Week 2 Chp16 AKL 1

Advanced Accounting
Thirteenth Edition, Global Edition
Chapter 16
Partnerships –
Formation, Operations,
and Changes in
Ownership Interests
Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Partnerships: Objectives
16.1 Comprehend the legal characteristics of
partnerships.
16.2 Understand initial investment valuation and record
keeping.
16.3 Grasp the diverse nature of profit- and loss-sharing
agreements and their computation.
16.4 Value a new partner's investment in an existing
partnership.
16.5 Value a partner's share on retirement or death.
16.6 Understand limited liability partnership
characteristics.

16.1: Partnership Characteristics
Partnerships – Formation, Operations, and Changes in Ownership
Interests

Partnerships
RUPA "Revised Uniform Partnership Act“
– Has been adopted by most states
– Entity theory:
● partners own their share of the partnership,
but not its individual assets.
– Dissociation:
● partners can dissociate without dissolution of
the partnership.
Partners have
– Mutual agency – the ability to legally bind the
partnership
– Unlimited liability – liable for partnership debts,
including the use of personal assets
Articles of Partnership
The partnership agreement should specify:
1. Products or services, line of business
2. Partner rights and responsibilities
3. Initial investment and value assigned to noncash
investments
4. Additional investment conditions
5. Asset withdrawal provisions
6. Profit and loss sharing
7. Dissolution procedures

Partnership Reporting
Financial reporting should provide for the needs of
● Partners
● Creditors of the partnership
● IRS – Partnerships do not pay federal income
taxes, but partnership information returns allow
the IRS to verify that each partner pays income
taxes on his/her share of partnership income.

16.2: Initial Investment
Interests

Initial Investment
A partnership is started by Ash and Bec, each
investing cash.
Cash 20,000 blank
Ash Capital blank 20,000
Cash 20,000 blank
Bec Capital blank 20,000
If Bec invests other assets, the value of those assets

should be agreed upon in advance.
Cash XXX blank
Equipment XXX blank
Land XXX blank
Bec Capital blank XXX

Bonus or Goodwill on Initial Investment
Partner initial investments may not represent
ownership percentage. Partners may bring
● Individual talent
● Business connections
● Customer base
● Intellectual know-how
Partners choose method to record their capital.
● Bonus method
- Adjustment within the capital accounts
● Goodwill method
- Goodwill is recorded on the books
Initial Investment with Bonus
Total fair value received is split, as desired, between
partner capital accounts.
For example: Col contributes assets of $50,000, and

Cro contributes assets of $42,000. They agree to
have equal shares: 92 / 2 = $46 each.
Cash 7 blank
Inventory 35 blank
Land 10 blank
Building 40 blank
Col, Capital blank 50
Cro, Capital blank 42

Initial Investment with Bonus (continued)
● Increase Col’s capital and decrease Cro’s capital by
$4,000.
Cro, Capital 4,000 blank

Col, Capital blank 4,000

Initial Investment with Goodwill
The partner contributing the greater fair value sets
the implied value of the partnership, and goodwill is
recorded to make up the difference for the partner
who invested the lesser amount.
In the Col and Cro partnership:

Col's: (10 + 40) / 50% = $100
Cro's: (7 + 35) / 50% = $84
Use Col’s investment to determine implied value of

firm -- $100.
Initial Entry with Goodwill
Col's 50%($100) $50 Cro's 50%($100) $50

He invests: He invests:
Land $10 Cash $7
Building $40 $50 Inventory $35 $42
Goodwill $8
Goodwill 8,000 blank

Cro, Capital blank 8,000
blank blank blank
blank blank blank
blank blank blank
blank blank blank
blank blank blank

Additional Partner Transactions
Each partner has his/her own accounts for
– Capital (the balance of a partner’s equity)
– Drawings (periodic amounts, similar to a salary)
– Withdrawals (other large or unusual amounts)
Additional investments increase Capital.
Drawings and withdrawals reduce Capital.
Income Summary (Revenue and Expense Summary)

is closed to Capital.

