Needles Powers Crosson Principles of Accounting 12e Accounting for Partnerships 12 C H A P T E R © human/iStockphoto

LEARNING OBJECTIVES ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  LO1: Define the partnership form of business, and identify its principal characteristics.  LO2: Record partners’ investments of cash and other assets when a partnership is formed.  LO3: Compute and record the income or losses that partners share, based on stated ratios, capital balance ratios, and partners’ salaries and interest.  LO4: Record a person’s admission to or withdrawal from a partnership.  LO5: Compute and record the distribution of assets to partners when they liquidate their partnerships.  LO6: Identify alternate forms of partnership-type entities.

SECTION 1: CONCEPTS ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Separate entity: a business that is treated as distinct from its creditors, customers, and owners

Concepts Underlying Partnerships  A partnership, as defined by the Uniform Partnership Act, is an association of two or more persons to carry on as co-owners of a business for profit. –Partnerships are treated as separate entities, with their own accounting records and financial statements. –Legally, there is no economic separation between a partnership and its owners. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Characteristics of Partnerships (slide 1 of 3)  Voluntary association—A partnership is a voluntary association of individuals. Therefore, a partner is legally responsible for his or her partners’ actions within the scope of the business.  Partnership agreement—Although not required, it is good business practice to have a written partnership agreement that clearly states: –Name, location, and purpose of the business –Names of the partners and their respective duties –Investments of each partner –Method of distributing income and losses –Procedures for the admission and withdrawal of partners, the withdrawal of assets, and the liquidation of the business ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Characteristics of Partnerships (slide 2 of 3)  Limited life—A partnership has a limited life. It may be dissolved when: –a new partner is admitted –a partner withdraws, goes bankrupt, is incapacitated, retires, or dies –the terms of the partnership agreement are met, such as when the project for which the partnership was formed is completed  Mutual agency—Each partner is an agent of the partnership within the scope of the business. Because of this mutual agency, any partner can bind the partnership to a business agreement as long as he or she acts within the scope of the company’s normal operations. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Characteristics of Partnerships (slide 3 of 3)  Unlimited liability—Each partner has personal unlimited liability for all the debts of the partnership. If the assets of the business are not enough to pay all the debts of the business, creditors can seek payment from the personal assets of each partner.  Co-ownership of partnership property—When individuals invest property in a partnership, the property becomes an asset of the partnership and is owned jointly by the partners.  Participation in partnership income—Each partner has the right to share in the partnership’s income and the responsibility to share in its losses. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Advantages and Disadvantages of Partnerships  Advantages –Can be easy to form, change, and dissolve. –Facilitates the pooling of capital resources and individual talents. –Has no corporate tax burden. –Gives the partners a certain amount of freedom and flexibility.  Disadvantages –The life of a partnership is limited. –One partner can bind the partnership to a contract. –Partners have unlimited personal liability. –It is more difficult for a partnership to raise capital than it is for a corporation. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

