Accounting Principles, 7th Edition

Weygandt • Kieso • Kimmel

Chapter 13

Accounting for
Partnerships

John Wiley & Sons, Inc. © 2005

 CHAPTER 13
ACCOUNTING FOR PARTNERSHIPS
After studying this chapter, you should be
able to:
1 Identify the characteristics of the
partnership form of business organization.
2 Explain the accounting entries for the
formation of a partnership.
3 Identify the basis for dividing net income or
net loss.
4 Describe the form and content of
partnership financial statements.
5 Explain the effects of the entries to record
liquidation of a partnership.
 PARTNERSHIP FORM OF ORGANIZATION
STUDY OBJECTIVE 1

• Uniform Partnership Act

– basic rules for the formation and operation
of partnerships in more than 90 percent of
the states
– defines a partnership
• an association of two or more
persons to carry on as
co-owners of a business for
a profit.
 CHARACTERISTICS OF
PARTNERSHIPS

Principal characteristics of a partnership

1 Association of individuals
2 Mutual agency
3 Limited life
4 Unlimited liability
5 Co-ownership of property
 PARTNERSHIP
CHARACTERISTICS
 MUTUAL AGENCY

• Mutual agency
– each partner acts on behalf of the partnership
when engaging in partnership business
– act of any partner is binding on all other
partners
• (true even when partners act beyond the scope of
their authority, so long as the act appears to be
appropriate for the partnership)
 ASSOCIATION OF
INDIVIDUALS
• Association of individuals
– may be based on as simple an act as a handshake, it is
preferable to state the agreement in writing
• A partnership
– legal entity for certain purposes (i.e., property can be owned in
the name of the partnership)
– accounting entity for financial reporting purposes
• Net income of a partnership
– not taxed as a separate entity
– each partner’s share of income is taxable at personal tax rates.
 LIMITED LIFE

• Partnerships
– have a limited life
– dissolution
• whenever a partner withdraws or a new partner is
admitted
– ends involuntarily
• by death or incapacity of a partner
– may end voluntarily
• through acceptance of a new partner or withdrawal of a
partner
 UNLIMITED LIABILITY

• Unlimited liability
– each partner is personally and individually
liable for all partnership liabilities.
– creditors’ claims attach first to partnership
assets
– if insufficient assets
• claims then attach to the personal resources of any
partner, irrespective of that partner’s capital equity in
the company
 CO-OWNERSHIP OF
PROPERTY
• Partnership Assets
– assets invested in the partnership are owned jointly by all
the partners
• Partnership Income or Loss
– co-owned; if the partnership contract does not specify to
the contrary, net income or net loss is shared equally by the
partners
ADVANTAGES AND DISADVANTAGES
OF A PARTNERSHIP
 THE PARTNERSHIP
AGREEMENT
Partnership agreement (Articles of co-partnership)
– written contract
1 Names and capital contributions of the partners.
2 Rights and duties of partners.
3 Basis for sharing net income or net loss.
4 Provision for withdrawals of assets.
5 Procedures for submitting disputes to arbitration.
6 Procedures for the withdrawal or addition of a partner.
7 Rights and duties of surviving partners in the event of a partner’s
death.
 FORMING A PARTNERSHIP
STUDY OBJECTIVE 2

• Initial investment
– recorded at the fair market value of the assets
at the date of their transfer to the partnership
– values assigned must be agreed to by all of the
partners
• Once partnership has been formed
– accounting is similar to accounting for
transactions of any other type of business
organization

Computer recorded at its FMV of $2,500

instead of book value, which after
depreciation may be much lower.
 BOOK AND MARKET VALUE
OF ASSETS INVESTED
A. Rolfe and T. Shea combine their proprietorships to start a
partnership. They have the following assets prior to the
formation of the partnership:

Book Value Market Value

A. Rolfe T. Shea A. Rolfe T. Shea
Cash $ 8,000 $ 9,000 $ 8,000 $ 9,000
Office equipment 5,000 4,000
Accumulated depreciation ( 2,000)
Accounts receivable 4,000 4,000
Allowance for doubtful accounts ( 700) ( 1,000)
$ 11,000 $ 12,300 $ 12,000 $ 12,000
 RECORDING
INVESTMENTS IN A
PARTNERSHIP

Entries to record the investments are:

8,000
4,000
12,000

9,000
4,000
1,000
12,000
DIVIDING NET INCOME
OR NET LOSS
• Partnership net income or net loss
– shared equally unless the partnership
contract indicates otherwise
– is called the income ratio or the profit and
loss ratio
– partner’s share of net income or net loss is
recognized in the accounts through closing
entries
 CLOSING ENTRIES

4 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 ENTRIES

The first 2 entries are the same as a

proprietorship, while the last 2 entries are
different because:
1) there are 2 or more owners’
capital and drawing accounts
2) it is necessary to divide net
income or loss among the
partners.
 CLOSING NET INCOME
AND DRAWING ACCOUNTS
The AB Company has net income of $32,000 for 2005. The partners,
L. Arbor and D. Barnett, share net income and net loss equally, and
drawings for the year were Arbor $8,000 and Barnett $6,000. The last two
closing entries are:

32,000
16,000
16,000

8,000
6,000
8,000
6,000
 PARTNERS’ CAPITAL AND
DRAWING ACCOUNTS AFTER
CLOSING

Beginning capital balance is $47,000 for Arbor and

$36,000 for Barnett,
the capital and
drawing accounts
will show the
following after
posting the closing
entries:
 INCOME RATIOS
STUDY OBJECTIVE 3
The partnership agreement should specify the basis for sharing
net income or net loss. Typical income ratios:
1 A fixed ratio
– expressed as a proportion (6:4), a percentage (70% and 30%), 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 on a fixed ratio.
4 Interest on partners’ capital balances and the remainder on a
fixed ratio
5 Salaries to partners, interest on partners’ capitals, and the
remainder on a fixed ratio
 TYPICAL INCOME-SHARING RATIOS
Salaries, Interest and the Remainder on a Fixed Ratio

Sarah King and Ray Lee agree to

A. Salary Allowance of $8,400 to King, $6,000 to
Lee
B. Interest of 10% on capital Balances
C. Remainder Equally
 TYPICAL INCOME-SHARING RATIOS
Salaries, Interest and the Remainder on a Fixed Ratio

Capital balances - January 1, 2005

Sara King – $28,000
Ray Lee – $24,000
 INCOME STATEMENT
WITH DIVISION OF NET
INCOME
Sara King and Ray
Lee are copartners 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 remainder
equally. The division
of the 2005 net
income of $22,000 is
as follows:
 Income Division
• Salaries $ 8400
• $ 6000
• Interest $ 2800
• $ 2400
• Total $19600
• Net income ($22000)
• Left to split $ 2400 = $1200 & $1200
• each share
SALARIES, INTEREST, AND
REMAINDER ON A FIXED
RATIO

22,000
12,400
9,600
TYPICAL INCOME-SHARING
RATIOS CAPITAL BALANCES

•Income-sharing ratio
– may be based either on capital balances
at the beginning of the year
– or on average capital balances during
the year.
• Capital balances income-sharing
– may be equitable when a manager is
hired to run the business and the
partners do not plan to take an active
role in daily operation.
TYPICAL INCOME-SHARING
RATIOS SALARIES
Income-sharing based on salary allowances
may be:
1) Salary allowances to partners and the remainder
on a fixed ratio or
2) Salary allowances to partners, interest on
partners’ capitals, and the remainder on a fixed ratio.

