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Chapter Fourteen

Chapter Fourteen. Partnerships: Formation and Operation. 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.

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Chapter Fourteen

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  1. Chapter Fourteen Partnerships: Formation and Operation

  2. PartnershipsCapital 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.

  3. Alternative Legal FormsSubchapter S Corporation Often referred to as an S-Corp . . . Has all the legal characteristics of a corporation. . . . Profit passes to owner just as with a partnership. . . . Ownership is limited to 75 stockholders.

  4. Alternative Legal FormsLimited Partnership . . . A limited number of owners who are not allowed to participate in management. . . . Losses are restricted to amount originally invested. . . . Must have a one or more general partners. Tax benefits of a partnership without unlimited liability.

  5. Alternative Legal FormsLimited Liability Partnerships LLP laws differ from state to state. . . . Most of the characteristics of a general partnership. . . . Partners are liable only for their own acts and omissions; an the acts an omissions of those under their direct supervision.

  6. Alternative Legal FormsLimited Liability Companies . . . Classified as a partnership for tax purposes. . . . Owners only risk their own investments. . . . The number of owners is not usually restricted. LLC laws differ from state to state.

  7. 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.

  8. Articles of Partnership Method for admitting new partners Method for dispute settlements Profit/loss sharing percentages Initial contribution to be made by each partner Withdrawal limits Put it in writing! Method for valuing individual contributions Rights and responsibilities of partners

  9. Accounting for Capital Contributions If the partners each contribute cash . . . • . . . debit Cash. • . . . credit individual Partner Capital accounts.

  10. Accounting for Capital Contributions If the partners each contribute cash and other assets . . . • . . . debit Cash & contributed assets for FMV. • . . . credit individual Partner Capital accounts.

  11. 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.

  12. On 2/15/03, Greene and Redd form a partnership. They agree to equal capital balances. Greene contributes $80,000 cash. Redd contributes land valued at $40,000. Intangible ContributionsBonus Method Prepare the journal entry to set up the partnership.

  13. Intangible ContributionsBonus 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 thoughReddonly contributed land worth$40,000, essentially,Greenehas givenRedda$20,000bonus.

  14. Intangible ContributionsGoodwill 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.

  15. Intangible ContributionsGoodwill Method On 2/15/03, 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. Prepare the journal entry to set up the partnership.

  16. Intangible ContributionsGoodwill Method On 2/15/03, 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. ÷

  17. Intangible ContributionsGoodwill 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.

  18. 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 Bonuses Allocated compensation

  19. Allocation of IncomeExample Bell and Sutton, a retail partnership selling hats, 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 (Bell:Sutton). What are the ending capital balances for each partner?

  20. Allocation of IncomeExample

  21. Allocation of IncomeExample

  22. Allocation of IncomeExample

  23. Allocation of IncomeExample

  24. Admission of a New PartnerThe Rights of a Partner An individual partner’s ownership rights include: • The right to co-ownership of the partnership property. • The right to share in profits and losses as specified in the partnership agreement • The right to participate in the management of the partnership. These two rights can be sold. This right cannot be sold without the other partners’ approval.

  25. Partnership DissolutionAdmission 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.

  26. Admission of a New PartnerPurchase 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

  27. Admission of a New PartnerPurchase of a Current Interest Book Value Example • Doe, Raye, and Mee have a partnership. • Using the Book Value Approach, prepare the entry assuming Flatt pays $60,000 directly to the other partners for a 20% partnership interest.

  28. Admission of a New PartnerPurchase of a Current Interest Book Value Example • The cash goes to Doe, Raye, and Mee, NOT to the partnership. • Each partner gives up 20% of their existing capital. Prepare the journal entry to admit Flatt to the partnership.

  29. Admission of a New PartnerPurchase of a Current Interest Book Value Example • The cash goes to Doe, Raye, and Mee, NOT to the partnership. • Each partner gives up 20% of their existing capital.

  30. Admission of a New PartnerPurchase of a Current Interest Now, let’s take a look at the Goodwill (Revaluation) Approach.

  31. Admission of a New PartnerPurchase of a Current Interest Goodwill (Revaluation) Example • Doe, Raye, and Mee have a partnership. • Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 directly to the other partners for a 20% partnership interest.

  32. Admission of a New PartnerPurchase 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

  33. Admission of a New PartnerPurchase 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) Prepare the journal entry to allocate goodwill to Doe, Raye, & Mee.

  34. Admission of a New PartnerPurchase 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)

  35. Admission of a New PartnerPurchase of a Current Interest Goodwill (Revaluation) Example The new balances for Doe, Raye, and Mee appear as follows: Next, allocate 20% from each of the existing partners to Flatt.

  36. Admission of a New PartnerPurchase of a Current Interest Revaluation Example Note that Flatt’s balance, after allocation from the current partners, equals Flatt’s contribution of $60,000.

  37. Admission of a New PartnerContribution 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

  38. Admission of a New PartnerContribution to the Partnership Bonus Example • Doe, Raye, and Mee have a partnership. • Using the Bonus Approach, prepare the entry assuming Flatt pays $60,000 to the partnership for a 20% partnership interest.

  39. Admission of a New PartnerContribution to the Partnership Note that the $200,000 results from the net assets of the partnership of $140,000 + Flatt’s $60,000 contribution. Prepare the journal entry. 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.

  40. Admission of a New PartnerContribution to the Partnership Note that the $200,000 results from the net assets of the partnership of $140,000 + Flatt’s $60,000 contribution. Prepare the journal entry. 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.

  41. Admission of a New PartnerContribution to the Partnership Now, let’s take a look at the Goodwill Approach.

  42. Admission of a New PartnerContribution to the Partnership Goodwill Example • Doe, Raye, and Mee have a partnership. • Using the Goodwill Approach, prepare the entry assuming Flatt pays $60,000 to the partnership for a 20% partnership interest.

  43. Admission of a New PartnerContribution 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) Prepare the journal entry to allocate goodwill to Doe, Raye, & Mee.

  44. Admission of a New PartnerContribution 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)

  45. Admission of a New PartnerContribution to the Partnership Goodwill Example After allocating the goodwill to the original partners, record Flatt’s cash contribution and credit Flatt’s capital account. Prepare the journal entry to admit Flatt to the partnership.

  46. Admission of a New PartnerContribution to the Partnership Goodwill Example After allocating the goodwill to the original partners, record Flatt’s cash contribution and credit Flatt’s capital account. Prepare the journal entry to admit Flatt to the partnership.

  47. End of Chapter 14 Accounting for my partners is easy. It’s accounting for their taste that I find difficult!

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