Partnerships

1
Partnerships
22
A review of the Equity section of the balance
sheet will indicate the partnership form of
business organization
2
Objective 22.1 Identify characteristics of a
partnership

• Characteristics or partnerships
• Voluntary association
• Mutual agency
• Limited life
• Unlimited liability
• Co-ownership of property
• Income taxes
• Partnership agreement

Partner?
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Partnership characteristics

• Voluntary Association
• Agreements to form a partnership are voluntary
• They can be dissolved at will (existing
  liabilities will remain however)
• They can be formed by an oral
• agreement (handshake) or a written agreement

Fetch!! (If you want to)
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Partnership characteristics

• Limited Life (generally)
• Partnerships terminate with the death or
  bankruptcy of any partner
• Partnerships terminate with
• The withdrawal of an existing partner or
• The admission of a new partner

Playing dead doesnt count. Were still partners
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Partnership characteristics

• Mutual Agency
• As an agent, each and every partner can bind the
  partnership within the scope of the partnership
  business
• Partners, by agreement, can limit the scope of
  partners acting for the partnership
• Outsiders, unless they have knowledge of a
  partners limitation to bind the partnership, can
  legally assume no limitations exist

You said we would mow the lawn?? You cant push
the mower...
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Partnership characteristics

• Unlimited Liability
• Each partner is fully liable for all the debts of
  the partnership
• Partners are personally liable for debts of the
  partnership

We owe what ?? How could you have possibly eaten
that much ?
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Partnership characteristics

• Co-ownership of property
• Partnership property is jointly owned by the
  partners regardless of which partner invests the
  property

Look, we own your doghouse together. OK ? Dont
be so territorial.
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Partnership characteristics

• Income tax
• Partnerships do not pay taxes on income
• Individual partners are responsible for income
  taxes on their allocation of partnership income

Partner Schmartner You pay your own taxes. . .
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Partnership characteristics

• Partnership Agreement
• Most partnerships use a written partnership
  agreement
• In the absence of a written agreement, the
  Uniform Partnership Act rules prevail in an
  agreement dispute

I know its embarrassing but a paw print is all
you can sign with. . .
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Partnership characteristics

• Partnership Advantages
• Can raise more capital and expertise than
  proprietorships
• Less expensive to form than corporations
• Partnership income is not taxed separately
• Can be formed very quickly

Remind me again of the expertise you were
bringing to this deal . . .
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Partnership characteristics

• Partnership Disadvantages
• Agreements can become difficult to negotiate
• Mutual agency and unlimited liability create
  personal obligations and exposure for individual
  partners
• Success often dependent on
• mutual trust between partners

For you, Im a partner. For me, youre a burden.
. .
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Partnership characteristics

• Partnership Agreement
• The nature of the partnership business, its name
  and location
• The names, initial capital investments and duties
  of each partner
• Method of allocating (sharing) profits and losses
  among partners
• Agreements on
• Withdrawals of assets
• Admission of new partners
• Withdrawals of partners
• Liquidation of the partnership
• Dispute resolution procedures

So?? You still get 2 of profits after I get my
50,000 salary allowance. . .
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Types of Partnerships
General partnerships are the traditional and most
common form of partnership. The preceding
characteristics apply to all general partners.  
Limited partnerships have two types of partners,
general and limited. The general partner is
responsible for management of the business and
has unlimited liability for partnership debts.
Limited partners have no management duties or
authority. Their liability to partnership debts
is limited to the amount of their partnership
investment.
Youre limited only your ability. Youre still
responsible buddy. . .
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Objective 22.2 Account for organization of a
partnership
Basic accounting for partnerships is similar to
that of proprietorships. The exceptions are those
transactions that involve the partners equity
accounts
The Equity section will tell you if the firm is a
partnership
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15
Account for organization of a partnership

• Partners equity accounts must be used for
• Initial and subsequent equity investments
• Distribution of profits and losses to individual
  partners
• Withdrawal of assets by individual partners
• Dissolutions and liquidation of the partnership

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Account for organization of a partnership

• Partnership accounting requires the following
• A separate equity account for each partner
• A separate withdrawal account for each partner
• Allocation of profits and losses among partners
  according to a partnership agreement

