Partnership Formation Accounting

PRINCIPLES OF ACCOUNTING II
CHAPTER 5
Accounting for Partnership Form of Organization
- A partnership is an unincorporated association of two or more individuals to carry on a
business for profit. Many small businesses, including retail, service, and professional
practitioners, are organized as partnerships.
Formation
- A partnership agreement may be oral or written. However, to avoid misunderstandings, the
partnership agreement should be in writing. The written agreement by which a partnership is
formed is called the articles of partnership (copartnership).
- The articles of partnership contains the following:
o Name of the business, location, purpose and duration of the partnership.
o Name, address and duties of each partner.
o Initial investments to be made by partners
o Methods of income or loss distribution
o Amount and timing of withdrawal of money
o Procedures for admission and withdrawal of partners
o Liquidation procedures.
- The partnership form is less widely used than the proprietorship and corporate forms.
Characteristics of Partnerships
- Partnerships have several characteristics that have accounting implications. Some of them
that distinguish it from a corporation are:
Characteristics of General Partnerships:
o It is a simple voluntary association– a person is not forced into a partnership
agreement against his will
o Mutual agency– every partner is an agent of the partnership and can enter into and
bind it to any contract within the normal scope of its business. This is why
partnerships should be formed only with people you trust.
o Limited life – the life of a partnership may be established as a certain number of years
by the agreement. If no such agreement is made, the death, inability to carry out
specific responsibilities, bankruptcy, or the desire of a partner to withdraw
automatically terminates the partnership. Every time a partner withdraws or is added,
a new partnership agreement is required if the business will continue to operate as a
partnership. With proper provisions, the partnership's business may continue and the
termination or withdrawal of the partnership will be a documentation issue that does
not impact ongoing operations of the partnership. Dissolution may or may not be
followed by liquidation (winding up of business).
o Unlimited liability– Each partner is personally and individually liable for all
partnership liabilities.
1 Principles of Accounting II, Summarized Lecture Note: Partnership

Types of partnership:
General partnership– A partnership in which all partners are individually liable
(general partners)
Limited partnership– Have two classes of partners, general and limited. The general
partners assume unlimited liability for the debts of the partnership. The limited
partners assume no personal liability beyond their invested amounts and cannot take
active role in managing the company.
A limited partnership must include at least one general partner who maintains
unlimited liability.
o Not subject to tax on income– no tax is levied as an organization on the partnership
because partnerships have no legal personality. Only the income distributed to
owners (partners) will be taxed as personal income tax. Thus, individual partners
must report their income share to tax authorities. However, revenue, expenses and
other financial details of the partnership operation must be reported annually to tax
authorities.
o Co-ownership of Property– all partnership assets are owned jointly by the partners
but claims on partnerships assets are based on their capital account. Unless an
agreement exists to the contrary, each partner has an equal right to the partnership
property. This claim does not attach to specific assets.
o Participation in income– net income/loss is distributed amount partners according to
their agreement. In the absence of any agreement, all partners share equally.
Advantages of a Partnership
o Ease of formation-- Other than registration of the business, a partnership has few
requirements to be formed.
o Non-taxable(single-taxation)
o Brings together more capital, skills, experience (relative to sole proprietorship)
o Share risk and cost of operating the business.
o Subject to less government rules and regulations than a corporation
o Gives freedom and flexibility to its partner’s action.
Disadvantages of a Partnership
o Unlimited liability—perhaps the greatest disadvantage of a partnership lies in the fact
that each partner may be held personally liable for all partnership debts. In this
respect a corporation has an advantage over partnership
o Limited life—by virtue of the limited life feature a partnership is subject to possible
termination due to many uncontrollable circumstances, such as death of a partner.
o Mutual agency— a partner who fails to exercise good judgment may bring loss for
partnership assets and possibly the loss of personal assets of other partners.
o Raising large amount of capital is difficult
o Ownership is not easily transferred. Although it is relatively easy to dissolve a
partnership, the transfer of ownership, whether to a new or existing partner, requires
approval of the remaining partners.
o Loss of freedom of action

