©CourseCollege.com 1 22 Partnerships Learning Objectives 1.Identify characteristics of a partnership 2.Account for organization of a partnership 3.Account for income allocation among partners 4.Account for the admission and retirement of partners 5.Account for the liquidation of partnerships 6.Analysis: Compute and explain return on partners’ equity A review of the Equity section of the balance sheet will indicate the partnership form of business organization

©CourseCollege.com 2 Characteristics or partnerships 1.Voluntary association 2.Mutual agency 3.Limited life 4.Unlimited liability 5.Co-ownership of property 6.Income taxes 7.Partnership agreement Characteristics or partnerships 1.Voluntary association 2.Mutual agency 3.Limited life 4.Unlimited liability 5.Co-ownership of property 6.Income taxes 7.Partnership agreement Objective 22.1: Identify characteristics of a partnership O22.1 Partner?

©CourseCollege.com 3 Partnership characteristics O22.1 Voluntary Association Agreements to form a partnership are voluntary  They can be dissolved at will (existing liabilities will remain however)  They can be formed by an oral agreement (handshake) or a written agreement Fetch!! (If you want to)

©CourseCollege.com 4 Limited Life (generally)  Partnerships terminate with the death or bankruptcy of any partner  Partnerships terminate with:  The withdrawal of an existing partner or  The admission of a new partner Partnership characteristics O22.1 Playing dead doesn’t count. We’re still partners…

©CourseCollege.com 5 Mutual Agency As an agent, each and every partner can bind the partnership within the scope of the partnership business  Partners, by agreement, can limit the scope of partners acting for the partnership  Outsiders, unless they have knowledge of a partner’s limitation to bind the partnership, can legally assume no limitations exist Partnership characteristics O22.1 You said we would mow the lawn?? You can’t push the mower...

©CourseCollege.com 6 Unlimited Liability  Each partner is fully liable for all the debts of the partnership  Partners are personally liable for debts of the partnership Partnership characteristics O22.1 We owe what ?? How could you have possibly eaten that much ?

©CourseCollege.com 7 Co-ownership of property  Partnership property is jointly owned by the partners regardless of which partner invests the property Partnership characteristics O22.1 Look, we own “your” doghouse together. OK ? Don’t be so territorial.

©CourseCollege.com 8 Income tax  Partnerships do not pay taxes on income  Individual partners are responsible for income taxes on their allocation of partnership income Partnership characteristics O22.1 Partner Schmartner You pay your own taxes...

©CourseCollege.com 9 Partnership Agreement  Most partnerships use a written partnership agreement  In the absence of a written agreement, the Uniform Partnership Act rules prevail in an agreement dispute Partnership characteristics O22.1 I know its embarrassing but a paw print is all you can sign with...

©CourseCollege.com 10 Partnership Advantages  Can raise more capital and expertise than proprietorships  Less expensive to form than corporations  Partnership income is not taxed separately  Can be formed very quickly Partnership characteristics O22.1 Remind me again of the expertise you were bringing to this deal...

©CourseCollege.com 11 Partnership Disadvantages Agreements can become difficult to negotiate  Mutual agency and unlimited liability create personal obligations and exposure for individual partners  Success often dependent on mutual trust between partners Partnership characteristics O22.1 For you, I’m a partner. For me, you’re a burden...

©CourseCollege.com 12 Partnership Agreement The nature of the partnership business, its name and location  The names, initial capital investments and duties of each partner  Method of allocating (sharing) profits and losses among partners  Agreements on:  Withdrawals of assets  Admission of new partners  Withdrawals of partners  Liquidation of the partnership  Dispute resolution procedures Partnership Agreement The nature of the partnership business, its name and location  The names, initial capital investments and duties of each partner  Method of allocating (sharing) profits and losses among partners  Agreements on:  Withdrawals of assets  Admission of new partners  Withdrawals of partners  Liquidation of the partnership  Dispute resolution procedures Partnership characteristics O22.1 So?? You still get 2% of profits after I get my $50,000 salary allowance...

