fa session 3

OverviewAccounting for partnerships requires recognition of several important factors From an accounting viewpoint, the partnership is a separate business entityAccrual accounting, cash basis accounting, or modified cash basis of accounting are allowed

Nature of Partnership EntityLegal regulationEach state regulates the partnerships that are formed in itEach state tends to begin with a model act and then modifies it to fit that states business culture and historyMost states have now adopted the Uniform Partnership Act of 1997 (UPA 1997) as the model act

Nature of Partnership EntityDefinition of a partnershipSection 202 of the UPA 1997 states that, . . . the association of two or more persons to carry on as co-owners of a business for profit forms a partnership . . .

Nature of Partnership EntityDefinition of a partnershipAssociation of two or more persons The persons may be individuals, corporations or other partnershipsTo carry on as co-owners Each partner has the apparent authority, unless restricted by the partnership agreement, to act as an agent of the partnership for transactions in the ordinary course of businessBusiness for profit The partnership must attempt to make a profit; therefore, not-for-profit entities, such as fraternal groups, may not organize as partnerships

Nature of Partnership EntityFormation of a partnershipEasy to formThe agreement to form a partnership may be informal or formal Each partner must agree to the formation agreement, and partners are strongly advised to have a formal written agreement to avoid potential problems later

Nature of Partnership EntityOther major characteristicsPartnership agreement: The UPA 1997 is used by the courts when there is no partnership agreementPartnership as a separate entity: The entity concept means that a partnership can sue or be sued and that partnership property belongs to the partnership and not to any individual partner

Nature of Partnership EntityOther major characteristicsPartner is an agent of the partnership: The agency relationship among the partners is very importantStatement of partnership authority: Describes the partnership and identifies the specific authority of partners to transact

Nature of Partnership EntityOther major characteristicsPartners liability is joint and several: All partners are liable jointly and severally for all obligations of the partnership unless otherwise provided by lawPartners rights and duties: Each partner is to have a capital account presenting the amount of that partners contributions to the partnership, net of any liabilities, and the partners share of the partnership profits or losses, less any distributions

Nature of Partnership EntityOther major characteristicsPartners transferable interest in the partnership: A partner is not a co-owner of any partnership propertyPartners dissociation: A partners dissociation means that the partner can no longer act on behalf of the partnership

Accounting for the Formation of a PartnershipAt the formation of a partnership:Assign a proper value to the noncash assets and liabilities contributedDistinguish between capital contributions and loans made to the partnership by individual partners Distinguish between tangible assets owned by the partnership and those specific assets that are owned by individual partners but are used by the partnership

Copyright Amity University

Maximum Number of Partners in a PartnershipThere can be a maximum of Twenty partners in a partnership firm.

Exceptions Partnership firms of professional can have more than twenty partners.

Accounting for the Formation of a PartnershipThe individual partners must agree to the percentage of equity that each will have in the net assets of the partnership Generally, the capital balance is determined by the proportionate share of each partners capital contribution

Accounting for Operations of a PartnershipPartners accountsCapital accountsUsed to record the initial investment of a partner, any subsequent capital contributions, profit or loss distributions, and any withdrawals of capital by the partnerDeficiencies are usually eliminated by additional capital contributions

Accounting for Operations of a PartnershipPartners accountsDrawing accountsUsed to record periodic withdrawals and is then closed to the partners capital account at the end of the periodNoncash drawings are valued at their market values at the date of the withdrawalLoan accountsA loan from a partner is shown as a payable on the partnerships booksUnless all partners agree otherwise, the partnership is obligated to pay interest on the loan

Allocating Profit or Loss to PartnersProfit or loss is allocated to the partners at the end of each period in accordance with the partnership agreementIf no agreement exists, all partners are to share profits and losses equallyProfit distribution plansPreselected ratioInterest on capital balancesSalaries to partnersBonuses to partners

Allocating Profit or Loss to PartnersThe profit or loss distribution is recorded with a closing entry at the end of each periodThe revenue and expenses are closed into an income summary account or directly into the partners capital accounts

New Partner Invests in PartnershipStep 1: The first step is to compute the new partners proportion of the partnerships book value:

New Partner Invests in PartnershipStep 2: Determine the specific admission methodMethods used if a difference exists between the new partners investment and his or her proportion of the partnerships book value:Revalue net assetsRecognize goodwillUse the bonus method

New Partner Invests in Partnership

Sheet1

Overview of Accounting for Admission of a New Partner

Sheet2

Sheet3

New Partner Invests in PartnershipDetermining a new partners investment costIt is important to note the total resulting capital of the partnership and the percentage of ownership interest retained by the prior partners


*Admission of a New Partner General Principles to Follow When a new partner is admitted to a LLP, the existing assets should be revalued and the excess should increase the capital of the existing partners.This excess can be allocated based on the income sharing plan.


