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College Accounting

College Accounting. Heintz & Parry 20 th Edition. 19. Accounting for Partnerships. 1. Describe the various types of partnerships, their characteristics, the partnership agreement, and the advantages and disadvantages of a partnership. PARTNERSHIP.

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College Accounting

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  1. College Accounting Heintz & Parry20th Edition

  2. 19 Accounting for Partnerships

  3. 1 • Describe the various types of partnerships, their characteristics, the partnership agreement, and the advantages and disadvantages of a partnership.

  4. PARTNERSHIP • “An association of two or more persons who carry on, as co-owners, a business for profit” • Used for all types of enterprises • More popular among personal service enterprises than merchandising businesses

  5. PARTNERSHIP AGREEMENT • Defined as “a written agreement containing the provisions for operating a partnership” • Essential provisions include: • Date of the agreement • Names of the partners • Kind of business to be conducted • Length of time the partnership is to run • Name and location of the business • Investment of each partner • Basis on which profits and losses are to be shared • Limitation of partners’ rights and activities • Salary allowances to partners • Division of assets upon dissolution of partnership • Signatures of the partners

  6. CHARACTERISTICS CO-OWNERSHIP OF ASSETS • All assets held by a partnership are co-owned by all partners. If one partner contributes an asset to the business, the asset is jointly owned by all partners. Advantages: Ability and expertise combined into one enterprise and easier to raise capital

  7. CHARACTERISTICS MUTUAL AGENCY • Any partner can bind the other partners to a contract if he or she is acting within the general scope of the business. Disadvantage: Serious consequences if partners don’t act responsibly

  8. CHARACTERISTICS LIMITED LIFE • A partnership may be dissolved as the result of any change in the ownership (e.g. death, bankruptcy, incapacity, withdrawal of a partner, addition of a new partner, or expiration of the time specified in the partnership agreement).

  9. CHARACTERISTICS • Each partner is personally liable for ALL debts incurred by the partnership. UNLIMITED LIABILITY Major disadvantage: A partner could lose personal assets

  10. CHARACTERISTICS FEDERAL INCOME TAXES • A partnership is not subject to federal income tax. But, partners must report their share of the partnership’s income on their personal income tax returns.

  11. 2 • Prepare entries for the initial investments in a partnership.

  12. INVESTMENTS EXAMPLE: Sam Mitchell and Lisa Jenkins begin the Mitchell & Jenkins Partnership by investing $350,000 and $200,000, respectively. Let’s look at the journal entry!

  13. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Cash 350,000 2 Sam Mitchell, Capital 350,000 3 S. Mitchell invested 4 $350,000 in cash 5 6 Cash 200,000 7 Lisa Jenkins, Capital 200,000 8 L. Jenkins invested 9 $200,000 in cash 10 Separate capital and drawing accounts are maintained for each partner. 11

  14. INVESTMENTS • What if instead of $200,000 in cash, Lisa Jenkins had invested: • Inventory valued at $47,500, on which $10,500 was owed • Office equipment valued at $40,000 • Delivery equipment valued at $92,000, on which $19,000 was owed on a note • $50,000 in cash

  15. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Cash 50,000 2 Inventory 47,500 3 Office Equipment 40,000 4 Delivery Equipment 92,000 5 Notes Payable 19,000 6 Accounts Payable 10,500 7 Lisa Jenkins, Capital 200,000 8 Each asset invested and liability assumed is recorded. The difference is credited to the capital account. 9 10 11

  16. COMBINING BUSINESSES • On April 1, Donna Morning and Larry Knight form a partnership under the firm name of Morning & Knight Sports • They agree to invest their assets in the partnership. The partnership will also assume the liabilities shown on their balance sheets • Profits/losses are to be shared 50-50 • In the case of dissolution, assets are to be distributed between partners in the ratio of their capital interests at the time of dissolution

  17. COMBINING BUSINESSES Morning Sports Balance Sheet March 31, 20-- Assets Liabilities Cash $ 6,344 Notes payable $4,600 Accts. receivable $5,524 Accounts payable 9,082 Less allow. for Total liabilities $13,682 bad debts 430 5,094 Mdse. inventory 24,574 Store equipment $3,840 Owner’s Equity Less accum. depr. 1,000 2,840 Morning, capital 25,170 $38,852 Total assets Total liab. & O.E. $38,852 Let’s look at the journal entry to record Donna Morning’s investment in the new partnership.

