Partnerships Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University Chapter 13

Copyright © Houghton Mifflin Company. All rights reserved.13–2 Learning Objectives 1.Identify the characteristics, advantages, and disadvantages of the partnership form of business. 2.Record partners’ investments of cash and other assets when a partnership is formed.

Copyright © Houghton Mifflin Company. All rights reserved.13–3 Learning Objectives 3.Compute and record the income or losses that partners share, based on stated ratios, capital balance ratios, and partners’ salaries and interest. 4.Record a person’s admission to or withdrawal from a partnership. 5.Compute the distribution of assets to partners when they liquidate their partnership.

Copyright © Houghton Mifflin Company. All rights reserved.13–4 Partnership Characteristics Objective 1 –Identify the principal characteristics, advantages, and disadvantages of the partnership form of business

Copyright © Houghton Mifflin Company. All rights reserved.13–5 Partnership … an association of two or more persons to carry on as co-owners of a business for profit Defined by the Uniform Partnership Act, which has been adopted by most states Treated as a separate accounting entity from its owners –Legally, there is no economic separation between a partnership and its owners

Copyright © Houghton Mifflin Company. All rights reserved.13–6 Voluntary Association A partnership is a voluntary association of individuals rather than a legal entity in itself –Therefore, A partner is responsible under the law for his or her partners’ actions within the scope of the business A partner has unlimited liability for the debts of the partnership It is important to select partners who share the same business objectives

Copyright © Houghton Mifflin Company. All rights reserved.13–7 Partnership Agreement Two or more competent individuals agree to be partners in a common business purpose Does not have to be in writing –Good business practice calls for a written document that clearly states the details of the agreement

Copyright © Houghton Mifflin Company. All rights reserved.13–8 Partnership Agreement (cont’d) Important components of a partnership agreement include –Name, location, and purpose of business –Names of partners and their respective duties –The investments of each partner –Method of distributing income and losses –Procedures for the admission and withdrawal of partners –Withdrawal of assets allowed by each partner –Liquidation (termination) of the business

Copyright © Houghton Mifflin Company. All rights reserved.13–9 Limited Life The life of a partnership is dissolved when 1.A new partner is admitted 2.A partner –Withdraws –Goes bankrupt –Is incapacitated –Retires –Dies 3.The terms of the partnership agreement are met

Copyright © Houghton Mifflin Company. All rights reserved.13–10 Limited Life (cont’d) If the partners want the partnership to continue legally, the partnership agreement can be written to cover these situations For example, a partnership agreement can state that if a partner dies, the remaining partner(s) must purchase the deceased partner's capital at book value from the heirs

Copyright © Houghton Mifflin Company. All rights reserved.13–11 Mutual Agency … means each partner is an agent of the partnership within the scope of the business This means any partner can bind the partnership to a business agreement as long as he or she acts within the scope of the company’s normal operations Because of this, it is very important to choose business partners who have integrity and who share the same business objectives

Copyright © Houghton Mifflin Company. All rights reserved.13–12 Mutual Agency (cont’d) A partner in a used-car business purchases and sells used cars The partnership is bound to these business agreements because they fall within the scope of the used-car business A partner in a used-car business signs a contract to purchase men’s clothing The partnership is not bound to this agreement because it does not fall within the scope of the used-car business

Copyright © Houghton Mifflin Company. All rights reserved.13–13 Unlimited Liability …means that each partner is personally liable for all of the debts of the partnership All partners have unlimited liability Each partner can be required by law to pay all the debts of the partnership

Copyright © Houghton Mifflin Company. All rights reserved.13–14 Unlimited Liability (cont’d) If a partnership cannot pay its debts –Creditors must first satisfy their claims from the assets of the business –If these assets are not enough to cover all debts, creditors can seek payment from the personal assets of each partner If one partner’s assets are used up before complete payment of the debt, creditors can claim additional assets from the remaining partners who are able to pay

Copyright © Houghton Mifflin Company. All rights reserved.13–15 Co-ownership of Partnership Property Property invested in a partnership becomes an asset of the partnership and is jointly owned by the partners –Partners give up the right to their separate use of the property

Copyright © Houghton Mifflin Company. All rights reserved.13–16 Participation in Partnership Income Each partner has the right to share in the company's income and the responsibility to share in its losses The partnership agreement should state the method of distributing income and losses to each partner –If the agreement describes how to distribute income but not losses, the losses are distributed in the same way as income –If no method is stated for income or loss distribution, the partners must by law share income and losses equally

Copyright © Houghton Mifflin Company. All rights reserved.13–17 Advantages and Disadvantages of Partnerships Advantages –Easy to form, change, and dissolve –Facilitates the pooling of capital resources and individual talents –Has no corporate tax burden Is not a legal entity for tax purposes Does not have to pay federal income tax But, must file an informational return –Gives partners a certain amount of freedom and flexibility

