ACCOUNTING FOR ACCOUNTING FOR PARTNERSHIPSPARTNERSHIPS

UNITUNIT

1010

ILLUSTRATIONILLUSTRATION 10-1 10-1PARTNERSHIP CHARACTERISTICSPARTNERSHIP CHARACTERISTICS

ILLUSTRATIONILLUSTRATION 10-1 10-1PARTNERSHIP CHARACTERISTICSPARTNERSHIP CHARACTERISTICS

Unlimited Liability

Partnership Form of Business

Organization

Association of Individuals

Mutual Agency

Co-ownership of Property

Limited Life

Association of individuals. A partnership is a voluntary association of two or more individuals that may be based on as simple an act as a handshake or preferably a written agreement.  

Division of income. The net income (loss) of a partnership is divided among the partners according to their agreement.  

Mutual agency. Each partner acts on behalf of the partnership when engaging in partnership business. The act of any partner is binding on all other partners.

Co-ownership of property. Partnership assets are owned jointly by all the partners. If the partnership is terminated, the assets do not legally return to the original contributor.

Limited life. A partnership does not have unlimited life. A partnership is ended any time through the acceptance of a new partner into the firm or the withdrawal of a partner. Partnership dissolution occurs whenever there is a change in the makeup of the partners, regardless of the cause. Dissolution does not mean that the business ends. Operations can continue without interruption through the formation of a new partnership.

 Unlimited liability. Each partner is jointly and severally (individually) liable for all partnership liabilities. Creditors’ claims attach first to partnership assets and then to the personal resources of any partner, regardless of that partner’s equity in the partnership. Because each partner is responsible for all the debts of the partnership, each partner is said to have unlimited liability.

PARTNERSHIP CHARACTERISTICSPARTNERSHIP CHARACTERISTICS

ILLUSTRATIONILLUSTRATION 10-2 10-2 ADVANTAGES AND DISADVANTAGES ADVANTAGES AND DISADVANTAGES

OF A PARTNERSHIPOF A PARTNERSHIP

ILLUSTRATIONILLUSTRATION 10-2 10-2 ADVANTAGES AND DISADVANTAGES ADVANTAGES AND DISADVANTAGES

OF A PARTNERSHIPOF A PARTNERSHIP

FORMING FORMING A PARTNERSHIPA PARTNERSHIPFORMING FORMING A PARTNERSHIPA PARTNERSHIP Each partner’s initial investment in a partnership

should be recorded at the fair market value of the assets at the date of their transfer to the partnership.

The values assigned must be agreed to by all of the partners.

After the partnership has been formed, the accounting is similar to accounting for transactions of any other type of business organization.

Upon the formation of a partnership, this personal computer should be recorded at its FMV of $2,500 instead of net book value.

Upon the formation of a partnership, this personal computer should be recorded at its FMV of $2,500 instead of net book value.

FORMING FORMING A PARTNERSHIPA PARTNERSHIPExampleExample

FORMING FORMING A PARTNERSHIPA PARTNERSHIPExampleExample

M. Gan and K. Sin start a partnership name Interactive Software with the following assets stated at their fair market value.

Gan SinCash $8,000 $9,000Office Equipment 4,000Accumulated Amortization (2,000)Accounts Receivable 4,000Allowance for Doubtful Accounts (1,000)

Investment of GanJan 2 Cash 8,000

Office Equipment 4,000M. Gan, Capital 12,000

Investment of SinJan 2 Cash 9,000

Accounts Receivable 4,000Allowance for DA 1,000K. Sin, Capital 12,000

Journal Entry

DIVIDING NET INCOME DIVIDING NET INCOME OR NET LOSSOR NET LOSS

DIVIDING NET INCOME DIVIDING NET INCOME OR NET LOSSOR NET LOSS

Partnership net income or net loss is shared equally unless the partnership contract specifically indicates otherwise.

The same basis of division usually applies to both net income and net loss, and is called the income ratio or the profit and loss ratio.

A partner’s share of net income or net loss is recognized in the accounts through

closing entries.

CLOSING ENTRIESCLOSING ENTRIESCLOSING ENTRIESCLOSING ENTRIES

Four closing entries are required for a partnership:

1. Debit each revenue account for its balance and credit Income Summary for total revenues.

2. Debit Income Summary for total expenses and credit each expense account for its balance.

3. Debit (credit) Income Summary for its balance and credit (debit) each partner’s capital account for his or her share of net income (net loss).

4. Debit each partner’s capital account for the balance in that partner's drawing account and credit each

partner’s drawing account for the same amount.