Partner Closing Entries
Drawings/ Revenue and Expense Summary 34,500 blank

withdrawals Rat capital blank 20,700
are closed to Yan capital blank 13,800
individual blank blank blank
capital Rat capital 6,000 blank
accounts. Yan capital 9,000 blank
Rat drawing blank 6,000
Yan drawing blank 9,000
blank blank blank
blank blank blank
Income is shared between the partners. A loss

would cause the entry to be reversed. It is
possible for some partners to have losses
overall while others have profits.

Statement of Partners' Capital
RAT AND YAN
STATEMENT OF PARTNER’S CAPITAL
FOR THE YEAR ENDED DECEMBER 31, 2016 blank blank blank
blank 60% Rat 40% Yan Total
Capital balances January 1, 2016 $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 capita; 39,000 23,000 62,000
Add: Net income for 2016 20,700 13,800 34,500
Capital balances December 31, 2016 $59,700 $36,800 $96,500
Beginning capital + investments – drawings and/or

withdrawals + income or – loss = ending capital

16.3: Profit- and Loss-Sharing
Agreements
Interests

Profit- and Loss-Sharing Agreements
The partnership articles should clearly state the
means of distributing profits and distributing losses.
Items commonly considered (in addition to time and
investment given):
– Bonus allowance
– Salary allowance
– Interest allowance on capital invested
● Based on average, beginning or ending
capital balance
– Sharing of remaining amounts

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, provided to partners who manage the
partnership. Salary allowances are not expenses in
the determination of partnership net income.

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.

Allocating Income
Partners’ allowances for bonus, salary, and interest
are allocated to them, whether or not sufficient
profits exist.
Remaining profits (or deficit) are then split according

to the agreed-upon proportions.
These are general procedures. The partnership

articles provide the specific requirements.

Example: Sharing Profits (1 of 3)
Leo and Drake agree to share profits and losses.
● Leo and Drake have $60 and $30 salary
allowances, respectively.
● Drake has a bonus of 50% of profits in excess of
$500.
● Each has interest allowances of 10% of beginning
capital:
- Leo Capital, 1/1 $400
- Drake Capital, 1/1 $350
● Remaining profits or losses are shared: Leo 60%,
Drake 40%.
● Partnership profits are $660 for the year.

blank Total Leo Drake
Net income $660 blank blank
Salary allowance (90) $60 $30
Bonus allowance (80) 0 80
Interest allowance (75) 40 35
Subtotal $415 blank blank
Split 60:40 (415) 249 166
Allocated net income $0 $349 $311
Bonus = 50%(660 - 500) = 80

Leo Interest = 10%(400) = 40
Drake Interest = 10%(350) = 35
Allocation: 60%(415) = 249; 40%(415) = 166

Assume instead that income was only $120.
blank Total Leo Drake
Net income $120 blank blank
Salary allowance (90) $60 $30
Bonus allowance 0 0 0
Interest allowance (75) 40 35
Subtotal, deficit ($45) blank blank
Split 60:40 45 (27) (18)
Allocated net income $0 $73 $47
Bonus = zero (income does not exceed $500)

Leo Interest = 10%(400) = 40
Drake Interest = 10%(350) = 35
Allocation: 60%(-45) = -27; 40%(-45) = -18
16.4: Admitting a New Partner
Interests

Admitting a New Partner
Methods of entry for a new partner into an existing
partnership:
1. New partner purchases interest from existing

partner(s).
● Goodwill method
● Bonus method
2. New partner invests directly in partnership.
● Goodwill method
● Bonus method

Buy from Partner: Simple
Alf and Bal have capital balances of $50k each, and
each has a 50% interest in the firm.
Cob buys half of Alf's interest for $25.
Alf Capital 25 blank

Cob Capital blank 25
blank Before blank blank After blank

blank Capital Share blank Capital Share
Alf $50 50% blank $25 25%
Bal 50 50% blank 50 50%
Cob blank blank blank 25 25%
Total $100 blank blank $100 blank

Buy from Partner: Goodwill
Alf and Bal have capital of $50 and $40, each with
50% interest.
Cob will pay $50 directly to the partners and receive
50% interest in the firm. Alf and Bal each keep 25%.
Assets are at fair value.
Implied value of firm, $50/.50 100

Old capital, $50 + 40 90
Goodwill 10
The goodwill increases Alf & Bal's capital by $5 each.

