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Chapter 11 March 8

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Chapter 11 March 8

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Partnerships

CHAPTER

11

© 2013 McGraw-Hill Ryerson Limited.


Partnership
An unincorporated association of two or
more persons to pursue a business for
profit as co-owners.

© 2016 McGraw-Hill Ryerson Limited.


Partnership Agreement
Usually include the partners’:
1.Names and contributions,
2.Rights and duties,
3.Sharing of profits and losses,
4.Withdrawal provisions,
5.Dispute procedures,
6.Procedures for admission and withdrawal of partners, and
7.Rights and duties of surviving partners in the event of a
partner’s death.

© 2016 McGraw-Hill Ryerson Limited.


Characteristics of Partnerships
• Limited life
• Taxation of partners
• Co-ownership of property
• Mutual agency
• Unlimited liability

© 2016 McGraw-Hill Ryerson Limited.


Liability of Partners
Partners’ liabilities depend upon the form of
partnership.
Partnership forms:
1. General partnerships
2. Limited partnerships
3. Limited liability partnerships

© 2016 McGraw-Hill Ryerson Limited.


Liability of Partners
General Partnerships
Each partner has unlimited liability for the
partnership’s debts.

© 2016 McGraw-Hill Ryerson Limited.


Liability of Partners
Limited Partnerships
• At least one general partner who assumes
management duties and unlimited liability
for the debts of the partnership.
• Other partners may be limited partners who
have no personal liability beyond the
amounts they invested in the partnership.

© 2016 McGraw-Hill Ryerson Limited.


Liability of Partners
Limited Liability Partnerships
• Protects innocent partners from malpractice
or negligence resulting from the acts of
another partner.
• All partners are personally responsible for
other partnership debts.
• Identified by the words “Limited Liability
Partnership” or “LLP.”

© 2016 McGraw-Hill Ryerson Limited.


QS 11-1: Partnership liability:

Bowen and Campbell are partners in operating a store.


Without consulting Bowen, Campbell enters into a contract for
the purchase of merchandise for the store. Bowen contends
that he did not authorize the order and refuses to take
delivery. The vendor sues the partners for the contract price of
the merchandise. Will the partnership have to pay? Why? Does
your answer differ if Bowen and Campbell are partners in a
public accounting firm?
SOLUTION: Quick Study 11-1:

The partnership will probably have to pay because it is a


merchandising firm. That is, if the vendor knows nothing to
the contrary, the vendor may assume that Campbell has the
right, because of mutual agency, to bind the firm to contracts
for the purchase of merchandise.
 
Under these circumstances, the public accounting firm is not
in the merchandising business. Because the purchase of
merchandise to be sold is not within the normal scope of the
business of this firm, the vendor has no right to assume
Campbell is acting as the agent for the partnership. Hence,
the firm probably will not have to pay.
QS 11-2: Liability in limited partnerships:

Stanley organized a limited partnership and is the only general


partner. Hillier invested $20,000 in the partnership and was
admitted as a limited partner with the understanding that he
would receive 10% of the profits. After two unprofitable years,
the partnership ceased doing business. At that point, partnership
liabilities were $85,000 larger than partnership assets. How
much money can the creditors of the partnership obtain from
the personal assets of Hillier in satisfaction of the unpaid
partnership debts?
SOLUTION: Quick Study 11-2:

Since Hillier is a limited partner, he is not personally liable for


any debts of the partnership.
Partnership Accounting
• Separate capital account and withdrawal
account for each partner.
• Partnership profit or loss is allocated to
partners based on partnership agreement.
• Partners can invest assets and liabilities in the
partnership.
• Assets invested are recorded at fair market
value.

© 2016 McGraw-Hill Ryerson Limited.


Illustration: Formation of a partnership

Jackson and Thompson create a partnership. Jackson


invests $20,000 cash and Thompson invests $20,000
cash and equipment with a fair market value of
$10,000.
The entries to record these investments are:
Cash 20,000
Jackson, capital 20,000

Cash 20,000
Equipment 10,000
Thompson, capital 30,000

© 2016 McGraw-Hill Ryerson Limited.


QS 11-3: Journal entry when forming a partnership:

Len Peters and Beau Silver form a partnership to operate a


catering business, called A Catered Affair. Peters invests
$20,000 cash and Silver invests $30,000 cash on March 1,
2017. Prepare the journal entry to record the establishment
of the partnership.
SOLUTION: Quick Study 11-3:

2014
2017
Mar. 1 Cash ........................................................................................
50,000
Len Peters, Capital ........................................................... 20,000
Beau Silver, Capital.......................................................... 30,000
To record initial capital investments.
Dividing Profit or Loss
The partnership profit or loss may be
allocated based on:
• Fractional basis
• Ratio of capital investments
• Salaries, interest allowance, and a fixed ratio

© 2016 McGraw-Hill Ryerson Limited.


Illustration: Profit and loss sharing based on a
fractional basis.

