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CHAPTER 21

CHAPTER 21. PARTNERSHIPS: CHANGES IN OWNERSHIP. FOCUS OF CHAPTER 21. Tangible Assets Having Values Different from Book Values Intangible Element Exists: Recording Methods and Alternative Approaches Intangible Element Exists: Specific Situations Legal Aspects of Changes in Ownership

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CHAPTER 21

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  1. CHAPTER 21 PARTNERSHIPS: CHANGES IN OWNERSHIP

  2. FOCUS OF CHAPTER 21 • Tangible Assets Having Values Different from Book Values • Intangible Element Exists: Recording Methods and Alternative Approaches • Intangible Element Exists: Specific Situations • Legal Aspects of Changes in Ownership • Tax Aspects of Changes in Ownership

  3. Partner’s Admission:Purchase of An Existing Interest • The purchase of an interest from one or more of a partnership’s existing partners is a: • PERSONAL TRANSACTION betweenthe incoming partner and the selling partner(s). • The ONLY entry required on the partnership’s books is to TRANSFER an amount: • From the selling partner’s Capital account. • To the new partner’s Capital account.

  4. Methods to Minimize Inequities • The Three Methods: • The revaluing of assets/recording the goodwill method. • The special profit-and-loss sharing provision method. • The bonus method. • Some methods can still result in inequities if events do not materialize as assumed. #1 #2 #3

  5. Best Minimizing Inequities • ONLY the SPECIAL PROFIT-AND-LOSS SHARING PROVISION METHOD will prevent an inequity to one or more of the partners in the event that: • The agreed-upon values of the assets are erroneous. • The agreed-upon value of goodwill does not materialize.

  6. The Bonus Method • Major Advantages: • Does not result in a departure from GAAP. • Minimizes bookkeeping & tax return effort. • Mechanics: • A portion of one or more partner’s capital balance is TRANSFERRED to one or more other partners. • The hope is that the transferred amount will later be recouped via future profits.

  7. The Bonus Method:When to Apply It • The bonus method may be applied when: New Old New Partnership = Partner’s + Partner’s Asset Capital Capital Investment

  8. The Revaluing of Assets/Recording The Goodwill Method • Advantages: • Incoming partners ALWAYS get credited to their capital accounts the full value of their asset investment (sometimes important psychologically). • Disadvantages: • Departs from GAAP. • Complicates income tax preparation.

  9. The Goodwill Method:When to Apply It • The goodwill method is applied when: New Old New Partnership> Partners’ + Partner’s Asset Capital Capital Investment

  10. Legal Aspects:Joining a Partnership • A major risk of joining an existing partnership is the general practice of requiring the new partner to become jointly responsible for: • ALL pre-existing partnership liabilities. • ALL pre-existing contingent liabilities.

  11. Legal Aspects:Withdrawing From a Partnership • A partner that withdraws from a partnership is still responsible for the following items that exist at the time of the withdrawal: • ALL partnership obligations. • ALL contingent liabilities. • ONLYcreditors can expressly release a partner from this responsibility.

  12. Legal Aspects:Withdrawing From a Partnership • Disassociation: A broad term that refers to when a partner is no longer associated with a partnership. • Dissolution: A narrow term that refers to when a (1) partnership is dissolved and (2) its affairs must be wound up. Thus the partnership’s existence is terminated.

  13. Review Question #1 Newby contributes $36,000 cash for a 25% interest in the new net assets of the partner-ship (that has existing equity of $120,000). The old partners capital accounts are not to decrease. Newby’s capital account is credited:A. $6,000B. $36,000C. $39,000 D. $40,000 E. $51,000

  14. Review Question #1With Answer Newby contributes $36,000 cash for a 25% interest in the new net assets of the partner-ship (that has existing equity of $120,000). The old partners capital accounts are not to decrease. Newby’s capital account is credited:A. $6,000B. $36,000C. $39,000 D. $40,000 ([$120,000/75%] - $120,000)E. $51,000

  15. Review Question #2 Upon withdrawal from a partnership, Leavy received $7,000 cash in excess of his capital balance. Leavy’s share of profits and losses was20%. Partnership land was undervalued $25,000. The partnership goodwill is:A. $2,000 B. $10,000C. $12,000 D. $35,000

  16. Review Question #2With Answer Upon withdrawal from a partnership, Leavy received $7,000 cash in excess of his capital balance. Leavy’s share of profits and losses was20%. Partnership land was undervalued $25,000. The partnership goodwill is:A. $2,000 B. $10,000 (5 x [$7,000 - {20% x $25,000}]) C. $12,000 D. $35,000

  17. End of Chapter 21(Appendix 21A follows) Time to Clear Things Up—Any Questions?

  18. Appendix 21A: Income Tax Aspects Appendix 21A • Upon withdrawal from a partnership, the partner must determine whether there is again or loss for tax-reporting purposes. • This determination is made by comparing: • The partner’s proceeds with • The partner’s tax basis.

  19. Appendix 21A: Income Tax Aspects Appendix 21A • A partner’s proceeds are the sum of: • Cash received plus • The partner’s share of existing liabilitiesfor which he or she is relieved of responsibility. • The share is determined by applying the partner’s profit-sharing percentage.

  20. Review Question #21A-1 Appendix 21A Gale contributes $50,000 cash and a $24,000 liability upon admission into a partnership that has existing liabilities of $60,000. Gale’s share of profits and losses is 25%. What is Gale’s tax basis immediately after admission? A. $32,000B. $41,000C. $47,000D. $50,000E. $59,000

  21. Review Question #21A-1With Answer Appendix 21A Gale contributes $50,000 cash and a $24,000 liability upon admission into a partnership that has existing liabilities of $60,000. Gale’s share of profits and losses is 25%. What is Gale’s tax basis immediately after admission? A. $32,000B. $41,000C. $47,000 ($50,000 + [$60,000/4] - [$24,000 x 75%])D. $50,000E. $59,000

  22. Review Question #21A-2 Appendix 21A Upon withdrawal from a partnership (that has existing liabilities of $80,000), Gawner receives $50,000 cash. Gawner’s share of profits and losses was25%. What is Gawner’s taxable gain or loss if his tax basisimmediately before withdrawing was $66,000? A. $4,000B. $14,000C. $16,000 D. $36,000

  23. Review Question #21A-2With Answer Appendix 21A Upon withdrawal from a partnership (that has existing liabilities of $80,000), Gawner receives $50,000 cash. Gawner’s share of profits and losses was25%. What is Gawner’s taxable gain or loss if his tax basisimmediately before withdrawing was $66,000? A. $4,000 ($50,000 + [$80,000/4] - $66,000)B. $14,000C. $16,000 D. $36,000

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