Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
CHAPTER 12
ACCOUNTING FOR PARTNERSHIPS
LEARNING OBJECTIVES
1. DISCUSS AND ACCOUNT FOR THE FORMATION OF A
PARTNERSHIP.
2. EXPLAIN HOW TO ACCOUNT FOR NET INCOME OR
NET LOSS OF A PARTNERSHIP.
CHAPTER REVIEW
Partnership Form of Organization
1. A partnership is an association of two or more persons to carry on as co-owners of
a business for a profit.
Characteristics of Partnerships
2. The principal characteristics of the partnership form of business organization are
(a) association of individuals, (b) mutual agency, (c) limited life, (d) unlimited liability, and
(e) co-ownership of property.
3. The association of individuals in a partnership may be based on as simple an act as a handshake;
however, it is preferable to state the agreement in writing.
a. A partnership is a legal entity for certain purposes.
Advantages and Disadvantages
8. Organizations with partnership characteristics include limited partnerships, limited liability partner-
ships, limited liability companies, and S corporations.
9. The major advantages of a partnership are:
a. Combining skills and resources of two or more individuals.
b. Ease of formation.
Limited Partnerships
11. Under limited partnerships, the liability of a limited partner is limited to the partners’ capital
equity. However, there must always be at least one partner with unlimited liability, often referred to
as the general partner.
Limited Liability Partnership
12. Professionals such as lawyers, doctors, and accountants can be protected from malpractice or
negligence claims of other partners by forming a limited liability partnership.
Limited Liability Companies
The Partnership Agreement
14. The written contract, often referred to as the partnership agreement, contains such basic infor-
mation as the name and principal location of the firm, the purpose of the business, and the date of
inception.
Forming a Partnership
Dividing Net Income or Net Loss
16. (L.O. 2) Partnership net income or net loss is shared equally unless the partnership contract
specifically indicates otherwise.
a. A partner’s share of net income or net loss is recognized in the accounts through closing
entries.
b. Closing entries for a partnership are identical to the entries made for a proprietorship, except
for the use of multiple capital and drawing accounts.
17. The various income ratios that may be used include:
a. A fixed ratio, expressed as a proportion (6:4), a percentage (70% and 30%), or a fraction (2/3
and 1/3).
Partnership Financial Statements
19. The financial statements of a partnership are similar to a proprietorship. The differences are
generally related to the fact that a number of owners are involved in a partnership. The income
statement for a partnership is identical to the income statement for a proprietorship except for the
division of net income.
Liquidation of a Partnership
21. (L.O. 3) The liquidation of a partnership terminates the business. In a liquidation, it is
necessary to:
a. Sell noncash assets for cash and recognize a gain or loss on realization. The journal entry to
record this will include a debit to Cash for the amount received from the sale, debits to any
contra-asset accounts, a debit for the loss on realization/or a credit for the gain on realization
and credits to all asset accounts.
b. Allocate gain/loss on realization to the partners based on their income ratios. The journal entry
Each of the steps must be performed in sequence.
22. The liquidation of a partnership may result in no capital deficiency (all partners have credit
23. A schedule of cash payments may be used to determine the distribution of cash to each partner.
24. When there is a capital deficiency, the partner with the deficiency may pay the amount owed and
the deficiency is eliminated.
25. If a partner with a capital deficiency is unable to pay the amount owed to the partnership, the
partners with credit balances must absorb the loss as follows:
Admission of a Partner
*26. (L.O. 4) A new partner may be admitted either by (1) purchasing the interest of one or more
existing partners, or (2) investing assets in the partnership. The former affects only partners’ capital
accounts whereas the latter increases both net assets and total capital of the partnership.
*27. When a new partner is admitted by purchase of an interest,
a. The transaction is a personal one between one or more existing partners and the new partner.
b. Any money or other consideration exchanged is the property of the participants and not the
property of the partnership.
