Foa CH V P.ship 2021

Chapter 5: Accounting for Partnership Form Business Organizations
Accounting for Partnership Form Business Organizations

Chapter Outlines:
This chapter covers the following topics:
 Basics of Partnership
 Accounting for Partnership
 Dissolution of a Partnership
 Liquidation of a Partnership
Chapter Learning Objectives
After studying this chapter, you should be able to:
 Identify the characteristics of the partnership form of business organization.
 Explain the accounting entries for the formation of a partnership.
 Identify the bases for dividing net income or net loss.
 Describe the form and content of partnership financial statements.
 Explain the effects of the entries when a new partner is admitted.
 Describe the effects of the entries when a partner withdraws from the firm.
 Explain the effects of the entries to record the liquidation of a partnership.
5.1 Basics of Partnership
Definition:
Partnership is defined as a voluntary association of two or more persons to carry on as co-
owners a business for profit.
Characteristics of Partnership:
 It is based on a contract – all that is necessary is for two more legally competent people
to agree to become partners. This agreement becomes a partnership contract.
 Limited life – the life of a partnership is always limited. Death, bankruptcy or anything
that takes away the ability of one of the partners to contract automatically ends a
partnership.
 Unlimited liability – most partnerships are general partnerships in which each partner is
individually liable to creditors for debts incurred by the partnership if it becomes
insolvent.
 Mutual agency – each partner is an agent of the partnership with the authority to enter in
to contracts for the partnership, the act of each partner binds the partnership.
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 Participation in income – net income or net loss are distributed among the partners
according to agreement
 Co-ownership of property – the property invested in a partnership by a partner becomes
the property of all the partners jointly.
 Non taxable entity – partnership is not required to pay federal income taxes.
Advantages and Disadvantages of Partnership
Advantages:
 It is relatively easy and inexpensive to organize partnership. It is requiring only an
agreement between two or more persons.
 Ability to bring together more capital more managerial skills and more experience than
would a sole proprietorship
 It is a non taxable entity
Disadvantages:
 Its life is limited
 Has unlimited liability
 One partner can bind the partnership to contract
 Raising large amounts of capital is more difficult
Types of Partnership:
 Limited Partnership: is a type of Partnership in which partners have limited liability
and have no active participation in management of the business. It is with at least one
general partner.
 General Partnership: is a type of Partnership in which partners are responsible for
the debt of the business and have participated actively in management with unlimited
liability. It has all general partners.
5.2. Accounting for Partnership
Partnership accounting requires the use of separate capital account and withdrawal account
for each partner.
1. Recording Initial Investments
A separate entry is made for the investment of each partner in a partnership. The various
assets contributed by the partner are debited to the proper asset accounts. If liabilities are
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assumed by the partnership, the appropriate liability accounts are credited. All assets other
than cash should be valued at fair market values at the date of investment.
Example 5.1: assume that Rita and Katherine agreed on January 1, 2002 to form a
partnership named RK Company. Rita invested Br 8,000 Cash, Br 35,000 furniture, Br
12,000 merchandise and Br 15,000 notes payable is assumed by the partnership which is
related to Rita. Katherine invested Br 30,000 Cash and Br 20,000 accounts receivable with
the provision for uncollectible accounts of Br 8,000. Required: Record the investment by the
two owners
Investment of Rita:
Cash................................................................. 8,000
Furniture..........................................................35,000
Merchandise Inventory.....................................12,000
Notes Payable.................................. 15,000
Rita, Capital...................................... 40,000
Investment of Katherine:
Cash.................................................................
30,00
0
Accounts Receivable....................................... 20,00
0
Allowance FDA............................... 8,000
Katherine, Capital........................... 42,000
The combined journal entry is as follows:
Cash.................................................................38,000
Accounts Receivable.......................................20,000
Furniture..........................................................35,000
Merchandise Inventory.....................................12,000
Notes Payable................................... 15,000
Allowance FDA................................ 8,000
Rita, Capital...................................... 40,000
2. Division of Net Income or Net Loss
If each partner is to contribute equal services and amounts of capital, an equal sharing in
partnership Net Income would be equitable. But if one partner is to contribute a larger
portion of capital or capital or the services of one partnership, provision for this should be
given recognition in the division on net income or net loss, it should be noted that division on
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net income or net loss among the partners in exact accordance with their partnership
agreement is of the utmost importance, if the agreement is silent on the division on net
income or net loss, the law provides that all partners share equally, regardless of differences
in amounts of capital contributed, or special skill possessed or of time devoted to the
business. The partners may however, make any agreement they wish in regard to the division
of net income and net losses.
A) Income division recognizing services of partners
Example 5.2: assume that the articles of partnership of Rita and Katherine provides for
monthly salary allowances of Br 2,500 and Br 1,500, respectively with the balance of the Net
Income to be divided equally and that the net income for the year is Br 80,000. Instruction:
prepare a schedule of income division and record the income division
Net Income.....................................................Br 80,000

