Accounting for Partnerships

Partnerships: Formation,
Operation, and Changes
in Membership
ARTHIK DAVIANTI

Understand and explain
the nature and regulation
of partnerships.

What is a Partnership?
An association of two or
more persons who
• are co-owners of a
business, and
• share profits and losses in
an agreed-upon manner. ABC
Company
A B

What is a “Person”?
• An individual
• A corporation
• Another partnership
Z Corp
T&D
Partnership

Partnerships: Pros & Cons
Advantages:
• Ease of formation
• Lack of formality
• Single taxation
Disadvantages:
• Unlimited liability (for general partnerships)
• Difficulty in disposing of partnership interests
• Mutual agency

The Partnership Agreement
• What is a partnership agreement?
A written expression of what the
partners have agreed to.
• Examples of areas addressed:
• Manner of sharing profits.
• Limitations on withdrawals.
• Rights of partners.
• Settling with withdrawing partners.
• Expulsion of partners.
• Conflicts of interest.

Make calculations and
journal entries for the
formation of partnerships.

Partners’ Accounts
• Each partner can have
• a capital account.
• a drawing account (a contra capital
account—closed out at year-end).
• a loan account (loans usually earn
interest—a partnership expense).
• Partnerships do NOT use a retained
earnings account.
DR CR

Initial Investment in a Partnership
Initial investment in a partnership are recorded in
capital accounts maintained for each partner.
If Ash and Bec each invest $20,000 cash in a new
partnership, the accounting records:
Cash (+A) 20,000
Ash capital (+OE) 20,000
To record Ash’s original investment of cash
Cash (+A) 20,000
Bec capital (+OE) 20,000
To record Bec’s original investment of cash

Noncash Investments
The noncash property is recorded at the fair value of
the property at the time of the investment.
Example, Col and Cro enter into a partnership with the
following investment:
Col
(Fair Value)
Cro
(Fair Value)
Cash - 7,000
Land (cost to Coll, $5,000) 10,000 -
Building (cost to Col, $30,000) 40,000 -
Inventory item (cost to Cro, $28,000) - 35,000
Total 50,000 42,000

Noncash Investments
Record of the investments:
Land (+A) 10,000
Building (+A) 40,000
Col capital (+OE) 50,000
To record Col’s original investment of land and building at fair value
Cash (+A) 7,000
Inventory (+A) 35,000
Cro capital (+OE) 42,000
To record Cro’s original investment of cash and inventory items at fair value

Bonus or Goodwill in Initial Investments
• The partnership agreement specifies equal capital
interest – account balances of Col and Cro to meet
the agreement’s conditions.
• Under the bonus approach, the unidentifiable asset
is not recorded on the partnership books.

The total identifiable contributed capital is $92,000,
each partner will start with $46,000 if the unidentifiable
assets is not recorded.
Bonus approach:
Col capital (-OE) 4,000
To establish equal capital interests of $46,000 by recording a $4,000 from Col
to Cro

Goodwill approach:
The unidentifiable asset contributed by Cro – measured
on the basis of Col’s $50,000 investment (50%).
Total partnership capital of $100,000 ($50,000 : 50%)
Goodwill of $8,000 ($100,000 total capital - $92,000
identifiable assets)
Record:
Goodwill (+A) 8,000
To establish equal capital interests of $50,000 by recognizing Cro’s
investment of an $8,000 unidentifiable asset.

Additional Investments and
Withdrawals
Additional investments are credited to the investing
partner’s capital account at fair value.
Withdrawals are recorded directly in the withdrawing
partner’s capital account.
Such a withdrawal is:
Smith capital (-OE) 20,000
Cash (-A) 20,000
To record the withdrawal of cash

Drawings
Withdrawals – drawings, drawing allowances, or
sometimes salary allowances.
Example, if Tow and Lee withdraw $1,000 from the
partnership each month, the records:
Tom drawing (-OE) 1,000
Cash (-A) 1,000
To record Tow’s drawing allowance for January
Lee drawing (-OE) 1,000
Cash (-A) 1,000
To record Lee’s drawing allowance for January

Drawings
If Tow draws $1,000 each month during the year, at
year-end the balance is $12,000.
His drawing account is closed:
Tom capital (-OE) 12,000
Tow drawing (+OE) 12,000
To record Tow’s drawing allowance for January

Partnership Operations
Partnership general-purpose financial statement: an
income statement, a balance sheet, a statement of
partnership capital, and a statement of cash flows.
Assume: Rat & Yan are partner sharing profits in a
60:40 ratio. Relevant data for 2011:
Partnership net income 2011 $34,500
Rat capital January 1, 2011 40,000
Rat additional investment 2011 5,000
Rat drawing 2011 6,000
Yan capital January 1, 2011 35,000
Yan drawing 2011 9,000
Yan withdrawal 2011 3,000

