1. © The McGraw-Hill Companies, Inc., 2004 Slide 14-1 McGraw-Hill/Irwin Chapter Fourteen Partnerships: Formation and Operation

2. © The McGraw-Hill Companies, Inc., 2004 Slide 14-2 McGraw-Hill/Irwin Partnerships Capital Accounts The equity section of a partnership consists of capital balances for each partner. Profits/losses each period are allocated to each partner’s capital account. Withdrawals by partners reduce their capital accounts. The equity section of a partnership consists of capital balances for each partner. Profits/losses each period are allocated to each partner’s capital account. Withdrawals by partners reduce their capital accounts.

3. © The McGraw-Hill Companies, Inc., 2004 Slide 14-3 McGraw-Hill/Irwin Alternative Legal Forms Subchapter S Corporation Often referred to as an S-Corp... Has all the legal characteristics of a corporation.... Profit passes to owner just as with a partnership.... Ownership is limited to 75 stockholders.... Has all the legal characteristics of a corporation.... Profit passes to owner just as with a partnership.... Ownership is limited to 75 stockholders.

4. © The McGraw-Hill Companies, Inc., 2004 Slide 14-4 McGraw-Hill/Irwin Alternative Legal Forms Limited Partnership Tax benefits of a partnership without unlimited liability.... A limited number of owners who are not allowed to participate in management.... Losses are restricted to amount originally invested.... Must have a one or more general partners.... A limited number of owners who are not allowed to participate in management.... Losses are restricted to amount originally invested.... Must have a one or more general partners.

5. © The McGraw-Hill Companies, Inc., 2004 Slide 14-5 McGraw-Hill/Irwin Alternative Legal Forms Limited Liability Partnerships... Most of the characteristics of a general partnership.... Partners are liable only for their own acts and omissions; an the acts an omissions of those under their direct supervision.... Most of the characteristics of a general partnership.... Partners are liable only for their own acts and omissions; an the acts an omissions of those under their direct supervision. LLP laws differ from state to state.

6. © The McGraw-Hill Companies, Inc., 2004 Slide 14-6 McGraw-Hill/Irwin Alternative Legal Forms Limited Liability Companies... Classified as a partnership for tax purposes.... Owners only risk their own investments.... The number of owners is not usually restricted.... Classified as a partnership for tax purposes.... Owners only risk their own investments.... The number of owners is not usually restricted. LLC laws differ from state to state.

7. © The McGraw-Hill Companies, Inc., 2004 Slide 14-7 McGraw-Hill/Irwin Articles of Partnership Partnerships can exist even in the absence of a written partnership agreement. The Uniform Partnership Act establishes standards and rules for partnerships. A written agreement will supercede the UPA standards. Partnerships can exist even in the absence of a written partnership agreement. The Uniform Partnership Act establishes standards and rules for partnerships. A written agreement will supercede the UPA standards.

8. © The McGraw-Hill Companies, Inc., 2004 Slide 14-8 McGraw-Hill/Irwin Articles of Partnership Put it in writing! Rights and responsibilities of partners Initial contribution to be made by each partner Method for valuing individual contributions Profit/loss sharing percentages Withdrawal limits Method for dispute settlements Method for admitting new partners

9. © The McGraw-Hill Companies, Inc., 2004 Slide 14-9 McGraw-Hill/Irwin Accounting for Capital Contributions If the partners each contribute cash...... debit Cash.... credit individual Partner Capital accounts.

10. © The McGraw-Hill Companies, Inc., 2004 Slide 14-10 McGraw-Hill/Irwin Accounting for Capital Contributions If the partners each contribute cash and other assets...... debit Cash & contributed assets for FMV.... credit individual Partner Capital accounts. If the partners each contribute cash and other assets...... debit Cash & contributed assets for FMV.... credit individual Partner Capital accounts.