Copyright © Houghton Mifflin Company. All rights reserved.13–18 Advantages and Disadvantages of Partnerships (cont’d) Disadvantages –Limited life –Mutual agency One partner can bind the partnership to a contract –Unlimited personal liability –More difficult to raise large amounts of capital and transfer ownership interests than for a corporation

Copyright © Houghton Mifflin Company. All rights reserved.13–19 Other Forms of Association Limited partnerships Joint ventures These two common forms of association are a type of partnership or similar to a partnership

Copyright © Houghton Mifflin Company. All rights reserved.13–20 Limited Partnership A special type of partnership that confines the limited partner’s loss to the amount of his or her investment –Overcomes the unlimited liability disadvantage Usually, a general partner has unlimited liability, but other partners are allowed to limit their potential loss –Subject to personal bankruptcy laws

Copyright © Houghton Mifflin Company. All rights reserved.13–21 Joint Venture An association of two or more entities for the purpose of achieving a specific goal Many have an agreed-upon limited life –End when the common goal is achieved Usually involve companies, but can sometimes involve governments, especially in emerging economies Profits and losses are shared on an agreed- upon basis

Copyright © Houghton Mifflin Company. All rights reserved.13–22 Discussion Q.Is mutual agency considered an advantage or disadvantage of a partnership? A.Mutual agency means one partner can bind the partnership to a contract, or agreement. This can be a disadvantage if the partner makes binding agreements that are not in the best interest of the partnership. However, it could be difficult to conduct business without mutual agency. For example, it would be impractical to have every partner approve a contract to sell each car on a car lot

Copyright © Houghton Mifflin Company. All rights reserved.13–23 Accounting for Partners’ Equity Objective 2 –Record partners’ investments of cash and other assets when a partnership is formed

Copyright © Houghton Mifflin Company. All rights reserved.13–24 Partners’ Equity The owners’ equity in a partnership Separate Capital and Withdrawals accounts are maintained for each partner –With a sole proprietorship, there is only one Capital account and one Withdrawals account Income and losses must be divided among the partners

Copyright © Houghton Mifflin Company. All rights reserved.13–25 Partners’ Equity Section of the Balance Sheet The balance of each partner’s Capital account is listed separately

Copyright © Houghton Mifflin Company. All rights reserved.13–26 Partners’ Investments in the Partnership Each partner invests cash, other assets, or both in the partnership –According to the partnership agreement Noncash assets should be valued at their fair market value on the date they are transferred to the partnership To record the investment –Assets are debited to the proper account –The total amount is credited to the partner’s Capital account

Copyright © Houghton Mifflin Company. All rights reserved.13–27 Recording Partners’ Investments Jerry Adcock and Rose Villa have agreed to enter into a partnership to operate a jewelry store. Adcock invests $28,000 in cash and $37,000 worth of furniture and displays. Villa invests $40,000 in cash and $30,000 worth of equipment. Related to the equipment is a $10,000 note payable, which the partnership assumes Record the partners’ initial investments

Copyright © Houghton Mifflin Company. All rights reserved.13–28 Assigning Values to Assets The values assigned to assets invested in the partnership should be included in the partnership agreement –These values can differ from those carried on the partners’ personal books –The book value of Villa’s equipment is not important –The fair market value of the equipment at time of transfer is important Represents the amount of money Villa has invested in the partnership The equipment Rose Villa invested in the partnership had a value of $22,000 on her books. At the date it was invested in the partnership, the equipment had a fair market value of $30,000

Copyright © Houghton Mifflin Company. All rights reserved.13–29 Discussion Q.How are noncash assets invested in the partnership valued? A.Noncash assets should be valued at their fair market value on the date they are transferred to the partnership

Copyright © Houghton Mifflin Company. All rights reserved.13–30 Distribution of Partnership Income and Losses Objective 3 –Compute and record the income or losses that partners share, based on stated ratios, capital balance ratios, and partners’ salaries and interest

Copyright © Houghton Mifflin Company. All rights reserved.13–31 Partnership Income and Losses …can be distributed according to whatever method the partners specify in the partnership agreement

Copyright © Houghton Mifflin Company. All rights reserved.13–32 Partnership Income and Losses (cont’d) Partnership income normally has three components 1.Interest on partners’ capital Return to the partners for the use of their capital 2.Partners’ salaries Compensation for services the partners have rendered 3.Other income For any special contributions partners may make to the partnership or risks they may take

Copyright © Houghton Mifflin Company. All rights reserved.13–33 Distribution of Income Among Partners Equal distribution –Appropriate if partners contribute equal capital, have similar talents, and spend the same amount of time in the business Unequal distribution –Reflects the differences in partners’ contributions to the business

