Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
CHAPTER 14
PARTNERSHIPS: FORMATION AND OPERATION
B. The basis of accounting for these capital balances is the Articles of Partnership
agreement which establishes provisions for initial investments, withdrawals, admission of
a new partner, retirement of a partner, etc.
C. The actual contribution made by the partners to the business should be recorded at fair
1. In the bonus method, only identifiable assets are valued and recorded. The capital
2. In the goodwill method, the amount being contributed and the corresponding
percentage of the initial capital balance are used to calculate the value of the
business and the presence of goodwill, a figure which is physically recorded as an
intangible asset.
Commented [S1]: Footnote has 2018 as copyright year.
14-2
Education.
1. The partners can simply assume an equal division of profits and losses.
2. The partners, however, can select any method that is designed to arrive at an
equitable allocation. Such factors as the amounts of capital invested, the time worked
in the business, and the degree of business expertise may all serve to influence the
1. A new partner will often buy all (or a portion) of the interest owned by one or more of
the present partners.
2. A new partner can also be admitted by a direct contribution to the partnership
business.
a. The bonus (or no revaluation) method records the identifiable assets being
1. The final asset distribution to an individual should be based on the agreement
2. The difference between the amount paid and the final capital balance can simply be
3. As an alternative, all accounts can be adjusted to fair value with the amount of
payment being used as the basis for computing goodwill.
Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
14-3
Education.
Answers to Discussion Questions
What kind of business is this?
The owners of this business face a common problem: they began operations without seriously
considering the company’s legal form. The accountant now needs to specify the advantages and
disadvantages of the partnership versus corporate or some other legal form. Eventually, the
owners must make this decision but should consider all relevant factors in their choice.
The accountant should discuss the following issues with the two owners:
—Ease of formation. A formal partnership can be created by the writing of an Articles of
Partnership. If income allocation and partners’ contributions are already determined, the
document preparation should be relatively simple. Forming a corporation is a usually a more
—Lawsuits. Some businesses are more susceptible to lawsuits than others. A florist, for
example, would likely have less risk than a pharmaceutical company. The concept of personal
liability for business debts becomes especially important when litigation risk is high. To reduce
such risk, creating a corporation to protect the personal property of the stockholders may be a
used to reduce other taxable income. However, in a corporation, losses are carried back and
forward to reduce other taxable income that is earned by the business, possibly delaying the
benefits of the loss. As mentioned in the textbook, the owners should consider forming an S
Corporation—a business that is incorporated but still taxed as a partnership.
Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
14-4
Education.
—Bankruptcy. If the business should ever fail and have to be liquidated, losses of a partnership
are passed directly to the owners to reduce taxable income immediately. For a corporation,
the loss is a capital loss to the stockholders which can only offset their own capital gains or be
Therefore, the accountant may want to address the following questions in advising these
clients:
▪ What amount of time and energy is involved in becoming incorporated?
▪ How much profit or loss is anticipated from the operations of this business in the
foreseeable future?
▪ How much debt will the new business incur?
▪ Will this debt be guaranteed by the owners?
How Will the Profits Be Split?
This case is designed to point up the difficulty of designing a profit-sharing arrangement that is
fair to all parties. Currently, these three individuals have incomes totaling an amount in excess of
needs to reward all participants properly over time.
Dewars has built up the firm and still handles the bigger clients although he plans to reduce his
workload over the next few years. Thus, one method of compensation would be to credit him with
interest on the capital built up in the business. However, if that number alone is used, it will tend
to escalate even if his work hours are reduced. For this reason, Dewars’ share of the profits
Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
14-5
Education.
Scriba’s role is to develop a tax practice within the firm. Consequently, one suggestion would be
to credit her capital account with a percentage of the tax revenues (20 percent, for example)
each year. In that way, she benefits by the amount of business that she is able to bring to the
Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
14-6
Education.
Answers to Questions
1. The advantages of operating a business as a partnership include the ease of formation and
the avoidance of the double taxation effect that inherently reduces the profits distributed to
the owners of a corporation. In addition, because the losses of a partnership pass, for tax
purposes, directly through to the owners, partnerships have historically been used (especially
in certain industries) to reduce or defer income taxes.
2. Specific partnership accounting problems center in the equity (or capital) section of the
balance sheet. In a corporation, stockholders’ equity is divided between earned capital and
3. The balance in each partner’s capital account measures that partner’s interest in the book
4. A Subchapter S corporation is formed legally as a corporation so that its owners enjoy limited
legal liability and easy transferability of ownership. However, if a company qualifies and
becomes a Subchapter S Corporation, it will be taxed in virtually the same manner as a
partnership. Hence, income will be taxed only once and that is to the owners at the time that
it is earned by the corporation.