Partnership Operations
Format for a Statement of Partners’ Capital
Rat and Yan Statement of Partners’ Capital
For the Year Ended December 31, 2011
60% Rat 40% Yan Total
Capital balances January 1, 2011 40,000 35,000 75,000
Add: Additional investment 5,000 - 5,000
Deduct: Withdrawals - (3,000) (3,000)
Deduct: Drawings (6,000) (9,000) (15,000)
Net contributed capital 39,000 23,000 62,000
Add: Net income for 2011 20,700 13,800 34,500
Capital balances December 31,
2011 59,700 36,800 96,500

Drawings
Closing entries for the Rat and Yan partnership at
December 31, 2011:
December 31, 2011
Revenue and expense summary (-OE) 34,500
Rat capital (+OE) 20,700
Yan capital (+OE) 13,800
To divide net income 60% to Rat and 40% to Yan
December 31, 2011
Rat capital (-OE) 6,000
Yan capital (-OE) 9,000
Rat drawing (+OE) 6,000
Yan drawing (+OE) 9,000
To close partner drawing accounts to capital accounts

Profit and Loss Sharing
• Equal division – no profit and loss agreement
• Agreement on a specified ratio, such as 60:40
• Capital as factor for profit sharing
• A partner who devotes time – a salary allowance
Illustration:
Ann, Gary, and Kate partnership – Ann is the managing
partner, Gary is the sales manager, and Kate works outside
the partnership.
Ann and Gary receive salary allowances of $12,000 each.
The remaining income allocated equally.
Partnership income is $60,000 for 2011 and $12,000 for
2012.

INCOME ALLOCATION SCHEDULE - 2011
Ann Gary Kate Total
Net income 60,000
Salary allowance to Ann and Gary (24,000) 12,000 12,000 24,000
Remainder to be divide 36,000
Divided equally (36,000) 12,000 12,000 12,000 36,000
Remander to devide 0
Net income allocation 24,000 24,000 12,000 60,000
INCOME ALLOCATION SCHEDULE - 2011
Ann Gary Kate Total
Net income 12,000
Salary allowance to Ann and Gary (24,000) 12,000 12,000 24,000
Remainder to be divide (12,000)
Divided equally 12,000 (4,000) (4,000) (4,000) (12,000)
Remainder to devide 0
Net income allocation 8,000 8,000 (4,000) 12,000

Entries to distribute partnership income:
December 31, 2011
Ann capital (+OE) 24,000
Gary capital (+OE) 24,000
Kate capital (+OE) 12,000
Partnership income allocation for 2011
December 31, 2012
Kate capital (-OE) 4,000
Gary capital (+OE) 8,000
Partnership income allocation for 2011

Value a new partner’s
investment in an existing
partnership.

Purchase of an Interest from
Existing Partners
Alf and Bal are partners with caital balances of $50,000
each, they share profit and loss equally.
Cob purchases one-half of Alf’s interest from Alf for
$25,000, the partnership becomes Alf, Bal, and Cob.
Alf and Cob each have a 25 percent interest in the
capital and profit. Bal has 50 percent. Entry:
Alf capital (-OE) 25,000
Cob capital (+OE) 25,000
To record Cob’s admission into the partnership with the purchase of one-half
of Alf’s interest

Existing Partners
• Capital and income interests are align before and after
the admission of Cob.
• The net assets of old partnership were correctly
valued on the books, so no basis for revaluation.
• Cob’s payment – 25% in the capital and future
income.

Existing Partners
• Alf and Ball have capital balances of $50,000 and
$40,000 – they share profit equally.
• Agree to take Cob with payment of $25,000 directly to
Alf.
• The partners may agree – half of Alf’s capital balance
is transferred to Cob.
• Net assets are not to be revalued and profit share will
be Alf 25%, Bal 50%, and Cob 25%.
• The capital and income interest were not aligned.

Existing Partners
Capital
Investment
Income
Interest
Capital
Investment
Income
Interest
Alf 50000 5/9 50% 25000 5/18 25%
Bal 40000 4/9 50% 40000 8/18 50%
Cob 25000 5/18 25%
90000 90000
Old Partnership New Partnership

Revaluation: Goodwill Approach
• Alf and Bal have capital balances of $50,000 and
$40,000 and share profit equally.
• Cob enters partnerships with $50,000 payment
directly to partner.
• Cob is to have a 50% interest in the capital and
income in the new partnership.
• If assets are to be revalued, the revaluation is
recorded as follows:
Goodwill (or identifiable net assets) (+A) 10,000
Alf capital (+OE) 5,000
Bal capital (+OE) 5,000

