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19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

Dec 15, 2015

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Page 1: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

19-1

Page 2: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

Page 3: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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 partnership

Objective 1

Page 4: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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A partnership agreement is a legal contract forming a partnership and specifying certain details of the operation.

ANSWER:

QUESTION:

What is a partnership agreement?

Explain the important provisions which should be included in a partnership agreement

Objective 2

Page 6: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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 7: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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 8: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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 partnership.

Objective 3

Page 9: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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Memorandum Entry to Record Formation of Partnership

20--

Jan. 1 On this date a partnership was formed between Ellen Barret

and Jerry Reed to carry on a retail clothing business under

the name of Old Army, according to the terms of the partnership agreement effective this date.

Page 10: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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20-- Jan. 1 Accounts Receivable 20,500.00 Merchandise Inventory 105,200.00 Store Equipment 3,000.00 Allow. for Doubtful Accts. 1,200.00 Notes Payable—Bank 39,100.00 Accounts Payable 34,700.00 Interest Payable 500.00 Ellen Barret, Capital 53,200.00 Investment of Ellen Barret

Assets that are transferred to a partnership should be appraised and recorded at the agreed-upon fair market value at the time of transfer.

Investments of Assets and Liabilities by a Sole Proprietor

Page 11: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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Investment of Cash by Partner

New Partner Given Credit for Amount Invested

Jan. 1 Cash 28,000.00

Jerry Reed, Capital 28,000.00

Investment of cash by Reed

Page 12: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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Drawing AccountsDrawing Accounts

Any withdrawal by a partner, whether it is cash or some other asset, is a return of equity to that partner.

The partner’s drawing account balance reduces that partner’s equity.

Page 13: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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.

McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

Page 14: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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 15: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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 16: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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Agreed Upon Ratio

Step 1: Add the figures given in the ratio.

Barret 3 + Reed 2

Example: Barret and Reed agreed that net income should be split in a 3:2 ratio to Barret and Reed, respectively.

Step 2: Express each figure as a fraction of the total.

Barret’s share 3/5 Reed’s share 2/5

Step 3: Convert each fraction into a percentage.

Barret’s share 3/5 = 60% Reed’s share 2/5 = 40%

= Total 5

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Net Income X partner’s share percentage:

Agreed Upon Ratio

20--

Dec. 31 Income Summary 100,000.00 Ellen Barret, Capital 60,000.00

Jerry Reed, Capital 40,000.00

Net Income = $100,000 Barret’s share ($100,000 x 60% = $60,000) Reed’s share ($100,000 x 40% = $40,000)

Page 18: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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Capital Account Balances

Step 1: Add the capital account balances.

Barret $53,200

Reed + 28,000

Total = $81,200

Step 2: Express each balance as a fraction and convert it to a percentage.

Barret $53,200/$81,200 = 65.517%

Reed $28,000/$81,200 = 34.483%

Page 19: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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 20: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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 21: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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 22: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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20--

Dec. 31 Income Summary 52,800.00 Ellen Barret, Capital 30,000.00

Jerry Reed, Capital 22,800.00

Net Income is $112,800.

Salary Allowances

Salary allowances for Barret $30,000 and Reed is $22,800.

Page 23: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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20--

Dec. 31 Income Summary 60,000.00 Ellen Barret, Capital 36,000.00

Jerry Reed, Capital 24,000.00

Salary AllowancesNet Income $112,800

Less: Salary Allowances – 52,800

Using the agreed upon ratio, the amount of net income after salary allowances is allocated 60% to Barret and 40% to Reed.

Balance in Income Summary = $ 60,000

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Net Loss

Net Loss 30,000

Their capital accounts are debited (decreased).

Income Summary

Distributed between Ross and Wright.

Dec. 31Sal. All. 52,800

Dec. 31Int. All. 6,496

Bal. $89,296

Assume net loss = $30,000 Record the salary allowances of $30,000 for Barret and $22,800

for Reed. Record the interest allowances of $4,256 to Barret and $2,240

to Reed.

Page 25: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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Partnership Financial Statements

Income 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’ equities

Objective 5

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OLD ARMY Statement of Partners’ Equities Year Ended December 31, 2010

Barret Reed Total Capital Capital Capital

Capital Balances, Jan. 1, 2010 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, 2010 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 27: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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.McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

Page 28: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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 29: 19-1. Accounting for Partnerships Section 1: Forming a Partnership Chapter 19 Section Objectives 1.Explain the major advantages and disadvantages of a.

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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.

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An adjusting entry is prepared for the revalued items.

GENERAL JOURNAL PAGE 4 DATE DESCRIPTION POST. DEBIT CREDIT REF.20--April 1 Merchandise Inventory 9,000.00

Allow. for Doubtful Accounts 2,300.00 Tom Lee, Capital 2,680.00 Joan Wilner, Capital 2,680.00 Nau Flores, Capital 1,340.00 To record revaluation of assets and allocation of

gain to partners.

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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 interest

Objective 7

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Account for the investment of a new partner in an existing partnership.

Objective 8

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New Partner Given Credit for Amount Invested

20--

April 1 Cash 51,500.00Beth Rivera, Capital 51,500.00

To record investment of Rivera for one-fourth interest in partnership.

New partner, Rivera, pays $51,500 for ¼ interest in partnership.

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New Partner Given Credit for More Than Amount Invested

After the cash investment is recorded, a bonus is given to the new partner by crediting the new partner’s capital account. This credit is offset by debits to the original partners’ capital accounts.

20--

April 1 Tom Lee, Capital 1,800.00 Joan Wilner, Capital 1,800.00 Nau Flores, Capital 900.00 Beth Rivera, Capital 4,500.00

To record bonus allowed new partner

New partner paid $45,500 for one-fourth interest in partnership. (¼ of partnership capital = $50,000)

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If a new partner is given credit for less than the amount invested, a bonus is allowed to the existing partners and is credited to their capital accounts in the former profit and loss ratio.

20--

April 1 Beth Rivera , Capital 5,500.00 Tom Lee, Capital 2,200.00

Joan Wilner, Capital 2,200.00 Nau Flores, Capital 1,100.00

To record bonus to original partners.

New Partner Given Credit for Less Than Amount Invested

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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 partnership

Objective 9

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The revalued assets result in the following capital account balances:Lee $40,980 Wilner 61,180Flores 52,340 Total $154,500

Withdrawal of Partner(Paid the balance of her capital account.)

New Partner Given Credit for Amount Invested

20--

Mar. 31

Nau Flores, Capital 52,340.00Cash 52,340.00

To record cash payment made to Flores on withdrawal from partnership.

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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.

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The revalued assets result in the following capital account balances:Lee $40,980 Wilner 61,180Flores 52,340 Total $154,500

Withdrawal of Partner(Paid more than the balance of her capital account.)

New Partner Given Credit for Amount Invested

20--

Mar. 31

Nau Flores, Capital 52,340.00Tom Lee, Capital 4,500.00Joan Wilner, Capital 4,500.00 Cash 61,340

Flores receives a bonus of $61,340- 52,340 = $9,000

The bonus comes out of the remaining partner’s capital accounts.

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College Accounting, 12th Edition

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