Copyright © Houghton Mifflin Company. All rights reserved.13–34 Distribution of Income and Losses Among Partners Accomplished by –Using stated ratios –Using capital balance ratios –Paying the partners’ salaries and interest on their capital and sharing the remaining income according to ratios Salaries and interest are not expenses of the business, rather ways of determining the distribution of net income among partners

Copyright © Houghton Mifflin Company. All rights reserved.13–35 Stated Ratios …represent the percentage of income or loss distributed to each partner If partners contribute unequally to the business, unequal stated ratios can be appropriate –Partners’ contributions to the business may be based on the amount of capital invested, as well as the amount of time invested

Copyright © Houghton Mifflin Company. All rights reserved.13–36 Illustration of Stated Ratios Adcock and Villa had net income last year of $30,000. Their partnership agreement states that the percentages of income and losses distributed to Jerry Adcock and Rose Villa should be 60 percent and 40 percent, respectively Compute each partners’ share of net income Record the entry to show the distribution to the partners

Copyright © Houghton Mifflin Company. All rights reserved.13–37 Capital Balance Ratios If invested capital produces the most income for the partnership, then income and losses may be distributed according to capital balances Ratio may be based on –Each partners’ balance at the beginning of the year, or –The average capital balance of each partner during the year The partnership agreement must describe the method used

Copyright © Houghton Mifflin Company. All rights reserved.13–38 Ratios Based on Beginning Capital Balances At the start of the fiscal year, July 1, 20x3, Jerry Adcock, Capital showed a $65,000 balance and Rose Villa, Capital showed a $60,000 balance. Income for the year was $140,000 Total partners’ equity in the business was $125,000

Copyright © Houghton Mifflin Company. All rights reserved.13–39 Ratios Based on Beginning Capital Balances At the start of the fiscal year, July 1, 20x3, Jerry Adcock, Capital showed a $65,000 balance and Rose Villa, Capital showed a $60,000 balance. Income for the year was $140,000 Each partners’ beginning balance capital ratio is equal to that partner’s capital balance at the beginning of the year divided by the total partners’ equity at the beginning of the year

Copyright © Houghton Mifflin Company. All rights reserved.13–40 Ratios Based on Beginning Capital Balances At the start of the fiscal year, July 1, 20x3, Jerry Adcock, Capital showed a $65,000 balance and Rose Villa, Capital showed a $60,000 balance. Income for the year was $140,000 The income that each partner should receive is determined by multiplying the total income by each partner’s capital ratio

Copyright © Houghton Mifflin Company. All rights reserved.13–41 Ratios Based on Average Capital Balances Investments and withdrawals usually change the partners’ capital ratios These changes are not considered when beginning capital balances are used to distribute income Ratios based on average capital balances may be used if partners believe their capital balances will change dramatically during the year

Copyright © Houghton Mifflin Company. All rights reserved.13–42 Illustration of Ratios Based on Average Capital Balances Jerry Adcock, Capital Rose Villa, Capital Jerry Adcock, Withdrawals Rose Villa, Withdrawals The following T accounts show the activity over the year in Adcock and Villa’s partners’ Capital and Withdrawals accounts 7/1/x3 65,000 7/1/x3 60,000 2/1/x4 8,000 11/1/x3 10,000 1/1/x4 10,000 Examine the changes that have occurred during the year in each partner’s capital balance

Copyright © Houghton Mifflin Company. All rights reserved.13–43 Calculate Adcock’s Average Capital Balance Jerry Adcock, Capital Jerry Adcock, Withdrawals Jerry Adcock invested $65,000 into the partnership on July 1, 20x3, and withdrew $10,000 on January 1, 20x4 7/1/x3 65,000 1/1/x4 10,000 This means that from July through December, Adcock had $65,000 invested in the partnership and from January through June he had $55,000 invested ($65,000 initial investment – $10,000 withdrawal)

Copyright © Houghton Mifflin Company. All rights reserved.13–44 Calculate Adcock’s Average Capital Balance Jerry Adcock, Capital Jerry Adcock, Withdrawals Jerry Adcock invested $65,000 into the partnership on July 1, 20x3, and withdrew $10,000 on January 1, 20x4 7/1/x3 65,000 1/1/x4 10,000 Calculate Adcock’s average capital balance Multiply the beginning balance by the number of months the balance remains unchanged When the balance changes, multiply the new balance by the number of months it remains unchanged Repeat for each time the capital balance changes

Copyright © Houghton Mifflin Company. All rights reserved.13–45 Calculate Adcock’s Average Capital Balance Jerry Adcock, Capital Jerry Adcock, Withdrawals Jerry Adcock invested $65,000 into the partnership on July 1, 20x3, and withdrew $10,000 on January 1, 20x4 7/1/x3 65,000 1/1/x4 10,000 Calculate Adcock’s average capital balance Add the totals and divide by 12 months to determine the average capital balance