* Salaries to partners and interest on partner’s capital

balances are not expenses-these items are not included in
determination of net income or net loss. They really do not
have a salary, this is a draw against capital.
The NBC Company reports net income of
$60,000. If partners N, B, and C have an
income ratio of 50%, 30%, and 20%,
respectively, C’s share of net income is:

a. $30,000.
b. $12,000.
c. $18,000.
d. No correct answer is given.
The NBC Company reports net income of
$60,000. If partners N, B, and C have an
income ratio of 50%, 30%, and 20%,
respectively, C’s share of net income is:

a. $30,000.
b. $12,000.
c. $18,000.
d. No correct answer is given.
 PARTNER’S CAPITAL
STATEMENT
STUDY OBJECTIVE 4

KINGSLEE COMPANY
The owners’ Partners’ Capital Statement
equity statement For the Year Ended December 31, 2005
for a partnership
Sara Ray
is called the King Lee Total
partners’ capital Capital, January 1 $ 28,000 $ 24,000 $52,000
statement. Its Add: Additional investment 2,000 2,000
function is to Net income 12,400 9,600 22,000
explain the 42,400 33,600 76,000
changes 1) in each Less: Drawings 7,000 5,000 12,000
partner’s capital Capital, December 31 $ 35,400 $ 28,600 $ 64,000
account and 2) in
total partnership capital during the year. The enclosed partners’
capital statement for the Kingslee Company is based on the division of
$22,000 of net income.
 OWNER’S EQUITY SECTION OF
A PARTNERSHIP BALANCE
SHEET

The partners’
capital statement
is prepared from
the income
statement and the
partners’ capital
and drawing
accounts. The
balance sheet for
a partnership is the same as for a proprietorship except in the
owners’ equity section. The capital balances of the partners are
shown in the balance sheet. The owners’ equity section of the balance
sheet for Kingslee Company is enclosed.
 LIQUIDATION OF A
PARTNERSHIP
The liquidation of a partnership terminates the business. In
a liquidation, it is necessary to:
1) sell noncash assets for cash and recognize a gain or loss
on realization
2) allocate gain/loss on realization to the partners based on
their income ratios
3) pay partnership liabilities in cash, and
4) distribute remaining cash to partners on the basis of
their remaining capital balances
Each of the steps:
1) must be performed in sequence- Creditors must be paid
before partners receive any cash distributions and
2) must be recorded by an accounting entry
ACCOUNT BALANCES PRIOR TO
LIQUIDATION
STUDY OBJECTIVE 5

•No capital deficiency

–all partners have credit balances in their capital accounts
•Capital deficiency
–one partner’s capital account has a debit balance
Ace Company is liquidated with these balances
 LIQUIDATION OF A PARTNERSHIP
NO CAPITAL DEFICIENCY

Ace Company partners decide to liquidate. The income ratios are 3:2:1

1. Noncash assets are sold for $75,000.

2. Book value of these assets is $60,000
3. A gain of $15,000 is realized on the sale - The entry is:

75,000
8,000
15,000
18,000
35,000
15,000
 LIQUIDATION OF A PARTNERSHIP
NO CAPITAL DEFICIENCY

2. The gain on realization of $15,000 is allocated to the

partners on their income ratios, which are 3:2:1.
The entry is:

15,000
7,500
5,000
2,500
 LIQUIDATION OF A PARTNERSHIP
NO CAPITAL DEFICIENCY

3. Partnership liabilities consist of Notes Payable $15,000

and Accounts Payable $16,000. Creditors are paid in
full by a cash payment of $31,000. The entry is:

15,000
16,000
31,000
 LEDGER BALANCES
BEFORE DISTRIBUTION OF CASH

4. The remaining cash is distributed to the partners on the basis of

their capital balances. After the entries in the first 3 steps are
posted, all partnership accounts – including Gain on
Realization – will have zero balances except for 4 accounts:
Cash $49,000; R. Arnet, Capital $22,500; P. Carey, Capital
$22,800; and W. Eaton, Capital $3,700 – as shown below:
 LIQUIDATION OF A PARTNERSHIP
CAPITAL DEFICIENCY
A capital deficiency may be caused by 1) recurring net losses, 2) excessive drawings
before liquidation, or 3) losses from realization suffered through liquidation. Ace
Company is on the brink of bankruptcy. The partners decide to liquidate by having a
“going-out-of-business” sale in which 1) merchandise is sold at substantial discounts
and 2) the equipment is sold at auction. Cash proceeds from 1) these sales and 2)
collections from customers total only $42,000. Therefore, the loss from liquidation is
$18,000
1. The entry for the realization of noncash assets is:
($60,000
– 42,000).
The steps in
the 42,000
liquidation 8,000
process are 18,000
as follows: 15,000
18,000
35,000
LIQUIDATION OF A PARTNERSHIP
CAPITAL DEFICIENCY

