CHAPTER TWENTY-ONE ACCOUNTING FOR PARTNERSHIPS. PARTNERSHIP Def. - “..an association of two or...

CHAPTER TWENTY-ONE

ACCOUNTING FOR PARTNERSHIPS

PARTNERSHIP

Def. - “..an association of two or more persons who carry on, as co-owners, a business for profit”

o Used for all types of enterprises

• More popular in service industry than merchandising businesses

PARTNERSHIP AGREEMENT Def. - a written agreement containing the provisions for

operating a partnership.o Essential provisions include:

• Date of the agreement

• Names of the partners

• Kind of business to be conducted

• Length of time the partnership is to run

• Name and location of the business

• Investment of each partner

• Basis on which profits and losses are to be shared

• Limitation of partners’ rights and activities

• Salary allowance to partners

• Division of assets upon dissolution of the partnership

• Signatures of the partners

CHARACTERISTICS

CO-OWNERSHIP OF ASSETS

All assets held by a partnership are co-owned by all partners. If one partner contributes an asset to the business, the asset is jointly owned by all partners.

Advantages:Ability and expertise

combined into one enterprise & easier to raise capital

CHARACTERISTICS

MUTUAL AGENCYAny partner can bind the other partners to a contract if he or she is acting within the general scope of the business.

Disadvantage:Serious consequences if

partners don’t act responsibly

CHARACTERISTICS

LIMITED LIFE

Partnership may be dissolved as the result of any change in the ownership. (e.g. death, bankruptcy, incapacity, withdrawal of a partner, addition of a new partner, or expiration of the time specified in the partnership agreement)

CHARACTERISTICS

UNLIMITED LIABILITY

Each partner is personally liable for ALL debts incurred by the partnership.

Major Disadvantage:A partner could lose

personal assets.

CHARACTERISTICS

FEDERAL INCOME TAXES

Partnership is not subject to federal income tax. But, partners must report their share of the partnership’s income on their income tax return.

INVESTMENTS

EXAMPLE: Sam Mitchell and Lisa Jenkins begin the Mitchell & Jenkins partnership by investing $350,000 and $200,000, respectively.

Let’s look at thejournal entry!

GENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

1

2

3

4

5

6

7

8

9

10

11

Cash 350,000

Sam Mitchell, Capital 350,000

S. Mitchell invested

$350,000 in cash

Cash

Lisa Jenkins, Capital

L. Jenkins invested

$200,000 in cash

200,000

200,000

Separate Capital and Drawing accountsare maintained for each partner.

INVESTMENTS

What if instead of $200,000 in cash, Lisa Jenkins had invested:

o Inventory valued at $47,500

• on which $10,500 was owed

o Office Equipment valued at $40,000

o Delivery Equipment valued at $92,000

• on which $19,000 was owed on a note

o $50,000 in cash

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 50,000

47,500Inventory

Lisa Jenkins, Capital

19,000

200,000

Each asset invested and liability assumedis recorded. The difference is credited

to the Capital account.

Office Equipment 40,000

Delivery Equipment 92,000

Notes Payable

Accounts Payable 10,500

COMBINING BUSINESSES• On April 1, Donna Morning and Larry Knight form a partnership under the firm name of Morning & Knight Sports.

• They agree to invest their assets in the partnership. The partnership will also assume the liabilities shown on their balance sheets.

• Profits/losses are to be shared 50-50.

• In the case of dissolution, assets are to be distributed between partners in the ratio of their capital interests at the time of dissolution.

COMBINING BUSINESSESMorning SportsBalance SheetMarch 31, 20--

Assets LiabilitiesCash $ 6,344Accts. Receivable $ 5,524Less Allow forBad debts 430 5,094Merchandise Inv 24,574Store Equipment $3,840Less Accum Depr 1,000 2,840Total Assets $38,852

Notes Payable $ 4,600Accounts Payable 9,082Total Liabilities $ 13,682

Owner’s EquityMorning, Capital 25,170

$38,852Total Liab & O.E.