Accounting for Partnership
- Accounting for partnerships is similar to other forms of business organization. The same
accounts are used, with the exception of capital accounts. Partnerships have separate drawing
and capital accounts for each partner. Income is distributed differently from other forms of
business organizations. The net income or loss is added to each capital account in the closing
process. Drawing accounts for each partner are closed to the capital account of each partner.
- In a partnership we have the following unique transactions/events.
1) Formation 3) Dissolution
2) Income division 4) Liquidation
- In the remaining sections of this chapter, we will discuss and illustrate these unique
transactions/events for a partnership.
1) Accounting for Formation of a Partnership:
- Each partner's investment is recorded at an agreed upon value, normally the fair market
value of the assets and liabilities at their date of contribution. Usually assets contributed have
fair values that differ from their historical cost in the separate records of each individual.
- The assets contributed by a partner are debited to the partnership asset accounts. If liabilities
are assumed by the partnership, the partnership liability accounts are credited. The partner’s
capital account is credited for the net amount of the investment.
- If plant assets are contributed, any existing accumulated depreciation accounts are not
assumed by the partnership. The partnership establishes and records the equipment at its
current fair market value and then begins depreciating the equipment over its useful life to
the partnership. Similarly, any allowance for doubtful accounts would not be transferred to
the partnership as the partnership would establish its own allowance account.
Example:
On January 3, year 2 Mr.A, B & C form a partnership. Mr. A contributed cash of
$15,000, B & C invested their sole proprietorship business with the following balance
sheet.
B,C
Balance Sheet
December 31, year 1
B C
Cash $5,000 $8,000
Accounts Receivable $4,500 $6,400
AFDA -200 4,300 -300 6,100
Merchandise Inventory 2,200 3,500
Store equipment 12,000
Office Equipment 7,500
Total Assest $23,500 $25,100
Accounts Payable $1,700 $4,000
Notes Payable 2,500
B - Capital 21,800
C - Capital 18,600
Total Liab.&Capital $23,500 $25,100
Fair value of B’s Assets
1) Receivables for $200 were agreed to be totally worthless and no allowance is taken by
the partnership
2) Merchandise inventory had a balance of $1,800
3) Store equipment had a balance of $13,000
Fair value of C’s Assets
1) Receivables for $150 were agreed to be totally worthless and the partnership accepted
allowance for uncollectible for $100.
2) Merchandise inventory had a balance of $4,000
3) Office equipment had a balance of $8,000
Required: Journalize the investment of each partner

Entries:
Jan. 3 Cash 15,000
A, Capital 15,000
To record investment by Mr. A
Jan. 3 Cash 5,000
Accounts Receivable(4500-200) 4,300
Merchandise Inventory 1,800
Store Equipment 13,000
Accounts Payable 1,700
B, Capital 22,400
To record investment by Mr. B
Jan. 3 Cash 8,000
Accounts Receivable(6400 – 150) 6,250
Merchandise Inventory 4,000
Office Equipment 8,000
Allowance for Uncollectible 100
Accounts Payable 4,000
Notes Payable 2,500
C, Capital 19,650
To record investment by Mr. C
2) Division of Income or Loss
- The partnership agreement should include how the net income or loss will be allocated to the
partners. The agreed way that a partnership’s income or losses are to be shared is called
income and loss ratio (profit and loss ratio or earnings and loss ratio).
- If the agreement is silent, the net income or loss is allocated equally to all partners.
- The method of distribution may consider several factors such as: level of investment, the
amount of service provided and talents/skills possessed by each partner.
- The three frequently used methods of sharing earnings are:
i) On a stated fractional/percentage basis-- The easiest way to divide earnings is to give
each partner an agreed-upon fraction/percentage of the total.(e.g., 3/4, 1/4; or 75%,
25% etc)

