college accounting

College AccountingCollege Accounting

Heintz & ParryHeintz & Parry2020thth Edition Edition

ChapterChapter 1919

Accounting for Partnerships

1Describe the various types of

partnerships, their

characteristics, the

partnership agreement, and the

advantages and disadvantages

of a partnership.

PARTNERSHIPPARTNERSHIP

• “An association of two or more persons who carry on, as co-owners, a business for profit”

– Used for all types of enterprises• More popular among personal service

enterprises than merchandising businesses

PARTNERSHIP AGREEMENTPARTNERSHIP AGREEMENT

• Defined as “a written agreement containing the provisions for operating a partnership”– Essential provisions include:

• Date of the agreement• Names of the partners• Kind of business to be conducted• Length of time the partnership is to run• Name and location of the business• Investment of each partner• Basis on which profits and losses are to be shared• Limitation of partners’ rights and activities• Salary allowances to partners• Division of assets upon dissolution of partnership• Signatures of the partners

CHARACTERISTICSCHARACTERISTICS

• All assets held by a partnership are co-owned by all partners. If one partner contributes an asset to the business, the asset is jointly owned by all partners.

CO-OWNERSHIP OF ASSETS

Advantages: Ability and expertise combined

into one enterprise and easier to raise capital

• Any partner can bind the other partners to a contract if he or she is acting within the general scope of the business.

MUTUAL AGENCY

Disadvantage:Serious

consequences ifpartners don’t

act responsibly

• A partnership may be dissolved as the result of any change in the ownership (e.g. death, bankruptcy, incapacity, withdrawal of a partner, addition of a new partner, or expiration of the time specified in the partnership agreement).

LIMITED LIFE

• Each partner is personally liable for ALL debts incurred by the partnership.

UNLIMITED LIABILITY

Major disadvantage:A partner could

losepersonal assets

• A partnership is not subject to federal income tax. But, partners must report their share of the partnership’s income on their personal income tax returns.

FEDERAL INCOME TAXES

Prepare entries for the

initial investments in a

partnership.

INVESTMENTSINVESTMENTS

EXAMPLE: Sam Mitchell and Lisa Jenkins begin the Mitchell & Jenkins Partnership by investing $350,000 and $200,000,

respectively.

Let’s look at thejournal entry!

GENERAL JOURNALGENERAL JOURNAL

DATE DESCRIPTION PR DEBIT CREDIT

Cash 350,000

Sam Mitchell, Capital 350,000

S. Mitchell invested

$350,000 in cash

Lisa Jenkins, Capital

L. Jenkins invested

$200,000 in cash

200,000

Separate capital and drawing accountsare maintained for each partner.

INVESTMENTSINVESTMENTS

• What if instead of $200,000 in cash, Lisa Jenkins had invested:

– Inventory valued at $47,500, on which $10,500 was owed

– Office equipment valued at $40,000– Delivery equipment valued at $92,000,

on which $19,000 was owed on a note– $50,000 in cash

Cash 50,000

47,500Inventory

Lisa Jenkins, Capital

19,000

200,000

Each asset invested and liability assumed is recorded. The

difference is credited to the capital account.

Office Equipment 40,000

Delivery Equipment 92,000

Notes Payable

Accounts Payable 10,500

COMBINING BUSINESSESCOMBINING BUSINESSES

• On April 1, Donna Morning and Larry Knight form a partnership under the firm name of Morning & Knight Sports

• They agree to invest their assets in the partnership. The partnership will also assume the liabilities shown on their balance sheets

• Profits/losses are to be shared 50-50• In the case of dissolution, assets are to be

distributed between partners in the ratio of their capital interests at the time of dissolution

COMBINING BUSINESSES COMBINING BUSINESSES

Morning SportsBalance SheetMarch 31, 20--

Assets LiabilitiesCash $ 6,344Accts. receivable $5,524Less allow. forbad debts 430 5,094Mdse. inventory 24,574Store equipment $3,840Less accum. depr. 1,000 2,840Total assets $38,852

Notes payable $4,600Accounts payable 9,082Total liabilities $13,682

Owner’s EquityMorning, capital 25,170

$38,852Total liab. & O.E.