Buy from Partner: Goodwill (continued)
After
blank Before Revaluation revaluation Transfer Final
Alf $50 $5 $55 ($25) $30
Bal 40 5 45 (25) 20
Cob blank blank blank 50 50
Total $90 blank $100 blank $100
Presumably, Cob paid $25 to Alf and $25 to Bal.
If the partners had decided to realign the capital, the

capital of Alf and Bal would be reduced by $30 and
$20 respectively to transfer the $50 to Cob.

Buy from Partner: Bonus
If Alf and Bal had decided not to revalue the assets
or record goodwill, the bonus method would be used.
blank Before Transfer Final

Alf $50 ($22.5) $27.5
Bal 40 (22.5) 17.5
Cob blank 45.0 45.0
Total $90 blank $90.0
Cob's capital is 50%(90) = $45.

Entries for Purchase from Partner
Entries for Cob's admission, under goodwill and
bonus methods:
Goodwill 10 blank
Alf Capital blank 5
Bal Capital blank 5
Alf Capital 25 blank
Bal Capital 25 blank
Goodwill method, not aligning capital
accounts blank blank
Alf Capital 22.5 blank

Bal Capital 22.5 blank

Bonus method, not aligning capital accounts blank blank

New Partner Investment: Goodwill to Old
Partners
Dre and Boy each have capital balances of $40 and
share equally in the firm. Cry will be admitted with
an investment of $50 cash.
All three will have equal shares, and net assets are
at fair value. Goodwill will be recorded.
Implied value of firm, $50/(1/3) blank $150

Old capital, $40 + 40 $80 blank
Additional investment 50 130
Goodwill blank $20
Cry: $130*1/3 = $43.3, but he pays $50 … so

goodwill goes to old partners. Implied firm value is
based on Cry's investment.

New Partner Investment: Goodwill to Old
Partners (continued)
After
blank Before Re-valuation re-valuation Investment Final
Dre $40 $10 $50 blank $50
Boy 40 10 50 blank 50
Cry blank blank blank $50 50
Total $80 blank $100 blank $150
Capital of $80 at the start, increases by the $20

goodwill and the $50 cash investment.

New Partner Investment: Goodwill to
New Partner
Dre and Boy each have capital balances of $40 and
share equally in the firm. Cry will be admitted with
an investment of $50 cash.
Cry will be given a 40% share; Dre and Boy will each
have 30%, and net assets are at fair value. Goodwill
will be recorded.
Implied value of firm, $80/(.60) blank $133.3
Old capital, $40 + 40 $80 blank
Additional investment 50 130.0
Goodwill blank $3.3
Cry: $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.

New Partner Investment: Goodwill to
New Partner (continued)
After
blank Before Re-valuation re-valuation Investment Final
Dre $40 blank $40 blank $40.0
Boy 40 blank 40 blank 40.0
Cry blank $3.3 3.3 $50 53.3
Total $80 blank $83.3 blank $133.3
Capital of $80 at the start, increases by the

$3.3 goodwill and the $50 cash investment.

New Partner Investment: Bonus
Dre and Boy decide not to revalue the business
assets, and Cry invests $50 cash in the business for
a 40% interest.
blank Before Investment Bonus Final
Dre $40 blank ($1) $39
Boy 40 blank (1) 39
Cry blank $50 2 52
Total $80 blank blank $130
Cry's new capital = 40% of the total $140. Since he

invests $50 cash for a $52 interest, the $2 bonus is
transferred from the old partners.

