Chapter 17
Partnership
Chapter Overview
This chapter discusses another form of a business organization – a partnership. A partnership is the association
of two or more persons who co-own a business. Partners are governed by the Uniform Partnership Act or laws
that are enacted in most states to govern how a partnership is formed, operated, and liquidated. Partnership
characteristics include: limited life, mutual agency, unlimited liability, and co-ownership. A partnership does
not pay taxes, but the partners pay taxes on the share of income allocated to them. The partnership agreements
dictate the division of net income and net losses and may include salary allowances or interest allowances, and
the chapter explains how to make those calculations.
Learning Objectives
After studying Chapter 17, your students should gain proficiency in the following:
2. Journalize Entries to Record Division of Net Income and Net Loss Among Partners.
4. Journalize Entries to Record Liquidation of a Partnership.
Chapter 17 Assignment Grid
Estimated Level
Learning Time in of
Assignment Topic(s) Objective(s) Minutes Difficulty
Discussion Questions and Critical Thinking/Ethical Case
1 Partnership Equity 1 5 Easy
2 Partnership Characteristics 1 5 Easy
3 Articles of Partnership 1 5 Easy
4 Partnership Operations 1 5 Easy
5 Mutual Agency 1 5 Easy
Concept Checks
1 Forming a Partnership 1 10 Easy
2 Division of Net Income 2 10 Easy
Exercises (Set A)
17A-1 Forming a Partnership 1 20 Easy
Exercises (Set B)
17B-1 Forming a Partnership 1 20 Easy
17B-2 Update Capital Balances 2 20 Easy
Problems (Set A)
17A-1 Income Allocation 2 30 Medium
17A-2 Admission of New Partner 3 30 Medium
Estimated Level
Learning Time in of
Assignment Topic(s) Objective(s) Minutes Difficulty
Problems (Set B)
17B-1 Income Allocation 2 30 Medium
17B-2 Admission of New Partner 3 30 Medium
Learning Unit 17-1: Journalizing Entries to Form a Partnership
Summary: A partnership, as defined by the Uniform Partnership Act, is “an association of two or more
persons to carry on as co-owners of a business for profit”. Partnerships can be formed by an oral or written
agreement. Although the oral agreement is binding, it makes more sense to seek legal advice and have a formal
written agreement prepared. When two or more people agree orally or in writing to be partners, a contract
results. Formalizing agreements in writing may minimize conflicts in the future. This written agreement, which
Key Concepts: Partnership, Uniform Partnership Act, articles of partnership, limited life, mutual agency,
unlimited liability, general partner, limited partner, co-ownership of property.
Lecture Outline:
1. Articles of Partnership are written contracts that spell out the details of the agreement among the partners.
a. Name and address of each partner, along with the date of the agreement
b. Rights and responsibilities of each partner
2. Characteristics of Partnerships:
a. Limited Life – a partnership is dissolved by admission, withdrawal, or death of a partner. Although the
partnership is dissolved, the operations of the business continue.
b. Mutual Agency – an act of one partner is binding on all members of the partnership.
i. Entering into contracts that are in the normal scope of the operations of the business.
c. Unlimited liability – partners may be personally liable for debts of the partnership.
i. All partners are individually liable to cover with their personal assets the obligations the
partnership cannot meet.
ii. The partner has the obligation of covering the obligations the other partners cannot meet.
a) New partner just entering the partnership is not responsible for past obligations before
to the amount of investment in the partnership.)
d. Co-ownership of Property – each partner owns a share of the assets. All partners share all the assets of
the partnership, and partners do not have specific claims to the assets they invest in the business.
e. Taxation – the partnership itself does not pay taxes. The partners pay taxes on the share of the net
take withdrawals from the company.
3. Formation of a Partnership:
a. The assets partners invest in the business should be recorded at their fair market value as per an
appraiser.
b. The journal entry to record investing from an old business into the partnership for the first partner:
Cash XX
Teaching Tips/ Strategy: Use the Concept Check #1 to prepare journal entry of partnership formation.
Discussion Questions #1 – #5 are useful to introduce the topic during lecture. Review the Success Coach LU 17-
1 to further review the concept.
Use the “Ten-Minute Quiz” questions #1 and #2 to reinforce the learning concept.
Learning Unit 17-2: Journalizing Entries to Record Division of Net
Income and Net Loss Among Partners
Summary: One way of calculating a partner’s share is through a salary allowance. A salary allowance is not
the same thing as the salary expense involved in paying employees; and it is not, in fact, a salary at all. It is just
a way to divide net income. It is usually used to account for unequal service contributions among partners, such
as if one partner worked full-time for the business and the other put in only 20 hours a week. Another way to
divide net income among partners is through interest allowance. This method is usually used when partners
Key Concepts: Salary allowance, interest allowance, profit-and-loss ratio, deficit, statement of partners’ equity.
Lecture Outline:
Partners cannot legally hire themselves and pay themselves a salary.