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Account for organization of a partnership
Assume J. Ross and T. Smith form a partnership
with equal cash equity investments of 25,000
Total equity in the partnership is now J. Ross,
Capital 25,000 T. Smith Capital 25,000 Total
Equity 50,000
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Account for organization of a partnership
J. Ross withdraws 1,000 and T. Smith withdraws
2,000
Total equity in the partnership is now J. Ross,
Capital 25,000 Less withdrawals (1,000) T.
Smith Capital 25,000 Less withdrawals
(2,000) Total Equity 47,000
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Account for organization of a partnership
J. Ross and T. Smith have agreed to share profits
50-50. First year profits are 10,000
Total equity in the partnership is now J. Ross,
Capital 30,000 Less J. Ross, Withdrawals
(1,000) T. Smith Capital 30,000 Less T. Smith
Withdrawals (2,000) Total Equity 57,000
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Account for organization of a partnership
Accounting for the start-up of a partnership is
similar to that of a proprietorship. Partners
invest both assets and liabilities.
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Account for organization of a partnership

• T. Will and R. Star form a partnership.
• T. Will invests 90,000 cash.
• R. Star invests 10,000 and a commercial building
  and land that cost 125,000.
•  
• The building and land recently appraised for
  300,000, (land at 100,000 and building at
  200,000).
• R. Star has a 150,000 loan on the real estate
  which the partnership agrees to assume.

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Account for organization of a partnership
90,000 Will 10,000 Star
Assumption of Stars real estate debt
Star 10,000 cash 150,000 real estate equity
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Objective 22.3 Account for income allocation
among partners

• Various method of income (and loss) sharing are
  used by partners. Some examples include
  allocation by
• Percentage
• Capital balances
• Both percentage and capital balances
• Combination of service, capital balances and
  percentage

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Partner income allocation -percentage
Tina Boss and Mary Wisk form a partnership and
agree that profits and losses should be shared
with 1/3 to Tina and 2/3 to Mary. The recent
year end resulted in a loss of 60,000.
2/3 for me
1/3 for me
2/3 x 60,000 40,000
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Partner income allocation capital balances
Ryo Tan, Mike West and Han Lee form a new
partnership and agree to allocate income and
losses based on their end of the year capital
balances. The first year net income is 50,000.
Total capital Ryos 30,000 Mikes
50,000 Hans 20,000 100,000

• Ryos share 30/100 x 50,000 15,000
• Mikes share 50/100 x 50,000 25,000
• Hans share 20/100 x 50,000 10,000

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Partner income allocation -capital balances
The second year, Ryo, Mike Han decide to
allocate income based on end-of-year capital
balances for the first 60,000 with any remainder
shared equally. Net income for the year was
90,000.
20 x 60,000 12,000
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Partner income allocation service, capital
The end of the third year Ryo, Mike and Han
decide to change their income allocation
agreement again. The plan is as follows First, a
service (salary allowance) allocation, Ryo
40,000 Mike 10,000 Han 80,000 Second, 10 of
end-of-year capital balances Third, an remaining
balance (positive or negative) to be shared
equally.Total income the third year was 175,000.
 
175,000 130,000 13,500 31,500
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Partner income allocation service, capital
In the fourth year the Ryo, Mike and Han
partnership earned 125,000. Notice the (7,500)
allocated to each in step 3. When income is
adequate, a positive equal distribution will
result, however, when income is inadequate, all
partners share, per their agreement, in the
shortfall.
125,000 130,000 17,500 (22,500)
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Objective 22.4 Account for the admission and
retirement of partners

• Admit partners (new partnership results)
• Personal transaction
• At book, below book or above book value
• Partnership transaction
• At book, below book or above book value

