chapter 15 firma

15 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Partnerships – Formation,
Operations, and Changes in
Ownership Interests
Chapter 15

Learning Objective 1
Comprehend the legal
characteristics of partnerships.

Partnership Characteristics
It is an association of two or more persons
who co-own a business for a profit.
The legal life of a partnership terminates
with the admission of a new partner, the
withdrawal or death of a partner, voluntary
dissolution by the partners, or involuntary
dissolution such as bankruptcy proceedings.

Articles of Partnership
A partnership may be formed by a simple
oral agreement among two or more
people to operate a business for profit.

Articles of Partnership
The types of products and services to be provided
Each partner’s rights and responsibilities
Each partner’s initial investment
Additional investment conditions
Asset drawing provisions
Profit and loss sharing formulas
Procedures for dissolving the partnership

Partnership Financial Reporting
The accounting reports are designed to
meet the needs of three user groups…
The partners
Partnership creditors
Internal Revenue Service

Understand initial investment
valuation and record keeping.

Initial Investment in a Partnership
Ashley and Becker each invest $20,000
cash in a new partnership.
Cash 20,000
Ashley, Capital 20,000
To record Ashley’s original investment of cash
Cash 20,000
Becker, Capital 20,000
To record Becker’s original investment of cash

Noncash Investments
C. Cola R. Crown
Fair Value Fair Value
Cash $ — $ 7,000
Land (cost to C. Cola, $5,000) 10,000 —
Building (cost to C. Cola, $30,000) 40,000 —
Inventory (cost to R. Crown, $28,000) — 35,000
Total $50,000 $42,000
C. Cola and R. Crown enter into a partnership.

Noncash Investments
Land 10,000
Building 40,000
C. Cola, Capital 50,000
To record C. Cola’s original investment
of land and building at fair value

Noncash Investments
Cash 7,000
Inventory 35,000
R. Crown, Capital 42,000
To record R. Crown’s original investment
of cash and inventory items at fair value

Bonus or Goodwill
on Initial Investment
The partnership agreement specifies
equal capital interests.
C. Cola, Capital 4,000
To establish equal capital interests of $46,000 by
recording a $4,000 bonus from C. Cola to R. Crown

Bonus or Goodwill
on Initial Investment
Goodwill 8,000
To establish equal capital interests of $50,000
by recognizing R. Crown’s investment
of an $8,000 unidentifiable asset

Drawings
Regular withdrawals are called
drawings, drawing allowances,
or sometimes salary allowances.
Debit Drawing and credit Cash.
At period end, credit Drawing
and debit each partner’s Capital.

Loans and Advances
Loans and advances to the partnership
and accrued interest are regarded as
liabilities of the partnership.
Loans and advances to partners are
regarded as assets of the partnership.

Partnership Operations
Ratcliffe and Yancey are partners sharing
profits in a 60:40 ratio, respectively.

Partnership Operations
Partnership net income 2003 $34,500
Ratcliffe capital January 1, 2003 40,000
Ratcliffe additional investment 2003 5,000
Ratcliffe drawing 2003 6,000
Yancey capital January 1, 2003 35,000
Yancey drawing 2003 9,000
Yancey withdrawal 2003 3,000
Equity Accounts, 2003

Format for a Statement
of Partners’ Capital
Ratcliffe and Yancey Statement of Partners’ Capital
For the Year Ended 12/31/2003
60% 40%
Ratcliffe Yancey Total
Capital balances 1/1/03 $40,000 $35,000 $75,000
Add: Additional investments 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 2003 20,700 13,800 34,500
Capital balances 12/31/03 $59,700 $36,800 $96,500

Closing Entries
December 31, 2003
Revenue and Expense Summary 34,500
Ratcliffe, Capital 20,700
Yancey, Capital 13,800
To divide net income for the year 60% to Ratcliffe
and 40% to Yancey

Closing Entries
December 31, 2003
Ratcliffe, Capital 6,000
Yancey, Capital 9,000
Ratcliffe, Drawing 6,000
Yancey, Drawing 9,000
To close partner drawing accounts to capital accounts

Grasp the diverse nature of profit
and loss sharing agreements
and their computation.

Profit and Loss Sharing
Agreements
Equal division of partnership income is required in
the absence of a profit and loss sharing agreement.

Service Considerations in
Profit and Loss Sharing Agreements
A partner who devotes time to the partnership
business while other partners work elsewhere
may receive a salary allowance.
Salary allowances are also used to
compensate for differences in the fair
value of the talents of partners.

Salary Allowance in Profit
Sharing Agreements
Bob, Gary, and Pete are partners.
The partnership agreement provides that
Bob and Gary receive salary allowances
of $12,000 each, with the remaining
income allocated equally.
Partnership net income is $60,000 for 2003
and $12,000 for 2004.

