Chapter 12

Accounting for Partnerships

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
 12 - 2

C1

Partnership Form of Organization

Voluntary
Voluntary Limited
Limited
Association
Association Partnership
Partnership Life
Life
Agreement
Agreement

Taxation
Taxation

Mutual
Mutual Unlimited
Unlimited
Agency
Agency Co-
Co- Liability
Liability
Ownership
Ownership
of
of Property
Property
 12 - 3

C1 Organizations with Partnership

Characteristics
Limited
Limited Limited
Limited
Limited
Limited Liability
Liability Liability
Liability
Partnerships
Partnerships Partnerships
Partnerships Corporations
Corporations
(LP)
(LP) (LLP)
(LLP) (LLC)
(LLC)

•• General
General partners
partners •• Protects
Protects innocent
innocent •• Owners
Owners have
have same
same
assume
assume management
management partners
partners from
from limited
limited liability
liability feature
feature
duties
duties and
and unlimited
unlimited malpractice
malpractice or or as
as owners
owners of of aa
liability
liability for
for partnership
partnership negligence
negligence claims.
claims. corporation.
corporation.
debts.
debts.
•• Limited
Limited partners
partners •• Most
Most states
states hold
hold all
all •• A
A limited
limited liability
liability
have
have no no personal
personal partners
partners personally
personally corporation
corporation typically
typically
liability
liability beyond
beyond liable
liable for
for partnership
partnership has
has aa limited
limited life.
life.
invested
invested amounts.
amounts. debts.
debts.
 12 - 4

C1

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.
 12 - 5

P1

Organizing a Partnership
Partners can invest both assets and liabilities in
the partnership.

Assets and liabilities are recorded at an agreed-

upon value, normally fair market value.

Asset contributions increase the partner’s capital

account.

Withdrawals from the partnership decrease the

partner’s capital account.
 12 - 6

P1

Organizing a Partnership
In
In accounting
accounting for for partnerships:
partnerships:
1.
1.Partners
Partners’’ withdrawals
withdrawals are are debited
debited toto their
their own
own separate
separate
withdrawals
withdrawals account.
account.
2.
2.Partners
Partners’’ capital
capital accounts
accounts areare 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 partner
partner’’ss withdrawal
withdrawal account
account isis closed
closed toto that
that
partner
partner’’ss capital
capital account.
account. Separate
Separate capital
capital and
and withdrawals
withdrawals
accounts
accounts areare kept
kept for
for each
each partner.
partner.
 12 - 7

P1

Organizing a Partnership
On 1/11, Kayla Zayn and Hector Perez organize a
partnership called BOARDS. Zayn’s initial investment is
$7,000 cash, $33,000 in boarding facilities, and a note
payable for $10,000 on the boarding facilities. Perez’s
initial investment is $10,000 cash.
Jan 11 Cash 7,000
Boarding Facilities 33,000
Notes Payable 10,000
K. Zayn, Capital 30,000
To record Zayn's initial investment.

Jan 11 Cash 10,000

H. Perez, Capital 10,000
To record Perez's initial investment.
 12 - 8

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.
 12 - 9

P2

Allocation on Stated Ratios

In the partnership agreement, Zayn is to receive
2/3 and Perez 1/3 of partnership income or loss. If
the partnership income is $60,000, we will allocate
the income to partners as follows:

$60,000 × 2/3 = $40,000

 12 - 10

P2

Allocation on Capital Balances

In
In their
their partnership
partnership agreement,
agreement, Zayn
Zayn and
and Perez
Perez agree
agree
to
to allocate
allocate profits
profits and
and losses
losses on
on the
the basis
basis of
of their
their
beginning
beginning capital
capital balances.
balances.