  18. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Cash 6,344 2 Accounts Receivable 5,524 3 4 Any uncollectible accounts should be written off before forming the partnership. Morning Sports had no accounts considered uncollectible. 5 6 7 8 9 10 11

  19. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Cash 6,344 2 Accounts Receivable 5,524 3 Merchandise Inventory 24,574 4 5 Since Donna uses FIFO, the merchandise inventory account reflects current market values. 6 7 8 9 10 11

  20. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Cash 6,344 2 Accounts Receivable 5,524 3 Merchandise Inventory 24,574 4 Store Equipment 3,600 5 6 Assets are recorded at their fair market values (not book values) at the time of investment. 7 8 9 10 11

  21. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Cash 6,344 2 Accounts Receivable 5,524 3 Merchandise Inventory 24,574 4 Store Equipment 3,600 5 Allowance for Bad Debts 430 6 Notes Payable 4,600 7 Accounts Payable 9,082 8 The allowance account and the liabilities are recorded at the values shown on Morning Sports’ balance sheet. 9 10 11

  22. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Cash 6,344 2 Accounts Receivable 5,524 3 Merchandise Inventory 24,574 4 Store Equipment 3,600 5 Allowance for Bad Debts 430 6 Notes Payable 4,600 7 Accounts Payable 9,082 8 D. Morning, Capital 25,930 The capital account is credited for the difference between assets invested and liabilities assumed. 9 10 11

  23. COMBINING BUSINESSES Knight AthleticsBalance SheetMarch 31, 20-- Assets Liabilities Cash $ 3,544 Notes payable $ 6,000 Accts. receivable $5,280 Accounts payable 13,238 Less allow. for Total liabilities $19,238 bad debts 720 4,560 Owner’s Equity Mdse. inventory 29,692 Knight, capital 25,664 Supplies 286 Total liab. & O.E. $44,902 Office equipment $4,320 Less accum. depr. 1,100 3,220 Knight’s assets and liabilities are brought into the new partnership. Store equipment $4,800 3,600 Less accum. depr. 1,200 $44,902 Total assets

  24. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Cash 3,544 2 Accounts Receivable 5,280 3 Merchandise Inventory 29,692 4 Supplies 286 5 Office Equipment 3,850 6 Store Equipment 4,200 7 Allowance for Bad Debts 720 8 Notes Payable 6,000 9 Accounts Payable 13,238 10 L. Knight, Capital 26,894 11

  25. 3 • Explain how partners are compensated and account for the allocation of net income.

  26. ALLOCATING PROFIT OR LOSS EXAMPLE: The partnership of Mitchell and Jenkins earned net income of $190,800 for the year. S. Mitchell L. Jenkins $95,400 $95,400 If Mitchell and Jenkins had not specified how the income was to be split, it would be split evenly.

  27. PARTNERSHIP CLOSING ENTRIES • Four Entries • Close all revenues to Income Summary • Close all expenses to Income Summary • Close Income Summary by allocating each partner’s share of net income or loss to the individual capital accounts • Close each partner’s drawing account to the individual capital accounts. Entries #1 & 2 are the same as for sole proprietorships. Entries #3 & 4 are different for partnerships.

  28. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Closing Entries 2 (3) Income Summary 190,800 3 S. Mitchell, Capital 95,400 4 L. Jenkins, Capital 95,400 5 Instead of all the net income being credited to one capital account, it is allocated to each partner’s capital account. 6 7 8 9 10 11

  29. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Closing Entries Assume Mitchell withdrew $36,000 and Jenkins withdrew $48,000 during the year. Each partner’s drawing account is closed to his respective capital account. 2 (3) Income Summary 190,800 3 S. Mitchell, Capital 95,400 4 L. Jenkins, Capital 95,400 5 6 (4) S. Mitchell, Capital 36,000 7 S. Mitchell, Drawing 36,000 8 9 L. Jenkins, Capital 48,000 10 48,000 L. Jenkins, Drawing 11

  30. ALLOCATING PROFIT OR LOSS EXAMPLE: The partnership of Mitchell and Jenkins earned net income of $190,800 for the year. S. Mitchell L. Jenkins Mitchell and Jenkins did specify how the income was to be split— after salary allowances, the remaining net income was to be split 60-40.

  31. ALLOCATING PROFIT OR LOSS EXAMPLE: The partnership of Mitchell and Jenkins earned net income of $190,800 for the year. S. Mitchell L. Jenkins $36,000 $48,000 Salary allowances Salary allowances total $84,000. Remaining net income is $106,800 ($190,800 – $84,000).

  32. ALLOCATING PROFIT OR LOSS EXAMPLE: The partnership of Mitchell and Jenkins earned net income of $190,800 for the year. S. Mitchell L. Jenkins $36,000 $48,000 Salary allowances 64,080 $106,800  60% = $64,080

  33. ALLOCATING PROFIT OR LOSS EXAMPLE: The partnership of Mitchell and Jenkins earned net income of $190,800 for the year. S. Mitchell L. Jenkins $36,000 $48,000 Salary allowances 42,720 64,080 Remaining income $106,800 40% = $42,720

  34. ALLOCATING PROFIT OR LOSS EXAMPLE: The partnership of Mitchell and Jenkins earned net income of $190,800 for the year. S. Mitchell L. Jenkins $ 36,000 $48,000 Salary allowances 64,080 42,720 Remaining income $100,080 $90,720

