15 - 0 advanced accounting by debra jeter and paul chaney chapter 15: partnerships: formation,...

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Advanced Accounting by Debra Jeter and Paul Chaney

Chapter 15: Partnerships: Formation, Operation, and

Ownership Changes

Slides Authored by Hannah Wong, Ph.D.Rutgers University

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Partnership

Definition An association of two or more persons

to carry on as co-owners of a business for profit

Attributes an agreement the business operates for profit members of the firm must be co-

owners

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General Partnership

All partners are general partners

Mutual agency

Right to dispose of a partnership interest

Unlimited liability

Limited or uncertain life

Tax implications: partnership income is allocated to partners who are taxed on their individual tax returns (form 1040)

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Limited Partnership

At least one general partner and one limited partner

General partner: manage the firm unlimited liability

Limited partner: invest capital only limited liability

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Joint Venture

An agreement by two or more parties to accomplish a limited purpose for their mutual benefit, often to earn a profit.

Each joint venturer participates directly or indirectly in the management of the resources

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Partnership Agreement

name of the firm, identity of the partners nature, purpose and scope of business date of organization length of operating time location of business allocation of profit and loss salaries and withdrawals of assets by

partners rights, duties and obligations of each partner contractual authority of each partner

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Partnership Agreement

procedure for admitting a new partner plan on withdrawal or death of a partner procedures for arbitration of disputes fiscal period identification and valuation of initial asset

investments situations for dissolution of partnership accounting practices whether an audit is to be performed

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Financial Statement Presentation

Difference between partnership and corporation reporting: changes in partners’ equity during the

year should be disclosed partners’ salary allowances is not an

expense no income tax expense interest on capital investment is not an

expense.

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Capital vs. Drawing Accounts

Capital Account – Reflects permanent investment of partner periodically updated for withdrawals.

Drawing Account – Used to record withdrawals during the year. Closed to capital account at end of year.

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Bonus Method

MV of asset investment = negotiated capital interest

Assets contributed by Wright$40,000

Assets contributed by Young$50,000

Fair value of assets

invested$90,000

Wright, capital $45,000

Young, capital $45,000

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Goodwill Method

MV of asset investment = negotiated capital interest

Assets contributed by Wright$40,000

Assets contributed by Young$50,000

$90,000

Fair value of assets

invested

Wright, capital $50,000

Young, capital $50,000

Goodwill of $10,000 is recorded

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Profit/Loss Allocation

Profit $20,000

Fixed Ratio

Adams $14,000

Brown$6,000

7:3

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Profit/Loss Allocation

Profit $20,000

Capital Balances

Adams $14,000

Brown$6,000

7:3Adams Capital $60,000 Brown Capital $40,000

3:2

= 3:2

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Profit/Loss Allocation

Steps:

(1) Allocate profit as interest on capital investment

(2) allocate the remaining income on another basis

Interest Allocation

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Profit/Loss Allocation

The following should be specified: the interest rate capital balance to be used how remaining profit should be allocated whether or not interest should be

allocated if profit < agreed interest allocation

Interest Allocation

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Profit/Loss Allocation

Profit $20,000

Interest Allocation

Adams $5,400

Brown$5,4001:1

Interest allocated = capital balance

x interest rate

7:3Adams $6,200

Brown $3,000

Unallocated profit

Interest allocation

Allocation of remaining profit

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Profit/Loss Allocation

Allocate profit as: fixed salary or provide for a bonus as a % of net income

The net income used in bonus calculation can be before allocation of income to partners after other allocations, but before the bonus after bonus, but before other allocations after bonus and all other allocations

Salary and Bonus Allocation

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Insufficient Income to Cover Allocation

If partnership income > interest and/or salary allocation

allocate the deficiency in the agreed ratio for allocating residual income

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Insufficient Income to Cover Allocation

Profit $11,000

Adams ($2,100)

Brown($2,100)1:1

7:3Adams$4,000

Brown $3,000

Deficiency in profit

Salary allocation

Adams$6,200

Brown $2,000

Interest allocation

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Salary and Interest

Partnerships pay salary and interest to effect an equitable distribution of income.

Pay interest on initial investment as a return on investment. Compensates each partner for use of assets.

Pay salaries to partners reflective of time dedicated to partnership.

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Admission of New Partner

A new partner can acquire an interest in a partnership by:

purchasing an interest from an existing partner New partner acquires the right to share

profits only no right to participate in management

unless granted by all remaining partners

investing assets

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Assignment of Partnership Interest

By Payment to Partners - Bonus Method

Adams, Capital 18,000

Brown, Capital 12,000

Call, Capital 30,000

To transfer capital from capital accounts of Adams and Brown to Call’s capital account.

Amounts = recorded capital x % interest acquired by Call

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Assignment of Partnership Interest

By Payment to Partners - Goodwill Method

Adams, Capital 18,000

Brown, Capital 12,000

Call, Capital 30,000

To transfer capital from capital accounts of Adams and Brown to Call’s capital account.

Goodwill 20,000

Adams, Capital 12,000

Brown, Capital 8,000

To record implied goodwill = Call’s payments / % interest acquired - recorded partnership net assets

= $36000 / 30% -$100,000

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Asset Investment

BV Acquired = Assets Invested

Cash 35,000

Call, Capital 35,000

To record Call’s 1/3 capital in the partnership= (existing net assets + assets invested by Call) x 1/3

= ($70,000 + $35,000) x 1/3= $35,000

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Asset Investment

BV Acquired < Assets Invested : Bonus Method

Cash 50,000

Call, Adams 6,000

Call, Brown 4,000

Call, Capital 40,000

To record Call’s 1/3 capital in the partnership= (existing net assets + assets invested by Call) x 1/3

= ($70,000 + $50,000) x 1/3

The excess is considered

a bonus to the

existing partners

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Asset Investment

BV Acquired < Assets Invested : Goodwill Method

Goodwill 30,000

Adams, Capital 18,000

Brown, Capital 12,000

Implied total net assets = Call’s payments / % interest acquired= $50000 / 30% = $150,000

goodwill for existing partners= implied net assets x % ownership - current capital accounts

= $150,000 x 2/3 - $70,000 = $30,000

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Asset Investment

BV Acquired < Assets Invested : Goodwill Method

Cash 50,000

Call, Capital 50,000

To record Call’s 1/3 capital in the partnership= (implied net assets) x 1/3 = $150,000x 1/3

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Payment to a Retiring Partner

Payment > BV: Bonus Method

Call, Adams 30,000

Call, Brown 6,000

Call, Capital 4,000

Liability to Adams 40,000

To record $40,000 agreed payment

to Adams

The excess is considered a bonus to the retiring partners; allocated

to existing partners by their profit and loss ratio

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Payment to a Retiring Partner

Payment > BV: Goodwill Method

Goodwill 20,000

Adams, Capital 10,000

Brown, Capital 6,000

Call, Capital 4,000

Implied goodwill = excess payment to Adams / % interest withdrawn

= $10000 / 50% = $200,000

The goodwill is allocated to partners by their profit and loss ratio

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Rational for Goodwill Method in Accounting for Partnership

Membership

Differences between historical cost and market value of assets

Presence of intangible assets

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Advanced Accounting by

Debra Jeter and Paul Chaney

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