ii) Based on the ratio of capital investments---If the business is of a nature that earnings
are closely related to money invested, a division based on the ratio of partners'
investment (capital accounts) offers a fair sharing method. It can be beginning of the
year, end of the year, or average capital balance during the fiscal year.
iii) Based on salary and interest allowances and the remainder in a fixed ratio.
When capital contribution and service contribution of the partners are unequal, an
agreement may be reached whereby earnings are allocated first as "interest
allowance"—to recognize differences in investment level and then as "salary
allowance"— to recognize differences in service provided which includes time
devoted, abilities and skills possessed, and the remainder on a fractional basis.
- Note: In a legal sense, partners do not earn interest or salaries. These are, therefore, not
expenses of the business.These terms are used to reflect the basis for allocating earnings (i.e.,
"interest" is a return on investment and "salary" is a return for services). Therefore, there are
NO accounting entries for these allocations. The only entries that are made are for the final
distribution of income to the partners.
- Once net income is allocated to the partners, it is transferred to the individual partners' capital
accounts through closing entries. Remember that allocating net income does not mean the
partners receive cash. Cash is paid to a partner only when it is withdrawn from the
partnership. Note also that salary allowance is different from withdrawal.
- Each partner has the right to withdraw assets up to the level of his/her capital account
balance. If the partnership uses the accrual basis of accounting, the partners pay federal
income taxes on their share of net income, regardless of how much cash they actually
withdraw from the partnership during the year.
Example:
Mr. X invests $7,000 in cash, equipment with a fair value of $33,000 and a note payable for
$10,000 into XY Company. Mr. Y invests $10,000 cash to form a partnership in the
business. Determine their participation (share) in the year’s net income of $60,000 according
to each of the following assumptions and record the closing entries under each case.
a) No agreement concerning income and loss sharing
Income Allocation: X Y
Income to be allocated $60,000
Distribution- equally (1: 1) $30,000 $30,000 $60,000
b) Income is divided in the ratio of original investment
Distribution ratio (3 : 1) $45,000 $15,000 $60,000
c) Interest at the rare of 12% allowed on original investment and the reminder
divided equally
Interest Allow.(12% of $30,000 &$10,000) 3,600 1,200 4,800
Remainder equally (1 : 1) 27,600 27,600 55,200
Allocation to partners $31,200 $28,800 $ 60,000

d) Annual salary allowance of $5,000 and $12,000 respectively and the remainder
divided in a 3 : 2 ratio.
Salary allowance 5,000 12,000 17,000
e) Interest allowance at the rate of 12% on original investment and annual salary
allowance of $5,000 and $12,000 respectively and the remainder divided equally.
Income division- Allowances exceed net income
If net income is less than the sum of allowances, the remaining balance will be a negative
figure (deficit) that must be divided among the partners as though it were a net loss. In
allocating deficits (or losses) it is possible that one partner may loose while the other
gains.
f) Assume the same facts as case (e) above except change net income to $15,000.
Deficit(excess of allow. over NI) 1 : 1 (3,400) (3,400) (6,800)
Allocation to partners $5,200 $9,800 $15,000
Exercise 1:
 Two partners: L & M
 Income summary account shows a debit balance (Net loss) of $10,000
 Income sharing agreement: Annual salary allowances of $13,000 to L and $2,000 to M.
Any remaining balance of income or loss shared equally.
Required: Close the income summary account
Exercise 2:
 Partners X and Y have original investment of $160,000 and $140,000 respectively with
the following income sharing agreement:
- The first $30,000 is divided in the ratio of original investment
- The next $90,000 is allocated on the basis of service performed; $40,000 given to X and
$50,000 given to Y.
- Any excess is divided in the ratio of 8 : 2

Required:
i) If there is a net income of $236,000, X’s share is _____________
ii) If NI is $62,000, the amount allocated to Y is _______________
iii) If there is net loss of $32,000, X’s capital would be ________________ and Y’s capital
would be ___________
Financial Statement of a Partnership