Copyright © Houghton Mifflin Company. All rights reserved.13–46 Calculate Villa’s Average Capital Balance Rose Villa invested $60,000 into the partnership on July 1, 20x3, withdrew $10,000 on November 1, 20x3, and invested an additional $8,000 of equipment on February 1, 20x4 This means that from July through November, Villa had $60,000 invested in the partnership, from November through February she had $50,000 invested ($60,000 initial investment – $10,000 withdrawal), and from February through June she had $58,000 invested in the partnership ($50,000 balance + $8,000 investment) Rose Villa, CapitalRose Villa, Withdrawals 7/1/x3 60,000 2/1/x4 8,000 11/1/x3 10,000

Copyright © Houghton Mifflin Company. All rights reserved.13–47 Calculate Villa’s Average Capital Balance Rose Villa invested $60,000 into the partnership on July 1, 20x3, withdrew $10,000 on November 1, 20x3, and invested an additional $8,000 of equipment on February 1, 20x4 Rose Villa, CapitalRose Villa, Withdrawals 7/1/x3 60,000 2/1/x4 8,000 11/1/x3 10,000 Calculate Villa’s average capital balance

Copyright © Houghton Mifflin Company. All rights reserved.13–48 Calculate the Total Average Capital

Copyright © Houghton Mifflin Company. All rights reserved.13–49 Determine the Partners’ Average Capital Balance Ratios

Copyright © Houghton Mifflin Company. All rights reserved.13–50 Determine the Partners’ Average Capital Balance Ratios

Copyright © Houghton Mifflin Company. All rights reserved.13–51 Determine the Partners’ Average Capital Balance Ratios

Copyright © Houghton Mifflin Company. All rights reserved.13–52 Calculate the Distribution of Income The income for the year’s operations (July 1, 20x3 to June 30, 20x4) was $140,000

Copyright © Houghton Mifflin Company. All rights reserved.13–53 Salaries, Interest, and Stated Ratios … represent a method of arriving at an equitable distribution of income or loss Necessary because partners’ contributions to the business are usually not equal Partnership agreement can allow for partners’ salaries, interest on partners’ capital balances, or both –Salaries Allow for differences in services that partners provide the business –Interest Allows for differences in invested capital –Stated ratios Used to distribute any remaining income or loss

Copyright © Houghton Mifflin Company. All rights reserved.13–54 Distributing Income or Loss Using Salaries and Stated Ratios Net income or loss is distributed to partners in the following order 1.Salaries Each salary is charged to the appropriate partners’ Withdrawal account when paid 2.Stated Ratios Distribute any remaining income to the partners according to the agreed upon state ratios

Copyright © Houghton Mifflin Company. All rights reserved.13–55 Illustration of Distributing Income or Loss Using Salaries and Stated Ratios Adcock and Villa agree to annual salaries of $8,000 and $7,000, respectively, and to divide any remaining income equally between them. The income for the year’s operations was $140,000 $ 8,000 $ 7,000(15,000) $125,000 ($125,000 x.50)62,500 ($125,000 x.50) 62,500 (125,000) ― $70,500 $69,500 $140,000

Copyright © Houghton Mifflin Company. All rights reserved.13–56 Distributing Income or Loss Using Salaries, Interest, and Stated Ratios Net income or loss is distributed to partners in the following order 1.Salaries Each salary is charged to the appropriate partners’ Withdrawal account when paid 2.Interest Distribute stated interest on each partners’ capital balance 3.Stated Ratios Distribute any remaining income to the partners according to the agreed upon stated ratios

Copyright © Houghton Mifflin Company. All rights reserved.13–57 Illustration of Distributing Income or Loss Using Salaries, Interest, and Stated Ratios Adcock and Villa agree to annual salaries of $8,000 and $7,000, respectively, as well as 10 percent interest on their beginning capital balances, and to share any remaining income equally. Income for the year was $140,000 $ 8,000 $ 7,000(15,000) $125,000 ($65,000 x.10)6,500 ($60,000 x.10) 6,000 (12,500) ― $70,500 $69,500 $140,000 $112,500 ($112,500 x.50)56,250 ($112,500 x.50) 56,250 (112,500)

Copyright © Houghton Mifflin Company. All rights reserved.13–58 Distributing a Negative Balance Profits may not be enough to cover salaries and interest The company may have a loss

Copyright © Houghton Mifflin Company. All rights reserved.13–59 Illustration of Distributing a Negative Balance Adcock and Villa agree to annual salaries of $70,000 and $60,000, respectively, as well as 10 percent interest on their beginning capital balances, and to share any remaining income equally. Income for the year was $140,000 $70,000 $ 60,000(130,000) $ 10,000 ($65,000 x.10)6,500 ($60,000 x.10) 6,000 (12,500) ― $75,250 $64,750 $140,000 ($ 2,500) ($2,500 x.50)(1,250) ($2,500 x.50) (1,250) 2,500

