1. Beams, Advanced Accounting 10e, Ch. 15
4/7/2017
Chapter 15: Partnerships – Formation, Operations, and Changes in Ownership Interests
by Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompany Advanced Accounting, 10th edition
by Floyd A. Beams, Robin P. Clement,
Joseph H. Anthony, and Suzanne Lowensohn
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2. Partnerships: Objectives
Comprehend the legal characteristics of partnerships.
Understand initial investment valuation and record keeping.
Grasp the diverse nature of profit and loss sharing agreements and their computation.
Value a new partner's investment in an existing partnership.
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3. Objectives (cont.) Value a partner's share upon retirement or death.
Understand limited liability partnership characteristics.
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4. 1: Characteristics of Partnerships
Partnerships – Formation, Operations, and Changes in Ownership Interests
1: Characteristics of Partnerships
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5. Partnerships RUPA "Revised Uniform Partnership Act" Entity theory:
partners own their share of the partnership, but not its individual assets
Dissociation:
partners can dissociate without dissolution
Partners have
Mutual agency
Unlimited liability
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6. Articles of Partnership
Products or services, line of business
Partner rights & responsibilities
Initial investment and value assigned to noncash investments
Additional investment conditions
Asset withdrawals
Profit and loss sharing
Dissolution procedures
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7. Partnership Reporting
Financial reporting should provide for the needs of
Partners
Creditors of the partnership
IRS
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8. Partnerships – Formation, Operations, and Changes in Ownership Interests
2: Initial Investment
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9. Initial Investment
Cash
XXX
Amy Capital
Paul Capital
A partnership is started by Amy and Paul, each investing cash.
If they invest other assets, the value of those assets should be agreed upon in advance.
Cash
XXX
Equipment
Land
Paul Capital
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10. Initial Investment with Bonus or Goodwill
Partner initial investments, at fair value, will not represent their ownership.
Individual talent
Business connections
Customer base
Partners choose method
Bonus method
Adjustment within the capital accounts
Goodwill method
Goodwill is recorded on the books
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11. Initial Investment with Bonus
Total fair value received is split, as desired, between partners
Cola invests land and building worth $10 and $40.
Crown invests cash and inventory at $7 and $35.
Agree to have equal shares:
( ) / 2 = $46 each
Cash 7
Inventory 35
Land 10
Building 40
Cola Capital 46
Crown Capital
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12. Initial Investment with Goodwill
If Cola and Crown agree to equal shares, use larger implied total value of firm.
Cola's: ( ) / 50% = $100
Crown's: (7 + 35) / 50% = $84
Implied value of firm $100
Cola's 50%(100) $50
He invests:
Land $10
Building $ $50
Crown's 50%(100) $50
He invests:
Cash $7
Inventory $ $42
Goodwill $8
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13. Initial Entry with Goodwill
Land 10
Building 40
Cola Capital 50
To record Cola's investment
Cash 7
Inventory 35
Goodwill 8
Crown Capital
To record Crown's investment and goodwill
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14. Partner Accounts Each partner has his/her own accounts for Capital
Drawings (periodic, salary-like, amounts)
Withdrawals (other, large, unusual amounts)
Investments increase Capital
Drawings and withdrawals are closed to Capital
Income Summary or Revenue and Expense Summary is closed to Capital.
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15. Sample Partner Closing Entries
Drawings / withdrawals are closed to individual capital accounts.
Amy Capital
XXX
Amy Drawings XX
Amy Withdrawals
Reduces Amy's capital for drawings and withdrawals
Paul Capital
Paul Drawings
Income Summary
Profit
To share profits between Amy and Paul
Income is shared between the partners. A loss would cause the entry to be reversed. It is possible for some partners to have losses while other have profits.
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16. Statement of Partners' Capital
Beginning capital + investments – drawings and/or withdrawals + income or – loss = ending capital
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17. 3: Sharing Profit and Loss
Partnerships – Formation, Operations, and Changes in Ownership Interests
3: Sharing Profit and Loss
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18. Profit/ Loss Sharing Agreements
The partnership articles should clearly state the means of distributing profits and distributing losses.