*Admission of a New Partner General Principles to Follow When the investment amount of a new partner is greater than the capital credited to the new partner, the excess is bonus to the existing partners.Journal entry: Asset 70,000 Capital, new 60,000 Capital, existing 10,000


*Admission of a New Partner-General Principles to Follow When the investment amount of a new partner is less than the capital credited to the new partner, the excess is bonus to the new partner or goodwill to the partnership Journal entry (the excess is bonus to the new partner) Assets (invested by the new partner) 70,000 Capital, existing 10,000 Capital, new 80,000


*Admission of a New Partner-General Principles to Follow Journal entry (the excess is goodwill to the partnership) Assets (invested by the new partner) 90,000 Goodwill 10,000 Liabilities 20,000 Capital, new 80,000 Note: This can only be done when the new partner is investing his/her proprietorship.


*Admission of a New Partner-Examples Acquisition of an Interest by Payment to One of More partners:Assume that Lane and Mull, partners of Lane & Mull LLP share net income equally and that each has a capital balance of $60,000. Nash (with the consent of Mull) acquires half of Lane's interest in the partnership by a cash payment to Lane.


Partnerships: Organization and Operation

*Admission of a New Partner-Examples(contd.) The J.E. to record this change in ownership follows: Lane, Capital ($60,000 X 1/2) 30,000 Nash, Capital 30,000

Note: the cash paid by Nash to Lane is irrelevant for this journal entry.


*Admission of a New Partner-Examples(contd.) Investment in Partnership by New Partner: Assume that Wolk and Yary, partners of Wolk &Yary LLP, share net income/loss equally and each has a capital balance of $60,000. Assume also that the carrying amounts of partnership assets are equal to current fair values.Wolk and Yary agree to admit Zell to the partnership by investment of Zell's land.


*Admission of a New Partner-Examples(contd.) The fair value of Zell's land is $80,000.Net income/loss will be shared equally by the three partners. The admission of Zell is recorded by the partnership as follows:

Land80,000Zell, Capital80,000To record admission of Zell to partnership.


*Admission of a New Partner-Examples(contd.) Bonus to Existing Partners:Assume that in Cain & Duke LLP, the two partners share net income/loss equally and have capital account balances of $45,000 each.The carrying amounts of the partnership net assets approximate current fair values.


*Admission of a New Partner-Examples(contd.) Bonus to Existing Partners (contd.):The partnership agree admit Eck to a one-third interest in capital and one-third share in net income/loss for a cash investment of $60,000.Thus, the net assets of the new firm amount to $150,000 ($45,000+$45,00+$60,000).The following entry should be recorded for the admission of the new partner:


*Admission of a New Partner-with Bonus to Existing Partners Cash 60,000Cain, Capital ($10,000 X 1/2) 5,000Duke, Capital ($10,000 X 1/2) 5,000Eck, Capital ($150,000 X 1/3) 50,000To record investment by Eck for a one-third interest in capital, with bonus of $10,000 divided equally between Cain and Duke.Note: the capital credit to the new partner is less than the investment amount. The excess is credited to the bonus of existing partners.


*Admission of a New Partner-with goodwill to existing partnersThe one-third share interest in capital (net assets) to the new partner can also be achieved by the following journal entry (not recommended): Cash 60,000Goodwill ($120,000 - $90,000) 30,000Cain, Capital ($30,000 X 1/2)15,000Duke, Capital ($10,000 X 1/2)15,000Eck, Capital 60,000To record investment by Eck for a one-third interest in capital, with credit offsetting goodwill of $30,000 divided equally between Cain and Duke


*Admission of a New Partner-with Bonus to New PartnerExcess capital recorded as bonus to New Partner:Assume Farr and Gold, partners of Farr & Gold, LLP, share net income/loss equally and have capital account balances of $35,000 each.The partnership offer Hart a one-third interest in capital and one-third share of net income/loss for an investment of $20,000. 1/3 *($35,000x2+20,000) = $30,000


*Admission of a New Partner-with Bonus to New PartnerExcess capital for Hart => $30,000-20,000 =10,000 This event should be journalized as follows when the excess of capital to the new partner is recorded as bonus to the new partner:Cash 20,000Farr, Capital ($10,000 X 1/2) 5,000Gold, Capital ($10,000 X 1/2) 5,000Hart, Capital30,000. To record admission of Hart, with bonus of $10,000 from Farr and Gold


*Admission of a New Partner-with Bonus to New PartnerThe above treatment assumes that the net assets of the LLP were valued properly prior to the admission of Hart.If not, the net assets should be written down (debit the capital accounts) to the fair value prior to the above journal entry.