Copyright © Houghton Mifflin Company. All rights reserved.13–60 Reporting the Distribution of Income or Losses on the Income Statement The distribution of net income or losses is shown below the net income figure

Copyright © Houghton Mifflin Company. All rights reserved.13–61 Discussion Q.Oscar and Vince share income in their partnership in a 2:1 ratio and each receive salaries of $10,000. Net income for the year is $50,000, before any distributions. How much of the income is distributed to Vince? A.Salaries are distributed first. Oscar and Vince each receive $10,000, leaving $30,000 ($50,000 - $20,000) to be distributed according to the stated ratios. Vince receives one-third of the remaining $30,000, or $10,000. Therefore, $20,000 ($10,000 salary + $10,000) of the income is distributed to Vince

Copyright © Houghton Mifflin Company. All rights reserved.13–62 Dissolution of a Partnership Objective 4 –Record a person’s admission to or withdrawal from a partnership

Copyright © Houghton Mifflin Company. All rights reserved.13–63 Dissolution of a Partnership …occurs when there is a change in the original association of partners Admission of a new partner Withdrawal of a partner Death of a partner

Copyright © Houghton Mifflin Company. All rights reserved.13–64 Dissolution of a Partnership The partners lose their authority to continue business as a going concern –The remaining partners can act for the partnership in finishing the affairs of the business or forming a new partnership If a new partnership is formed, it will be a new legal and accounting entity Dissolution of a partnership does not necessarily mean the business operation is ended or interrupted

Copyright © Houghton Mifflin Company. All rights reserved.13–65 Admission of a New Partner The admission of a new partner dissolves the old partnership –A new association has been formed –Requires the consent of all the original partners and ratification of a new partnership agreement

Copyright © Houghton Mifflin Company. All rights reserved.13–66 Admission of a New Partner (cont’d) Two ways to admit a new partner 1.Purchasing an interest from one or more of the original partners 2.Investing assets in the partnership

Copyright © Houghton Mifflin Company. All rights reserved.13–67 Purchasing an Interest from a Partner Is a personal transaction between the buyer and seller The interest purchased must be transferred from the Capital account of the selling partner to the Capital account of the new partner

Copyright © Houghton Mifflin Company. All rights reserved.13–68 Purchasing an Interest from a Partner Jerry Adcock decides to sell his interest of $70,000 in Adcock and Villa to Richard Davis for $100,000 on August 31, 20x5. Rose Villa agrees to the sale Record the sale on the partnership books Notice the entry records the book value of the equity, not the sale price The amount paid is a personal matter between Adcock and Davis and does not affect the assets or liabilities of the firm

Copyright © Houghton Mifflin Company. All rights reserved.13–69 Purchasing an Interest from a Partner Jerry Adcock and Rose Villa each decide to sell one half of their interests in Adcock and Villa to Richard Davis for $100,000 on August 31, 20x5. Rose Villa’s interest is $80,000 Record the sale on the partnership books

Copyright © Houghton Mifflin Company. All rights reserved.13–70 Investing Assets in a Partnership When a new partner invests assets in the partnership, both the partnership assets and partners’ equity increase

Copyright © Houghton Mifflin Company. All rights reserved.13–71 Investing Assets in a Partnership (cont’d) Jerry Adcock and Rose Villa agree to allow Richard Davis to invest $75,000 in return for a one-third interest in their partnership. The Capital accounts of Jerry Adcock and Rose Villa are $70,000 and $80,000, respectively Davis’s $75,000 investment equals a one-third interest in the firm after the investment is added to the previously existing capital of the partnership One-third interest = $225,000 ÷ 3 = $ 75,000

Copyright © Houghton Mifflin Company. All rights reserved.13–72 Investing Assets in a Partnership (cont’d) Jerry Adcock and Rose Villa agree to allow Richard Davis to invest $75,000 in return for a one-third interest in their partnership. The Capital accounts of Jerry Adcock and Rose Villa are $70,000 and $80,000, respectively Record the investment on the partnership books

Copyright © Houghton Mifflin Company. All rights reserved.13–73 Bonus to the Old Partners A new investor is sometimes willing to pay more than the actual dollar interest he or she receives for the partnership –When a partnership is very profitable or otherwise advantageous The excess of the payment over the interest purchased is a bonus to the original partners –Must be distributed according to the method for distributing income and losses

Copyright © Houghton Mifflin Company. All rights reserved.13–74 Bonus to the Old Partners Richard Davis wants to join the firm of Adcock and Villa. He offers to invest $100,000 on December 1, 20x5, for a one- fifth interest in the business and income. The original partners agree to the offer Adcock and Villa Company has operated for several years and the partners’ capital balances and stated ratios for distribution of income and loss are as follows