Balance Ratio Income Allocation

K. Zayn, Capital $ 30,000 75% $ 60,000 $ 45,000
H. Perez, Capital 10,000 25% 60,000 15,000
Totals $ 40,000 100% $ 60,000

Dec 31 Income Summary 60,000

K. Zayn, Capital 45,000
H. Perez, Capital 15,000
To allocate income to partner's capital.
 12 - 11

P2 Allocation on Services, Capital,

and Stated Ratios
Zayn and Perez have a partnership agreement
with the following conditions:
1.Zayn receives a $36,000 annual salary
allowance and Perez receives an allowance of
$24,000.
2.Each partner is allowed an annual interest
allowance of 10% on their beginning capital
balance.
3.Any remaining balance of income or loss is
allocated equally.
Net income is $70,000.
 12 - 12

P2
Allocation on Services, Capital,
and Stated Ratios

Income Allocation
Zayn Perez Remainder
Net income $ 70,000
Salaries $ 36,000 $ 24,000 10,000
Interest 3,000 1,000 6,000
Equal allocation 3,000 3,000 -
Income to each partner 42,000 28,000

$30,000 ×× 10%
10% == $3,000
$3,000

$6,000 × ½
½ == $3,000
$3,000
 12 - 13

P2
Allocation on Services, Capital, and Stated
Ratios
Now let’s assume that net income is only $50,000.
Income Allocation
Zayn Perez Remainder
Net income $ 50,000
Salaries $ 36,000 $ 24,000 (10,000)
Interest 3,000 1,000 (14,000)
Equal allocation (7,000)
3,000 (7,000)
3,000 (20,000)
-
Income to each partner 42,000
32,000 28,000
18,000

($14,000)
($14,000) ×× ½
½ == ($7,000)
 12 - 14

P2

Partnership Financial Statements

During 2009, Zayn withdrew $20,000 cash from the partnership and
Perez withdrew $12,000. Net income for the year is $70,000.

BOARDS
Statement of Partners' Equity
For the Year Ended December 31, 2011
Zayn Perez Total
Beginning capital balances $ - $ - $ -
Investments by owners 30,000 10,000 40,000
Net income
Salary allowances $ 36,000 $ 24,000
Interest allowances 3,000 1,000
Balance allocated 3,000 3,000
Total net income 42,000 28,000 70,000
Less partners' withdrawals (20,000) (12,000) (32,000)
Ending capital balances $ 52,000 $ 26,000 $ 78,000
 12 - 15

P3

Admission and Withdrawal of Partners

 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. Purchasing it from the other partners, or
2. Investing assets in the partnership.
 12 - 16

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.
 12 - 17

P3

Purchase of Partnership Interest

On January 4th, Hector Perez sells one-half of his
partnership interest to Tyrell Rasheed for $18,000. Perez
gives up a $13,000 recorded interest in the partnership.

Zayn Perez Rasheed Total

Capital balances before new partner $ 52,000 $ 26,000 $ - $ 78,000
Allocation to new partner (13,000) 13,000 -
Capital balances after new partner $ 52,000 $ 13,000 $ 13,000 $ 78,000
 12 - 18

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 partnership’s net assets.
 After admission, both assets
and equity will increase.
 12 - 19

P3

Investing Assets in a Partnership

On January 4th, Tyrell Rasheed is admitted to the
partnership with a payment of $22,000 cash.

Zayn Perez Rasheed Total

Capital balances before new partner $ 52,000 $ 26,000 $ - $ 78,000
Allocation to new partner 22,000 22,000
Capital balances after new partner $ 52,000 $ 26,000 $ 22,000 $ 100,000
 12 - 20

P3

Bonus to Old or New Partners

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

The
The partnership
partnership may
may grant
grant aa bonus
bonus toto
Bonus to New aa new
new partner
partner if
if the
the business
business is
is in
in
Partners need
need ofof cash
cash or
or if
if the
the new
new partner
partner has
has
exceptional
exceptional talents.
talents.
 12 - 21

P3

Bonus to Old Partners

On January 4th, Zayn and Perez agree to accept Rasheed
as a partner upon his investment of $42,000 cash in the
partnership. Rasheed is to receive a 25% ownership interest
in the new partnership. Any bonus is attributable to the
existing partners and is shared equally.

Equity of Zayn and Perez $ 78,000

Investment by Rasheed 42,000
Total partnership equity 120,000
Rasheed's ownership percent 25%
Rasheed's equity balance $ 30,000
 12 - 22

P3

Bonus to Old Partners

On January 4th, Zayn and Perez agree to accept Rasheed
as a partner upon his investment of $42,000 cash in the
partnership. Rasheed is to receive a 25% ownership interest
in the new partnership. Any bonus is attributable to the
existing partners and is shared equally.