©CourseCollege.com 13 Limited partnerships have two types of partners, general and limited. The general partner is responsible for management of the business and has unlimited liability for partnership debts. Limited partners have no management duties or authority. Their liability to partnership debts is limited to the amount of their partnership investment. General partnerships are the traditional and most common form of partnership. The preceding characteristics apply to all general partners. General partnerships are the traditional and most common form of partnership. The preceding characteristics apply to all general partners. Types of Partnerships O22.1 You’re limited only your ability. You’re still responsible buddy...

©CourseCollege.com 14 Objective 22.2: Account for organization of a partnership The Equity section will tell you if the firm is a partnership O22.2 Basic accounting for partnerships is similar to that of proprietorships. The exceptions are those transactions that involve the partner’s equity accounts

©CourseCollege.com 15 Account for organization of a partnership O22.2 Partner’s equity accounts must be used for: Initial and subsequent equity investments Distribution of profits and losses to individual partners Withdrawal of assets by individual partners Dissolutions and liquidation of the partnership

©CourseCollege.com 16 Account for organization of a partnership O22.2 Partnership accounting requires the following: A separate equity account for each partner A separate withdrawal account for each partner Allocation of profits and losses among partners according to a partnership agreement

©CourseCollege.com 17 Account for organization of a partnership O22.2 Assume J. Ross and T. Smith form a partnership with equal cash equity investments of $25,000 Separate equity account for each partner Total equity in the partnership is now: J. Ross, Capital$25,000 T. Smith Capital$25,000 Total Equity$50,000

©CourseCollege.com 18 Account for organization of a partnership O22.2 Total equity in the partnership is now: J. Ross, Capital$25,000 Less withdrawals (1,000) T. Smith Capital$25,000 Less withdrawals (2,000) Total Equity$47,000 J. Ross withdraws $1,000 and T. Smith withdraws $2,000 Separate withdrawal account for each partner

©CourseCollege.com 19 Total equity in the partnership is now: J. Ross, Capital$30,000 Less J. Ross, Withdrawals (1,000) T. Smith Capital$30,000 Less T. Smith Withdrawals (2,000) Total Equity$57,000 Account for organization of a partnership O22.2 J. Ross and T. Smith have agreed to share profits First year profits are $10,000 Allocation of profits and losses per agreement

©CourseCollege.com 20 Account for organization of a partnership O22.2 Accounting for the start-up of a partnership is similar to that of a proprietorship. Partners invest both assets and liabilities. LIABILITIES ASSETS With agreement by partners, BOTH can be invested into the partnerships

©CourseCollege.com 21 Account for organization of a partnership O22.2 T. Will and R. Star form a partnership. T. Will invests $90,000 cash. R. Star invests $10,000 and a commercial building and land that cost $125,000. The building and land recently appraised for $300,000, (land at $100,000 and building at $200,000). R. Star has a $150,000 loan on the real estate which the partnership agrees to assume.

©CourseCollege.com 22 Account for organization of a partnership O ,000 Will; 10,000 Star Star: 10,000 cash; 150,000 real estate equity Assumption of Star’s real estate debt

©CourseCollege.com 23 Objective 22.3: Account for income allocation among partners O22.3 Various method of income (and loss) sharing are used by partners. Some examples include allocation by: Percentage Capital balances Both percentage and capital balances Combination of service, capital balances and percentage

©CourseCollege.com 24 Partner income allocation -percentage O22.3 Tina Boss and Mary Wisk form a partnership and agree that profits and losses should be shared with 1/3 to Tina and 2/3 to Mary. The recent year end resulted in a loss of $60,000. Tina Mary 1/3 for me 2/3 for me 2/3 x 60,000 = 40,000

©CourseCollege.com 25 Partner income allocation –capital balances O22.3 Total capital = Ryo’s $30,000 Mike’s $50,000 Han’s $20,000 $100,000 Total capital = Ryo’s $30,000 Mike’s $50,000 Han’s $20,000 $100,000 Ryo Tan, Mike West and Han Lee form a new partnership and agree to allocate income and losses based on their end of the year capital balances. The first year net income is $50,000.  Ryo’s share 30/100 x $50,000 = $15,000  Mike’s share 50/100 x $50,000 = $25,000  Han’s share 20/100 x $50,000 = $10,000

