Accounting For Partnerships: Accounting Principles, Ninth Edition

Chapter
12
Accounting for
Partnerships
Chapter
12-1
Accounting Principles, Ninth Edition
Study Objectives
1.
Identify the characteristics of the partnership form

of business organization.
2. Explain the accounting entries for the formation of a

partnership.
3. Identify the bases for dividing net income or net loss.
4. Describe the form and content of partnership

financial statements.
5. Explain the effects of the entries to record the
liquidation of a partnership.
Chapter
12-2
Accounting for Partnerships
Partnership Form
of Organization
Characteristics
Organizations
with partnership
characteristics
Advantages /
disadvantages
Partnership
agreement
Chapter
12-3
Basic Partnership
Accounting
Liquidation of a
Partnership
Forming a
partnership
No capital
deficiency
Dividing net
income / loss
Capital deficiency
Financial
statements
Partnership Form of Organization

A partnership is an association of two or more
persons to carry on as co-owners of a business
for profit.
Type of Business:
Small retail, service, or manufacturing companies.
Accountants, lawyers, and doctors.
Chapter
12-4
SO 1 Identify the characteristics of the

partnership form of business organization.
Partnership Form of Organization
Discussion Question
Q12-1: The characteristics of a partnership
include the following: (a) association of individuals,
(b) limited life, and (c) co-ownership of property.
Explain each of these terms.
See notes page for discussion

Chapter
12-5

Characteristics of Partnerships
Association of Individuals
Legal entity.
Accounting entity.
Net income not taxed as a separate entity.
Mutual Agency
Act of any partner is binding on all other
partners, so long as the act appears to be
appropriate for the partnership.
Chapter
12-6

Limited Life
Dissolution occurs whenever a partner withdraws
or a new partner is admitted.
Dissolution does not mean the business ends.
Unlimited Liability
Each partner is personally and individually liable
for all partnership liabilities.
Chapter
12-7

Co-ownership of Property
Each partner has a claim on total assets.
This claim does not attach to specific assets.
All net income or net loss is shared equally by the
partners, unless otherwise stated in the
partnership agreement.
Chapter
12-8

Question
All of the following are characteristics of
partnerships except:
a. co-ownership of property.
b. mutual agency.
c. limited life.
d. limited liability.
Chapter
12-9

Organizations with
Partnership Characteristics
Special forms of business organizations are often used
to provide protection from unlimited liability.
Special partnership forms are:
1.
Limited Partnerships,
2. Limited Liability Partnerships, and
3. Limited Liability Companies.
Chapter
12-10

Organizations with
Regular Partnership
Major Advantages
Simple and
inexpensive to create
and operate.
Chapter
12-11
Major Disadvantages
Owners (partners)
personally liable for
business debts.

Organizations with
Major Advantages
Ltd., or LP
Limited partners have

limited personal liability
for business debts as long
as they do not participate
in management.
General partners can
raise cash without
involving outside
investors in management
of business.
Chapter
12-12
Major Disadvantages
General partners
personally liable for
business debts.
More expensive to create
than regular partnership.
Suitable for companies
that invest in real estate.

Organizations with
LLP
Major Advantages
Mostly of interest to
partners in old-line
professions such as law,
medicine, and accounting.
Owners (partners) are
not personally liable for
the malpractice of other
partners.
Major Disadvantages
Unlike a limited liability
company, partners remain
personally liable for many
types of obligations owed
to business creditors,
lenders, and landlords.
Often limited to a short
list of professions.
Chapter
12-13

Organizations with
LLC
Major Advantages
Owners have limited
personal liability for
business debts even if
they participate in
management.
Chapter
12-14
Major Disadvantages
More expensive to create
than regular partnership.

Discussion Question
Q12-3: Brent Houghton and Dick Kreibach are
considering a business venture. They ask you to
explain the advantages and disadvantages of the
partnership form of organization.

