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Understanding Partnerships in Business: Characteristics and Accounting

Learn the characteristics and accounting principles of partnerships, including partner investment, profit allocation, new partner admission, and more. Discover various partnership types like general and limited partnerships.

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Understanding Partnerships in Business: Characteristics and Accounting

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  1. Partnerships Chapter 12

  2. Ch.12 – Objectives: • 1. Characteristics of a Partnership • 2. Account for Partner Investment • 3. Allocate Profit/Loss • 4. Account for Admission of new partner • 5. Account for a partner’s Withdrawal • 6. Account for Liquidation of a Partnership • 7. Prepare Partnership Fin. Statement

  3. Objective 1 Identify the characteristics of a partnership

  4. Partnership • Association of two or more persons who co-own a business for a profit • Combines • Capital • Talent • Experience

  5. Partnership Agreement • Contract between partners should specify • Name, location, and nature of business • Name, investment, and duties of each partner • How new partners are admitted • How profits and losses are divided up • Withdrawals of assets by the partners • How to settle up with a withdrawing partner • How to liquidate the partnership

  6. Characteristics of a Partnership • Limited life • Mutual agency • Unlimited liability • Co-ownership of property • No partnership income taxes • Partners’ capital accounts

  7. Types of Partnerships • General partnership – basic form • Limited partnership – two classes of partners

  8. Limited Liability Company • Its own form of business organization • Owners are called members • Limited liability • Members can participate in management • Can elect not to pay business income tax

  9. S Corporations • Corporation taxed as a partnership • Limited liability of owners • No corporate income tax • Stockholders pay personal income tax on their share of income

  10. Objective 2 Account for partner investments

  11. The Partnership Start-Up • Record assets invested by partners at fair market values • Record liabilities assumed at fair market values • Each partner has his/her own capital and withdrawals account

  12. E12-15 Cash 8,000 Accounts Receivable 10,000 Furniture 1,000 Building 90,000 Note Payable 10,000 Accounts Payable 3,000 N. Fuentes, Capital 96,000

  13. Objective 3 Allocate profits and losses to the partners

  14. Sharing Profits and Losses • Stated fraction for each partner • Based on percent of capital balances of the partners • Based on each partner’s service • Combination

  15. Sharing Profits and Losses • If no partnership agreement, the law states earnings will be divided equally • If agreement specifies how to share profits, but not losses – losses are shared the same way as profits

  16. E12-16 a Net loss ($90,000) B. Fultz 45,000 J. Hardie 45,000 B. Fultz, Capital 45,000 J. Hardie, Capital 45,000 Income Summary 90,000

  17. E12-16 b Net income $60,000 B. Fultz (40,000/120,000) x 60,000 20,000 J. Hardie (80,000/120,000) x 60,000 40,000 Income Summary 60,000 B. Fultz, Capital 20,000 J. Hardie, Capital 40,000

  18. E12-16 c $20,000 $40,000 40,000 12,000 18,000 10,000 5,000 5,000 0 $37,000 $63,000

  19. E12-16 c Income Summary 100,000 B. Fultz, Capital 37,000 J. Hardie, Capital 63,000

  20. Partner Drawings • Reduces capital • Debit Drawing and credit Cash • At period end, close drawing to capital

  21. Objective 4 Account for the admission of a new partner

  22. Purchasing a Partner’s Interest • Equity is transferred from retiring partner to new partner • Debit retiring partner’s capital • Credit new partner’s capital • Partnership assets are not affected

  23. E12-18 a G. Rose, Capital $100,000 C. Novak, Capital 50,000 Total $150,000 C. Novak, Capital 50,000 H. Hollis, Capital 50,000

  24. E12-18 a Balances: G. Rose, Capital $100,000 H. Hollis, Capital 50,000 Total $150,000

  25. Investing in the Partnership • New partner contributes assets to the partnership in exchange for a share of the business

  26. Investing in the Partnership at Book Value • New partner invests assets equal to his/her interest in the new partnership • Debit assets • Credit new partner’s capital

  27. E12-18 b G. Rose, Capital $100,000 C. Novak, Capital 50,000 Total before admitting $150,000 Hollis investment 50,000 Total after admitting $200,000 ¼ interest = $50,000

