Accounting II   ©
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© 1989 John Petroff

Chapter 2:

PARTNERSHIPS

 

INTRODUCTION TO PARTNERSHIPS
The Uniform Partnership Act has been adopted by most states, and its purpose is to provide basic laws governing the formation and the operation of partnerships. The combination of entrepreneurial talents, experience, and capital make the formation of partnerships attractive. Small businesses and professional services typically enter into partnership agreements. When a partnership is formed, the articles of partnership stipulate in particular how profits and losses are to be divided, the responsibilities of partners, the initial contributions, the name and the nature of the business.

INTRODUCTION TO PARTNERSHIPS
Major characteristics of partnerships are:
1) Partnerships have a limited life.
2) Partners have unlimited personal liability (unless they are silent partners in a limited partnership in which case their liability is limited to the amount of their investment).
3) All full partners have the right to use partnership property.
4) All full partners are bound by contracts entered by other partners.
5) All partners share in profits and losses.
6) A partnership is a non-taxable entity. Income taxes are only paid by partners to the extent of their share of profits. Information forms must, however, be sent annually to the Internal Revenue Service indicating the income of the business and the payments received by the partners.

ADVANTAGES & DISADVANTAGES
OF PARTNERSHIPS The following are advantages of partnerships:
1) capital, entrepreneurial skills and experience are combined,
2) easy and inexpensive formation,
3) little government regulation, and
4) non-taxable entity.
The following are disadvantages of partnerships:
1) mutual agency,
2) unlimited liability,
3) limited life, and
4) limited capital raising abilities.

 

ACCOUNTING FOR PARTNERSHIPS
Accounting for partnerships is similar to other forms of business organization. The same accounts are used, with the exception of capital accounts. Partnerships have separate drawing and capital accounts for each partner. Income is distributed differently from other forms of business organizations. Since a partnership has a limited life, special transactions need to be performed upon the death or withdrawal of a partner, dissolution and liquidation.

INVESTING IN PARTNERSHIPS
Separate entries are required for each member that joins a partnership. A monetary value is assigned to all non-cash assets contributed by each partner. Only receivables which are collectible should be recorded in the partnerships books. Any liability entered into by members of the partnership becomes a liability of the newly formed business. To record the initial investment, entries are performed to debit assets and credit liabilities. The net difference between assets and liabilities is a credit to the capital account of the partner.

 

DIVIDING NET PROFITS OR LOSSES
All members of a partnership are entitled to share profits. If no provisions are set forth in the articles of partnership as to how profits or losses are to be divided, they must be shared equally. Partners commonly receive a salary and an interest allowance. If net income remains after all allowances have been satisfied, the remaining income is split according to agreed proportions. A loss is shared in the same proportions.

FINANCIAL STATEMENTS FOR PARTNERSHIPS
Partnerships must provide information on how net income was distributed among partners. This information can be combined with the balance sheet or the income statement. If desired, it can also be reported separately. The changes of a partner's equity can be found in the statement of owners' equity, which reflects any investment withdrawal or income distribution. The ending capital balance represents the owners' equity at the end of an accounting period.

ADMITTING NEW PARTNERS
Partners can be admitted into a partnership by either 1) purchasing an interest of the firm from a current partner, or 2) contributing assets to the business. When a partner purchases an interest in a business, only the capital accounts change. When a new partner contributes assets to a business, both assets and owners' equity increase. When a new partner contributes assets, current partners should assign a fair market value to the asset. In the event an asset is improperly valued, and is reevaluated at a later date, the partners divide an increase or a decrease among themselves.

NEW PARTNERS AND GOODWILL
When a new partner is admitted, the profitability of a partnership often increases. Either the new partner or the former partners may be entitled to a bonus or goodwill. The bonus or goodwill is determined by bargaining between members of a partnership. Goodwill is recorded as an asset, and is credited to the proper capital accounts.

WITHDRAWAL OR DEATH OF PARTNER
The withdrawal or death of a partner dissolves a partnership. A partnership can operate undisturbed only if the remaining partners agree to purchase the withdrawing partner's interest. In the event of the death of a partner, a stipulation in the partnership agreement may allow a business to operate for a period of time until assets are transferred to the deceased's estate. When a withdrawing partner's assets are bought out by existing partners, only capital accounts are effected.

General Journal
Date Account title and explanation Post ref.  Debit Credit
     FGSDFG              
     FDSAF              
     DFSAF              
     FDSA              
     FDAS              

If a partner is paid from assets of the business, the result will be a decrease in asset and capital accounts.

General Journal
Date Account title and explanation Post ref.  Debit Credit
                   
                   
                   
                   
                   

LIQUIDATING A PARTNERSHIP
When a partnership liquidates, the following occurs:
1) assets are sold,
2) creditors are paid, and
3) cash is distributed to partners.
Difficulties arise because the proceeds from the sale of assets rarely equal the value stated in the books of the partnership. Gains or losses on realization are recorded to the Gain and Loss on Realization account. The net gain or loss represents a change in equity, and is divided among partners according to the income-sharing agreement.

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