Accounting Principles, 7th Edition Weygandt • Kieso • Kimmel Chapter 13 Accounting for Partnerships Prepared by Naomi Karolinski Monroe Community College and Marianne Bradford Bryant College John Wiley & Sons, Inc © 2005 CHAPTER 13 ACCOUNTING FOR After studying this chapter, you should be PARTNERSHIPS able to: Identify the characteristics of the partnership form of business organization Explain the accounting entries for the formation of a partnership Identify the basis for dividing net income or net loss Describe the form and content of partnership financial statements Explain the effects of the entries to record liquidation of a partnership PARTNERSHIP FORM OF ORGANIZATION STUDY OBJECTIVE • Uniform Partnership Act – basic rules for the formation and operation of partnerships in more than 90 percent of the states – defines a partnership • an association of two or more persons to carry on as co-owners of a business for a profit CHARACTERISTICS OF PARTNERSHIPS Principal characteristics of a partnership Association of individuals Mutual agency Limited life Unlimited liability Co-ownership of property PARTNERSHIP CHARACTERISTICS MUTUAL AGENCY • Mutual agency – each partner acts on behalf of the partnership when engaging in partnership business – act of any partner is binding on all other partners • (true even when partners act beyond the scope of their authority, so long as the act appears to be appropriate for the partnership) ASSOCIATION OF INDIVIDUALS • Association of individuals – may be based on as simple an act as a handshake, 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 LIMITED LIFE • Partnerships – have a limited life – dissolution • whenever a partner withdraws or a new partner is admitted – ends involuntarily • by death or incapacity of a partner – may end voluntarily • through acceptance of a new partner or withdrawal of a partner UNLIMITED LIABILITY • Unlimited liability – each partner is personally and individually liable for all partnership liabilities – creditors’ claims attach first to partnership assets – if insufficient assets • claims then attach to the personal resources of any partner, irrespective of that partner’s capital equity in the company CO-OWNERSHIP OF PROPERTY • Partnership Assets – assets invested in the partnership are owned jointly by all the partners • 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 BONUS TO OLD PARTNERS Determine the amount of bonus by subtracting the new partner’s capital credit from the new partner’s investment The bonus in this case is $30,000 ($80,000 – $50,000) Allocate the bonus to the old partners on the basis of their income ratios Assuming the ratios are Bart, 60% and Cohen, 40%, the allocation is: Bart, $18,000 ($30,000 X 60%) and Cohen, $12,000 ($30,000 X 40%) The entry to record the admission is: 80,000 18,000 12,000 50,000 BONUS TO NEW PARTNER • A bonus to a new partner – results when the new partner’s investment is less than his or her capital credit in the firm – capital balances of the old partners are decreased based on their income ratios before the admission of the new partner BONUS COMPUTATION OF CAPITAL CREDIT AND BONUS TO NEW PARTNER Lea Eden invests $20,000 in cash for a 25% ownership interest in the Bart-Cohen partnership The calculations for Eden’s capital credit and the bonus are as follows: The entry to record the admission of Eden is as follows: 20,000 9,000 6,000 35,000 WITHDRAWAL OF A PARTNER STUDY OBJECTIVE • A partner may withdraw – voluntarily selling his or her equity – involuntarily by reaching mandatory retirement age or by dying • Withdrawal of a partner - payment from remaining assets or partners’ personal PROCEDURES IN PARTNERSHIP WITHDRAWAL PAYMENT FROM PARTNERS’ PERSONAL ASSETS • The withdrawal of a partner when payment made from partners’ personal assets – is the direct opposite of admitting a new partner who purchases a partner’s interest – is a personal transaction between the partners Partnership Assets Bye LEDGER BALANCES AFTER PAYMENT FROM PARTNERS’ PERSONAL ASSETS Anne Morz, Mary Nead, and Jill Odom have capital balances of $25,000, $15,000, and $10,000, respectively, when Morz and Nead agree to buy out Odom’s interest Each of them agrees to pay Odom $8,000 in exchange for one-half of Odom’s total interest of $10,000 The entry to record the withdrawal is: 10,000 5,000 5,000 The effect of this entry on the partnership accounts is shown below: PAYMENT FROM PARTNERSHIP ASSETS Using partnership assets to pay for a withdrawing partner’s interest decreases both total assets and total partnership capital In accounting for a withdrawal by payment from partnership assets: 1) asset revaluations should not be recorded and 2) any difference between the amount paid and the withdrawing partner’s capital balance should be considered a bonus to the retiring partner or a bonus to the remaining partners Bye Partnership Assets BONUS TO RETIRING PARTNER A bonus may be paid to a retiring partner when: the fair market value of partnership assets is greater than their book value, there is unrecorded goodwill resulting from the partnership’s superior earnings record, or the remaining partners are anxious to remove the partner from the firm BONUS BONUS TO RETIRING PARTNER The bonus is deducted from the remaining partners’ capital balances on the basis of their income ratios at the time of the withdrawal Terk retires from the RST partnership and receives a cash payment of $25,000 from the firm Terk has a capital balance of $20,000 The procedure for determining the bonus to the retiring partner and the allocation of the bonus to the remaining partners is: 1) Determine the amount of the bonus by subtracting the retiring partner’s capital balance from the cash paid by the partnership The bonus in this case is $5,000 ($25,000 – $20,000) 2) Allocate the bonus to the remaining partners on the basis of their income ratios The ratios of Roman and Sand are 3:2, so the allocation of the $5,000 bonus is: Roman $3,000 ($5,000 X 3/5) and Sand $2,000 ($5,000 X 2/5) The appropriate entry is: 20,000 3,000 2,000 25,000 BONUS TO REMAINING PARTNERS The retiring partner may pay a bonus to the remaining partners when: recorded assets are overvalued the partnership has a poor earnings record or the partner is anxious to leave the partnership BONU S BONUS TO REMAINING PARTNERS The bonus is allocated (credited) to the capital balances of the remaining partners on the basis of their income ratios Assume that Terk is paid only $16,000 for her $20,000 equity upon withdrawing from the RST partnership In such a case: 1) The bonus to remaining partners is $4,000 ($20,000 – $16,000) 2) The allocation of the $4,000 bonus is: Roman $2,400 ($4,000 X 3/5) and Sand $1,600 ($4,000 X 2/5) The entry to record the withdrawal is: 20,000 2,400 1,600 16,000 DEATH OF A PARTNER • The death of a partner dissolves the partnership But provision generally is made for the surviving partners to continue operations by purchasing the deceased partner’s equity from their personal assets • When a partner dies it is necessary to determine the partner’s equity at the date of death This is done by: 1) determining the net income or loss for the year to date, 2) closing the books, and 3) preparing financial statements DEATH OF A PARTNER • The surviving partners will agree to either 1) purchase the deceased partner’s equity from their personal assets or 2) use partnership assets to settle with the deceased partner’s estate • In both instances, the entries to record the withdrawal of the partner are similar to those 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damages,caused causedby bythe theuse useof ofthese these programs programsor orfrom fromthe theuse useof ofthe theinformation informationcontained containedherein herein .. .CHAPTER 13 ACCOUNTING FOR After studying this chapter, you should be PARTNERSHIPS able to: Identify the characteristics of the partnership form of business organization Explain the accounting. .. assigned must be agreed to by all of the partners • Once partnership has been formed – accounting is similar to accounting for transactions of any other type of business organization Computer recorded... 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