WEYGANDT. KIESO. KIMMEL. TRENHOLM. KINNEAR. BARLOW. ATKINS PRINCIPLES OF FINANCIAL ACCOUNTING CANADIAN EDITION Chapter 12 Accounting for Partnerships Prepared by: Debbie Musil Kwantlen Polytechnic University 1

Copyright John Wiley & Sons Canada, Ltd.2 Partnership form of organization – Characteristics – Advantages and disadvantages – Partnership agreement Basic partnership accounting – Forming a partnership – Dividing partnership profit or loss – Partnership financial statements Admission and withdrawal of partners Liquidation of a partnership – With or without a capital deficiency Accounting for Partnerships

Copyright John Wiley & Sons Canada, Ltd.3 Chapter 12: Accounting for Partnerships Study Objectives 1.Describe the characteristics of the partnership form of business organization. 2.Account for the formation of a partnership. 3.Allocate and record profit or loss to partners. 4.Prepare partnership financial statements. 5.Account for the admission of a partner. 6.Account for the withdrawal of a partner. 7.Account for the liquidation of a partnership.

Copyright John Wiley & Sons Canada, Ltd.4 Characteristics of Partnerships

Copyright John Wiley & Sons Canada, Ltd.5 Association of individuals – Usually based on a written agreement – A legal and accounting entity, but not taxed Co-ownership of property – Assets are jointly owned by partners Division of profit – Partners determine how profit or loss is to be divided – Otherwise shared equally Limited life – Partnership ends when change in ownership – New partnership can be formed to continue business Characteristics of Partnerships 2

Copyright John Wiley & Sons Canada, Ltd.6 Mutual agency – Each partner acts for (binds) the partnership Unlimited liability – Each partner is liable for all partnership liabilities – Special types of partnerships created to limit liability Limited partnership (LP) Limited liability partnership (LLP) Characteristics of Partnerships 3

Copyright John Wiley & Sons Canada, Ltd.7 Written contract between two or more parties to form a partnership Contains basic information: – Name and location of firm – Purpose of the business – Date of inception (formation) Specifies relationship of partners: – Names and capital contributions of partners – Rights and duties of partners – Basis for sharing profit or loss – Procedures for admission, withdrawal, death of partner, resolving disputes, liquidation of partnership Partnership Agreement

Copyright John Wiley & Sons Canada, Ltd.8 Many partnerships are private and therefore follow ASPE Limited Partnerships are often public enterprises and therefore follow IFRS International partnerships must also follow IFRS Basic Partnership Accounting: ASPE Versus IFRS

Copyright John Wiley & Sons Canada, Ltd.9 1.Describe the characteristics of the partnership form of business organization. 2.Account for the formation of a partnership. 3.Allocate and record profit or loss to partners. 4.Prepare partnership financial statements. 5.Account for the admission of a partner. 6.Account for the withdrawal of a partner. 7.Account for the liquidation of a partnership. Chapter 12: Accounting for Partnerships Study Objectives

Copyright John Wiley & Sons Canada, Ltd.10 Partner’s initial investment is recorded at fair value of assets contributed – As at date of transfer into partnership Values assigned are agreed to by all partners After partnership formed, accounting for transactions is similar to other types of business organizations Basic Partnership Accounting: Forming a Partnership

Copyright John Wiley & Sons Canada, Ltd.11 1.Describe the characteristics of the partnership form of business organization. 2.Account for the formation of a partnership. 3.Allocate and record profit or loss to partners. 4.Prepare partnership financial statements. 5.Account for the admission of a partner. 6.Account for the withdrawal of a partner. 7.Account for the liquidation of a partnership. Chapter 12: Accounting for Partnerships Study Objectives

Copyright John Wiley & Sons Canada, Ltd.12 Partnership profit/loss is shared equally – Unless partnership agreement indicates otherwise The same basis of division applies to profit and losses – Called the profit ratio or profit and loss ratio Each partners’ share of profit or loss is recognized through closing entries Basic Partnership Accounting: Dividing Profit or Loss