• Goodwill of $10,000 gives Alf and Bal capital balances
of $55,000 and $45,000.
• If equals amounts of capital are to be transferred to
Cob, the entry is the following:
Bal capital (-OE) 25,000

• The capital balances are summarized as follows:
Before
Revaluation
Revaluation
After
Revaluation
Capital
Transferred
Capital After
Transfer
Alf $50,000 $5,000 $55,000 $-25,000 $30,000 30%
Bal 40,000 5,000 45,000 -25,000 20,000 20%
Cob 50,000 50,000 50%
$90,000 $10,000 $100,000 0 $100,000

• Realign the capital of Alf and Bal in the new
partnership – 25% interest each.
• The admission Cob would be:
Bal capital (-OE) 20,000

Before
Revaluation
Revaluation
After
Revaluation
Capital
Transferred
Capital After
Transfer
Alf $50,000 $5,000 $55,000 $-30,000 $25,000 25%
Bal 40,000 5,000 45,000 -20,000 25,000 25%
Cob 50,000 50,000 50%
$90,000 $10,000 $100,000 0 $100,000

Nonrevaluation: Bonus Approach
• If the assets of the new partnership is not to be
revalued, but equal amounts of capital are to be
transferred to Cob.
• Alf and Bal transfer equal amounts of capital and
rights to future income to Cob, receiving $25,000 cash
from Cob.
• Each receives $2,500 excess ($25,000 capital received
less $22,500 capital transferred).
• The entry is:

Per Books
Capital
Transferred
Capital After
Transfer
Alf $50,000 $-22,500 $27,500 30.6%
Bal 40,000 -25,500 17,500 19.4%
Cob 45,000 45,000 50.0%
$90,000 0 $90,000

• If Alf and Bal want their recorded capital and income
interests in the new partnership to be equal (25%) –
Alf would receive $30,000 and Bal would receive
$20,000 from Cob
• The entry is:

Per Books
Capital
Transferred
Capital After
Transfer
Alf $50,000 $-27,500 $22,500 25%
Bal 40,000 -17,500 22,500 25%
Cob 45,000 45,000 50%
$90,000 0 $90,000
• A summary of the capital balances:

Investing in an Existing Partnership
An new partner into an existing partnership – investing
cash or other cash.
The net assets contributed by the old partners’
partnership may or may not be revalued.
The investment could be identified to assets (based on
appraisal or other valuation technique).

Partnership Investment
at Book Value
Dre and boy have $40,000 capital balances eash and share
profit equally.
Agree to admid Cry to a one-third interest in capital and
profit in Dre, boy, and Cry partnership – $40,000
investment.
The investment ($40,000) is equal to the capital interest
[($80,000 + $40,000)/3]
Investment entry:
Cash (+A) 40,000
Cry capital (+OE) 40,000
To record Cry’s $40,000 cash investment for a one-third interest in
partnership capital and income.

Partnership Assets Revalued
(Goodwill to Old Partners)
Cry invests $50,000 for a one-third interest in capital
and profit.
The old partnership had unrecorded asset values (fair
value from Cry’s investment).
The unrecorded asset – $20,000 ($150,000 total value –
$80,000 recorded assets + $50,000 net investment)

The entries:
Goodwill (+A) 20,000
Dre capital (+OE) 10,000
Boy capital (+OE) 10,000
To revalue the assets contributed by the old partnership based on the value
of Cry’s investment.
Cash (+A) 50,000
To record Cry’s investment for a one-third interest in partnership capital and
income.

Before
Revaluation
Revaluation After
Revaluation
Capital
Transferred
Capital After Transfer
Dre $40,000 $10,000 $50,000 $50,000 1/3
Boy 40,000 10,000 50,000 50,000 1/3
Cry $50,000 50,000 1/3
$80,000 $20,000 $100,000 $50,000 $150,000

Partnership Assets Not Revalued
(Bonus to Old Partners)
Partnership net assets are increased by the amount of
new investment.
New capital account is credited for one-third interest in
the $130,000 ($80,000 book value plus $50,000 Cry’s
contribution) = $130,000/3 = $43,334
Cash (+A) 50,000
Dre capital (+OE) 3,333
Boy capital (+OE) 3,333
To record Cry’s investment in the partnership and to allow Dre and Boy a
bonus due to unrecorded asset values.