Jackson and Thompson agree to share profits


and losses on a 2:1 ratio. The profit for the
year is $90,000.
The entry to close the income summary
account is :
Income summary 90,000
Jackson, capital 60,000
Thompson, capital 30,000
2/3 x 90,000 = 60,000
1/3 x 90,000 = 30,000

© 2016 McGraw-Hill Ryerson Limited.


Profit and loss sharing based on ratio of capital
investments.
Jackson and Thompson agree to share profits and
losses on the basis of their beginning capital
investments. Assume partnership profit for the year is
$90,000, and Jackson and Thompson’s beginning-of-
year capital balances are $20,000 and $30,000
respectively.
The entry to close the income summary account is :
Income summary 90,000
Jackson, capital 36,000
Thompson, capital 54,000
20,000/50,000 x 90,000 = 36,000
30,000/50,000 x 90,000 = 54,000

© 2016 McGraw-Hill Ryerson Limited.


Profit and loss sharing based on salaries,
interest allowance, and a fixed ratio
Jackson and Thompson agree to share profits or losses
as follows:
1. Annual salary allowances of $30,000 for Jackson
and $10,000 for Thompson.
2. Interest allowances of 10% of beginning-of-year
capital balance.
3. Remainder to be shared equally.
Assume partnership profit for the year is $90,000 and
Jackson and Thompson’s beginning-of-year capital
balances are $80,000 and $70,000 respectively.

© 2016 McGraw-Hill Ryerson Limited.


Profit Allocation:
Jackson Thompson Balance
Profit $ 90,000
Salary allowances $ 30,000 $ 10,000 (40,000)
Interest allowances 8,000 7,000 (15,000)
10% x 80,000 = 8,000
10% x 70,000 = 7,000
Remainder 35,000
shared equally 17,500 17,500 (35,000)
-
Allocation to partners $ 55,500 $ 34,500 $ 90,000

The entry to close the income summary account is :


Income summary 90,000
Jackson, capital 55,500
Thompson, capital 34,500

© 2016 McGraw-Hill Ryerson Limited.


Profit and loss sharing based on salaries,
interest allowance, and a fixed ratio

Assume the same profit and loss sharing


agreement as before and that there is a loss of
$10,000 for the year.

© 2016 McGraw-Hill Ryerson Limited.


Profit Allocation:
Jackson Thompson Total
Loss $ (10,000)
Salary allowances $ 30,000 $ 10,000 (40,000)
Interest allowances 8,000 7,000 (15,000)
10% x 80,000 = 8,000
10% x 70,000 = 7,000
Remainder (65,000)
shared equally (32,500) (32,500) 65,000
-
Allocation to partners $ 5,500 $ (15,500) $ (10,000)

The entry to close the income summary account is :

Thompson, capital 15,500


Income summary 10,000
Jackson, capital 5,500
© 2016 McGraw-Hill Ryerson Limited.
QS 11-4: Partnership income allocation:

Bill Ace and Dennis Bud are partners in AMPAC Company.


Profit for the year ended March 31, 2017, is $120,000.

a. How much profit should be allocated to each partner


assuming there is no partnership agreement?

b. Prepare the entry to allocate the profit.

c. Prepare the entry to allocate the $120,000 assuming it is


a loss.
Exercise 11-3: Profit allocation in a partnership:

Dallas and Weiss began a partnership by investing $115,000 and $135,000,


respectively. During its first year, the partnership recorded profit of $394,000.

Required:
Prepare calculations showing how the profit should be allocated to the partners
under each of the following plans for sharing profit and losses:

a. The partners failed to agree on a method of sharing profit.

b. The partners agreed to share profits and losses in proportion to their initial
investments.

c. The partners agreed to share profit by allowing a $140,000 per year salary
allowance to Dallas, a $70,000 per year salary allowance to Weiss, 25% interest
on their initial investments, and the balance equally.
Mini-Quiz
R, H, and D formed a partnership with R contributing
$60,000, H contributing $50,000, and D contributing
$40,000. Their partnership agreement called for the
earnings division to be based on the ratio of capital
investments. If the partnership had earnings of $74,000
for its first year of operation, what amount of earnings
(rounded) would be credited to D's capital account?

The amount credited would be $19,733.


40,000/(60,000+50,000+40,000) x $74,000 = $19,733
© 2016 McGraw-Hill Ryerson Limited.
Admission and Withdrawal of a
Partner
New partners may be admitted to the
partnership by either :
1. Purchasing a partnership interest.
or
2. Investing assets in the partnership.

© 2016 McGraw-Hill Ryerson Limited.


Purchase of Partnership Interest
• Personal transaction between one or more
current partners and the new partner.
• New partner must be accepted by current
partners.
• New profit-and-loss sharing agreement is
prepared.

© 2016 McGraw-Hill Ryerson Limited.


Illustration: Purchase of Partnership Interest

Jackson and Thompson continues to operate


for several years. Jackson’s beginning of the
year capital balance is $100,000. Jackson
sells one half of his partnership interest to
Harris for $60,000.
The entry to record the admission of Harris is:
Jackson, capital 50,000
Harris, capital 50,000
50% x $100,000

© 2016 McGraw-Hill Ryerson Limited.