Copyright John Wiley & Sons Canada, Ltd.13 Four closing entries for partnership: 1.Close revenue accounts to income summary 2.Close expense accounts to income summary 3.Close income summary to partners’ capital accounts If profit: Dr. Income summary (= total profit) Cr. Each partner’s capital account (= their share) If loss: Dr. Each partner’s capital account (= their share of loss) Cr. Income summary (= total loss) 4.Close each partner’s drawings account to their respective capital accounts Partnership Accounting: Closing Entries

Copyright John Wiley & Sons Canada, Ltd.14 Typical ratios used to share profit or loss: – Fixed ratio: a proportion (2:1), percentage (67%) or fraction (2/3) – A ratio based on capital balances at beginning or end of year or on average capital balances during the year – Salaries to partners and the remainder in a fixed ratio – Interest on partners’ capital balances, remainder in a fixed ratio – Salaries to partners, interest on partners’ capital balances, remainder in a fixed ratio Partnership Accounting: Profit and Loss Ratios

Copyright John Wiley & Sons Canada, Ltd.15 Salaries and interest: – Are allocated first even if greater than profit or if partnership incurred a loss for the year – Are NOT expenses of the partnership – only used to divide profit or loss among the partners – Are NOT distributions of cash (or other assets) – drawings by partners are distributions Partners are neither employees or creditors Partnership Accounting: Profit and Loss Ratios 2

Copyright John Wiley & Sons Canada, Ltd.16 1.Describe the characteristics of the partnership form of business organization. 2.Account for the formation of a partnership. 3.Allocate and record profit or loss to partners. 4.Prepare partnership financial statements. 5.Account for the admission of a partner. 6.Account for the withdrawal of a partner. 7.Account for the liquidation of a partnership. Chapter 12: Accounting for Partnerships Study Objectives

Copyright John Wiley & Sons Canada, Ltd.17 The equity statement for a partnership is the statement of partners' equity Explains changes in each partner’s individual capital account and total partnership equity during the year Partnership Financial Statements: Statement of Partners’ Equity

Copyright John Wiley & Sons Canada, Ltd.18 Capital balances of each partner are shown on the balance sheet in section called partners’ equity: Partnership Financial Statements: Balance Sheet

Copyright John Wiley & Sons Canada, Ltd.19 1.Describe the characteristics of the partnership form of business organization. 2.Account for the formation of a partnership. 3.Allocate and record profit or loss to partners. 4.Prepare partnership financial statements. 5.Account for the admission of a partner. 6.Account for the withdrawal of a partner. 7.Account for the liquidation of a partnership. Chapter 12: Accounting for Partnerships Study Objectives

Copyright John Wiley & Sons Canada, Ltd.20 Causes the legal dissolution of the existing partnership and the beginning of a new partnership A new partner may be admitted either by: – Purchasing all or part of the interest of one or more existing partners – Investing assets in the partnership Admission of a Partner

Copyright John Wiley & Sons Canada, Ltd.21 A personal transaction between one or more existing partners and the new partner – Consideration exchanged is personal property of the partners involved and not property of the partnership In the partnership, only the transfer of the partnership interest is recorded: – Existing partners’ equity is decreased by the amount of equity given to the new partner – New partner’s equity is increased by same amount Admission of a Partner: Purchase of a Partner’s Interest

Copyright John Wiley & Sons Canada, Ltd.22 Admission of a Partner: Investment of Assets in Partnership A transaction between the new partner and the partnership: – Partnership receives assets from new partner in exchange for an interest in the partnership Both net assets and total partners’ equity of the partnership will increase Complications occur when new partner’s investment differs from the capital equity acquired: – The difference is considered a bonus either to the existing (old) partners or to the new partner

Admission of a Partner: Bonus to Existing (Old) Partners Copyright John Wiley & Sons Canada, Ltd.23 Bonus to old partners may be necessary: – Fair value of partnership assets may be greater than their carrying value – Unrecognized good will may exist Bonus to old partners occurs when: – New partner’s investment > capital credit on the date of admission to partnership – Amount of bonus = difference

