Partnerships: Objectives 1. Comprehend the legal characteristics of partnerships. 2. Understand initial investment valuation and record keeping. 3. Grasp the diverse nature of profit and loss sharing agreements and their computation. 4. Value a new partner's investment in an existing partnership.
Partnerships RUPA "Revised Uniform Partnership Act" – Entity theory: • partners own their share of the partnership, but not its individual assets – Dissociation: • partners can dissociate without dissolution Partners have – Mutual agency – Unlimited liability
Articles of Partnership 1. Products or services, line of business 2. Partner rights & responsibilities 3. Initial investment and value assigned to noncash investments 4. Additional investment conditions 5. Asset withdrawals 6. Profit and loss sharing 7. Dissolution procedures
Initial Entry with Goodwill Land 10 Building 40 Cola Capital 50 To record Cola's investment Cash 7 Inventory 35 Goodwill 8 Crown Capital 50 To record Crown's investment and goodwill
Partner Accounts Each partner has his/her own accounts for – Capital – Drawings (periodic, salary-like, amounts) – Withdrawals (other, large, unusual amounts) • Investments increase Capital • Drawings and withdrawals are closed to Capital • Income Summary or Revenue and Expense Summary is closed to Capital.
Interest Allowances and Capital Interest Allowances are generally based on a measure of the partner's capital – Beginning of the year capital balance – Average* capital balance for the year Weighted average balance – Ending* capital balance Beginning balance – withdrawals + investments * Periodic drawings are often ignored, although withdrawals are considered
Allocating Income Partner's allowances for bonus, salary and interest are allocated to them, whether or not sufficient profits exist. Remaining profits (or deficit) is then split according to the agreed-upon proportions.
Example: Sharing Profits Tom and Betty agree to share profits and losses: • Tom and Betty have $60 and $30 salary allowances • Betty has a bonus of 50% of profits in excess of $500 • Each have interest allowances of 10% of beginning capital – Tom Capital, 1/1 $400 – Betty Capital, 1/1 $350 • Remaining profits or losses are shared Tom 60%, Betty 40%. Partnership profits are $660 for the year.
Share Profits of $180 Assume instead that income was only $180. Total Tom Betty Net income $120 Salary allowance (90) $60 $30 Bonus allowance 0 0 0 Interest allowance (75) 40 35 Subtotal, deficit ($45) Split 60:40 45 (27) (18) Allocated net income $0 $73 $47 Bonus = zero, income does not exceed threshold Tom Interest = 10%(400) = 40 Betty Interest = 10%(350) = 35 60%(-45) = -27; 40%(-45) = -18
Admitting a New Partner 1. A current partner assigns interest to new partner. 2. New partner purchases interest from existing partner. • Goodwill method • Bonus method 3. New partner invests directly in partnership. • Goodwill method • Bonus method
Assignment Assignment gives the assignee right to a share of future earnings and share of assets in liquidation – Not a partner – No share in management Old Partner Capital XXX Assignee Capital XXX
Goodwill Revalues Capital After Before Revaluation revaluation Transfer Final Don $50 $15 $65 ($35) $30 Ed 40 15 55 (25) 30 Fay 60 60 Total $90 $120 $120 Presumably, Fay paid $35 to Don and $25 to Ed. If the partners had not wanted to realign the capital, the capital of Don and Ed would each be reduced by $30 to transfer the $60 to Fay.
Buy from Partner: Bonus If Don and Ed had decided not to revalue the assets or record goodwill, the bonus method is used. Before Transfer Final Don $50 ($27.5) $22.5 Ed 40 (17.5) 22.5 Fay 45.0 45.0 Total Fay's capital $90 = $45. is 50%(90) $90.0 Don and Ed Capital accounts are adjusted to their new balances 25%(90) = $22.5
Invest in Business: Bonus Andrew and Boyles decide not to revalue the business assets, and Criner invests $50 cash in the business for a 1/3 interest. Before Investment Bonus Final Andrew $50 ($1) $49 Boyles 40 (1) 39 Criner $50 2 52 Criner's new capital = 1/3 of the total $130. Since he Total on $50 cash invests $90 for a $52 interest, the $2$130 bonus is transferred from the old partners.
Dissociation Firm value, according to RUPA, is the greater of – Liquidation value – Sales value as a going concern without the dissociated partner Payment to exiting partner is – Equal to existing capital – More than existing capital • Implied goodwill or bonus to exiting partner – Less than existing capital • Write down overvalued assets, or bonus to remaining partners
Limited Partnerships Limited partnerships must have one or more general partners Limited partner – Excluded from participating in management – Limited liability – Partnership agreement • In writing, signed and filed
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