5. In a general partnership, each partner can have unlimited liability for the debts of the
business. Therefore, a partner may face a significant risk, especially in connection with the
actions and activities of other partners. However, general partnerships are easy to form and
Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
once when earned by the business so that no second tax is incurred when distributions are
made to owners.
A limited liability partnership (LLP) is very similar to a general partnership except in the
method by which a partner’s liability is measured. In an LLP, the partners can still lose their
6. The Articles of Partnership is a legal agreement that should be created as a prerequisite for
the formation of a partnership. This document defines the rights and responsibilities of the
partners in relation to the business and in relation to each other. Thus, it serves as a
governing document for the partnership. The Articles of Partnership may contain any number
of provisions but should normally specify each of the following:
a. Name and address of each partner
b. Business location
j. Method for settling a partner’s share in the business upon withdrawal, retirement, or
death
7. To give fair recognition to noncash contributions, all assets donated by the partners (such as
8. In forming a partnership, one or more of the partners may be contributing some factor (such
as an established clientele or an expertise) which is not viewed normally as an asset in the
traditional accounting sense. In effect, the partner will be receiving a larger capital balance
than the identifiable contributions would warrant.
Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
14-8
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
As an alternative, the amounts contributed along with the established capital percentages
can be used to determine mathematically the implied total value of the business and the
presence of any goodwill brought into the business. This goodwill is recognized at the time
that the partnership is created so that the amount can be credited to the appropriate partner.
9. The Drawing account measures the amount of assets that a particular partner takes from the
10. At the end of each fiscal year, when revenues and expenses are closed out, some
assignment must be made of the resulting income figure Because a partnership will have two
11. The allocation process can be based on any number of factors. The actual assignment of
income should be designed to give fair and equitable treatment to each of the partners.
12. If agreement as to the allocation of income has not been specified, an equal division among
13. The dissolution of a partnership is the breakup or cessation of the partnership. Many reasons
can exist for a partnership to dissolve. One partner may withdraw, retire, or die. A new
14. A new partner can join a partnership by acquiring part or all of the interest of one or more of
15. In selling an interest in a partnership, three rights are conveyed to the new owner:
a. The right of co-ownership of the business property;
b. The right to a specified allocation of profits and losses generated by the partnership’s
Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
14-9
Education.
16. Goodwill recognized in a capital transaction is allocated to the original partners based on the
profit and loss ratio. The amount is assumed to represent unrealized gains in the value of the
17. Allocating goodwill to an entering partner may be necessary for several reasons. One of the
most common is that the partner is bringing to the partnership an attribute that is not an asset
18. Book values in most cases measure historical cost expenditures which often have undergone
years of allocation and changes in value. For this reason, book value will frequently fail to
Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
Answers to Problems
1. B
4. C MaryAnn’s investment equals 1/3 of total capital ($50,000 ÷ $150,000).
However, she receives only a 1/4 interest capital balance. One explanation
5. C Based on the new contribution, the company’s implied value is $312,500
($125,000 ÷ 40%) which is less than the capital balances ($300,000 in
original capital plus $125,000 to be invested). Thus, either the assets are
overvalued or the new partner is contributing goodwill in addition to a cash
investment. Because the problem indicates that goodwill is recognized,
goodwill must be computed. Note that the $125,000 cash contribution is
going into the business and, thus, increases capital.
7. B Total capital is $200,000 ($110,000 + $40,000 + $50,000) after the new
investment. As Evan‘s portion is 30 percent, the capital balance becomes
$60,000 ($200,000 × 30%). Because only $50,000 was paid, a bonus of
14–11
Education.
8. B Total capital is $270,000 ($120,000 + $90,000 + $60,000) after the new
investment. However, the implied value of the business based on the new
investment is $300,000 ($60,000 ÷ 20%). Thus, goodwill of $30,000 must be
10. D ALLOCATION OF NET INCOME
ALFRED BERNARD COLLINS TOTAL
Net income $60,000
Interest—5% of beginning capital $ 2,500 $ 3,000 $ 3,500 (9,000)
Salary …………………………..……. 18,000 (18,000)
Remainder to allocate …………. $33,000
($33,000 divided on a 3:3:4 basis) 9,900 9,900 13,200 (33,000)
Total allocation ………… $12,400 $30,900 $16,700 -0-
STATEMENT OF CAPITAL—YEAR ONE
WINSTON DURHAM SALEM TOTAL
Beginning capital ………………. $110,000 $80,000 $110,000 $300,000
Net loss (above) ………………… (9,000) (8,000) (3,000) (20,000)
Drawings (given) ……………….. (10,000) (10,000) (10,000) (30,000)
Ending capital ………………. $ 91,000 $62,000 $ 97,000 $250,000
14–12
Education.
