©2014 Pearson Education, Inc. Publishing as Prentice Hall Partnerships Chapter 12 ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Learning Objectives Identify the characteristics and types of partnerships Account for the start-up of a partnership and prepare partnership financial statements Allocate profits and losses to the partners ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Learning Objectives Account for the admission of a new partner Account for a partner’s withdrawal from the partnership Account for the liquidation of a partnership ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Identify the characteristics and types of partnerships Learning Objective 1 Identify the characteristics and types of partnerships ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Partnerships A partnership exists whenever two or more owners act as if they are in business together. The equity section of a partnership consists of capital balances for each partner. Characteristics: Limited Life Mutual Agency Unlimited Liability Co-Ownership of Property No Partnership Income Tax Whenever two or more people act as if they are in business together, then a partnership is deemed to exist. The equity section of a partnership will differ from the equity section of either a corporation or a sole proprietorship. The partnership equity section includes a separate capital account for each partner. The characteristics of a partnership include limited life, mutual agency, unlimited liability, co-ownership of property by all partners, and no separate partnership income taxes (though the profit or loss will flow through to the individual partners and appear on their personal tax returns.) ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Articles of Partnership A partnership can exist even in the absence of a written partnership agreement. With no written partnership agreement, the Uniform Partnership Act establishes standards and rules for partnerships. A written agreement will supersede the UPA. Many partnerships fail because the rules for making decisions and the assignment of responsibilities are not made clear at the founding of the business. A partnership can exist even without the presence of a written or signed partnership agreement. In the event that a written partnership agreement does not exist then the Uniform Partnership Act will provide guidance for the management of the partnership. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Articles of Partnership Method for admitting new partners Method for dispute resolution Profit/loss sharing ratios Withdrawal limits Typically, a partnership agreement will include the “rules” for managing the partnership. Typical clauses will include: A method for dispute resolution. Profit/loss sharing ratios. Rules for admitting new partners to the partnership. Limits on the amount of withdrawals that a partner can make from the partnership each period. The initial contribution that must be made by each partner. The approach for valuing individual contributions to the partnership (such as tangible assets). A listing of the rights and responsibilities of each partner. Put it in writing! Initial contribution to be made by each partner Method for valuing individual contributions Rights and responsibilities of partners ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Alternative Legal Forms Limited Partnerships Two classes of partners 1 General Partner 1 or more Limited Partners Limited Partners do not participate in management. They primarily provide investment capital. The General Partner usually is the last to receive a share of the profits or losses, and has unlimited personal liability. There are several different kinds of partnerships and partners. Basically, partners fall into two categories: General Partner(s) and Limited Partner(s). The General Partner(s) is(are) usually in charge of making management decisions and is the last to share in profits or losses of the partnership. The General Partner also must carry the burden of unlimited personal liability for the debts of the partnership. The Limited Partner(s) is(are) entitled to share in the profits and losses of the partnership. Unlike the General Partner, the Limited Partner does not share unlimited liability for the debts of the partnership. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Alternative Legal Forms Limited Liability Partnerships (LLP) Multiple General Partners Partners are not personally liable for the actions of other partners. Useful for partnerships with offices in different locations. Most of the large CPA firms in the United States are organized as LLP’s. Rules for LLP’s differ from state to state. In a General Partnership, all partners are general partners. In a Limited Liability Partnership, the General Partners are not personally liable for the malpractice or negligence of the other partners. This form of partnership is usually most appropriate for very large partnerships where some of the partners may work in diverse locations, and in fact may not have even met each other in some circumstances. Most of the large accounting firms in the United States are organized as LLP’s. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Alternative Legal Forms Limited Liability Companies (LLC) . . . A legal entity that must file articles of incorporation. . . . Members are not personally liable for the business’s debts. . . . Members can actively participate in management. An LLC can elect not to pay income tax. Instead, profits and losses will be distributed to members, as if the LLC was a partnership. The Limited Liability Company (LLC) is a legal entity that must file articles of incorporation. Although technically a corporation, and not a partnership, the LLC can elect to share its profits and losses with the members in the same way as if it were a partnership. In this way, the LLC can avoid the problem of double-taxation that normally accompanies the corporate form of business. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Alternative Legal Forms Subchapter S Corporation . . . Has all the legal characteristics of a corporation. . . . Profit passes to owners just as with a partnership. . . . Ownership is limited to 100 shareholders. No personal liability for business’s debts. Only US citizens can be shareholders. Cannot be owned by other companies. The Subchapter S Corporation is a special form of the corporation that is limited to 100 shareholders. It has all the legal characteristics of a corporation, but the profit and losses pass directly through to the shareholders, as in a partnership. One other unique characteristic of the S Corporation is that ownership is limited to US citizens only. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Types of Business Organizations ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! Match the accounting terms below to the proper definitions. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Learning Objective 2 Account for the start-up of a partnership and prepare partnership financial statements ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Partnership Start-Up If the partners each contribute cash . . . . . . debit Cash. . . . credit individual Partner Capital accounts. Generally, when a partnership is first formed, the partners will each contribute some form of capital to the business. Sometimes it is different kinds of assets, such as land, a building, a vehicle, etc. In many cases, each partner contributes cash into the partnership, and we need to establish a separate capital account for each partner. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Partnership Start-Up If the partners each contribute cash and other assets . . . debit Cash and Assets for their market value. credit Partner Capital accounts for the market value of their contributions. Sometimes, the new partners contribute something other than cash. In such cases, debit Cash and the appropriate asset account(s) for the fair value of the asset that was contributed by each partner. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Prepare the journal entry to record the Bright’s contribution. Partnership Start-Up Bright and Gonzalez form a partnership on June 1. Bright contributes $15,000 cash, inventory with a market value of $40,000, and Accounts Payable of $80,000. Bright also contributed computer equipment with a cost of $80,000 and accumulated depreciation of $20,000. Current market value is $55,000. In this example, Bright and Gonzalez form a partnership. Bright contributes $15,000 cash, inventory with a market value of $40,000, and an accounts payable (likely related to the inventory) of $80,000. Bright also contributed some computer equipment that had an original cost of $80,000, accumulated depreciation of $20,000, and a market value of $55,000. Prepare the entry to record Bright’s contribution to the partnership. Prepare the journal entry to record the Bright’s contribution. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Partnership Start-Up Bright and Gonzalez form a partnership on June 1. Bright contributes $15,000 cash, inventory with a market value of $40,000, and Accounts Payable of $80,000. Bright also contributed computer equipment with a cost of $80,000 and accumulated depreciation of $20,000. Current market value is $55,000. Each of the assets are recorded at their market value. Note that we ignore the cost and accumulated depreciation of the computer equipment. In addition, the accounts payable of $80,000 (that is likely related to the inventory) must also be added to the partnership books. The remainder is a $30,000 credit to Bright’s Capital account. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Prepare the journal entry to record Gonzalez’s contribution. Partnership Start-Up Bright and Gonzalez form a partnership on June 1. Gonzalez contributed cash of $2,000, and office furniture with a market value of $18,000. The furniture had a cost of $20,000 and accumulated depreciation of $1,500. For the same partnership, Gonzalez contributed cash of $2,000 and office furniture that had a market value of $18,000. The furniture had an original cost on Gonzalez’s books of $20,000 along with accumulated depreciation of $1,500. Prepare the entry to record Gonzalez’s contribution. Prepare the journal entry to record Gonzalez’s contribution. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Partnership Start-Up Bright and Gonzalez form a partnership on June 1. Gonzalez contributed cash of $2,000, and office furniture with a market value of $18,000. The furniture had a cost of $20,000 and accumulated depreciation of $1,500. As with Bright, the assets are debited on the partnership’s books for their market value. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Prepare the journal entry to record Lewis’s contribution. >TRY IT! Stevie Lewis and Mack Young form a partnership to develop a golf course. Lewis contributes $1,000,000 cash and land with a market value of $10,000,000. The land cost $7,000,000 when it was purchased. Steve and Mack form a partnership. Steve contributes $1,000,000 cash and land with a market value of $10,000,000. The land had an original cost of $7,000,000. Prepare the entry to record Steve Lewis’s contribution to the partnership. Prepare the journal entry to record Lewis’s contribution. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! Stevie Lewis and Mack Young form a partnership to develop a golf course. Lewis contributes $1,000,000 cash and land with a market value of $10,000,000. The land cost $7,000,000 when it was purchased. The entry will include a debit to Cash for $1,000,000 and a debit to Land for $10,000,000. Lewis’s Capital is then credited. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Prepare the journal entry to record Young’s contribution. >TRY IT! Stevie Lewis and Mack Young form a partnership to develop a golf course. Young contributes $3,000,000 cash and equipment with a market value of $800,000. Mack, the other partner, contributes cash of $3,000,000 and equipment with a market value of $800,000. Prepare the entry to record Mack’s contribution to the partnership. Prepare the journal entry to record Young’s contribution. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! Stevie Lewis and Mack Young form a partnership to develop a golf course. Young contributes $3,000,000 cash and equipment with a market value of $800,000. As with Lewis, we will debit Cash and Equipment for the market value of the assets contributed to the partnership. Young’s Capital account should then be credited. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Partnership Financial Statements The asset and liability sections for a partnership balance sheet do not differ from any other form of business. The equity section of a partnership balance sheet will show a capital balance for each partner. The primary difference between a partnership’s balance sheet and the balance sheet of any other entity is the equity section. The equity section of any partnership will show a separate capital account for each partner. The model for a partnership balance sheet is: Assets = Liabilities + Partnership Capital ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Partnership Financial Statements In Exhibit 12-3, Bright and Gonzalez will end up (after recording their contributions) with assets of $130,000. This will include the cash that was contributed along with the inventory, computer equipment, and office furniture. The balance sheet will also show the Account Payable contributed by Bright. Finally, the equity section will show a separate Capital account for each partner. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocate profits and losses to the partners Learning Objective 3 Allocate profits and losses to the partners ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocating Profits and Losses The allocation of income is usually based on negotiated profit/loss sharing percentages. Items to be allocated: In a corporation, any profit goes to Retained Earnings. If the Board of Directors so decides, then some of those profits can be distributed to the shareholders in the form of dividends. However, in a partnership, there are no shareholders. By definition, all profit from the partnership will be allocated to the various partners. In a partnership, profits and losses may be allocated based on negotiated rules. In the simplest case, profits and losses will be allocated to partners based on a negotiated profit/loss sharing ratio. In more complex cases, a portion of the profits is first allocated to various partners unequally before profits or losses are allocated based on the negotiated profit/loss sharing ratios. In the example shown here, interest is first assigned to each partner based on their capital balances at the beginning of the period. Any interest that is allocated reduces the amount of profit that may subsequently be allocated based on the profit/loss sharing ratio. Next, a “compensation” amount or bonus is sometimes allocated to some of the partners, based on the amount of work they did within the partnership. This allocation also reduces any amounts that are to be allocated to the partners using the profit/loss sharing ratio. Remaining income Interest on beginning capital balances Bonuses Allocated compensation ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocating Profits and Losses Example Bright and Gonzalez earlier formed a partnership to develop a golf course. Bright and Gonzalez agreed to allocate 2/3 of the profits/losses to Bright and 1/3 of the profits/losses to Gonzalez. If the profit for the year was $60,000, how much would be allocated to each partner? Let’s first look at a simple allocation of profits to the partners. Bright and Gonzalez earlier formed a partnership to develop a golf course. Bright and Gonzalez agreed to allocate 2/3 of the profits/losses to Bright and 1/3 of the profits/losses to Gonzalez. If the partnership had $60,000 profit for the year, how much would be allocated to each partner? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocating Profits and Losses Example Bright and Gonzalez earlier formed a partnership to develop a golf course. Bright and Gonzalez agreed to allocate 2/3 of the profits/losses to Bright and 1/3 of the profits/losses to Gonzalez. If the profit for the year was $60,000, how much would be allocated to each partner? With no other required allocations, the profit is simply allocated based on the profit/loss sharing ratio of 2/3 to Bright and 1/3 to Gonzalez. Remember, this is NOT a distribution of cash. Rather, this is simply an allocation of the profit to the capital accounts of the partnership. Using these ratios, there will be an allocation of $40,000 to Bright’s capital account and $20,000 to Gonzalez’s capital account. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocating Profits and Losses Example Bright and Gonzalez earlier formed a partnership to develop a golf course. Bright and Gonzalez agreed to allocate 2/3 of the profits/losses to Bright and 1/3 of the profits/losses to Gonzalez. If the profit for the year was $60,000, how much would be allocated to each partner? Next, we need to prepare the journal entry. Prepare the journal entry to record the distribution of income. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocating Profits and Losses Example Bright and Gonzalez earlier formed a partnership to develop a golf course. Bright and Gonzalez agreed to allocate 2/3 of the profits/losses to Bright and 1/3 of the profits/losses to Gonzalez. If the profit for the year was $60,000, how much would each partner receive? With the income residing in the income summary account (following the posting of Closing Entries for all revenue and expense accounts), the entry will require a debit to Income Summary for $60,000, a credit to Bright, Capital for $40,000 and a credit to Gonzalez, Capital for $20,000. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocation Based on Other Factors Sometimes, some of the income is specially allocated before the general allocation. Partners may get extra income because they work more. An interest amount may be allocated to each partner. These are all accounting allocations. They do not represent actual cash distributions. As stated earlier, sometimes amounts are first allocated to the partners individually and unequally based on contractual commitments prior to the application of the general profit/loss sharing ratio. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocation Based on Other Factors Bright and Gonzalez share the $60,000 net income as follows: Bright receives a “salary allowance” of $16,000. Gonzalez receives a “salary allowance” of $24,000. Each partner is allocated 10% of their current capital balance. All remaining profit is allocated equally. Assume that Bright and Gonzalez are using the 2:1 ratio used in the earlier example. Per the partnership agreement, Bright will receive an allocation of $16,000 as salary for extra work that Bright has done for the partnership. Gonzalez will receive a salary allocation of $24,000. In addition, each partner will be allocated interest of 10% based on their current capital balance as of the beginning of the year. After these allocations, the profit/loss sharing ratio will be applied to any unallocated profit or loss. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocation Based on Other Factors Bright’s capital balance was $30,000 and Gonzalez’s capital balance was $20,000 before any allocations are made at the end of the year. As stated, Bright will receive a salary allocation of $16,000 and Gonzalez will receive a salary allocation of $24,000. This allocation will reduce the amount of profit/loss available for allocation to $20,000. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocation Based on Other Factors Next, a 10% interest allocation will be made to each partner based on their capital balances prior to the allocations ($30,000 for Bright and $20,000 for Gonzalez). This will mean an allocation of an additional $5,000 to the capital balances, leaving only $15,000 available for allocation based on the profit/loss sharing ratio. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Allocation Based on Other Factors The $15,000 is allocated based on the ratio of ½ to Bright and ½ to Gonzalez. So the remaining $15,000 is allocated $7,500 to Bright and $7,500 to Gonzalez. The end result is that Bright’s ending capital balance is $56,500 and Gonzalez’s capital balance is $53,500. If the initial results of operations had been a loss, or if the preliminary allocations had resulted in pushing an initial net income amount into a net loss position, then whatever amount was remaining to be allocated would be allocated. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Account for the admission of a new partner Learning Objective 4 Account for the admission of a new partner ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner An individual partner’s ownership rights include: The right to co-ownership of the partnership property. The right to share in profits and losses as specified in the partnership agreement. The right to participate in the management of the partnership. These rights can be sold or given to anyone. Along with membership in a partnership, each partner has certain rights as an owner. Among those rights are (1) the right to co-ownership of the partnership property, (2) the right to share in profits and losses as specified in the partnership agreement, and (3) the right to participate in the management of the partnership. The first two of these rights can be assigned by a partner to a third party without the consent of the other partners. However, the right to participate in management cannot be assigned without the approval of the other partners. This right can only be sold or given to someone with the permission of the other partners. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner by Purchasing a Partner’s Interest Bright has capital of $53,500 and Gonzalez has capital of $50,500. Bright sells ½ of her partnership interest to Cheryl Kaska for $30,000. How is this recorded? When the makeup of a partnership changes, the partnership is dissolved. A new partnership is immediately formed. New partner acquires partnership interest by: Purchasing it from the other partners, or Making a contribution to the partnership. Anytime the partnership team changes, then officially, the partnership is dissolved and a new partnership is immediately formed with the new partners included. Two questions must be answered, how does the new partner gain a share of the partnership and how must we account for the addition of the new partner? Assume that Bright and Gonzalez are partners. Bright has capital of $53,500 and Gonzalez has capital of $50,500 ($104,000 total capital). Bright sells ½ of her partnership interest to Cheryl Kaska for $30,000 (with the approval of Gonzalez). How do we record this transaction? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner by Purchasing a Partner’s Interest Bright’s capital is $53,500 prior to the sale of ½ of that to Kaska. Simply transfer ½ of Bright’s capital to Kaska’s capital account. Note that the cash was exchanged between Bright and Kaska. The partnership never saw any cash. Note that Kaska’s payment went to Bright, not into the partnership. The partnership did not actually receive more cash. Kaska is buying her share of the partnership directly from Bright. In this case, we must record the transfer of a part of Bright’s capital to Kaska. Prepare the journal entry to record Kaska’s contribution. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner by Purchasing a Partner’s Interest Bright’s capital is $53,500 prior to the sale of ½ of that to Kaska. Simply transfer half of Bright’s capital to Kaska’s capital account. Note that the cash was exchanged between Bright and Kaska. The partnership never saw any cash. Bright’s capital account prior to Kaska entering the partnership is $53,500. By allocation ½ of Bright’s balance to Kaska, the capital balances will now be properly stated. Debit Bright’s capital account for $26,750 and credit Kaska’s capital account for $26,750. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner by Contributing to the Partnership Kaska wants to join Bright and Gonzalez. The capital for Bright and Gonzalez is $104,000. Kaska contributes land with a market value of $52,000 for a 1/3 share. How is this recorded? In some cases, the new partner contributes assets to the partnership in return for a share of the business. The old partnership dissolves and a new one is formed. When the new partner contributes assets directly to the partnership, then we have to not only allocate an amount to the new partner’s capital account, but we must also account for the inflow of new assets to the business. Assume that Kaska wants to join the partnership. Bright and Gonzalez have total capital of $104,000. Kaska contributes land with a market value of $52,000 to the partnership for a 1/3 interest of the business. How is this contribution of land recorded? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner by Contributing to the Partnership Before Kaska joins the partnership, total capital is $104,000. After Kaska’s contribution (land with a market value of $52,000), the new capital is $156,000. Kaska’s contribution is exactly 1/3 of the new partnership capital. After Kaska’s contribution of land with a market value of $52,000, the total capital of the partnership has increased to $156,000 ($104,000 + $52,000). Kaska will be allocated 1/3 of the $156,000 in total capital. In this case, 1/3 of the capital is $52,000, exactly the same amount as the value of the contributed land. Prepare the journal entry to record Kaska’s contribution. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner by Contributing to the Partnership Before Kaska joins the partnership, total capital is $104,000. After Kaska’s contribution (land with a market value of $52,000), the new capital is $156,000. Kaska’s contribution is exactly 1/3 of the new partnership capital. Then entry requires a debit to Land for $52,000 and a credit to Kaska’s capital of $52,000. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner—Bonus to the Existing Partners Kaska wants to join Bright and Gonzalez. The capital for Bright and Gonzalez is $104,000. Kaska contributes cash of $100,000 for a 1/4 share. How is this recorded? The new partner contributes more in assets to the partnership than their share of the business dictates. The old partners share the “bonus.” In some cases, the value of the contributed asset is greater than the share of the business that the new partner is to receive. In this case, the excess is allocated to the existing partners in the form of a “bonus.” The allocation is made using the existing profit/loss sharing ratio. Kaska wants to join the partnership of Bright and Gonzalez. Kaska contributes cash of $100,000 for a ¼ share of the business. How is the contribution recorded? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner—Bonus to the Existing Partners The new partnership’s capital is now $204,000, but Kaska’s ¼ share is only $51,000. The remaining $49,000 ($100,000 - $51,000) is allocated to the original partners as a bonus. Assume Bright and Gonzalez share profits equally. The partnership capital, after the contribution of the $100,000 cash is $204,000 ($104,000 + $100,000). Kaska’s ¼ share of the business is $51,000. The difference ($49,000) must be allocated between Bright and Gonzalez. According to the partnership agreement, they share profits and losses equally. Prepare the entry. Prepare the journal entry to record Kaska’s contribution. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner—Bonus to the Existing Partners The new partnership’s capital is now $204,000, but Kaska’s ¼ share is only $51,000. The remaining $49,000 ($100,000 - $51,000) is allocated to the original partners as a bonus. Assume Bright and Gonzalez share profits equally. Obviously, Cash is debited for $100,000. In addition, we will credit Kaska’s capital balance for $51,000. The remaining $49,000 must be allocated as a bonus to Bright and Gonzalez. Where do we credit the “bonus”? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner—Bonus to the Existing Partners The new partnership’s capital is now $204,000, but Kaska’s ¼ share is only $51,000. The remaining $49,000 ($100,000 - $51,000) is allocated to the original partners as a bonus. Assume Bright and Gonzalez share profits equally. Because Bright and Gonzalez share profits and losses equally, then the $49,000 will be share equally. A bonus of $24,500 ($49,000 x ½) is credited to each partner’s capital account. Note that the newly created partnership of Bright, Gonzalez, and Kaska will need to re-negotiate a new profit/loss sharing ratio. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner—Bonus to the New Partner Kaska wants to join Bright and Gonzalez. The capital for Bright and Gonzalez is $104,000. Kaska contributes cash of $98,000 for a 60% share. How is this recorded? The new partner contributes less in assets to the partnership than their share of the business dictates. The old partners share the bonus to Kaska equally. In other cases, the new partner’s contribution has a value that is less than would be suggested by the share of the business acquired by the new partner. This is often a result of the new partner bringing a valued skill or other value to the business in addition to the contribution of the tangible asset. Kaska wants to join the partnership of Bright and Gonzalez. Kaska contributes $98,000 cash in exchange for a 60% share of the business. How is this recorded? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner—Bonus to the New Partner The new partnership’s capital is now $202,000, but Kaska’s 60% share is $121,200, which is $23,200 more than her contribution. The “bonus” will be allocated from the original partners to Kaska. Assume Bright and Gonzalez share profits equally. The capital of the new partnership is $202,000 ($104,000 + $98,000). Kaska’s 60% share of that capital is $121,200, which is $23,200 more than her contribution. The difference will be treated as a bonus from Bright and Gonzalez to Kaska. Prepare the journal entry to record Kaska’s contribution. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner—Bonus to the New Partner The new partnership’s capital is now $202,000, but Kaska’s 60% share is $121,200, which is $23,200 more than her contribution. The “bonus” will be allocated from the original partners to Kaska. Assume Bright and Gonzalez share profits equally. The entry will require a debit to Cash for $98,000 and a credit to Kaska’s capital of $121,200. To balance the entry, we will debit the capital accounts of Bright and Gonzalez. From where do we get Kaska’s “bonus”? ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Admission of a New Partner—Bonus to the New Partner The new partnership’s capital is now $202,000, but Kaska’s 60% share is $121,200, which is $23,200 more than her contribution. The “bonus” will be allocated from the original partners to Kaska. Assume Bright and Gonzalez share profits equally. To complete the entry, we will debit Bright, Capital for $11,600 (1/2 of $23,200) and we will debit Gonzalez, Capital for $11,600. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Prepare the journal entry to record Rivera’s contribution. >TRY IT! Parker has $40,000 capital and Flores has $20,000 capital. They share profits/losses equally. Ray Rivera contributes $30,000 cash to the partnership to acquire a 25% ownership in the partnership. In this Try It example, Parker and Flores have a partnership. Parker’s capital balance is $40,000 and Flores’s capital balance is $20,000. The two partners share profits and losses equally. Ray Rivera wants to join the partnership by contributing $30,000 cash to the partnership in exchange for a 25% share of the business. How do we record Rivera’s contribution? Prepare the journal entry to record Rivera’s contribution. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! The new partnership has $90,000 in capital. Rivera’s 25% share of that is $22,500. This will leave $7,500 ($30,000 - $22,500) to distribute as a bonus to Parker and Flores equally. The new partnership has total capital of $90,000 ($40,000 + $20,000 + $30,000). Rivera’s 25% share of the partnership is $22,500 ($90,000 x 25%). The entry will require a debit to Cash for $30,000 and a credit to Rivera, Capital of $22,500. The remaining $7,500 will be allocated to Parker and Flores equally. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall >TRY IT! The new partnership has $90,000 in capital. Rivera’s 25% share of that is $22,500. This will leave $7,500 ($30,000 - $7,500) to distribute as a bonus to Parker and Flores equally. To complete the entry, we will credit Parker, Capital for $3,750 and Flores, Capital for $3,750. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Account for a partner’s withdrawal from the partnership Learning Objective 5 Account for a partner’s withdrawal from the partnership ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Accounting for the Withdrawal of a Partner at Book Value Bright, Gonzalez, and Kaska share profits 1:2:3. Record Bright leaving the partnership for $53,500 cash. When a partner leaves the partnership, the change in partnership capital must be accounted for. Remove the exiting partner’s capital account and distribute it. When a partner leaves the partnership, not only the ownership team will change. The exiting partner will usually receive some kind of “buyout” or payment when they exit the partnership. Bright, Gonzalez, and Kaska have a partnership. Their combined partnership capital is $156,000. Bright wants to leave the partnership, and will receive $53,500 upon exit. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of a Partner at Book Value The cash amount paid to Bright is determined by the terms of the partnership agreement. When the cash is paid, Bright’s capital account is zeroed out. Prepare the entry to record Bright’s withdrawal from the partnership. Prepare the journal entry to record Bright’s withdrawal from the partnership. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of a Partner at Book Value The cash amount paid to Bright is determined by the terms of the partnership agreement. When the cash is paid, Bright’s capital account is zeroed out. The entry will require a debit to Bright, Capital for $53,500 and a credit to Cash for the $53,500 payment. In this case, the payment was exactly equal to the value of the withdrawing partner’s capital account. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of Partner—Bonus to Other Partners Bright, Gonzalez, and Kaska share profits 1:2:3. Record Bright leaving the partnership for only $47,200 cash. A partner may choose to “pay” the other partners to allow withdrawal from the partnership. Cash paid < Capital of departing partner. A “bonus” is attributed to each of the remaining partners. Sometimes, the amount that the withdrawing partner receives will be less than their current capital balance. Essentially, the remaining capital balance of the withdrawing partner, after accounting for the cash payment, will be allocated to the remaining partners in the form of a “bonus.” Bright wants to leave the partnership, but will receive only $47,200 cash, even though her current capital balance is $53,500. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of Partner—Bonus to Other Partners The cash amount paid to Bright is < than Bright’s capital of $53,500. The difference must be allocated to Gonzalez and Kaska based on their relative profit sharing %. Prepare the entry to record Bright’s withdrawal from the partnership. Prepare the journal entry to record Bright’s withdrawal from the partnership. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of Partner—Bonus to Other Partners The cash amount paid to Bright is < than Bright’s capital of $53,500. The difference must be allocated to Gonzalez and Kaska based on their relative profit sharing %. The entry will require a debit to Bright, Capital for $53,500 and a credit to Cash for $47,200. The remaining $6,300 will be allocated to Gonzalez and Kaska based on the remaining relative profit/loss sharing ratio. The original ratio for the partnership was 1/6 to Bright, 2/6 to Gonzalez, and 3/6 to Kaska. After Bright leaves, there are only 5 allocation points left. So, Gonzalez will now receive 2/5 of any allocation and Kaska will receive 3/5. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of Partner—Bonus to Other Partners After Bright leaves, Gonzalez and Kaska will split profits 2:3; i.e. 2/5 will go to Gonzalez: (53,500 – 47,200) x 2/5 = 2,520 The bonus to Gonzalez will require a credit of $2,520 to Gonzalez, Capital. ($53,500 - $47,200) x 2/5 = $2,520 ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of Partner—Bonus to Other Partners After Bright leaves, Gonzalez and Kaska will split profits 2:3; i.e. 3/5 will go to Kaska: (53,500 – 47,200) x 3/5 = 3,780 The bonus to Kaska will require a credit of $3,780 to Kaska, Capital. ($53,500 - $47,200) x 3/5 = $3,780 ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of Partner—Bonus to Withdrawing Partner Bright, Gonzalez, and Kaska share profits 1:2:3. Record Bright leaving the partnership for $57,200 cash. Sometimes the agreement agrees to pay a bonus to the exiting partner. Cash paid > Capital of departing partner. A “bonus” is paid by the remaining partners to the withdrawing partner. In the final example, the withdrawing partner receives cash in excess of the existing capital balance. Essentially, a bonus is paid TO the withdrawing partner by the remaining partners. In this case, Bright will withdraw from the partnership and will receive a payment of $57,200. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of Partner—Bonus to Withdrawing Partner The cash amount paid to Bright is > than Bright’s capital of $53,500. The difference must be allocated from Gonzalez and Kaska based on their relative profit sharing %. The $57,200 paid to Bright is greater than Bright’s capital balance of $53,500. The difference will be allocated to Bright from Gonzalez and Kaska based on their relative profit/loss sharing ratio. Prepare the journal entry to record Bright’s withdrawal from the partnership. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of Partner—Bonus to Withdrawing Partner The cash amount paid to Bright is > than Bright’s capital of $53,500. The difference must be allocated from Gonzalez and Kaska based on their relative profit sharing %. The entry will require a debit to Bright, Capital of $53,500 and a credit to Cash of $57,200. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of Partner—Bonus to Withdrawing Partner Gonzalez’s capital account will be reduced by 2/5 of the difference, effectively giving a bonus to Bright. (57,200 – 53,500) x 2/5 = 1,480 The difference of $3,700 will be allocated based on the relative profit/loss sharing ratio of 2/5 to Gonzalez and 3/5 to Kaska. The entry will require a debit to Gonzalez, Capital of $1,480 ($57,200 - $53,500) x 2/5 = $1,480 ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Withdrawal of Partner—Bonus to Withdrawing Partner Kaska’s capital account will be reduced by 3/5 of the difference, effectively giving a bonus to Bright. (57,200 – 53,500) x 3/5 = 2,220 The entry will require a debit to Kaska, Capital of $2,220 ($57,200 - $53,500) x 3/5 = $2,220 ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Account for the liquidation of a partnership Learning Objective 6 Account for the liquidation of a partnership ©2014 Pearson Education, Inc. Publishing as Prentice Hall

Liquidating the Partnership Sell all assets and allocate gains/losses to the partners based on profit/loss sharing %. Pay all partnership liabilities. Pay the remaining cash to the partners based on their capital balances. When a partnership ceases to engage in business operations, the partnerships assets should be liquidated. Each partner will eventually receive an appropriate share of the cash raised. Liquidating a partnership is a fairly simple task that requires three basic steps. Sell all assets and allocate the gains/losses to the partners based on the profit/loss sharing ratio. Pay all partnership liabilities. Distribute the remaining cash to the partners based on their capital balances. ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall Practice Questions ©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall

©2014 Pearson Education, Inc. Publishing as Prentice Hall End of Chapter 12 ©2014 Pearson Education, Inc. Publishing as Prentice Hall