- Financial reporting is similar to other forms of organizations. The differences are generally
related to the fact that a number of owners are involved in a partnership.
- In a balance sheet, for instance, each partner’s capital balance is reported. The income
statement for a partnership is identical to the income statement for a proprietorship.
- Partnerships must provide information on how net income/loss was distributed among
partners. This information can be combined with the balance sheet or the income statement.
If desired, it can also be reported separately.
- The changes of a partner's capital can be found in the statement of partners’ capital which
shows the changes in each partner's capital account for the year or period being reported on.
It has the same format as the statement of owner's equity except that it includes a column for
each partner and a total column for the company rather than just one column. The statement
of partners' capital is presented below with assumed figures.
AB Company
Partners' Capital Statement
For the Year Ended December 31, Year 4
Mr. A Mr. B Total
Capital balances, Jan.1, Year 4 $50,000 $100,000 $150,000
Add: Investments 25,000 10,000 35,000
Net Income 40,000 40,000 80,000
Less: Withdrawals -45,000 -30,000 -75,000
Capital balances, Dec.31, Year 4 $70,000 $120,000 $190,000
Dissolution of a Partnership
- Change in ownership because of admitting a new partner and withdrawal of existing partner
by retirement or death results in legal dissolution of the existing partnership and the
beginning of a new partnership and preparation of a new articles of partnership. This is
based on the fact that a partnership is an agreement between specific individuals. Dissolution
may also result from the bankruptcy of the firm or of any partner, the expiration of a time
period stated in the partnership contract.
- From an economic point of view, however, the change in partners may be of minor
significance in the continuity of the business. The partnership often continues with little
outward evidence of change.
- Thus, the term dissolution may be used to describe events ranging from a minor change of
ownership interest not affecting operations of the partnership to a decision by the partners to
terminate the partnership.

Admitting a Partner
- A person may be admitted to a partnership only with the consent of all the current partners
by:
o Purchasing an interest from one or more of the current partners
o Contributing assets to the partnership
Admission of a New Partner by Purchase of Interest

- When a new partner purchases an interest directly from an existing partner, the partnership’s
assets and liabilities and capital (in total) remain unchanged. This is because the exchange of
cash and other assets for the equity interest is a personal transaction between two
individuals, occurring outside the partnership.
- The entry on the partnerships books simply transfers a portion of the partnership capital from
the outgoing partner to the incoming partner.
Example:
X, Y and Z are partners with capital balances of $30,000 and $40,000, and $60,000
respectively. Mr.A purchased 100% of the capital interest of Mr. X for $35,000 and 10%
of the capital interest of Mr. Z for $5,000.
Required:
1. Record the admission of Mr. A
2. Calculate the new capital balance of each partner
3. Given liabilities of $27,000, compute total assets before and after admission of Mr. A
1) X, Capital 30,000
Z, Capital 6,000
A, Capital 36,000
2) Partners Capital Balance

A $36,000
Y 40,000
Z 54,000
Total $130,000
Note that after Mr. A is admitted, the total owners’ equity of the firm is still $130,000
3) Total Assets = $27,000 + $130,000 = $157,000 both before and after admitting A
Note: the price that Mr. A paid might be more or less than $36,000, but this
difference is not reflected on the books of the partnership since there is no flow of
assets to or from the partnership. Note also that the extent of A’s share in partnership
net income will be determined by the partnership agreement not by his share of
equity.
Admission of a Partner by Investment of Assets
- The assets and liabilities invested in the partnership should be recorded at their fair market
value at the date of investment in the partnership, and establish a capital account for the new
partner. Thus, total assets and total capital of the partnership will increase.

- The amount recorded as capital for the new partner depends on his ownership interest (share
of equity) in the partnership. With this regard we can have three possible situations.
a) Ownership interest is equal to amount invested.
b) Ownership interest is less than the amount invested.-premium given to old
partners—this happens if an existing partnership is very attractive because it
consistently earns above-average income
c) Ownership interest is greater than the amount invested.- premium given to new
partner —happens because either an incoming partner may be able to provide
cash that is desperately needed by the business, or may have extraordinary
abilities or business contacts that can help increase the partnership’s income.
- There are two methods to treat premium given to either party: bonus and goodwill.
Premium given to old partners