Per Books
Capital
Transferred
Capital After
Transfer
Dre $40,000 $3,333 $43,333 1/3
Boy 40,000 3,333 43,333 1/3
Cry 43,334 43,334 1/3
$80,000 $50,000 $130,000
(Bonus to Old Partners)

(Goodwill to New Partner)
Dre and Boy agreed to admit Cry – a 40% interest in
capital and profit with $50,000 investment (Cry brings
goodwill).
Dre and Boy must be will to admit Cry to a 40% interest
in the $80,000 recorded assets + $50,000 investment
(40% X $130,000 = $52,000).
Total capital in the new partnership is $133,333
($80,000 : 60%)
Cash (+A) 50,000
Goodwill (+A) 3,333
To admit Cry to a 40 percent interest in capital and profits.

Per Books
Capital
Transferred
Capital After
Transfer
Dre $40,000 $40,000 30%
Boy 40,000 40,000 30%
Cry $53,333 53,333 40%
$80,000 $53,333 $133,333
(Goodwill to New Partner)

(Bonus to New Partner)
The bonus procedure can be used to ensure – the beginning
partnership capital balances reflect the profit sharing
arrangement percentage.
Total assets of the new partnership: $130,000 ($80,000 by
Dre and Boy puls $50,000 by Cry).
Cry’s share is $52,000, but her contribution is $50,000.
The $2,000 excess – charge against Dre and Boy’s
Cash (+A) 50,000
Dre capital (-OE) 1,000
Boy capital (-OE) 1,000
To admit Cry ‘s investment of $50,000 for a 40% interest in the partnership
and allow her a $2,000 bonus

(Bonus to New Partner)
Per Books Investment
Capital After
Transfer
Dre $40,000 $(1,000) $39,000 30%
Boy 40,000 (1,000) 39,000 30%
Cry $52,000 52,000 40%
$80,000 $52,000 $130,000

Value a partner’s upon
retirement or death

Dissociation of a Continuing Partnership
through Death or Retirement
Disassociation because of death or retirement –
settlement with the retiring partner or the estate of the
deceased partner.
Valuation models could be use to determine the value of
the entire business.
The retiring partner – paid an amount equal to the final
balance of capital account, the entry is a charge to the
capital account and a credit to cash.
The settlement with a retiring partner is more or less
than the final capital account balance, the revaluation
(goodwill) and nonrevaluation (bonus) provide alternate
methods.

Excess Payment to Retiring Partner
Illustration:
Ann, Mic, and Jus are partners with profit sharing
percentage of 40%, 30%, and 40%. Jus decides to retire.
The capital and interests of the three partners on the
date of Jun’s retirement are as follows
Capital
Balances ($)
Percentage of
Capital (%)
Profit and Loss
Percentage (%)
Ann 70,000 35 40
Mic 50,000 25 20
Jus 80,000 40 40
Total 200,000 100 100

Excess Payment to Retiring Partner
The excess payment can be recorded by three methods:
1) The retiring partner is granted a bonus
2) Partnership revalued to the extent of payment to
retiring partner
3) Partnership revalued based on the amount implied
by the excess payment.

Bonus to Retiring Partner
(1) The partnership would record Jus’s withdrawal under
the bonus procedure as follows:
Jus capital (-OE) 80,000
Ann capital (-OE) 8,000
Mic capital (-OE) 4,000
Cash (-A) 92,000
Ann and Mic granted a $12,000 bonus to Jus – reduces
their capital accounts (40:20 relative profit sharing
ratios)

Goodwill Equal to Excess Payment
is Recorded
(2) To record $12,000 excess of cash paid to Jus over his
capital account balance as goodwill:
Goodwill (+A) 12,000
Cash (-A) 92,000

Revaluation of Total Partnership
Based on Excess Payment
(3) Revalue total partnership capital on the basis of the
$12,000 excess payment.
Revaluation, as follows:
Goodwill (other assets) (+A) 30,000
Mic capital (+OE) 6,000
Jus capital (+OE) 12,000
The partnership records Jus’s retirement as follows:
Cash 92,000

Payment to Retiring Partner Less
than Capital Balance
Jus is paid $72,000 in final settlement of his capital
interest.
The three partners may have agreed that the business is
worth less than its book value.
Overvalued Assets Written Down
A retirement payment to Jus of $8,000 less than his final
capital balance – overvalued by $20,000 [($80,000 -
$72,000) : 40%]
The overvalued should be identified and reduced to
their fair values.

The partnership records the revaluation and payment to
Jus as follows:
Ann capital (-OE) 8,000
Mic capital (-OE) 4,000
Net assets (-A) 20,000
Cash (-A) 72,000

Bonus to Continuing Partners
The partnership records the revaluation and payment to
Jus as follows:
Mic capital (+OE) 2,667
Cash (-A) 72,000

Source:
BAKER CHRISTENSEN COTTLRELL
Advanced Financial Accounting 9th
BEAMS, ANTHONY, BETTINGHAUS, & SMITH
Advanced Financial Accounting 11th

Accounting for Partnerships

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