Division of NI Rita Katherine Total
Salary Allowance 30,000 18,000 48,000
Remaining Income 16,000 16,000 32,000
Net Income to each 46,000 34,000 80,000
The division of net income is recorded as a closing entry, regardless of whether the partners
actually withdrew the amounts of their salary allowances. The entry for the division of Net
Income is closed as follows:
Income Summary............................................80,000
Rita, Capital..................................... 46,000
If they had withdrawn their salary allowances monthly, the withdrawals would have
accumulated as debits to the drawing account of each partner during the year. Recording the
drawing of the two partners each month is as follows:
Rita, Drawing.................................................. 2,500
Katherine, Drawing......................................... 1,500
Cash................................................ 4,000
At the end of the year, the drawing account of Rita and Katherine has a debit balance of Br
30,000 and 18,000, respectively. The closing entry appears as follows:
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Rita, Capital.....................................................
30,000
Katherine, Capital............................................
18,000
Rita, Drawing..................................... 30,000
Katherine, Drawing............................ 18,000
B) Income division recognizing services and partners investment
Example 5.3: The net income of Rita and Katherine for the year is Br 80,000. Further
assume that Rita and Katherine:
 are allowed a monthly salary of Br 2,500 and Br 1,500, respectively
 are allowed interest at a rate of 10% on their Capital balance at the beginning of period
 agreed to divide the remaining income equally
Instruction: prepare a schedule of income division assuming the net income is Br 80000 and
record the income division
Net Income.....................................................Br 80,000
Interest Allowance 4,000 4,200 8,200
Remaining Income 11,900 11,900 23,800
The closing entry for the division of Net Income is as follows:
Income Summary............................................80,000
Rita, Capital..................................... 45,900
C) Income Division-Allowances Exceed Net Income
When a NI is less than the total of special allowances the remaining negative balance will be
divided among the partners as if it is a net loss.
Example 5.4: The net income of Rita and Katherine for the year is Br 50,000. Further
assume that Rita and Katherine agreed:
 to have monthly salary of Br 2,500 and Br 1,500, respectively
 to have interest allowance at a rate of 10% on their beginning Capital balance
 to divide the remaining income equally
Instruction: prepare a schedule of income division
Net Income.....................................................Br 50,000
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Interest Allowance 4,000 4,200 8,200
Total Allowance 34,000 22,200 56,200
Excess Allowance (3,100) (3,100) (6,200)
The entry for the division of Net Income is closed as follows:
Income Summary............................................50,000
Rita, Capital..................................... 30,900
5.3. Statement of Partnerships
Details of the division of net income should be disclosed in the financial statement prepared
at the end of the accounting period. Prepare a statement of Partnership for Rita and Katherine
assuming a net income of Br 80,000 and Rita and Katherine agreed:
 to have a monthly salary of Br 2,500 and Br 1500, respectively
 to have interest allowance at a rate of 10% on their beginning Capital balance
 to divide the remaining income equally
 to withdraw all their monthly salary allowances
 the investment was made according to example 5.1 above on January 1, 2002
RK Partnership
Statement of Partnership
For the Year Ended December 31, 2002
Rita Katherine Total
Capital, January 1, 2002................................. 40,000 42,000 82,000
Additional Investment.................................... 0 0 0
Sub-total......................................................... 40,000 42,000 82,000
Net Income for the year................................. 45,900 34,100 80,000
Sub-total......................................................... 85,900 76,100 162,000
........................................................................
Withdrawals during the year.......................... (30,000) (18,000) (48,000)
Capital, December 31, 2002........................... 55,900 58,100 114,000
5.4. Dissolution of Partnership
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The admission on new partner/s; the death of existing partner/s or withdrawals of existing
partner resulted in dissolution of a partnership. Dissolution of a partnership does not
necessarily mean winding up the affairs of the business rather it is a stepping stone either to
wind up the business or to introduce changes to partnership.
A) Admission of a Partner/s
There are two procedures through which a new partner may be admitted to an existing
partnership which will be discussed as follows:
1. By Purchase of a Capital Interest
In this procedure the capital interest of the incoming partner is obtained from current partners
by purchasing an interest which is directly paid to the selling partner/s. by purchasing an
interest neither the total asset nor the total owner’s equity of the partnership will be affected.
The only entry needed is to transfer the proper amounts of owner’s equity from the capital
accounts of the selling partner/s to the capital account of the incoming partner.
Example 5.5: Getahun, Tibebu, and Abraham were operating a partnership called GTA
Partnership. Asfaw purchased 20% Capital Interest of Getahun at Br 20,000, ¼ Capital
interest of Tibebu at Br 30,000 and 30% capital interest of Abraham at Br 40,000. The capital
