chapter partnerships: characteristics, formation, and accounting for activities fundamentals of...
TRANSCRIPT
CHAPTER
Partnerships:Characteristics, Formation,
and Accounting for Activities
Fundamentals of Advanced Accounting 1st Edition
Fischer, Taylor, and Cheng
88
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #2
Characteristics of a Partnership
• Association of two or more people as co-owners of a business
• Often governed by the Uniform Partnership Act (UPA)
• Voluntary association of individuals• Partners have fiduciary relationship• Mutual agency – Each partner is an agent
for other partners and the partnership
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #3
Legal Liability of Partnerships
• General partnership– Partners are general partners– All partners personally liable for all obligations of the
partnership
• Limited partnership– One or more general partners
• Personally liable for obligations of the partnership
– One or more limited partners• Maximum risk of loss is capital in the partnership• Do not participate in management of the firm
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #4
Legal Liability of Partnerships - continued
• Limited Liability Company (LLC)– Hybrid of corporation and partnership– Shareholders do not have personal liability for actions
by the entity– Not protected from their own wrongdoings
• Limited Liability Partnership (LLP)– All partners participate in management– Partners have limited liability caused by wrongdoings
of other partners– Partners are personally liable based on their own
actions or actions of those supervised
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #5
Equity Theories
• Proprietary Theory – Entity is viewed as the individual owners– Salaries to partners are distributions of income (not
expenses)– Unlimited liability extends to personal assets of owners– Partnership is not a taxable entity – income is passed
through and taxed to the individual partners– Original partnership is dissolved with admission or
withdrawal of a partner
• Entity Theory – business unit separate & distinct– Partnership enters contracts in it’s own name– Partners give up title to their contributions
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #6
Formation and Agreements
• Partnerships can be formed just by actions• The partnership agreement captures the
intent of the partners for major issues– Admission of partners– Withdrawal of partners– Allocation of profits and losses
• Uniform Partnership Act (UPA) covers some topics in the partnership agreement– Mostly used when there is no formal agreement or
if the agreement is silent on an issue
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #7
Acceptable Accounting Principles
• Partnerships may use GAAP– Not required if it adversely affects fairness of
financial statements
• There are other comprehensive basis of accounting (OCBOA) principles applicable– Cash basis accounting– Tax basis accounting
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #8
Accounts Used for a Partner’s Capital Investment
• Drawing account– A temporary account– Periodically closed to capital accounts– Represent assets withdrawn by partner from
partnership
• Capital account– A permanent account– Represents partner’s interest in the net assets
of the partnership (book value)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #9
The Drawing Account Illustrated
Debit
Periodic withdrawals of partnership assets
Credit
Closing of balance to partner’s capital account
Drawing Account
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #10
The Capital Account Illustrated
Debit
Withdrawals in excess of a specified amount
Closing of a net debit balance in the partner’s drawing account
Partner’s share of partnership losses
Credit
Initial and subsequent investments of capital
Partner’s share of partnership profits
Capital Account
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #11
Partner’s Interest
• A partner’s interest in the net assets (book value) of the firm is different from their interest in profits and losses
• Partner may have a loan account– Partner borrows from the partnership– Partnership borrow from the partner
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #12
Initial Capital Investment
• Assets contributed by the partners are recorded at the agreed upon fair value
Example– Partner A contributes cash– Partner B contributes inventory & office equipment– Partnership assumes debt on the equipment– Equipment has $6,000 book value and $4,000 fair
value
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #13
Initial Capital Investment – Journal Entry
Cash 10,000Inventory 5,000Office equipment 4,000
Note payable 2,000Partner A, Capital 10,000Partner B, Capital 7,000
Note: Office equipment is recorded at fair value B’s capital account is reduce by loan assumed by
the partnership
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #14
Review – Partnership entries
Partner A loans partnership cash DR CashCR Partner A, Capital
Personal debt of partner B paid by partnershipDR Partner B, DrawingCR Cash
Partner B withdraws cash from partnershipDR Partner B, DrawingCR Cash
Net income is divided between partners A & BDR Income SummaryCR Partner A, CapitalCR Partner B, Capital
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #15
Division of Profits
• Should be identified in partnership agreement– If not, UPA says divide it evenly
• Several methods for allocating profit/loss– According to a ratio/percentage – According to capital investments of the partners– According to the labor/service rendered by
partners• Typically involving a salary and/or bonus
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #16
Profit and Loss ratios
• Partners are allocated % of profits/losses.