Copyright © Houghton Mifflin Company. All rights reserved.13–75 Bonus to the Old Partners Richard Davis wants to join the firm of Adcock and Villa. He offers to invest $100,000 on December 1, 20x5, for a one- fifth interest in the business and income. The original partners agree to the offer Davis is willing to pay $100,000 for an $80,000 interest in the partnership Assign partners’ equity to Richard Davis

Copyright © Houghton Mifflin Company. All rights reserved.13–76 Bonus to the Old Partners Richard Davis wants to join the firm of Adcock and Villa. He offers to invest $100,000 on December 1, 20x5, for a one- fifth interest in the business and income. The original partners agree to the offer Compute the bonus to the original partners

Copyright © Houghton Mifflin Company. All rights reserved.13–77 Bonus to the Old Partners Richard Davis wants to join the firm of Adcock and Villa. He offers to invest $100,000 on December 1, 20x5, for a one- fifth interest in the business and income. The original partners agree to the offer Record Davis’s admission to the partnership

Copyright © Houghton Mifflin Company. All rights reserved.13–78 Bonus to the New Partner A new partner may be admitted to the partnership by transferring part of the original partners’ capital to the new partner’s Capital account –Reasons Additional cash required because of financial trouble Additional cash required to expand the company’s markets To bring a unique talent to the company

Copyright © Houghton Mifflin Company. All rights reserved.13–79 Bonus to the New Partner Richard Davis has been invited to join the firm of Adcock and Villa and accepts the offer. Davis invests $60,000 on December 1, 20x5, for a one-fourth interest in the company The original partners are willing to give Davis a $90,000 interest in the partnership for his $60,000 investment Assign partners’ equity to Richard Davis

Copyright © Houghton Mifflin Company. All rights reserved.13–80 Bonus to the New Partner Compute the bonus to the new partner Richard Davis has been invited to join the firm of Adcock and Villa and accepts the offer. Davis invests $60,000 on December 1, 20x5, for a one-fourth interest in the company

Copyright © Houghton Mifflin Company. All rights reserved.13–81 Bonus to the New Partner Record Davis’s admission to the partnership Richard Davis has been invited to join the firm of Adcock and Villa and accepts the offer. Davis invests $60,000 on December 1, 20x5, for a one-fourth interest in the company

Copyright © Houghton Mifflin Company. All rights reserved.13–82 Withdrawal of a Partner A partnership is a voluntary association –A partner usually has the right to withdraw at any time A partnership agreement should describe the procedures to be followed when a partner decides to withdraw or retire –Avoids disputes

Copyright © Houghton Mifflin Company. All rights reserved.13–83 Withdrawal of a Partner (cont’d) The partnership agreement should specify 1.Whether an audit will be performed 2.How the assets will be reappraised 3.How a bonus will be determined 4.By what method the withdrawing partner will be paid

Copyright © Houghton Mifflin Company. All rights reserved.13–84 Alternative Ways for a Partner to Withdraw Sell his or her interest –To another partner –To an outsider with the consent of the remaining partners Withdraw assets –Equal to his or her capital balance –Less than his or her capital balance Remaining partners receive a bonus –Greater than his or her capital balance Withdrawing partner receives a bonus

Copyright © Houghton Mifflin Company. All rights reserved.13–85 Alternative Ways for a Partner to Withdraw

Copyright © Houghton Mifflin Company. All rights reserved.13–86 Withdrawal by Selling Interest Is a personal transaction Does not change the partnership assets or the partners’ equity

Copyright © Houghton Mifflin Company. All rights reserved.13–87 Withdrawal by Selling Interest to Another Partner Rose Villa wants to withdraw from the partnership. She has agreed to sell her interest to Richard Davis for $110,000 Record the transfer Davis has paid Villa from his personal assets The partnership accounting records only show the transfer of Villa’s interest to Davis

Copyright © Houghton Mifflin Company. All rights reserved.13–88 Withdrawal by Selling Interest to an Outsider Rose Villa wants to withdraw from the partnership. She has agreed to sell her interest to Judy Jones for $120,000 Record the transfer Whether Villa sells to another partner or outsider, the accounting records would show only the transfer of Villa’s interest

Copyright © Houghton Mifflin Company. All rights reserved.13–89 Withdrawal by Removing Assets A partnership agreement can allow a withdrawing partner to remove assets from the firm equal to his or her capital balance

Copyright © Houghton Mifflin Company. All rights reserved.13–90 Withdrawal by Removing Assets Richard Davis decides to withdraw from Adcock, Villa, and Davis Company. By request of the remaining partners, he agrees to take only $50,000 in cash According to the partnership agreement of Adcock, Villa, and Davis, a withdrawing partner can withdraw cash from the firm equal to his or her capital balance. If there is not enough cash, the withdrawing partner must accept a promissory note from the new partnership for the balance Record Davis’s withdrawal

