weygandt. kieso. kimmel. trenholm. kinnear. barlow. atkins principles of financial accounting...

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WEYGANDT . KIESO . KIMMEL . TRENHOLM . KINNEAR . BARLOW . ATKINS

PRINCIPLES OF FINANCIAL ACCOUNTING

CANADIAN EDITION

Chapter 12Accounting for Partnerships

Prepared by:

Debbie MusilKwantlen Polytechnic University

Copyright John Wiley & Sons Canada, Ltd. 2

• Partnership form of organization– Characteristics– Advantages and disadvantages– Partnership agreement

• Basic partnership accounting– Forming a partnership– Dividing partnership profit or loss– Partnership financial statements

• Admission and withdrawal of partners• Liquidation of a partnership– With or without a capital deficiency

Accounting for Partnerships


Chapter 12: Accounting for Partnerships

Study Objectives

1. Describe the characteristics of the partnership form of business organization.

2. Account for the formation of a partnership.3. Allocate and record profit or loss to partners.4. Prepare partnership financial statements.5. Account for the admission of a partner.6. Account for the withdrawal of a partner.7. Account for the liquidation of a partnership.


Characteristics of Partnerships


• Association of individuals– Usually based on a written agreement– A legal and accounting entity, but not taxed

• Co-ownership of property– Assets are jointly owned by partners

• Division of profit– Partners determine how profit or loss is to be

divided– Otherwise shared equally

• Limited life– Partnership ends when change in ownership– New partnership can be formed to continue

business

Characteristics of Partnerships 2


• Mutual agency– Each partner acts for (binds) the partnership

• Unlimited liability– Each partner is liable for all partnership liabilities– Special types of partnerships created to limit liability

• Limited partnership (LP)• Limited liability partnership (LLP)

Characteristics of Partnerships 3


• Written contract between two or more parties to form a partnership

• Contains basic information:– Name and location of firm– Purpose of the business– Date of inception (formation)

• Specifies relationship of partners:– Names and capital contributions of partners– Rights and duties of partners– Basis for sharing profit or loss– Procedures for admission, withdrawal, death of

partner, resolving disputes, liquidation of partnership

Partnership Agreement


• Many partnerships are private and therefore follow ASPE

• Limited Partnerships are often public enterprises and therefore follow IFRS

• International partnerships must also follow IFRS

Basic Partnership Accounting:ASPE Versus IFRS





Study Objectives


• Partner’s initial investment is recorded at fair value of assets contributed– As at date of transfer into partnership

• Values assigned are agreed to by all partners

• After partnership formed, accounting for transactions is similar to other types of business organizations

Basic Partnership Accounting:Forming a Partnership





Study Objectives


• Partnership profit/loss is shared equally– Unless partnership agreement indicates

otherwise• The same basis of division applies to

profit and losses– Called the profit ratio or profit and loss

ratio• Each partners’ share of profit or loss is

recognized through closing entries

Basic Partnership Accounting:Dividing Profit or Loss


• Four closing entries for partnership:1. Close revenue accounts to income summary2. Close expense accounts to income summary3. Close income summary to partners’ capital

accounts• If profit:

Dr. Income summary (= total profit)Cr. Each partner’s capital account (= their

share)• If loss:

Dr. Each partner’s capital account (= their share of loss)

Cr. Income summary (= total loss)4. Close each partner’s drawings account to their

respective capital accounts

Partnership Accounting:Closing Entries


• Typical ratios used to share profit or loss:– Fixed ratio: a proportion (2:1), percentage (67%)

or fraction (2/3)– A ratio based on capital balances at beginning or

end of year or on average capital balances during the year

– Salaries to partners and the remainder in a fixed ratio

– Interest on partners’ capital balances, remainder in a fixed ratio

– Salaries to partners, interest on partners’ capital balances, remainder in a fixed ratio

Partnership Accounting:Profit and Loss Ratios


• Salaries and interest:– Are allocated first even if greater than profit or if

partnership incurred a loss for the year– Are NOT expenses of the partnership – only

used to divide profit or loss among the partners– Are NOT distributions of cash (or other assets) –

drawings by partners are distributions• Partners are neither employees or

creditors

Partnership Accounting:Profit and Loss Ratios 2





Study Objectives


• The equity statement for a partnership is the statement of partners' equity

• Explains changes in each partner’s individual capital account and total partnership equity during the year

