Copyright © 2007 Prentice-Hall. All rights reserved 1 PartnershipsPartnerships Chapter 12

Copyright © 2007 Prentice-Hall. All rights reserved 2 Objective 1 Identify the characteristics of a partnership

Copyright © 2007 Prentice-Hall. All rights reserved 3 PartnershipPartnership Association of two or more persons who co-own a business for a profit Combines –Capital –Talent –Experience

Copyright © 2007 Prentice-Hall. All rights reserved 4 Partnership Agreement Contract between partners should specify 1.Name, location, and nature of business 2.Name, investment, and duties of each partner 3.How new partners are admitted 4.How profits and losses are divided up 5.Withdrawals of assets by the partners 6.How to settle up with a withdrawing partner 7.How to liquidate the partnership

Copyright © 2007 Prentice-Hall. All rights reserved 5 Characteristics of a Partnership Limited life Mutual agency Unlimited liability Co-ownership of property No partnership income taxes Partners’ capital accounts

Copyright © 2007 Prentice-Hall. All rights reserved 6 Types of Partnerships General partnership – basic form Limited partnership – two classes of partners

Copyright © 2007 Prentice-Hall. All rights reserved 7 Limited Liability Company (LLC) Its own form of business organization –Owners are called members –Limited liability –Members can participate in management –Can elect not to pay business income tax

Copyright © 2007 Prentice-Hall. All rights reserved 8 S Corporations Corporation taxed as a partnership –Limited liability of owners –No corporate income tax –Stockholders pay personal income tax on their share of income

Copyright © 2007 Prentice-Hall. All rights reserved 9 Objective 2 Account for partner investments

Copyright © 2007 Prentice-Hall. All rights reserved 10 The Partnership Start-Up Record assets invested by partners at fair market values Record liabilities assumed at fair market values Each partner has his/her own capital and withdrawals account

Copyright © 2007 Prentice-Hall. All rights reserved 11ExampleExample GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Jun1Cash10,000 Inventory40,000 Computer Equipment 450,000 Accounts Payable 80,000 Lane, Capital420,000 To record Lane’s Investment Jun1Cash5,000 Computer Software100,000 Reed, Capital105,000 To record Reed’s Investment

Copyright © 2007 Prentice-Hall. All rights reserved 12 Objective 3 Allocate profits and losses to the partners

Copyright © 2007 Prentice-Hall. All rights reserved 13 Sharing Profits and Losses Stated fraction for each partner Based on percent of capital balances of the partners Based on each partner’s service Combination

Copyright © 2007 Prentice-Hall. All rights reserved 14 Sharing Profits and Losses If no partnership agreement, the law states earnings will be divided equally If agreement specifies how to share profits, but not losses – losses are shared the same way as profits

Copyright © 2007 Prentice-Hall. All rights reserved 15 E12-16 b Net income$60,000 Cruz (2/3) x 60,00040,000 Moore (1/3) x 60,000 20,000 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Income Summary60,000 Cruz, Capital40,000 Moore, Capital20,000

Copyright © 2007 Prentice-Hall. All rights reserved 16 E12-16 a Net loss($15,000) Cruz10,000 Moore5,000 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Cruz, Capital10,000 Moore, Capital5,000 Income Summary15,000 When there is no written agreement, partners share profits and losses equally. Remember, a debit to Capital decreases it

Copyright © 2007 Prentice-Hall. All rights reserved 17 E12-16 c Net income to be distributed HiltonLee$125,000 Capital Bal. Service Remainder Total $30,000 $20,00050,000 24,00036,00060,000 7,500 0 $61,500$63,500

Copyright © 2007 Prentice-Hall. All rights reserved 18 E12-16 c GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Dec31Income Summary125,000 Hilton, Capital61,500 Lee, Capital63,500

Copyright © 2007 Prentice-Hall. All rights reserved 19 Partner Drawings Reduces capital Debit Drawing and credit Cash At period end, close drawing to capital

Copyright © 2007 Prentice-Hall. All rights reserved 20 Objective 4 Account for the admission of a new partner