Goodwill treatment:
- New asset is recognized by the partnership (goodwill) and allocated to old partners based on
their income sharing ratio. Thus the capital of older partners is inceased(credited).
- Thus, increase in total asset and capital for the partnership is equal to goodwill plus
investment by new partner.
- Capital of new partner = his investment
Bonus treatment:
- The bonus is deducted from the new partner’s investment and added (allocated) to the old
partners’ capital account according to their income sharing ratio.
- Thus, increase in total asset and capital for the partnership is equal to investment by new
partner.
- Capital of new partner < his investment (i.e, investment – bonus)
Premium given to new partner

Goodwill treatment:
- New asset is recognized by the partnership (goodwill) and entirely given to new partner. So
capital of old partners remains unchanged.
- Thus, increase in total asset and capital for the partnership is equal to investment by new
partner plus goodwill to new partner.
- Capital of new partner > his investment (i.e, investment + goodwill)
Bonus treatment:
- The bonus is deducted from the old partners’ capital according to their income sharing ratio
and given to the new partner thus increasing the new partner’s ownership interest (capital)
above his investment.
- Capital of new partner > his investment (i.e, investment + bonus)
- Thus, increase in total asset for the partnership is equal to investment by new partner.

Example:
The capital balances of an existing partnership are:
Partners Capital Balance Profit/ loss sharing ratio
A $20,000 26%
Note: To keep B 32,000 34% the examples
focused we C 48,000 40% will assume
that the Total $100,000 100% existing
partnerships assets and liabilities are recorded at their fair values prior to the admission of
the partner.
Required: Journalized the transaction under the following independent cases.
a) Ownership interest is equal to amount invested
i) Partner D was admitted by investing $25,000 worth of equipment for a 20% interest
in the partnership. Journalize the admission of D
Equipment 25,000
D, Capital 25,000
Note: The share of equity is the claim to assets of the business. D’s share of income
and losses is a separate matter and, as discussed earlier, may have no relationship to
capital ratios
b) Ownership interest is less than the amount invested
ii) If D received a 16% interest in the partnership, journalize the admission of D using
the two alternatives for treatment of any premium.(we have premium to old
partners )
Premium to old partners as goodwill:
0.16 × Total Capital of partnership = Capital of new partner
0.16 × ($125,000 + G) = $25,000
20,000 + 0.16G = $25,000
G = $5,000 = $31,250
0.16
Note that the value of the partnership is = $125,000 + $31,250 = $156,250
Distribution of goodwill:
To A ($31,250 × 26%) $8,125
To B ($31,250 × 34%) 10,625
To C ($31,250 × 40%) 12,500 $31,250
Entry:
Equipment 25,000
D, Capital 25,000
To record the investment of D
Goodwill 31,250
A, Capital 8,125
B, Capital 10,625
C, Capital 12,500
To record goodwill
Premium to old partners as bonus:

0.16 × $125,000 = $25,000 − B
$20,000 − $25,000 = B
B = $5,000
Division of bonus:
To A ($5,000 × 26%) $1,300
To B ($5,000 × 34%) 1,700
To C ($5,000 × 40%) 2,000 $5,000
Entry:
Equipment 25,000
A, Capital 1,300
B, Capital 1,700
C, Capital 2,000
D, Capital(25,000 – 5,000) 20,000
To record investment by D and bonus
Example:
c) Ownership interest is greater than the amount invested
The capital balances of an existing partnership are:
Partners Capital Balance Profit/ loss sharing ratio
X $50,000 50%
Y 60,000 50%
Total $110,000 100%
Z is admitted by investing cash of $20,000 for an interest of 20 %( here we have
premium to new partner)
Note: To keep the examples focused we will assume that the existing partnerships assets
and liabilities are recorded at their fair values prior to the admission of the partner.
Required: Journalized the transaction using the two alternatives for the treatment of the
premium.
Solution:
Premium to new partner as goodwill:
0.2 × ($130,000 + G) = $20,000 + G
$26,000 + 0.2G = $20,000 + G
$6,000 = 0.8G
G = $6,000 = $7,500
0.8
Entry: Cash 20,000
Goodwill 7,500
Z, Capital 27,500

Premium to new partner as bonus:
0.2 × $130,000 = $20,000 + B
$26,000 = $20,000 + B
B = $6,000
Division of bonus:
To X ($6,000 × 50%) $3,000
To Y ($6,000 × 50%) 3,000 $6,000
Entry: Cash 20,000

