Slide

13-1

13
McGraw-Hill/Irwin

Partnerships

The McGraw-Hill Companies, Inc.

Slide
13-2

Characteristics of Partnerships
Voluntary
Voluntary
Association
Association

Limited
Limited
Life
Life
Partnership
Partnership
Agreement
Agreement

Taxation
Taxation
Mutual
Mutual
Agency
Agency
McGraw-Hill/Irwin

Unlimited
Unlimited
Liability
Liability

The McGraw-Hill Companies, Inc.

Slide
13-3

Organizations with Partnership

Characteristics
Limited
Limited
Partnerships
Partnerships

General
Generalpartners
partners
assume
assumemanagement
management
duties
dutiesand
andunlimited
unlimited
liability
liabilityfor
forpartnership
partnership
debts.
debts.
Limited
Limitedpartners
partnershave
have
no
nopersonal
personalliability
liability
beyond
beyondinvested
invested
amounts.
amounts.
McGraw-Hill/Irwin

Limited
Limited
Liability
Liability
Partnerships
Partnerships

Protects
Protectsinnocent
innocent
partners
partnersfrom
from
malpractice
malpracticeor
or
negligence
negligenceclaims.
claims.
Most
Moststates
stateshold
holdall
all
partners
partnerspersonally
personally
liable
liablefor
forpartnership
partnership
debts.
debts.

Limited
Limited
Liability
Liability
Corporation
Corporation
ss

Owners
Ownershave
havesame
same
limited
limitedliability
liabilityfeature
feature
as
asowners
ownersof
ofaa
corporation.
corporation.
AAlimited
limitedliability
liability
corporation
corporationtypically
typically
has
hasaalimited
limitedlife.
life.

The McGraw-Hill Companies, Inc.

Slide
13-4

Choosing a Business Form

Proprietorship Partnership
LLP
Business entity
yes
yes
yes
Legal entity
no
no
no
Limited liability
no
no
limited*
Business taxed
no
no
no
One owner allowed
yes
no
no

LLC
yes
yes
yes
no
yes

S Corp. Corporation
yes
yes
yes
yes
yes
yes
no
yes
yes
yes

*A partner's personal liability for LLP debts is lim ited. Most LLPs carry insurance to protect against
m alpractice.

Many
Many factors
factors should
should
be
be considered
considered when
when
choosing
choosing the
the proper
proper
business
business form.
form.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-5

Organizing a Partnership

Partners
Partners can
can invest
invest both
both assets
assets and
and liabilities
liabilities in
in the
the
partnership.
partnership.
Assets
Assets and
and liabilities
liabilities are
are recorded
recorded at
at an
an agreedagreedupon
upon value,
value, normally
normally fair
fair market
market value.
value.
Contributions
Contributions increase
increase the
the partners
partners capital
capital
account.
account.
Withdrawals
Withdrawals decrease
decrease the
the partners
partners
capital
capital account.
account.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-6

Organizing a Partnership
On
On 2/15/02,
2/15/02, Greene
Greene and
and Redd
Redd form
form aa partnership.
partnership.
Greene
Greene contributes
contributes $80,000
$80,000 cash.
cash. Redd
Redd
contributes
contributes land
land valued
valued at
at $40,000.
$40,000.

GENERAL JOURNAL
Date

Description

Page 34
PR

Debit

Credit

Prepare
Prepare the
the journal
journal entry
entry to
to set
set
up
up the
the partnership.
partnership.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-7

Organizing a Partnership
On
On 2/15/02,
2/15/02, Greene
Greene and
and Redd
Redd form
form aa partnership.
partnership.
Greene
Greene contributes
contributes $80,000
$80,000 cash.
cash. Redd
Redd
contributes
contributes land
land valued
valued at
at $40,000.
$40,000.