  28. E12-18 b Cash 50,000 H. Hollis, Capital 50,000

  29. E12-18 b Balances G. Rose, Capital $100,000 C. Novak, Capital 50,000 Hollis investment 50,000 $200,000

  30. Investing in the Partnership - Bonus to the Old Partners • New partner invests assets greater than his/her equity in the new partnership • Bonus increases old partner’s capital in profit-and-loss sharing ratio • Debit assets • Credit new partner’s capital for his/her share • Credit each old partners’ capital for his/her share of the bonus

  31. E12-18 c G. Rose, Capital $100,000 C. Novak, Capital 50,000 Total before admitting $150,000 Hollis investment 90,000 Total after admitting $240,000 ¼ interest = $60,000 Bonus of $30,000 paid to existing partners

  32. E12-18 c Distribution of bonus: G. Rose, Capital (30,000 x 1/2) $15,000 C. Novak, Capital (30,000 x 1/2) 15,000

  33. E12-18 c Cash 90,000 H. Hollis, Capital 60,000 G. Rose, Capital 15,000 C. Novak, Capital 15,000

  34. E12-19 c Balances: G. Rose, Capital $115,000 C. Novak, Capital 65,000 Hollis investment 60,000 $240,000

  35. Investing in the Partnership - Bonus to New Partners • New partner invests assets less than his/her equity in the new partnership • Bonus decreases old partner’s capital in profit-and-loss sharing ratio • Debit assets • Debit each old partners’ capital for his/her share of the bonus to the new partner • Credit new partner’s capital for his/her share

  36. Objective 5 Account for a partner’s withdrawal from the firm

  37. Withdrawal of a Partner • Assets may be revalued • Any gain or loss is allocated among the partners based on their profit- and-loss ratios

  38. Partner Sells Interest to Existing Partner • Transfer equity from the withdrawing partner to the purchaser • No assets flows through the partnership • Debit withdrawing partner’s capital • Credit purchaser’s capital

  39. Withdrawal at Book Value • Partner takes assets with value equal to his capital account (equal to book value) • Debit withdrawing partner’s capital • Credit assets taken

  40. Withdrawal at Less Than Book Value • Remaining partners share the difference (bonus) based on their profit-and loss-sharing ratio • Debit withdrawing partner’s capital • Credit assets and remaining partners’ capital

  41. Withdrawal at More Than Book Value • Bonus to the withdrawing partner reduces the remaining partners’ capital balances based on their profit-and-loss ratio • Debit withdrawing partner’s capital • Debit remaining partners’ capital • Credit assets

  42. E12-21 Distribute gain on land to partners based on profit-loss ratio Sam (32,000 x 4/10) $12,800 Bob (32,000 x 3/10) 9,600 Tim (32,000 x 3/10) 9,600

  43. E12-21 May 31 Land 32,000 Sam, Capital 12,800 Bob, Capital 9,600 Tim, Capital 9,600

  44. E12-21 Distribute loss on inventory to partners based on profit-loss ratio Sam (12,000 x 4/10) $4,800 Bob (12,000 x 3/10) 3,600 Tim (12,000 x 3/10) 3,600

  45. E12-21 May 31 Sam, Capital 4,800 Bob, Capital 3,600 Tim, Capital 3,600 Inventory 12,000

  46. E12-21 Sam, Capital Bob, Capital Tim, Capital 36,000 51,000 22,000 12,800 9,600 9,600 4,800 3,600 3,600 44,000 57,000 28,000 Sam receives a bonus of $16,000 ($60,000 - $44,000)

  47. E12-21 Distribute bonus to withdrawing partner based on profit-loss ratio Bob (16,000 x 3/6) $8,000 Tim (16,000 x 3/6) 8,000

  48. E12-21 May 31 Sam, Capital 44,000 Bob, Capital 8,000 Tim, Capital 8,000 Cash 60,000

  49. Objective 6 Account for the liquidation of a partnership

  50. Death of a Partner • Dissolves partnership • Settlement with the deceased partner’s estate - based on partnership agreement • Or, a remaining partner may buy the deceased partner’s equity

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