Entries for Investment in Business
Entries for Cry's investment, under goodwill and
bonus methods:
Goodwill 20 blank
Dre Capital blank 10
Boy Capital blank 10
Cash 60 blank
Cry Capital blank 60
Goodwill method, goodwill to old partners blank blank
Cash 50 blank
Dre Capital 1 blank
Boy Capital 1 blank
Cry Capital blank 52
Bonus method, bonus to new partner blank blank

16.5: Death or Retirement of a Partner
Interests

Dissociation
Firm value, according to the Uniform Partnership Act,
is the greater of
● Liquidation value
● Sales value as a going concern without the
dissociated partner
Payment to exiting partner may be
● Equal to retiring capital
● More than retiring capital
- Implied goodwill or bonus to retiring partner
● Less than existing capital
- Write down overvalued assets, or bonus to
remaining partners

Payment to Retiring Partner
Ann, Mic, and Jus are partners with capital balances
and profit-sharing percentages, shown respectively,
as follows:
Capital Percentage Profit and
Balances Of Capital Loss Percentage
$70,000 35% 40%
50,000 25 20
80,000 40 40
$200,000 100% 100%
Jus retires, and his partnership interest is paid out

by the partnership.

Payment Equals Partner Capital
Jus Capital 80 blank
Cash blank 80
The Ann, Mic, and Jus partnership would be

dissolved. Ann and Mic could continue the
partnership, but would need to establish a new
partnership agreement if a partner’s retirement was
not addressed in the original partnership agreement.

Payment Exceeds Partner Capital
If Jus is paid $92,000 in final settlement of his
partnership interest, the excess may be treated as
1. A bonus to Jus, or
2. Goodwill, in the amount of the excess, or
3. A revaluation of partnership capital based on the
fair value implied by the excess.

Excess Payment: Bonus to Exiting
Partner
Ann Capital 8 blank
Mic Capital 4 blank
Cash blank 92
By treating the excess payment as a bonus to Jus,

Ann and Mic each have their capital accounts
reduced by their relative profit sharing ratios of
40:20 for the total amount of the $12,000 bonus
amount.

Excess Payment: Goodwill Recorded
Goodwill 12 blank
Cash blank 92
By treating the excess payment as an indication

that partnership assets were undervalued,
Goodwill is recorded. Note that Ann and Mic’s
capital accounts are not revalued.

Excess Payment: Used to Revalue
Partnership Capital
Goodwill 30 blank
Ann Capital blank 12
Mic Capital blank 6
Jus Capital blank 12
The excess payment is used to determine the implied fair
value of the partnership.
$12,000 excess / Jus’s 40% share =
implied partnership under-valuation of $30,000

Cash blank 92
The exiting partner is then paid the amount of his capital
account.

16.6: Limited Partnerships
Interests

Limited Partnerships
Limited partnerships must have one or more general
partners with unlimited liability for partnership debt.
There may be any number of limited partners.

● Excluded from participating in management
● Limited liability for partnership debt
● Partnership agreement must be in writing,
signed and filed

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Advanced Accounting

Thirteenth Edition, Global Edition

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

If Bec invests other assets, the value of those assets

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

For example: Col contributes assets of $50,000, and

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Cro, Capital 4,000 blank

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

In the Col and Cro partnership:

Use Col’s investment to determine implied value of

Col's 50%($100) $50 Cro's 50%($100) $50

Goodwill 8,000 blank

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Drawings and withdrawals reduce Capital.

Income Summary (Revenue and Expense Summary)

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Drawings/ Revenue and Expense Summary 34,500 blank

Income is shared between the partners. A loss

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Beginning capital + investments – drawings and/or

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Salary allowances are generally pre-determined

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

* Periodic drawings are often ignored, although

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Remaining profits (or deficit) are then split according

These are general procedures. The partnership

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Bonus = 50%(660 - 500) = 80

Allocation: 60%(415) = 249; 40%(415) = 166

Bonus = zero (income does not exceed $500)

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1. New partner purchases interest from existing

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Alf Capital 25 blank

blank Before blank blank After blank

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Implied value of firm, $50/.50 100

The goodwill increases Alf & Bal's capital by $5 each.

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Presumably, Cob paid $25 to Alf and $25 to Bal.

If the partners had decided to realign the capital, the

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

blank Before Transfer Final

Cob's capital is 50%(90) = $45.

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Alf Capital 22.5 blank

Cob Capital blank 45

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Implied value of firm, $50/(1/3) blank $150