$42,000
$42,000 -- $30,000
$30,000 == $12,000
$12,000 ×× ½
½ == $6,000
$6,000
 12 - 23

P3

Bonus to New Partner

On January 4thth, Zayn and Perez agree to accept
Rasheed as a partner upon his investment of $18,000
cash in the partnership. Rasheed is to receive a 25%
ownership interest in the new partnership. Any bonus is
attributable to Rasheed’s excellent business skills.

Equity of Zayn and Perez $ 78,000

Investment by Rasheed 18,000
Total partnership equity 96,000
Rasheed's ownership percent 25%
Rasheed's equity balance $ 24,000
 12 - 24

P3

Bonus to New Partner

On January 4thth, Zayn and Perez agree to accept
Rasheed as a partner upon his investment of $18,000
cash in the partnership. Rasheed is to receive a 25%
ownership interest in the new partnership. Any bonus is
attributable to Rasheed’s excellent business skills.

$18,000
$18,000 -- $24,000
$24,000 == ($6,000)
($6,000) ×× ½
½ == ($3,000)
($3,000)
 12 - 25

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.
 12 - 26

P3

Withdrawal of a Partner
At
At the
the date
date of
of the
the withdrawal
withdrawal of
of Perez,
Perez, the
the partners
partners have
have the
the following
following
capital
capital balances:
balances: Perez
Perez -- $38,000,
$38,000, Zayn
Zayn -- $84,000,
$84,000, and
and Rasheed
Rasheed --
$38,000.
$38,000. The
The partners
partners share
share income
income and
and loss
loss equally.
equally. Perez
Perez is
is to
to receive
receive
$38,000
$38,000 cash
cash upon
upon withdrawal
withdrawal from
from the
the partnership.
partnership.

No Bonus
 12 - 27

P3

Withdrawal of a Partner
At
At the
the date
date of
of the
the withdrawal
withdrawal of
of Perez,
Perez, the
the partners
partners have
have the
the following
following
capital
capital balances:
balances: Perez
Perez -- $38,000,
$38,000, Zayn
Zayn -- $84,000,
$84,000, and
and Rasheed
Rasheed --
$38,000.
$38,000. The
The partners
partners share
share income
income and
and loss
loss equally.
equally. Perez
Perez is
is to
to receive
receive
$34,000
$34,000 cash
cash upon
upon withdrawal
withdrawal from
from the
the partnership.
partnership.
Bonus to Remaining Partners

Capital balance $ 38,000

Cash settlement 34,000
Bonus 4,000
Times 50%
Bonus to each partner $ 2,000
   
 12 - 28

P3

Withdrawal of a Partner
At
At the
the date
date of
of the
the withdrawal
withdrawal of
of Perez,
Perez, the
the partners
partners have
have the
the following
following
capital
capital balances:
balances: Perez
Perez -- $38,000,
$38,000, Zayn
Zayn -- $84,000,
$84,000, and
and Rasheed
Rasheed --
$38,000.
$38,000. The
The partners
partners share
share income
income and
and loss
loss equally.
equally. Perez
Perez is
is to
to receive
receive
$40,000
$40,000 cash
cash upon
upon withdrawal
withdrawal from
from the
the partnership.
partnership.

Bonus to Withdrawing Partner

Capital balance $ 38,000

Cash settlement 40,000
Deficiency 2,000
Times 50%
To each partner $ 1,000
   
 12 - 29

P3

Death of a Partner
AA partner
partner’’ss death
death dissolves
dissolves aa partnership.
partnership. A A deceased
deceased
partner
partner’’ss estate
estate isis entitled
entitled to
to receive
receive his
his or
or her
her equity.
equity. The
The
partnership
partnership agreement
agreement shouldshould contain
contain provisions
provisions forfor
settlement.
settlement. TheseThese provisions
provisions usually
usually require:
require:
1.
1.Closing
Closing thethe 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 partner
partner’’ss estate
estate can
can involve
involve
selling
selling thethe equity
equity to to remaining
remaining partners
partners oror to
to an
an outsider,
outsider, or
or
itit can
can involve
involve withdrawal
withdrawal of of assets.
assets.
 12 - 30

P3

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.
 12 - 31

P4

No Capital Deficiency
No capital deficiency means that all partners have a zero or
credit balance in their capital accounts.

