Chapter Fourteen

Partnerships:
Formation and
Operation

McGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
LO 1
Partnership Advantages
A partnership is defined as an association of two or
more persons to carry on a business as co-owners
for profit. (Section 6 of Uniform Partnership Act).
Flexibility in defining relationships
Profits and losses, and management operating
decisions, may be shared independent of ownership
percentages
Ease of formation and dissolution
Taxes flow-through the partnership (conduit) to
the partners, and are taxed to the individuals (no
double- taxation).
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 Partnership Disadvantages

Unlimited liability incurred by each

partner (they are jointly and
severally liable)
Mutual agency (each partner has the
right to incur liabilities in the name
of the partnership)
Inability to participate in various
corporate tax benefits

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LO 2
Articles of Partnership
Partnerships can exist even in the
absence of a written partnership
agreement.
The Uniform Partnership Act
establishes standards and rules for
partnerships.
A written agreement will supersede
the UPA standards.

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LO 3 Accounting for Capital
Contributions
The initial transaction is the contribution the
original partners make to start the business.
In the simplest situation, the partners invest
only cash amounts.
Partnership Journal Page ##
Date Description Debit Credit
Cash $$$
Capital - Partner A $$$
Capital - Partner B $$$

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LO 4 Accounting for Capital
Contributions
Contributed intangible assets
require special consideration.
Contributions made by one or more
of the partners may go beyond assets
and liabilities, for example, a
particular line of expertise or
established clientele.
Use either the Bonus Method or
Goodwill Method for recording
contributed intangible assets.

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LO 5
Allocation of Income
Items to be allocated:
The allocation of
Interest on income is not
beginning capital necessarily based
balances
on the relative
capital balances.
Allocated
compensation It is a separately
negotiated item.
Bonuses Remaining
income
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 Allocation of Income --
Example
Assume that Tinker, Evers, and Chance form a
partnership by investing cash of $120,000,
$90,000, and $75,000, respectively.
Evers will be allotted 40 %of all profits and
losses because of previous business experience.
Tinker and Chance are to divide the remaining
60 % equally. This agreement also stipulates that
each partner is allowed to withdraw $10,000 in
cash annually from the business.
Net income for the period is $60,000.

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LO 6
Alternative Technique-1

Assume the original facts for the Tinkers, Evers, and

Chance partnership except an articles of partnership
agreement credits each partner annually for interest
equal to 10 % of that partners beginning capital
balance for the year.
Evers and Chance will also be allotted $15,000 each as
a compensation allowance in recognition of their
participation in daily operations.
Any remaining profit or loss will be split 4:3:3, with
the largest share going to Evers because of the work
experience that this partner brings to the business.

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Alternative Technique- 1

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 Alternative Techniques-
The assignment process is merely a series of
mechanical steps reflecting the change in each
partners capital balance resulting from the
provisions of the partnership agreement.
The number of different allocation procedures
that could be employed is limited solely by the
partners imagination.
Although interest, compensation allowances,
and various ratios are the predominant factors
encountered in practice, numerous other
possibilities exist.
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LO 7
Legal Dissolution
Any alteration in the specific individuals
composing a partnership results in legal
dissolution
Departures
Retirement
Death
Admission (including promotion) of a
New Partner
Frequently leads to immediate formation of
a new partnership as business continues
Can lead to termination and liquidation
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 Admission of a New Partner -
The Rights of a Partner
An individual partners These two rights
ownership rights include: can be sold (unless
The right to co- restricted by the
ownership in the business
property. articles of
The right to share in partnership).
profits and losses as
specified in the
partnership agreement This right cannot
The right to participate be sold without the
in the management of the other partners
business. approval.

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LO 8 Admission of a New Partner -
Purchase of a Current Interest
A new partner can purchase
partnership interest directly from the
existing partners.
The cash goes to the partners, not the
partnership.
Two methods are available to account
for the transfer of ownership:
Book Value Approach
Goodwill (Revaluation) Approach

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LO 9 Admission of a New Partner -
Contribution to the Partnership
The new partner can also gain
partnership interest by contributing
cash to the partnership.
Remember that the new cash will
increase the partnerships net assets.
Two methods are:
Bonus Approach
Goodwill Approach

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LO 10
Withdrawal of a Partner
The Withdrawing Partner is paid out in
accordance with the Partnership Agreement.
Using the Bonus Method, any amount paid in
excess of that partners capital account is
allocated against the remaining partners capital
accounts.
Using the Goodwill Method, the books are first
adjusted to FMV, with a proportion of the
increase allocated to each partners account.
The withdrawing partner is then paid based on
the balance in the individual capital account.

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