11. © The McGraw-Hill Companies, Inc., 2004 Slide 14-11 McGraw-Hill/Irwin Accounting for Capital Contributions Intangible assets, such as expertise, require special consideration Use either the Bonus Method or the Goodwill Method. Intangible assets, such as expertise, require special consideration Use either the Bonus Method or the Goodwill Method. Record the tangible assets contributed. Adjust the partner capital balances to reflect the relative value of the intangible asset. Record the tangible assets contributed. Adjust the partner capital balances to reflect the relative value of the intangible asset.

12. © The McGraw-Hill Companies, Inc., 2004 Slide 14-12 McGraw-Hill/Irwin Prepare the journal entry to set up the partnership. Intangible Contributions Bonus Method On 2/15/03, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes $80,000 cash. Redd contributes land valued at $40,000.

13. © The McGraw-Hill Companies, Inc., 2004 Slide 14-13 McGraw-Hill/Irwin Intangible Contributions Bonus Method Total tangible assets for the partnership are $120,000. The partners have agreed to have equal capital balances, based on the contributed assets. Even though Redd only contributed land worth $40,000, essentially, Greene has given Redd a $20,000 bonus.

14. © The McGraw-Hill Companies, Inc., 2004 Slide 14-14 McGraw-Hill/Irwin Intangible Contributions Goodwill Method Record the tangible assets contributed. Record the tangible assets contributed. Record the contributed intangible asset as the difference between the contributed tangible assets and the implied value of the partnership. Record the contributed intangible asset as the difference between the contributed tangible assets and the implied value of the partnership. Record the tangible assets contributed. Record the tangible assets contributed. Record the contributed intangible asset as the difference between the contributed tangible assets and the implied value of the partnership. Record the contributed intangible asset as the difference between the contributed tangible assets and the implied value of the partnership.

15. © The McGraw-Hill Companies, Inc., 2004 Slide 14-15 McGraw-Hill/Irwin Prepare the journal entry to set up the partnership. Intangible Contributions Goodwill Method On 2/15/03, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes $80,000 cash. Redd contributes land valued at $40,000, and brings years of experience to the new business.

16. © The McGraw-Hill Companies, Inc., 2004 Slide 14-16 McGraw-Hill/Irwin Intangible Contributions Goodwill Method ÷ On 2/15/03, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes $80,000 cash. Redd contributes land valued at $40,000, and brings years of experience to the new business.

17. © The McGraw-Hill Companies, Inc., 2004 Slide 14-17 McGraw-Hill/Irwin Intangible Contributions Goodwill Method Greene’s capital account is credited for the tangible contribution of $80,000. Redd’s capital account is credited for the tangible contribution of $40,000, plus the intangible contribution valued at $40,000. Greene’s capital account is credited for the tangible contribution of $80,000. Redd’s capital account is credited for the tangible contribution of $40,000, plus the intangible contribution valued at $40,000.

18. © The McGraw-Hill Companies, Inc., 2004 Slide 14-18 McGraw-Hill/Irwin Allocation of Income The allocation of income is not based on the relative capital balances.  It is a separately negotiated item. Items to be allocated: Allocated compensation Bonuses Remaining income Interest on beginning capital balances

19. © The McGraw-Hill Companies, Inc., 2004 Slide 14-19 McGraw-Hill/Irwin Allocation of Income Example Bell and Sutton, a retail partnership selling hats, has beginning of period capital balances of $50,000 and $70,000 respectively. Net income for the period is $100,000. Both partners are credited with 10% interest on their beginning capital balance. In addition, Lebo is credited with a bonus of $20,000 per the partnership agreement. They share income 40:60 (Bell:Sutton). What are the ending capital balances for each partner?