GENERAL JOURNAL
Date

Description

Page 34
PR

Debit

Feb. 15 Cash

80,000

Land

40,000

Credit

Greene, Capital

80,000

Redd, Capital

40,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-8

Dividing Income or Loss

In the absence of an agreement,

the Uniform Partnership Act

says that the income or loss is
shared equally by the partners.
Three frequently used methods

to divide income or loss are:

A stated ratio
The ratio of capital balances
Salary and interest allowances and
any remainder in a fixed ratio.

McGraw-Hill/Irwin

Lets look at each

of these
methods!

The McGraw-Hill Companies, Inc.

Slide
13-9

Allocation on Stated Ratios

Greene and Redd agree to a three-fourths,
one-fourth allocation of partnership income
and loss, respectively. For 2002, net
income is $60,000.
GENERAL JOURNAL
Date

Description

Page 34
PR

Debit

Credit

Prepare the closing entry for Income

Summary that will allocate the income to the
partners based on their agreement.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-10

Allocation on Stated Ratios

Greene and Redd agree to a three-fourths,
one-fourth allocation of partnership income
and loss, respectively. For 2002, net
income is $60,000.
GENERAL JOURNAL

Date

Description
Income Summary

Page 34
PR

Debit

Credit

60,000

Greene, Capital

45,000

Redd, Capital

15,000

Greene: $60,000 (3/4) = $45,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Redd: $60,000 (1/ ) =$15,000

Slide
13-11

Allocation on Capital Balances

Greenes capital balance is $80,000 and Redds
capital balance is $40,000. The partnership
agreement calls for income or loss to be
allocated based on the relative capital
balances. Net income for 2002 is $60,000.
GENERAL JOURNAL

Date

Description

Page 34
PR

Debit

Credit

Prepare the closing entry for Income

Summary that will allocate the income to the
partners based on their agreement.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-12

Allocation on Capital Balances

Greenes capital balance is $80,000 and Redds
capital balance is $40,000. The partnership
agreement calls for income or loss to be
allocated based on the relative capital
balances. Net income for 2002 is $60,000.
GENERAL JOURNAL

Date

Description
Income Summary

Page 34
PR

Debit

Credit

60,000

Greene, Capital

40,000

Redd, Capital

20,000

Greene: $60,000 ($80,000/$120,000) = $40,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Redd: $60,000 ($40,000
/
) = $20,000

Slide
13-13

Allocation on Services, Capital,

and Stated Ratios
Greene and Redds partnership agreement contains the
following information:
Greene receives $15,000 and Redd receives $10,000 as
annual salaries.
Each partner is allowed an annual interest allowance of
5% on the beginning-of-year capital balance.
Any remaining balance of income or loss is allocated
equally.
Net income for 2002 is $60,000.
What amount of the net income will be allocated to each
partner based on their agreement?

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-14

Allocation on Services, Capital,

and Stated Ratios
Greene

Net income
Salaries
Interest
Remainder
Equal allocation of remainder
Balance of net income
Income of each partner

15,000 $
4,000
14,500

33,500 $

Redd

Total
$
60,000
10,000
25,000
2,000
6,000
29,000
14,500
29,000
$
26,500

If the allowances exceed net income, the deficit

would be allocated equally, just as the excess is in
the example above.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-15

Partnership Financial Statements

Although most partnership financial statements are very

similar to those of a proprietorship, the Statement of
Changes in Partners Equity is one exception.
Greene and Redd Partnership
Statement of Changes in Partners' Equity
For the Year Ended December 31, 2002
Greene
Redd
Beginning capital balances
$
$
Investments by owners
80,000
Net income
Salary allowances
$ 15,000
$
10,000
Interest allowances
4,000
2,000
Balance allocated
14,500
14,500
Total net income
33,500
Less partners' withdrawals
(5,000)
Ending capital balances
$ 108,500
$
McGraw-Hill/Irwin

Total
$
40,000

120,000

26,500
(1,000)
65,500

60,000
(6,000)
174,000

The McGraw-Hill Companies, Inc.