1. Salary allowance is a mechanism for dividing earnings of a partnership based on personal services
provided by the partners. It is:
a. Used to account for unequal service contributions to the partnership.
2. Interest allowance method is a mechanism for dividing earnings of a partnership based on a percentage
of capital balances of the partners and is not an expense.
a. If the partners cannot agree on sharing net income, it is divided equally.
b. The partner’s share of net income is the ratio of their beginning capital investments (See Figure
17.3). Each partner’s share is computed by:
3. Each partners’ ownership:
4. Partners’ services and capital contributions are unequal, but net income does not cover salary and
interest allowance. Partners must all share in the reduction of profits. Each partners’ ownership:
a. Annual salary allowance based on personal service provided
5. Journal entry for distribution of net income / loss would be the same in all situations except for the
dollar amount.
6. Statement of Partners’ Equity (See Figure 17.6)
a. Similar to a statement of owner’s equity.
b. The ending balances for each partner would then be reported on the balance sheet.
Teaching Tips/Strategy: Use the Concept Checks #2 – #5 to discuss the details of the partnership divisions
based on income, ratios, and other situations. Exercises 17A-2 and 17B-2 are excellent to practice the unit
calculations.
Use the “Ten-Minute Quiz” questions #3 – #6 to reinforce the learning concepts.
Learning Unit 17-3: Journalizing Entries to Record Admissions and
Withdrawals of Partners
Summary: This unit looks at how the capital structure of a partnership may change due to (1) admission of a
new partner or (2) withdrawal of a partner. Joining a partnership can happen in two ways: purchase of an
equity interest from one or more of the existing partners or make an investment in the business. No matter
what approach is taken, the admission of a new partner will technically dissolve the old partnership. As an
alternative to buying equity from an existing partner, one may simply invest assets in the partnership on one’s
own. When the equity of a partnership in reality is worth more than the amounts recorded in its accounting
records, the partners may require an incoming partner to pay an additional amount or bonus that will increase
the old partners’ equity. This situation could result if a company had an outstanding earnings record with even
higher expectations in the future compared with other companies in the industry. A firm often is anxious to
Key Concepts: Purchase of an equity interest, bonus.
Lecture Outline:
1. Partnerships structure changes with the admission or withdrawal of a partner.
a. Admission of a new partner dissolves the old partnership and can occur:
i. With a purchase of an equity interest from one or more of the existing partners.
The entry to record the buying of equity interest:
Dr. Original partner’s capital XX
a) The other partners need to agree on the equity change, and a new partnership agreement
will be formed.
b) If the other partners do not agree, the partner still has a right to share in the profit and loss
of the partnership. However, the new partner will not have a voice in running of the
company until he or she is an admitted partner.
ii. With a cash investment in the business.
The entry is recorded:
Dr. Cash XX
Cr. Partner, capital XX
a) The partners must agree on how to share the profit and loss.
b) The example in the text (See details above Figure 17.9) shows two existing partners having
a total of $4,000 in equity.
a) If the new partner wants a 1/3 interest, the other partners will have 2/3 interest in the
company.
b) If $4,000 is 2/3 interest, then $2,000 will be a 1/3 interest.
c) The new partner must contribute $2,000.
iii. Recording a bonus to the old partners when admitting a new partner (See Figure 17.10):
a) Usually happens when the equity of a partnership is worth more than the amounts recorded
in the accounting records.
a) Bonus – when a partner is admitted, he or she may pay more or less than equity
interest. If the new partner pays more, the old partners share a bonus in the profit-and-
b) Situation could result if a company had an outstanding earnings record with even
higher expectations in the future compared with other companies in the industry.
c) Calculation of the bonus – the difference between the new partner’s required
investment to be an equal partner (3 partners = 1/3) and the amount the current partners
want the new partner to invest.
The journal entry is:
Dr. Cash XX
iv. Recording a bonus to a new partner – a firm is anxious to bring into the company a new partner
who has special skills, business contacts, or abilities.
a) The old partners must accept a reduction in their capital balances to make up the difference
b) Using the example in the text (See Figure 17.11), a partnership with a combined capital of
c) Calculation:
$1,400, the other partners capital accounts must be reduced by $400 ($1,800 – 1,400). The
entry to record the admission of the new partner:
b. Recording the permanent withdrawal of a partner – procedures are usually established in the
partnership agreement and often include:
i. An audit of the accounting records
ii. Adjustment of assets to their fair market value to reflect current value of the retiring
partner’s equity in the business when a partner takes assets of less value than book equity
Journal entry to revalue the current merchandise inventory to fair market value
(adjustment based on percentage of equity):
a) If assets are not revalued, the partners have to agree whether the assets are overvalued
b) Usually happens when a partner is extremely anxious to withdraw from the partnership.
c) The remaining partners will share in appropriate equity ratio portions of the equity that
the departing partner does not take.
c. Recording permanent withdrawal when a partner takes assets of greater value than book equity
i. Partnership assets are undervalued.
ii. The other partners are anxious to have the partner retire.
iii. The other capital accounts will be reduced to cover the increase in the leaving partner’s
capital.