Zayn,
Zayn, Perez
Perez and
and Rasheed
Rasheed agree agree to
to dissolve
dissolve their
their partnership.
partnership.
The
The only
only outstanding
outstanding liability
liability is an
an account payable of $20,000. Prior to
dissolution
dissolution the
the partnership
partnership has the the following
following balance sheet:
sheet:

BOARDS'
Balance Sheet
At January 15, 2011
Cash $ 178,000 Accounts payable $ 20,000
Land 40,000 K. Zayn, Capital 70,000
H. Perez, Capital 66,000
T. Rasheed, Capital 62,000
$ 218,000 $ 218,000
 12 - 32

P4

No Capital Deficiency
BOARDS’
BOARDS’ begins the dissolution process by by selling the land
land for
for $46,000
cash.
cash. The
The gain
gain on
on the
the sale
sale of
of the
the land
land is
is distributed
distributed equally
equally among
among the
the
partners.
partners. After
After the
the sale
sale of
of the
the land
land the
the company
company payspays the
the account
account payable.
payable.

Jan. 15 Cash 46,000

Land 40,000
K. Zayn, Capital 2,000
H. Perez, Capital 2,000
T. Rasheed, Capital 2,000
To record sale of land.

Jan. 15 Accounts payable 20,000

Cash 20,000
To record payment of accounts payable.
 12 - 33

P4

No Capital Deficiency
After the sale of land for
for a gain and the payment of the company’s
company’s
accounts
accounts payable,
payable, BOARDS’
BOARDS’ hashas the
the following
following balance
balance sheet:
sheet:
BOARDS'
Balance Sheet
At January 15, 2011
Accounts payable $ -
Cash $ 204,000 K. Zayn, Capital $ 72,000
H. Perez, Capital 68,000
T. Rasheed, Capital 64,000
$ 204,000 $ 204,000
 12 - 34

P4

Capital Deficiency
Capital
Capital deficiency
deficiency means
means thatthat at
at least
least one
one partner
partner
has
has aa debit
debit balance
balance inin his
his or
or her
her capital
capital account
account at
at
the
the point
point of
of final
final cash
cash distribution.
distribution. This
This can
can arise
arise from
from
liquidation
liquidation losses,
losses, excessive
excessive withdrawals
withdrawals before
before
liquidation,
liquidation, or
or recurring
recurring losses
losses inin prior
prior periods.
periods. AA
partner
partner with
with aa capital
capital deficiency
deficiency must,
must, ifif possible,
possible,
cover
cover the
the deficit
deficit by
by paying
paying cash
cash into
into the
the partnership.
partnership.
 12 - 35

P4

Capital Deficiency
Zayn,
Zayn, Perez,
Perez, and
and Rasheed
Rasheed agree
agree to
to dissolve
dissolve their
their partnership.
partnership.
Prior
Prior to the final
final distribution of cash to the partners, Zayn
Zayn has
has a capital
balance
balance of $19,000, PerezPerez $8,000, and
and Rasheed
Rasheed ($3,000).
($3,000). Rasheed
Rasheed owes
owes
the
the partnership
partnership $3,000
$3,000 and
and is
is able
able to
to pay
pay the
the amount.
amount.
 12 - 36

P4

Partner Cannot Pay Deficiency

Let’s
Let’s use the information from our previous
previous example
example of a capital deficiency
and assume
assume partners divide profit and
and losses equally.
equally.
Zayn Perez Rasheed Total
Ending capital balances $ 19,000 $ 8,000 $ (3,000) $ 24,000
Allocation of $3,000 deficiency (1,500) (1,500) 3,000 -
Capital balances for dissolution 17,500 6,500 - 24,000
 12 - 37

A1

Partner Return on Equity

Partner return Partner net income

=
on equity Average partner equity

Boston Celtics
Total LP I LP II Celtics LP
Balance, Beginning of year $ 85 $ 122 $ (307) $ 270
Net income (loss) for year 216 44 61 111
Cash distribution (48) - - (48)
Balance, End of year $ 253 $ 166 $ (246) $ 333
Partner return on equity 128% 31% NA 37%

216/[(85+253)/2] = 128%
 12 - 38

End of Chapter 12