X, Capital 3,000
Y, Capital 3,000
Z, Capital 26,000
Revaluation of Asset
- Before recording the new partners’ investment and crediting his capital, there may be
revaluation of assets of the partnership to reflect fair market value at the date of change in
ownership. Since a change in ownership creates a new partnership, this practice is justifiable.
This was assumed to have been completed in the previous examples. The net adjustment
(increase or decrease) in asset values is divided among the capital accounts of the existing
partners according to their income-sharing ratio.
Example:
G and H have a partnership sharing profit and losses equally. Before admitting K, they
determined that the partnership’s land and equipment with a carrying amount of $85,000 and
$14,000 are now worth $130,000 and $9,000 respectively. Record the revaluation of the
assets for the partnership
Land 45,000
Equipment 5,000
G, Capital 20,000
H, Capital 20,000
- If a number of assets are revalued, the adjustments may be debited or credited to a temporary
account entitled Asset Revaluations which at the end will be closed to the capital accounts.
- As an alternative to revaluation of the existing partnership assets, it may be preferable to
evaluate any discrepancies between the carrying amounts and current fair values of assets
and adjust the terms of the admission of the new partner. In this way, the amount invested by
the incoming partner may be set at a level that reflects the current fair value of the
partnership, even though the carrying amounts of existing partnership assets remain
unchanged.

Retirement or Withdrawal of a Partner
- If an existing partner wishes to retire or withdraw from the partnership, the partner may be
bought out by an existing partner or may receive assets from the partnership.
- If an existing partner purchases the interest of the retiring partner, the partnership records an
entry to close out the capital account balance of the retiring partner and adds the amount to
the capital account balance of the partner who purchased the interest. The transaction is
between individuals, in a manner similar to the admission of a new partner by purchase of an
interest, and thus is not recorded by the partnership.
- If the partnership gives assets to the retiring partner, the effect is to reduce the assets and
owner’s equity of the firms. To determine the ownership equity of the withdrawing partner,
the asset accounts should be adjusted to current market prices and the net amount (gain/loss)
is allocated among the capital accounts of the partners in the income sharing ratio. In the
event that the cash or the other available assets are insufficient to make complete payment at
the time of withdrawal, a liability account should be credited for the balance owed to the
withdrawing partner. After the equity of the retiring partner has been computed in terms of
current fair values for assets, we can have the following three possible situations:
1. Withdraws and takes cash equal to the partner's capital account balance− an entry
is made to reduce the assets and zero out the retiring partner's capital account
balance.
2. Withdraws and takes cash less than share equity (gain/bonus to remaining
partners)− the gain is added to the capital accounts of the remaining partners
according to how they share in gains or losses.
3. Withdraws and takes cash greater than share equity (loss to remaining partners
(bonus to withdrawing partner)) − the loss is deducted from the capital accounts
of the remaining partners according to how they share in gains or losses.
Example:
K, L and M have a partnership sharing income/loss equally. On January 4, K, with a
capital balance of $38, 000, decides to withdraw.
Required: Record the withdrawal of K under the following separate condition:
a) K withdraws and takes cash equal to his capital.
Entry:
Jan. 4 K, Capital 38,000
Cash 38,000
To record withdrawal from partnership by K
b) K withdraws and agrees to take $34,000 cash in settlement of his equity.
Entry:
Cash 34,000
L, Capital 2,000
M, Capital 2,000
* Note: K received $34,000 for his equity valued at $38,000. Therefore, there is a gain
of $4,000 on the transaction. As per the agreement, this gain has been split equally
between the remaining partners.

