Partnerships Formation,

Operations, and Changes in

Ownership Interests
Chapter 15

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Learning Objective 1
Comprehend the legal
characteristics of partnerships.

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Partnership Characteristics
It is an association of two or more persons
who co-own a business for a profit.
The legal life of a partnership terminates
with the admission of a new partner, the
withdrawal or death of a partner, voluntary
dissolution by the partners, or involuntary
dissolution such as bankruptcy proceedings.
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Articles of Partnership

A partnership may be formed by a simple

oral agreement among two or more
people to operate a business for profit.

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Articles of Partnership
The types of products and services to be provided
Each partners rights and responsibilities
Each partners initial investment
Additional investment conditions
Asset drawing provisions
Profit and loss sharing formulas
Procedures for dissolving the partnership
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Partnership Financial Reporting

The accounting reports are designed to
meet the needs of three user groups
The partners
Partnership creditors
Internal Revenue Service
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Learning Objective 2
Understand initial investment
valuation and record keeping.

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Initial Investment in a Partnership

Ashley and Becker each invest $20,000
cash in a new partnership.
Cash
20,000
Ashley, Capital
20,000
To record Ashleys original investment of cash
Cash
20,000
Becker, Capital
20,000
To record Beckers original investment of cash
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Noncash Investments
C. Cola and R. Crown enter into a partnership.
C. Cola R. Crown
Fair Value Fair Value
Cash
$

Land (cost to C. Cola, $5,000)

10,000
Building (cost to C. Cola, $30,000)
40,000
Inventory (cost to R. Crown, $28,000)

Total
$50,000

$ 7,000

35,000
$42,000

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Noncash Investments

Land
10,000
Building
40,000
C. Cola, Capital
50,000
To record C. Colas original investment
of land and building at fair value

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Noncash Investments

Cash
7,000
Inventory
35,000
R. Crown, Capital
42,000
To record R. Crowns original investment
of cash and inventory items at fair value

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Bonus or Goodwill
on Initial Investment
The partnership agreement specifies
equal capital interests.

C. Cola, Capital
4,000
R. Crown, Capital
4,000
To establish equal capital interests of $46,000 by
recording a $4,000 bonus from C. Cola to R. Crown
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Bonus or Goodwill
on Initial Investment

Goodwill
8,000
R. Crown, Capital
8,000
To establish equal capital interests of $50,000
by recognizing R. Crowns investment
of an $8,000 unidentifiable asset

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Drawings
Regular withdrawals are called
drawings, drawing allowances,
or sometimes salary allowances.
Debit Drawing and credit Cash.
At period end, credit Drawing
and debit each partners Capital.

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Loans and Advances

Loans and advances to the partnership
and accrued interest are regarded as
liabilities of the partnership.
Loans and advances to partners are
regarded as assets of the partnership.

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Partnership Operations
Ratcliffe and Yancey are partners sharing
profits in a 60:40 ratio, respectively.

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Partnership Operations
Equity Accounts, 2003
Partnership net income 2003
Ratcliffe capital January 1, 2003
Ratcliffe additional investment 2003
Ratcliffe drawing 2003
Yancey capital January 1, 2003
Yancey drawing 2003
Yancey withdrawal 2003

$34,500
40,000
5,000
6,000
35,000
9,000
3,000

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Format for a Statement

of Partners Capital
Ratcliffe and Yancey Statement of Partners Capital
For the Year Ended 12/31/2003
60%
40%
Ratcliffe Yancey Total
Capital balances 1/1/03
$40,000 $35,000 $75,000
Add: Additional investments 5,000

5,000
Deduct: Withdrawals
3,000 3,000
Deduct: Drawings
6,000 9,000 15,000
Net contributed capital
39,000 23,000 62,000
Add: Net income for 2003
20,700 13,800 34,500
Capital balances 12/31/03
$59,700 $36,800 $96,500
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Closing Entries
December 31, 2003
Revenue and Expense Summary 34,500
Ratcliffe, Capital
20,700
Yancey, Capital
13,800
To divide net income for the year 60% to Ratcliffe
and 40% to Yancey

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Closing Entries
December 31, 2003
Ratcliffe, Capital
6,000
Yancey, Capital
9,000
Ratcliffe, Drawing
6,000
Yancey, Drawing
9,000
To close partner drawing accounts to capital accounts

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Learning Objective 3
Grasp the diverse nature of profit
and loss sharing agreements
and their computation.

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Profit and Loss Sharing

Agreements

Equal division of partnership income is required in

the absence of a profit and loss sharing agreement.

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Service Considerations in
Profit and Loss Sharing
Agreements
A partner who devotes time to the partnership
business while other partners work elsewhere
may receive a salary allowance.
Salary allowances are also used to
compensate for differences in the fair
value of the talents of partners.
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Salary Allowance in Profit

Sharing Agreements
Bob, Gary, and Pete are partners.
The partnership agreement provides that
Bob and Gary receive salary allowances
of $12,000 each, with the remaining
income allocated equally.
Partnership net income is $60,000 for 2003
and $12,000 for 2004.
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Income Allocation Schedule: 2003

Bob
Net income
$60,000
Salary allowances
to Bob and Gary (24,000) $12,000
Remainder to divide 36,000
Divided equally
(36,000) 12,000
Remainder to divide
0
Net income allocation
$24,000

Gary

Pete

$12,000
12,000

$12,000

$24,000

$12,000

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Income Allocation Schedule: 2004

