978-1133939283 Chapter 12 Lecture Note Part 2

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Dissolution of a partnership occurs whenever there is a change in partners. Dissolution can

occur upon admission of a new partner, withdrawal of a partner, or death of a partner. For

example, when a new partner is admitted to a partnership with two partners creating a three

person partnership, the old partnership agreement is dissolved and is replaced with a new

partnership agreement for the three partners. The partnership may continue business

uninterrupted from the point of view of the clients or customers. Dissolution is not

necessarily liquidation, which is discussed next, but can result in the creation of a new

partnership agreement when there is a change in the composition of the partners.

When a new partner is admitted by purchasing a partnership interest directly from an

existing partner or partners, cash is paid directly to the selling partner or partners and not to

the partnership. The journal entry recorded by the partnership only needs to adjust the

capital accounts.

A new partner may also be admitted by investing cash or noncash assets directly to the

partnership. The new partner’s capital account may be credited with an amount equal to

the fair market value of the assets contributed, may be credited with an amount that is less

than the fair market value of the assets contributed (bonus to the old partners), or may be

credited with an amount larger than the assets contributed (bonus to the new partner).

or posted to a publicly accessible website, in whole or in part.

Chapter 12: Accounting for Partnerships Instructor’s Manual, p. 2

The following journal entries related to partner admission and withdrawals are introduced in

this section:

Original Partner, Capital XX (close account balance)

New Partner, Capital XX (new partner’s interest)

Withdrawal of old partner; transfer of equity to new partner

Original Partner A, Capital XX (half of balance)

Original Partner B, Capital XX (half of balance)

New Partner, Capital XX (new partner’s interest)

Transfer of half of equity to new partner

Cash XX (amount contributed)

New Partner, Capital XX (new partner’s interest)

Admission of new partner for a one-third interest in the company

Cash XX (amount contributed)

Original Partner A, Capital XX (bonus)

Original Partner B, Capital XX (bonus)

New Partner, Capital XX (new partner’s interest)

Investment by new partner for a one-7fth interest in the 7rm, and the bonus

distributed to the original partners

Cash XX (amount contributed)

Original Partner A, Capital XX (bonus transferred)

Original Partner B, Capital XX (bonus transferred)

New Partner, Capital XX (new partner’s interest)

To record the investment of cash by new partner and a bonus from original

partners

Original Partner B, Capital XX (close account balance)

New Partner, Capital XX (new partner’s interest)

Original partner’s withdrawal by sale of interest to new partner

Partner C, Capital XX (balance)

Cash XX (cash withdrawn)

Notes Payable, Partner C XX (amount still owed)

Withdrawal of Adam Novak from the partnership by removing assets

Partnership liquidation is the process of selling enough assets to pay the partnership

liabilities and distributing any remaining assets among the partners. When a partnership is

liquidated, the business will not continue. Gains and losses are distributed to the partners

according to the stated ratios. As cash becomes available, outside creditors are paid 7rst,

then loans from the partners are repaid, and 7nally the remaining partners’ capital balances

are distributed to them. The chapter introduces two liquidation examples: (1) assets sold for

a gain and (2) assets sold at a loss. Journal entries and a statement of liquidation are

presented for each liquidation example.

or posted to a publicly accessible website, in whole or in part.

Chapter 12: Accounting for Partnerships Instructor’s Manual, p. 3

The following journal entries related to partnership liquidation where assets are sold at a

gain are introduced in this section:

Cash XX (cash received)

Gain or Loss from Realization XX (loss realized)

Accounts Receivable XX (close account balance)

Collection of accounts receivable where cash received is less than receivables’

balance

Cash XX (cash received)

Merchandise Inventory XX (close account balance)

Gain or Loss from Realization XX (gain realized)

Sale of inventory at more than book value

Cash XX (cash received)

Plant Assets XX (close account balances)

Sale of plant assets at book value

Accounts Payable XX (close account balance)

Cash XX (cash paid)

Payment of accounts payable

Gain or Loss from Realization XX (close account balance)

Partner A, Capital XX (share of net gain)

Partner B, Capital XX (share of net gain)

Partner C, Capital XX (share of net gain)

Distribution of the net gain on assets to the partners

Partner A, Capital XX (close account balance)

Partner B, Capital XX (close account balance)

Partner C, Capital XX (close account balance)

Cash XX (close account balance)

Distribution of cash to the partners

or posted to a publicly accessible website, in whole or in part.

