FINANCING Part 1: Partnerships CHAPTERS 13-16

Kinds 1. General All partners have unlimited liability 2. Limited Only one partner has limited liability, but the rest cannot have a role in management. PARTNERSHIPS From Grade 11

ProsCons Combining skills and resources of two or more people Limited life Ease of formation Unlimited liability (in a general partnership) Freedom from government restrictions and regulations Ease of decision making

FORMING A PARTNERSHIP A partner’s initial investment should be recorded at the FAIR MARKET VALUE (not book value) of the assets at the date of their transfer to the partnership. Values assigned must be agreed to by all. Upon the formation of a partnership, this personal computer should be recorded at its FMV of $350 instead of current book value of $1,800. ACHTUNG!

ADMISSION OF A PARTNER The admission of a new partner results in the legal dissolution of the existing partnership and the beginning of a new one. A new partner may be admitted either by: 1.Buying out an existing partner, or 2.Investing assets in the partnership.

PROCEDURES IN ADDING PARTNERS Admission of Partner through: 1. Buying out an existing partner Partnership Assets This is a personal transaction between an existing partner and the new partner. Any money exchanged is the personal property of the participants and not the property of the partnership.

PROCEDURES IN ADDING PARTNERS 2. Investment of Assets in Partnership Hello Partnership Assets When a partner is admitted by investment, both total net assets and total partnership capital change. When a new partner’s investment differs from the business equity acquired by him, the difference is a bonus to either 1) the old partners or 2) the new partner.

For example, assume a business worth $1,000,000 acquires a new partner. This is now a “new” business She added assets of $ 200,000, but because of the expertise and extensive client base that she brought with her, she received a 30% stake in the capital of the “new” business. Observe… PROCEDURES IN ADDING PARTNERS Total old capital Total new capital FMV of her asset invested Her stake is: So the addition of her to the business resulted in a bonus of $160,000, which was distributed to the new partner for the reasons mentioned above. $1,000,000 $1,200,000 only $200,000 30% Which works out to be$360,000 Compare

The journal entry to record the entry of this partner would then look like this: The old partners take a penalty in order to reward the $160,000 bonus to the new partner. PROCEDURES IN ADDING PARTNERS DateParticularsDebitCredit July 31 Various Assets Accounts 200,000 NEW PARTNER, Capital 360,000 Partner 1, Capital 80,000 Partner 2, Capital 80,000

PARTNERSHIPS Income ratios A partner’s share of profit/loss is determined by the income ratio, and allocated during closing entries. The following are typical income ratios: 1.Fixed ratio, for example 60% and 40%. 2.A ratio based on each partner’s share of total company capital. 3.Salaries to partners. 4.Interest on partners’ capital balances. Note: some or all of the above are often combined together

INCOME RATIOS Division Of Net Income Sara and Ray are partners. The partnership agreement provides for the following income ratio: 1) Salary allowances of $8,400 for Sara and $6,000 for Ray 2) Interest allowances of 10% on beginning capital balances, and 3) Split remaining profit equally. Beginning capital balances: Sara $28,000 and Ray $24,000. The division of this year’s partnership income of $22,000 is as follows: SARARAYTOTAL Total Profit 1. Allocate Salaries 8,4006,000 22,000 (14,400) Total Profit Remaining 7, Allocate Interest Allowance Sara, 10% of $28,000 Ray, 10% of 24,000 2,800 2,400 Total Profit Remaining (2,800) (2,400) 2, Allocate Remaining Profit Equally 1,200 (2,400) Division of Profit 12,400 9,600 22,000

PARTNERSHIPS Closing Entries – Allocating the Income Ratio The income ratio determines how much profit to close out to each partner. Closing entries are the same for a partnership except as follows: When you close out the Income Summary account, you now have a Capital account and a Drawings account for each partner.

PARTNERSHIPS Closing Entries DateParticularsDebitCredit All Revenues 100,000 All Expenses 78,000 Sara, Capital 7,000 Income Summary 100,000 Income Summary 78,000 Income Summary 22,000 Ray, Capital 9,600 Sara, Capital 12,400 Ray, Capital 5,000 Sara, Drawings 7,000 Ray, Drawings 5,000 (as determined by the income ratio) Step 3 Step 4 Step 2 Step 1 At year end, a company would make the following entries

PARTNERSHIPS Partner’s Capital Statement The equity statement for a partnership is called the statement of partners' capital. It’s function is to explain changes in 1) Each partner’s capital account and 2) Total partnership capital.

The statement of partners’ equity is prepared from the income statement and the partners’ capital and drawings accounts. The balance sheet for a partnership is the same as for a proprietorship except in the equity section. The capital balances of the partners are shown in the balance sheet. PARTNERSHIPS Equity Section Of A Balance Sheet KINGSLEE COMPANY Balance Sheet- partial December 31, 2005 Total liabilities (assumed amount) $ 115,000 Partners’ equity Sara King, Capital $ 35,400 Ray Lee, Capital 28,600 Total partners’ equity 64,000 Total liabilities and partners’ equity $ 179,000

Do Problems: E13-1 E13-5 P13-4A 3(a-d) only For (d), journalize the closing entries