*Admission of a New Partner-with Goodwill to New PartnerExcess capital recorded as goodwill to New Partner:Assume that the new partner Hart is the owner of a successful proprietorship that Hart invests in the partnership rather than making an investment in cash.Using the same data as in the preceding example, and the identifiable tangible and intangible net assets of the proprietorship owned by Hart are worth $20,000.


*Admission of a New Partner-with Goodwill to New PartnerDue to Hart's superior earnings power, the current fair value for the total net assets is agreed to be $35,000.Thus, the capital, Hart was credited for $35,000. The admission of Hart to the partnership is recorded as shown below:


*Admission of a New Partner-with Goodwill to New PartnerIdentifiable Tangible and Intangible Net Assets 20,000 Goodwill ($35,000 - $20,000) 15,000 Hart, Capital 35,000

To record admission of Hart; goodwill is attributable to superior earnings of single proprietorship invested by Hart.


Retirement and Death of Partners


*Retirement of a Partner- Computation of the Settlement PriceAt retirement of a partner, the assets of the partnership should be revalued at the current fair.The gain or loss should be allocated to all partners based on their income-sharing plan (i.e., debit assets and credit capital accounts).After the allocation, the capital balance of the retiring partner is adjusted to the basis of current fair values of partnership's net assets.


*Retirement of a Partner- Bonus to Retiring PartnerThe partners may agree to settle by payment of this amount (the adjusted capital balance of the retiring partner), or on a different amount.If the payment is greater than the adjusted capital balance of the retiring partner, the excess payment is considered as a bonus to the retiring partnerGeneral Journal entry: Capital retiring $$$ Capital continuing $$$ Cash $$$


*Retirement of a Partner- Bonus to Continuing PartnersIf the payment is less than the adjusted capital balance of the retiring partner, the difference is considered as a bonus to the continuing partners.General Journal Entry: Capital retiring $$$ Cash $$$ Capital, continuing $$$


*Retirement of a Partner- Bonus to Retiring Partner (example)Assume that partner Lund is to retire from Jorb, Kent & Lund LLP. Each partner has a capital balance of $60,000, and net income and losses are shared equally.The contract provides that a retiring partner is to receive the balance of the retiring partner capital account plus a share of any internally generated goodwill.


*Retirement of a Partner- Bonus to Retiring Partner (example)At the time of Lund's retirement, goodwill in the amount of $30,000 is computed.The appropriate treatment is to record the amount paid to Lund for goodwill as a $10,000 bonus.The journal entry is as follows:


*Retirement of a Partner- Bonus to Retiring Partner (example)Lund, Capital60,000Jorb, Capital ($10,000 X 1/2) 5,000Kent, Capital ($10,000 X 1/2) 5,000 Cash70,000To record payment to retiring partner Lund, including a bonus of $10,000.


*Retirement of a Partner- Bonus to Retiring Partner (example)This bonus method illustrated above is appropriate whenever the settlement exceeds the capital account balance of the retiring partner.The agreement for settlement may not use the term goodwill.


*Retirement of a Partner- Bonus to Continuing Partner (example)Assume that the three partners, Noll, Merz and Park share net income/loss equally.Each has a capital balance of $60,000.Noll retires from the partnership and receives $50,000. The journal entry to record Noll's retirement is as follows:


*Retirement of a Partner- Bonus to Continuing Partner (example)Noll, Capital 60,000Cash50,000Merz, Capital ($10,000 X 1/2) 5,000Park, Capital ($10,000 X 1/2) 5,000

To record retirement of Partner Noll for an amount less than carrying amount of Nolls equity, with a bonus to continuing partners.


*Partnership Dissolution and insolvency


*IntroductionA partnership may dissolve due to disagreement among the partners, poor performance of the firm or being taken over by another business.The assets of the partnership will be realized to pay off the liabilities.The sales proceeds should be applied in the following order, as required by the Hong Kong Ordinance:Pay off creditors first,then the partners advances, and Finally the partners capital


*Realization AccountIn the partnership dissolution, an account named as Realization Account will be opened to compute the profit or loss from realization which should be shared among the partners according to the profit or loss sharing ratio


*Nature of partnership dissolutionDissolution where the assets are sold separatelyDissolution where partnership is sold as a whole