*29. A bonus to old partners results when the new partner’s capital credit on the date of admittance
is less than the new partner’s investment in the firm. The procedure for determining the new
partner’s capital credit and the bonus to the old partners is as follows:
a. Determine the total capital of the new partnership by adding the new partner’s investment to
the total capital of the old partnership.
b. Determine the new partner’s capital credit by multiplying the total capital of the new partnership
Withdrawal of a Partner
*31. As in the case of the admission of a partner, the withdrawal of a partner legally dissolves the
partnership. The withdrawal of a partner may be accomplished by (a) payment from partners’
personal assets or (b) payment from partnership assets. The former affects only the partners’
capital accounts, whereas the latter decreases total net assets and total capital of the partnership.
*32. The withdrawal of a partner when payment is made from partners’ personal assets is the direct
opposite of admitting a new partner who purchases a partner’s interest.
*33. Using partnership assets to pay for a withdrawing partner’s interest is the reverse of admitting a
partner through the investment of assets in the partnership.
a. Payment from partnership assets is a transaction that involves the partnership.
b. Both partnership net assets and total capitals are decreased.
c. Asset revaluations should not be recorded.
*34. When the partnership assets paid are in excess of the withdrawing partner’s capital interest,
Death of a Partner
*36. The death of a partner dissolves the partnership, but provision generally is made for the surviving
partners to continue operations. When a partner dies it is necessary to determine the partner’s
equity at the date of death.
LECTURE OUTLINE
A. Characteristics of Partnerships.
1. A partnership is an association of two or more persons to carry on as
co-owners of a business for profit.
2. The principal characteristics of partnerships are:
a. Association of individuals. A partnership is a legal entity that can own
property and can sue or be sued. A partnership is also an accounting
entity.
c. Limited life. Corporations have unlimited life, but partnerships do not.
A partnership may be ended voluntarily any time through the
acceptance of a new partner or the withdrawal of a partner.
Partnership dissolution occurs whenever a partner withdraws or a
new partner is admitted.
B. Organizations with Partnership Characteristics.
1. Special forms of business organizations with partnership characteristics
are often used to provide protection from unlimited liability for people
who want to work together in some activity.
2. The special partnership forms are:
a. Limited partnership. One or more partners have unlimited liability
and one or more partners have limited liability for the debts of the
firm. Those with limited liability are responsible for partnership
debts up to the limit of their investment in the firm.
ACCOUNTING ACROSS THE ORGANIZATION
Whenever a group of individuals wants to form a partnership, the limited liability
company is usually the popular choice. One other form of business organization
is a subchapter S corporation, but it is losing its popularity.
Why do you think that the use of the limited liability company is gaining in
popularity?
Answer: The LLC is gaining in popularity because owners in such companies
have limited liability for business debts even if they participate in
C. Advantages and Disadvantages of Partnerships.
1. Advantages of partnerships are:
a. Combining skills and resources of two or more individuals.
2. Major disadvantages of a partnership are:
a. Mutual agency.
D. The Partnership Agreement.
1. The partnership contract, called the partnership agreement, or articles of
co-partnership, contains such basic information as the name and principal
location of the firm, the purpose of the business, and date of inception.
ACCOUNTING ACROSS THE ORGANIZATION
What should you do when you and your business partner do not agree on things,
to the point where you are no longer on speaking terms? Unfortunately, in many
instances the partners do everything they can to undermine the other partner,
eventually destroying the business.
How can partnership conflicts be minimized and more easily resolved?
Answer: First, it is important to develop a business plan that all parties agree to.
Second, it is vital to have a well-thought-out partnership agreement.
E. Forming a Partnership.
1. Each partner’s initial investment in a partnership is entered in the partnership
records. The partnership should record these investments at the fair
value of the assets at the date of their transfer to the partnership.
F. Dividing Net Income or Net Loss.
1. Partners equally share partnership net income or net loss unless the
partnership contract indicates otherwise.
2. The same basis of division usually applies to both net income and net
loss, and is referred to as the income ratio, or the profit and loss (P&L)
ratio.
3. Typical income ratios are:
a. A fixed ratio, expressed as a proportion, a percentage, or a fraction.
c. Salaries to partners and the remainder on a fixed ratio.
d. Interest on partners’ capital balances and the remainder on a fixed
ratio.
G. Partnership Financial Statements.
1. The financial statements of a partnership are similar to those of a pro-
prietorship.
2. The partnership’s income statement shows the division of net income at
the bottom of the income statement.
