19-1 1-1 mcgraw-hill/irwin copyright © 2012 by the mcgraw-hill companies, inc. all rights reserved

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Page 1: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-11-1McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-2

Accounting for Partnerships

Accounting for Partnerships Section 1: Forming a

Partnership

Chapter

19

Section Objectives1. Explain the major advantages and disadvantages

of a partnership.

2. State the important provisions that should be included in every partnership agreement.

3. Account for the formation of a partnership.

Page 3: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-3

Advantages of a Partnership

Each partner is taxed individually on his or her share of the partnership’s income

It pools the skills, abilities, and financial resources of two or more individuals.

It is easy and inexpensive to form.

A partnership does not pay income tax.

Explain the major advantages and disadvantages of a partnershipObjective 1

Page 4: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-4

Disadvantages of a Partnership

Each partner has unlimited liability.

The partnership is a mutual agency.

The business lacks continuity. It has a limited life.

Ownership rights are not freely transferable.

Page 5: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-5

Names of the partners. Name, location, and nature of the business. Starting date of the agreement. Life of the partnership. Rights and duties of each partner.

Every partnership agreement should contain:

Page 6: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-6

Amount of capital to be contributed by each partner

Every partnership agreement should contain:

Drawings (withdrawals) by the partners. Fiscal year and accounting method. Method of allocating income or loss to the

partners. Procedures to be followed if the partnership is

dissolved or the business is liquidated.

Page 7: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-7

Memorandum entry to record formation of partnership.

Investment of assets and liabilities by partners.

Setting up partners’ capital accounts.

Setting up partners’ drawing accounts.

Subsequent investments and permanent withdrawals.

Account for the formation of a partnershipObjective 3

Page 8: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-8

Accounting for Partnerships

Accounting for Partnerships Section 2: Allocating

Income or Loss

Chapter

19

Section Objectives

4. Compute and record the division of net income or net loss between partners in accordance with the partnership agreement.

5. Prepare a statement of partners’ equities.

Page 9: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-9

Allocating Partnership Income or Loss

In step 3 the business determines the distributive share for each partner.

Step 1. Close revenue to Income Summary.

Step 2. Close expenses to Income Summary.

Step 3. Close Income Summary to the partners’ capital accounts.

Step 4. Close each partner’s drawing account to the partner’s capital account.

Compute and record the division of net income or net loss between partners in accordance with the partnership agreement

Objective 4

Page 10: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-10

Allocation of Partnership Income or Loss

Based on the partnership agreement.

Allocated equally to each partner if the partnership agreement is “silent.”

Income distribution does not mean cash distribution.

Page 11: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-11

Capital Account Balances

Net Income X partner’s share percentage: Net Income $100,000

Barret $100,000 x 65.517% = $65,517

Reed $100,000 x 34.483% = $34,483

Page 12: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-12

Salary and Interest Allowances

Allowances for partners’ salaries and interest on

their investments can be included in the allocation of net income or loss.

Allowances are debited to the Income Summary account and credited to the partners’ capital accounts.

The remaining net income or loss is then allocated in the proper ratio.

Page 13: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-13

Salary allowances are intended to reward the partners for the time they spend in the business and for the expertise and talents they bring to it.

Salary Allowances

Salary allowances are withdrawals

Salary allowances do not represent salary expense

Page 14: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-14

Partnership Financial StatementsPartnership Financial StatementsIncome Statement Same as that for a sole

proprietorship.

One exception—on the bottom of the statement, the division of net income is shown between the partners.

Balance Sheet Same as that for a sole

proprietorship.

One exception—there exists a separate capital account for each of the partners in Partner’s Equity section.

Prepare a statement of partners’ equitiesObjective 5

Page 15: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-15

OLD ARMY Statement of Partners’ Equities Year Ended December 31, 2013

Barret Reed Total Capital Capital Capital

Capital Balances, Jan. 1, 2013 0.00 0.00 0.00

Investment During Year 53,200.00 28,000.00 81,200.00

Net Income (Loss) for Year 6,308.00 (2,908.00) 3,400.00

Totals 59,508.00 25,092.00 84,600.00

Less Withdrawals During Year 30,000.00 22,800.00 52,800.00

Capital Balances, Dec. 31, 2013 29,508.00 2,292.00 31,800.00

Statement of Partners’ Equities

Each partner’s salary is treated as a withdrawal on the statement

Page 16: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-16

Accounting for Partnerships

Accounting for Partnerships

Section 3: Partnership

Changes

Chapter

19

Section Objectives6. Account for the revaluation of assets and

liabilities prior to the dissolution of a partnership.7. Account for the sale of a partnership interest.8. Account for the investment of a new partner in an

existing partnership. 9. Account for the withdrawal of a partner from a

partnership.

Page 17: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-17

Dissolution Step 1

Accounting records are closed.

Net income or net loss on the date of dissolution is recorded and transferred to the partners’ capital accounts.

Step 2

Assets and liabilities are revalued at fair market value.

Account for the revaluation of assets and liabilities prior to the dissolution of a partnership

Objective 6

Page 18: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-18

Asset Revaluation

When transferred from one partnership to another, assets are revalued to their fair market value.

The new value will not necessarily agree with the book value carried by the old firm.

The revaluation of assets affects the balance sheet only.

Page 19: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-19

There are two ways a new partner may be admitted to the partnership:

By purchasing all or part of the interest of an existing partner and paying that partner directly.

By investing cash or other assets directly in the existing partnership.

Admission of a New Partner

Account for the sale of a partnership interestObjective 7

Page 20: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-20

When a partner withdraws, the payment given to the withdrawing partner may be more or less than the withdrawing partner’s capital balance.

The difference in the cash payment and the withdrawing partner’s capital account is debited or credited to the remaining partners according to their profit-and-loss ratio.

Account for the withdrawal of a partner from a partnershipObjective 9

Page 21: 19-1 1-1 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved

19-21

Withdrawing Partner’s Capital Account

If the amount paid is higher than the withdrawing partner’s capital account balance, the excess is debited to the capital accounts of the remaining partners according to their income and loss ratio.

If the amount paid is less than the withdrawing partner’s capital account balance, the difference is credited to the remaining partners’ capital accounts based on their income and loss ratio.