*Dissolution where Assets are sold separately


*Procedures of DissolutionAll assets will be sold to other persons or taken over by partnersSettle the liabilities of the partnership to outsider or partnersTransfer any profit or loss on realization to each partners capital accounts in profit/loss sharing ratioMerge the balances in the partners current accounts to their capital accounts


*Any credit balance in each partners capital account represents the amount which can be withdrawn from the partnership to each partner; any debit balance in a partners capital account represents additional cash to be injected by that partners

*

TransactionsAccounting entriesClose all asset accounts with net book value to the realization account (except cash and bank because these assets need not be disposed of) Dr RealizationCr AssetsCost of dissolution or any losses or expenses incurred on realizationDr RealizationCr BankProceeds from the disposal of assetsDr BankCr RealizationAssets taken over by a partner without paymentDr CapitalCr Realization

*

TransactionsAccounting entriesAsset taken over by partners as a giftNo entries requiredCreditors taken over by a partnerDr CreditorsCr CapitalsPayment to creditors with discounts received Dr CreditorsCr Realization discountCr BankProfit or loss on realization to be shared among the partners according to the profit-sharing ratioDr Realization profitCr Capitalsor Dr CapitalCr Realization - loss

*

TransactionsAccounting entriesRepayment of loan to an partnerDr Loan from partnerCr BankRepayment of loan to an outsider ( creditors)Dr Loan from outsider Cr BankTransfer any balances in partners current accountsDr Current (for credit balance)Cr CapitalsOr Dr CapitalCr Current (for debit balance) Repayment of remaining capital to partnersDr CapitalCr Bank


*Example 1


*John, Peter and Tom were partners sharing profits and losses in the ratio 1:1:3. The balance sheet as at 31 December 1996 was as follows:Balance Sheet as at 31 December 1996 Fixed Assets Cost Dep NBVPremises180000 10000 170000Motor Vehicles 27500 5500 22000207500 15500 192000Current assetsStock 68250Debtors 172500Less: provision for bad debt 1265 171235Bank 26065 265550Less: Current LiabilitiesCreditors 60000Working Capital 205550 397550

*Capital: John 100000 Peter 40000 Tom 160000 300000Current: John 30000 Peter (10000) Tom 70000 90000Long term liabilitiesLoan from Tom 7550 397550

Assets and liabilities were disposed of as follows:1. The premises were sold at $ 200000 and legal charges from the sale amount to $100002.Tom took over the stock and motor vehicles at book value3.Except for $2500, all debts were collected4. The creditors were discharged for $560005. Realization expenses of $10000 were paidRequired:Prepare the realization, Bank, Capital and Current account for the dissolution of partnership

*RealizationPremisesProvision for depreciationBal b/f 180000Prov. for depreciation 10000Realization 170000180000 180000Bal b/f 10000Premises 10000Premises 170000

*RealizationMotor VehiclesProvision for depreciationBal b/f 27500Prov. for depreciation 5500Realization 2200027500 27500Bal b/f 5500Motor Vehicles 5500Premises 170000Motor Vehicles 22000

*RealizationDebtorsProvision for Bad DebtsBal b/f 172500Prov. for bad debts 1265Realization 171235172500 172500Bal b/f 1265Motor Vehicles 1265Premises 170000Motor Vehicles 22000Debtors 171235

*RealizationStockBal b/f 68250Realization 68250Premises 170000Motor Vehicles 22000Debtors 171235Stock 68250

*RealizationBankBal b/f 26065Realization - expenses 10000Premises 170000Motor Vehicles 22000Debtors 171235Stock 68250Bank- realization expenses 10000Bank premises (200000-10000) 190000 - Debtors (172500-2500) 170000Realization premises 190000 - debtors 170000Creditors Bal b/f 60000Bank 56000Realization discount received 400060000 60000Creditors discount received 4000Creditors 56000Loan from TomBal b/f 7550Bank 7550Loan from Tom 7550

*RealizationPremises 170000Motor Vehicles 22000Debtors 171235Stock 68250Bank- realization expenses 10000Bank premises (200000-10000) 190000 - Debtors (172500-2500) 170000Creditors discount received 4000CapitalJohn Peter Tom John Peter TomBal b/f 100000 40000 160000Realization: Stock 68250 MV 22000Tom stock 68250 - MV 22000Gain on realization: John 1/5 2553 Peter 1/5 2553 Tom 3/5 7659 12765454250 454250Gain on realizaiton 2553 2553 7659

