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PARTNERSHIPS

CAPE ACCOUNTING: UNIT 1special objectives #9

RaMoore©2013:reserved

Contents:

1. The formation of a partnership • The agreement• The concept of assets at fair value• The appropriation & current accounts

2. The admission of new members to the partnership• Admission by acquiring part of an individual’s interest• Admission by acquiring part of the entity’s interest

• Using the bonus method• Using the goodwill method

• The concepts of revaluation and goodwill

3. The retirement of a member from the partnership• Sale of interest (to one member or the entity)

4. The dissolution of the partnership as an entity• Where there is solvency• Where there is insolvency


A FORMAL AGREEMENT

• In order to avoid complications in the future, it is advised that partners in this type of business venture draw up a formal agreement;

• Where there is no formal agreement, the Partnership Act states that all profits or losses MUST be share equally.


The agreement should contain (inter alia) some of the following:

1. The agreed capital contribution of each partner

2. The method of sharing the business’ profits and losses

3. The rate of interest (if any) payable on capital invested

4. The rate of interest (if any) payable on drawings made

5. The salaries or bonuses (if any) payable to particular (or all) partners

6. The method for admitting or removing partners to/from the business


FAIR VALUE ASSESSMENTS

• A partnership involves the pooling of the business interests of two or more parties (with a primary objective of making a profitable return on the investment).

• In order to disclose these assets in the new entity… they must be recorded at their FAIR VALUES.

• The Fair value is the amount one would expect to obtain for the asset under current market conditions in an arm’s length transaction.


The Appropriation Account

• This is that half of the double-entry accounting that reflects how the partners agreed on the distribution of the entity’s profits and/or losses.

• The appropriation account begins with– A transfer of the net profits from the Trading, Profit & Loss a/c– The non-operating income from INTEREST ON DRAWINGS is added– The agreed interest on capital is deducted from the transferred profits– The agreed salaries/bonuses are also deducted – The BALANCE OF THE PROFITS are shared as agreed(that is by

• Fixed ratio method OR• Proportionate to Capital contributions


The Current Account

• This is that half of the double-entry accounting that reflects how the partners’ interest in the entity has been impacted due to their activities during that period.

• The current account begins with– The brought down balance of the previous period (if applicable)– The interest on capital gained is transferred from the Appropriation – The salary/bonus received is transferred from the Appropriation– The share of profit/loss is transferred from the Appropriation– The drawings made by the individual are deducted from his account– The interest on drawings paid are transferred and deducted– The amount remaining after these adjustments is the BALANCE (that is

the partner’s current business interest (excluding his capital)).


The admission of new partners

An entity may seek out new partners for several reasons, such as –

– To raise new/additional funding– To increase efficiency with new management skills– To benefit from expertise in other area of business


A new partner can be

• someone who obtains a percentage of a partner’s interest in the entity.

The only disclosure required in this instance is– The change in capital of the selling party and the

one to be admitted.– Anything else is just part of a private arrangement

between the two parties.


OR a new partner can be

• someone who obtains a percentage of the entity’s interest in exchange for his/her capital contribution.

• This type of admission may require– A revaluation of existing assets– recognition of intangible assets traceable to the

partnership. (esp. goodwill)– A determination of the method of application • (i.e bonus or goodwill)


Admission by bonus method

• Calculate the book value of the new partnership.– [old partners’ capital + incoming partner’s capital]

• Calculate the interest acquired by the incoming partner– [book value X percentage of interest acquired]

• Calculate the amount paid in as bonus – [difference between cash invested and interest acquired]– [distribute the amount amongst old partners in p/l ratio]

• Allocation the bonus– [credit the partners’ capital if the excess comes from the new partner]– [debit the partners’ capital if the excess comes from the old partners]


Admission by goodwill method

• Calculate the book value of the new partnership.– [old partners’ capital + incoming partner’s capital]

• Calculate the implied capital from the new partner’s investment– [investment/ percentage of interest acquired]

• Calculate the amount of goodwill arising– [difference between book vale and implied capital]– [distribute the amount amongst old partners in p/l ratio]

– By opening an account– By not opening an account

• Remember : goodwill is an (intangible) non-current asset– [create through reputation, clientele, location, skilled labour]


Retirement of a partner

• may be VOLUNTARY • (he/she may sell their equity in firm)

• may be INVOLUNTARY • (he/she may have to leave due to age or death)

Once a partner leaves the firm … then the old

partnership dies, and a new one is born.


Retirement of a partner

• Can be through a sale of interest to a partner– (same as admission of new partner by personal transaction)

• Can be through a sale of interest to the entity – Bonus method (if interest own is greater than amount received)– Goodwill method (if interest owned is less than amount received)

• Determine the goodwill credited to the retiring partner [only]

– OR• Determine the total goodwill (due to this revaluation of the partnership)• Distribute the goodwill amongst all the partners (don’t forget the retiree)

• Write up the goodwill by debiting goodwill and crediting their capital• Write out the retiree by debiting their new capital and crediting cash.


Dissolution of a partnership

Possible reasons for a partnership to dissolve (comes to a formal end) are -:

Due to a partner or partners going bankrupt The partners have agreed to discontinue the business A partner may have been found guilty of misconduct.

At dissolution of a partnership, all the assets are disposed of (liquidated) and the cash collected is used to pay off the obligations of the business.

Debts owed to persons outside the partnership must always be paid first.


Dissolution of a partnership

• [unless otherwise stated] Dispose of the entity’s assets (except cash)

Transfer the profit/loss to the capital accounts using the p/l ratio

Pay off the creditors out of (all) the cash

Pay off any loans made to or by the entity by the partners

Pay off the partners’ capital balances Credit the partners if there is solvency Debit the other partners if there is insolvency


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