Chapter 12: Accounting for Partnerships Instructor’s Manual, p. 4

The following journal entries related to partnership liquidation where assets are sold at a loss

are introduced in this section:

Cash XX (cash received)

Gain or Loss from Realization XX (loss)

Accounts Receivable XX (close account balance)

Merchandise Inventory XX (close account balance)

Plant Assets XX (close account balance)

Collection of accounts receivable and the sale of inventory and plant assets

Accounts Payable XX (close account balance)

Cash XX (cash paid)

Payment of accounts payable

Partner A, Capital XX (share of loss)

Partner B, Capital XX (share of loss)

Partner C, Capital XX (share of loss)

Gain or Loss from Realization XX (close account

balance)

Distribution of the loss on assets to the partners

Partner A, Capital XX (close account balance)

Partner B, Capital XX (close account balance)

Partner C, Capital XX (close account balance)

Cash XX (close account balance)

Distribution of cash to the partners

The following journal entries related to liquidation where the loss is greater than a partner’s

capital balance and the negative partner pays cash to the partnership to cover the negative

capital account balance are introduced in this section:

Cash XX (cash received)

Partner C, Capital XX (close negative balance)

Additional investment of Partner C to cover negative balance

Partner A, Capital XX (close account balance)

Partner B, Capital XX (close account balance)

Cash XX (close account balance)

Distribution of cash to the partners

The following journal entries related to liquidation where the loss is greater than a partner’s

capital balance and the other partners share the loss are introduced in this section:

Partner A, Capital XX (share of loss)

Partner B, Capital XX (share of loss)

Partner C, Capital XX (close negative balance)

Distribution of partner’s negative balance to other partners

Partner A, Capital XX (close account balance)

Partner B, Capital XX (close account balance)

Cash XX (close account balance)

Distribution of cash to the partners

Relevant Examples and Exhibits

or posted to a publicly accessible website, in whole or in part.

Chapter 12: Accounting for Partnerships Instructor’s Manual, p. 5

Example: Capital accounts of a sole proprietorship and a partnership

Example: Recording Partners’ Investments

Example: Distributing Income Using Stated Ratios

Example: Ratios Based on Beginning Capital Balances

Example: Ratios Based on Average Capital Balances

Example: Distributing Income Using Salaries, Interest, and Stated Ratios

Exhibit 1 Partial Income Statement for Mind and Padilla

Example: Purchasing All Interest from a Partner

Example: Purchasing Partial Interest from Partners

Example: New Partner Investing Assets in a Partnership

Example: Bonus to Old Partners

Example: Bonus to New Partner

Exhibit 2 Alternative Ways for a Partner to Withdraw

Example: Withdrawal by Selling Interest

Example: Withdrawal by Removing Assets

Example: Liquidation with Gain on Sales of Assets

Exhibit 3 Statement of Liquidation Showing Gain on Sale of Assets

Exhibit 4 Statement of Liquidation Showing Loss on Sale of Assets

Example: Liquidation with Loss on Sale of Assets

Example: Liquidations Where Loss Is Greater than a Partners’ Capital Balance

Example: Liquidation Where Partners Share the Loss

Exhibit 5 Partnership Balance Sheet

Teaching Strategy

Discussion should begin by comparing the equity section of a sole proprietorship to the

equity section of a partnership where each partner has a separate capital account. Review

the transaction and analysis for recording partners’ investments and the related journal

entries. Short Exercise 2 and Exercise 3A may be assigned to reinforce partnership formation

entries.