Chapter
12-15

Question
Under which of the following business organization
forms do limited partners have little, if any, active
role in the management of the business?
a.
Limited liability partnership.
b. Limited partnership.
c.
Limited liability companies.
d. None of the above.
Chapter
12-16

Chapter
12-17
Partnership Agreement
Should specify relationships among the partners:
1. Names and capital contributions of partners.
2. Rights and duties of partners.
3. Basis for sharing net income or net loss.
4. Provision for withdrawals of assets.
5. Procedures for submitting disputes to arbitration.
6. Procedures for the withdrawal or addition of a partner.
7. Rights and duties of surviving partners in the event of a
partners death.
Chapter
12-18

Forming a Partnership
Question
When a partner invests noncash assets in a
partnership, the assets should be recorded at their:
a. book value.
b. carrying value.
c. fair market value.
d. original cost.
Chapter
12-19
SO 2 Explain the accounting entries for the formation of a partnership.
Illustration: Assume that A. Rolfe and T. Shea combine
their proprietorships to start a partnership named U.S.
Software. Rolfe and Shea have the following assets prior to
the formation of the partnership.
Illustration 12-3
Chapter
12-20
Illustration: Prepare the entry to record the investment of
A. Rolfe.
Cash
8,000
Office equipment
4,000
A. Rolfe, Capital
12,000
Prepare the entry to record the investment of T. Shea.

Cash
Accounts receivable
Allowance for doubtful accounts
T. Shea, Capital
Chapter
12-21
9,000
4,000
1,000
12,000
Chapter
12-22
Dividing Net Income or Net Loss

Partners equally share net income or net loss unless
the partnership contract indicates otherwise.
Closing Entries:
Close all Revenue and Expense accounts to Income
Summary.
Close Income Summary to each partners Capital account
for his or her share of net income or loss.
Close each partners Drawing account to his or her
respective Capital account.
Chapter
12-23
SO 3 Identify the bases for dividing net income or net loss.

Income Ratios
Partnership agreement should specify the basis for
sharing net income or net loss. Typical income ratios:
Fixed ratio.
Ratio based on capital balances.

Salaries to partners and remainder on a fixed ratio.
Interest on partners capital balances and the remainder
on a fixed ratio.
Salaries to partners, interest on partners capital, and
the remainder on a fixed ratio.
Chapter
12-24
Discussion Question
Q12-7: Blue and Grey are discussing how income
and losses should be divided in a partnership they
plan to form. What factors should be considered in
determining the division of net income or net loss?

Chapter
12-25
Question
Which of the following statements is correct?
a. Salaries to partners and interest on partners'
capital are expenses of the partnership.
b. Salaries to partners are an expense of the
partnership but not interest on partners' capital.
c. Interest on partners' capital are expenses of the
partnership but not salaries to partners.
d. Neither salaries to partners nor interest on

partners' capital are expenses of the partnership.
Chapter
12-26

Illustration: Assume that King and Lee are co-partners in the
Kingslee Company. The partnership agreement provides for: (1)
salary allowances of $8,400 to King and $6,000 to Lee, (2)
interest allowances of 10% on capital balances at the beginning
of the year, and (3) the remainder equally. Capital balances on
January 1 were King $28,000, and Lee $24,000. In 2010,
partnership net income is $22,000. The division of net income
is as follows.
Instructions
(a) Prepare a schedule showing the distribution of net income.
(b) Journalize the allocation of net income.
Chapter
12-27

Illustration: (a) Prepare a schedule showing the distribution
of net income.
Illustration 12-5
Chapter
12-28

Illustration: (b) Journalize the allocation of income.
Dec. 31
Income summary
Sara King, Capital
Ray Lee, Capital
Chapter
12-29
22,000
12,400
9,600

Illustration: Prepare a schedule showing the distribution of
net income assuming net income is only $18,000.
Illustration 12-5
Chapter
12-30
Partnership Financial Statements

