Chapter 13. Identify the characteristics of a partnership. Learning Objectives. Objective 1. Partnerships

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1 PowerPoint to accompany Partnerships Chapter 13 Learning Objectives 1. Identify the characteristics of a partnership 2. Account for the partners investment in a partnership 3. Allocate profits and losses to the partners 4. Account for the admission of a new partner 5. Account for a partner s withdrawal from the firm 6. Horngren, Account Best, Fraser, Willett: Accounting for 6e the 2010 Pearson liquidation Australia of a partnership Objective 1 Identify the characteristics of a partnership.

2 Characteristics of a Partnership It is an association of two or more persons carrying on a business with a view to profit. A partnership combines: capital talent experience Characteristics of a Partnership written agreement deed of partnership limited life mutual agency unlimited liability co-ownership of property non-taxpaying entity partnership accounting Objective 2 Account for the partners investments in a partnership.

3 The Partnership Start-up Lisa Lane and Don Reed forma partnership on June 1 December 4, 2006, to sell Software Lane s contributions are cash of $10,000 Inventory $40,000 Accounts payable $80,000 Computer equipment costing $800,000, acc. Dep n $ and a current market value of $450,000. What is the journal entry? The Partnership Start-up 1 June Cash 10,000 Inventory 40,000 Equipment 450, Accounts Payable 80,000 Lane, Capital 420,000 To record Lanes s investment in the partnership The Partnership Start-up Reed s contributions are: Cash of $5,000 Computer Software cost $20,000 Market Value $100, What is the journal entry?

4 The Partnership Start-up June 1 Cash 5,000 Building 100,000 Reed, Capital 105, To record Reed s investment in the partnership The Partnership Start-up Assets Cash $ 15,000 Inventory 40,000 Equipment 450,000 Software 100,000 Total assets $605,000 L$R Software Balance Sheet June 1 Liabilities i Accounts Payable $80,000 Capital Lane, Capital $420,000 Paul, Capital 105,000 Total capital $605,000 Objective 3 Allocate profits and losses to the partners.

5 Fraction Allocation Example Jason Wong and Susan Moore agreed to split profits and losses as follows: 2/3 to Wong and 1/3 to Moore How do we allocate $60, net profit $60,000 2/3 = $40,000 to Wong $60,000 2/3 = $20,000 to Moore Fraction Allocation Example Assume that they incurred a $15,000 loss for the year Wong, Capital 10,000 Moore, Capital 5,000 Income Summary 15,000 To allocate net loss to partners Capital Contributions Example Karen, Capital $410,000 Paul, Capital 330,000 Total $740,000 The partnership earned a profit of $120,000 for the year.

6 Capital Contributions Example Karen: $410,000 $740,000 $120,000 = $66,486 (Karen s share) Paul: $330,000 $740,000 $120,000 = $53,514 (Paul s share) Capital and Service Example Sometimes partners may invest more capital, while others invest more time In cases like this profits may be split on both service and contribution Net profit is $125,000. The first $50,000 is allocated based on capital contribution (60% Hilton, 40% Lee). The next $60,000 is allocated $24,000 to Hilton and $36,000 to Lee based on service. Any remaining amount is to be allocated Horngren, equally. Best, Fraser, Willett: Accounting 6e 2010 Pearson Australia Capital and Service Example Hilton Lee Total Total net profit: $125,000 First $50,000 allocation: 60% $50,000 $30,000 40% $540,000 $20,000 50,000 Net profit remaining 80,000 Next $60,000 allocation: 24,000 36,000 60,000 Net profit remaining 20,000 Next $15,000 allocation: 7,500 7,500 15,000 Net profit remaining -0- Total profit allocated $61,500 $63,500 $125,000

7 Partner Drawings Cash withdrawals by partners represent a reduction of capital much as a dividend is a distribution of corporate equity. Debit (Partner A) Drawing and credit Cash. At period end, drawing accounts are closed to partners capital accounts. Credit Drawing and debit each partner s Capital. Objective 4 Account for the admission of a new partner. Purchase a Partner s Interest Debit old partner s Capital and credit new partner s Capital. The price paid by the new partner to the old partner is not reflected on the partnership books.