11. (continued)
ALLOCATION OF NET INCOME—YEAR TWO
WINSTON DURHAM SALEM TOTAL
Net income $40,000
Interest—10% of
beginning capital ………….. $ 9,100 $ 6,200 $ 9,700 (25,000)
Salary …………………………..……. 20,000 -0- 10,000 (30,000)
Remainder to allocate …………. $(15,000)
($15,000 divided on a 5:2:3 basis) (7,500) (3,000) (4,500) 15,000
Total allocation ………… $21,600 $3,200 $15,200 -0-
13. D Clark receives an additional $10,000. Because Clark receives 20 percent of
profits and losses, this allocation indicates total goodwill of $50,000.
20% of Goodwill = $10,000
Goodwill = $10,000 ÷ .20 = $50,000
14–13
Education.
15. A The implied value of the company is $900,000 ($270,000 ÷ 30%). Because the
money is going to the partners rather than into the business, the capital
total is $490,000 before realigning the balances. Hence, goodwill of $410,000
17. (10 Minutes) (Compute capital balances under both goodwill and bonus
methods)
a. Goodwill Method
Implied value of partnership ($80,000 ÷ 40%) ………….. $200,000
Total capital after investment ($70,000 + $40,000 + $80,000) 190,000
Goodwill …………………………..…………………………..………. $ 10,000
b. Bonus Method
Total capital after investment ($70,000 + 40,000 + $80,000) $190,000
Ownership portion—Lear ………………………………………. 40%
Lear, capital …………………………..…………………………..…. $ 76,000
Bonus payment made by Lear ($80,000 – $76,000) …… $ 4,000
Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
19. (16 Minutes) (Determine capital balances after admission of new partner using
both goodwill and bonus methods)
Part a.
Total capital is $490,000 ($200,000 + $120,000 + $90,000 + $80,000) after the
new investment. However, the implied value of the business based on the
G’s Investment = .18 ($200,000 + $120,000 + $90,000 + G’s Investment)
$80,000 + Goodwill = .18 ($410,000 + $80,000 + Goodwill)
$80,000 + Goodwill = $88,200 + .18 Goodwill
.82 Goodwill = $8,200
Goodwill = $10,000
Nixon …………………………..…………………………..…. $200,000
Hoover …………………………..………………………….... 120,000
Polk ……………………………………………………….…. 90,000
Grant …………………………..…………………………..…. 90,000
Part b.
Total capital is $510,000 ($200,000 + $120,000 + $90,000 + $100,000) after the
new investment. As Grant’s portion is to be 20 percent, this partner’s capital
CAPITAL BALANCES
Original Investment Bonus Total
Nixon ……………….. $200,000 $(1,000) $199,000
Chapter 14 – Partnerships: Formation and Operation – Hoyle, Schaefer, Doupnik, 13e
14–16
Education.
20. (10 Minutes) (Record admission of new partner and allocation of new income)
Part a.
Total capital is $167,000 ($70,000 + $60,000 + $37,000) after the new
investment. However, the implied value of the business based on the new
investment is $185,000 ($37,000 ÷ 20%). Consequently, goodwill of $18,000
(1,750) (1,050) (700) 3,500
Total allocation …………… $6,690 $5,310 $3,000 –0-
21. (5 Minutes) (Allocation of income to partners)
Jones King Lane Total
Net income……………………….. $90,000
Bonus (20%) ……………………. $18,000 $ -0- $ -0- (18,000)
14–18
Education.
23. (30 Minutes) (Allocate income for several years and determine ending capital
balances)
NET INCOME ALLOCATION—2017
Angela Diaz Krause Total
Net income $70,000
STATEMENT OF PARTNERS’ CAPITAL—DECEMBER 31, 2017
Angela Diaz Krause Total
Beginning balances ……….. $30,000 $58,000 $60,000 $148,000
Net income allocation …….. 21,840 28,480 19,680 70,000
Drawings ……………………….. (15,000) (15,000) (15,000) (45,000)
Salary …………………………... 12,000 9,000 -0- (21,000)
Remaining net income: $ 3,700
740 1,480 1,480 (3,700)
Total allocation ……… $16,424 $17,628 $7,948 -0-
Drawings ……………………….. (15,000) (15,000) (15,000) (45,000)
Ending balances $ 38,264 $74,108 $62,628 $175,000