Illustration 12-7
As in a proprietorship, partners capital may change due to (1)

additional investment, (2) drawing, and (3) net income or net loss.
Chapter
12-31
SO 4 Describe the form and content of partnership financial statements.
Partnership Financial Statements

Illustration 12-8
The balance sheet for a partnership is the same as for a

proprietorship except for the owners equity section.
Chapter
12-32
SO 4 Describe the form and content of partnership financial statements.
Liquidation of a Partnership
Question
The first step in the liquidation of a partnership is
to:
a. allocate gain/loss on realization to the partners.
b. distribute remaining cash to partners.

c. pay partnership liabilities.
d. sell noncash assets and recognize a gain or loss
on realization.
Chapter
12-33
SO 5 Explain the effects of the entries to record

the liquidation of a partnership.
Ends both the legal and economic life of the entity.
In liquidation, sale of noncash assets for cash is called

realization. To liquidate, it is necessary to:
1. Sell noncash assets for cash and recognize a gain or loss
on realization.
2. Allocate gain/loss on realization to the partners based
on their income ratios.
3. Pay partnership liabilities in cash.
4. Distribute remaining cash to partners on the basis of
their capital balances.
Chapter
12-34

No Capital
Deficiency
Illustration: Assume that Ace Company is liquidated when

its ledger shows the following assets, liabilities, and owners
equity accounts.
Illustration 12-9
Chapter
12-35

No Capital
Deficiency
Illustration: Prepare a cash payments schedule.

Illustration 12-11
Chapter
12-36

No Capital
Deficiency
Illustration: The partners of Ace Company agree to

liquidate the partnership on the following terms:
(1) The partnership will sell its noncash assets to
Jackson Enterprises for $75,000 cash.
(2) The partnership will pay its partnership liabilities.
The income ratios of the partners are 3 : 2 : 1,
respectively.
Chapter
12-37

No Capital
Deficiency
Illustration: (1) Ace sells the noncash assets (accounts

receivable, inventory, and equipment) for $75,000. The
book value of these assets is $60,000 ($15,000 + $18,000 +
$35,000 - $8,000). Prepare the entry to record the sale of
the noncash assets.
(1)
Cash
75,000
Accumulated depreciation
Chapter
12-38
8,000
Accounts receivable
15,000
Inventory
18,000
Equipment
35,000
Gain on realization
15,000

No Capital
Deficiency
Illustration: (2) Prepare the entry to record the

allocation of the gain on liquidation to the partners.
(2)
Chapter
12-39
Gain on realization
15,000
R. Arnet, Capital ($15,000 x 3/6)
7,500
P. Carey, Capital ($15,000 x 2/6)
5,000
W. Eaton, Capital ($15,000 x 1/6)
2,500

No Capital
Deficiency
Illustration: (3) Prepare the entry to record the payment

in full to the creditors.
(3)
Notes payable
15,000
Accounts payable
16,000
Cash
Chapter
12-40
31,000

Illustration: (4) Record the
distribution of cash.
R. Arnet, Capital
22,500
P. Carey, Capital
22,800
W. Eaton, Capital
Cash
Chapter
12-41
3,700
49,000
SO 5 Explain the effects of the entries to

record the liquidation of a partnership.
No Capital
Deficiency
Question
If a partner with a capital deficiency is unable to
pay the amount owed to the partnership, the
deficiency is allocated to the partners with credit
balances:
a. equally.
b. on the basis of their income ratios.
c. on the basis of their capital balances.
d. on the basis of their original investments.
Chapter
12-42