The journal entries:
Teaching Tips/Strategy: Use the Concept Checks #6 and #7 to practice a partnership’s ownership changes.
Exercises 17A-3, 17A-4, 17B-3, and 17B-4 are excellent to practice the calculations.
Use the “Ten-Minute Quiz” questions #7 – #10 to reinforce the learning concepts.
Learning Unit 17-4: Entries for the Liquidation of a Partnership
Summary: Up to this point we have looked at the admission and withdrawal of partners. Each time this
happens, a new partnership is formed and any losses or gains are shared in an agreed-upon ratio. The operations
The following steps complete a liquidation:
1. Assets are sold for cash with any loss or gain recognized.
3. Creditors are paid off.
4. Remaining cash is distributed to the partners based on their capital balances.
Key Concepts: Liquidation, realization.
Lecture Outline:
Liquidation occurs when a business is finished, the assets are sold, and the liabilities are paid off.
1. Steps in completing the liquidation process.
a. Temporary accounts have been closed out.
2. Selling assets at a gain:
a. Record sale of assets along with any loss or gain from realization – the conversion of noncash
3. Selling assets at a loss:
a. Record sale of assets with a loss or gain from realization. (See Figure 17.24)
Teaching Tips/Strategy: Exercises 17A-5 and 17B-5 are excellent to practice partnership liquidation.
Name Date Section
CHAPTER 17
TEN-MINUTE QUIZ
Circle the letter of the best response.
1. Which of the following is not a characteristic of partnerships?
a. Actions of one partner are binding on all partners.
b. The removal of one partner dissolves the partnership.
c. The partnership does not pay taxes.
d. The partnership has an unlimited life.
2. Which of the following is an advantage of a partnership?
a. The partnership has unlimited liability. b. The partnership has pooled resource of talents.
c. The partnership has mutual agency. d. The partnership may never be dissolved.
3. Partner A has a capital balance of $120,000; Partner B has a capital balance of $80,000;
Partner C has a capital balance of $100,000; Net income for the year totaled $27,000 and the
partnership agreement allocates income according to the capital account percentages. How much net
income is allocated to Partner A?
a. $7,200 b. $9,000
c. $9,500 d. $10,800
4. Partner A has a capital balance of $120,000; Partner B has a capital balance of $80,000;
Partner C has a capital balance of $100,000; Net income for the year totaled $24,000 and the
partnership agreement allocates income equally. How much net income is allocated to Partner A?
a. $6,200 b. $8,000
c. $8,500 d. $9,600
5. Partner A has a capital balance of $120,000; Partner B has a capital balance of $80,000; Partner C has a
capital balance of $100,000; Net income for the year totaled $36,000 and the partnership agreement
includes an interest allowance at 10% of their capital account balances and remaining income allocated
as a percentage of capital. How much net income is allocated to Partner A?
a. $9,600 b. $12,000
c. $14,400 d. $16,000
6. Partner A has a capital balance of $120,000; Partner B has a capital balance of $80,000, Partner C has a
capital balance of $100,000; Net income for the year totaled $36,000 and the partnership agreement
includes a salary allowance of $7,000 for Partner A, $3,500 for Partner B, and $0 for Partner C and
remaining income allocated as a percentage of capital. How much net income is allocated to Partner A?
a. $6,752 b. $8,039
c. $10,209 d. $17,200
7. What is the entry to record admission of a partner that resulted in a bonus to the new partner?
a. Cash XX
Partner A, Capital XX
Partner B, Capital XX
Partner C, Capital XX
b. Cash XX
Partner A, Capital XX
Partner B, Capital XX
Partner C, Capital XX
c. Cash XX
Capital C, Capital XX
d. Partner C, Capital XX
Cash XX
8. What is the entry to record admission of a partner that resulted in a bonus to the old partners?
a. Cash XX
Partner A, Capital XX
Partner B, Capital XX
Partner C, Capital XX
b. Cash XX
Partner A, Capital XX
Partner B, Capital XX
Partner C, Capital XX
c. Cash XX
Capital C, Capital XX
d. Partner C, Capital XX
Cash XX
9. What is the entry to record the permanent withdrawal when a partner takes assets of less value than
book value?
a. Partner A, Capital XX
Partner B, Capital XX
Partner C, Capital XX
Cash XX
b. Partner A, Capital XX
Partner B, Capital XX
Partner C, Capital XX
Cash XX
c. Partner A, Capital XX
Cash XX
d. Partner A, Capital XX
Cash XX
Gain from Realization XX
10. What is the entry to record the permanent withdrawal when a partner takes assets of greater value than
book value?
a. Partner A, Capital XX
Partner B, Capital XX
Partner C, Capital XX
Cash XX
b. Partner A, Capital XX
Partner B, Capital XX
Partner C, Capital XX
Cash XX
c. Partner A, Capital XX
Cash XX
d. Partner A, Capital XX
Cash XX
Gain from Realization XX
Answer Key to Chapter 17 Quiz