2. The loss on realization is allocated to the partners on

the basis of their income ratios. The entry is:

9,000
6,000
3,000
18,000
LIQUIDATION OF A PARTNERSHIP
CAPITAL DEFICIENCY

3. Partnership liabilities are paid. The

entry is the same as in the previous
example.

15,000
16,000
31,000
 LEDGER BALANCES
BEFORE DISTRIBUTION OF CASH

4. After posting the 3 entries 2 accounts will have debit balances

– Cash $16,000 and W. Eaton, Capital $1,800 – and 2 accounts
will have credit balances –R. Arnet, Capital $6,000 and P.
Carey, Capital $11,800, as shown below. Eaton has a capital
deficiency of $1,800 and therefore owes the partnership
$1,800. Arnet and Carey have a legally enforceable claim against
Eaton’s personal assets. The distribution of cash is still
made on the basis of capital balances, but the amount will vary
depending on how the deficiency is settled.
 LEDGER BALANCES
AFTER PAYING CAPITAL DEFICIENCY

Partner with the capital deficiency pays the amount owed partnership
Deficiency eliminated.
Eaton pays $1,800 to the partnership, the entry is:

1,800
1,800
LIQUIDATION OF A PARTNERSHIP
CAPITAL DEFICIENCY

The cash balance of $17,800 is now equal to the credit balances in

the capital accounts (Arnet $6,000 + Carey $11,800), and cash is
distributed on the basis of these balances. The entry (shown
below) – once it is posted – will cause all accounts to have zero
balances.

6,000
11,800
17,800
 LEDGER BALANCES AFTER
NONPAYMENT OF CAPITAL
DEFICIENCY
Partner - Capital deficiency unable to pay the amount owed
Partners with credit balances must absorb the loss.
Allocated on the basis of pre-existing ratios of partners with credit balances.
Income ratios of Arnet and Carey are 3/5 and 2/5, respectively.
Entry is made to remove Eaton’s capital deficiency.

1,080
720
1,800

After posting this entry, the cash and capital accounts will have
the following balances:
LIQUIDATION OF A PARTNERSHIP
CAPITAL DEFICIENCY

The cash balance of $16,000 now equals the credit

balances in the capital accounts (Arnet $4,920 + Carey
$11,080). The entry (shown below) – once it is posted –
will cause all accounts to have zero balances.

4,920
11,080
16,000
 APPENDIX

ADMISSION AND
WITHDRAWAL OF PARTNERS
 ADMISSION OF A PARTNER
STUDY OBJECTIVE 6

• The admission of a new partner

– results in legal dissolution of the existing
partnership and the beginning a new one
• To recognize economic effects
– it is necessary only to open a capital account for each
new partner.
• A new partner may be admitted either by:
1) Purchasing the interest of an existing
partner or
2) Investing assets in a partnership.
 PROCEDURES IN ADDING
PARTNERS

I. Purchase of a Partner’s Interest

The admission of a partner by purchase of an interest in the firm is a

personal transaction between one or more existing partners and the
new partner. The price paid is negotiated and determined by the
individuals involved; it may be equal to or different from the capital
equity acquired. Any money or other consideration exchanged is the
personal property of the participants and not the property of the
partnership.
 PROCEDURES IN ADDING
PARTNERS