Capital
Deficiency
Illustration: Assume that Ace Company is on the brink of

bankruptcy. They sell merchandise at substantial discounts,
and sell the equipment at auction. Cash proceeds from
these sales and collections from customers totals $42,000.
(1) Prepare the entry for the realization of noncash assets.
(1)
Cash
42,000
Accumulated depreciation
Loss on realization
Chapter
12-43
8,000
18,000
Accounts receivable
15,000
Inventory
18,000
Equipment
35,000
Capital
Deficiency
Illustration: (2) Ace allocates the loss on realization to the

partners on the basis of their income ratios. The entry is:
(2)
R. Arnet, Capital ($18,000 x 3/6)
9,000
P. Carey, Capital ($18,000 x 2/6)
6,000
W. Eaton, Capital ($18,000 x 1/6)
3,000
Gain on realization
Chapter
12-44
18,000

Capital
Deficiency
Illustration: (3) Prepare the entry to record the payment

in full to the creditors.
(3)
Notes payable
15,000
Accounts payable
16,000
Cash
Chapter
12-45
31,000

Payment of Deficiency
R. Arnet
P. Carey
W. Eaton
Capital
Capital
Capital
Cash
Balances before liquidation
$ 16,000
Farley payment
$ 17,800
Cash
W. Eaton, Capital
R. Arnet, Capital
P. Carey, Capital
Cash
Chapter
12-46
(6,000) $ (11,800) $
1,800
Balance
(a)
Capital
Deficiency
1,800
(1,800)
(6,000) $ (11,800) $
1,800
1,800
6,000
11,800
17,800

E12-10 (b)
Nonpayment
of Deficiency
R. Arnet
P. Carey
W. Eaton
Capital
Capital
Capital
Cash
Balances before liquidation
$ 16,000
Allocation of deficiency
Balance
(b)
(6,000) $ (11,800) $
1,080
$ 16,000
R. Arnet, Capital
P. Carey, Capital
Capital
Deficiency
720
Chapter
12-47
(1,800)
(4,920) $ (11,080) $
1,080
720
Farley, Capital
R. Arnet, Capital
P. Carey, Capital
Cash
1,800
1,800
4,920
11,080
16,000
Admission of a Partner
Results in the legal dissolution of the existing
partnership and the beginning of a new one.
New partner may be admitted either by
1. purchasing the interest of one or more existing
partners or
2. investing assets in the partnership.
Chapter
12-48
SO 6 Explain the effects of the entries when a new partner is admitted.
Purchase of a Partners Interest
APPENDIX
Illustration: Assume that L. Carson agrees to pay $10,000

each to C. Ames and D. Barker for 33 1/3% of their
interest in the Ames-Barker partnership. At the time of
admission of Carson, each partner has a $30,000 capital
balance. Both partners, therefore, give up $10,000 of their
capital equity. The entry to record the admission of Carson
is:
C. Ames, Capital
D. Barker, Capital
L. Carson, Capital
10,000
10,000
20,000
The cash paid by Carson goes directly to the individual partners and not to
the partnership. Net assets remain unchanged.
Chapter
12-49
Investment of Assets in a Partnership

Illustration: Assume that L. Carson agrees to invest
$30,000 in cash in the Ames-barker partnership for a 33
1/3% capital interest. At the time of admission of Carson,
each partner has a $30,000 capital balance. The entry to
record the admission of Carson is:
Cash
30,000
L. Carson, Capital
30,000
Note that both net assets and total capital

have increased by $30,000.
Chapter
12-50
Withdrawal of a Partner
APPENDIX
A partner may withdraw from a partnership

voluntarily, by selling his or her equity in the firm.
Or, he or she may withdraw involuntarily, by
reaching mandatory retirement age or by dying.
The withdrawal of a partner, like the admission of
a partner, legally dissolves the partnership.
Chapter
12-51
SO 7 Describe the effects of the entries when

a partner withdraws from the firm.
Withdrawal of a Partner
APPENDIX
3. Death of a Partner
Chapter
12-52

