Intermediate Accounting 1

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1 Intermediate Accounting 1 Lecture 1 Accounting for Partnerships Partnership Form of Organization: A partnership is an association of two or more persons to carry on as co-owners of a business for profit. 1

2 Characteristics of Partnerships: The principal characteristics of the partnership form of business organization are explained below: Association of Individuals: * Association of individuals may be based on as simple an act as a handshake, however, it is preferable to state the agreement in writing. * A partnership legal entity for certain purposes (i.e., property can be owned in the name of the partnership). accounting entity for financial reporting purposes. * Net income of a partnership not taxed as a separate entity. each partner s share of income is taxable at personal tax rates Mutual Agency: Mutual agency means that: Each partner acts on behalf of the partnership when engaging in partnership business. The act of any partner is binding on all other partners. This is true even when partners act beyond the scope of their authority, so long as the act appears to be appropriate for the partnership. Because of mutual agency, an individual should be extremely cautious in selecting partners. Characteristics of Partnerships: Limited Life: Partnerships have a limited life. It may be ended at any time either: a) voluntarily through acceptance of a new partner or withdrawal of a partner, or b) involuntarily by death or incapacity of a partner. Unlimited Liability: Each partner is personally and individually liable for all partnership liabilities. Co-Ownership of Property: Assets invested in the partnership are owned jointly by all the partners. If the partnership is dissolved, each partner has a claim on total assets equal to the balance in his or her respective capital account. Partnership Income or Loss: co-owned; if the partnership contract does not specify to the contrary, net income or net loss is shared equally by the partners. 2

3 Basic Partnership Accounting: The major accounting issues relate to: 1. Forming the partnership, 2. Dividing income or loss, and 3. Preparation of financial statements. 4. Admission of a partner 5. Withdrawal of a partner 6. Liquidation of a partnership Forming a Partnership: Each partner s initial investment in a partnership is entered in the partnership records at the fair market value of the assets at the date of their transfer to the partnership. The values assigned to the assets must be agreed to by all the partners. 3

4 Example: Assume that A. Rolfe and T. Shea combined their proprietorships to start a partnership named U.S. Software. Rolfe and Shea have the following assets prior to the formation of partnership. Book Value Market Value Rolfe Shea Rolfe Shea Cash $8000 $9000 $8000 $9000 Office Equipment Accumulated Depreciation (2000) Accounts Receivable Allowance for doubtful accounts (700) (1000) $11000 $12300 $12000 $

5 The journal entries to record the investments are shown below: Date Account Titles and Explanations Dr. Cr. Cash Office Equipment A. Rolfe, Capital To record the initial investment of Rolfe in the partnership. Cash Accounts Receivable Allowance for doubtful accounts T. Shea, Capital To record the initial investment of Shea in the partnership Note that: The office equipment is recorded at their market value. Because the equipment has not been used by the partnership, there is no accumulated depreciation. The Gross claims on customers (Accounts Receivable of $4000) are carried forward to the partnership. The allowance for doubtful accounts is adjusted to $1000 to arrive at a net realizable value of $3000 (the amounts expected to be collected from customers which equals accounts receivable less allowance for doubtful accounts ($4000 $1000 = $3000). A partnership may start with an allowance for doubtful accounts because it will continue to collect existing accounts receivable, some of which are expected to be uncollectible. After the partnership has been formed, the accounting for transactions is similar to any other type of business organization. The steps in the accounting cycle described for a proprietorship also apply to a partnership. 5

6 Ex 2: Meissner, Cohen, and Hughes are forming a partnership. Meissner is transferring $50,000 of cash to the partnership. Cohen is transferring land worth $15,000 and a small building worth $80,000. Hughes transfers cash of $9,000, accounts receivable of $32,000 and equipment worth $19,000. The partnership expects to collect $29,000 of the accounts receivable. Instructions: Prepare the journal entries to record each of the partners investments. Answer: Meissner is transferring $50,000 of cash to the partnership. Prepare the entry. Cash 50,000 Meissner, Capital 50,000 Cohen is transferring land worth $15,000 and a small building worth $80,000. Prepare the entry. Land 15,000 Building 80,000 Cohen, Capital 95,000 6

7 Hughes transfers cash of $9,000, accounts receivable of $32,000 and equipment worth $19,000. The partnership expects to collect $29,000 of the accounts receivable. Cash 9,000 Accounts receivable 32,000 Equipment 19,000 Allowance for doubtful accounts 3,000 Hughes, Capital 57,000 Ex3: Jack Herington has owned and operated a proprietorship for several years. On January1, he decides to terminate this business and become a partner in the firm of Herington and Kaspar. Herington s investment in the partnership consists of $12,000 in cash, and the following : assets of the proprietorship: accounts receivable $14,000 less allowance for doubtful accounts of $2,000, and equipment $20,000 less accumulated depreciation of $4,000. It is agreed that the allowance for doubtful accounts should be $3,000 for the partnership. The fair market value of the equipment is $13,500. Instructions: Journalize Herington s admission to the firm of Kaspar and Herington. 7

8 Jan. 1 Cash 12,000 Accounts Receivable 14,000 Equipment 13,500 Allowance for Doubtful Accounts... 3,000 Jack Herington, Capital... 36,500 Next Lecture Dividing income or loss (Income distribution) 8

9 End of Lecture 1 9

Accounting for Partnerships

appendix G Accounting for Partnerships study objectives After studying this appendix, you should be able to: 1 Identify the characteristics of the partnership form of business organization. 2 Explain the