Partnership Financial Statements:Statement of Partners’ Equity


• Capital balances of each partner are shown on the balance sheet in section called partners’ equity:

Partnership Financial Statements:Balance Sheet





Study Objectives


• Causes the legal dissolution of the existing partnership and the beginning of a new partnership

• A new partner may be admitted either by:– Purchasing all or part of the interest of

one or more existing partners– Investing assets in the partnership

Admission of a Partner


• A personal transaction between one or more existing partners and the new partner – Consideration exchanged is personal property of

the partners involved and not property of the partnership

• In the partnership, only the transfer of the partnership interest is recorded:– Existing partners’ equity is decreased by the

amount of equity given to the new partner– New partner’s equity is increased by same

amount

Admission of a Partner:Purchase of a Partner’s Interest


Admission of a Partner:Investment of Assets in

Partnership• A transaction between the new partner and

the partnership:– Partnership receives assets from new partner in

exchange for an interest in the partnership• Both net assets and total partners’ equity of

the partnership will increase• Complications occur when new partner’s

investment differs from the capital equity acquired:– The difference is considered a bonus either to

the existing (old) partners or to the new partner


Admission of a Partner:Bonus to Existing (Old) Partners

• Bonus to old partners may be necessary:– Fair value of partnership assets may be

greater than their carrying value– Unrecognized good will may exist

• Bonus to old partners occurs when:– New partner’s investment > capital credit

on the date of admission to partnership– Amount of bonus = difference


• Bonus to new partner may be necessary:– New partner has resources or attributes that the

partnership wants (cash, expertise)– Carrying amount of partnership assets is greater

than their fair value

• Bonus to new partner occurs when:– New partner’s investment < capital credit on the

date of admission to partnership– Amount of bonus = difference

Admission of a Partner:Bonus to New Partner


1. Determine the total capital of partnership= Capital of old partnership + new partner’s investment

2. Determine new partner’s capital credit= Total capital determined above × new partner’s ownership

interest3. Determine the amount of the bonus

= New partner’s investment ± new partner’s capital credit• If investment > capital credit: bonus to new partner• If investment < capital credit: bonus to old partners

4. Allocate the bonus to/from old partners– Based on profit ratios of old partners

Admission of a Partner:Determining Amount of Bonus


• Old partners’ capital balance = $120,000Peart $72,000 and Sampson $48,000

• Old partners’ profit ratios:Peart 60% and Sampson 40%

• Trent purchases 25% share:Scenario 1: for $80,000Scenario 2: for $20,000

Admission of a Partner:Example Calculation of Bonus


1. Total capital of new partnership: $120,000 + $80,000 = $200,000

2. New partner’s capital credit:$200,000 × 25% = $50,000

3. Amount of bonus to old partners: $80,000 − $50,000 = $30,000

4. Allocation of bonus to old partners:To Peart: $30,000 × 60% = $18,000To Sampson: $30,000 × 40% = $12,000

Admission of a Partner:Bonus Calculation – Scenario 1


1. Total capital of new partnership: $120,000 + $20,000 = $140,000

2. New partner’s capital credit:$140,000 × 25% = $35,000

3. Amount of bonus to new partner: $20,000 − $35,000 = $(15,000)

4. Allocate bonus from old partners:From Peart: $15,000 × 60% = $9,000From Sampson: $15,000 × 40% = $6,000

Admission of a Partner:Bonus Calculation – Scenario 2





Study Objectives


• Voluntary withdrawal: Partner sells their equity in the firm

• Involuntary withdrawal: Partner reaches mandatory retirement age, dies or is expelled