SECTION 2: ACCOUNTING APPLICATIONS  Record partners’ investments  Compute and record income and loss  Record a person’s admission to or withdrawal from a partnership  Compute and record distribution of assets to partners when a partnership is liquidated ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Accounting for Partners’ Equity  Accounting for a partnership is similar to accounting for a sole proprietorship, but there are differences. –Owner’s equity in a partnership is called partners’ equity. –It is necessary to divide the income and losses of the company between the partners. –It is necessary to maintain separate Capital and Withdrawals accounts for each partner, as shown on the next slide. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Accounting for Partners’ Equity ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Accounting for Partners’ Equity  Each partner invests cash or other assets or both in the partnership, according to the partnership agreement. –Noncash assets should be valued at their fair market value on the date they are transferred to the partnership. –The assets invested by a partner are debited to the proper account, and the total amount is credited to the partner’s Capital account. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Recording Partners’ Investments (slide 1 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Recording Partners’ Investments (slide 2 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Distribution of Partnership Income and Losses  A partnership’s income and losses can be distributed according to whatever method the partners specify in the partnership agreement. –If the agreement does not specify this, the partners share income and losses equally. –Income in a partnership normally has three components:  Return to the partners for the use of their capital (called interest on partners’ capital)  Compensation for services the partners have rendered  Other income for any special contributions individual partners may make to the partnership or for risks they may take ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Stated Ratios  One method of distributing income and losses is to give each partner a stated ratio of the total income or loss. –If each partner is making an equal contribution to the firm, each can assume the same share of income and losses. –An equal contribution does not necessarily mean an equal capital investment, because one partner may be devoting more time and another partner more capital. –If the partners contribute unequally to the firm, unequal stated ratios can be appropriate. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Distributing Income Using Stated Ratios (slide 1 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Distributing Income Using Stated Ratios (slide 2 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Capital Balance Ratios  Income and losses may be distributed according to capital balances.  The ratio used may be based on each partner’s capital balance at the beginning of the year or on the average capital balance of each partner during the year. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Ratios Based on Beginning Capital Balances ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Ratios Based on Average Capital Balances (slide 1 of 3) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Ratios Based on Average Capital Balances (slide 2 of 3) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Ratios Based on Average Capital Balances (slide 3 of 3) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Salaries, Interest, and Stated Ratios (slide 1 of 5)  To make up for unequal contributions to a firm, a partnership agreement can allow for partners’ salaries, interest on partners’ capital balances, or both in the distribution of income. –Salaries and interest of this kind are not deducted as expenses before the partnership income is determined. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Salaries, Interest, and Stated Ratios (slide 2 of 5) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Salaries, Interest, and Stated Ratios (slide 3 of 5) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Salaries, Interest, and Stated Ratios (slide 4 of 5) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Salaries, Interest, and Stated Ratios (slide 5 of 5) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Partial Income Statement for Mind and Padilla ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Dissolution of a Partnership  Dissolution of a partnership occurs whenever there is a change in the original association of partners. –When a partnership is dissolved, the partners lose their authority to continue the business as a going concern. –This does not mean that the business operation necessarily is ended or interrupted, but from a legal standpoint, the separate entity ceases to exist. –The dissolution may take place through the admission of a new partner, the withdrawal of a partner, or the death of a partner. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Admission of a New Partner  The admission of a new partner dissolves the old partnership because a new association has been formed. –Dissolving the old partnership and creating a new one requires the consent of all the original partners and the ratification of a new agreement. –An individual can be admitted to a partnership in one of two ways:  Purchasing an interest in the partnership from one or more of the original partners  Investing assets in the partnership ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Purchasing an Interest from a Partner (slide 1 of 2)  When a person purchases an interest in a partnership from an original partner, the transaction is personal between these two people. –However, the interest purchased must be transferred from the Capital account of the selling partner to the Capital account of the new partner. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Purchasing an Interest from a Partner (slide 2 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Purchasing Partial Interest from Partners (slide 1 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Purchasing Partial Interest from Partners (slide 2 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Investing Assets in a Partnership  When a new partner is admitted through an investment in the partnership, both the assets and the partners’ equity in the firm increase. –This is because the assets the new partner invests become partnership assets, and as partnership assets increase, partners’ equity increases. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

New Partner Investing Assets in a Partnership (slide 1 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