Let’s look at the journal entryto record Donna Morning’s

investment in the new partnership.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 6,344

5,524Accounts Receivable

Any uncollectible accounts shouldbe written off before forming

the partnership….Morning Sports had no

accounts considered uncollectible.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 6,344


Merchandise Inventory 24,574

Since Donna uses FIFO,the Merchandise Inventory account

reflects current market values.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 6,344



Store Equipment 3,600

Assets are recorded at theirfair market values (not book values)

at the time of investment.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 6,344


Accounts Payable

430

9,082



Allowance for Bad Debts

Notes Payable 4,600

The allowance account and the liabilitiesare recorded at the values shown

on Morning Sports’ Balance Sheet.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 6,344


Accounts Payable

430

9,082




Notes Payable 4,600

Capital account is credited for thedifference between assets

invested and liabilities assumed.

D. Morning, Capital 25,930

COMBINING BUSINESSESKnight Athletics

Balance SheetMarch 31, 20--

Assets LiabilitiesCash $ 3,544Accts. Receivable $ 5,280Less Allow forBad debts 720 4,560Merchandise Inv 29,692Supplies

$ 4,320Less Accum Depr 1,100 3,220

Total Assets $44,902

Notes Payable $ 6,000Accounts Payable 13,238Total Liabilities $ 19,238

Owner’s EquityKnight, Capital 25,644


720Office Equipment

Store Equipment $ 4,800Less Accum Depr 1,200 3,600

Knight’s assets andliabilities are brought into

the new partnership.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 3,544


Accounts Payable

3,850

720


Store Equipment

286


Notes Payable

4,200

L. Knight, Capital

6,000

Supplies

Office Equipment

13,238

26,894

ALLOCATING PROFIT/LOSS

Example: The partnership of Mitchell and Jenkins earned net income of $190,800 for the year.

S. Mitchell L. Jenkins

$95,400 $95,400

If Mitchell and Jenkins had notspecified how the income was to be

split, it would be split evenly.

PARTNERSHIP CLOSING ENTRIES

FOUR ENTRIES:

Entries #1 & 2 are the same as for sole proprietorships.Entries #3 & 4 are different for partnerships.

1. Close all revenues to Income Summary

2. Close all expenses to Income Summary

3. Close Income Summary by allocating each partner’s share of net income or loss to the individual capital accounts

4. Close each partner’s drawing account to the individual capital accounts.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Income Summary 190,800

95,400S. Mitchell, Capital

Instead of all the net income beingcredited to one capital account…it is allocated to each partner’s

capital account.

95,400L. Jenkins, Capital

Closing Entry #3

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11




S. Mitchell, Capital

S. Mitchell, Drawing

36,000

36,000

L. Jenkins, Capital

L. Jenkins, Drawing

48,000

48,000

Closing Entry #3




Mitchell and Jenkins did specifyhow the income was to be split...

after salary allowances, the remainingnet income was to be split 60-40.




$36,000 $48,000

Salary allowances total $84,000.Remaining Net Income is $106,800

($190,800-$84,000).

Salary allowances




$36,000 $48,000

$106,800 x 60% = $64,080

Salary allowances64,080




$36,000 $48,000

$106,800 x 40% = $42,720

Salary allowances64,080 42,720Remaining Income




$36,000 $48,000Salary allowances64,080 42,720Remaining Income

$100,080 $90,720

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11




Closing entry is made for the total allocated to each

partner.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11




S. Mitchell, Capital

S. Mitchell, Drawing

36,000

36,000

L. Jenkins, Capital

L. Jenkins, Drawing

48,000

48,000

Close eachowner’s drawing

account


Example: Let’s look at the allocation if the partnership of Mitchell and Jenkins earned net

income of $44,000 for the year. S. Mitchell L. Jenkins

$36,000 $48,000Salary allowances

The salary allowancesalone total more

than the Net Income!