Copyright © Houghton Mifflin Company. All rights reserved.13–91 Withdrawal by Removing Assets When a withdrawing partner removes assets that represent less than his or her capital balance –The equity the partner leaves behind is divided among the remaining partners according to their stated ratios –Is considered a bonus When a withdrawing partner removes assets that represent more than his or her capital balance –The excess is treated as a bonus to the withdrawing partner –The remaining partners absorb the bonus according to their stated ratios Alternate arrangements can be spelled out in the partnership agreement

Copyright © Houghton Mifflin Company. All rights reserved.13–92 Death of a Partner The partnership dissolves –The original association has been changed Actions to be taken should be stated in the partnership agreement

Copyright © Houghton Mifflin Company. All rights reserved.13–93 Death of a Partner Normally, books are closed and financial statements are prepared –Determines the capital balance of each partner on the date of death The partnership agreement may also stipulate the following –Conduct an audit –Appraise assets –Record bonus –Procedures for settling with the deceased partner’s heirs

Copyright © Houghton Mifflin Company. All rights reserved.13–94 Death of a Partner Remaining partners may –Purchase the deceased partner’s equity –Sell it to outsiders –Deliver specified assets to the estate A new partnership must be formed if the business is to continue

Copyright © Houghton Mifflin Company. All rights reserved.13–95 Discussion Q.Sherry Daniels offers to invest $125,000 in the partnership of Jones & Franklin for a one-third interest. The partners agree to the offer. Total partners’ equity in the original partnership is $175,000. What amount of partners’ equity is assigned to Sherry Daniels? A.Total partners’ equity in the new partnership is $300,000 ($175,000 + $125,000). Sherry Daniels is assigned a one-third interest, which is equal to $100,000 ($300,000 x 1/3)

Copyright © Houghton Mifflin Company. All rights reserved.13–96 Liquidation of a Partnership Objective 5 –Compute the distribution of assets to partners when they liquidate their partnership

Copyright © Houghton Mifflin Company. All rights reserved.13–97 Liquidation of a Partnership … is the process of ending the business, selling enough assets to pay the partnership’s liabilities, and distributing any remaining assets among the partners Is a special form of dissolution –The business will not continue

Copyright © Houghton Mifflin Company. All rights reserved.13–98 Liquidation of a Partnership (cont’d) Usually, the books are adjusted and closed, with the income or loss distributed to the partners As the assets are sold, any gain or loss is distributed to the partners according to the stated ratios As cash becomes available, it is applied in the following order 1.Outside creditors 2.Loans from partners 3.Partners’ capital balances

Copyright © Houghton Mifflin Company. All rights reserved.13–99 Liquidation of a Partnership (cont’d) The process of liquidation can have a variety of outcomes, including –Assets sold for a gain –Assets sold for a loss

Copyright © Houghton Mifflin Company. All rights reserved.13–100 Illustration of Liquidation The books have been closed for Adcock, Villa, Davis & Company. The stated ratios of Adcock, Villa, and Davis are 3:3:4, or 30, 30, and 40 percent The following balance sheet exists before liquidation

Copyright © Houghton Mifflin Company. All rights reserved.13–101 Illustration of Gain on Sale of Assets The following transactions took place in the liquidation of Adcock, Villa, Davis & Company 1.The accounts receivable were collected for $35,000 2.The inventory was sold for $110,000 3.The plant assets were sold for $200,000 4.The accounts payable of $120,000 were paid 5.The gain of $5,000 from the realization of the assets was distributed according to the partners’ stated ratios 6.The partners received cash equivalent to the balances of their Capital accounts These transactions are summarized in the statement of liquidation

Copyright © Houghton Mifflin Company. All rights reserved.13–102 Statement of Liquidation Showing Gain on Sale of Assets

Copyright © Houghton Mifflin Company. All rights reserved.13–103 Illustration of Gain on Sale of Assets 1.The accounts receivable were collected for $35,000 2.The inventory was sold for $110,000

Copyright © Houghton Mifflin Company. All rights reserved.13–104 Illustration of Gain on Sale of Assets 3.The plant assets were sold for $200,000 4.The accounts payable of $120,000 were paid

Copyright © Houghton Mifflin Company. All rights reserved.13–105 Illustration of Gain on Sale of Assets 5.The gain of $5,000 from the realization of the assets was distributed according to the partners’ stated ratios The realized gain is distributed to the partners according to their stated ratios

Copyright © Houghton Mifflin Company. All rights reserved.13–106 Illustration of Gain on Sale of Assets 6.The partners received cash equivalent to the balances of their Capital accounts Notice that the cash distributed to the partners is the balance in their respective Capital accounts Cash is not distributed according to the partners’ stated ratios

