Slide

14-1

CHAPTER

14
Partnerships:
Formation and
Operation

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14-2
Partnerships
Capital Accounts
 The equity section of a
partnership consists of
capital balances for each
partner.
 Profits/losses each period
are allocated to each
partner’s capital account.
 Withdrawals by partners
reduce their capital
accounts.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
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14-3

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
supercede the UPA
standards.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
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14-4

Articles of Partnership

Method for Method for

Profit/loss admitting
dispute
sharing new partners
settlements
percentages

Initial
Withdrawal contribution to
limits Put it in be made by
writing! each partner

Method for
valuing Rights and
individual responsibilities
contributions of partners

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Slide
14-5
Accounting for Capital
Contributions

If the partners each contribute cash . . .

 . . . debit Cash.
 . . . credit individual Partner Capital accounts.

Partnership Journal Page ##

Date Description Debit Credit
Cash $$$
Capital - Partner A $$$
Capital - Partner B $$$

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

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14-6
Accounting for Capital
Contributions
If the partners each contribute cash and other
assets . . .
 . . . debit Cash & contributed assets for FMV.
 . . . credit individual Partner Capital accounts.

Partnership Journal Page ##

Date Description Debit Credit
Cash $$$
Contributed Assets (FMV) $$$
Capital - Partner A $$$
Capital - Partner B $$$

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

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14-7
Accounting for Capital
Contributions
 Intangible assets, such as expertise, require
special consideration
 Use either the Bonus Method or the Goodwill
Method.

 Record the tangible assets

contributed.
 Adjust the partner capital
balances to reflect the
relative value of the
intangible asset.

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14-8
Intangible Contributions
Bonus Method
On 2/15/98, Greene and Redd form a partnership.
They agree to equal capital balances. Greene
contributes $80,000 cash. Redd contributes
land valued at $40,000.

Partnership Journal Page ##

Date Description Debit Credit

Prepare the journal entry to set

up the partnership.

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14-9
Intangible Contributions
Bonus Method
Total tangible assets for the partnership are $120,000.
The partners have agreed to have equal capital
balances, based on the contributed assets. Even
though Redd only contributed land worth $40,000,
essentially, Greene has given Redd a $20,000 bonus.

Partnership Journal Page ##

Date Description Debit Credit
15-Feb Cash 80,000
Land 40,000
Capital - Greene 60,000
Capital - Redd 60,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

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Intangible Contributions
Goodwill Method

 Record the tangible

assets contributed.
 Record the contributed
intangible asset as the
difference between the
contributed tangible
assets and the implied
value of the
partnership.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

Slide
14-11
Intangible Contributions
Goodwill Method
On 2/15/98, Greene and Redd form a partnership. They
agree to equal capital balances. Greene contributes
$80,000 cash. Redd contributes land valued at
$40,000, and brings years of experience to the new
business.

Partnership Journal Page ##

Date Description Debit Credit

Prepare the journal entry to set

up the partnership.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

Slide
14-12
Intangible Contributions
Goodwill Method
On 2/15/98, Greene and Redd form a partnership. They
agree to equal capital balances. Greene contributes
$80,000 cash. Redd contributes land valued at
$40,000, and brings years of experience to the new
business.

Greene's Tangible Contributed Assets $ 80,000

Greene's Capital % ÷ 50%
Implied Value of the Partnership $ 160,000

Implied Value of the Partnership $ 160,000

Total Tangible Contributed Assets 120,000
Goodwill Attributed to Redd $ 40,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
Slide
14-13
Intangible Contributions
Goodwill Method
Greene’s capital account is credited for the tangible
contribution of $80,000.
Redd’s capital account is credited for the tangible
contribution of $40,000, plus the intangible
contribution valued at $40,000.