$84,000 Salary Allow. - 44,000$40,000

Net IncomeExcess to be absorbed by partners


income of $44,000 for the year.




$40,000 x 60%

(24,000)






$40,000 x 40%

(24,000) (16,000)






(24,000) (16,000)$12,000 $32,000

$12,000 + $32,000 =$44,000 Net Income



GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11




Entries to close the drawingaccounts would be

the same as the previous example.

ALLOCATING PROFIT/LOSSExample: B. K. Kelly and S. B. Arthur form a partnership on January 1 of the current year. Kelly will devote full time to operating the business, invest $50,000, and draw a salary of $35,000 per year. Arthur will devote about 10 hours per week, invest $150,000, and draw a salary of $10,000 per year. The partners will be allowed interest of 10% on capital balances on January 1 of each year and the balance of the earnings will be divided equally.

Let’s allocate the first yearNet Income of $80,000.


Kelly had a capital balanceof $50,000 on January 1.

$50,000 x 10%

B. K. Kelly S. B. ArthurSalary Allow.$35,000 $10,000

Interest Allow.5,000


Arthur had a capital balanceof $150,000 on January 1.

$150,000 x 10%


Interest Allow.5,000 15,000


Kelly has allowances of $40,000 so farArthur has $25,000 so far…

$80,000 - $65,000 = $15,000 remainingSplit evenly = $7,500 each


Interest Allow.5,000 15,000Remaining Income7,500 7,500



Interest Allow.5,000 15,000Remaining Income7,500 7,500

$47,500 $32,500

What if the partnership hada loss of $20,000 in the first year?




Salary and Interest allowanceswould still be given, totaling $65,000.




The allowances plus the lossleave $85,000 to be absorbed

equally.

(42,500) (42,500)$(2,500) $(17,500)

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Income Summary

2,500

17,500

B. K. Kelly, Capital

20,000

S. B. Arthur, Capital

Capital accounts arereduced this year.

PARTNERSHIP FINANCIAL STATEMENTS

The allocation of net income and its impact on the capital balances should be disclosed in the financial statements.

FINANCIAL STATEMENTSKelly and Arthur

Income Statement (Partial)

For Year Ended December 31, 20--Net Income $80,000

Kelly Arthur Total

Allocation of net income:

Salary allowances

Interest allowances

Remaining income

Allocation of net income $47,500 $32,500 $80,000

$35,000 $10,000 $45,000

5,000

7,500

15,000

7,500

20,000

15,000

Distribution of income is shown atthe bottom of the Income Statement.


Statement of Partners’ Equity

For Year Ended December 31, 20--Kelly Arthur Total

Capital, January 1, 20--

Net Income for the year

Withdrawals (salaries during the year)

Capital, December 31, 20-- $62,500 $182,500 $245,000

$50,000 $150,000 $200,000

35,000

10,000

10,000 45,000

Additional Investments during year 10,000

$50,000 $160,000 $210,000

47,500 32,500 80,000

$97,500 $192,500 $290,000

Replaces Statement of

Owner’sEquity


Balance Sheet (Partial)

December 31, 20--

B. K. Kelly, capital

Total partners’ equity

$ 62,500

182,500S. B. Arthur, capital

$245,000

Partners’ Equity

Owner’s Equity is nowPartners’ Equity

DISSOLUTION

Any change in the members of the partnership results in dissolution.o Does not imply that business operations will

halto New Partnership agreement is createdo Can be caused by:

• Admitting a new partner

• Death or withdrawal of a partner

• Bankruptcy

ADMITTING A NEW PARTNER

A new partner may buy into the business in three ways:o by purchasing an interest directly from existing

partnerso by making a cash investment in the businesso by contributing assets from an existing business


Example: Morning and Knight admit Sunny Noon as a new partner as of July 1, 20--, when Morning and Knight have capital interests of $30,000 and $20,000, respectively. Noon pays $12,000 to Morning for one-third of her interest and $12,000 to Knight for one-half of his interest.

