CHAPTER 04

Accounting for
Partnerships
Study Objectives
•Nature of a Partnership
•Formation of a Partnership
•Division of Income or Loss
•Dissolution of a Partnership
•Liquidation of a Partnership

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 Partnership Form of Organization
 Partnership, an association of two or more persons to
carry on as co-owners of a business for profit.
 Characteristics of Partnerships
1. Association of Individuals
 Legal entity – artificial person
 Accounting entity – separate/own books & accounts
 Economic entity – undertake production & supply of
goods and services
2. Mutual Agency [joint or common]
 Act of any partner is binding on all other partners, so long
as the act appears to be appropriate for the partnership.
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 Partnership Form of Organization
 Characteristics of Partnerships

3. Limited Life
 Dissolution occurs whenever a partner withdraws or a
new partner is admitted.
 Dissolution does not mean the business ends or
liquidation.
4. Unlimited Liability
 Each partner is personally, jointly and
individually/severally liable for all partnership liabilities.

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 Partnership Form of Organization

 Characteristics of Partnerships…

5. Co-ownership of Property
 Each partner has a claim on total assets.
 This claim does not attach to specific assets.
 All net income or net loss is shared equally by the
partners, unless otherwise stated in the partnership
agreement.

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 I. Formation of Partnership
 Partnership Agreement

Should specify relationships among the partners:

1. Names and capital contributions of partners.
2. Rights and duties of partners.
3. Basis for sharing net income or net loss.
4. Provision for withdrawals of assets.
5. Procedures for submitting disputes to arbitration.
6. Procedures for the withdrawal or addition of a partner.
7. Rights and duties of surviving partners in the event of a
partner’s death.

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 Equity Reporting for Partnerships

• EQUITY ACCOUNTS
- Use a separate capital account to record the investments of each partner in
the partnership.
- Use a separate drawing account to record the withdrawals of assets by each
partner from the partnership.
- Comparison of the owners’ equity accounts reported on a balance sheet for
a proprietorship, a partnership, and a corporation.

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 I. Formation of Partnership

 Valuation of investments/contributions

• at fair value

• Partners’ agreement

 Contributions – money, movable or immovable

property, skill, trademark, goodwill, patent, copyright,

lease right, debt

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 I. Formation of Partnership

Illustration: A and B combine their proprietorships to start a

partnership named A.B. Software. A and B have the following
assets prior to the formation of the partnership.

Book Value Fair Value

A B A B
Cash 8,000.00 9,000.00 8,000.00 9,000.00
Equipment 5,000.00 4,000.00
Accumulated depreciation (2,000.00)
Accounts receivable 4,000.00 4,000.00
Allowance for doubtful accounts (700.00) (1,000.00)
11,000.00 12,300.00 12,000.00 12,000.00

12-8
 I. Formation of Partnership

Illustration: Prepare the entry to record the investment of A

Cash 8,000
Equipment 4,000
A, Capital 12,000

Prepare the entry to record the investment of B.

Cash 9,000
Accounts receivable 4,000
Allowance for doubtful accounts 1,000
B, Capital 12,000

12-9
 II. Allocation of Profits and Losses

Dividing Net Income or Net Loss

Partners equally share net income or net loss unless the
partnership contract indicates otherwise.

Closing Entries:
 Close all Revenue and Expense accounts to Income
Summary.
 Close Income Summary to each partner’s Capital account
for his or her share of net income or loss.
 Close each partners Drawing account to his or her
respective Capital account.