Bob

Gary

Net income
$12,000
Salary allowances
to Bob and Gary (24,000) $12,000 $12,000
Remainder to divide (12,000)
Divided equally
12,000
(4,000) (4,000)
Remainder to divide
0
Net income allocation
$ 8,000 $ 8,000

Pete

$(4,000)
$(4,000)

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Journal Entries
December 31, 2003
Revenue and Expense Summary 60,000
Bob, Capital
Gary, Capital
Pete, Capital
Partnership income allocation for 2003

24,000
24,000
12,000

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Journal Entries
December 31, 2004
Revenue and Expense Summary 12,000
Pete, Capital
4,000
Bob, Capital
Gary, Capital
Partnership income allocation for 2004

8,000
8,000

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Bonus and Salary Allowances

The partnership agreement provides that Bob
receive a bonus of 10% of partnership net income.
Bob and Gary receive salary allowances
of $10,000 and $8,000, respectively, and
the remaining income is allocated equally.
Partnership net income is $60,000
for 2003 and $12,000 for 2004.
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Income Allocation Schedule: 2003

Bob
Net income
$60,000
Bonus to Bob
(6,000) $ 6,000
Remainder to divide 54,000
Salary allowances
to Bob and Gary (18,000) 10,000
Remainder to divide 36,000
Divided equally
(36,000) 12,000
Remainder to divide
0
Net income allocation
$28,000

Gary

Pete

$ 8,000
12,000

$12,000

$20,000

$12,000

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Income Allocation Schedule: 2004

Bob

Gary

Net income
$12,000
Bonus to Bob
(1,200) $ 1,200
Remainder to divide 10,800
Salary allowances
to Bob and Gary (18,000) 10,000 $8,000
Remainder to divide (7,200)
Divided equally
7,200
(2,400) (2,400)
Remainder to divide
0
Net income allocation
$ 8,800 $5,600

Pete

$(2,400)
$(2,400)

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Income Allocated in Relation

to Partnership Capital
Ace

Capital balances 1/1/2003

Investment April 1
Withdrawal July 1
Investment September 1
Withdrawal October 1
Investment December 28
Capital balances 12/31/2003

$20,000
2,000

3,000

$25,000

Butch

$20,000

(5,000)

(4,000)
8,000
$19,000

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Comparison of Capital Bases

Ace
Butch
Total

Beginning
Capital
Investment
$20,000
20,000
$40,000

Ending
Capital
Investment
$25,000
19,000
$44,000

Weighted
Average
Capital
Investment
$22,500
16,500
$39,000

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Alternatives
Net income of $100,000 is divided
on the basis of capital balances.
Beginning Capital Balances
Ace ($100,000 20/40)
$ 50,000
Butch ($100,000 20/40)
50,000
Total income
$100,000

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Alternatives
Ending Capital Balances
Ace ($100,000 25/44)
$ 56,818.18
Butch ($100,000 19/44)
43,181.82
Total income
$100,000.00
Average Capital Balances
Ace ($100,000 22.5/39)
$ 57,692.31
Butch ($100,000 16.5/39)
42,307.69
Total income
$100,000.00
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn 15 - 35

Interest Allowances
on Partnership Capital
An agreement may provide for interest
allowances on partnership capital in
order to encourage capital investments,
as well as salary allowances.
Remaining profits are then divided
equally or in any other ratio specified
in the profit sharing agreement.
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Learning Objective 4
Value new partners investment
in an existing partnership.

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Changes in Partnership Interest

The existing legal partnership entity is
dissolved when a new partner is admitted
or an existing partner retires or dies.

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Changes in Partnership Interest

Assignment of an interest to a third party
Admission of a new partner
Purchase of an interest from existing partners
Investing in an existing partnership
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Learning Objective 5
Value partners share upon
retirement or death.

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Dissolution of a Continuing
Partnership
Through Death or Retirement
Profit and
Capital
Balances

Bonnie
Clyde
Dillinger
Total capital

$ 70,000
50,000
80,000
$200,000

Percentage Loss
of Capital Percentage
35%
25
40
100%

40%
20
40
100%

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Dissolution of a Continuing
Partnership
Through Death or Retirement
Dillinger decides to retire.
The partners agree that the business is
undervalued on the partnership books
and that Dillinger will be paid $92,000.

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Bonus to Retiring Partner

Dillinger, Capital
Bonnie, Capital
Clyde, Capital
Cash

80,000
8,000
4,000

Dillinger, Capital
Goodwill
Cash

80,000
12,000

92,000

92,000

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Reevaluation of Total
Partnership Capital

Goodwill (other assets)

Bonnie, Capital
Clyde, Capital
Dillinger, Capital

30,000
12,000
6,000
12,000

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Payment to Retiring Partner

Less than Capital Balance
Suppose that Dillinger is paid $72,000
in final settlement of his capital interest.

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Overvalued Assets Written Down

Bonnie, Capital
Clyde, Capital
Dillinger, Capital
Net assets

8,000
4,000
8,000

Dillinger, Capital
Cash

72,000

20,000

72,000

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Bonus to Continuing Partners

Dillinger, Capital
Bonnie, Capital
Clyde, Capital
Cash

80,000
5,333
2,667
72,000

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Learning Objective 6
Understand limited liability
partnership characteristics.

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Limited Partnerships
The limited partnership consists
of at least one general partner
and one or more limited partners.
The limited partner is excluded from
the management of the business.

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End of Chapter 15

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