Accounting for

Chapter
Partnerships

12
Powerd By : Ma7moud Sala7 …… Mob :0104118340
E-mail : m_ghost30@yahoo.com
: admin@muzicboy.com
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 Partnership
Partnership Form
Form of
of Organization
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
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 Organizations
Organizations with
with Partnership
Partnership
Characteristics
Characteristics
Limited
Limited
Limited
Limited
Limited
Limited Liability
Liability
Liability
Liability
Partnerships
Partnerships Corporation
Corporation
Partnerships
Partnerships
(LP)
(LP) ss
(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 oror 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 have
have ••Most
Most states
states hold
hold all
all ••AA limited
limited liability
liability
no
no personal
personal liability
liability partners
partners personally
personally corporation
corporation typically
typically
beyond
beyond invested
invested liable
liable for
for partnership
partnership has
has aa limited
limited life.
life.
amounts.
amounts. debts.
debts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Choosing
Choosing aa Business
Business Form
Form
Proprietorship Partnership LLP LLC S Corp. Corporation
Business entity yes yes yes yes yes yes
Legal entity no no no yes yes yes
Limited liability no no limited* yes yes yes
Business taxed no no no no no yes
One owner allowed yes no no yes yes yes
*A partner's personal liability for LLP debts is lim ited. Most LLPs carry insurance to protect
against malpractice.

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 © The McGraw-Hill Companies, Inc., 2005

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

Assets
Assets and
and liabilities
liabilities are
are recorded
recorded atat an
an agreed-
agreed-
upon
upon value,
value, normally
normally fair
fair market
market value.
value.

Asset
Asset contributions
contributions increase
increase the
the partner’s
partner’s capital
capital
account.
account.

Withdrawals
Withdrawals from
from the
the partnership
partnership decrease
decrease the
the
partner’s
partner’s capital
capital account.
account.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 Organizing
Organizing aa Partnership
Partnership
On
On 2/15/05,
2/15/05, Smith
Smith and
and Jones
Jones form
form aa partnership.
partnership.
Smith
Smith contributes
contributes $80,000
$80,000 cash.
cash. Jones
Jones
contributes
contributes land
land valued
valued at
at $40,000.
$40,000.

Feb. 15 Cash 80,000

Land 40,000
Smith, Capital 80,000
Jones, Capital 40,000
To record initial investment in partnership

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Dividing
Dividing Income
Income or
or Loss
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 © The McGraw-Hill Companies, Inc., 2005

 Allocation
Allocation on
on Stated
Stated Ratios
Ratios
Smith and Jones agree to divide profits or
losses ¾ for Smith and ¼ for Jones. For
2005, the partnership reported net income
of $60,000.
Dec. 31 Income Summary 60,000
Smith, Capital 45,000
Jones, Capital 15,000
To record division of 2005 net income.

$60,000 × ¾ = $45,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Allocation
Allocation on
on Capital
Capital Balances
Balances
Smith’s capital balance, before division of profits or
losses is $80,000 and Jones’s capital balance is
$40,000. The partnership agreement calls for income
or loss to be allocated based on the relative capital
balances. Net income for 2005 is $60,000.

Balance Ratio Income Allocation

Smith, Capital $ 80,000 66.67% $ 60,000 $ 40,000
Jones, Capital 40,000 33.33% 60,000 20,000
Totals $ 120,000 100.00% $ 60,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Allocation
Allocation on
on Capital
Capital Balances
Balances
Smith’s capital balance, before division of profits or
losses is $80,000 and Jones’s capital balance is
$40,000. The partnership agreement calls for income
or loss to be allocated based on the relative capital
balances. Net income for 2005 is $60,000.

Dec. 31 Income Summary 60,000

Smith, Capital 40,000
Jones, Capital 20,000
To record division of 2005 net income.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Allocation
Allocation on
on Services,
Services, Capital,
Capital, and
and
Stated
Stated Ratios
Ratios
Smith and Jones have a partnership agreement with
the following conditions:
 Smith receives $15,000 and Jones receives
$10,000 as annual salaries.
 Each partner is allowed an annual interest
allowance of 5% on the beginning-of-year capital
balance.
 Any remaining balance of income or loss is
allocated equally.
Net income for 2005 is $60,000.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Allocation
Allocation on
on Services,
Services, Capital,
Capital, and
and
Stated
Stated Ratios
Ratios
Income Distribution
Smith Jones Remainder
Net income $ 60,000
Salaries $ 15,000 $ 10,000 35,000
Interest 4,000 2,000 29,000
Equal allocation 14,500 14,500 -
Income to each partner 33,500 26,500