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 II. Allocation of Profits and Losses
Income Ratios
Partnership agreement should specify the basis for sharing net
income or net loss. Typical income ratios:
 Fixed ratio.
 Ratio based on capital balances.
 Salaries to partners and remainder on a fixed ratio.
 Interest on partners’ capital balances & the remainder on a fixed
ratio.
 Salaries to partners, interest on partners’ capital, and the
remainder on a fixed ratio.
N.B.
1. Bonus factor not applicable in case of loss situations.
2. Apply income sharing plans with multiple factors exactly as in the
order indicated in the agreement .
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 II. Allocation of Profits and Losses

Illustration: King and Lee are co-partners in the Kingslee

Company. The partnership agreement provides for: (1) salary
allowances of $8,400 to King and $6,000 to Lee, (2) interest
allowances of 10% on capital balances at the beginning of the
year, and (3) the remainder equally. Capital balances on
January 1 were King $28,000, and Lee $24,000. In 2012,
partnership net income is $22,000. The division of net income is
as follows.
Instructions
(a) Prepare a schedule showing the distribution of net income.
(b) Journalize the allocation of net income.

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 II. Allocation of Profits and Losses

Illustration: (a) Prepare a schedule showing the distribution of

net income.

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 II. Allocation of Profits and Losses

Illustration: (b) Journalize the allocation of income.

Dec. 31

Income summary 22,000

Sara King, Capital
Ray Lee, Capital
12,400
9,600

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 II. Allocation of Profits and Losses

Illustration: Prepare a schedule showing the distribution of net

income assuming net income is only $18,000.

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 II. Allocation of Profits and Losses

Partners’ capital may change due to (1) additional investment,

(2) drawing, and (3) net income or net loss.
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 II. Allocation of Profits and Losses

The balance sheet for a partnership is the same as for a

proprietorship except for the owner’s equity section.

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 III. Dissolution - Liquidation of Partnership

Ends both the legal and economic life of the entity.

To liquidate, it is necessary to:

1. Sell noncash assets for cash and recognize a gain or loss
on realization.
2. Allocate gain/loss on realization to the partners based on
their income ratios.
3. Pay partnership liabilities in cash.

4. Distribute remaining cash to partners on the basis of their

capital balances.

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 III. Dissolution - Liquidation of Partnership

Illustration I: Ace Company is liquidated when its ledger

shows the following assets, liabilities, and owners’ equity
accounts.

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 III. Dissolution - Liquidation of Partnership

The partners of Ace Company agree to liquidate the partnership

on the following terms:
(1) The partnership will sell its noncash assets to Jackson
Enterprises for $75,000 cash.
(2) The partnership will pay its partnership liabilities. The
income ratios of the partners are 3:2:1, respectively.

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 III. Dissolution - Liquidation of Partnership

Prepare a cash payments schedule.

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 III. Dissolution - Liquidation of Partnership

Prepare a cash payments schedule.

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 III. Dissolution - Liquidation of Partnership

Prepare a cash payments schedule.

It is given that the partnership will sell its

noncash assets to Jackson Enterprises for
$75,000 cash & income sharing ratio of 3:2:1

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 III. Dissolution - Liquidation of Partnership

Prepare a cash payments schedule.

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 III. Dissolution - Liquidation of Partnership

Prepare a cash payments schedule.

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 III. Dissolution - Liquidation of Partnership

Prepare a cash payments schedule.

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 III. Dissolution - Liquidation of Partnership

Prepare a cash payments schedule.

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 III. Dissolution - Liquidation of Partnership

Prepare a cash payments schedule.

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 III. Dissolution - Liquidation of Partnership

(1) Ace sells the noncash assets (accounts receivable,

inventory, and equipment) for $75,000. The book value of these
assets is $60,000 ($15,000 + $18,000 + $35,000 - $8,000).
Prepare the entry to record the sale of the noncash assets.

(1) Cash 75,000

Accumulated depreciation 8,000
Accounts receivable
Inventory 18,000
15,000
Equipment
Gain on realization
35,000
12-29 15,000
 III. Dissolution - Liquidation of Partnership

(2) Prepare the entry to record the allocation of the gain on

liquidation to the partners.

