’s interest.
C. When a partner dies, the partnership is dissolved.
1. The remaining partners may purchase the deceased’s equity, sell it to
outsiders, and/or deliver certain business assets to the deceased’s estate.
2. If the rm intends to continue, a new partnership is formed.
IV. Liquidation is a special form of partnership dissolution.
A. Assets are sold to pay liabilities, and remaining assets are distributed to
partners.
B. The business will not continue.
C. With a gain on the sale of assets, the cash distributed to partners is the
balance in their respective Capital accounts.
D. With a loss on the sale of assets, partners share the loss based on their stated
ratios.
1. If the loss is greater than a partners’ capital balance, the diAerence must be
paid out of personal funds.
2. If personal funds are inadequate, the remaining partners share the loss.
E. The balance sheet for a partnership is structured as shown in text Exhibit 5.
Summary
Owner’s equity in a partnership is called partners’ equity. Each partner has a separate
capital account. Each partner invests cash or other assets or both in the partnership
according to the partnership agreement. Noncash assets are valued at fair market value on
the date of transfer to the partnership.
The following journal entries are introduced in this section for initial partner investments:
Cash XX
Noncash Assets XX (at FMV)
Partner A, Capital XX
Initial investment of cash and noncash assets
Cash XX
Noncash Assets at FMV XX (at FMV)
Notes Payable XX
Partner B, Capital XX
Initial investment of cash and noncash assets plus a note payable
Partnership income and losses can be distributed according to whatever method is specied
in the partnership agreement. Income and losses can be distributed based on stated income
and loss ratios for each partner. Income and losses can be distributed based on capital
balance ratios, using either beginning capital balances or average capital balances. Income
and losses can also be distributed based on a combination of salaries, interest on capital
balances, with the remainder (positive or negative) distributed based on stated ratios.
Income and loss sharing ratios need not be the same. If the partnership is silent as to loss
ratios, then losses are distributed in the same ratios as the income ratios. A partnership
agreement can be simple or complex. Depending on the partnership agreement, income and
loss ratios can be distributed based on whatever the partners agree to with their attorneys.
The following example of income sharing ratios based on beginning year capital balances is
provided in the text:
…..
…..
The following example of income sharing ratios based on average capital balances is
provided in the text:
…..
……..
The following example of income sharing using salaries with the remaining income (positive
or negative) distributed based on stated ratios is provided in the text:
…….
…….
The following example of income sharing using salaries as the rst step, interest on
beginning capital balances as the second step, with the remaining income (positive or
negative) distributed based on stated ratios is provided in the text:
……
………