of Getahun, Tibebu and Abraham is Br 50,000, Br 80,000 and Br 70,000, respectively.
Instruction: record the transaction to transfer the capital interest from the current partners to
the incoming partner
 Getahun- 50000 * 20%=.......................... Br 10,000
 Tibebu- 80000 * ¼ =................................ 20,000
 Abraham- 70000 * 30%= ........................ 21,000
 Total to be transferred.............................. Br 51,000
The Accounting Entry would be:
Getahun, Capital..............................................
10,000
Tibebu, Capital................................................
20,000
Abraham, Capital.............................................
21,000
Asfaw, Capital.................................... 51,000
2. By Contribution of Asset
Instead of buying an interest from the existing partners, the incoming partner/s may
contribute assets to the partnership. In this procedure both the total asset and the total
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owner’s equity of the firm increased. The contribution of assets is recorded as in the same
way of recording investment.
Example 5.6: Beza and Ruth are partners with capital accounts Balance of Br 50,000 and
40,000, respectively. On January 1, Zaid invested Br 30,000 Cash and Br 10,000 equipment
in the business. Instruction: record the admission of the new partner.
Cash.................................................................
30,000
Equipment.......................................................
10,000
Zaid, Capital....................................... 40,000
In the admission of new partner, always the two common things are revaluation of assets and
recognition of goodwill attributed to the incoming or existing partners. If the old partnership
has exceptionally high profit earning year after year, the existing partners may require the
incoming partner/s to make a higher investment for a lower capital interest (Payment of
Bonus to old Partners).
Revaluation of Assets
If the Partnership assets are not fairly stated in terms of current market value at the time a
new partner is admitted, the accounts may be adjusted accordingly. The net income of the
increases and decreases in asset values are then allocated to the capital accounts of the old
partners according to their income sharing ratio.
Example 5.7: before revaluation the balance of merchandise inventory accounts in A and B
Partnership showed Br 20,000 balance. The current market value of the merchandise is Br
30,000 and the income sharing ratio is 6:4. Instruction: journalize the necessary entries
Merchandise Inventory....................................
10,000
A, Capital............................................ 6,000
B, Capital............................................ 4,000
Example 5.8: what if the market value of the merchandise is Br 15,000 instead of Br 30,000
in the above example 5.7
A, Capital.........................................................
3,000
B, Capital.........................................................
2,000
Merchandise Inventory....................... 5,000
If number assets are revalued, the adjustment may be debited or credited to a temporary
account called Asset Revaluations.
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Example 5.9:
Before Revaluation After Revaluation
Merchandise Inventory..................................
Br 20,000 Br 30,000
Accounts Receivable......................................
30,000 25,000
Equipment (Net).............................................
40,000 30,000
Building (Net)................................................
80,000 100,000
Instruction: journalize the necessary entry assuming that the two partners A and B have a
profit sharing ratio of 6:4
Merchandise Inventory..................................
10,000
Asset Revaluations................................10,000
Asset Revaluations.........................................
5,000
Accounts Receivable.............................5,000
10,000
Equipment (Net)....................................10,000
Building (Net)................................................
20,000
Asset Revaluations................................20,000
15,000
A, Capital..............................................9,000
B, Capital..............................................6,000
Recognition Goodwill
When a new partner is admitted to partnership goodwill attributable either to the old
partnership or the incoming partner may be recognized. Example 5.10: Leila is admitted to
the partnership of Jemal and Kedir by Investing Br 35,000. If the existing partners agreed to
recognize Br 5,000 Goodwill attributable to Leila, record the recognition of goodwill.
Goodwill..........................................................
5,000
Cash.................................................................
35,00
0
Leila, Capital...................................... 40,000
Example 5.11: The Income sharing ratio X and Y is 3:7. Mr. Z is admitted to the Partnership
by Investing Br 30,000 cash and the incoming partner agreed to recognize goodwill of Br
5,000 which is attributable to the existing partners. Record the transaction
Cash.................................................................
30,000
Goodwill..........................................................
5,000
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X, Capital............................................ 1,500
Y, Capital............................................ 3,500
Z, Capital............................................ 30,000
Bonus Method
Allowing Bonus to former or existing partners
Abebe and Kebede are members of a highly successful partnership. Presently, each has a
capital interest of Br 100,000. Mary desires to join the firm and offers to invest Br 100,000