  35. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Income Summary 190,800 2 S. Mitchell, Capital 100,080 3 L. Jenkins, Capital 90,720 4 5 6 7 A closing entry is made for the total allocated to each partner. 8 9 10 11

  36. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT Next, close each owner’s drawing account. 1 Income Summary 190,800 2 S. Mitchell, Capital 100,080 3 L. Jenkins, Capital 90,720 4 5 S. Mitchell, Capital 36,000 6 S. Mitchell, Drawing 36,000 7 8 L. Jenkins, Capital 48,000 9 L. Jenkins, Drawing 48,000 10 11

  37. ALLOCATING PROFIT OR LOSS EXAMPLE: Let’s look at the allocation if the partnership of Mitchell and Jenkins earned net income of $44,000 for the year. S. Mitchell L. Jenkins $36,000 $48,000 Salary allowances The salary allowances alone total more than the net income!

  38. ALLOCATING PROFIT OR LOSS EXAMPLE: Let’s look at the allocation if the partnership of Mitchell and Jenkins earned net income of $44,000 for the year. S. Mitchell L. Jenkins $36,000 $48,000 Salary allowances $84,000 Salary allow. – 44,000 Net income $40,000 Excess to be absorbed by partners

  39. ALLOCATING PROFIT OR LOSS EXAMPLE: Let’s look at the allocation if the partnership of Mitchell and Jenkins earned net income of $44,000 for the year. S. Mitchell L. Jenkins $ 36,000 $48,000 Salary allowances (24,000) $40,000 60%

  40. ALLOCATING PROFIT OR LOSS EXAMPLE: Let’s look at the allocation if the partnership of Mitchell and Jenkins earned net income of $44,000 for the year. S. Mitchell L. Jenkins $ 36,000 $ 48,000 Salary allowances (16,000) (24,000) $40,000 40%

  41. ALLOCATING PROFIT OR LOSS EXAMPLE: Let’s look at the allocation if the partnership of Mitchell and Jenkins earned net income of $44,000 for the year. S. Mitchell L. Jenkins $ 36,000 $ 48,000 Salary allowances (16,000) (24,000) $ 32,000 $ 12,000 $12,000 + $32,000 = $44,000 net income

  42. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 Income Summary 44,000 2 S. Mitchell, Capital 12,000 3 L. Jenkins, Capital 32,000 4 5 Entries to close the drawing accounts would be the same as the previous example. 6 7 8 9 10 11

  43. ALLOCATING PROFIT OR LOSS EXAMPLE: B. K. Kelly and S. B. Arthur form a partnership on January 1 of the current year. Kelly will devote full time to operating the business, invest $50,000, and draw a salary of $35,000 per year. Arthur will devote about 10 hours per week, invest $150,000, and draw a salary of $10,000 per year. The partners will be allowed interest of 10% on capital balances on January 1 of each year and the balance of the earnings will be divided equally. Let’s allocate the first year net income of $80,000.

  44. ALLOCATING PROFIT OR LOSS B. K. Kelly S. B. Arthur $10,000 $35,000 Salary allow. 5,000 Interest allow. Kelly had a capital balance of $50,000 on January 1. ($50,000  10%)

  45. ALLOCATING PROFIT OR LOSS B. K. Kelly S. B. Arthur $35,000 $10,000 Salary allow. 5,000 15,000 Interest allow. Arthur had a capital balance of $150,000 on January 1. ($150,000  10%)

  46. ALLOCATING PROFIT OR LOSS B. K. Kelly S. B. Arthur $35,000 $10,000 Salary allow. 5,000 15,000 Interest allow. 7,500 7,500 Remaining income Kelly has allowances of $40,000 so far. Arthur has $25,000 so far. $80,000 – $65,000 = $15,000 remaining Split evenly = $7,500 each

  47. ALLOCATING PROFIT OR LOSS B. K. Kelly S. B. Arthur $35,000 $10,000 Salary allow. 5,000 15,000 Interest allow. 7,500 7,500 Remaining income $32,500 $47,500 What if the partnership had a loss of $20,000 in the first year?

  48. ALLOCATING PROFIT OR LOSS B. K. Kelly S. B. Arthur $35,000 $10,000 Salary allow. 15,000 5,000 Interest allow. Salary and interest allowances would still be given, totaling $65,000.

  49. ALLOCATING PROFIT OR LOSS B. K. Kelly S. B. Arthur $ 35,000 $ 10,000 Salary allow. 15,000 5,000 Interest allow. (42,500) (42,500) $ (2,500) $(17,500) The allowances plus the loss leave $85,000 to be absorbed equally.

  50. GENERAL JOURNAL DATE DESCRIPTION DEBIT PR CREDIT 1 B. K. Kelly, Capital 2,500 2 S. B. Arthur, Capital 17,500 3 Income Summary 20,000 4 5 Capital accounts are reduced this year. 6 7 8 9 10 11

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