New Partner Investing Assets in a Partnership (slide 2 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Bonus to the Old Partners (slide 1 of 3)  A new investor is sometimes willing to pay more than the actual dollar interest he or she receives in the partnership.  The excess of the payment over the interest purchased is a bonus to the original partners. –The bonus must be distributed to the original partners according to the partnership agreement or, if the agreement does not cover the distribution of bonuses, in accordance with the method for distributing income and losses. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Bonus to the Old Partners (slide 2 of 3) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Bonus to the Old Partners (slide 3 of 3) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Bonus to the New Partner (slide 1 of 3)  A partnership might want a new partner for several reasons. –A partnership in financial trouble might need additional cash, or the partners might want to expand the firm’s markets and need more capital. –The partners might also know a person who would bring a unique talent to the firm. –Under these conditions, part of the original partners’ capital may be transferred to the new partner’s Capital account as a bonus. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Bonus to the New Partner (slide 2 of 3) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Bonus to the New Partner (slide 3 of 3) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Withdrawal of a Partner  Generally, a partner has the right to withdraw from a partnership in accord with legal requirements. –The partnership agreement should describe the procedures to be followed, including:  Whether an audit will be performed  How the assets will be reappraised  How a bonus will be determined  By what method the withdrawing partner will be paid –A partner can withdraw from a partnership in one of several ways, as shown on the next slide. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Alternative Ways for a Partner to Withdraw ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Withdrawal by Selling Interest (slide 1 of 2)  When a partner sells his or her interest to another partner or to an outsider, the transaction is personal. It does not change the partnership assets or the partners’ equity. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Withdrawal by Selling Interest (slide 2 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Withdrawal by Removing Assets (slide 1 of 2)  A partnership agreement can allow a withdrawing partner to remove assets equal to his or her capital balance. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Withdrawal by Removing Assets (slide 2 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Withdrawal Not Equal to Capital Balance  A partner’s withdrawal is not always equal to that partner’s capital account. –When a withdrawing partner removes assets that are less than his or her capital balance, the equity that the partner leaves in the business is divided among the remaining partners according to their stated ratios. –When a withdrawing partner takes out assets that are greater than his or her capital balance, the excess is treated as a bonus to the withdrawing partner. The remaining partners absorb the bonus by reducing their capital accounts according to their stated ratios. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Death of a Partner  When a partner dies, the partnership is dissolved because the original association has changed. –Normally the books are closed, and financial statements are prepared to determine the capital balance of each partner on the date of death. –The remaining partners may purchase the deceased’s equity, sell it to outsiders, or deliver certain business assets to the estate of the deceased partner. –If the firm intends to continue, a new partnership must be formed. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Liquidation of a Partnership  The liquidation of a partnership is the process of selling enough assets to pay the partnership’s liabilities and distributing any remaining assets among the partners. –Liquidation is a special form of dissolution. –As the assets of the business are sold, any gain or losses should be distributed according to the stated ratios. –As cash becomes available, it must be applied first to outside creditors, then to loans from partners, and finally to the partners’ capital balances. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Illustration of the Process of Liquidation  Assume that the books have been closed for Mind, Padilla, and Novak, and that the following balance sheet exists before liquidation. The stated ratios for Mind, Padilla, and Novak are 3:3:4, respectively. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Gain on Sale of Assets (slide 1 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Gain on Sale of Assets (slide 2 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Statement of Liquidation Showing Gain on Sale of Assets ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Loss on Sale of Assets  When a firm’s assets are sold at a loss, the partners share the loss on liquidation according to their stated ratios. –Assume that during the liquidation of Mind, Padilla, and Nova, the total cash received from the collection of accounts receivable and the sale of inventory and plant assets was $140,000. –The statement of liquidation and the journal entries for the transactions in the statement of liquidation are shown on the next two slides. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Statement of Liquidation Showing Loss on Sale of Assets ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Loss on Sale of Assets: Journal Entries ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Liquidations Where Loss Is Greater than a Partner’s Capital Balance (slide 1 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Liquidations Where Loss Is Greater than a Partner’s Capital Balance (slide 2 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Liquidations Where Partners Share the Loss (slide 1 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Liquidations Where Partners Share the Loss (slide 2 of 2) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Partnership Balance Sheet ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

SECTION 3: BUSINESS APPLICATIONS  Identify alternate forms of partnership-type entities ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Alternate Forms of Partnership-Type Entities  Other common forms of association that are a type of partnership or similar to a partnership include: –Limited partnerships –Joint ventures –Companies with some partnership-like characteristics ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Limited Partnerships  A limited partnership (LP) is a special type of partnership that, like corporations, confines the limited partner’s potential loss to the amount of his or her investment in the business. –Under this type of partnership, the unlimited liability disadvantage can be overcome. –Usually, the limited partnership has a general partner who has unlimited liability but allows other partners to limit their potential loss. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Joint Ventures  A joint venture is an association of two or more entities for the purpose of achieving a specific goal, such as the manufacture of a product in a new market. –Many joint ventures have an agreed-upon limited life. –Profits and losses are shared on an agreed-upon basis. –Joint ventures frequently take the form of partnerships between two or more corporations and other investors. –They are often used by U.S. companies that want to make investments abroad. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Companies That Look Like Partnerships  S corporations—corporations that U.S. tax laws treat as partnerships –Unlike normal corporations, they do not pay federal income taxes. –They have a limited number of stockholders, who report the income or losses on their investments in the business on their personal tax returns.  Limited liability company (LLC)—companies whose members are partners, but their liability is limited to their investment in the business  Special-purpose entities (SPEs)—firms with limited lives that a company creates to achieve a specific objective, such as raising money by selling receivables ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.