Partnership Journal Page ##

Date Description Debit Credit
15-Feb Cash 80,000
Land 40,000
Goodwill 40,000
Capital - Greene 80,000
Capital - Redd 80,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
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14-14

Allocation of Income

 The allocation of income is

not based on the relative
capital balances.
 It is a separately negotiated
item.
 Items to be allocated: Remaining
income
Interest on
beginning
capital balances

Allocated Bonuses
compensation
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Slide
14-15
Allocation of Income
Example
Lebo and Smith, a retail partnership, has beginning
of period capital balances of $50,000 and $70,000
respectively. Net income for the period is
$100,000.
Both partners are credited with 10% interest on their
beginning capital balance. In addition, Lebo is
credited with a bonus of $20,000 per the
partnership agreement. They share income 40:60
(Lebo:Smith).
What are the ending capital balances for each
partner?
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14-16
Allocation of Income
Example
Lebo Smith Total
Interest on capital
balances 5,000 7,000 12,000
Bonus to Lebo 20,000 20,000
Allocation of
remaining income 27,200 40,800 68,000
Total $ 52,200 $ 47,800 $ 100,000

( 100,000 - 12,000 - 20,000 ) × 40% = $ 27,200

( 100,000 - 12,000 - 20,000 ) × 60% = $ 40,800
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
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14-17
Admission of a New Partner
The Rights of a Partner
An individual partner’s
ownership rights include:
 The right to co-ownership of
the partnership property. These two
 The right to share in profits rights can be
and losses as specified in sold.
the partnership agreement
This right
 The right to participate in cannot be sold
the management of the without the
partnership. other partners’
approval.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
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14-18
Partnership Dissolution
Admission of a New Partner
 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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

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Admission of a New Partner
Purchase of a Current Interest
 A new partner can purchase
partnership interest directly
from the existing partners.
 The cash goes to the
partners, not to the
partnership.
 Two methods are available
to account for the transfer
of ownership.
 Book Value Approach
 Goodwill (Revaluation)
Approach
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
Slide
14-20
Admission of a New Partner
Purchase of a Current Interest
Book Value Example
 Doe, Raye, and Mee have a partnership.

Partner Capital Balance Profit & Loss Ratio

Doe $ 30,000 40%
Raye $ 50,000 25%
Mee $ 60,000 35%

 Using the Book Value Approach, prepare the

entry assuming Flatt pays $60,000 directly to
the other partners for a 20% partnership
interest.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
Slide
14-21
Admission of a New Partner
Purchase of a Current Interest
Book Value Example
 The cash goes to Doe,
Raye, and Mee, NOT to $30,000 x 20% = $6,000
the partnership. $50,000 x 20% = $10,000
 Each partner gives up $60,000 x 20% = $12,000
20% of their existing
capital.

Partnership General Journal Page 18

Date Description Debit Credit
31-Dec Partner Capital - Doe 6,000
Prepare
Partner the
Capital journal entry10,000
- Raye to
Partner
admitCapital
Flatt -toMee 12,000
the partnership.
Partner Capital - Flatt 28,000
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Slide
14-22
Admission of a New Partner
Purchase of a Current Interest

Now, let’s take a

look at the
Goodwill
Approach.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

Slide
14-23
Admission of a New Partner
Purchase of a Current Interest
Goodwill (Revaluation) Example
 Doe, Raye, and Mee have a partnership.

Partner Capital Balance Profit & Loss Ratio

Doe $ 30,000 40%
Raye $ 50,000 25%
Mee $ 60,000 35%
 Using the Goodwill Approach, prepare the
entry assuming Flatt pays $60,000 directly to
the other partners for a 20% partnership
interest.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
Slide
14-24
Admission of a New Partner
Purchase of a Current Interest
Goodwill (Revaluation) Example
 The implied value of the partnership is $300,000
 $60,000 ÷ 20% = $300,000
 First, compute the Goodwill

Implied Value of the Partnership $ 300,000

Current Book Value of the Net Assets* 140,000
Implied Goodwill to be Allocated $ 160,000

* Current book value is inferred from the combined

capital balances of the existing partners.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
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14-25
Admission of a New Partner
Purchase of a Current Interest
Goodwill (Revaluation) Example
Allocate the $160,000 of Goodwill to the existing
partners, based on their income sharing %.
(40:25:35)