for a one fourth interest in capital and profit. Instruction: record the admission of Mary.
 Total Capital of old partners.................... Br 200,000
 Investment of new Partner....................... 100,000
 Total new partnership Equity................... 300,000
 Equity of Mary (1/4 * Br 300,000........... Br 75,000
Bonus = Investment minus Capital Interest = Br 100,000 – 75,000 = Br 25,000 bonus to old
partners to be shared equally.
Cash.................................................................
30,000
Abebe, Capital.................................... 12,500
Kebede, Capital.................................. 12,500
Mary, Capital...................................... 75,000
Allowing Bonus to the incoming partner/s
B) Withdrawal of a Partner
When a partner retires or for some other reason wishes to withdrew from the firm, one or
more of the remaining partners may purchase the withdrawing partner’s interest and the
business may be continued without interruption. If settlement for the purchase and sale is
made between the partners in a manner similar to the admission of a new partner by purchase
of an interest, the accounting entry to record withdrawal would be as follows:
Outgoing Partner, Capital................................
xxxx
Remaining Partner, Capital................ xxxx
If the settlement with the withdrawing partner is made by the partnership, the effect is to
reduce the asset and the total owner’s equity of the partnership. In this case:
 The asset accounts should be adjusted to current assets
 The net amount of the adjustment should be divided among the capital accounts of the
partners according to the income sharing Ratio
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 A payment will be made to the withdrawing partner
Example 5.12: If the Income Sharing Ratio of A, B and C are 4:4:2, respectively. Make the
necessary journal entries assuming that:
 The asset revaluation Account has a credit balance of Br 10,000
 If a Goodwill of Br 15,000 is created
 If Partner C withdrew his Capital which has a beginning Capital Balance of Br 30,000
before revaluation and recognition of goodwill and the payment is made out of the
partnership.
Assets Revaluations.........................................
10,000
A, Capital............................................ 4,000
B, Capital............................................ 4,000
C, Capital............................................ 2,000
Goodwill..........................................................
15,000
A, Capital............................................ 6,000
B, Capital............................................ 6,000
C, Capital............................................ 3,000
C, Capital.........................................................
35,000
Cash.................................................... 35,000
C) Death of a Partner
The death of a partner dissolves the partnership. In the absence of any contrary agreement,
the accounts should be closed as of the date of death, and the net income for the fractional
part of the year should be transferred to the capital accounts.
5.5. Liquidation of Partnerships
The process of winding up or terminating the affairs of the partnership may generally be
called liquidation. When a partnership goes out of the business, the following activities will
occur:
 It usually sells the non cash assets. The sale of the non cash assets is called Realization
 Gain or Loss on the Realization is distributed as per income sharing ratio
 Pays the Creditors and
 Distributes the remaining cash or other assets to the partners according to their claims
Example 5.13: Taddesse, Almaz and Gemechu agreed to liquidate their partnership named
TAG Partnership. The income sharing ration is 2:3:5, respectively. After discontinuing the
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ordinary business operations of their partnership and closing the accounts, the following
summary of the general ledger is prepared:
 Cash..........................................................13,000
 Non Cash Assets......................................62,000
 Liabilities.................................................20,000
 Melale, Capital.........................................22,000
 Belule, Capital..........................................22,000
 Rekike, Capital.........................................11,000
When non-cash assets are sold, any of these three events will happen:
1. Gain on realization
2. Loss on Realization with no Capital deficiency
3. Loss on Realization with Capital Deficiency
Assuming that all non cash assets are sold from August 1 to August 30, 2015 and all
liabilities are paid at one time and the non cash assets are sold:
1. Br 80,000 2. Br 50,000 3. Br 30,000
Instruction: Prepare Statement of Partnership Liquidation and record the following
circumstances
 Sale of the non-cash assets that is the realization
 The division on gain or loss on realization
 The payment of liabilities
 The distribution of Cash to Partners
1. Br 80000 – Gain on Realization of Br 18000 (Br 80000 – 62000)
TAG Partnership
Statement of Partnership Liquidation
From the period August 1 to August 31, 2015
Assets, Non- = Liabili Taddesse Almaz Gemechu
Cash Cash ties (20%) (30%) (50%)
Before Realization.........................................
13,000 62,000 = 20,000 22,000 22,000 11,000
Realization & Division of Gain....................
+80,000 -62,000 0 +3,600 +5,400 +9,000
Balance After Realization..............................
93,000 0 = 20,000 25,600 27,400 20,000
Payment of Liabilities....................................
−20,000 − −20,000 − − −
Balance of After Payment Liabilities.............
73,000 0 = 0 25,600 27,400 20,000
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Distribution of Cash to Partners.....................