• Withdrawal may be accomplished by:– Payment from remaining partners’

personal assets– Payment from partnership assets

Withdrawal of a Partner


• A personal transaction between partners – Payment is from remaining partners’ personal

assets– Partnership assets are not involved and total

capital of partnership does not change

• In the partnership, only the transfer of the partnership interest is recorded:– Departing partner’s equity is eliminated– Remaining partners’ equity increased by same

amount– Amount is split between remaining parties on

same basis as they paid departing party

Withdrawal of a Partner:Payment from Partners’ Personal Assets


• A transaction between the withdrawing partner and the partnership:– Partnership pays assets in exchange for the

withdrawing partner’s interest in the partnership

• Both net assets and total partners’ equity of the partnership will decrease

• Complications occur when amount paid differs from withdrawing partner’s capital balance:– The difference is considered a bonus either to the

departing partner or to the remaining partners

Withdrawal of a Partner:Payment from Partnership Assets


• Bonus to withdrawing partner may be necessary:– Fair value of partnership assets may be greater

than their carrying amount– Goodwill may exist that has not been recorded– Remaining partners wish to remove partner

from firm• Bonus to withdrawing partner occurs when:

– Payment to departing partner > departing partner’s capital balance on the date of departure

– Amount of bonus = difference

Withdrawal of a Partner:Bonus to Withdrawing Partner


• Bonus to remaining partners may be necessary:– Recorded assets are overvalued– Partnership has a poor earnings record– Partner wishes to leave partnership

• Bonus to remaining partners occurs when:– Payment to departing partner < departing

partner’s capital balance on departure date

– Amount of bonus = difference

Withdrawal of a Partner:Bonus to Remaining Partners


Withdrawal of a Partner:Determining Amount of Bonus

1. Determine the amount of the bonus= Payment from partnership to departing partner ±

departing partner’s capital balance• If payment > capital balance: bonus to departing

partner• If payment < capital balance: bonus to remaining

partners

2. Allocate payment of bonus to remaining partners based on their profit ratios– Amount allocated to each remaining partner =

bonus × profit ratio for each partner


• Partners’ capital balance:Roman $50,000Sand $30,000 Terk $20,000

• Partners’ profit ratio:Roman, Sand, Terk: 3:2:1

• Terk retires and is paid:Scenario 1: $25,000Scenario 2: $16,000

Withdrawal of a Partner:Example Calculation of Bonus


Scenario 1:1. Amount of bonus:

$25,000 - $20,000 = $5,0002. Allocate payment of bonus by remaining

partners:From Roman: $5,000 × 3/5 = $3,000From Sand: $5,000 × 2/5 = $2,000

Scenario 2:1. Amount of bonus:

$16,000 − $20,000 = $(4,000)2. Allocate payment of bonus to remaining

partners:To Roman: $4,000 × 3/5 = $2,400To Sand: $4,000 × 2/5 = $1,600

Withdrawal of a Partner:Bonus Calculation





Study Objectives


• Liquidation ends the business• Steps in liquidating a partnership:

1. Sell non-cash assets for cash2. Allocate any gain or loss from sale to

partners’ capital accounts based on profit and loss ratios

3. Pay partnership liabilities4. Distribute remaining cash to partners

based on their capital balances (not their profit ratios)

Liquidation of a Partnership


• Capital deficiency: if one or more partners’ capital account is in a debit balance

• If no capital deficiency:– Remaining cash after all assets sold and

liabilities paid is distributed to partner– Distribution is based on partners’ capital

balances• Since this is the final distribution to partners

all accounts will have zero balances afterwards

Liquidation of a Partnership:No Capital Deficiency


• Capital deficiency may be caused by:– Recurring losses– Excessive drawings by one or more partners– Losses from sale of assets during liquidation

• Partners having a capital deficiency immediately before final distribution:– May or may not be able to pay the deficiency

from personal funds– This will affect the amount of funds available for

distribution to other partners

Liquidation of Partnership:Capital Deficiency


• Partnership has a legally enforceable claim against partners with a capital deficiency

• If partner repays deficiency to partnership:– Amount repaid is added to cash available

for distribution– Total cash after repayment is distributed

to partners with credit balances in their capital accounts

Liquidation of Partnership:Payment of Capital Deficiency


• If partner does not repay deficiency to partnership:– Amount of deficiency is considered a loss– Loss is allocated between partners with

credit balances based on their profit ratios

– Allocation of loss will affect remaining partners capital accounts

– Final distribution of remaining cash is to partners with credit balances in capital accounts

Liquidation of Partnership:Nonpayment of Deficiency


Copyright

Copyright © 2014 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.

weygandt. kieso. kimmel. trenholm. kinnear. barlow. atkins principles of financial accounting...

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