© 2009 The McGraw-Hill Companies, Inc., All Rights Reserved ACCOUNTING FOR PARTNERSHIPS Chapter 12

McGraw-Hill/Irwin Slide 2 McGraw-Hill/Irwin Slide 2 P ARTNERSHIP F ORM OF O RGANIZATION Partnership Agreement Voluntary Association Limited Life Taxation Unlimited Liability Mutual Agency Co- Ownership of Property C1

McGraw-Hill/Irwin Slide 3 McGraw-Hill/Irwin Slide 3 O RGANIZATIONS WITH P ARTNERSHIP C HARACTERISTICS Limited Partnerships (LP) General partners assume management duties and unlimited liability for partnership debts. Limited partners have no personal liability beyond invested amounts. General partners assume management duties and unlimited liability for partnership debts. Limited partners have no personal liability beyond invested amounts. Limited Liability Partnerships (LLP) Protects innocent partners from malpractice or negligence claims. Most states hold all partners personally liable for partnership debts. Protects innocent partners from malpractice or negligence claims. Most states hold all partners personally liable for partnership debts. Limited Liability Corporations (LLC) Owners have same limited liability feature as owners of a corporation. A limited liability corporation typically has a limited life. Owners have same limited liability feature as owners of a corporation. A limited liability corporation typically has a limited life. C1

McGraw-Hill/Irwin Slide 4 McGraw-Hill/Irwin Slide 4 C HOOSING A B USINESS F ORM Many factors should be considered when choosing the proper business form.

McGraw-Hill/Irwin Slide 5 McGraw-Hill/Irwin Slide 5 O RGANIZING A P ARTNERSHIP Partners can invest both assets and liabilities in the partnership. Assets and liabilities are recorded at an agreed- upon value, normally fair market value. Asset contributions increase the partner’s capital account. Withdrawals from the partnership decrease the partner’s capital account. P1

McGraw-Hill/Irwin Slide 6 McGraw-Hill/Irwin Slide 6 O RGANIZING A P ARTNERSHIP In accounting for partnerships: 1.Partners’ withdrawals are debited to their own separate withdrawals account. 2.Partners’ capital accounts are credited (or debited) for their shares of net income (or net loss) when closing the accounts at the end of the period. 3.Each partner’s withdrawal account is closed to that partner’s capital account. Separate capital and withdrawals accounts are kept for each partner. In accounting for partnerships: 1.Partners’ withdrawals are debited to their own separate withdrawals account. 2.Partners’ capital accounts are credited (or debited) for their shares of net income (or net loss) when closing the accounts at the end of the period. 3.Each partner’s withdrawal account is closed to that partner’s capital account. Separate capital and withdrawals accounts are kept for each partner. P1

McGraw-Hill/Irwin Slide 7 McGraw-Hill/Irwin Slide 7 D IVIDING I NCOME OR L OSS Three frequently used methods to divide income or loss are allocation on: 1. Stated ratios. 2. Capital balances. 3. Services, capital and stated ratios. Partners are not employees of the partnership but are its owners. This means there are no salaries reported as expense on the income statement. Profits or losses of the partnership are divided on some agreed upon ratio. P2

McGraw-Hill/Irwin Slide 8 McGraw-Hill/Irwin Slide 8 A DMISSION AND W ITHDRAWAL OF P ARTNERS When the makeup of the partnership changes, the existing partnership is dissolved. A new partnership may be immediately formed. New partner acquires partnership interest by: 1. Purchasing it from the other partners, or 2. Investing assets in the partnership. P3

McGraw-Hill/Irwin Slide 9 McGraw-Hill/Irwin Slide 9 P URCHASE OF P ARTNERSHIP I NTEREST A new partner can purchase partnership interest directly from the existing partners. The cash goes to the partners, not to the partnership. The cash goes to the partners, not to the partnership. To become a partner, the new partner must be accepted by the current partners. P3

McGraw-Hill/Irwin Slide 10 McGraw-Hill/Irwin Slide 10 I NVESTING A SSETS IN A P ARTNERSHIP The new partner can gain partnership interest by contributing assets to the partnership. The new assets will increase the partnership’s net assets. After admission, both assets and equity will increase. P3

McGraw-Hill/Irwin Slide 11 McGraw-Hill/Irwin Slide 11 B ONUS TO O LD OR N EW P ARTNERS Bonus to Old Partners When the current value of a partnership is greater than the recorded amounts of equity, the old partners usually require a new partner to pay a bonus when joining. Bonus to New Partners The partnership may grant a bonus to a new partner if the business is in need of cash or if the new partner has exceptional talents. P3

McGraw-Hill/Irwin Slide 12 McGraw-Hill/Irwin Slide 12 W ITHDRAWAL OF A P ARTNER A partner can withdraw in two ways: A partner can withdraw in two ways: The partner can sell his/her partnership interest to another person. The partnership can distribute cash and/or other assets to the withdrawing partner. P3

McGraw-Hill/Irwin Slide 13 McGraw-Hill/Irwin Slide 13 D EATH OF A P ARTNER A partner’s death dissolves a partnership. A deceased partner’s estate is entitled to receive his or her equity. The partnership agreement should contain provisions for settlement. These provisions usually require: 1.Closing the books to determine income or loss since the end of the previous period, and 2.Determining and recording current market values for both assets and liabilities. Settlement of the deceased partner’s estate can involve selling the equity to remaining partners or to an outsider, or it can involve withdrawal of assets. A partner’s death dissolves a partnership. A deceased partner’s estate is entitled to receive his or her equity. The partnership agreement should contain provisions for settlement. These provisions usually require: 1.Closing the books to determine income or loss since the end of the previous period, and 2.Determining and recording current market values for both assets and liabilities. Settlement of the deceased partner’s estate can involve selling the equity to remaining partners or to an outsider, or it can involve withdrawal of assets. P4

McGraw-Hill/Irwin Slide 14 McGraw-Hill/Irwin Slide 14 L IQUIDATION OF A P ARTNERSHIP A partnership dissolution requires four steps:  Noncash assets are sold for cash and a gain or loss on liquidations is recorded.  Gain or loss on liquidation is allocated to partners using their income-and-loss ratio.  Liabilities are paid or settled.  Any remaining cash is distributed to partners based on their capital balances. A partnership dissolution requires four steps:  Noncash assets are sold for cash and a gain or loss on liquidations is recorded.  Gain or loss on liquidation is allocated to partners using their income-and-loss ratio.  Liabilities are paid or settled.  Any remaining cash is distributed to partners based on their capital balances. P4

McGraw-Hill/Irwin Slide 15 McGraw-Hill/Irwin Slide 15 P ARTNER R ETURN ON E QUITY Partner return on equity Partner net income Average partner equity = A4 216/[(84+252)/2] = 128.6%

McGraw-Hill/Irwin Slide 16 McGraw-Hill/Irwin Slide 16 END OF CHAPTER 12