©CourseCollege.com 26 Partner income allocation -capital balances & % O22.3 The second year, Ryo, Mike & Han decide to allocate income based on end-of-year capital balances for the first $60,000 with any remainder shared equally. Net income for the year was $90, % x 60,000 = 12,000

©CourseCollege.com 27 Partner income allocation –service, capital & % O22.3 The end of the third year Ryo, Mike and Han decide to change their income allocation agreement again. The plan is as follows: First, a service (salary allowance) allocation, Ryo $40,000; Mike $10,000; Han $80,000 Second, 10% of end-of-year capital balances Third, an remaining balance (positive or negative) to be shared equally.Total income the third year was $175, ,000 – 130,000 – 13,500 = 31,500

©CourseCollege.com 28 Partner income allocation –service, capital & % O22.3 In the fourth year the Ryo, Mike and Han partnership earned $125,000. Notice the ($7,500) allocated to each in step #3. When income is adequate, a positive equal distribution will result, however, when income is inadequate, all partners share, per their agreement, in the shortfall. 125,000 – 130,000 – 17,500 = (22,500)

©CourseCollege.com 29 Objective 22.4: Account for the admission and retirement of partners O22.4 Admit partners (new partnership results) : Personal transaction*  At book, below book or above book value Partnership transaction  At book, below book or above book value *In a general partnership, all partners must agree to allow a new partner into the firm. However, the financial interest in the partnership can often be sold separately in a personal transaction. No change to the partnership accounts would result.

©CourseCollege.com 30 Admit partner –personal transaction* O22.4 In the Ryo, Mike, Han partnership, Ryo sells his partnership interest to Fred for $125,000. Mike and Han agree to Fred Small as a new partner. Ryo ’ s capital account totals $115,000 at the time of the sale. Fred pays Ryo personally, the partnership receives no cash. The partnership simply records the following: *Acknowledged and accepted by the partnership

©CourseCollege.com 31 Admit partner –partnership transaction at book value O22.4 Partners Tina and Mary agree to admit Kim Chu as a 20% partner for a cash investment of $25,000. Beginning capital Tina 60,000 Mary 40,000 Total100,000 Beginning capital Tina 60,000 Mary 40,000 Total100,000 Projected capital Beginning100,000 New partner 25,000 Total125,000 Projected capital Beginning100,000 New partner 25,000 Total125,000 New partner’s capital Total125,000 x 20% = 25,000 New partner’s capital Total125,000 x 20% = 25,000

©CourseCollege.com 32 Admit partner – partnership transaction above book value O22.4 Partners Tina and Mary agree to admit Kim Chu as a 20% partner for a cash investment of $31,000. Tina will receive 1/3 and Mary 2/3 of any bonus or deficiency. Beginning capital Tina 60,000 Mary 40,000 Total100,000 Beginning capital Tina 60,000 Mary 40,000 Total100,000 Projected capital Beginning100,000 New partner 31,000 Total131,000 Projected capital Beginning100,000 New partner 31,000 Total131,000 New partner’s capital Total131,000 x 20% = 26,200 New partner’s capital Total131,000 x 20% = 26,200 Bonus

©CourseCollege.com 33 24, ,000 = 2,400 x 1/3 = 800 Admit partner – partnership transaction below book value O22.4 Partners Tina and Mary agree to admit Kim Chu as a 20% partner for a cash investment of $22,000. Tina will receive 1/3 and Mary 2/3 of any bonus or deficiency. Beginning capital Tina 60,000 Mary 40,000 Total100,000 Beginning capital Tina 60,000 Mary 40,000 Total100,000 Projected capital Beginning100,000 New partner 22,000 Total122,000 Projected capital Beginning100,000 New partner 22,000 Total122,000 New partner’s capital Total122,000 x 20% = 24,400 New partner’s capital Total122,000 x 20% = 24,400

©CourseCollege.com 34 O22.4  Partner may withdraw voluntarily or due to natural death  The original partnership ends upon withdrawal  A partner may withdraw at book, below book or above book value  Partnership agreement may contain withdrawal agreement or conditions  In general, remaining partners usually must agree on how the withdrawing partner’s equity is dealt with Partnership transaction partner withdraws

©CourseCollege.com 35 Partner withdraws at book value O22.4 Consider HMS partnership with three partners Hiko, Millie and Sam. The partnership has been successful and current partner equity account balances are Hiko $250,000; Millie $175,000; and Sam $185,000. All profits and losses are shared equally. Sam has asked to withdraw from the partnership at book value. His partners agree.

