Partnerships: Characteristics, Formation, and Accounting for Activities 13

Learning Objectives Explain the basic characteristics of a partnership. Identify basic components that should be included in a partnership agreement. Describe the relationship between a partner’s drawing and capital accounts. Demonstrate an understanding of the various bases that could be used to allocate profits or losses among partners. COPYRIGHT © 2012 South-Western/Cengage Learning

Characteristics of a Partnership Relationship of partners Fiduciary responsibility Mutual agency Legal liability General Limited COPYRIGHT © 2012 South-Western/Cengage Learning

Characteristics of a Partnership Underlying equity theories Proprietary theory Entity theory Formation and agreements Articles of partnership Uniform Partnership Act, revised (RUPA) gives supremacy to the partnership Accounting principles GAAP or OCBOA COPYRIGHT © 2012 South-Western/Cengage Learning

Characteristics of a Partnership Partner dissociation Voluntary or involuntary Partnership not dissolved Sale of partnership interest Partnership dissolved Express will, agreed-upon event, judicial determination Tax considerations A conduit of taxable income or operating losses to the tax returns of the individuals partners Files an information return COPYRIGHT © 2012 South-Western/Cengage Learning

The Capital Account A permanent account Measures a partner’s interest in the net assets of the partnership Does not report fair value or tax basis Capital Account Debit Withdrawals in excess of a specified amount Closing of a net debit balance in the partner’s drawing account Partner’s share of partnership losses Credit Initial and subsequent investments of capital Partner’s share of partnership profits COPYRIGHT © 2012 South-Western/Cengage Learning

The Drawing Account A temporary account Periodically closed to respective capital account Drawing Account Debit Periodic withdrawals of partnership assets up to a specified amount Credit Closing of balance to partner's capital account COPYRIGHT © 2012 South-Western/Cengage Learning

Allocation of Profits According to a ratio/percentage Assumed to be equal if not otherwise stated According to capital investments of the partners Important to define how capital is measured According to the labor/service rendered by partners Typically involving a salary and/or bonus COPYRIGHT © 2012 South-Western/Cengage Learning

Basic Schedule for Allocating Profits Net income: $33,000 Interest: 6% on ending capital in excess of $100,000 Bonus to C: 10% of income after the bonus Salaries: $13,000 to A; $12,000 to C Balance: allocate 2-to-1-to-1 COPYRIGHT © 2012 South-Western/Cengage Learning

Allocation of Profit Deficiencies and Losses Completely satisfy all provisions of the profit and loss agreement and use the profit and loss ratios to absorb any deficiency or additional loss caused by such action or Satisfy each of the provisions to whatever extent is possible COPYRIGHT © 2012 South-Western/Cengage Learning

Allocating Deficiency Income: $22,000 Interest: 6% on ending capital in excess of $100,000 Bonus to C: 10% of income after the bonus Salaries: $13,000 to A; $12,000 to C Balance: allocate 2-to-1-to-1 COPYRIGHT © 2012 South-Western/Cengage Learning

Deficiency Allocated by Priority Income: $22,000 allocated to whatever extent possible Interest: 6% on ending capital in excess of $100,000 Bonus to C: 10% of income after the bonus Salaries: $13,000 to A; $12,000 to C Income is insufficient for full distribution; allocate proportionally COPYRIGHT © 2012 South-Western/Cengage Learning