Copyright © 2007 Prentice-Hall. All rights reserved 21 Purchasing a Partner’s Interest Equity is transferred from retiring partner to new partner –Debit retiring partner’s capital – Credit new partner’s capital Partnership assets are not affected

Copyright © 2007 Prentice-Hall. All rights reserved 22 Purchasing A Partner’s Interest Purchasing A Partner’s Interest Fisher, Capital$170,000 Garcia, Capital110,000 Total$280,000 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Fisher, Capital170,000 Holt, Capital170,000 Notice, this is an agreement between two individuals. No new assets are acquired by the partnership

Copyright © 2007 Prentice-Hall. All rights reserved 23 Purchasing A Partner’s Interest Balances: Holt, Capital$170,000 Garcia, Capital110,000 Total$280,000

Copyright © 2007 Prentice-Hall. All rights reserved 24 Investing in the Partnership New partner contributes assets to the partnership in exchange for a share of the business

Copyright © 2007 Prentice-Hall. All rights reserved 25 Investing in the Partnership at Book Value New partner invests assets equal to his/her interest in the new partnership –Debit assets –Credit new partner’s capital

Copyright © 2007 Prentice-Hall. All rights reserved 26 Investing in Partnership at Book Value Investing in Partnership at Book Value Ingel, Capital$70,000 Jay, Capital90,000 Total before admitting$160,000 Kaska investment80,000 Total after admitting$240,000 1/3 interest = $80,000

Copyright © 2007 Prentice-Hall. All rights reserved 27 Investing in Partnership at Book Value GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Other Assets80,000 Kaska, Capital80,000

Copyright © 2007 Prentice-Hall. All rights reserved 28 Investing in Partnership at Book Value Balances Ingel, Capital$70,000 Jay, Capital90,000 Kaska, Capital80,000 $240,000

Copyright © 2007 Prentice-Hall. All rights reserved 29 Investing in the Partnership - Bonus to the Old Partners New partner invests assets greater than his/her equity in the new partnership Bonus increases old partner’s capital in profit-and-loss sharing ratio –Debit assets –Credit new partner’s capital for his/her share –Credit each old partners’ capital for his/her share of the bonus

Copyright © 2007 Prentice-Hall. All rights reserved 30 Investing in Partnership Bonus to Existing Partners Kaga, Capital$70,000 Opper, Capital80,000 Total before admitting$150,000 Fry investment90,000 Total after admitting$240,000 ¼ interest = $60,000 Bonus of $30,000 paid to existing partners Fry contributed $90,000. The credit to her capital account is $60,000. The extra $30,000 is considered a bonus to the existing partners

Copyright © 2007 Prentice-Hall. All rights reserved 31 Investing in Partnership Bonus to Existing Partners Distribution of bonus: Kaga, Capital (30,000 x 1/2)$15,000 Opper, Capital (30,000 x 1/2)15,000

Copyright © 2007 Prentice-Hall. All rights reserved 32 Investing in Partnership Bonus to Existing Partners GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Cash90,000 Fry, Capital60,000 Kaga, Capital15,000 Opper, Capital15,000

Copyright © 2007 Prentice-Hall. All rights reserved 33 Investing in Partnership Bonus to Existing Partners Balances: Kaga, Capital$85,000 Opper, Capital95,000 Fry, Capital60,000 $240,000

Copyright © 2007 Prentice-Hall. All rights reserved 34 Investing in the Partnership - Bonus to New Partners New partner invests assets less than his/her equity in the new partnership Bonus decreases old partner’s capital in profit-and-loss sharing ratio –Debit assets –Debit each old partners’ capital for his/her share of the bonus to the new partner –Credit new partner’s capital for his/her share

Copyright © 2007 Prentice-Hall. All rights reserved 35 Investing in the Partnership - Bonus to New Partners Page, Capital$230,000 Franco, Capital150,000 Total before admitting$380,000 Jones investment100,000 Total after admitting$480,000 1/3 interest = $160,000 Bonus of $60,000 paid to new partner Jones contributed $100,000. The credit to his capital account is $160,000. The extra $60,000 is considered a bonus to the new partners and will be donated by the other partners