Income Allocation Schedule: 2003
Bob Gary Pete
Net income $60,000
Salary allowances
to Bob and Gary (24,000) $12,000 $12,000
Remainder to divide 36,000
Divided equally (36,000) 12,000 12,000 $12,000
Remainder to divide 0
Net income allocation $24,000 $24,000 $12,000

Bob Gary Pete
Net income $12,000
Salary allowances
to Bob and Gary (24,000) $12,000 $12,000
Remainder to divide (12,000)
Divided equally 12,000 (4,000) (4,000) $(4,000)
Net income allocation $ 8,000 $ 8,000 $(4,000)

Journal Entries
December 31, 2003
Bob, Capital 24,000
Gary, Capital 24,000
Pete, Capital 12,000
Partnership income allocation for 2003

Journal Entries
December 31, 2004
Pete, Capital 4,000
Bob, Capital 8,000
Gary, Capital 8,000
Partnership income allocation for 2004

Bonus and Salary Allowances
The partnership agreement provides that Bob
receive a bonus of 10% of partnership net income.
Partnership net income is $60,000
for 2003 and $12,000 for 2004.
Bob and Gary receive salary allowances
of $10,000 and $8,000, respectively, and
the remaining income is allocated equally.

Bob Gary Pete
Net income $60,000
Bonus to Bob (6,000) $ 6,000
Salary allowances
to Bob and Gary (18,000) 10,000 $ 8,000
Divided equally (36,000) 12,000 12,000 $12,000
Net income allocation $28,000 $20,000 $12,000

Bob Gary Pete
Net income $12,000
Bonus to Bob (1,200) $ 1,200
Salary allowances
to Bob and Gary (18,000) 10,000 $8,000
Remainder to divide (7,200)
Divided equally 7,200 (2,400) (2,400) $(2,400)
Net income allocation $ 8,800 $5,600 $(2,400)

Income Allocated in Relation
to Partnership Capital
Capital balances 1/1/2003 $20,000 $20,000
Investment April 1 2,000 —
Withdrawal July 1 — (5,000)
Investment September 1 3,000 —
Withdrawal October 1 — (4,000)
Investment December 28 — 8,000
Capital balances 12/31/2003 $25,000 $19,000
Ace Butch

Comparison of Capital Bases
Weighted
Beginning Ending Average
Capital Capital Capital
Investment Investment Investment
Ace $20,000 $25,000 $22,500
Butch 20,000 19,000 16,500
Total $40,000 $44,000 $39,000

Alternatives
Beginning Capital Balances
Ace ($100,000 × 20/40) $ 50,000
Butch ($100,000 × 20/40) 50,000
Total income $100,000
Net income of $100,000 is divided
on the basis of capital balances.

Alternatives
Ending Capital Balances
Ace ($100,000 × 25/44) $ 56,818.18
Butch ($100,000 × 19/44) 43,181.82
Total income $100,000.00
Average Capital Balances
Ace ($100,000 × 22.5/39) $ 57,692.31
Butch ($100,000 × 16.5/39) 42,307.69
Total income $100,000.00

Interest Allowances
on Partnership Capital
An agreement may provide for interest
allowances on partnership capital in
order to encourage capital investments,
as well as salary allowances.
Remaining profits are then divided
equally or in any other ratio specified
in the profit sharing agreement.

Value new partners’ investment
in an existing partnership.

Changes in Partnership Interest
The existing legal partnership entity is
dissolved when a new partner is admitted
or an existing partner retires or dies.

Changes in Partnership Interest
Assignment of an interest to a third party
Admission of a new partner
Purchase of an interest from existing partners
Investing in an existing partnership

Value partner’s share upon
retirement or death.

Dissolution of a Continuing Partnership
Through Death or Retirement
Profit and
Capital Percentage Loss
Balances of Capital Percentage
Bonnie $ 70,000 35% 40%
Clyde 50,000 25 20
Dillinger 80,000 40 40
Total capital $200,000 100% 100%

Dissolution of a Continuing Partnership
Through Death or Retirement
Dillinger decides to retire.
The partners agree that the business is
undervalued on the partnership books
and that Dillinger will be paid $92,000.

Bonus to Retiring Partner
Dillinger, Capital 80,000
Bonnie, Capital 8,000
Clyde, Capital 4,000
Cash 92,000
Goodwill 12,000
Cash 92,000

Reevaluation of Total
Partnership Capital
Goodwill (other assets) 30,000

Payment to Retiring Partner
Less than Capital Balance
Suppose that Dillinger is paid $72,000
in final settlement of his capital interest.

Overvalued Assets Written Down
Net assets 20,000
Cash 72,000

Bonus to Continuing Partners
Cash 72,000

Understand limited liability
partnership characteristics.

Limited Partnerships
The limited partnership consists
of at least one general partner
and one or more limited partners.
The limited partner is excluded from
the management of the business.

End of Chapter 15

chapter 15 firma

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