ACCOUNTING FOR PARTNERSHIPS

Chapter 12

2009 The McGraw-Hill

Companies, Inc.,

PARTNERSHIP FORM OF
ORGANIZATION

C1

Voluntary
Voluntary
Association
Association

Partnership
Partnership
Agreement
Agreement

Limited
Limited
Life
Life

Taxation
Taxation

Mutual
Mutual
Agency
Agency
McGraw-Hill/Irwin

CoCoOwnership
Ownership
of
of Property
Property

Unlimited
Unlimited
Liability
Liability
Slide 2

C1

ORGANIZATIONS WITH
PARTNERSHIP CHARACTERISTICS
Limited
Limited
Partnerships
Partnerships
(LP)
(LP)

General
General partners
partners
assume
assume management
management
duties
duties and
and unlimited
unlimited
liability
liability for
for partnership
partnership
debts.
debts.
Limited
Limited partners
partners have
have
no
no personal
personal liability
liability
beyond
beyond invested
invested
amounts.
amounts.
McGraw-Hill/Irwin

Limited
Limited
Liability
Liability
Partnerships
Partnerships
(LLP)
(LLP)
Protects
Protects innocent
innocent
partners
partners from
from
malpractice
malpractice or
or
negligence
negligence claims.
claims.
Most
Most states
states hold
hold all
all
partners
partners personally
personally
liable
liable for
for partnership
partnership
debts.
debts.

Limited
Limited
Liability
Liability
Corporations
Corporations
(LLC)
(LLC)

Owners
Owners have
have same
same
limited
limited liability
liability feature
feature
as
as owners
owners of
of aa
corporation.
corporation.
A
A limited
limited liability
liability
corporation
corporation typically
typically
has
has aa limited
limited life.
life.

Slide 3

CHOOSING A BUSINESS FORM

Many
Many factors
factors should
should be
be considered
considered when
when
choosing
choosing the
the proper
proper business
business form.
form.

McGraw-Hill/Irwin

Slide 4

P1

ORGANIZING A PARTNERSHIP
Partners can invest both assets and liabilities in
the partnership.
Assets and liabilities are recorded at an agreedupon value, normally fair market value.
Asset contributions increase the partners capital
account.
Withdrawals from the partnership decrease the
partners capital account.
McGraw-Hill/Irwin

Slide 5

P1

ORGANIZING A PARTNERSHIP
In
In accounting
accounting for
for partnerships:
partnerships:
1.
1.Partners
Partners withdrawals
withdrawals are
are debited
debited to
to their
their own
own separate
separate
withdrawals
withdrawals account.
account.
2.
2.Partners
Partners capital
capital accounts
accounts are
are credited
credited (or
(or debited)
debited) for
for
their
their shares
shares of
of net
net income
income (or
(or net
net loss)
loss) when
when closing
closing the
the
accounts
accounts at
at the
the end
end of
of the
the period.
period.
3.
3.Each
Each partners
partners withdrawal
withdrawal account
account is
is closed
closed to
to that
that
partners
partners capital
capital account.
account. Separate
Separate capital
capital and
and withdrawals
withdrawals
accounts
accounts are
are kept
kept for
for each
each partner.
partner.

McGraw-Hill/Irwin

Slide 6

P2

DIVIDING INCOME OR LOSS

Partners are not employees of the partnership but are its
owners. This means there are no salaries reported as
expense on the income statement. Profits or losses of the
partnership are divided on some agreed upon ratio.

Three frequently used methods to divide

income or loss are allocation on:
1. Stated ratios.
2. Capital balances.
3. Services, capital and stated ratios.
McGraw-Hill/Irwin

Slide 7

ADMISSION AND WITHDRAWAL OF

PARTNERS

P3

When the makeup of the partnership changes,

the existing partnership is dissolved.
A new partnership may be immediately
formed.
New partner acquires partnership interest by:
1.
2.

Purchasing it from the other partners, or

Investing assets in the partnership.

McGraw-Hill/Irwin

Slide 8

P3

PURCHASE OF PARTNERSHIP
INTEREST
A new

partner can purchase

partnership interest directly from
the existing partners.
The cash goes to the partners, not

to the partnership.
To become

a partner, the new

partner must be accepted by the
current partners.

McGraw-Hill/Irwin

Slide 9

P3

INVESTING ASSETS IN A PARTNERSHIP

The

new partner can gain

partnership interest by
contributing assets to the
partnership.
The new assets will increase
the partnerships net assets.
After admission, both assets
and equity will increase.

McGraw-Hill/Irwin

Slide 10

P3

BONUS TO OLD OR NEW PARTNERS

Bonus to Old
Partners

When
When the
the current
current value
value of
of aa
partnership
partnership is
is greater
greater than
than the
the
recorded
recorded amounts
amounts of
of equity,
equity, the
the old
old
partners
partners usually
usually require
require aa new
new partner
partner
to
to pay
pay aa bonus
bonus when
when joining.
joining.

Bonus to New
Partners

The
The partnership
partnership may
may grant
grant aa bonus
bonus to
to
aa new
new partner
partner if
if the
the business
business is
is in
in
need
need of
of cash
cash or
or if
if the
the new
new partner
partner has
has
exceptional
exceptional talents.
talents.

McGraw-Hill/Irwin

Slide 11

P3

WITHDRAWAL OF A PARTNER

A partner can withdraw

in two ways:
The

partner can sell his/her

partnership interest to
another person.
The partnership can
distribute cash and/or other
assets to the withdrawing
partner.

McGraw-Hill/Irwin

Slide 12

P4

DEATH OF A PARTNER
A
A partners
partners death
death dissolves
dissolves aa partnership.
partnership. A
A deceased
deceased
partners
partners estate
estate is
is entitled
entitled to
to receive
receive his
his or
or her
her equity.
equity. The
The
partnership
partnership agreement
agreement should
should contain
contain provisions
provisions for
for
settlement.
settlement. These
These provisions
provisions usually
usually require:
require:
1.
1.Closing
Closing the
the books
books to
to determine
determine income
income or
or loss
loss since
since the
the
end
end of
of the
the previous
previous period,
period, and
and
2.
2.Determining
Determining and
and recording
recording current
current market
market values
values for
for both
both
assets
assets and
and liabilities.
liabilities.
Settlement
Settlement of
of the
the deceased
deceased partners
partners estate
estate can
can involve
involve
selling
selling the
the equity
equity to
to remaining
remaining partners
partners or
or to
to an
an outsider,
outsider, or
or
itit can
can involve
involve withdrawal
withdrawal of
of assets.
assets.

McGraw-Hill/Irwin

Slide 13

P4

LIQUIDATION OF A PARTNERSHIP
A partnership dissolution requires four steps:
Noncash assets are sold for cash and a gain or
loss on liquidations is recorded.
Gain or loss on liquidation is allocated to partners
using their income-and-loss ratio.
Liabilities are paid or settled.
Any remaining cash is distributed to partners based
on their capital balances.
McGraw-Hill/Irwin

Slide 14

A4

PARTNER RETURN ON EQUITY

Partner return
=
on equity

Partner net income

Average partner equity

216/[(84+252)/2] = 128.6%
McGraw-Hill/Irwin

Slide 15

END OF CHAPTER 12

McGraw-Hill/Irwin

Slide 16