Discuss the distribution of partnership income and losses and the three common

components of income distributed to the partners (1) Interest on partners’ capital, (2)

partners‘ salaries, and (3) remainder distributed based on income-sharing ratios. Note that

interest on partners’ capital accounts is not recorded as interest expense to the partnership

or interest income to the partners. It is only part of a mathematical calculation to divide up

the income of the partnership based on the partnership agreement.

Review the example for distributing income using only stated ratios and the related journal

entries. Also review the example using only capital balance ratios and the related

calculations based on beginning capital balances and based on average capital balances.

Explain that the average calculation uses a weighted average approach.

Review the examples using a combination of interest on capital balances, partner salaries,

and division of the remainder of income.

Short Exercises 3, 4, and 5 and Exercises 4A, 5A, and 6A cover the distribution of income.

Case 1 can be used for discussion of income and loss distributions to the partners.

Discuss the diBerence between dissolution of a partnership where partnership operations

continue and partnership liquidation where partnership operations cease. Review admission

of a new partner by purchasing all or part of an interest directly from an existing partner.

or posted to a publicly accessible website, in whole or in part.

Chapter 12: Accounting for Partnerships Instructor’s Manual, p. 6

Note that the cash transaction is outside the partnership and the result is only an

adjustment to partner capital account balances.

Next, review admission of a partner by contribution of cash and/or noncash assets to the

partnership. Discuss the reasons why there may be a bonus to the new partner or a bonus to

the old partners. Walk through the following transactions:

Purchasing all interest from a partner

Purchasing a partial interest from partners

New partner investing assets in a partnership with capital account equal to the FMV

of the contributed assets

New partner investing assets in a partnership with a bonuses to the old partners

New partner investing assets in a partnership with bonus to the new partner

Discuss reasons for the withdrawal of a partner using Exhibit 2. Compare withdrawal by

selling a partnership interest to withdrawal by removing assets and the related journal

entries.

Short Exercises 6, 7, 8, and 9 and Exercises 7A and 8A cover partnership

withdrawal/admission.

Discuss partnership liquidation where there is a gain on the sale of assets using the journal

entries and Exhibit 3. Discuss liquidation of a partnership where there is a loss on sale of

assets using the journal entries and Exhibit 4. Review the journal entries for liquidations

where the loss is greater than the partner’s capital balance and the de7cit partner

contributes cash to make up the negative balance, and where the nonde7cit partners share

the loss.

Short Exercise 10 and Exercises 9A and 10A cover partnership liquidation.

Section 3: Business Applications

Business Application

Identify alternative forms of partnership-type entities

Lecture Outline

I. There are many alternative forms of association that are a type of partnership or similar

to partnerships.

II. A limited partnership allows a partner to enjoy limited liability.

A. The limited partner’s potential loss is con7ned to the amount of his or her

investment.

B. There is usually at least one general partner who has unlimited liability.

III. A joint venture is an association of two or more entities for the purpose of achieving a

speci7c goal.

A. Many joint ventures have an agreed-upon limited life.

B. Joint ventures frequently take the form of partnerships among two or more

corporations and other investors.

C. This form is often used as a way to invest abroad, where national law requires

local investors to own a substantial percentage.

IV. There are several corporate forms of companies that mimic the characteristics of

partnerships.

or posted to a publicly accessible website, in whole or in part.

Chapter 12: Accounting for Partnerships Instructor’s Manual, p. 7

A. S corporations do not pay federal taxes.

B. Limited liability companies (LLC) have partner members that enjoy limited

liability.

C. Special purpose entities (SPEs) are companies created for a speci7c objective

that dissolve when the objective is met.

1. Allows sponsoring company to avoid disclosing related debt on balance

sheet.