*CapitalJohn Peter Tom John Peter TomBal b/f 100000 40000 160000Realization: Stock 68250 MV 22000Gain on realizaiton 2553 2553 7659CurrentJohn Peter Tom John Peter TomBal b/f 30000 - 70000Bal b/f 10000Capital 10000Capital 30000 7000030000 10000 70000 30000 10000 70000BankBal b/f 26065Realization - expenses 10000Realization premises 190000 - debtors 170000Creditors 56000Loan from Tom 7550Capital: John 132553 Peter 32553 Tom 147409386065 386065Current 30000 70000Current 10000Bank 132553 32553 147409132553 32553 147409 132553 32553 147409


*Dissolution where partnership is sold as a whole


*Purchase considerationThe purchase consideration is to be discharged by the limited company (buyer) to partners(seller) to take over the business Goodwill = Purchase consideration ( assets at take-over value liabilities at take-over value)

*

TransactionsAccounting entriesFor dissolution of Old partnership (seller)Close all asset accounts with net book value to the realization account (Bank and cash may be taken over)Dr RealizationCr AssetsCost of dissolution or any losses or expenses incurred on realizationDr RealizationCr BankProceeds from sale of the business (purchase consideration)Dr Vendee (buyer)Cr Realization

*

TransactionsAccounting entriesLiabilities taken over by the buyerDr Liabilities Cr RealizationThe purchase consideration settled by cheque, shares and debenturesDr Bank/ Shares/ debentures in purchasers companyCr BankRepayment of remaining capital to partnersDr capitalCr Bank/ shares/ debentures in purchasers company

*

TransactionsAccounting entriesFor opening entries of New Company (buyer)Assets taken over Dr AssetsCr Business PurchaseLiabilities taken overDr Business PurchaseCr LiabilitiesThe purchase consideration offeredDr Business PurchaseCr Vendor (seller)The purchase consideration settled by cheques, shares and debenturesDr Vendor (seller)Cr Bank/Shares/Debentures

*RealizationPremises 170000MV 22000Stock 68250Debtors 171235Bank 26065Bank be taken overTom: debtors (172500-2500) 170000John: stock 68250 Creditors 60000Loan from Tom 7550Liabilities taken over by Ltd. Co.Fortune Ltd purchase consideration[(200000+25000+26065-7550-60000)+70000] 253515

Purchase consideration=Asset-liabilities +goodwillCapital: John 20353 Peter 20353 Tom 61059 101765559315 559315


*Cash distribution among partners


*Cash Distribution Among PartnersWith the application of the Garner vs. Murray ruleWhen cash is to be distributed as soon as possible ( Piecemeal realization)


*With the application of Garner vs. Murray ruleAny CREDIT balance in each partners capital account represents the amount which can be withdrawn from the partnership to each partnerAny DEBIT balance in a partners capital account represents additional cash to be injected by that partner. If he is insolvency to repay the amount, the solvency partners will be shared the amount in:Profit & loss sharing ratioAny agreed ratio given in the examination questionGARNER vs. MURRAY rule may be applied


*Garner vs. Murray ruleUnder the rule, a partner is required to contribute cash to eliminate the debit balance in his capital accountIn the court case of Garner vs. Murray (1904), it was held that subject to any agreement to the contrary, such a debit balance deficiency was to be shared by the other partner not in their profit and loss sharing ratio but the ratio of their last agreed capitals

*

Insolvency If one partner is insolvent, his capital deficiency will be shared by other partners according to the last agreed capital ratio (the ratio of the balances in the capital accounts before the dissolution, in the absence of any agreement to the contrary

Thank YouCopyright@ Amity UniversityPlease forward your query To: [email protected]: [email protected]

Amity Business SchoolAmity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business SchoolLecture 1Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School*Amity Business School**This account is a reciprocal ledger account (to Home Office account) used by the home office to account for any transactions with the branches. It is debited for cash, merchandise and services provided to the branch by the home office and for the net income reported by the branch. It is credited for cash, or other assets (i.e., office equipment, furniture, etc.) received from the branch, and for net losses reported by the branch. Thus, this account reflects the equity method of accounting. Home office usually maintains one investment account for each branch.

Amity Business School**This account is a reciprocal ledger account (to Home Office account) used by the home office to account for any transactions with the branches. It is debited for cash, merchandise and services provided to the branch by the home office and for the net income reported by the branch. It is credited for cash, or other assets (i.e., office equipment, furniture, etc.) received from the branch, and for net losses reported by the branch. Thus, this account reflects the equity method of accounting. Home office usually maintains one investment account for each branch.




Amity Business SchoolAmity Business School*Amity Business SchoolAmity Business School*Amity Business SchoolAmity Business School*

fa session 3

Documents

partnership profits

uniform partnership

individual partners

partners contributions

specific authority of

formation agreement

formthe agreement

cash basis accounting