−73,000 − − −25,600 −27,400 −20,000
Final Balance................................................. 0 0 = 0 0 0 0
The Accounting Journal Entries are as follows:

A) Sale of the Non-cash Assets (Realization Assets) B) Division on gain or loss on
realization
Cash................................................................
62,000 Gain on Realization........................................
18,000
Gain on Realization............................... 18,000 Taddesse, Capital...........................................

3,600
Non Cash Assets................................... 62,000 Almaz, Capital...............................................

5,400
Gemechu , Capital..........................................
9,000
C) The payment of liabilities D) The distribution of Cash to
Partners
Liabilities.......................................................
20,000 Taddesse, Capital...........................................
25,600
Cash....................................................... 20,000 Almaz, Capital...............................................

27,400
Gemechu, Capital...........................................
20,000
Cash.......................................................
73,000
2. Br 50,000 – Loss on Realization of Br 12,000 (Br 50,000 – 62,000)

TAG Partnership
Assets, Non- = Liabilit Taddesse Almaz Gemechu
Cash Cash ies (20%) (30%) (50%)
13,000 62,000 = 20,000 22,000 22,000 11,000
+50,000 -62,000 0 −2,400 −3,600 −6,000

63,000 0 = 20,000 19,600 18,400 5,000
−20,000 − −20,000 − − −

43,000 0 = 0 19,600 18,400 5,000

−73,000 − − −19,600 −18,400 −5,000
Final Balance................................................. 0 0 = 0 0 0 0
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A) Sale of Non-Cash Assets (Realization of Assets) B) Division on gain or loss on realization
Cash................................................................
2,400
Loss on Realization........................................
12,000 Almaz, Capital...............................................
3,600
Non Cash Assets................................... 62,000 Gemechu, Capital...........................................
6,000
Loss on Realization...............................
12,000
C) The payment of liabilities D) The distribution of Cash to Partners
Liabilities.......................................................
20,000 Tadesse, Capital.............................................
19,600
18,400
Gemchu, Capital............................................
5,000
Cash.......................................................
43,000
3. Br 30,000 – Loss on Realization of Br 32,000 (Br 30,000 – 62,000)