Copyright © Houghton Mifflin Company. All rights reserved.13–107 Loss on Sale of Assets The partners share the loss on liquidation according to their stated ratios Two cases 1.Losses are small enough to be absorbed by the partners’ capital balances 2.One partner’s share of the losses is too large for his or her capital balance to absorb

Copyright © Houghton Mifflin Company. All rights reserved.13–108 Illustration of Loss on Sale of Assets The following transactions took place in the liquidation of Adcock, Villa, Davis & Company 1.The accounts receivable were collected for $40,000 and merchandise inventory and plant assets were sold for $100,000 and $200,000, respectively 2.The accounts payable of $120,000 were paid 3.The loss of $200,000 from the realization of the assets was distributed according to the partners’ stated ratios 4.The partners received cash equivalent to the balances of their Capital accounts

Copyright © Houghton Mifflin Company. All rights reserved.13–109 Statement of Liquidation Showing Loss on Sale of Assets

Copyright © Houghton Mifflin Company. All rights reserved.13–110 Illustration of Loss on Sale of Assets 1.The accounts receivable were collected for $40,000 and merchandise inventory and plant assets were sold for $100,000 and $200,000, respectively

Copyright © Houghton Mifflin Company. All rights reserved.13–111 Illustration of Loss on Sale of Assets 2.The accounts payable of $120,000 were paid

Copyright © Houghton Mifflin Company. All rights reserved.13–112 Illustration of Loss on Sale of Assets 3.The loss of $200,000 from the realization of the assets was distributed according to the partners’ stated ratios The realized loss is distributed to the partners according to their stated ratios

Copyright © Houghton Mifflin Company. All rights reserved.13–113 Illustration of Loss on Sale of Assets 6.The partners received cash equivalent to the balances of their Capital accounts

Copyright © Houghton Mifflin Company. All rights reserved.13–114 Partner’s Share of Loss Is Greater Than His or Her Capital Balance The partner must make up the deficit in his or her Capital account from personal assets –Because partners are subject to unlimited liability If the partner does not have the cash to cover his or her obligations –The remaining partners share the loss according to their stated ratios All partners have unlimited liability

Copyright © Houghton Mifflin Company. All rights reserved.13–115 Illustration of Partner’s Share of Loss Exceeding His or Her Capital Balance Richard Davis’s share of loss is greater than his Capital balance After the sale of assets and the payment of liabilities, the remaining assets and partners’ equity for Adcock, Villa, Davis & Company are as follows Richard Davis must pay $15,000 into the partnership from personal funds to cover the deficit

Copyright © Houghton Mifflin Company. All rights reserved.13–116 Illustration of Partner’s Share of Loss Exceeding His or Her Capital Balance Richard Davis pays $15,000 cash to the partnership. There is now enough cash to pay Adcock and Villa their capital balances and complete the liquidation

Copyright © Houghton Mifflin Company. All rights reserved.13–117 Illustration of Partner’s Share of Loss Exceeding His or Her Capital Balance Richard Davis does not have the cash to cover his obligation to the partnership The remaining partners must share the deficit according to their stated ratios

Copyright © Houghton Mifflin Company. All rights reserved.13–118 Illustration of Partner’s Share of Loss Exceeding His or Her Capital Balance Richard Davis does not have the cash to cover his obligation to the partnership The remaining partners must share the deficit according to their stated ratios

Copyright © Houghton Mifflin Company. All rights reserved.13–119 Illustration of Partner’s Share of Loss Exceeding His or Her Capital Balance Richard Davis does not have the cash to cover his obligation to the partnership The remaining partners must share the deficit according to their stated ratios Davis is now liable to Adcock and Villa If Davis is able to pay his liabilities at some time in the future, Adcock and Villa can collect the amount of Davis's deficit they absorbed

Copyright © Houghton Mifflin Company. All rights reserved.13–120 Discussion Q.Upon liquidation of a partnership, how is any remaining cash distributed to the partners? A.First, any gains or losses from the sale of the partnership assets are distributed among the partners, based on their stated ratios. Any cash remaining in the partnership is then distributed according to the partners’ balances in their Capital accounts

Copyright © Houghton Mifflin Company. All rights reserved.13–121 Time for Review 1.Identify the characteristics, advantages, and disadvantages of the partnership form of business 2.Record partners’ investments of cash and other assets when a partnership is formed

Copyright © Houghton Mifflin Company. All rights reserved.13–122 And Finally… 3.Compute and record the income or losses that partners share, based on stated ratios, capital balance ratios, and partners’ salaries and interest 4.Record a person’s admission to or withdrawal from a partnership 5.Compute the distribution of assets to partners when they liquidate their partnership