©CourseCollege.com 36 Partner withdraws above book value O22.4 Consider the same HMS partnership in a different scenario. Current partner equity account balances are Hiko $250,000; Millie $175,000; and Sam $185,000. All profits and losses are shared equally. Sam agrees to leave for $215,000 cash. His partners agree. Amount necessary to balance is 215,000 – 185,000 = 30,000/2 = 15,000 debit (reduction) to each remaining partner’s equity account

©CourseCollege.com 37 Partner withdraws below book value O22.4 Consider the same HMS partnership in a different scenario. Current partner equity account balances are Hiko $250,000; Millie $175,000; and Sam $185,000. All profits and losses are shared equally. Sam agrees to leave for $145,000 cash. His partners agree. Amount necessary to balance is 185,000 – 145,000 = 40,000/2 = 20,000 credit (increase) to each remaining partner’s equity account

©CourseCollege.com 38 Objective 22.5: Account for liquidation of partnerships O22.5 Liquidation process: 1.Complete the liquidation sale of non-cash assets 2.Allocate gains or losses from liquidation to partners according to their allocation agreement 3.Pay all creditors 4.Disburse remaining cash to partners according to their capital balances Liquidation risk: cash received for the rapid sale of assets may result in losses -less cash received than the book values recorded for the assets sold

©CourseCollege.com 39 Liquidation of a partnership at book value Han Mike Ryo O22.5 Final disbursement when all non-cash assets are sold for book value

©CourseCollege.com 40 Liquidation of a partnership below book value O22.5 Cash received is less than book values creating a loss

©CourseCollege.com 41 Liquidation of a partnership below book value O22.5 The loss is allocated based on partnership agreement

©CourseCollege.com 42 Liquidation of a partnership below book value O22.5 This entry records the cash received for the sale of non-cash assets Existing cash balance = $5,000

©CourseCollege.com 43 Liquidation of a partnership below book value O22.5 This entry records the final cash disbursement to creditors and partners

©CourseCollege.com 44 Liquidation of a partnership below book value O22.5 Beginning equity balance for Ryo was 75,000 – 30,000 loss on liquidation = 45,000 remaining Beginning equity balance for Ryo was 75,000 – 30,000 loss on liquidation = 45,000 remaining

©CourseCollege.com 45 Liquidation of a partnership above book value O22.5 Cash received is more than book values creating a gain

©CourseCollege.com 46 Liquidation of a partnership above book value O22.5 The gain is allocated based on partnership agreement

©CourseCollege.com 47 Liquidation of a partnership above book value O22.5 This entry records the cash received for the sale of non-cash assets Existing cash balance = $5,000

©CourseCollege.com 48 Liquidation of a partnership above book value O22.5 This entry records the final cash disbursement to creditors and partners

©CourseCollege.com 49 Liquidation of a partnership above book value O22.5 Beginning equity balance for Ryo was 75, ,000 gain on liquidation = 90,000 remaining Beginning equity balance for Ryo was 75, ,000 gain on liquidation = 90,000 remaining

©CourseCollege.com 50 Objective 22.6: Analysis: Compute and explain partner return on equity O22.6 Average partner equity can be estimated by adding the beginning partner equity to the ending partner equity and dividing by 2 This would be computed for each partner in the partnership Partner return on equity Average partner equity Partner net income =

©CourseCollege.com 51 Price Earnings Ratio Price = the market price per share Earnings = the basic earnings per share The higher the ratio, the more investors are paying for the annual earnings per share reported by the firm O22.6 PE ratio Basic earnings per share Market price per share =

©CourseCollege.com 52 Example O22.6

©CourseCollege.com 53 End Unit 14