Slide
13-16

Admission of a Partner

When
When the
the makeup
makeup of
of the
the

partnership
partnership changes,
changes, the
the
partnership
partnership is
is dissolved.
dissolved.

A
Anew
new partnership
partnership may
may be
be
immediately
immediately formed.
formed.

New
New partner
partner acquires
acquires
partnership
partnership interest
interest by:
by:

Purchasing
Purchasingititfrom
from the
theother
other

partners,
partners,or
or

Investing
Investingassets
assets in
inthe
the
partnership.
partnership.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-17

Purchase of Partnership Interest

A
Anew
new partner
partner can
can purchase
purchase

partnership
partnership interest
interest directly
directly
from
from the
the existing
existing partners.
partners.

The
The cash
cashgoes
goesto
tothe
the

partners,
partners, not
not to
to the
the
partnership.
partnership.

To
Tobecome
become aa partner,
partner, the
the

new
new partner
partner must
must be
be
accepted
accepted by
by the
the current
current
partners.
partners.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-18

Purchase of Partnership Interest

Redd agrees to sell Blue $10,000 of her
partnership interest for $25,000.

Capital balances before new partner

Allocation to new partner
Capital balances after new partner

Greene
Redd
Blue
$ 108,500 $
65,500 $
$
(10,000)
10,000
$ 108,500 $
55,500 $
10,000 $

GENERAL JOURNAL
Date

Description
Redd, Capital
Blue, Capital

Total
174,000
174,000

Page 34
PR

Debit

Credit

10,000
10,000

A new partnership agreement must be prepared that

identifies the allowances and profit sharing basis.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-19

Investing Assets in a Partnership

The
The new
new partner
partner can
can gain
gain

partnership
partnership interest
interest by
by
contributing
contributing assets
assets to
to the
the
partnership.
partnership.

Remember
Remember that
that the
the new
new
assets
assets will
will increase
increase the
the
partnerships
partnerships net
net assets.
assets.

After
After this
this entry,
entry,both
both
assets
assets and
and equity
equity will
will
increase.
increase.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-20

Investing Assets in a Partnership

Greene and Redd agree to accept Blue as a
partner upon his investment of $30,000 cash in
the partnership.

Capital balances before new partner

Allocation to new partner
Capital balances after new partner

Greene
Redd
Blue
$ 108,500 $
65,500 $
$
30,000
$ 108,500 $
65,500 $
30,000 $

GENERAL JOURNAL
Date

Description
Cash
Blue, Capital

Total
174,000
30,000
204,000

Page 34
PR

Debit

Credit

30,000
30,000

A new partnership agreement must be prepared that

identifies the allowances and profit sharing basis.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-21

Bonus to Old or New Partners

Bonus to Old
Partners

When the current value of a

partnership is greater than the
recorded amounts of equity, the old
partners usually require a new partner
to pay a bonus when joining.

Bonus to New
Partners

The partnership may grant a bonus to

a new partner if the business is in
need of cash or if the new partner has
exceptional talents.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-22

Withdrawal of a Partner
AA partner
partner can
can withdraw
withdraw in
in
two
two ways:
ways:

The
The partner
partner can
can sell
sell his/her
his/her

partnership
partnership interest
interest to
to
another
another person.
person.

The
The partnership
partnership can
can distribute
distribute
cash
cash and/or
and/or other
other assets
assets to
to
the
the withdrawing
withdrawing partner.
partner.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-23

Withdrawal of a Partner
Redd has a capital balance of $65,500. She decides to
withdraw from the partnership and takes cash equal to
her equity.

GENERAL JOURNAL
Date

Description
Redd, Capital
Cash

McGraw-Hill/Irwin

Page 34
PR

Debit

Credit

65,500
65,500

The McGraw-Hill Companies, Inc.