Let’s look at the journal entryto record Donna Morning’s

investment in the new partnership.

Cash 6,344

5,524Accounts Receivable

Any uncollectible accounts should

be written off before formingthe partnership. Morning Sports

had no accounts considered

uncollectible.

Cash 6,344

Merchandise Inventory 24,574

Since Donna uses FIFO,the merchandise inventory

account reflects current market values.

Cash 6,344

Store Equipment 3,600

Assets are recorded at theirfair market values (not book

values) at the time of investment.

Cash 6,344

Accounts Payable

Allowance for Bad Debts

Notes Payable 4,600

The allowance account and the liabilities

are recorded at the values shown on Morning Sports’ balance sheet.

Cash 6,344

Accounts Payable

Notes Payable 4,600

The capital account is credited for thedifference between assets

invested and liabilities assumed.

D. Morning, Capital 25,930

COMBINING BUSINESSES COMBINING BUSINESSES

Knight AthleticsBalance SheetMarch 31, 20--

Assets LiabilitiesCash $ 3,544Accts. receivable $5,280Less allow. forbad debts 720 4,560Mdse. inventory 29,692Supplies

$4,320Less accum. depr. 1,100 3,220

Total assets $44,902

Notes payable $ 6,000Accounts payable 13,238Total liabilities $19,238

Knight, capital 25,664$44,902Total liab. & O.E.

286Office equipment

Store equipment $4,800Less accum. depr. 1,200 3,600

Knight’s assets andliabilities are brought

intothe new partnership.

Owner’s Equity

Cash 3,544

Accounts Payable

Store Equipment

Notes Payable

L. Knight, Capital

Supplies

Office Equipment

13,238

26,894

3Explain how partners are

compensated and account

for the allocation of net

income.

ALLOCATING PROFIT OR LOSSALLOCATING PROFIT OR LOSS

EXAMPLE: The partnership of Mitchell and Jenkins earned net income of

$190,800 for the year.

S. Mitchell L. Jenkins

$95,400 $95,400

If Mitchell and Jenkins had notspecified how the income was to

besplit, it would be split evenly.

Entries #1 & 2 are the same as for sole proprietorships.

Entries #3 & 4 are different for partnerships.

PARTNERSHIP CLOSING ENTRIESPARTNERSHIP CLOSING ENTRIES

• Four Entries

1.Close all revenues to Income Summary

2.Close all expenses to Income Summary

3.Close Income Summary by allocating each partner’s share of net income or loss to the individual capital accounts

4.Close each partner’s drawing account to the individual capital accounts.

(3) Income Summary 190,800

95,400S. Mitchell, Capital

Instead of all the net income being

credited to one capital account,it is allocated to each partner’s

capital account.

95,400L. Jenkins, Capital

Closing Entries

(3) Income Summary 190,800

(4) S. Mitchell, Capital

S. Mitchell, Drawing

36,000

L. Jenkins, Capital

L. Jenkins, Drawing

48,000

Closing EntriesAssume Mitchell withdrew $36,000 and Jenkins withdrew $48,000 during the year. Each partner’s drawing account is

closed to his respective capital account.

Mitchell and Jenkins did specifyhow the income was to be split—

after salary allowances, the remaining

net income was to be split 60-40.

$36,000 $48,000

Salary allowances total $84,000.Remaining net income is

$106,800($190,800 – $84,000).

Salary allowances

$36,000 $48,000

$106,800 60% = $64,080

Salary allowances64,080

$36,000 $48,000

$106,800 40% = $42,720

Salary allowances64,080 42,720Remaining income

$ 36,000 $48,000Salary allowances64,080 42,720Remaining income

$100,080 $90,720

Income Summary 190,800

A closing entry is made for the total allocated to each

partner.

