Module 3

Partnerships and
Proprietorships

Slide M3.1
 Module 3 Learning
Objectives
Identify the key advantages and disadvantages of
the partnership and proprietorship forms of
business organization.
Account for initial investments in partnerships.
Apply several methods of allocating partnership
profits and losses to individual partners.
Prepare a statement of partners’ capital.
Account for the dissolution of a partnership.
Account for the liquidation of a partnership.
Account for the ownership interest of a
proprietorship.

Slide M3.2
 Partnerships and
Proprietorships Defined

Partnership: an association
of two or more
persons to carry on as
co-owners a business for
profit.

Proprietorship: a business
owned by one individual.

Slide M3.3
 Key Advantages &
Disadvantages of Partnerships

Avoid “double taxation” of profits

Subject to less regulation than
corporations
Partners face “unlimited liability” for
their firm’s debts
“Mutual agency”
exposes partners to
economic risk
A partnership terminates
when one partner
withdraws or is admitted
to the firm

Slide M3.4
Key Advantages & Disadvantages
of Proprietorships

Avoid “double taxation” of profits

Subject to less regulation than
corporations
Sole proprietors face unlimited
liability for their firm’s
debts
Avoid problems posed by
the mutual agency feature
of partnerships
Do not benefit from experience and
insight of fellow partners

Slide M3.5
Accounting for the Ownership
Interests of Partnerships

Initial investments of partners

Division of partnership profits and
losses
Withdrawals by
partners
Preparation of a
statement of partners’ capital
Dissolution of a partnership
Liquidation of a partnership

Slide M3.6
 Initial Investments of
Partners
A “capital account” is
maintained for each
member of a
partnership.
Initial investments and subsequent
shares of partnership profits are
credited to partners’ capital
accounts.
Noncash assets contributed to a
partnership are recorded at their
fair market value.

Slide M3.7
 Factors That May Be
Considered in Allocating
Partnership Profits & Losses
Original investments of
partners
Skills and expertise
of individual
partners
Time committed to a
firm’s daily operations by
individual partners

Slide M3.8
 Allocation of Partnership
Profits . . . one example

Partnership: Hair Care Distributors

Partners’ salary allowances: Johnson, $40,000
Karim, $20,000
Lopez, $10,000
1997 profit: $124,000

Salary Remaining Profit

Allowance Profit Allocation
Johnson $40,000 $18,000 $ 58,000
Karim 20,000 18,000 38,000
Lopez 10,000 18,000 28,000
Total $124,000

Slide M3.9
Partnership Profit Allocation
Example . . . continued

Journal entry to record allocation of

partnership profit:

Income Summary 124,000

Johnson, Capital 58,000
Karim, Capital 38,000
Lopez, Capital 28,000

Notes:
Any remaining profit (income deficiency)
after the allocation of salary and interest
allowances is shared equally by partners.

Recognize that salary and interest

allowances are not true “expenses” of a
partnership.
Slide M3.10
 Withdrawals by Partners

Cash distributions generally don’t

accompany partnership profit
allocations.
But, partners typically
are permitted to
withdraw cash or
other assets from
their firm.
Withdrawals are recorded in a
“drawing” account.
Drawing accounts are closed to
partners’ capital accounts.

Slide M3.11
 Statement of
Partners’ Capital

A Statement of Partners’
Capital, rather than a
Statement of
Stockholders’
Equity, is prepared for a
partnership.
This financial statement
documents the changes in
individual partners’ capital
accounts during an accounting
period.

Slide M3.12
 Dissolution of A Partnership

Admissions and withdrawals of partners

result in the “dissolution” of a
partnership.
A new partner can
be admitted by ...
. purchasing an existing
partner’s ownership
interest or by
contributing assets to the firm.
A “bonus” may be allocated to new or
existing partners when a partner is
admitted or withdraws.
Such bonuses are allocated based on the
firm’s profit-sharing agreement.

Slide M3.13
 Liquidation of A Partnership

Liquidation: the process of converting a

discontinued partnership’s assets into cash,
paying its liabilities, and distributing any
remaining cash to the partners.

A business liquidation typically

results in losses on the
disposal of noncash
assets.
Such losses (or gains) are
closed directly to partners’
capital accounts.
Statement of Partnership Liquidation: a
financial report of a partnership’s account
balances at various stages of its liquidation.
(See Exhibit M3.3)

Slide M3.14
Accounting for the Ownership
Interest of Proprietorships

A capital account and drawing account

are maintained for the
owner of a proprietorship.
A proprietorship’s revenue
and expense accounts are
closed to its Income Summary account.
The balance of the Income Summary account
and the owner’s drawing account are closed
to the owner’s capital account.
Salary and interest allowances granted a
proprietor are not true expenses of the
business.

Slide M3.15