The payments go to the partnersdirectly, not the business.



Morning, Capital x 1/3

$30,000 x 1/3

Noon buys $10,000 ofMorning’s equity.



Knight, Capital x 1/2

$20,000 x 1/2

Noon buys $10,000 ofKnight’s equity.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Donna Morning, Capital 10,000

Donna’s Capital account is reducedby the amount sold to Sunny Noon.

20--July 1

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11


10,000Larry Knight, Capital

20,000Sunny Noon, Capital

Larry’s Capital accountis reduced by the 1/2 interest

he sold to Sunny.A Capital account is created for Sunny.

20--July 1

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11


10,000Larry Knight, Capital


The $12,000 paid to eachpartner is not recorded

on the partnership books.

20--July 1

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 25,000


If Sunny had paid $25,000directly to the partnership…..

20--July 1

ADMITTING A NEW PARTNERSunny Noon’s Golf

Balance SheetJune 30, 20--

Assets LiabilitiesCash $ 5,000Accts. Receivable $ 14,290Less Allow forBad debts 1,078 13,212Merchandise Inv 27,290

Total Assets $45,502

Notes Payable $ 9,048Accounts Payable 7,550Total Liabilities $16,598

Owner’s EquityNoon, Capital 28,904


If Sunny has a business that thenew partnership will take over...

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 5,000

Accounts Receivable

No adjustment necessarysince Noon has no knowledgeof any uncollectible accounts.

20--July 1

14,290

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 5,000

Accounts Receivable

No adjustment necessarysince Noon has been

using the FIFO method.

20--July 1

14,290


GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 5,000

Accounts Receivable

20--July 1

14,290


Allowance for Bad Debts 1,078

Notes Payable 9,048

Accounts Payable 7,550

Sunny Noon, Capital 28,904

WITHDRAWAL OF A PARTNER

A partner may retire and withdraw assets equal to, less than, or greater than the amount of his or her interest in the partnership.o determined after all profits and losses are

allocatedo and books are closed

WITHDRAWAL OF A PARTNER

Example: Many years later Sunny Noon decides to retire. The partners have agreed to the withdrawal of cash equal to the amount of Noon’s equity in the assets of the partnership.

Donna Morning

20,000Sunny Noon will take home

$40,000 cash.

Capital account balances:$55,000

Sunny Noon 40,000Larry Knight

GENERAL JOURNAL


1

2

3

4

5

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7

8

9

10

11


Her capital account is closed out.

GENERAL JOURNAL


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2

3

4

5

6

7

8

9

10

11


The other capital accountsare not affected.

Cash 40,000

GENERAL JOURNAL


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5

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8

9

10

11


What if Sunny agreesto only $30,000 cash?

Cash 40,000

GENERAL JOURNAL


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2

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5

6

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8

9

10

11


Sunny’s capital accountis closed out.

GENERAL JOURNAL


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5

6

7

8

9

10

11


But Cash received is lessthan the capital balance…

difference is split between tworemaining partners.

Cash 30,000

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11


Cash 30,000


Remaining capital = $100,000($55,000 + $45,000)

Morning has 55% interestShe received 55% of the $10,000 difference.

GENERAL JOURNAL


1

2

3

4

5

6

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8

9

10

11


Cash 30,000

Donna Morning, Capital

Larry Knight, Capital

5,500

4,500

Larry receives 45% of the difference.

GENERAL JOURNAL


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2

3

4

5

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8

9

10

11


Cash 30,000



5,500

4,500

If Noon received $45,000 cash($5,000 more than her capital balance)

GENERAL JOURNAL


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2

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Cash 45,000



2,750

2,250

The remaining partners contributetheir capital to make the $5,000 difference.

GENERAL JOURNAL


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11


Cash 45,000



2,750

2,250

One last alternative…..Sunny sells her interest

in the business to Donna.