S. Mitchell, Capital

S. Mitchell, Drawing

36,000

L. Jenkins, Capital

L. Jenkins, Drawing

48,000

Next, close eachowner’s drawing

account.

EXAMPLE: Let’s look at the allocation if the partnership of Mitchell and Jenkins earned net income of $44,000 for the

year. S. Mitchell L. Jenkins

$36,000 $48,000Salary allowances

The salary allowancesalone total more

than the net income!

$36,000 $48,000Salary allowances

$84,000

Salary allow. –

44,000$40,000

Net incomeExcess to be absorbed by partners

$ 36,000 $48,000Salary allowances

$40,000 60%

(24,000)

$ 36,000 $ 48,000Salary allowances

$40,000 40%

(24,000) (16,000)

$ 36,000 $ 48,000Salary allowances

(24,000) (16,000)

$ 12,000 $ 32,000

$12,000 + $32,000 =

$44,000 net income

Entries to close the drawingaccounts would be

the same as the previous example.

EXAMPLE: B. K. Kelly and S. B. Arthur form a partnership on January 1 of the current year.

Kelly will devote full time to operating the business, invest $50,000, and draw a salary of $35,000 per year. Arthur will devote about 10 hours per week, invest $150,000, and draw a salary of $10,000 per year. The partners will

be allowed interest of 10% on capital balances on January 1 of each year and the balance of

the earnings will be divided equally. Let’s allocate the first

yearnet income of $80,000.

Kelly had a capital balance

of $50,000 on January 1.($50,000 10%)

B. K. Kelly S. B. Arthur

Salary allow.$35,000 $10,000Interest allow.5,000

Arthur had a capital balance

of $150,000 on January 1.($150,000 10%)

B. K. Kelly S. B. Arthur

Salary allow.$35,000 $10,000Interest allow.5,000 15,000

Kelly has allowances of $40,000 so far.

Arthur has $25,000 so far.$80,000 – $65,000 = $15,000

remainingSplit evenly = $7,500 each

B. K. Kelly S. B. ArthurSalary allow.$35,000 $10,000Interest allow.5,000 15,000

Remaining income7,500 7,500

B. K. Kelly S. B. ArthurSalary allow.$35,000 $10,000Interest allow.5,000 15,000Remaining income7,500 7,500

$47,500 $32,500

What if the partnership hada loss of $20,000 in the first

B. K. Kelly S. B. ArthurSalary allow.$35,000 $10,000Interest allow.5,000 15,000

Salary and interest allowances

would still be given, totaling $65,000.

B. K. Kelly S. B. ArthurSalary allow.$ 35,000 $ 10,000Interest allow.5,000 15,000

The allowances plus the lossleave $85,000 to be absorbed

equally.

(42,500) (42,500)$ (2,500) $(17,500)

Income Summary

17,500

B. K. Kelly, Capital

20,000

S. B. Arthur, Capital

Capital accounts arereduced this year.

Prepare financial

statements reporting the

allocation of net income

and partnership equity.

PARTNERSHIP FINANCIAL STATEMENTS

• The allocation of net income and its impact on the capital balances should be disclosed in the financial statements.

FINANCIAL STATEMENTSFINANCIAL STATEMENTS

Net income $80,000

Kelly Arthur Total

Allocation of net income:

Salary allowances

Interest allowancesRemaining incomeAllocation of net income $47,500 $32,500 $80,000

$35,000 $10,000 $45,000

15,000

20,000

15,000

Distribution of income is shown at the bottom

of the income statement.

Kelly and ArthurIncome Statement (Partial)

For Year Ended December 31, 20--

Kelly Arthur Total

Capital, January 1, 20--

Net income for the year

Withdrawals (salaries during the year)

Capital, December 31, 20-- $62,500 $182,500 $245,000

$50,000 $150,000 $200,000

35,000

10,000

10,000 45,000

Additional investments during year 10,000

$50,000 $160,000 $210,000

47,500 32,500 80,000

$97,500 $192,500 $290,000

Kelly and ArthurStatement of Partners’ Equity

For Year Ended December 31, 20--

Replaces the

statement of

owner’sequity

B. K. Kelly, capital

Total partners’ equity

$ 62,500

182,500S. B. Arthur, capital

$245,000

Partners’ Equity

Owner’s equity is nowpartners’ equity

Kelly and ArthurBalance Sheet (Partial)

December 31, 20--

Describe the actions that

result in the dissolution of

a partnership and account

for the dissolution.