Copyright © 2007 Prentice-Hall. All rights reserved 36 Investing in the Partnership - Bonus to New Partners Distribution of bonus: Page, Capital (60,000 x 2/3)$40,000 Franco, Capital (60,000 x 1/2)20,000

Copyright © 2007 Prentice-Hall. All rights reserved 37 Investing in the Partnership - Bonus to New Partners GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Cash100,000 Page, Capital40,000 Franco, Capital20,000 Jones, Capital160,000

Copyright © 2007 Prentice-Hall. All rights reserved 38 Investing in the Partnership - Bonus to New Partners Balances: Page, Capital$190,000 Franco, Capital130,000 Jones, Capital160,000 $480,000

Copyright © 2007 Prentice-Hall. All rights reserved 39 Objective 5 Account for a partner’s withdrawal from the firm

Copyright © 2007 Prentice-Hall. All rights reserved 40 Withdrawal of a Partner Assets may be revalued Any gain or loss is allocated among the partners based on their profit- and-loss ratios

Copyright © 2007 Prentice-Hall. All rights reserved 41 Partner Sells Interest to Existing Partner Transfer equity from the withdrawing partner to the purchaser No assets flows through the partnership Debit withdrawing partner’s capital Credit purchaser’s capital

Copyright © 2007 Prentice-Hall. All rights reserved 42 Withdrawal at Book Value Partner takes assets with value equal to his capital account (equal to book value) Debit withdrawing partner’s capital Credit assets taken

Copyright © 2007 Prentice-Hall. All rights reserved 43 Withdrawal at Less Than Book Value Remaining partners share the difference (bonus) based on their profit-and loss- sharing ratio. Debit withdrawing partner’s capital Credit assets and remaining partners’ capital based on agreed upon ratios

Copyright © 2007 Prentice-Hall. All rights reserved 44 Withdrawal at More Than Book Value Bonus to the withdrawing partner reduces the remaining partners’ capital balances based on their profit-and-loss ratio Debit withdrawing partner’s capital Debit remaining partners’ capital Credit assets

Copyright © 2007 Prentice-Hall. All rights reserved 45 ExampleExample Distribute gain on land to partners based on profit-loss ratio Green (50,000 x 1/4)$12,500 Henry (50,000 x 1/2)25,000 Jackson (50,000 x 1/4)12,500

Copyright © 2007 Prentice-Hall. All rights reserved 46 ExampleExample GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Jul31Land50,000 Green, Capital12,500 Henry, Capital25,000 Jackson, Capital12,500

Copyright © 2007 Prentice-Hall. All rights reserved 47 ExampleExample Distribute loss on inventory to partners based on profit-loss ratio Green (6,000 x 1/4)$1,500 Henry (6,000 x 1/2)3,000 Jackson (6,000 x 1/4)1,500

Copyright © 2007 Prentice-Hall. All rights reserved 48 ExampleExample GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Jul31Green, Capital1,500 Henry, Capital3,000 Jackson, Capital1,500 Inventory6,000

Copyright © 2007 Prentice-Hall. All rights reserved 49 ExampleExample Green, Capital Jackson, Capital Henry, Capital 50,00020,00040,000 12,50025,00012,500 61,00062,000 31,000 1,500 3,0001,500 Jackson is getting $40,000 cash so he receives a bonus of $9,000 ($40,000 - $31,000)

Copyright © 2007 Prentice-Hall. All rights reserved 50 ExampleExample Distribute bonus to withdrawing partner based on profit-loss ratio Green (9,000 x 1/2)$4,500 Henry (9,000 x 1/2)4,500

Copyright © 2007 Prentice-Hall. All rights reserved 51 ExampleExample GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Jul31Green, Capital4,500 Henry, Capital4,500 Jackson, Capital31,000 Cash40,000

Copyright © 2007 Prentice-Hall. All rights reserved 52 Objective 6 Account for the liquidation of a partnership

Copyright © 2007 Prentice-Hall. All rights reserved 53 Death of a Partner Dissolves partnership Settlement with the deceased partner’s estate - based on partnership agreement Or, a remaining partner may buy the deceased partner’s equity