$80,000 × 5% = $4,000

$29,000 × ½ = $14,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Partnership
Partnership Financial
Financial Statements
Statements
Assume that during 2005, Smith withdrew $5,000 cash from
the partnership and Jones withdrew $1,000.
Smith and Jones Partnership
Statement of Changes in Partners' Equity
For the Year Ended December 31, 2005
Smith Jones Total
Beginning capital balances $ - $ - $ -
Investments by owners 80,000 40,000 120,000
Net income
Salary allowances $ 15,000 $ 10,000
Interest allowances 4,000 2,000
Balance allocated 14,500 14,500
Total net income 33,500 26,500 60,000
Less partners' withdrawals (5,000) (1,000) (6,000)
Ending capital balances $ 108,500 $ 65,500 174,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Allocation
Allocation on
on Services,
Services, Capital,
Capital, and
and
Stated
Stated Ratios
Ratios
Smith and Jones have a partnership agreement with
the following conditions:
 Smith receives $15,000 and Jones receives
$10,000 as annual salaries.
 Each partner is allowed an annual interest
allowance of 5% on the beginning-of-year capital
balance.
 Any remaining balance of income or loss is
allocated equally.
Net income for 2005 is $30,000.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Allocation
Allocation on
on Services,
Services, Capital,
Capital, and
and
Stated
Stated Ratios
Ratios
Income Distribution
Smith Jones Remainder
Net income $ 30,000
Salaries $ 15,000 $ 10,000 5,000
Interest 4,000 2,000 (1,000)
Equal allocation (500) (500) -
Income to each partner 18,500 11,500

($1,000) × ½ = $500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 Purchase
Purchase of
of Partnership
Partnership Interest
Interest
On January 2, 2006, Jones agrees to sell Johnson
$10,000 of her partnership interest for $25,000 cash.
Smith agrees with this arrangement.
Smith Jones Johnson Total
Capital balances before new partner $ 108,500 $ 65,500 $ - $ 174,000
Allocation to new partner (10,000) 10,000 -
Capital balances after new partner $ 108,500 $ 55,500 $ 10,000 $ 174,000

Jan 2 Jones, Capital 10,000

Johnson, Capital 10,000
To record admission of new partner

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 Investing
Investing Assets
Assets in
in aa Partnership
Partnership
On January 2, 2006, Smith and Jones agree to accept
Johnson as a partner upon his investment of $30,000
cash in the partnership.
Smith Jones Johnson Total
Capital balances before new partner $ 108,500 $ 65,500 $ - $ 174,000
Allocation to new partner 30,000 30,000
Capital balances after new partner $ 108,500 $ 65,500 $ 30,000 $ 204,000

Jan 2 Cash 30,000

Johnson, Capital 30,000
To record admission of new partner

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Bonus
Bonus to
to Old
Old or
or New
New Partners
Partners
When
When the
the current
current value
value of
of aa
partnership
partnership isis greater
greater than
than the
the
Bonus
Bonus to
to Old
Old recorded
recorded amounts
amounts of of equity,
equity, the
the old
old
Partners
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 to to
Bonus
Bonus to
to New
New aa new
new partner
partner ifif the
the business
business is
is in
in
Partners
Partners need
need ofof cash
cash or
or ifif the
the new
new partner
partner has
has
exceptional
exceptional talents.
talents.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Bonus
Bonus to
to Old
Old Partners
Partners
On January 2, 2006, Smith and Jones agree to accept
Johnson as a partner upon his investment of $60,000
cash in the partnership. Johnson is to receive a 20%
ownership interest in the new partnership. Any bonus is
attributable to the existing partners and is shared equally.

Equity of Smith and Jones $174,000

Investment by Johnson 60,000
Total partnership equity 234,000
Johnson's ownership percent 20%
Johnson's equity balance $ 46,800

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Bonus
Bonus to
to Old
Old Partners
Partners
On January 2, 2006, Smith and Jones agree to accept
Johnson as a partner upon his investment of $60,000
cash in the partnership. Johnson is to receive a 20%
ownership interest in the new partnership. Any bonus is
attributable to the existing partners and is shared equally.
Jan 2 Cash 60,000
Johnson, Capital 46,800
Smith, Capital 6,600
Jones, Capital 6,600
To record admission of new partner

$60,000 - $46,800 = $13,200 × ½ = $6,600

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Bonus
Bonus to
to New
New Partner
Partner
On January 2, 2006, Smith and Jones agree to accept
Johnson as a partner upon his investment of $60,000
cash in the partnership. Johnson is to receive a 30%
ownership interest in the new partnership. Any bonus is
attributable to the new partner and is shared equally by
the existing partners.

