accounting for partnerships unit 10. illustration 10-1 partnership characteristics unlimited...
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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
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