Investing Assets in a Partnership
• Instead of purchasing the equity of an existing partner,
an individual may gain equity by investing assets.
• The invested assets become partnership property.

© 2016 McGraw-Hill Ryerson Limited.


Investing Assets in a Partnership
The amount invested may or may not equal the share of
equity obtained.
Three possibilities:
1. Investment is equal to share of equity.
2. Investment is greater than share of equity
(bonus to old partners).
3. Investment is less than share of equity (bonus to
new partner).

© 2016 McGraw-Hill Ryerson Limited.


Investment Equals Share of Equity
When the value of the partnership is
approximately equal to the equity recorded on
the accounting records, a new partner receives a
proportionate share of equity equal to his
investment.

© 2016 McGraw-Hill Ryerson Limited.


Illustration: Investment Equals Share of Equity

Jackson and Thompson accept Harris as a partner


with his investment of $40,000 for 20%* equity. The
partnership had total equity of $160,000 (Jackson
$90,000 and Thompson $70,000) before his
investment.
The entry to record this investment is:
Cash 40,000
Harris, capital 40,000

Note: Harris does not necessarily have a right to 20%


of profit.

*20% = 40,000 / (160,000 + 40,000)

© 2016 McGraw-Hill Ryerson Limited.


Investment is Greater Than Share of
Equity

When the current market value of the


partnership is greater than the recorded
amounts of equity, a new partner usually
pays a bonus (premium) for the privilege of
joining.

© 2016 McGraw-Hill Ryerson Limited.


Illustration: Investment is Greater Than Share of Equity

Jackson and Thompson accept Harris as a partner


with his investment of $60,000 for 20% equity. The
partnership had total equity of $160,000 (Jackson
$90,000 and Thompson $70,000) before his
investment.
Equities of existing partners $160,000
Investment of new partner 60,000
Total partnership equity $220,000
Equity of Harris (20% x $220,000) $44,000

© 2016 McGraw-Hill Ryerson Limited.


Illustration: Investment is Greater Than Share of Equity

The $16,000 difference between the amount invested


by Harris ($60,000) and his equity ($44,000)
represents a bonus to the old partners.
Assume that this bonus is allocated to the existing
partners in their profit/loss ratio of 50:50.
The entry to record this investment is:
Cash 60,000
Harris, capital 44,000
Jackson, capital 8,000
Thompson, capital 8,000
($16,000 x 50%)

© 2016 McGraw-Hill Ryerson Limited.


Investment is Less Than Share of Equity
• When existing partners are anxious to bring a new
partner into the firm, the old partners may be
willing to give the new partner a larger equity in
the business than the amount of the investment.
• The bonus given to the new partner is allocated to
the original partners (reducing their equity
balances) based on their profit-and-loss-sharing
ratio as per their agreement.

© 2016 McGraw-Hill Ryerson Limited.


Illustration: Investment is Less Than Share of Equity

Jackson and Thompson accept Harris as a partner


with his investment of $10,000 for 20% equity. The
partnership had total equity of $160,000 (Jackson
$90,000 and Thompson $70,000) before his
investment.
Equities of existing partners $160,000
Investment of new partner 10,000
Total partnership equity $170,000
Equity of Harris (20% x $170,000) $34,000

© 2016 McGraw-Hill Ryerson Limited.


Illustration: Investment is Less Than Share of Equity

The $24,000 difference between the amount invested


by Harris ($10,000) and his equity ($34,000)
represents a bonus to Harris.
Assume that this bonus is allocated to the existing
partners in their profit/loss ratio of 50:50.
The entry to record this investment is:
Cash 10,000
Jackson, capital 12,000
Thompson, capital 12,000
Harris, capital 34,000
($24,000 x 50%)

© 2016 McGraw-Hill Ryerson Limited.


QS 11-7: Admission of a partner:

Ramos and Bailey have a frozen yogurt shop in Victoria, BC.


They are equal partners, with $30,000 in each of their
partnership capital accounts. Bailey’s sister Kate is admitted to
the partnership on October 1, 2017, after paying $30,000 to
the partnership for a one-third interest. Prepare the entry to
show Kate’s admission to the partnership.
QS 11-9: Admission of a partner—bonus to new partner:

On June 17, 2017, Bishop agrees to invest $30,000 into an


online custom T-shirt print shop business for a 40% interest
in total partnership equity. At the time Bishop is admitted,
the existing partners, Pollard and Mission, each have a
$30,000 capital balance. Prepare the entry on June 17 to
record Bishop's admission to the partnership. Any bonus is
to be shared equally by Pollard and Mission.
Review
Discuss the options for the allocation of profit and
loss among partners.
In the absence of a partnership agreement, profits
and losses are shared equally by the partners. A
partnership agreement should specify how to
allocate partnership profit or loss among partners.
Allocation can be made based on a fractional share
of ownership, salary allowances, or interest
allowances.

© 2016 McGraw-Hill Ryerson Limited.


End of Chapter

© 2016 McGraw-Hill Ryerson Limited.

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