DISSOLUTION OF A PARTNERSHIPDISSOLUTION OF A PARTNERSHIP

• Any change in the members of the partnership results in dissolution– Does not imply that business

operations will halt– A new partnership agreement is

created– Can be caused by:

• Admitting a new partner• Death or withdrawal of a partner• Bankruptcy

ADMITTING A NEW PARTNERADMITTING A NEW PARTNER

• A new partner may buy into the business in three ways:

– By purchasing an interest directly from existing partners

– By making a cash investment in the business

– By contributing assets from an existing business

EXAMPLE: Morning and Knight admit Sunny Noon as a new partner as of July 1, 20--, when Morning and Knight have

capital interests of $30,000 and $20,000, respectively. Noon pays

$12,000 to Morning for one-third of her interest and $12,000 to Knight for one-

half of his interest. The payments go to the

partnersdirectly, not the business.

half of his interest. Morning, Capital 1/3

$30,000 1/3

Noon buys $10,000 ofMorning’s equity.

half of his interest. Knight, Capital 1/2

$20,000 1/2

Noon buys $10,000 ofKnight’s equity.

Donna Morning, Capital 10,000

Morning’s capital account is reduced

by the amount sold to Sunny Noon.

20--July 1

10,000Larry Knight, Capital

20,000Sunny Noon, Capital

Knight’s capital account is reduced

by the ½ interest he sold to Noon.A capital account is created for

20--July 1

10,000Larry Knight, Capital

The $12,000 paid to eachpartner is not recorded

on the partnership books.

20--July 1

Cash 25,000

If Noon had paid $25,000directly to the partnership…

20--July 1

ADMITTING A NEW PARTNER ADMITTING A NEW PARTNER

Assets LiabilitiesCash $ 5,000Accts. receivable $14,290Less allow. forbad debts 1,078 13,212Mdse. inv. 27,290

Total assets $45,502

Notes payable $9,048Accounts payable 7,550Total liabilities $16,598

Owner’s EquityNoon, capital 28,904

$45,502Total liab. & O.E.If Noon has a business that

thenew partnership will take

over...

Sunny Noon’s GolfBalance Sheet June 30, 20--

Cash 5,000

Accounts Receivable

No adjustment is necessarysince Noon has no

knowledgeof any uncollectible

accounts.

20--July 1

14,290

Cash 5,000

Accounts Receivable

No adjustment is necessarysince Noon has been

using the FIFO method.

20--July 1

14,290

Cash 5,000

Accounts Receivable

20--July 1

14,290

Allowance for Bad Debts 1,078

Notes Payable 9,048

Accounts Payable 7,550

Sunny Noon, Capital 28,904

WITHDRAWAL OF A PARTNERWITHDRAWAL OF A PARTNER

• A partner may retire and withdraw assets equal to, less than, or greater than the amount of his or her interest in the partnership

– Determined after:• All profits and losses are allocated and the

books are closed

WITHDRAWAL OF A PARTNERWITHDRAWAL OF A PARTNER

EXAMPLE: Many years later, Sunny Noon decides to retire. The partners have

agreed to the withdrawal of cash equal to the amount of Noon’s equity in the

assets of the partnership.

Donna Morning

45,000

Sunny Noon will take home$40,000 cash.

Capital account balances:

$55,000Sunny Noon 40,000

Larry Knight

Her capital account is closed out.

The other capital accountsare not affected.

Cash 40,000

What if Sunny agreesto only $30,000 cash?

Cash 40,000

Sunny’s capital accountis closed out.

But cash received is lessthan the capital balance.

The difference is split between

the remaining partners.

