McGraw-Hill/Irwin
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Partnerships
A partnership is defined as an association of two or more persons to carry on a business as co-owners for profit. (Section 6 of Uniform Partnership Act)
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Partnership Advantages
Flexibility in defining relationships Profits and losses, and management operating decisions, may be shared independent of ownership percentages Ease of formation and dissolution Taxes flow-through the partnership (conduit) to the partners, and are taxed to the individuals (no double- taxation).
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Partnership Disadvantages
Unlimited liability incurred by each partner (they are jointly and severally liable) Mutual agency (each partner has the right to incur liabilities in the name of the partnership) Inability to participate in various corporate tax benefits
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The number of owners is not usually restricted. HOWEVEROwners only risk their own investments, and are liable only for their own acts and omissions, and those of the individuals they directly supervise.
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The equity section of a partnership consists of capital balances for each partner. Profits/losses for each period are allocated to each partners capital account. Withdrawals by partners reduce their capital accounts.
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Articles of Partnership
Partnerships can exist even in the absence of a written partnership agreement. The Uniform Partnership Act establishes standards and rules for partnerships. A written agreement will supersede the UPA standards.
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Articles of Partnership
Method for dispute settlements Method for settling a partners share upon withdrawal, retirement or death Profit/loss sharing percentages Method for admitting new partners Initial contribution to be made by each partner
PUT IT IN WRITING!!
Rights and responsibilities of partners
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Articles of Partnership
Name and Address of Each Partner
Withdrawal limits
Description of the Nature of the Business
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Partnership Journal
Date Description
Page
Debit
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Credit
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If the partners each contribute cash and other assets . . . . . . debit Cash & Contributed Assets for FV. . . . credit individual Partner Capital accounts.
Partnership Journal
Date Description
Page
Debit
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Credit
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Use either the Bonus Method or the Goodwill Method for recording contributed intangible assets.
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On 2/15/08, Cookie and Bijou form a partnership. They agree to equal capital balances. Cookie contributes $80,000 cash. Bijou contributes land valued at $40,000, and brings years of experience to the new business. What is the journal entry to set up this partnership, using the Bonus Method?
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Partnership Journal
Date Description
Page
Debit
##
Credit
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On 2/15/08, Cookie and Bijou form a partnership. They agree to equal capital balances. Cookie contributes $80,000 cash. Bijou contributes land valued at $40,000, and brings years of experience to the new business. What is the journal entry to set up this partnership, using the Goodwill Method?
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Implied Value of the Partnership Total Tangible Contributed Assets Goodwill Attributed to Bijou
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Partnership Journal
Date Description
Page
Debit
##
Credit
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Allocation of Income
Items to be allocated:
Interest on beginning capital balances Allocated compensation
The allocation of income is not necessarily based on the relative capital balances. It is a separately negotiated item.
Remaining income
Bonuses
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Mushon and Gee, a retail partnership selling pet products, has beginning of period capital balances of $50,000 and $70,000, respectively. Net income for the period is $100,000. Both are credited with 10% interest on their beginning capital balance. Mushon is credited with a $20,000 bonus per the partnership agreement. They share income 40:60 (Mushon:Gee). What are the ending capital balances for each partner?
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Legal Dissolution
Any alteration in the specific individuals composing a partnership results in legal dissolution Departures Retirement Death Admission (including promotion) of a New Partner Frequently this leads to the immediate formation of a new partnership as the business continues Can lead to termination and liquidation
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An individual partners ownership rights include: The right to coownership in the business property. The right to share in profits and losses as specified in the partnership agreement The right to participate in the management of the business.
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When the makeup of the partnership changes, the partnership is dissolved. A new partnership is immediately formed. New partner acquires partnership interest by: Purchasing it from the other partners, or Making a contribution to the partnership.
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A new partner can purchase partnership interest directly from the existing partners. The cash goes to the partners, not the partnership. Two methods are available to account for the transfer of ownership: Book Value Approach Goodwill (Revaluation) Approach
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Using the Book Value Approach, prepare the entry assuming Nia pays $60,000 directly to the other partners for a 20% partnership interest.
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Page
Debit
18
Credit
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Using the Goodwill Approach, prepare the entry assuming Nia pays $60,000 directly to the other partners for a 20% partnership interest.
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Current book value is inferred from the combined capital balances of the existing partners,
$30,000 + $50,000 + $60,000 = $140,000.
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Page
Debit
18
Credit
Goodwill Partner Capital - Mare Partner Capital - Mic Partner Capital - Roma
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Page
Debit
18
Credit
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The new partner can also gain partnership interest by contributing cash to the partnership. Remember that the new cash will increase the partnerships net assets. Two methods are: Bonus Approach Goodwill Approach
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Using the Bonus Approach, prepare the entry assuming Nia pays $60,000 to the partnership for a 20% partnership interest.
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contribution = $200,000
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Debit
Credit
60,000 Capital - Nia Capital - Mare Capital - Mic Capital - Roma 40,000 8,000 5,000 7,000
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Using the Goodwill Approach, prepare the entry assuming Nia pays $60,000 to the partnership for a 20% partnership interest.
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Goodwill Example Net assets after the contribution are $200,000. Implied value of the partnership is $300,000.
$60,000 20% = $300,000
Date
Description
Debit
Credit
Goodwill Partner Capital - Mare Partner Capital - Mic Partner Capital - Roma
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60,000 60,000
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Withdrawal of a Partner
The Withdrawing Partner is paid out in accordance with the Partnership Agreement. Using the Bonus Method, any amount paid in excess of that partners capital account is allocated against the remaining partners capital accounts. Using the Goodwill Method, the books are first adjusted to FMV, with a proportion of the increase allocated to each partners account. The withdrawing partner is then paid based on the balance in the individual capital account.
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Summary
A partnership is defined as an association of two or more persons to carry on a business as co-owners for profit. This form of business organization is popular for many reasons, primarily ease of formation and organization. There are tax benefits as a result of their flow-through nature. Disadvantages include unlimited liability and mutual agency.
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Possible Criticisms
Because corporations can be considered persons for purpose of partnership formation, some critics contend that this form of business organization can be easily manipulated for fraudulent intent. Others argue that unlimited liability and mutual agency provisions are too strict and unduly limit commerce. WHAT DO YOU THINK????