Advanced accounting 10th by a beams athony ch15

2: Initial InvestmentPartnerships – Formation, Operations, and Changes in Ownership Interests... Initial Investment with BonusTotal fair value received is split, as desired, between part

Chapter 15: Partnerships – Formation, Operations, and Changes in Ownership Interests

by Jeanne M David, Ph.D., Univ of Detroit Mercy

to accompany

Advanced Accounting, 10 th edition

by Floyd A Beams, Robin P Clement, Joseph H Anthony, and Suzanne Lowensohn

3 Grasp the diverse nature of profit and loss

sharing agreements and their computation.

4 Value a new partner's investment in an existing

partnership.

1: Characteristics of Partnerships

Partnerships – Formation, Operations, and Changes in Ownership Interests

RUPA "Revised Uniform Partnership Act"

– Entity theory:

• partners own their share of the partnership,

but not its individual assets

Articles of Partnership

1 Products or services, line of business

2 Partner rights & responsibilities

3 Initial investment and value assigned to

2: Initial Investment

Partnerships – Formation, Operations, and Changes in Ownership Interests

Initial Investment

A partnership is started by Amy and Paul, each

investing cash.

If they invest other assets, the value of those assets

should be agreed upon in advance.

Initial Investment with Bonus or

Initial Investment with Bonus

Total fair value received is split, as desired, between partners

Cola invests land and building worth $10 and $40 Crown invests cash and inventory at $7 and $35.

Agree to have equal shares:

Initial Investment with Goodwill

If Cola and Crown agree to equal shares, use

larger implied total value of firm.

Cola's: (10 + 40) / 50% = $100

Crown's: (7 + 35) / 50% = $84

Implied value of firm $100

Initial Entry with Goodwill

Partner Accounts

Each partner has his/her own accounts for

– Capital

– Drawings (periodic, salary-like, amounts)

– Withdrawals (other, large, unusual amounts)

• Investments increase Capital

• Drawings and withdrawals are closed to Capital

• Income Summary or Revenue and Expense

Summary is closed to Capital.

Sample Partner Closing Entries

Statement of Partners' Capital

Beginning capital + investments – drawings and/or withdrawals

3: Sharing Profit and Loss

Partnerships – Formation, Operations, and Changes in Ownership Interests

Profit/ Loss Sharing Agreements

The partnership articles should clearly state the means of distributing profits and distributing losses.

Items commonly considered

– Bonus allowance

– Salary allowance

– Interest allowance on capital invested

• Based on average, beginning or ending

capital balance

– Sharing of remaining amounts

Bonus and Salary Allowances

Bonus allowances are often based on partnership profits and may be before or after:

(a) salary allowances and (b) bonus.

If the bonus is after both:

Bonus = b% x (NI – Salary Allow – Bonus)

Salary allowances are generally pre-determined amounts

Interest Allowances and Capital

Interest Allowances are generally based on a

measure of the partner's capital

– Beginning of the year capital balance

– Average* capital balance for the year

Weighted average balance

– Ending* capital balance

Beginning balance – withdrawals + investments

* Periodic drawings are often ignored, although withdrawals are considered

Allocating Income

Partner's allowances for bonus, salary and

interest are allocated to them, whether or not sufficient profits exist.

Remaining profits (or deficit) is then split

according to the agreed-upon proportions.

These are general procedures The partnership

articles provide the specific requirements.

Example: Sharing Profits

Tom and Betty agree to share profits and losses:

• Tom and Betty have $60 and $30 salary allowances

• Betty has a bonus of 50% of profits in excess of $500

• Each have interest allowances of 10% of beginning

Share Profits of $180

Assume instead that income was only $180.

Bonus = zero, income does not exceed threshold

4: Admitting a New Partner

Partnerships – Formation, Operations, and Changes in Ownership Interests

Admitting a New Partner

1 A current partner assigns interest to new

Buy from Partner: Simple

Alfano and Bailey have capital balances of $50

each and each have a 50% interest in the firm Cobb buys half of Alfano's interest for $25.

Buy from Partner: Goodwill

Don and Ed have capital of $50 and $40 with each 50% interest.

Fay will pay $60 directly to the partners and receive

50% interest in the firm Don and Ed each keep

25% Assets are at fair value.

The goodwill increases Don & Ed's capital each by $15.

Implied value of firm, $60/.50 120 Old capital, $50 + 40 90

Goodwill Revalues Capital

Presumably, Fay paid $35 to Don and $25 to Ed.

If the partners had not wanted to realign the

capital, the capital of Don and Ed would each

be reduced by $30 to transfer the $60 to Fay.

Before Revaluation revaluation Transfer FinalAfter

Buy from Partner: Bonus

If Don and Ed had decided not to revalue the assets

or record goodwill, the bonus method is used.

Entries for Purchase from Partner

Entries for Fay's admission, under goodwill and bonus methods:

Invest in Business: Goodwill

Andrew and Boyles have capital balances of $40 and $40 and share equally in the firm.

Criner will be admitted with an investment of $50 cash All three will have equal shares Net assets are at fair value; goodwill will be recorded.

Implied value of firm, $50/(1/3) $150

Criner: $130*1/3 = $43.3, but he pays $50 … so

goodwill goes to old partners.

Implied firm value is based on Criner's investment.

Investment and Goodwill Add to

Capital (Goodwill to Old Partners)

Capital of $80 at the start, increases by the $20

goodwill and the $50 cash investment.

Before Revalu-ation After re-valuation Investment Final

Invest in Business: Goodwill

Andrew and Boyles have capital balances of $40 and $40 and share equally in the firm.

Criner will be admitted with an investment of $50 cash Criner will be given a 40% share; Andrew and Boyles will each have 30% Net assets are at fair value; goodwill will be recorded.

Criner: $130*40% = $52, but he pays $50 … so goodwill

goes to new partner

Implied firm value is based on old partners' capital and

retained interest.

Investment and Goodwill Add to

Capital (Goodwill to New Partner)

Capital of $80 at the start, increases by the $3.3 goodwill and the $50 cash investment.

Before Revalu-ation After re-valuation Investment Final

Invest in Business: Bonus

Andrew and Boyles decide not to revalue the business

assets, and Criner invests $50 cash in the business for a 1/3 interest.

Criner's new capital = 1/3 of the total $130 Since he

invests on $50 cash for a $52 interest, the $2 bonus is transferred from the old partners

Before Investment Bonus Final

Entries for Investment in Business

Entries for Criner's investment, under goodwill and bonus methods:

5: Death or Retirement of a Partner

Partnerships – Formation, Operations, and Changes in Ownership Interests

Payment to exiting partner is

– Equal to existing capital

– More than existing capital

• Implied goodwill or bonus to exiting partner

– Less than existing capital

• Write down overvalued assets, or bonus to remaining

partners

6: Limited Liability Partnership

Partnerships – Formation, Operations, and Changes in Ownership Interests

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