Cash 30,000

Remaining capital = $100,000($55,000 + $45,000)

Morning has 55% interest.She receives 55% of the $10,000

difference.

Cash 30,000

Donna Morning, Capital

Larry Knight, Capital

Knight receives 45% of the difference.

Cash 30,000

If Noon received $45,000 cash($5,000 more than her capital

balance)…

Cash 45,000

The remaining partners contribute their capital to

make the $5,000 difference.

Cash 45,000

One last alternative…Sunny sells her interest

in the business to Donna.

The cash paid by Donna Morning to Sunny Noon is a

personal transaction between the two partners. Noon’s capital account is

closed and Morning’s capital account is credited for

$40,000.

Describe how a

partnership is liquidated

and prepare associated

entries and a statement of

partnership liquidation.

LIQUIDATION OF A PARTNERSHIPLIQUIDATION OF A PARTNERSHIP

• Assets are sold

• Liabilities are paid

• Remaining cash and assets are distributed to the partners

EXAMPLE: After many years of operations, the partnership is to be liquidated. After closing entries, the

following accounts remain.Cash

220,000

$ 10,000Inventory 120,000Other AssetsLiabilities $ 80,000D. Morning, Capital 95,000L. Knight, Capital 120,000S. Noon, Capital 55,000

Noncash assets are

sold for $370,000.

Cash 370,000

Inventory 120,000

Other Assets 220,000

Gain on Sale of Assets 30,000

Cash 370,000

Inventory 120,000

Gain on Sale of Assets 30,000

L. Knight, Capital 10,000

S. Noon, Capital 10,000

The gain is shared equallyby the partners.

following accounts remain.

$380,000

Other AssetsInventory

Cash is now $380,000 ($10,000 + $370,000),

Inventory and Other Assets are now zero.

following accounts remain. Cash

$380,000Inventory 0Other AssetsLiabilities $ 80,000D. Morning, Capital 105,000 95,000

+ 10,000

$380,000Inventory 0Other AssetsLiabilities $ 80,000D. Morning, Capital 105,000L. Knight, Capital 130,000

120,000+ 10,000

$380,000Inventory 0Other AssetsLiabilities $ 80,000D. Morning, Capital 105,000L. Knight, Capital 130,000S. Noon, Capital 65,000

55,000+ 10,000

Liabilitiesare paid

Liabilities 80,000

Cash 80,000

$300,000Inventory 0Other AssetsLiabilities $ 0D. Morning, Capital 105,000L. Knight, Capital 130,000S. Noon, Capital 65,000

Remaining cash = Capital account balances

Cash is distributed to partners.

Cash 300,000

$0Inventory 0Other AssetsLiabilities $0D. Morning, Capital 0L. Knight, Capital 0S. Noon, Capital 0

The partnership is liquidated!

220,000

$ 10,000Inventory 120,000Other AssetsLiabilities $ 80,000D. Morning, Capital 95,000L. Knight, Capital 120,000S. Noon, Capital 55,000

If these assets had been sold

for only $295,000…

Cash 295,000

Inventory 120,000

Loss on Sale of Assets 45,000

There is a $45,000 loss to be

allocated to the partners.

Cash 295,000

Inventory 120,000

$305,000Inventory 0Other AssetsLiabilities $ 80,000D. Morning, Capital 80,000L. Knight, Capital 105,000S. Noon, Capital 40,000

Liabilitiesare paid

Liabilities 80,000

Cash 80,000

$225,000Inventory 0Other AssetsLiabilities $ 0D. Morning, Capital 80,000L. Knight, Capital 105,000S. Noon, Capital 40,000

Cash is paid to the

partners.

Cash 225,000

$0Inventory 0Other AssetsLiabilities $0D. Morning, Capital 0L. Knight, Capital 0S. Noon, Capital 0

The partnership

is liquidated!

college accounting

mitchell jenkins partnership

new partner

cashcash lisa jenkins

partnerships income

sam mitchell

partnerskind of business

inventory lisa jenk

personal income tax

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