CLOSING ENTRIESCLOSING ENTRIESExampleExample

CLOSING ENTRIESCLOSING ENTRIESExampleExample

On Dec 31, Interactive Software had sales of $100,000 and operating expenses of $68,000. The partners share profits and losses equally. Drawings for the year were Gan $8,000 and Sin $6,000.

Dec 31 Sales 100,000 Income Summary 100,000To close revenue

Dec 31 Income Summary 68,000 Operating Expenses 68,000to close expenses

Dec 31 Income Summary (100,000-68,000) 32,000 M. Gan, Capital (32,000 x 50%) 16,000 K. Sin, Capital (32,000 x 50%) 16,000to close net income to capital accounts

Dec 31 M. Gan, Capital 8,000 K. Sin, Capital 6,000 M. Gan, Drawings 8,000 K. Sin, Drawings 6,000To close drawings to capital accounts

INCOME RATIOSINCOME RATIOSINCOME RATIOSINCOME RATIOSThe partnership agreement should specify the basis for sharing net income or net loss. The following are typical of the ratios that may be used:1. A fixed ratio, expressed as a proportion (2:1), a percentage (67% and 33%), or a fraction (2/3 and 1/3).2. A ratio based on either capital balances at the beginning of the year or on average capital balances during the year.3. Salaries to partners and the remainder in a fixed ratio.4. Interest on partners’ capital balances and the remainder in a fixed ratio.5. Salaries to partners, interest on partners’ capital balances, and the remainder in a fixed ratio.

INCOME STATEMENT WITH INCOME STATEMENT WITH DIVISION OF NET INCOMEDIVISION OF NET INCOME

Example 1Example 1

INCOME STATEMENT WITH INCOME STATEMENT WITH DIVISION OF NET INCOMEDIVISION OF NET INCOME

Example 1Example 1Sara King and Ray Lee are partners in the Kingslee Company. The partnership agreement provides for 1) salary allowances of $8,400 for Sara and $6,000 for Ray, 2) interest allowances of 10% on capital balances at the beginning of the year, and 3) the remaining income to be split equally. Beginning Capital balances were King $28,000 and Lee $24,000. The division of the 2003 partnership income of $22,000 is as follows:

2,4000

King Lee TotalTotal net income $22,000Based on salary allowance

Based on interest allowance:King - ($28,000 X 10%)Lee - ($24,000 X 10%)TotalRemaining incomeRemainder shared equally

Division of net income

$8,400 $6,000 (14,400)

2,800 2,400

(5,200)

1,200 1,200 (2,400)

$12,400 $ 9,600 $22,000

PARTNER’S CAPITAL STATEMENTPARTNER’S CAPITAL STATEMENTPARTNER’S CAPITAL STATEMENTPARTNER’S CAPITAL STATEMENT

The equity statement for a partnership is called the statement of partners' capital. It’s function is to explain the changes 1) in each partner’s capital account and 2) in total partnership capital during the year.

The statement of partners’ equity is prepared from the income statement and the partners’ capital and drawings accounts. The balance sheet for a partnership is the same as for a proprietorship except in the equity section. The capital balances of the partners are shown in the balance sheet.

PARTNER’S EQUITY SECTION OF A PARTNER’S EQUITY SECTION OF A PARTNERSHIP BALANCE SHEETPARTNERSHIP BALANCE SHEET

PARTNER’S EQUITY SECTION OF A PARTNER’S EQUITY SECTION OF A PARTNERSHIP BALANCE SHEETPARTNERSHIP BALANCE SHEET

INCOME STATEMENT WITH INCOME STATEMENT WITH DIVISION OF NET INCOMEDIVISION OF NET INCOME

Example 2Example 2

INCOME STATEMENT WITH INCOME STATEMENT WITH DIVISION OF NET INCOMEDIVISION OF NET INCOME

Example 2Example 2

INCOME STATEMENT WITH INCOME STATEMENT WITH DIVISION OF NET INCOMEDIVISION OF NET INCOME

Example 2 cont.Example 2 cont.Net Income of $100,000Net Income of $100,000

INCOME STATEMENT WITH INCOME STATEMENT WITH DIVISION OF NET INCOMEDIVISION OF NET INCOME

Example 2 cont.Example 2 cont.Net Income of $100,000Net Income of $100,000

INCOME STATEMENT WITH INCOME STATEMENT WITH DIVISION OF NET INCOMEDIVISION OF NET INCOME

Example 2 cont.Example 2 cont.Net Income of $20,000Net Income of $20,000

INCOME STATEMENT WITH INCOME STATEMENT WITH DIVISION OF NET INCOMEDIVISION OF NET INCOME

Example 2 cont.Example 2 cont.Net Income of $20,000Net Income of $20,000