Equity of Smith and Jones $174,000

Investment by Johnson 60,000
Total partnership equity 234,000
Johnson's ownership percent 30%
Johnson's equity balance $ 70,200

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Bonus
Bonus to
to New
New Partner
Partner
On January 2, 2006, Smith and Jones agree to accept
Johnson as a partner upon his investment of $60,000
cash in the partnership. Johnson is to receive a 30%
ownership interest in the new partnership. Any bonus is
attributable to the new partner and is shared equally by
the existing partners.
Jan 2 Cash 60,000
Smith, Capital 5,100
Johnson, Capital 5,100
Johnson, Capital 70,200
To record admission of new partner

$70,200 - $60,000 = $10,200 × ½ = $5,100

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 Withdrawal
Withdrawal of
of aa Partner
Partner
Jones has a capital balance of $65,500. She decides to
withdraw from the partnership of Smith, Jones, and Johnson
for $50,000 cash. Any bonus is attributable to the remaining
partners and is divided equally.

Jan 2 Jones, Capital 65,500

Cash 50,000
Smith, Capital 7,750
Johnson, Capital 7,750
To record withdrawal of partner

$65,500 - $50,000 = $15,500 × ½ = $7,750

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 Liquidation
Liquidation of
of aa Partnership
Partnership
When
When aa partnership
partnership is
is dissolved,
dissolved, four
four steps
steps are
are required:
required:

 Noncash
Noncash assets
assets are
are sold
sold for
for cash
cash and
and aa gain
gain or
or loss
loss
on
on liquidations
liquidations is
is recorded.
recorded.

 Gain
Gain or
or loss
loss on
on liquidation
liquidation is
is allocated
allocated to
to partners
partners
using
using their
their income-and-loss
income-and-loss ratio.
ratio.

 Liabilities
Liabilities are
are paid
paid or
or settled.
settled.

 Any
Any remaining
remaining cash
cash is
is distributed
distributed to
to partners
partners based
based
on
on their
their capital
capital balances.
balances.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

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

Smith, Jones, and Johnson agree to dissolve their partnership.

They sell all of their assets for a net gain of $10,000. Profits and losses
are shared as follows: Smith, ½; Jones, ¼; and Johnson, ¼.
Smith Jones Johnson Total
Beginning capital balances $ 108,500 $ 65,500 $ 30,000 $ 204,000
Allocation of $10,000 net gain 5,000 2,500 2,500 10,000
Capital balances for dissolution $ 113,500 $ 68,000 $ 32,500 $ 214,000

Dec 2 Smith, Capital 113,500

Jones, Capital 68,000
Johnson, Captial 32,500
Cash 214,000
To liquidate partnership
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 Capital
Capital Deficiency
Deficiency
Capital deficiency means that at least one partner has a
debit balance in his/her capital account. A partner with
a deficit must, if possible, cover the deficit by paying
cash into the partnership.

Smith, Jones, and Johnson agree to dissolve their partnership.

They sell all of their assets for a net loss of $10,000. Profits and losses
are shared as follows: Smith, ½; Jones, ¼; and Johnson, ¼.

Smith Jones Johnson Total

Beginning capital balances $ 25,000 $ 10,000 $ 2,000 $ 37,000
Allocation of $10,000 net loss (5,000) (2,500) (2,500) (10,000)
Subtotal 20,000 7,500 (500) 27,000
Contribution by Johnson 500 500
Capital balances for dissolution $ 20,000 $ 7,500 $ - $ 27,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Capital
Capital Deficiency
Deficiency
Smith Jones Johnson Total
Beginning capital balances $ 25,000 $ 10,000 $ 2,000 $ 37,000
Allocation of $10,000 net loss (5,000) (2,500) (2,500) (10,000)
Subtotal 20,000 7,500 (500) 27,000
Contribution by Johnson 500 500
Capital balances for dissolution $ 20,000 $ 7,500 $ - $ 27,500

Dec 2 Cash 500

Any partner’s unpaid
Johnson, deficiency
Capital 500 is
To make-up deficiency
absorbed by the remaining partners
Dec 2 Smith, Capital 20,000
with credit
Jones,balances
Capital in 7,500
accordance
Cash 27,500
with the partnership agreement.
To liquidate partnership

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Partner
Partner Return
Return on
on Equity
Equity

Partner return Partner net income

=
on equity Average partner equity

Boston Celtics
Total LP I LP II Celtics LP
Balance, June 30, 2001 $ 84 $ 122 $ (307) $ 270
Net income (loss) for year 216 44 61 111
Cash distribution (48) - - (48)
Balance, June 30, 2002 $ 252 $ 166 $ (246) $ 333
Partner return on equity 128.6% 30.6% NA 36.8%

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 End of Chapter 12

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005