Items commonly considered
Bonus allowance
Salary allowance
Interest allowance on capital invested
Based on average, beginning or ending capital balance
Sharing of remaining amounts
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19. Bonus and Salary Allowances
Bonus allowances are often based on partnership profits and may be before or after:
(a) salary allowances and (b) bonus.
If the bonus is after both:
Bonus = b% x (NI – Salary Allow – Bonus)
Salary allowances are generally pre-determined amounts
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20. Interest Allowances and Capital
Interest Allowances are generally based on a measure of the partner's capital
Beginning of the year capital balance
Average* capital balance for the year
Weighted average balance
Ending* capital balance
Beginning balance – withdrawals + investments
* Periodic drawings are often ignored, although withdrawals are considered
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21. Allocating Income
Partner's allowances for bonus, salary and interest are allocated to them, whether or not sufficient profits exist.
Remaining profits (or deficit) is then split according to the agreed-upon proportions.
These are general procedures. The partnership articles provide the specific requirements.
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22. Example: Sharing Profits
Tom and Betty agree to share profits and losses:
Tom and Betty have $60 and $30 salary allowances
Betty has a bonus of 50% of profits in excess of $500
Each have interest allowances of 10% of beginning capital
Tom Capital, 1/1 $400
Betty Capital, 1/1 $350
Remaining profits or losses are shared Tom 60%, Betty 40%.
Partnership profits are $660 for the year.
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23. Share Profits of $660 Total Tom Betty Net income $660 Salary allowance
Total
Tom
Betty
Net income
$660
Salary allowance
(90)
$60
$30
Bonus allowance
(80) 80
Interest allowance
(75) 40 35
Subtotal
$415
Split 60:40
(415)
249
166
Allocated net income $0
$349
$311
Bonus = 50%( ) = 80
Tom Interest = 10%(400) = 40
Betty Interest = 10%(350) = 35
60%(415) = 249; 40%(415) = 166
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24. Share Profits of $180 Assume instead that income was only $180.
Bonus = zero, income does not exceed threshold
Tom Interest = 10%(400) = 40
Betty Interest = 10%(350) = 35
60%(-45) = -27; 40%(-45) = -18
Total
Tom
Betty
Net income
$120
Salary allowance
(90)
$60
$30
Bonus allowance
Interest allowance
(75) 40 35
Subtotal, deficit
($45)
Split 60:40 45
(27)
(18)
Allocated net income $0
$73
$47
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25. 4: Admitting a New Partner
Partnerships – Formation, Operations, and Changes in Ownership Interests
4: Admitting a New Partner
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26. Admitting a New Partner
A current partner assigns interest to new partner.
New partner purchases interest from existing partner.
Goodwill method
Bonus method
New partner invests directly in partnership.
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27. Assignment
Assignment gives the assignee right to a share of future earnings and share of assets in liquidation
Not a partner
No share in management
Old Partner Capital
XXX
Assignee Capital
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28. Buy from Partner: Simple
Alfano and Bailey have capital balances of $50 each and each have a 50% interest in the firm.
Cobb buys half of Alfano's interest for $25.
Alfano Capital 25
Cobb Capital
Before
After
Capital
Share
Alfano
$50
50%
$25
25%
Bailey 50
Cobb 25
Total
$100
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29. Buy from Partner: Goodwill
Don and Ed have capital of $50 and $40 with each 50% interest.
Fay will pay $60 directly to the partners and receive 50% interest in the firm. Don and Ed each keep 25%. Assets are at fair value.
The goodwill increases Don & Ed's capital each by $15.
Implied value of firm, $60/.50
120
Old capital, $ 90
Goodwill 30
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30. Goodwill Revalues Capital
Before
Revaluation
After revaluation
Transfer
Final
Don
$50
$15
$65
($35)
$30 Ed 40 15 55
(25) 30
Fay
60  60
Total
$90
$120
Presumably, Fay paid $35 to Don and $25 to Ed.
If the partners had not wanted to realign the capital, the capital of Don and Ed would each be reduced by $30 to transfer the $60 to Fay.