Copyright John Wiley & Sons Canada, Ltd.24 Bonus to new partner may be necessary: – New partner has resources or attributes that the partnership wants (cash, expertise) – Carrying amount of partnership assets is greater than their fair value Bonus to new partner occurs when: – New partner’s investment < capital credit on the date of admission to partnership – Amount of bonus = difference Admission of a Partner: Bonus to New Partner

Copyright John Wiley & Sons Canada, Ltd Determine the total capital of partnership = Capital of old partnership + new partner’s investment 2. Determine new partner’s capital credit = Total capital determined above × new partner’s ownership interest 3. Determine the amount of the bonus = New partner’s investment ± new partner’s capital credit If investment > capital credit: bonus to new partner If investment < capital credit: bonus to old partners 4. Allocate the bonus to/from old partners – Based on profit ratios of old partners Admission of a Partner: Determining Amount of Bonus

Copyright John Wiley & Sons Canada, Ltd.26 Old partners’ capital balance = $120,000 Peart $72,000 and Sampson $48,000 Old partners’ profit ratios: Peart 60% and Sampson 40% Trent purchases 25% share: Scenario 1: for $80,000 Scenario 2: for $20,000 Admission of a Partner: Example Calculation of Bonus

Copyright John Wiley & Sons Canada, Ltd Total capital of new partnership: $120,000 + $80,000 = $200, New partner’s capital credit: $200,000 × 25% = $50, Amount of bonus to old partners: $80,000 − $50,000 = $30, Allocation of bonus to old partners: To Peart: $30,000 × 60% = $18,000 To Sampson: $30,000 × 40% = $12,000 Admission of a Partner: Bonus Calculation – Scenario 1

Copyright John Wiley & Sons Canada, Ltd Total capital of new partnership: $120,000 + $20,000 = $140, New partner’s capital credit: $140,000 × 25% = $35, Amount of bonus to new partner: $20,000 − $35,000 = $(15,000) 4. Allocate bonus from old partners: From Peart: $15,000 × 60% = $9,000 From Sampson: $15,000 × 40% = $6,000 Admission of a Partner: Bonus Calculation – Scenario 2

Copyright John Wiley & Sons Canada, Ltd.29 1.Describe the characteristics of the partnership form of business organization. 2.Account for the formation of a partnership. 3.Allocate and record profit or loss to partners. 4.Prepare partnership financial statements. 5.Account for the admission of a partner. 6.Account for the withdrawal of a partner. 7.Account for the liquidation of a partnership. Chapter 12: Accounting for Partnerships Study Objectives

Copyright John Wiley & Sons Canada, Ltd.30 Voluntary withdrawal: Partner sells their equity in the firm Involuntary withdrawal: Partner reaches mandatory retirement age, dies or is expelled Withdrawal may be accomplished by: – Payment from remaining partners’ personal assets – Payment from partnership assets Withdrawal of a Partner

Copyright John Wiley & Sons Canada, Ltd.31 A personal transaction between partners – Payment is from remaining partners’ personal assets – Partnership assets are not involved and total capital of partnership does not change In the partnership, only the transfer of the partnership interest is recorded: – Departing partner’s equity is eliminated – Remaining partners’ equity increased by same amount – Amount is split between remaining parties on same basis as they paid departing party Withdrawal of a Partner: Payment from Partners’ Personal Assets

Copyright John Wiley & Sons Canada, Ltd.32 A transaction between the withdrawing partner and the partnership: – Partnership pays assets in exchange for the withdrawing partner’s interest in the partnership Both net assets and total partners’ equity of the partnership will decrease Complications occur when amount paid differs from withdrawing partner’s capital balance: – The difference is considered a bonus either to the departing partner or to the remaining partners Withdrawal of a Partner: Payment from Partnership Assets

Copyright John Wiley & Sons Canada, Ltd.33 Bonus to withdrawing partner may be necessary: – Fair value of partnership assets may be greater than their carrying amount – Goodwill may exist that has not been recorded – Remaining partners wish to remove partner from firm Bonus to withdrawing partner occurs when: – Payment to departing partner > departing partner’s capital balance on the date of departure – Amount of bonus = difference Withdrawal of a Partner: Bonus to Withdrawing Partner