(2) Gain on realization 15,000

R. Arnet, Capital ($15,000 x 3/6) 7,500
P. Carey, Capital ($15,000 x 2/6) 5,000
W. Eaton, Capital ($15,000 x 1/6) 2,500

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 III. Dissolution - Liquidation of Partnership

(3) Prepare the entry to record the payment in full to the

creditors.

(3) Notes payable 15,000

Accounts payable 16,000
Cash 31,000

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 III. Dissolution - Liquidation of Partnership

(4) Record the distribution of cash.

R. Arnet, Capital 22,500

P. Carey, Capital 22,800
W. Eaton, Capital 3,700
Cash 49,000

12-32
 IV. Dissolution - Admission/Withdrawal of Partner/s

 Admission of a Partner
 Results in the legal dissolution of the existing
partnership and the beginning of a new one.
 New partner may be admitted either by
 purchasing the interest of one or more existing
partners or

outside  investing assets in the partnership. Within

the entity Admission with the entity

Purchase of interest Admission with investment

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 IV. Dissolution - Admission/Withdrawal of Partner/s
 Withdrawal of a Partner
 A partner may withdraw from a partnership
voluntarily, by selling his or her equity in the firm.
 Or, he or she may withdraw involuntarily, by
reaching mandatory retirement age or by dying.
 The withdrawal of a partner, like the admission of a
partner, legally dissolves the partnership.
outside Within
the entity Withdrawal with the entity

sale of interest Payment of partnership

Partners as individuals assets
12-34
 Admission - Purchase of Interest

Illustration: L. Carson agrees to pay $10,000 each to C. Ames

and D. Barker for 33 1/3% of their interest in the Ames-Barker
partnership. At the time of admission of Carson, each partner
has a $30,000 capital balance. Both partners, therefore, give
up $10,000 of their capital equity. The entry to record the
admission of Carson is:
C. Ames, Capital 10,000
D. Barker, Capital 10,000
L. Carson, Capital 20,000

12-35
 Admission - Investment of Assets

Illustration: Assume that L. Carson agrees to invest $30,000

in cash in the Ames-barker partnership for a 33 1/3% capital
interest. At the time of admission of Carson, each partner has a
$30,000 capital balance. The entry to record the admission of
Carson is:

Cash 30,000
L. Carson, Capital 30,000

12-36
 Withdrawal – Transfer of Interest (New/Old)

Illustration: Partners Morz, Nead, and Odom have capital

balances of $25,000, $15,000, and $10,000, respectively. Morz
and Nead agree to buy out Odom’s interest. Each of them
agrees to pay Odom $8,000 in exchange for one-half of Odom’s
total interest of $10,000. The entry to record the withdrawal is:

Odom, Capital 10,000

Morz, Capital 5,000
Nead, Capital 5,000

Note, net assets and total capital remain the same at $50,000. The $16,000 paid
to Odom by the remaining partners isn’t recorded by the partnership.

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 Withdrawal - Payment from the Partnership
APPENDIX

Illustration: Assume that the following capital balances exist in

the RST partnership: Roman $50,000, Sand $30,000, and Terk
$20,000. The partners share income in the ratio of 3:2:1,
respectively. Terk retires from the partnership and receives a
cash payment of $25,000 from the firm.

Note: A bonus is paid to the retiring partner since the

cash paid to the retiring partner is more than his/her
capital balance ($25,000 – $20,000 = $5,000).

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 Withdrawal - Payment from the Partnership
APPENDIX

Illustration: Assume that the following capital balances exist in

the RST partnership: Roman $50,000, Sand $30,000, and Terk
$20,000. The partners share income in the ratio of 3:2:1,
respectively. Terk retires from the partnership and receives a
cash payment of $25,000 from the firm.

Journal entry to record the withdrawal of Terk:

Terk, Capital 20,000

Roman, Capital 3,000
Sand, Capital 2,000
Cash 25,000

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 End of chapter 4

Next Chapter 5: Corporations:

Organization and Capital Stock
Transactions

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