H. Liquidation of a Partnership.
1. Liquidation may result from the sale of the business by mutual agreement
of the partners, from the death of a partner, or from bankruptcy.
c. Pay partnership liabilities in cash.
d. Distribute remaining cash to the partners on the basis of their capital
balances.
5. A partner’s capital deficiency may result from recurring net losses, excessive
drawings, or losses from realization suffered during liquidation.
a. The partner with a capital deficiency is obligated to pay the partnership
the amount owed.
*I. Admission of a Partner.
1. The admission of a new partner results in the legal dissolution of the existing
partnership and the beginning of a new one.
2. A new partner may be admitted either by:
a. Purchasing the interest of one or more existing partners. The part-
nership debits each partner’s capital account for the ownership
claims that have been sold, and credits the new partner’s capital
account with the capital equity purchased.
(1) The existing (old) partners or
(2) The new partner.
c. The partnership allocates a bonus to the old partners on the basis
of their income ratios before the admission of the new partner.
*J. Withdrawal of a Partner.
1. A partner may withdraw from a partnership voluntarily, by selling his or
her equity in the firm. Or he/she may withdraw involuntarily, by reaching
mandatory retirement age or by dying.
2. The withdrawal of a partner may be accomplished by:
a. Payment from partners’ personal assets, or
4. Using partnership assets to pay for a withdrawing partner’s interest
decreases both partnership net assets and total capital. In accounting
for a withdrawal by payment from partnership assets:
a. The partnership should not record asset revaluations.
5. A partnership may pay a bonus to a retiring partner when:
a. The fair value of partnership assets is more than their book value,
6. The retiring partner may give a bonus to the remaining partners when:
a. Recorded assets are overvalued,
7. Death of a partner: when a partner dies, it is usually necessary to determine
the partner’s equity at the date of death by:
a. Determining the net income or loss for the year to date,
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. A partner can bind the partnership to outside contracts without receiving permission from
the other partners.
True False
2. In a limited partnership, one or more partners have limited liability for the debts of the
firm.
True False
3. A partner is never liable for more than his or her capital investment in the partnership.
True False
4. In a partnership, when the division of profits and losses is based on salaries, interest,
and a fixed ratio, if the salary and interest allocation exceeds net income, then a net loss
has in fact occurred.
True False
5. A partnership is considered an accounting entity for financial reporting purposes.
True False
6. When the partnership contract does not specify the manner in which net income and net
loss are to be divided, profits and losses are distributed based on the average capital
balances of each partner during the year.
True False
7. The partners’ capital statement explains the changes in each partner’s capital account
and in total partnership capital during the year.
True False
8. Upon the sale of assets in liquidation, gains and losses are always divided equally
among partners.
True False
*9. If a partnership is admitting a new partner to the existing partnership and the existing
partners are to receive a bonus, this bonus would be allocated on the basis of their income
ratios before the admission of the new partner.
True False
*10. Admission of a new partner to the partnership does not result in the dissolution of the
existing partnership.
True False
Multiple Choice
1. Which one of the following is not a feature of partnerships?
a. Limited life
b. Limited liability
c. Mutual agency
d. Voluntary association
2. Selling partnership assets and paying the proceeds to creditors and owners refers to
a. dissolution.
b. unlimited liability.
c. mutual agency.
d. liquidation.
3. Partners A and B receive a salary allowance of $63,000 and $81,000, respectively, and
share the remainder equally. If the company earned $90,000 during the period, what is
the effect on A’s capital?
a. $63,000 increase
b. $36,000 decrease
c. $36,000 increase
d. $45,000 increase
*4. A invests $60,000 for a one-fifth interest in a partnership in which the other partners have
capital totaling $180,000 before admitting A. After distribution of the bonus, what would
A’s capital be?
a. $32,000
b. $36,000
c. $60,000
d. $48,000
*5. B invests $120,000 for a 20 percent interest in a partnership that has total capital of $400,000
after admitting B. Which of the following is true?
a. B’s capital is $120,000
b. B’s capital is $56,000
c. B received a bonus of $40,000
d. The original partners received a bonus of $40,000.
ANSWERS TO QUIZ
True/False
1. True 6. False
2. True 7. True
Multiple Choice
1. b.
