©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Partnerships – Formation, Operations, and Changes in Ownership Interests Chapter 15

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 1 Comprehend the legal characteristics of partnerships.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Partnership Characteristics It is an association of two or more persons who co-own a business for a profit. The legal life of a partnership terminates with the admission of a new partner, the withdrawal or death of a partner, voluntary dissolution by the partners, or involuntary dissolution such as bankruptcy proceedings.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Articles of Partnership A partnership may be formed by a simple oral agreement among two or more people to operate a business for profit.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Articles of Partnership The types of products and services to be provided Each partner’s rights and responsibilities Each partner’s initial investment Additional investment conditions Asset drawing provisions Profit and loss sharing formulas Procedures for dissolving the partnership

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Partnership Financial Reporting The accounting reports are designed to meet the needs of three user groups… The partners Partnership creditors Internal Revenue Service

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 2 Understand initial investment valuation and record keeping.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Initial Investment in a Partnership Ashley and Becker each invest $20,000 cash in a new partnership. Cash20,000 Ashley, Capital20,000 To record Ashley’s original investment of cash Cash20,000 Becker, Capital20,000 To record Becker’s original investment of cash

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Noncash Investments C. Cola R. Crown Fair Value Cash$ —$ 7,000 Land (cost to C. Cola, $5,000) 10,000 — Building (cost to C. Cola, $30,000) 40,000 — Inventory (cost to R. Crown, $28,000) — 35,000 Total$50,000$42,000 C. Cola and R. Crown enter into a partnership.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Noncash Investments Land10,000 Building40,000 C. Cola, Capital50,000 To record C. Cola’s original investment of land and building at fair value

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Noncash Investments Cash 7,000 Inventory35,000 R. Crown, Capital42,000 To record R. Crown’s original investment of cash and inventory items at fair value

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Bonus or Goodwill on Initial Investment The partnership agreement specifies equal capital interests. C. Cola, Capital4,000 R. Crown, Capital4,000 To establish equal capital interests of $46,000 by recording a $4,000 bonus from C. Cola to R. Crown

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Bonus or Goodwill on Initial Investment Goodwill8,000 R. Crown, Capital8,000 To establish equal capital interests of $50,000 by recognizing R. Crown’s investment of an $8,000 unidentifiable asset

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Drawings Regular withdrawals are called drawings, drawing allowances, or sometimes salary allowances. Debit Drawing and credit Cash. At period end, credit Drawing and debit each partner’s Capital.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Loans and Advances Loans and advances to the partnership and accrued interest are regarded as liabilities of the partnership. Loans and advances to partners are regarded as assets of the partnership.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Partnership Operations Ratcliffe and Yancey are partners sharing profits in a 60:40 ratio, respectively.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Partnership Operations Partnership net income 2003$34,500 Ratcliffe capital January 1, ,000 Ratcliffe additional investment ,000 Ratcliffe drawing ,000 Yancey capital January 1, ,000 Yancey drawing ,000 Yancey withdrawal ,000 Equity Accounts, 2003

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Format for a Statement of Partners’ Capital Ratcliffe and Yancey Statement of Partners’ Capital For the Year Ended 12/31/ % 40% RatcliffeYancey Total Capital balances 1/1/03$40,000$35,000$75,000 Add: Additional investments 5,000 — 5,000 Deduct: Withdrawals — – 3,000 – 3,000 Deduct: Drawings – 6,000 – 9,000–15,000 Net contributed capital 39,000 23,000 62,000 Add: Net income for ,700 13,800 34,500 Capital balances 12/31/03$59,700$36,800$96,500

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Closing Entries December 31, 2003 Revenue and Expense Summary34,500 Ratcliffe, Capital20,700 Yancey, Capital13,800 To divide net income for the year 60% to Ratcliffe and 40% to Yancey

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Closing Entries December 31, 2003 Ratcliffe, Capital6,000 Yancey, Capital9,000 Ratcliffe, Drawing6,000 Yancey, Drawing9,000 To close partner drawing accounts to capital accounts

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 3 Grasp the diverse nature of profit and loss sharing agreements and their computation.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Profit and Loss Sharing Agreements Equal division of partnership income is required in the absence of a profit and loss sharing agreement.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Service Considerations in Profit and Loss Sharing Agreements A partner who devotes time to the partnership business while other partners work elsewhere may receive a salary allowance. Salary allowances are also used to compensate for differences in the fair value of the talents of partners.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Salary Allowance in Profit Sharing Agreements Bob, Gary, and Pete are partners. The partnership agreement provides that Bob and Gary receive salary allowances of $12,000 each, with the remaining income allocated equally. Partnership net income is $60,000 for 2003 and $12,000 for 2004.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Income Allocation Schedule: 2003 Bob Gary Pete Net income$60,000 Salary allowances to Bob and Gary (24,000)$12,000$12,000 Remainder to divide 36,000 Divided equally (36,000) 12,000 12,000$12,000 Remainder to divide 0 Net income allocation$24,000$24,000$12,000

