Chapter 15: Partnerships – Formation, Operations, and Changes in Ownership Interests by Jeanne M David, Ph.D., Univ of Detroit Mercy to accompany Advanced Accounting, 10th edition by Floyd A Beams, Robin P Clement, Joseph H Anthony, and Suzanne Lowensohn © Pearson Education, Inc publishing as Prentice 15-1 Partnerships: Objectives Comprehend the legal characteristics of partnerships Understand initial investment valuation and record keeping Grasp the diverse nature of profit and loss sharing agreements and their computation Value a new partner's investment in an existing partnership © Pearson Education, Inc publishing as Prentice 15-2 Objectives (cont.) Value a partner's share upon retirement or death Understand limited liability partnership characteristics © Pearson Education, Inc publishing as Prentice 15-3 Partnerships – Formation, Operations, and Changes in Ownership Interests 1: Characteristics of Partnerships © Pearson Education, Inc publishing as Prentice 15-4 Partnerships RUPA "Revised Uniform Partnership Act" – Entity theory: • partners own their share of the partnership, but not its individual assets – Dissociation: • partners can dissociate without dissolution Partners have – Mutual agency – Unlimited liability © Pearson Education, Inc publishing as Prentice 15-5 Articles of Partnership Products or services, line of business Partner rights & responsibilities Initial investment and value assigned to noncash investments Additional investment conditions Asset withdrawals Profit and loss sharing Dissolution procedures © Pearson Education, Inc publishing as Prentice 15-6 Partnership Reporting • Financial reporting should provide for the needs of – Partners – Creditors of the partnership – IRS © Pearson Education, Inc publishing as Prentice 15-7 Partnerships – Formation, Operations, and Changes in Ownership Interests 2: Initial Investment © Pearson Education, Inc publishing as Prentice 15-8 Initial Investment Cash Amy Capital Cash Paul Capital XXX Cash Equipment Land Paul Capital XXX XXX XXX XXX XXX XXX A partnership is started by Amy and Paul, each investing cash If they invest other assets, the value of those assets should be agreed upon in advance © Pearson Education, Inc publishing as Prentice XXX 15-9 Initial Investment with Bonus or Goodwill Partner initial investments, at fair value, will not represent their ownership – Individual talent – Business connections – Customer base Partners choose method – Bonus method • Adjustment within the capital accounts – Goodwill method • Goodwill is recorded on the books © Pearson Education, Inc publishing as Prentice 15-10 Buy from Partner: Goodwill Don and Ed have capital of $50 and $40 with each 50% interest Fay will pay $60 directly to the partners and receive 50% interest in the firm Don and Ed each keep 25% Assets are at fair value Implied value of firm, $60/.50 Old capital, $50 + 40 Goodwill 120 90 30 The goodwill increases Don & Ed's capital each by $15 © Pearson Education, Inc publishing as Prentice 15-29 Goodwill Revalues Capital Don Ed Fay Total After Before Revaluation revaluation $50 $15 $65 40 15 55 $90 $120 Transfer ($35) (25) 60 Final $30 30 60 $120 Presumably, Fay paid $35 to Don and $25 to Ed If the partners had not wanted to realign the capital, the capital of Don and Ed would each be reduced by $30 to transfer the $60 to Fay © Pearson Education, Inc publishing as Prentice 15-30 Buy from Partner: Bonus If Don and Ed had decided not to revalue the assets or record goodwill, the bonus method is used Before Transfer Final Don $50 ($27.5) $22.5 Ed 40 (17.5) 22.5 Fay 45.0 45.0 Fay's capitalTotal is 50%(90) = $45 $90 $90.0 Don and Ed Capital accounts are adjusted to their new balances 25%(90) = $22.5 © Pearson Education, Inc publishing as Prentice 15-31 Entries for Purchase from Partner Entries for Fay's admission, under goodwill and bonus methods: Goodwill 30 Don Capital Ed Capital Don Capital 35 Ed Capital 25 Fay Capital Goodwill method, aligning capital accounts Don Capital 27.5 Ed Capital 17.5 Fay Capital Bonus method, aligning capital accounts © Pearson Education, Inc publishing as Prentice 15 15 60 45 15-32 Invest in Business: Goodwill Andrew and Boyles have capital balances of $40 and $40 and share equally in the firm Criner will be admitted with an investment of $50 cash All