c) K withdraws and agrees to take $40,000 cash in settlement of his equity.
Entry:
L, Capital 1,000
M, Capital 1,000
Cash 40,000
* Note: K received $40,000 for his equity valued at $38,000. Therefore, there is a loss of
$2,000 on the transaction. As per the agreement, this loss has been split equally
between the remaining partners.
Liquidation of a Partnership
- Liquidation is winding up of business operation because of achievement of goal, expiry of
time period, bankruptcy etc
- If the partnership decides to liquidate, it follows the following procedures:
Step1. Sell noncash assets for cash.
Step2. Allocate gain/loss on realization to the partners based on their income ratios.
Step3. Pay partnership liabilities in cash.
Step4. Distribute remaining cash to partners on the basis of their capital balances.
If a partner's capital account has a deficit balance, that partner should contribute
the amount of the deficit to the partnership. If it is impossible to collect the
deficit, it will be assumed by the remaining partners based on their profit and loss
ratio.
If the assets are sold piecemeal, the liquidation process may be prolonged and
more than one cash distribution may be made to the partners.
Example:
ABC Partnership is being liquidated on April 30, year 5. A, B and C’s income ratios
are 30%, 30% and 40%, respectively. On April 9, after discontinuing business
operations of the partnership, the following condensed balance sheet was prepared.
ABC Partnership
Balance Sheet
April 9, Year 5
Assets: Liabilities & Equities:
Cash $10,000 Accounts Payable $30,000
Noncash assets 70,000 A, Capital 15,000
B, Capital 10,000
C, Capital 25,000
Total assets $80,000 Total liab. & Equities $80,000

Required:
Prepare Statement of Partnership Liquidation and journalize all the necessary entries
under each of the following independent assumption. All the noncash assets were sold
between April 10 and April 30 of year 5.
a) All the noncash assets were sold for $100,000.
b) All the noncash assets were sold for $50,000.
c) All the noncash assets were sold for $30,000 and the partner with capital
deficiency is personally solvent
d) All the noncash assets were sold for $30,000 and the deficient partner can pay
only 50% of the deficiency
Solution
a) Gain on realization = $100,000 - $70,000 = $30,000
ABC Partnership
Statement of Partnership Liquidation
For Period April 10 -30, Year 5
Noncash Capital
Cash + Assets = Liabilities + A B C
Balance before realization $10,000 $70,000 $30,000 $15,000 $10,000 $25,000
Realization & distribution +100,000 -70,000 _______ +9,000 +9,000 +12,000
Balance $110,000 $0 $30,000 $24,000 $19,000 $37,000
Payment of creditors -30,000 ______ -30,000 ______ ______ ______
Balance $80,000 $0 $0 $24,000 $19,000 $37,000
Distribution of cash to partners -80,000 ______ ______ -24,000 -19,000 -37,000
Balance $0 $0 $0 $0 $0 $0
Entries:
1. Cash 100,000
Noncash assets 70,000
Gain on Realization 30,000
To record sale of noncash assets
2. Gain on Realization 30,000
A, Capital 9,000
B, Capital 9,000
C, Capital 12,000
To record division of gain
3. Liabilities 30,000
Cash 30,000
To record payment of liabilities
4. A, Capital 24,000
B, Capital 19,000
C, Capital 37,000
Cash 80,000
To record distribution of cash to partners

Note: We can make an entry without introducing the gain or loss account if we
directly allocate it to capital of partners
The amount of cash to which each partner is entitled in liquidation cannot be
determined until each capital account has been increased or decreased by the
proper share of the gain or loss on disposal of the assets.
b) Loss on realization = $70,000 - $50,000 = $20,000
ABC Partnership
Noncash Capital
Realization & distribution +50,000 -70,000 _______ -6,000 6,000 -8,000
Balance $60,000 $0 $30,000 $9,000 $4,000 $17,000
Balance $30,000 $0 $0 $9,000 $4,000 $17,000
Distribution of cash to partners -30,000 ______ ______ -9,000 -4,000 -17,000
Balance $0 $0 $0 $0 $0 $0
Entries:
1. Cash 50,000
Loss on Realization 20,000
2. A, Capital 6,000
B, Capital 6,000
C, Capital 8,000
To record division of loss
Cash 30,000
4. A, Capital 9,000
B, Capital 4,000
C, Capital 17,000
Cash 30,000
Note: We have loss on realization; but no capital deficiency. Each partner’s
capital was more than enough to absorb the appropriate share of the loss from
realization.