20. © The McGraw-Hill Companies, Inc., 2004 Slide 14-20 McGraw-Hill/Irwin Allocation of Income Example

21. © The McGraw-Hill Companies, Inc., 2004 Slide 14-21 McGraw-Hill/Irwin Allocation of Income Example

22. © The McGraw-Hill Companies, Inc., 2004 Slide 14-22 McGraw-Hill/Irwin Allocation of Income Example

23. © The McGraw-Hill Companies, Inc., 2004 Slide 14-23 McGraw-Hill/Irwin Allocation of Income Example

24. © The McGraw-Hill Companies, Inc., 2004 Slide 14-24 McGraw-Hill/Irwin These two rights can be sold. This right cannot be sold without the other partners’ approval. Admission of a New Partner The Rights of a Partner An individual partner’s ownership rights include: The right to co-ownership of the partnership property. The right to share in profits and losses as specified in the partnership agreement The right to participate in the management of the partnership. An individual partner’s ownership rights include: The right to co-ownership of the partnership property. The right to share in profits and losses as specified in the partnership agreement The right to participate in the management of the partnership.

25. © The McGraw-Hill Companies, Inc., 2004 Slide 14-25 McGraw-Hill/Irwin Partnership Dissolution Admission of a New Partner When the makeup of the partnership changes, the partnership is dissolved. When the makeup of the partnership changes, the partnership is dissolved. A new partnership is immediately formed. A new partnership is immediately formed. New partner acquires partnership interest by: New partner acquires partnership interest by:  Purchasing it from the other partners, or  Making a contribution to the partnership. When the makeup of the partnership changes, the partnership is dissolved. When the makeup of the partnership changes, the partnership is dissolved. A new partnership is immediately formed. A new partnership is immediately formed. New partner acquires partnership interest by: New partner acquires partnership interest by:  Purchasing it from the other partners, or  Making a contribution to the partnership.

26. © The McGraw-Hill Companies, Inc., 2004 Slide 14-26 McGraw-Hill/Irwin Admission of a New Partner Purchase of a Current Interest A new partner can purchase partnership interest directly from the existing partners. A new partner can purchase partnership interest directly from the existing partners.  The cash goes to the partners, not to the partnership. Two methods are available to account for the transfer of ownership. Two methods are available to account for the transfer of ownership.  Book Value Approach  Goodwill (Revaluation) Approach A new partner can purchase partnership interest directly from the existing partners. A new partner can purchase partnership interest directly from the existing partners.  The cash goes to the partners, not to the partnership. Two methods are available to account for the transfer of ownership. Two methods are available to account for the transfer of ownership.  Book Value Approach  Goodwill (Revaluation) Approach

27. © The McGraw-Hill Companies, Inc., 2004 Slide 14-27 McGraw-Hill/Irwin Book Value Example Doe, Raye, and Mee have a partnership. Using the Book Value Approach, prepare the entry assuming Flatt pays $60,000 directly to the other partners for a 20% partnership interest. Admission of a New Partner Purchase of a Current Interest

28. © The McGraw-Hill Companies, Inc., 2004 Slide 14-28 McGraw-Hill/Irwin Admission of a New Partner Purchase of a Current Interest Book Value Example The cash goes to Doe, Raye, and Mee, NOT to the partnership. Each partner gives up 20% of their existing capital. Book Value Example The cash goes to Doe, Raye, and Mee, NOT to the partnership. Each partner gives up 20% of their existing capital. Prepare the journal entry to admit Flatt to the partnership.

29. © The McGraw-Hill Companies, Inc., 2004 Slide 14-29 McGraw-Hill/Irwin Admission of a New Partner Purchase of a Current Interest Book Value Example The cash goes to Doe, Raye, and Mee, NOT to the partnership. Each partner gives up 20% of their existing capital. Book Value Example The cash goes to Doe, Raye, and Mee, NOT to the partnership. Each partner gives up 20% of their existing capital.

