0 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Unit 6 Additional Accounting Topics Chapter 27 Introduction to Partnerships Chapter 28Financial Statements and Liquidation of a Partnership Chapter 29Ethics in Accounting

1 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 27 Introduction to Partnerships What You’ll Learn  Identify the characteristics of a partnership.  Identify the various accounting functions involved with a partnership.  Account for investments in a partnership.  Account for partners’ withdrawals.  Allocate profits and losses to the partners by different methods.  Define the accounting terms introduced in this chapter.

2 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 27, Section 1 Partnership Characteristics and Partners’ Equity What Do You Think? What aspects of a partnership might create special issues for an accountant?

3 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Main Idea The partnership form of business organization has unique features. You Will Learn  the characteristics of a partnership.  how to account for equity in a partnership. Partnership Characteristics and Partners’ Equity SECTION 27.1

4 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Key Terms  partnership agreement  mutual agency Partnership Characteristics and Partners’ Equity SECTION 27.1

5 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Characteristics of a Partnership Some of the unique characteristics of a partnership organization include:  ease of formation  unlimited liability  limited life  mutual agency  co-ownership of partnership property Partnership Characteristics and Partners’ Equity SECTION 27.1

6 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Ease of Formation There are no special legal requirements to form a partnership. A partnership can be voluntarily arranged or formed when there is a verbal or written agreement between individuals. Partnership Characteristics and Partners’ Equity SECTION 27.1

7 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. A Voluntary Arrangement A partnership is formed when two or more persons agree to operate as a partner. Partnership Characteristics and Partners’ Equity SECTION 27.1

8 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. The Partnership Agreement A partnership can be formed verbally, but it is advisable to have a written partnership agreement. This should include:partnership agreement  each partner’s name and address  the name, location, and nature of the partnership  the agreement date and the length of time the partnership is to exist  each partner’s investment  each partner’s duties, rights, and responsibilities  the amount of withdrawals allowed each partner  the procedure for sharing profits and losses  the procedures to follow when the partnership is over Partnership Characteristics and Partners’ Equity SECTION 27.1

9 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Unlimited Liability If the partnership is unable to pay its creditors, the partners’ personal assets may be used to pay those debts. Partnership Characteristics and Partners’ Equity SECTION 27.1

10 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Limited Life A partnership may end  upon completion of a project,  at the expiration of the time set by the partners,  upon any partner’s death, withdrawal, bankruptcy, or incapacity, or  for other reasons. Partnership Characteristics and Partners’ Equity SECTION 27.1

11 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Mutual Agency Each partner has the legal right, in the name of the firm, to enter into agreements that are binding on all other partners. This is called mutual agency.mutual agency Partnership Characteristics and Partners’ Equity SECTION 27.1

12 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Co-ownership of Partnership Property The partners co-own all partnership assets. Partnership Characteristics and Partners’ Equity SECTION 27.1

13 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Advantages and Disadvantages of a Partnership Advantages of a partnership are:  It combines the abilities, experiences, and resources of two or more individuals.  It is easy to form.  Decisions can be made without formal meetings.  It does not pay federal or state income taxes. Disadvantages of a partnership are:  It has a limited life.  Each partner is liable for the partnership’s debts.  All partners can be held responsible for one partner’s decisions.  Partners cannot transfer their interest without permission.  It has potential for disagreements between partners. Partnership Characteristics and Partners’ Equity SECTION 27.1

14 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Accounting for Partners’ Equity Accounting for a partnership is basically the same as a sole proprietorship. A separate capital account and withdrawals account is set up for each partner. Partnership Characteristics and Partners’ Equity SECTION 27.1

15 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Recording Partner Investments Separate entries record each partner’s investment in the business. Partnership Characteristics and Partners’ Equity SECTION 27.1

16 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Recording Additional Partner Investments Additional investments are recorded in a similar manner. Asset accounts are debited for the total amount of investment and each partner’s capital account is credited for the amount of each individual’s investment. Partnership Characteristics and Partners’ Equity SECTION 27.1

17 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Recording Partner Withdrawals Partners may withdraw cash or other assets. The withdrawn amount must be debited to each partner’s withdrawals account and is credited to the appropriate asset account. Partnership Characteristics and Partners’ Equity SECTION 27.1

18 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Key Terms Review  partnership agreement A written agreement that states the terms under which the partnership will operate.  mutual agency The legal right of any partner to enter into agreements for the business that are binding on all other partners. Partnership Characteristics and Partners’ Equity SECTION 27.1

19 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 27, Section 2 Division of Income and Loss What Do You Think? Can you think of different ways partners might want to split profits in a partnership?

20 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Main Idea Partners divide profits and losses in several different ways. You Will Learn  how to divide net income and net loss equally.  how to divide net income and net loss on a fractional basis.  how to divide net income and net loss based on capital investments. Division of Income and Loss SECTION 27.2

21 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Dividing Profits and Losses Equally The law provides that net income or loss be divided equally among partners. This section will discuss three methods of dividing net income or loss. Dividing equally is the easiest way to divide net income or loss and is often used when equal amounts of capital were invested. Division of Income and Loss SECTION 27.2

22 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Dividing Profits and Losses on a Fractional Share Basis When partners invest unequal amounts of capital, assign each partner a stated fraction of the total. The size of the fraction can depend on  the amount of each partner’s investment, and  the value of each partner’s services to the business. Division of Income and Loss SECTION 27.2

23 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Dividing Profits and Losses Based on Capital Investments Net income and loss can be divided on the basis of the amount of capital contributed by individual partners. Compute the percentage using this formula: Multiply the net income or loss by each partner’s percentage. Division of Income and Loss SECTION 27.2

24 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Question 1 On December 31, Workman Company, a partnership between Fogg and Shelhon, realized a $33,000 net income. According to the partnership agreement, the partners split the profits on a 2:1 basis. Determine each partner’s split and the journal entries you will make to record the split of net income. Chapter 27 Review CHAPTER 27

25 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Answer 1 Step 1:Change the ratio to a fraction. 2:1 = (2 + 1 = 3) = 2/3 and 1/3. Step 2:Calculate Fogg’s share. $33,000  2/3 = $22,000 Step 3:Calculate Shelhon’s share. $33,000  1/3 = $11,000 Step 4:Which account(s) is (are) debited? For what amount? Debit Income Summary for $33,000. Step 5:Which account(s) is (are) credited? For what amount? Credit Dan Fogg, Capital for $22,000 and Lou Shelhon, Capital for $11,000. Chapter 27 Review CHAPTER 27

26 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Question 2 Fogg invested $46,500 and Shelhon invested $28,500. If you were Fogg, would you prefer to split profits or losses equally, by a 2:1 ratio, or based on the partners’ investment? Chapter 27 Review CHAPTER 27

27 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Answer 2 Assuming Fogg expects to generate a profit rather than a loss, the most favored method would be the one with the highest payout to him. Fogg would prefer the 2:1 ratio.  Equal split: Fogg would receive 50%  2:1 ratio: Fogg would receive 66.67%  Partner’s investments: Fogg would receive 62% [$46,500 / ($46,500 + $28,500)] Chapter 27 Review CHAPTER 27

28 Glencoe Accounting Unit 6 Chapter 27 Copyright © by The McGraw-Hill Companies, Inc. All rights reserved. Resources Glencoe Accounting Online Learning Center English Glossary Spanish Glossary