Copyright John Wiley & Sons Canada, Ltd.34 Bonus to remaining partners may be necessary: – Recorded assets are overvalued – Partnership has a poor earnings record – Partner wishes to leave partnership Bonus to remaining partners occurs when: – Payment to departing partner < departing partner’s capital balance on departure date – Amount of bonus = difference Withdrawal of a Partner: Bonus to Remaining Partners

Copyright John Wiley & Sons Canada, Ltd.35 Withdrawal of a Partner: Determining Amount of Bonus 1. Determine the amount of the bonus = Payment from partnership to departing partner ± departing partner’s capital balance If payment > capital balance: bonus to departing partner If payment < capital balance: bonus to remaining partners 2. Allocate payment of bonus to remaining partners based on their profit ratios – Amount allocated to each remaining partner = bonus × profit ratio for each partner

Copyright John Wiley & Sons Canada, Ltd.36 Partners’ capital balance: Roman $50,000 Sand $30,000 Terk $20,000 Partners’ profit ratio: Roman, Sand, Terk: 3:2:1 Terk retires and is paid: Scenario 1: $25,000 Scenario 2: $16,000 Withdrawal of a Partner: Example Calculation of Bonus

Copyright John Wiley & Sons Canada, Ltd.37 Scenario 1: 1. Amount of bonus: $25,000 - $20,000 = $5, Allocate payment of bonus by remaining partners: From Roman: $5,000 × 3/5 = $3,000 From Sand: $5,000 × 2/5 = $2,000 Scenario 2: 1. Amount of bonus: $16,000 − $20,000 = $(4,000) 2. Allocate payment of bonus to remaining partners: To Roman: $4,000 × 3/5 = $2,400 To Sand: $4,000 × 2/5 = $1,600 Withdrawal of a Partner: Bonus Calculation

Copyright John Wiley & Sons Canada, Ltd.38 1.Describe the characteristics of the partnership form of business organization. 2.Account for the formation of a partnership. 3.Allocate and record profit or loss to partners. 4.Prepare partnership financial statements. 5.Account for the admission of a partner. 6.Account for the withdrawal of a partner. 7.Account for the liquidation of a partnership. Chapter 12: Accounting for Partnerships Study Objectives

Copyright John Wiley & Sons Canada, Ltd.39 Liquidation ends the business Steps in liquidating a partnership: 1. Sell non-cash assets for cash 2. Allocate any gain or loss from sale to partners’ capital accounts based on profit and loss ratios 3. Pay partnership liabilities 4. Distribute remaining cash to partners based on their capital balances (not their profit ratios) Liquidation of a Partnership

Copyright John Wiley & Sons Canada, Ltd.40 Capital deficiency: if one or more partners’ capital account is in a debit balance If no capital deficiency: – Remaining cash after all assets sold and liabilities paid is distributed to partner – Distribution is based on partners’ capital balances Since this is the final distribution to partners all accounts will have zero balances afterwards Liquidation of a Partnership: No Capital Deficiency

Copyright John Wiley & Sons Canada, Ltd.41 Capital deficiency may be caused by: – Recurring losses – Excessive drawings by one or more partners – Losses from sale of assets during liquidation Partners having a capital deficiency immediately before final distribution: – May or may not be able to pay the deficiency from personal funds – This will affect the amount of funds available for distribution to other partners Liquidation of Partnership: Capital Deficiency

Copyright John Wiley & Sons Canada, Ltd.42 Partnership has a legally enforceable claim against partners with a capital deficiency If partner repays deficiency to partnership: – Amount repaid is added to cash available for distribution – Total cash after repayment is distributed to partners with credit balances in their capital accounts Liquidation of Partnership: Payment of Capital Deficiency

Copyright John Wiley & Sons Canada, Ltd.43 If partner does not repay deficiency to partnership: – Amount of deficiency is considered a loss – Loss is allocated between partners with credit balances based on their profit ratios – Allocation of loss will affect remaining partners capital accounts – Final distribution of remaining cash is to partners with credit balances in capital accounts Liquidation of Partnership: Nonpayment of Deficiency

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