30. © The McGraw-Hill Companies, Inc., 2004 Slide 14-30 McGraw-Hill/Irwin Now, let’s take a look at the Goodwill (Revaluation) Approach. Admission of a New Partner Purchase of a Current Interest

31. © The McGraw-Hill Companies, Inc., 2004 Slide 14-31 McGraw-Hill/Irwin Goodwill (Revaluation) Example Doe, Raye, and Mee have a partnership. Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 directly to the other partners for a 20% partnership interest. Goodwill (Revaluation) Example Doe, Raye, and Mee have a partnership. Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 directly to the other partners for a 20% partnership interest. Admission of a New Partner Purchase of a Current Interest

32. © The McGraw-Hill Companies, Inc., 2004 Slide 14-32 McGraw-Hill/Irwin Admission of a New Partner Purchase of a Current Interest Goodwill (Revaluation) Example The implied value of the partnership is $300,000  $60,000 ÷ 20% = $300,000 First, compute the Goodwill Goodwill (Revaluation) Example The implied value of the partnership is $300,000  $60,000 ÷ 20% = $300,000 First, compute the Goodwill

33. © The McGraw-Hill Companies, Inc., 2004 Slide 14-33 McGraw-Hill/Irwin Admission of a New Partner Purchase of a Current Interest Goodwill (Revaluation) Example Allocate the $160,000 of Goodwill to the existing partners, based on their income sharing %. (40:25:35) Goodwill (Revaluation) Example Allocate the $160,000 of Goodwill to the existing partners, based on their income sharing %. (40:25:35) Prepare the journal entry to allocate goodwill to Doe, Raye, & Mee.

34. © The McGraw-Hill Companies, Inc., 2004 Slide 14-34 McGraw-Hill/Irwin Admission of a New Partner Purchase of a Current Interest Goodwill (Revaluation) Example Allocate the $160,000 of Goodwill to the existing partners, based on their income sharing %. (40:25:35) Goodwill (Revaluation) Example Allocate the $160,000 of Goodwill to the existing partners, based on their income sharing %. (40:25:35)

35. © The McGraw-Hill Companies, Inc., 2004 Slide 14-35 McGraw-Hill/Irwin Admission of a New Partner Purchase of a Current Interest Goodwill (Revaluation) Example The new balances for Doe, Raye, and Mee appear as follows: Next, allocate 20% from each of the existing partners to Flatt. Goodwill (Revaluation) Example The new balances for Doe, Raye, and Mee appear as follows: Next, allocate 20% from each of the existing partners to Flatt.

36. © The McGraw-Hill Companies, Inc., 2004 Slide 14-36 McGraw-Hill/Irwin Admission of a New Partner Purchase of a Current Interest Revaluation Example Note that Flatt’s balance, after allocation from the current partners, equals Flatt’s contribution of $60,000. Revaluation Example Note that Flatt’s balance, after allocation from the current partners, equals Flatt’s contribution of $60,000.

37. © The McGraw-Hill Companies, Inc., 2004 Slide 14-37 McGraw-Hill/Irwin Admission of a New Partner Contribution to the Partnership The new partner can gain partnership interest by contributing cash to the partnership. The new partner can gain partnership interest by contributing cash to the partnership. Remember that the new cash will increase the partnership’s net assets. Remember that the new cash will increase the partnership’s net assets. Two methods are: Two methods are:  Bonus Approach  Goodwill Approach The new partner can gain partnership interest by contributing cash to the partnership. The new partner can gain partnership interest by contributing cash to the partnership. Remember that the new cash will increase the partnership’s net assets. Remember that the new cash will increase the partnership’s net assets. Two methods are: Two methods are:  Bonus Approach  Goodwill Approach

38. © The McGraw-Hill Companies, Inc., 2004 Slide 14-38 McGraw-Hill/Irwin Bonus Example Doe, Raye, and Mee have a partnership. Using the Bonus Approach, prepare the entry assuming Flatt pays $60,000 to the partnership for a 20% partnership interest. Admission of a New Partner Contribution to the Partnership