Partnership General Journal Page 18

Date Description Debit Credit
Goodwill
Prepare the journal entry160,000
to
Partner Capital
allocate - Doe
goodwill to Doe, Raye, 64,000
Partner Capital - Raye 40,000
& Mee.
Partner Capital - Mee 56,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
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14-26
Admission of a New Partner
Purchase of a Current Interest
Goodwill (Revaluation) Example
The new balances for Doe, Raye, and Mee appear as
follows:
Doe Capital Raye Capital Mee Capital
30,000 50,000 60,000
64,000 40,000 56,000
94,000 90,000 116,000

Next, allocate 20% from each of the existing

partners to Flatt.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

Slide
14-27
Admission of a New Partner
Purchase of a Current Interest
Revaluation Example
Note that Flatt’s balance,
after allocation from $94,000 x 20% = $18,800
the current partners, $90,000 x 20% = $18,000
equals Flatt’s $116,000 x 20% = $23,200
contribution of
$60,000.

Partnership General Journal Page 18

Date Description Debit Credit
31-Dec Partner Capital - Doe 18,800
Partner Capital - Raye 18,000
Partner Capital - Mee 23,200
Partner Capital - Flatt 60,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
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14-28
Admission of a New Partner
Contribution to the Partnership
 The new partner can gain
partnership interest by
contributing cash to the
partnership.
 Remember that the new
cash will increase the
partnership’s net assets.
 Two methods are:
 Bonus Approach
 Goodwill Approach

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

Slide
14-29
Admission of a New Partner
Contribution to the Partnership
Bonus Example
 Doe, Raye, and Mee have a partnership.

Partner Capital Balance Profit & Loss Ratio

Doe $ 30,000 40%
Raye $ 50,000 25%
Mee $ 60,000 35%

 Using the Bonus Approach, prepare the entry

assuming Flatt pays $60,000 to the
partnership for a 20% partnership interest.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
Slide
14-30
Admission of a New Partner
Contribution to the Partnership
Bonus Example
 Net assets after the contribution are $200,000.
 Flatt gets credit for 20% of net assets ($200,000 x 20%).
 The remainder of the $60,000 contribution is allocated
to the other partners.

Note
Datethat theDescription
$200,000 Debit Credit
Cashfrom the net
results 60,000
Partner Capital - Flatt 40,000
assets of the partnership
Partner Capital - Doe 8,000
of $140,000 + Flatt’s
Partner Capital - Raye Prepare the journal
5,000
$60,000Partner
contribution.
Capital - Mee entry. 7,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
Slide
14-31
Admission of a New Partner
Contribution to the Partnership

Now, let’s take a

look at the
Goodwill
Approach.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

Slide
14-32
Admission of a New Partner
Contribution to the Partnership
Goodwill Example
 Doe, Raye, and Mee have a partnership.

Partner Capital Balance Profit & Loss Ratio

Doe $ 30,000 40%
Raye $ 50,000 25%
Mee $ 60,000 35%

 Using the Goodwill Approach, prepare the

entry assuming Flatt pays $60,000 to the
partnership for a 20% partnership interest.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001
Slide
14-33
Admission of a New Partner
Contribution to the Partnership
Goodwill Example
 Net assets after the contribution are $200,000.
 Implied value of the partnership is $300,000.
 $60,000 ÷ 20% = $300,000
 Goodwill to be recorded is $100,000 (300,000 - 200,000)

Date Description Debit Credit

Goodwill 100,000
Prepare
Partner the journal
Capital - Doe entry to 40,000
allocate goodwill
Partner Capital to Doe, Raye,
- Raye 25,000
Partner Capital - Mee
& Mee. 35,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

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14-34
Admission of a New Partner
Contribution to the Partnership
Goodwill Example
After allocating the goodwill to the original
partners, record Flatt’s cash contribution and
credit Flatt’s capital account.

Date Description Debit Credit

Cash 60,000
Partner Capital - Flatt 60,000
Prepare the journal entry to
admit Flatt to the partnership.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001

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End of Chapter 14

Accounting for
my partners is
easy. It’s
accounting for
their taste that I
find difficult!
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2001