Payment From Partners Personal Assets

Illustration: Assume that partners Morz, Nead, and Odom
have capital balances of $25,000, $15,000, and $10,000,
respectively. Morz and Nead agree to buy out Odoms
interest. Each of them agrees to pay Odom $8,000 in
exchange for one-half of Odoms total interest of $10,000.
The entry to record the withdrawal is:
Odom, Capital
10,000
Morz, Capital
5,000
Nead, Capital
5,000
Note, net assets and total capital remain the same at $50,000. The $16,000
paid to Odom by the remaining partners isnt recorded by the partnership.
Chapter
12-53

Payment From Partnership Assets
APPENDIX
Illustration: Assume that the following capital balances

exist in the RST partnership: Roman $50,000, Sand
$30,000, and Terk $20,000. The partners share income in
the ratio of 3:2:1, respectively. Terk retires from the
partnership and receives a cash payment of $25,000 from
the firm.
Note: A bonus is paid to the retiring partner since
the cash paid to the retiring partner is more than
his/her capital balance ($25,000 $20,000 = $5,000).
Chapter
12-54

Payment From Partnership Assets
APPENDIX
Illustration: Assume that the following capital balances

exist in the RST partnership: Roman $50,000, Sand
$30,000, and Terk $20,000. The partners share income in
the ratio of 3:2:1, respectively. Terk retires from the
partnership and receives a cash payment of $25,000 from
the firm.
Journal entry to record the withdrawal of Terk:
Terk, Capital
Roman, Capital
3,000
Sand, Capital
2,000
Cash
Chapter
12-55
20,000
25,000
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Chapter
12-56

Accounting For Partnerships: Accounting Principles, Ninth Edition

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Chapter

Accounting Principles, Ninth Edition

Identify the characteristics of the partnership form

2. Explain the accounting entries for the formation of a

4. Describe the form and content of partnership

Accounting for Partnerships

Partnership Form of Organization

SO 1 Identify the characteristics of the

Partnership Form of Organization

See notes page for discussion

SO 1 Identify the characteristics of the

SO 1 Identify the characteristics of the

SO 1 Identify the characteristics of the

SO 1 Identify the characteristics of the

SO 1 Identify the characteristics of the

2. Limited Liability Partnerships, and

3. Limited Liability Companies.

SO 1 Identify the characteristics of the

SO 1 Identify the characteristics of the

Limited partners have

SO 1 Identify the characteristics of the

SO 1 Identify the characteristics of the

SO 1 Identify the characteristics of the

See notes page for discussion

SO 1 Identify the characteristics of the

Limited liability partnership.

Limited liability companies.

d. None of the above.

SO 1 Identify the characteristics of the

SO 1 Identify the characteristics of the

SO 2 Explain the accounting entries for the formation of a partnership.

SO 2 Explain the accounting entries for the formation of a partnership.

Prepare the entry to record the investment of T. Shea.

SO 2 Explain the accounting entries for the formation of a partnership.

Dividing Net Income or Net Loss

SO 3 Identify the bases for dividing net income or net loss.

Dividing Net Income or Net Loss

Ratio based on capital balances.

SO 3 Identify the bases for dividing net income or net loss.

Dividing Net Income or Net Loss

See notes page for discussion

SO 3 Identify the bases for dividing net income or net loss.

Dividing Net Income or Net Loss

d. Neither salaries to partners nor interest on

SO 3 Identify the bases for dividing net income or net loss.

Dividing Net Income or Net Loss

SO 3 Identify the bases for dividing net income or net loss.

Dividing Net Income or Net Loss

SO 3 Identify the bases for dividing net income or net loss.

Dividing Net Income or Net Loss

Ray Lee, Capital

SO 3 Identify the bases for dividing net income or net loss.

Dividing Net Income or Net Loss

SO 3 Identify the bases for dividing net income or net loss.

Partnership Financial Statements

As in a proprietorship, partners capital may change due to (1)

SO 4 Describe the form and content of partnership financial statements.

Partnership Financial Statements

The balance sheet for a partnership is the same as for a

SO 4 Describe the form and content of partnership financial statements.

b. distribute remaining cash to partners.

SO 5 Explain the effects of the entries to record