Example:
$20,000 profit
Partner A receives 60% x $20,000
Partner B receives 40% x $20,000
Total Partner A Partner B
Total Profit $20,000
Allocate 60/40 $12,000 $8,000
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #17
Capital Investment of Partners
Division of profits based on imputing interest on invested capital at a specified rate
Example• Partnership profit is $20,000• Interest on capital balances, 10% (before withdrawals)• Remaining profit allocated equally• Partner accounts are as follows:
10/1 30,000 1/1 100,000 4/1 10,000 1/1 60,0007/1 10,000
Partner A, Capital Partner B, Capital
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #18
Capital Investment of Partners (continued)
Partner A Partner B TotalInterest on beginning capital: A: 10% x $100,000 $10,000 $10,000 B: 10% x $60,000 $6,000 6,000
$16,000Balance per ratio (equally) 2,000 2,000 4,000
$12,000 $8,000 $20,000
•Interest is computed on beginning capital balances•Other alternatives:
•Ending capital balances•Average capital balances (weighted average)
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #19
Services Rendered by Partners
• Partner’s labor/service may be key to generating partnership revenue
• Allocate portion of income to partner as “salary”– Not an actual expense to partnership– Not considered drawing
• “Bonus” may recognize partner’s service– % of income before or after other criteria
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #20
Services Rendered by Partners - Example
ExampleNet Income = $120,000Allocation of salaries = $60,000Allocation of interest = $5,000Bonus = 10% of income after salaries and interest
Bonus = X% (Net income – Salaries – Interest)Bonus = 10% (120,000 – 60,000 – 5,000)Bonus = 10% (55,000)Bonus = $5,500
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #21
Multiple Bases of Allocation - Example
Example – ABC Partnership• Net Income = $33,000• Interest = 6% of ending capital balances over $100,000
– Partner A Ending Bal = $80,000– Partner B Ending Bal = $150,000– Partner C Ending Bal = $110,000
• Bonus = Partner C, 10% of NI after bonus• Salaries
– Partner A = $13,000– Partner B = $12,000
• Balance of income– 2:1:1 to A, B & C, respectively
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #22
Basic Schedule for Allocating ProfitsIllustration 8-2
A B C TotalInterest on capital - 3,000$ 600$ 3,600$ Bonus - - 3,000 3,000Salaries 13,000 - 12,000 25,000 Subtotal 13,000$ 3,000$ 15,600$ 31,600$ Remaining profit 700 350 350 1,400 Profit allocation 13,700$ 3,350$ 15,950$ 33,000$
Partner
Bonus is calculated as follows:Bonus = 10% (Net income – Bonus)Bonus = 10% (33,000 – Bonus)Bonus x 110% = $3,300Bonus = $3,000
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #23
Allocation of Profit Deficiencies and Losses:Two Alternatives
• Satisfy all provisions of the profit and loss agreement – Use the profit and loss ratios to absorb any
deficiency or additional loss caused by such action
• Satisfy each of the provisions to whatever extent is possible– For example, the allocation of salaries would be
satisfied to whatever extent possible before the allocation of interest is begun
– Ranked by order of priority
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #24
Deficiency Allocated By Order Of PriorityProfit allocation - Deficiency Allocated By P/L Ratio – Illustration 8-3
A B C TotalInterest on capital - 3,000$ 600$ 3,600$ Bonus - - 2,000 2,000Salaries 13,000 - 12,000 25,000 Subtotal 13,000$ 3,000$ 14,600$ 30,600$ Deficiency (4,300) (2,150) (2,150) (8,600) Loss allocation 8,700$ 850$ 12,450$ 22,000$
Partner
Bonus is calculated as follows:Bonus = 10% (Net income – Bonus)Bonus = 10% (22,000 – Bonus)Bonus x 110% = $2,200Bonus = $2,000
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #25
Deficiency Allocated By Order Of PriorityLoss Allocation - Deficiency Allocated By P/L Ratio – Illustration 8-4
A B C TotalInterest on capital - 3,000$ 600$ 3,600$ Bonus (not applicable)Salaries 13,000 - 12,000 25,000 Subtotal 13,000$ 3,000$ 12,600$ 28,600$ Deficiency (15,500) (7,750) (7,750) (31,000) Loss allocation (2,500)$ (4,750)$ 4,850$ (2,400)$
Partner
No bonus is calculated since it is based on a percentage of profit
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #26
Deficiency Allocated By Order Of PriorityProfit allocation - Deficiency Allocated
By Order of Priority – Illustration 8-5
A B C TotalInterest on capital - 3,000$ 600$ 3,600$ Bonus - - 2,000 2,000Salaries 8,528 - 7,872 16,400 Income allocation 8,528$ 3,000$ 10,472$ 22,000$
Partner
Bonus is calculated as follows:Bonus = 10% (Net income – Bonus)Bonus = 10% (22,000 – Bonus)Bonus x 110% = $2,200Bonus = $2,000
Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 8, Slide #27
Special Allocation Procedures
• Partnership agreement may include special provisions for items that represent– Correction of prior year’s income– Current period non-operating gains/losses
• May be more equitable to base allocation on prior ratios