Slide
13-24

Liquidation of a Partnership

When
Whenaa partnership
partnership is
is dissolved,
dissolved, four
four steps
stepsare
arerequired:
required:

Noncash
Noncashassets
assetsare
aresold
soldfor
forcash
cashand
andaagain
gainor
orloss
loss
on
on liquidations
liquidationsis
isrecorded.
recorded.

Gain
Gain or
or loss
losson
onliquidation
liquidationis
is allocated
allocatedto
topartners
partners
using
usingtheir
theirincome-and-loss
income-and-loss ratio.
ratio.

Liabilities
Liabilitiesare
arepaid
paidor
orsettled.
settled.

Any
Anyremaining
remainingcash
cash is
isdistributed
distributed to
to partners
partnersbased
based
on
on their
their capital
capitalbalances.
balances.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
13-25

No Capital Deficiency
No capital deficiency means that all partners have a zero or credit
balance in their capital accounts.

Greene, Redd, and Blue agree to dissolve their partnership.

They sell all of their assets for a net gain of $10,000. Profits and
losses are shared as follows: Green, one-half; Redd, one-fourth; and
Blue, one-fourth.
Beginning capital balances
Allocation of $10,000 net gain
Capital balances for dissolution

McGraw-Hill/Irwin

Greene
Redd
Blue
$ 108,500 $
65,500 $
30,000 $
5,000
2,500
2,500
$ 113,500 $
68,000 $
32,500 $

Total
204,000
10,000
214,000

The McGraw-Hill Companies, Inc.

Slide
13-26

Capital Deficiency

Capital deficiency means that at least one partner has a

debit balance in his/her capital account. A partner with a
deficit must, if possible, cover the deficit by paying cash
into the partnership.
Greene, Redd, and Blue agree to dissolve their
partnership. They sell all of their assets for a net loss of
$10,000. Profits and losses are shared as follows: Green,
one-half; Redd, one-fourth; and Blue, one-fourth.
Beginning capital balances
Allocation of $10,000 net loss
Subtotal
Contribution by Blue
Capital balances for dissolution
McGraw-Hill/Irwin

Greene
Redd
Blue
$ 25,000 $
10,000 $
2,000 $
(5,000)
(2,500)
(2,500)
20,000
7,500
(500)
500
$ 20,000 $
7,500 $
$

Total
37,000
(10,000)
27,000
500
27,500

The McGraw-Hill Companies, Inc.

Slide
13-27

Capital Deficiency

Beginning capital balances

Allocation of $10,000 net loss
Subtotal
Contribution by Blue
Capital balances for dissolution

Greene
Redd
Blue
$ 25,000 $
10,000 $
2,000 $
(5,000)
(2,500)
(2,500)
20,000
7,500
(500)
500
$ 20,000 $
7,500 $
$

GENERAL JOURNAL
Date

Description
Cash

Page 34
PR

Debit

Redd, Capital
Cash
McGraw-Hill/Irwin

Credit

500

Blue, Capital
Greene, Capital

Total
37,000
(10,000)
27,000
500
27,500

500
20,000
7,500
27,500

The McGraw-Hill Companies, Inc.

Slide
13-28

Capital Deficiency

Beginning capital balances

Allocation of $10,000 net loss
Subtotal
Contibution by Blue
Capital balances for dissolution

Greene
Redd
Blue
$ 25,000 $
10,000 $
2,000 $
(5,000)
(2,500)
(2,500)
20,000
7,500
(500)
500
$ 20,000 $
7,500 $
$

Total
37,000
(10,000)
27,000
500
27,500

Any partners unpaid deficiency is

GENERAL
JOURNAL
Page 34
absorbed
by
the
remaining
partners
Date
Description
PR
Debit
Credit
500
withCash
credit
balances
in
accordance
Blue, Capital
500
with the partnership agreement.
Greene, Capital
Redd, Capital
Cash

McGraw-Hill/Irwin

20,000
7,500

27,500

The McGraw-Hill Companies, Inc.

Slide
13-29

End of Chapter 13

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.