c) Loss on realization = $30,000 - $70,000 = $40,000
ABC Partnership
Noncash Capital
Realization & distribution +30,000 -70,000 _______ -12,000 -12,000 -16,000
Balance $40,000 $0 $30,000 $3,000 -2000 $9,000
Balance $10,000 $0 $0 $3,000 -2000 $9,000
Collection from B +2,000 ______ ______ ______ +2,000 _____
Balance $12,000 $0 $0 $3,000 $0 $9,000
Distribution of cash to partners -12,000 ______ ______ -3,000 ______ -9,000
Balance $0 $0 $0 $0 $0 $0
Entries:
1. Cash 30,000
2. A, Capital 12,000
B, Capital 12,000
C, Capital 16,000
Cash 30,000
4. Cash 2,000
B, Capital 2,000
To record collection of cash from B
5. A, Capital 3,000
C, Capital 9,000
Cash 12,000
Note: If total loss distributed to a partner is greater than his capital balance, the result will
be a debit balance in the capital account which is a deficiency (a claim of the partnership
against the partner).

d) Loss on realization = $30,000 - $70,000 = $40,000
Only the section of the statement of liquidation where we have a difference is
presented below:
Balance after payment of creditors $10,000 $0 $0 $3,000 -2000 $9,000
Collection from B +1,000 ______ ______ ______ +1,000 _____
Balance $11,000 $0 $0 $3,000 -$1,000 $9,000
Absorption of deficit by A & C ______ _______ _______ -428.57 +1,000 -571.43
Balance $11,000 $0 $0 $2,571.43 $0 $8,428.57
Distribution of cash to partners -11,000 ______ ______ -2571.43 ______ -8,428.57
Balance $0 $0 $0 $0 $0 $0
Entries:
1 , 2,& 3 have no change
4. Cash 1,000
B, Capital 1,000
5. A, Capital 428.57
C, Capital 571.43
B, Capital 1,000
To record absorption of B’s deficit
6. A, Capital 2,571.43
C, Capital 8,428.57
Cash 11,000
- There may be a situation whereby one (or more) of the partners end up with a deficiency in
their capital account(s). If the deficiency can be repaid, the cash account increases and the
capital account of the deficient partner is brought to zero. If the deficiency cannot be repaid,
the other partners must absorb this loss in their NEW ratios with each other. These scenarios
may be found multiple times in a liquidation of a partnership. Only when all capital account
balances are zero or in a positive balance will the cash be distributed among the remaining
partners.

Partnership Formation Accounting

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Partnership Formation Accounting

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PRINCIPLES OF ACCOUNTING II

1 Principles of Accounting II, Summarized Lecture Note: Partnership

2 Principles of Accounting II, Summarized Lecture Note: Partnership

Required: Journalize the investment of each partner

4 Principles of Accounting II, Summarized Lecture Note: Partnership

5 Principles of Accounting II, Summarized Lecture Note: Partnership

Required: Close the income summary account

6 Principles of Accounting II, Summarized Lecture Note: Partnership

Financial Statement of a Partnership

7 Principles of Accounting II, Summarized Lecture Note: Partnership

Admission of a New Partner by Purchase of Interest

2) Partners Capital Balance

8 Principles of Accounting II, Summarized Lecture Note: Partnership

Premium given to old partners

Premium given to new partner

9 Principles of Accounting II, Summarized Lecture Note: Partnership

0.16 × Total Capital of partnership = Capital of new partner

11 Principles of Accounting II, Summarized Lecture Note: Partnership

Entry: Cash 20,000

12 Principles of Accounting II, Summarized Lecture Note: Partnership

13 Principles of Accounting II, Summarized Lecture Note: Partnership

14 Principles of Accounting II, Summarized Lecture Note: Partnership

15 Principles of Accounting II, Summarized Lecture Note: Partnership

16 Principles of Accounting II, Summarized Lecture Note: Partnership

17 Principles of Accounting II, Summarized Lecture Note: Partnership

18 Principles of Accounting II, Summarized Lecture Note: Partnership

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