Copyright © 2007 Prentice-Hall. All rights reserved 54 Liquidation of a Partnership Adjust and close books Sell the noncash assets, allocate gains and losses to the partners based on their profit-and-loss-sharing ratio Pay all the liabilities Distribute the remaining cash based on the partners’ capital balances

Copyright © 2007 Prentice-Hall. All rights reserved 55 E12-24E12-24 Cash Noncash Assets Liabilitie s Dodd, Capital Gage, Capital Hamm, Capital $6,000$126,000$77,000$12,000$37,000$6, ,000(126,000) GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Cash140,000 Noncash Assets126,000 Gain on Sale of Assets14,000 Sell off the noncash assets

Copyright © 2007 Prentice-Hall. All rights reserved 56 E12-24E12-24 Distribute Gain on Sale of Assets: Dodd ($14,000 x 20%)$2,800 Gage ($14,000 x 30%)4,200 Hamm ($14,000 x 50%)7,000 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Gain on Sale of Assets14,000 Dodd, Capital2,800 Gage, Capital4,200 Hamm, Capital7,000 Distribute gain based on profit and loss ratio

Copyright © 2007 Prentice-Hall. All rights reserved 57 E12-24E12-24 Cash Noncash Assets Liabilitie s Dodd, Capital Gage, Capital Hamm, Capital $6,000$126,000$77,000$12,000$37,000$6, ,000(126,000)2,8004,2007,000 $146,0000$77,000$14,800$41,200$13,000 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Liabilities77,000 Cash77,000 Pay off the liabilities

Copyright © 2007 Prentice-Hall. All rights reserved 58 E12-24E12-24 Cash Noncash Assets Liabilitie s Dodd, Capital Gage, Capital Hamm, Capital $6,000$126,000$77,000$12,000$37,000$6, ,000(126,000)2,8004,2007,000 $146,0000$77,000$14,800$41,200$13,000 (77,000) $69,00000$14,800$41,200$13,000 $69,000 Distribute the cash to the partners and close out their accounts as well

Copyright © 2007 Prentice-Hall. All rights reserved 59 E12-24E12-24 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Dodd, Capital14,800 Gage, Capital41,200 Hamm, Capital13,000 Cash69,000

Copyright © 2007 Prentice-Hall. All rights reserved 60 E12-24E12-24 Cash Noncash Assets Liabilitie s Dodd, Capital Gage, Capital Hamm, Capital $6,000$126,000$77,000$12,000$37,000$6, ,000(126,000)2,8004,2007,000 $146,0000$77,000$14,800$41,200$13,000 (77,000) $69,00000$14,800$41,200$13,000 (69,000)(14,800)(41,200)(13,000)

Copyright © 2007 Prentice-Hall. All rights reserved 61 E12-22E Cash$80,000 Ray, capital$33,000 Scott, capital28,000 Van, capital19,000 80,000 Each partner receives cash equal to his capital balance because cash equals total partnership capital

Copyright © 2007 Prentice-Hall. All rights reserved 62 E12-22E Cash$50,000 Ray, capital$33,000 Scott, capital28,000 Van, capital19,00080,000 Loss$30,000 Each partner gets $10,000 ($30,000 / 3) less than his capital balance

Copyright © 2007 Prentice-Hall. All rights reserved 63 E12-22E Ray$23,000 Scott18,000 Van9,000 $50,000

Copyright © 2007 Prentice-Hall. All rights reserved 64 Objective 7 Prepare partnership financial statements

Copyright © 2007 Prentice-Hall. All rights reserved 65 Financial Statements Much like those of a proprietorship Income statement - section showing division of net income to the partners Balance sheet - capital of each partner in owners’ equity section Statement of Owners’ Equity shows changes to each partner’s capital account

Copyright © 2007 Prentice-Hall. All rights reserved 66 S12-13S12-13 Bush and Carter Income Statement Year Ended September 30, 2007 Service revenue$145,000 Total expenses 85,000 Net income$60,000 Allocation of net income: To Bush ($60,000 .60) $36,000 To Carter ($60,000 .40) 24,000$60,000

Copyright © 2007 Prentice-Hall. All rights reserved 67 End of Chapter 12