FINANCINGFINANCING

Part 1: PartnershipsPart 1: Partnerships

CHAPTERSCHAPTERS

13-1613-16

Kinds

1. General• All partners have unlimited liability

2. Limited• Only one partner has limited liability, but the rest

cannot have a role in management.

PARTNERSHIPSPARTNERSHIPSFrom Grade 11From Grade 11

PARTNERSHIPSPARTNERSHIPSFrom Grade 11From Grade 11

PARTNERSHIPSPARTNERSHIPSFrom Grade 11From Grade 11

PARTNERSHIPSPARTNERSHIPSFrom Grade 11From Grade 11

Pros Cons

Combining skills and resources of two or more people

Limited life

Ease of formation Unlimited liability (in a general partnership)

Freedom from government restrictions and regulations

Ease of decision making

FORMING FORMING A PARTNERSHIPA PARTNERSHIPFORMING FORMING A PARTNERSHIPA PARTNERSHIP

A partner’s initial investment should be recorded at the FAIR MARKET VALUE (not book value) of the assets at the date of their transfer to the partnership.

Values assigned must be agreed to by all.

Upon the formation of a partnership, this personal computer should be recorded at its FMV of $350 instead of current book value of $1,800.

Upon the formation of a partnership, this personal computer should be recorded at its FMV of $350 instead of current book value of $1,800.

ACHTUNG!

ADMISSION OF A PARTNERADMISSION OF A PARTNER

The admission of a new partner results in the legal dissolution of the existing partnership and the beginning of a new one.

A new partner may be admitted either by:1. Buying out an existing partner, or

2. Investing assets in the partnership.

PROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERS

Admission of Partner through:

1. Buying out an existing partner

Partnership Assets

This is a personal transaction between an existing partner and the new partner.

Any money exchanged is the personal property of the participants and not the property of the partnership.

PROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERS

2. Investment of Assets in Partnership

Hello

Partnership Assets

When a partner is admitted by investment, both total net assets and total partnership capital change.

When a new partner’s investment differs from the business equity acquired by him, the difference is a bonus to either

1) the old partners or 2) the new partner.

For example, assume a business worth $1,000,000 acquires a new partner. This is now a “new” business• She added assets of $200,000, but because of the expertise and

extensive client base that she brought with her, she received a 30% stake in the capital of the “new” business. Observe…

PROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERS

Total old capital

Total new capital

FMV of her asset invested

Her stake is:

So the addition of her to the business resulted in a bonus of $160,000, which was distributed to the new partner for the reasons

mentioned above.

$1,000,000

$1,200,000

only $200,000

30%

Which works out to be $360,000

Compare

The journal entry to record the entry of this partner would then look like this:

The old partners take a penalty in order to reward the $160,000 bonus to the new partner.

PROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERSPROCEDURES IN ADDING PARTNERS

Date Particulars Debit Credit

July 31 Various Assets Accounts 200,000

NEW PARTNER, Capital 360,000

Partner 1, Capital 80,000Partner 2, Capital 80,000

PARTNERSHIPSPARTNERSHIPSIncome ratiosIncome ratios

PARTNERSHIPSPARTNERSHIPSIncome ratiosIncome ratios

A partner’s share of profit/loss is determined by the income ratio, and allocated during closing entries.

The following are typical income ratios:

1. Fixed ratio, for example 60% and 40%.2. A ratio based on each partner’s share of total company

capital.3. Salaries to partners.4. Interest on partners’ capital balances.

Note: some or all of the above are often combined together

INCOME RATIOSINCOME RATIOSDivision Of Net IncomeDivision Of Net Income

INCOME RATIOSINCOME RATIOSDivision Of Net IncomeDivision Of Net Income

Sara and Ray are partners. The partnership agreement provides for the following income ratio:

1) Salary allowances of $8,400 for Sara and $6,000 for Ray2) Interest allowances of 10% on beginning capital balances, and 3) Split remaining profit equally.

Beginning capital balances: Sara $28,000 and Ray $24,000. The division of this year’s partnership income of $22,000 is as follows:

SARA RAY TOTALTotal Profit1. Allocate Salaries 8,400 6,000

22,000(14,400)

Total Profit Remaining 7,600

2. Allocate Interest AllowanceSara, 10% of $28,000Ray, 10% of 24,000

2,8002,400

Total Profit Remaining

(2,800)(2,400)2,400

3. Allocate Remaining Profit Equally 1,200 1,200 (2,400)

Division of Profit 12,400 9,600 22,000

PARTNERSHIPSPARTNERSHIPSClosing Entries – Allocating the Income RatioClosing Entries – Allocating the Income Ratio

PARTNERSHIPSPARTNERSHIPSClosing Entries – Allocating the Income RatioClosing Entries – Allocating the Income Ratio

The income ratio determines how much profit to close out to each partner.

Closing entries are the same for a partnership except as follows:

When you close out the Income Summary account, you now have a Capital account and a Drawings account for each partner.

PARTNERSHIPSPARTNERSHIPSClosing EntriesClosing Entries

PARTNERSHIPSPARTNERSHIPSClosing EntriesClosing Entries

Date Particulars Debit Credit

All Revenues 100,000

All Expenses 78,000

Sara, Capital 7,000

Income Summary 100,000

Income Summary 78,000

Income Summary 22,000

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

Ray, Capital 5,000

Sara, Drawings 7,000

Ray, Drawings 5,000

(as determined by the income ratio)

Step 3

Step 4

Step 2

Step 1

At year end, a company would make the following entries

PARTNERSHIPSPARTNERSHIPSPartner’s Capital StatementPartner’s Capital Statement

PARTNERSHIPSPARTNERSHIPSPartner’s Capital StatementPartner’s Capital Statement

The equity statement for a partnership is called the statement of partners' capital. It’s function is to explain changes in

1) Each partner’s capital account and 2) Total partnership capital.

The statement of partners’ equity is prepared from the income statement and the partners’ capital and drawings accounts. The balance sheet for a partnership is the same as for a proprietorship except in the equity section. The capital balances of the partners are shown in the balance sheet.

PARTNERSHIPSPARTNERSHIPSEquity Section Of A Balance SheetEquity Section Of A Balance Sheet

PARTNERSHIPSPARTNERSHIPSEquity Section Of A Balance SheetEquity Section Of A Balance Sheet

KINGSLEE COMPANY Balance Sheet - partial December 31, 2005 Total liabilities (assumed amount) $ 115,000 Partners’ equity Sara King, Capital $ 35,400 Ray Lee, Capital 28,600 Total partners’ equity 64,000 Total liabilities and partners’ equity $ 179,000

Do Problems:

E13-1

E13-5

P13-4A 3(a-d) only

For (d), journalize the closing entries