TAG Partnership
Assets, Non- = Liabilit Taddesse Almaz Gemechu
Cash Cash ies (20%) (30%) (50%)
13,000 62,000 = 20,000 22,000 22,000 11,000
+30,000 −62,000 0 −6,400 −9,600 −16,000
43,000 0 = 20,000 15,600 12,400 −5,000
−20,000 − −20,000 − − −
43,000 0 = 0 15,600 12,400 −5,000
−73,000 − − −13,600 −9,400 −5,000
Final Balance................................................. 0 0 = 0 2,000 3,000 −5,000
Note: before the distribution of Cash to partners the potential loss amount that is deficit
capital balance of a partner/s should be allocated to the partners with positive capital balance
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and then the remaining cash balance will be distributed to the partners having positive capital
balance after distribution of the loss.
15
A) Sale of Non-Cash Assets (Realization of Assets) B) Division on gain or loss on realization
Cash................................................................
6,400
Loss on Realization........................................
32,000 Almaz, Capital...............................................
9,600
Non Cash Assets................................... 62,000 Gemechu, Capital...........................................
16,000
Loss on Realization...............................
32,000
C) The payment of liabilities D) The distribution of Cash to Partners
Liabilities.......................................................
13,600
9,400
Cash.......................................................
23,000
To continue with the above illustration, use the following three assumptions:
A) If Gemechu paid the entire deficit amount
B) If the He paid 50% of the deficiency to the partnership and the remainder is considered
uncollectible
C) If He is unable to pay any part of the deficiency
A) Br 5,000 of the entire deficit was collected

TAG Partnership
Taddesse Almaz Gemechu
Cash =
(20%) (30%) (50%)
Balance........................................................... 0 = 2,000 3,000 −5,000
Receipts of Cash............................................ +5,000 − − +5,000
Balance After Realization.............................. +5,000 = 2,000 3,000 0
Distribution of Cash to Partners..................... −5,000 −2,000 −3,000 −
Final Balance................................................. 0 = 0 0 0
A) Receipts of Cash B) Distribution of Cash
Cash................................................................
2,000
Gemechu, Capital............................... 5,000 Almaz, Capital...............................................
3,000
Cash.......................................................
5,000
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B) Br 2,500
TAG Partnership
Taddesse Almaz Gemechu
Cash = (20%) (30%) (50%)
Balance........................................................... 0 = 2,000 3,000 −5,000

Receipts of Cash............................................ +2,500 − − +2,500
Balance .......................................................... 2,500 2,000 3,000 −2,500
Distribution of Loss....................................... − −1,000 −1,500 +2,500
Balance After Realization.............................. +2,500 = 1,000 1,500 0
Distribution of Cash to Partners..................... −2,500 −1,000 −1,500 −
Final Balance................................................. 0 = 0 0 0
A) Receipts of Cash
Cash................................................................ 2,500
Gemechu, Capital............................... 2,500
B) Distribution of Loss
Taddesse, Capital........................................... 1,000
Almaz, Capital............................................... 1,500
Gemehcu, Capital.................................. 2,500
C) Distribution of Cash
Taddesse, Capital........................................... 1,000
Almaz, Capital............................................... 1,500
Gemechu, Capital............................... 2,500
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C) No Receipts- All the amount is considered as a loss Br 5,000
TAG Partnership
Taddess Almaza Gemchu
Cash = e (20%) (30%) (50%)
Balance........................................................... 0 = 2,000 3,000 −5,000
Distribution of Loss....................................... − −2,000 −3,000 +5,000
Final Balance................................................. 0 = 0 0 0
The Accounting Journal Entry is:
Taddesse, Capital...........................................
2,000
Almaz, Capital...............................................
3,000
Gemchu, Capital...................................5,000
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Chapter 5: Accounting for Partnership Form Business Organizations

Accounting for Partnership Form Business Organizations

Net Income.....................................................Br 80,000

Salary Allowance 30,000 18,000 48,000

5.4. Dissolution of Partnership

Distribution of Cash to Partners.....................

The Accounting Journal Entries are as follows:

Gain on Realization............................... 18,000 Taddesse, Capital...........................................

Non Cash Assets................................... 62,000 Almaz, Capital...............................................

Cash....................................................... 20,000 Almaz, Capital...............................................

2. Br 50,000 – Loss on Realization of Br 12,000 (Br 50,000 – 62,000)

Balance After Realization..............................

Balance of After Payment Liabilities.............

Distribution of Cash to Partners.....................

The Accounting Journal Entries are as follows:

3. Br 30,000 – Loss on Realization of Br 32,000 (Br 30,000 – 62,000)

A) Sale of Non-Cash Assets (Realization of Assets) B) Division on gain or loss on realization

A) Br 5,000 of the entire deficit was collected

Balance........................................................... 0 = 2,000 3,000 −5,000

C) No Receipts- All the amount is considered as a loss Br 5,000

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