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Income Allocation Schedule: 2004 Bob Gary Pete Net income$12,000 Salary allowances to Bob and Gary (24,000)$12,000$12,000 Remainder to divide (12,000) Divided equally 12,000 (4,000) (4,000)$(4,000) Remainder to divide 0 Net income allocation$ 8,000$ 8,000$(4,000)

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Journal Entries December 31, 2003 Revenue and Expense Summary60,000 Bob, Capital24,000 Gary, Capital24,000 Pete, Capital12,000 Partnership income allocation for 2003

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Journal Entries December 31, 2004 Revenue and Expense Summary12,000 Pete, Capital 4,000 Bob, Capital8,000 Gary, Capital8,000 Partnership income allocation for 2004

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Bonus and Salary Allowances The partnership agreement provides that Bob receive a bonus of 10% of partnership net income. Partnership net income is $60,000 for 2003 and $12,000 for Bob and Gary receive salary allowances of $10,000 and $8,000, respectively, and the remaining income is allocated equally.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Income Allocation Schedule: 2003 Bob Gary Pete Net income$60,000 Bonus to Bob (6,000)$ 6,000 Remainder to divide 54,000 Salary allowances to Bob and Gary (18,000) 10,000$ 8,000 Remainder to divide 36,000 Divided equally (36,000) 12,000 12,000$12,000 Remainder to divide 0 Net income allocation$28,000$20,000$12,000

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Income Allocation Schedule: 2004 Bob Gary Pete Net income$12,000 Bonus to Bob (1,200)$ 1,200 Remainder to divide 10,800 Salary allowances to Bob and Gary (18,000) 10,000$8,000 Remainder to divide (7,200) Divided equally 7,200 (2,400)(2,400)$(2,400) Remainder to divide 0 Net income allocation$ 8,800$5,600$(2,400)

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Income Allocated in Relation to Partnership Capital Capital balances 1/1/2003$20,000$20,000 Investment April 1 2,000 — Withdrawal July 1 — (5,000) Investment September 1 3,000 — Withdrawal October 1 — (4,000) Investment December 28 — 8,000 Capital balances 12/31/2003$25,000$19,000 AceButch

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Comparison of Capital Bases Weighted Beginning EndingAverage Capital Capital Capital Investment Investment Investment Ace$20,000$25,000$22,500 Butch 20,000 19,000 16,500 Total$40,000$44,000$39,000

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Alternatives Beginning Capital Balances Ace ($100,000 × 20/40)$ 50,000 Butch ($100,000 × 20/40) 50,000 Total income$100,000 Net income of $100,000 is divided on the basis of capital balances.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Alternatives Ending Capital Balances Ace ($100,000 × 25/44)$ 56, Butch ($100,000 × 19/44) 43, Total income$100, Average Capital Balances Ace ($100,000 × 22.5/39)$ 57, Butch ($100,000 × 16.5/39) 42, Total income$100,000.00

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Interest Allowances on Partnership Capital An agreement may provide for interest allowances on partnership capital in order to encourage capital investments, as well as salary allowances. Remaining profits are then divided equally or in any other ratio specified in the profit sharing agreement.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 4 Value new partners’ investment in an existing partnership.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Changes in Partnership Interest The existing legal partnership entity is dissolved when a new partner is admitted or an existing partner retires or dies.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Changes in Partnership Interest Assignment of an interest to a third party Admission of a new partner Purchase of an interest from existing partners Investing in an existing partnership

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 5 Value partner’s share upon retirement or death.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Dissolution of a Continuing Partnership Through Death or Retirement Profit and Capital Percentage Loss Balances of Capital Percentage Bonnie$ 70,000 35% 40% Clyde 50, Dillinger 80, Total capital$200,000100%100%

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Dissolution of a Continuing Partnership Through Death or Retirement Dillinger decides to retire. The partners agree that the business is undervalued on the partnership books and that Dillinger will be paid $92,000.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Bonus to Retiring Partner Dillinger, Capital80,000 Bonnie, Capital 8,000 Clyde, Capital 4,000 Cash92,000 Dillinger, Capital80,000 Goodwill 12,000 Cash 92,000

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Reevaluation of Total Partnership Capital Goodwill (other assets)30,000 Bonnie, Capital12,000 Clyde, Capital 6,000 Dillinger, Capital12,000

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Payment to Retiring Partner Less than Capital Balance Suppose that Dillinger is paid $72,000 in final settlement of his capital interest.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Overvalued Assets Written Down Bonnie, Capital 8,000 Clyde, Capital 4,000 Dillinger, Capital 8,000 Net assets20,000 Dillinger, Capital72,000 Cash72,000

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Bonus to Continuing Partners Dillinger, Capital80,000 Bonnie, Capital 5,333 Clyde, Capital 2,667 Cash72,000

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Learning Objective 6 Understand limited liability partnership characteristics.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn Limited Partnerships The limited partnership consists of at least one general partner and one or more limited partners. The limited partner is excluded from the management of the business.

©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn End of Chapter 15