In a general partnership, all partners must
agree to allow a new partner into the firm.
However, the financial interest in the
partnership can often be sold separately in a
personal transaction. No change to the
partnership accounts would result.
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Admit partner personal transaction
In the Ryo, Mike, Han partnership, Ryo sells his
partnership interest to Fred for 125,000. Mike
and Han agree to Fred Small as a new partner.
Ryos capital account totals 115,000 at the time
of the sale. Fred pays Ryo personally, the
partnership receives no cash. The partnership
simply records the following
Acknowledged and accepted by the partnership
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Admit partner partnership transaction at book
value
Partners Tina and Mary agree to admit Kim Chu as
a 20 partner for a cash investment of 25,000.
Beginning capital Tina 60,000 Mary 40,000
Total 100,000
Projected capital Beginning 100,000 New partner
25,000 Total 125,000
New partners capital Total 125,000 x 20
25,000
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Admit partner partnership transaction above book
value
Partners Tina and Mary agree to admit Kim Chu as
a 20 partner for a cash investment of 31,000.
Tina will receive 1/3 and Mary 2/3 of any bonus
or deficiency.
Beginning capital Tina 60,000 Mary 40,000
Total 100,000
Projected capital Beginning 100,000 New partner
31,000 Total 131,000
New partners capital Total 131,000 x 20
26,200
Bonus
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Admit partner partnership transaction below book
value
Partners Tina and Mary agree to admit Kim Chu as
a 20 partner for a cash investment of 22,000.
Tina will receive 1/3 and Mary 2/3 of any bonus
or deficiency.
Beginning capital Tina 60,000 Mary 40,000
Total 100,000
Projected capital Beginning 100,000 New partner
22,000 Total 122,000
New partners capital Total 122,000 x 20
24,400
24,400 - 22,000 2,400 x 1/3 800
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Partnership transaction partner withdraws

• Partner may withdraw voluntarily or due to
  natural death
• The original partnership ends upon withdrawal
• A partner may withdraw at book, below book or
  above book value
• Partnership agreement may contain withdrawal
  agreement or conditions
• In general, remaining partners usually must agree
  on how the withdrawing partners equity is dealt
  with

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Partner withdraws at book value
Consider HMS partnership with three partners
Hiko, Millie and Sam. The partnership has been
successful and current partner equity account
balances are Hiko 250,000 Millie 175,000 and
Sam 185,000. All profits and losses are shared
equally. Sam has asked to withdraw from the
partnership at book value. His partners agree.  
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Partner withdraws above book value
Consider the same HMS partnership in a different
scenario. Current partner equity account balances
are Hiko 250,000 Millie 175,000 and Sam
185,000. All profits and losses are shared
equally. Sam agrees to leave for 215,000 cash.
His partners agree.
Amount necessary to balance is 215,000 185,000
30,000/2 15,000 debit (reduction) to each
remaining partners equity account
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Partner withdraws below book value
Consider the same HMS partnership in a different
scenario. Current partner equity account balances
are Hiko 250,000 Millie 175,000 and Sam
185,000. All profits and losses are shared
equally. Sam agrees to leave for 145,000 cash.
His partners agree.
Amount necessary to balance is 185,000 145,000
40,000/2 20,000 credit (increase) to each
remaining partners equity account
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Objective 22.5 Account for liquidation of
partnerships
Liquidation risk cash received for the rapid
sale of assets may result in losses -less cash
received than the book values recorded for the
assets sold

• Liquidation process
•  
• Complete the liquidation sale of non-cash assets
• Allocate gains or losses from liquidation to
  partners according to their allocation agreement
• Pay all creditors
• Disburse remaining cash to partners according to
  their capital balances  

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Liquidation of a partnership at book value
Final disbursement when all non-cash assets are
sold for book value
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Liquidation of a partnership below book value
Cash received is less than book values creating a
loss
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Liquidation of a partnership below book value
The loss is allocated based on partnership
agreement
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Liquidation of a partnership below book value
Existing cash balance 5,000
This entry records the cash received for the sale
of non-cash assets
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Liquidation of a partnership below book value
This entry records the final cash disbursement to
creditors and partners
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Liquidation of a partnership below book value
Beginning equity balance for Ryo was 75,000
30,000 loss on liquidation 45,000 remaining
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Liquidation of a partnership above book value
Cash received is more than book values creating a
gain
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Liquidation of a partnership above book value
The gain is allocated based on partnership
agreement
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Liquidation of a partnership above book value
Existing cash balance 5,000
This entry records the cash received for the sale
of non-cash assets
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Liquidation of a partnership above book value
This entry records the final cash disbursement to
creditors and partners
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Liquidation of a partnership above book value
Beginning equity balance for Ryo was 75,000
15,000 gain on liquidation 90,000 remaining
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Objective 22.6 Analysis Compute and explain
partner return on equity
Average partner equity can be estimated by adding
the beginning partner equity to the ending
partner equity and dividing by 2
Partner net income

Partner return on equity
Average partner equity
This would be computed for each partner in the
partnership
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Price Earnings Ratio
Price the market price per share Earnings the
basic earnings per share
Market price per share

PE ratio
Basic earnings per share
The higher the ratio, the more investors are
paying for the annual earnings per share reported
by the firm
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Example
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End Unit 14