2. This form was used extensively and fraudulently by Enron.

Summary

A limited partnership (LP) is a special type of partnership that, like corporations, con7nes

the limited partner’s loss to the amount of his or her investment. All limited partnerships

must have at least one general partner who is responsible for managing the company and

who has unlimited liability.

A joint venture is an association of two or more entities for the purpose of achieving a

speci7c goal, such as the manufacture of a product in a new market. Many joint ventures

have a limited life. Pro7ts and losses are shared on an agreed-upon basis. An example of a

joint venture is General Motors/SAIC Motor that manufactures and sells GM cars in China.

S corporations are corporations that are treated similarly to partnerships under U.S. tax

laws. They have a limited number of stockholders (100 maximum) who report income and

losses from the business on their personal tax returns, thus avoiding double taxation.

In a limited liability company (LLC), the members are partners, and their liability is

limited to their investment in the business. LLCs are taxed as partnerships. This form of

business is frequently used by accounting and consulting 7rms.

Special purpose entities (SPEs) are 7rms with limited lives that a company creates to

achieve a speci7c objective, such as raising money or selling receivables. By meeting certain

conditions, liabilities related to the SPE may be excluded from the balance sheet of the

parent or sponsoring company. This form of business was used extensively and fraudulently

by Enron.

Teaching Strategy

Discuss limited partnerships as an investment vehicle for the limited partners, pointing out

that limited partners’ losses are limited to their investment. Emphasize that all limited

partnerships must have at least one general partner who has unlimited liability.

Discuss joint ventures and give examples of joint ventures such as Ford/Mazda and General

Motors/SAIC Motor.

BrieHy discuss S corporation requirements, including the 100 shareholder maximum, one

class of stock, and that types of shareholders are limited to individuals who are U.S. citizens

or residents and certain types of trusts, estates, and tax-exempt entities. Having a C

corporation as a shareholder is prohibited because it would defeat the 100 shareholder

maximum. Emphasize to students that S corporation status must be elected by the

shareholders and that all pro7ts, losses, and distributions must be according to ownership

percentages.

Discuss the prevalence of LLCs for newly formed businesses. LLCs can be single-member

LLCs that are treated as a proprietorship or multi-member LLCs that are generally treated as

partnerships. Although not discussed in the text, you might consider explaining the basic

or posted to a publicly accessible website, in whole or in part.

Chapter 12: Accounting for Partnerships Instructor’s Manual, p. 8

diBerences between an LLC and an LLP. Both LLC and LLP structures provide owners with

limited liability protection related to lawsuits against the company. The personal assets of

LLC members are also protected from company debts such as business loans, whereas

personal assets of LLP partners are not protected from this type of liability. Owners of an LLP,

however, are protected against the actions and debts of their fellow partners.

BrieHy discuss special purpose entities (SPEs) and how they can be used appropriately to

achieve a speci7c objective, such as raising money or selling receivables. Explain that SPEs

were abused in the past by companies such as Enron, where liabilities that led to Enron’s

collapse were kept oB of Enron’s balance sheet. SPEs can only be omitted from the

sponsoring company’s balance sheet if it meets very strict conditions. Otherwise, SPEs must

be included in the consolidated 7nancial statements of the parent company.

Short Exercise 11 and Case 4 apply to this section.

Student Engagement Tactics

00. Assign Case 2 to small groups in class. Use previously established groups or assign

groups randomly. Each group should select a representative to speak for the group.

00. Be clear on the expected output of the learning activity. Identify questions to address

and determine whether written answers are necessary. For example, ask one person

from each group to present one alternative and explain why that alternative would be

best.

00. Elicit as many alternatives as possible for the class to consider. After each group has

presented one alternative, if time permits, ask if any other alternatives might be

available.

00. Allow groups one or two minutes to consider which alternative they prefer and why. Poll

the class as to their preferred response.

or posted to a publicly accessible website, in whole or in part.