8 Invest in the Partnership A new partner contributes assets to the partnership in exchange for a share of the business. The new partner s investment does not necessarily purchase an equivalent profit-sharing interest. To gain admission, a new partner may be willing to pay a bonus to existing partners. Invest in the Partnership Example Laura Kable wants to join the Inglis and Chan Partnership, she can contribute assets of $80,000 Inglis capital was $70, and Chan s was $80,000. Invest in the Partnership Example Partners capital before admitting new partner $ 160,000 Kable s investment 80,000 Capital after admitting Kable s $ 240, Other Assets 80,000 Kable, Capital 80,000 To admit Kable as a new partner

9 Bonus to Old Partners In some cases a new partner may be required to pay a bonus to existing partners when becoming a partner This is often the case when the partnership is highly successful The bonus increases the existing partners contributions. Bonus to existing partners New Partner contributes 100,000 70,000 goes to his contribution The remainder is split between the two existing partners as a bonus Entry would look like: Cash at Bank 100,000 New Partner, Capital 70,000 Partner A, Capital 15,000 Partner B, Capital 15,000 Bonus to the new partner Partnerships may also offer a bonus to a new partner to attract them to the partnership E.g. Restaurants having a famous partner to increase exposure In this case existing partners contributions are decreased

10 Bonus to new partners New Partner contributes 80, ,000 goes to his contribution The difference is contributed by the two existing partners as a bonus Entry would look like: Cash at Bank 80,000 Partner A, Capital 10,000 Partner B, Capital 10,000 New Partner, Capital 100,000 Objective 5 Account for a partner s withdrawal from the firm. Withdrawal of a Partner Withdrawal occur for variety of reasons Disputes Retirement Death Just moving on Withdrawals may be in the form of: Cash Assets Brought out by other partners

11 Withdrawal of a Partner Suppose that Jackson is retiring midyear from the partnership of Green, Henry and Jackson, An independent appraiser revalues the inventory at $34,000 (down from $40,000), and the land at $100,000 (up from $50,000). Withdrawal of a Asset If assets are being withdrawn they often have to be revalued first. The partnership agreement has allocated one-quarter of the profits to Green, one-half to Henry, and onequarter to Jackosn. How do we record the revaluation of the inventory if it has a carrying about of $40,000 and a market value of $34,000 Withdrawal of a Partner June 30 Green, Current 1,500 Henry, Current 3,000 Jackson, Current 1,500 Inventory 6,000 Revalue the inventory, allocate the loss to the partners

12 Withdrawal of a Partner If land is revalued to increase from $50,000 to $100,000 June 30 Land 50,000 Green, Current 12,500 Henry, Current 25,000 Jackson, Current 12,500 Revalue the land, allocate the gain to the partners Withdrawal of a Partner If Jackson s contribution and current remaining is 31,000 the entry would be July 31 Jackson, Capital and Current 31,000 Cash 31,000 Record withdrawal of M. Isaac from the business See the text book page for the balance sheet Withdrawal of a Partner at less then carrying amount If a partner is eager to leave they may settle for less then full equity Assume that Jackson is eager to leave the business and agrees to receive $10,000 and 15,000 later for his equity. The remaining partners share the $6,000 difference Green and Henry agree that Henry will earn two-thirds of partnership profits and losses and Green one-third.

13 Withdrawal of a Partner Jackson, Capital and Current 31,000 Cash 10,000 Amount payable to Jackson Green, Capital 2,000 Henry, Capital 4,000 To record withdrawal of Jackson from the business Withdrawal of a Partner Death of a partner also dissolves the partnership. Debit the partner s Capital account and credit the payable to the estate. The excess or deficiency paid to the withdrawing partner is allocated to the remaining partners in accordance with their profit sharing ratio. Objective 6 Account for the liquidation of a partnership.

14 Liquidation Jane, Elaine and Ly Partnership Balance Sheet (after adjusting and closing) Cash $ 10,000 Total liabilities $ 30,000 Jane, capital 40,000 Land 60,000 Elaine, capital 20,000 Building (net) 30,000 Ly, capital 10,000 Total Assets $100,000 Total L & P.E. $100,000 Liquidation Assume that Jane, Elaine, and Ly have shared profits and losses in the ratio of 3:1:1 (3/5, 1/5, 1/5). Assume that all of the non-cash assets are sold for $150,000 for a gain of $60,000. How do we allocate this gain to the partners? Liquidation $60,000 3/5 = $36,000 to Jane. $60,000 1/5 = $12,000 to Elaine. $60,000 1/5 = $12,000 to Ly. After paying the $30, liabilities, how much cash is left? $10,000 + $150,000 $30,000 = $130,000.

15 Liquidation To Jane: $40,000 + $36,000 = $76,000 To Elaine: $20,000 + $12,000 = $32,000 To Ly: $10,000 + $12,000 = $22,000 Compare this to the example pages of your textbook. Objective 7 Prepare partnership financial statements. Financial Statements Partnership financial statements are much like those of a proprietorship. The income statement includes a section showing the division of net profits to the partners. The balance sheet shows the capital of each partner under partners equity.

16 Statement of Changes in Equity The statement of changes in (partner s) equity shows additional investments by partner. It also shows drawings by partners. See Exhibit 13-7 page 517 in your textbook for a comparison. PowerPoint to accompany End of Chapter 13