I. Investment of Assets in Partnership

When a partner is admitted by investment, both the total net

assets and the total partnership capital change. When the new
partner’s investment differs from the capital equity acquired,
the difference is considered a bonus either to: 1) The existing
(old) partners or 2) The new partner.
PROCEDURES IN ADDING
PARTNERS
 LEDGER BALANCES AFTER
PURCHASE OF A PARTNER’S
INTEREST
L. Carson agrees to pay $10,000 each to to C. Ames and D. Barker for
1/3 of their interest in the Ames-Barker partnership. At the time of the
admission of Carson, each partner has a $30,000 capital balance. Both
partners
therefore
give up 10,000
10,000
$10,000 of 20,000
their capital
equity. The
entry to
record the
admission of
Carson is
shown.
 LEDGER BALANCES AFTER
INVESTMENT OF ASSETS

Assume that instead of purchasing an interest, Carson invests $30,000

in cash in the Ames-Barker partnership for a 1/3 capital interest. In
such a case, the entry would be as shown. The effects of this
transaction on the partnership accounts are shown in the t-accounts.

30,000
30,000
 COMPARISON OF PURCHASE OF AN INTEREST
AND ADMISSION BY INVESTMENT

The different effects of the purchase of an interest and admission

by investment are shown in the comparison of net assets and capital
balances. When an interest is purchased, the total net assets and
total capital of the partnership do not change. On the other hand,
when a partner is admitted by investment, both the total net assets
and the total
capital change. For
an admission by
investment, when the new
partner’s investment and
the capital equity acquired
are different, the difference
is considered a bonus to
1) the old
partners or
2) the new partner.
 BONUS TO OLD PARTNERS
Bonus to old partners-new partner’s investment in the firm > capital
credit on the date of admittance.
To determine new partner’s capital credit and the bonus to the old
partners
1) Determine the total capital of the new partnership:
• new partner’s investment + capital of the old partnership.
2) Determine the new partner’s capital credit
multiply the total capital of the new partnership by the new
partner’s ownership interest
3) Determine the amount of bonus:
• subtract the new partner’s capital credit from the new partner’s
investment
4) Allocate the bonus to the old partners on the basis of their
income ratios.
 BONUS TO OLD PARTNERS

Sam Bart and Tom Cohen -total capital of $120,000-Lea Eden is admitted
Lea acquires 25% ownership interest by making a cash investment of
$80,000 in the partnership. To determine Lea’s capital credit and the bonus
to the old partners is as follows:

1. Determine the total capital of the new partnership by adding the new
partner’s investment to the total capital of the old partnership. In this case,
the total capital of the new firm is $200,000, calculated as follows:

2. Determine the new partner’s capital credit by multiplying the

total capital of the new partnership by the new partner’s
ownership interest. Eden’s capital credit is $50,000 ($200,000 X
25%).
 BONUS TO OLD PARTNERS

3. Determine the amount of bonus by subtracting the new

partner’s capital credit from the new partner’s investment. The
bonus in this case is $30,000 ($80,000 – $50,000).
4. Allocate the bonus to the old partners on the basis of their income
ratios. Assuming the ratios are Bart, 60% and Cohen, 40%, the allocation
is: Bart, $18,000 ($30,000 X 60%) and Cohen, $12,000 ($30,000 X 40%).

The entry to record the admission is:

80,000
18,000
12,000
50,000
 BONUS TO NEW
PARTNER

• A bonus to a new partner

– results when the new partner’s investment is
less than his or her capital credit in the firm.
– capital balances of the old partners are
decreased based on their income ratios before
the admission of the new partner.
BONUS
 COMPUTATION OF CAPITAL CREDIT AND
BONUS TO NEW PARTNER

Lea Eden invests $20,000 in cash for a 25% ownership interest in the Bart-Cohen
partnership. The calculations for Eden’s capital credit and the bonus are as follows:

The entry to record the admission of Eden is as follows:

20,000
9,000
6,000
35,000
 WITHDRAWAL OF A
PARTNER
STUDY OBJECTIVE 6

• A partner may withdraw

– voluntarily selling his or her equity
– involuntarily by reaching mandatory retirement age
or by dying
• Withdrawal of a partner
- payment from remaining

partners’ personal assets or

- payment from partnership
assets
 PROCEDURES IN
PARTNERSHIP WITHDRAWAL
PAYMENT FROM PARTNERS’
PERSONAL ASSETS
• The withdrawal of a partner when
payment made from partners’ personal
assets
– is the direct opposite of admitting a new
partner who purchases a partner’s interest
– is a personal transaction between the partners

Partnership
Assets Bye
 LEDGER BALANCES AFTER
PAYMENT FROM PARTNERS’
PERSONAL ASSETS
Anne Morz, Mary Nead, and Jill Odom have capital balances of $25,000,
$15,000, and $10,000, respectively, when Morz and Nead agree to buy out
Odom’s interest. Each of them agrees to pay Odom $8,000 in exchange for
one-half of Odom’s total interest of $10,000. The entry to record the
withdrawal is:

10,000
5,000
5,000

The effect of this entry on the partnership accounts is shown below:

 PAYMENT FROM
PARTNERSHIP ASSETS
Using partnership assets to pay for a withdrawing
partner’s interest decreases both total assets and total
partnership capital.
In accounting for a withdrawal by payment from
partnership assets:
1) asset revaluations should not be recorded and
2) any difference between the amount paid and the
withdrawing partner’s capital balance should be
considered a bonus to the retiring partner or a
bonus to the remaining partners.

Bye
Partnership
Assets
 BONUS TO
RETIRING PARTNER
A bonus may be paid to a retiring partner when:
1 the fair market value of partnership assets is greater
than their book value,
2 there is unrecorded goodwill resulting from the
partnership’s superior earnings record, or
3 the remaining partners are anxious to remove the
partner from the firm.
BONUS
 BONUS TO
RETIRING PARTNER
The bonus is deducted from the remaining partners’ capital balances on the basis of
their income ratios at the time of the withdrawal. Terk retires from the RST
partnership and receives a cash payment of $25,000 from the firm. The procedure
for determining the bonus to the retiring partner and the allocation of the bonus to
the remaining partners is: 1) Determine the amount of the bonus by
subtracting the retiring partner’s capital balance from the cash paid by the
partnership. The bonus in this case is $5,000 ($25,000 – $20,000). 2) Allocate the
bonus to the remaining partners on the basis of their income ratios. The
ratios of Roman and Sand are 3:2, so the allocation of the $5,000 bonus is: Roman
$3,000 ($5,000 X 3/5) and Sand $2,000 ($5,000 X 2/5). The appropriate entry is:

20,000
3,000
2,000
25,000
 BONUS TO
REMAINING PARTNERS
The retiring partner may pay a bonus to the
remaining partners when:
1 recorded assets are overvalued
2 the partnership has a poor earnings record
or
3 the partner is anxious to leave the
partnership
BONUS
 BONUS TO
REMAINING PARTNERS
The bonus is allocated (credited) to the capital balances of the
remaining partners on the basis of their income ratios. Assume that
Terk is paid only $16,000 for her $20,000 equity upon withdrawing
from the RST partnership. In such a case: 1) The bonus to remaining
partners is $4,000 ($20,000 – $16,000). 2) The allocation of the $4,000
bonus is: Roman $2,400 ($4,000 X 3/5) and Sand $1,600 ($4,000 X
2/5). The entry to record the withdrawal is:

20,000
2,400
1,600
16,000
 DEATH OF A PARTNER

• The death of a partner dissolves the partnership.

But provision generally is made for the surviving
partners to continue operations by purchasing the
deceased partner’s equity from their personal assets.

• When a partner dies it is necessary to determine

the partner’s equity at the date of death.
This is done by:
1) determining the net income or loss
for the year to date,
2) closing the books, and
3) preparing financial statements.
 DEATH OF A PARTNER

• The surviving partners will agree to either

1) purchase the deceased partner’s equity
from their personal assets or
2) use partnership assets to settle with the
deceased partners estate.
• In both instances, the entries to record
the withdrawal of the partner are similar
to those earlier.