39. © The McGraw-Hill Companies, Inc., 2004 Slide 14-39 McGraw-Hill/Irwin Bonus Example Net assets after the contribution are $200,000. Flatt gets credit for 20% of net assets ($200,000 x 20%). The remainder of the $60,000 contribution is allocated to the other partners. Bonus Example Net assets after the contribution are $200,000. Flatt gets credit for 20% of net assets ($200,000 x 20%). The remainder of the $60,000 contribution is allocated to the other partners. Note that the $200,000 results from the net assets of the partnership of $140,000 + Flatt’s $60,000 contribution. Prepare the journal entry. Admission of a New Partner Contribution to the Partnership

40. © The McGraw-Hill Companies, Inc., 2004 Slide 14-40 McGraw-Hill/Irwin Note that the $200,000 results from the net assets of the partnership of $140,000 + Flatt’s $60,000 contribution. Prepare the journal entry. Bonus Example Net assets after the contribution are $200,000. Flatt gets credit for 20% of net assets ($200,000 x 20%). The remainder of the $60,000 contribution is allocated to the other partners. Bonus Example Net assets after the contribution are $200,000. Flatt gets credit for 20% of net assets ($200,000 x 20%). The remainder of the $60,000 contribution is allocated to the other partners. Admission of a New Partner Contribution to the Partnership

41. © The McGraw-Hill Companies, Inc., 2004 Slide 14-41 McGraw-Hill/Irwin Now, let’s take a look at the Goodwill Approach. Admission of a New Partner Contribution to the Partnership

42. © The McGraw-Hill Companies, Inc., 2004 Slide 14-42 McGraw-Hill/Irwin Goodwill Example Doe, Raye, and Mee have a partnership. Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 to the partnership for a 20% partnership interest. Goodwill Example Doe, Raye, and Mee have a partnership. Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 to the partnership for a 20% partnership interest. Admission of a New Partner Contribution to the Partnership

43. © The McGraw-Hill Companies, Inc., 2004 Slide 14-43 McGraw-Hill/Irwin Admission of a New Partner Contribution to the Partnership Goodwill Example Net assets after the contribution are $200,000. Implied value of the partnership is $300,000.  $60,000 ÷ 20% = $300,000 Goodwill to be recorded is $100,000 (300,000 - 200,000) Goodwill Example Net assets after the contribution are $200,000. Implied value of the partnership is $300,000.  $60,000 ÷ 20% = $300,000 Goodwill to be recorded is $100,000 (300,000 - 200,000) Prepare the journal entry to allocate goodwill to Doe, Raye, & Mee.

44. © The McGraw-Hill Companies, Inc., 2004 Slide 14-44 McGraw-Hill/Irwin Admission of a New Partner Contribution to the Partnership Goodwill Example Net assets after the contribution are $200,000. Implied value of the partnership is $300,000.  $60,000 ÷ 20% = $300,000 Goodwill to be recorded is $100,000 (300,000 - 200,000) Goodwill Example Net assets after the contribution are $200,000. Implied value of the partnership is $300,000.  $60,000 ÷ 20% = $300,000 Goodwill to be recorded is $100,000 (300,000 - 200,000)

45. © The McGraw-Hill Companies, Inc., 2004 Slide 14-45 McGraw-Hill/Irwin Admission of a New Partner Contribution to the Partnership Goodwill Example After allocating the goodwill to the original partners, record Flatt’s cash contribution and credit Flatt’s capital account. Prepare the journal entry to admit Flatt to the partnership.

46. © The McGraw-Hill Companies, Inc., 2004 Slide 14-46 McGraw-Hill/Irwin Admission of a New Partner Contribution to the Partnership Goodwill Example After allocating the goodwill to the original partners, record Flatt’s cash contribution and credit Flatt’s capital account. Prepare the journal entry to admit Flatt to the partnership.

47. © The McGraw-Hill Companies, Inc., 2004 Slide 14-47 McGraw-Hill/Irwin Accounting for my partners is easy. It’s accounting for their taste that I find difficult! End of Chapter 14