three will have equal shares Net assets are at fair value; goodwill will be recorded Implied value of firm, $50/(1/3) $150 Old capital, $40 + 40 $80 Additional investment 50 130 Goodwill $20 Criner: $130*1/3 = $43.3, but he pays $50 … so goodwill goes to old partners Implied firm value is based on Criner's investment © Pearson Education, Inc publishing as Prentice 15-33 Investment and Goodwill Add to Capital (Goodwill to Old Partners) Revalu- After re Before ation valuation Investment Final Andrew $40 $10 $50 $50 Boyles 40 10 50 50 Criner $50 50 Total $80 $100 $150 Capital of $80 at the start, increases by the $20 goodwill and the $50 cash investment © Pearson Education, Inc publishing as Prentice 15-34 Invest in Business: Goodwill Andrew and Boyles have capital balances of $40 and $40 and share equally in the firm Criner will be admitted with an investment of $50 cash Criner will be given a 40% share; Andrew and Boyles will each have 30% Net assets are at fair value; goodwill will be Implied value of firm, $80/(.60) $133.3 recorded Old capital, $40 + 40 $80 Additional investment 50 130.0 Goodwill $3.3 Criner: $130*40% = $52, but he pays $50 … so goodwill goes to new partner Implied firm value is based on old partners' capital and retained interest © Pearson Education, Inc publishing as Prentice 15-35 Investment and Goodwill Add to Capital (Goodwill to New Partner) Revalu- After re Before ation valuation Investment Final Andrew $40 $40 $40.0 Boyles 40 40 40.0 Criner $3.3 3.3 $50 53.3 Total $80 $83.3 $133.3 Capital of $80 at the start, increases by the $3.3 goodwill and the $50 cash investment © Pearson Education, Inc publishing as Prentice 15-36 Invest in Business: Bonus Andrew and Boyles decide not to revalue the business assets, and Criner invests $50 cash in the business for a 1/3 interest Before Investment Bonus Final Andrew $50 ($1) $49 Boyles 40 (1) 39 Criner $50 2 52 Criner's he invests Total new capital $90= 1/3 of the total $130 Since$130 on $50 cash for a $52 interest, the $2 bonus is transferred from the old partners © Pearson Education, Inc publishing as Prentice 15-37 Entries for Investment in Business Entries for Criner's investment, under goodwill and bonus methods: Goodwill Andrew Capital Boyles Capital Cash Criner Capital Goodwill method, goodwill to old partners Cash Andrew Capital Boyles Capital Criner Capital Bonus method, bonus to new partner © Pearson Education, Inc publishing as Prentice 20 10 10 60 60 50 1 52 15-38 Partnerships – Formation, Operations, and Changes in Ownership Interests 5: Death or Retirement of a Partner © Pearson Education, Inc publishing as Prentice 15-39 Dissociation Firm value, according to RUPA, is the greater of – Liquidation value – Sales value as a going concern without the dissociated partner Payment to exiting partner is – Equal to existing capital – More than existing capital • Implied goodwill or bonus to exiting partner – Less than existing capital • Write down overvalued assets, or bonus to remaining partners © Pearson Education, Inc publishing as Prentice 15-40 Partnerships – Formation, Operations, and Changes in Ownership Interests 6: Limited Liability Partnership © Pearson Education, Inc publishing as Prentice 15-41 Limited Partnerships Limited partnerships must have one or more general partners Limited partner – Excluded from participating in management – Limited liability – Partnership agreement • In writing, signed and filed © Pearson Education, Inc publishing as Prentice 15-42 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher Printed in the United States of America Copyright © 2009 Pearson Education, Inc Publishing as Prentice Hall © Pearson Education, Inc publishing as Prentice 15-43 ... Drawings / withdrawals are closed to individual capital accounts Amy Capital Amy Drawings Amy Withdrawals XXX XX XX Reduces Amy's capital for drawings and withdrawals Paul Capital XXX Paul Drawings... are generally based on a measure of the partner's capital – Beginning of the year capital balance – Average* capital balance for the year Weighted average balance – Ending* capital balance Beginning... have capital balances of $50 each and each have a 50% interest in the firm Cobb buys half of Alfano's interest for $25 Alfano Capital Cobb Capital Alfano Bailey Cobb Total Before Capita Share