GENERAL JOURNAL


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2

3

4

5

6

7

8

9

10

11



LIQUIDATION OF A PARTNERSHIP

Assets are sold Liabilities are paid Remaining cash and assets are

distributed to the partners


Example: After many years of operations the partnership is to be liquidated. After closing entries the following accounts remain:

Cash

220,000

$ 10,000Inventory 120,000Other AssetsLiabilities 80,000D. Morning, Capital 95,000L. Knight, Capital 120,000S. Noon, Capital 55,000

Non-CashAssets are

sold for$370,000.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 370,000

Inventory 120,000

Other Assets 220,000

Gain on Sale of Assets 30,000

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11

Cash 370,000

Inventory 120,000





L. Knight, Capital 10,000

S. Noon, Capital 10,000

Gain is shared equallyby the partners.



Cash

0

$380,0000

Other AssetsInventory

Cash is now $380,000 ($10,000 + $370,000),Inventory and Other Assets are now zero.



Cash

0

$380,000Inventory 0Other AssetsLiabilities 80,000D. Morning, Capital 105,000 95,000+10,000



Cash

0

$380,000Inventory 0Other AssetsLiabilities 80,000D. Morning, Capital 105,000L. Knight, Capital 130,000 120,000+10,000



Cash

0

$380,000Inventory 0Other AssetsLiabilities 80,000D. Morning, Capital 105,000L. Knight, Capital 130,000S. Noon, Capital 65,000 55,000+10,000

Liabilitiesare paid

off.

GENERAL JOURNAL


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2

3

4

5

6

7

8

9

10

11

Liabilities 80,000

Cash 80,000



Cash

0

$300,000Inventory 0Other AssetsLiabilities 0D. Morning, Capital 105,000L. Knight, Capital 130,000S. Noon, Capital 65,000

Remaining Cash = Capital account balancesCash is distributed to partners.

GENERAL JOURNAL


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2

3

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5

6

7

8

9

10

11


Cash 300,000





Cash

0

$ 0Inventory 0Other AssetsLiabilities 0D. Morning, Capital 0L. Knight, Capital 0S. Noon, Capital 0

Partnership is liquidated!



Cash

220,000

$ 10,000Inventory 120,000Other AssetsLiabilities 80,000D. Morning, Capital 95,000L. Knight, Capital 120,000S. Noon, Capital 55,000

If theseAssets hadbeen soldfor only$295,000

GENERAL JOURNAL


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2

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4

5

6

7

8

9

10

11

Cash 295,000

Inventory 120,000


Loss on Sale of Assets 45,000

There is a $45,000 loss to beallocated to the partners.

GENERAL JOURNAL


1

2

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4

5

6

7

8

9

10

11

Cash 295,000

Inventory 120,000









Cash

0

$ 305,000Inventory 0Other AssetsLiabilities 80,000D. Morning, Capital 80,000L. Knight, Capital 105,000S. Noon, Capital 40,000

Liabilitiesare paid

off.

GENERAL JOURNAL


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2

3

4

5

6

7

8

9

10

11

Liabilities 80,000

Cash 80,000



Cash

0

$ 225,000Inventory 0Other AssetsLiabilities 0D. Morning, Capital 80,000L. Knight, Capital 105,000S. Noon, Capital 40,000

Cash ispaid

topartners.

GENERAL JOURNAL


1

2

3

4

5

6

7

8

9

10

11


Cash 225,000





Cash

0

$ 0Inventory 0Other AssetsLiabilities 0D. Morning, Capital 0L. Knight, Capital 0S. Noon, Capital 0

Partnership is liquidated!

CHAPTER TWENTY-ONE ACCOUNTING FOR PARTNERSHIPS. PARTNERSHIP Def. - “..an association of two or...

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Transcript of CHAPTER TWENTY-ONE ACCOUNTING FOR PARTNERSHIPS. PARTNERSHIP Def. - “..an association of two or...