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31. Buy from Partner: Bonus
If Don and Ed had decided not to revalue the assets or record goodwill, the bonus method is used.
Fay's capital is 50%(90) = $45.
Don and Ed Capital accounts are adjusted to their new balances 25%(90) = $22.5
Before
Transfer
Final
Don
$50
($27.5)
$22.5 Ed 40
(17.5)
22.5
Fay
45.0 
45.0
Total
$90
$90.0
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32. Entries for Purchase from Partner
Entries for Fay's admission, under goodwill and bonus methods:
Goodwill 30
Don Capital 15
Ed Capital 35 25
Fay Capital 60
Goodwill method, aligning capital accounts
Don Capital
27.5
Ed Capital
17.5
Fay Capital 45
Bonus method, aligning capital accounts
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33. Invest in Business: Goodwill
Andrew and Boyles have capital balances of $40 and $40 and share equally in the firm.
Criner will be admitted with an investment of $50 cash. All three will have equal shares. Net assets are at fair value; goodwill will be recorded.
Implied value of firm, $50/(1/3)
$150
Old capital, $
$80
Additional investment 50
130
Goodwill
$20
Criner: $130*1/3 = $43.3, but he pays $50 … so goodwill goes to old partners.
Implied firm value is based on Criner's investment.
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34. Investment and Goodwill Add to Capital (Goodwill to Old Partners)
Before
Revalu-ation
After re-valuation
Investment
Final
Andrew
$40
$10
$50
Boyles 40 10 50
Criner
Total
$80
$100
$150
Capital of $80 at the start, increases by the $20 goodwill and the $50 cash investment.
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35. Invest in Business: Goodwill
Andrew and Boyles have capital balances of $40 and $40 and share equally in the firm.
Criner will be admitted with an investment of $50 cash. Criner will be given a 40% share; Andrew and Boyles will each have 30%. Net assets are at fair value; goodwill will be recorded.
Implied value of firm, $80/(.60)
$133.3
Old capital, $
$80
Additional investment 50
130.0
Goodwill
$3.3
Criner: $130*40% = $52, but he pays $50 … so goodwill goes to new partner.
Implied firm value is based on old partners' capital and retained interest.
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36. Investment and Goodwill Add to Capital (Goodwill to New Partner)
Before
Revalu-ation
After re-valuation
Investment
Final
Andrew
$40
$40.0
Boyles 40
40.0
Criner
$3.3 
3.3
$50
53.3
Total
$80
$83.3
$133.3
Capital of $80 at the start, increases by the $3.3 goodwill and the $50 cash investment.
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37. Invest in Business: Bonus
Andrew and Boyles decide not to revalue the business assets, and Criner invests $50 cash in the business for a 1/3 interest.
Criner's new capital = 1/3 of the total $130. Since he invests on $50 cash for a $52 interest, the $2 bonus is transferred from the old partners.
Before
Investment
Bonus
Final
Andrew
$50
($1)
$49
Boyles 40
(1) 39
Criner 2  52
Total
$90
$130
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38. Entries for Investment in Business
Entries for Criner's investment, under goodwill and bonus methods:
Goodwill 20
Andrew Capital 10
Boyles Capital
Cash 60
Criner Capital
Goodwill method, goodwill to old partners
Cash 50
Andrew Capital 1
Boyles Capital
Criner Capital 52
Bonus method, bonus to new partner
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39. 5: Death or Retirement of a Partner
Partnerships – Formation, Operations, and Changes in Ownership Interests
5: Death or Retirement of a Partner
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40. Dissociation Firm value, according to RUPA, is the greater of
Liquidation value
Sales value as a going concern without the dissociated partner
Payment to exiting partner is
Equal to existing capital
More than existing capital
Implied goodwill or bonus to exiting partner
Less than existing capital
Write down overvalued assets, or bonus to remaining partners
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41. 6: Limited Liability Partnership
Partnerships – Formation, Operations, and Changes in Ownership Interests
6: Limited Liability Partnership
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42. Limited Partnerships
Limited partnerships must have one or more general partners
Limited partner
Excluded from participating in management
Limited liability
Partnership agreement
In writing, signed and filed
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