Partnership Formation

Capital Balance of partner

AT THE DATE OF FORMATION

Non-cash: should be based FV; Cash received if sold

Liabilities assumed: Present Values
Building subject to mortgage loan (assumed by the partnership):
*Deduct on total capital balances of all the partners if asked "Total Amount Contributed by Partners in the Partnership
*Deduct on total capital balance of the partners if asked "Total Amount Contributed by PARTICULAR Partner in the Partnership
*Not deducted if the problem state that MORTGAGE LOAN is not assumed by the partnership.
Partner's Agreement as to adjustment on their balance sheet:
*Capital Account Given: Adjust directly to the capital account to get the adjusted capital balances
*Asset & Liabilities Given: First, get the difference of Asset & liab to get the capital balances then adjustment followed
Partners must invest to bring the partners capital balances proportionate to P & L:
*Get other partners adjusted capital balances and divide it to his P & L ratio such as:
Other partners = Partners Total Capital Balances
40%
Partnership Profit & Loss
Partnership Share in Profit & Loss: If the Partners agree to distribute profits based on profit sharing ratio but are sillent on loss sharing
partnership losses will be divided based on the agreed profit sharing proportions.
Profit & Loss Ratio - ratio in which partnership profits & losses are divided.
>divided in accordance with the agreement of the partners, In the absence of any agreement, profits and losses are divided in accordance
the partner's contributed capital.

Partners Total Capital Balances X Specific Partners P&L ratio (Asked) = Partners Cap Balances proportionate to P& L ratio

Partners Cap Balance proportionate to P& L ratio - Current Adjusted Capital balance of Specific Partner = Amount to be added to Specific
Partner

* Interest of P1,124 are accrued on the notes payable = meaning additional liability under Interest Payable
1.Interest Ratio is not given - Net Investment Method
Total Contributed Capital = Total Agreed Capital
A B Total
Asset 100 200 300
Liabilities 20 10 30
Net Asset 80 190 270

TAC TCC Difference (Bonus)

same A 80 80

same B 190 190

270 270
JE:
Asset 300
 Liabilities 30
A, Capital 80
B, Capital 190

2. Bonus Method
*Recording will be based on TAC
*If TAC < TCC -------> Partner WHO PROVIDE bonus
*If TAC > TCC -------> Partner WHO TAKE bonus

GOODWILL METHOD
The capital credit of the NEW PARTNER should be the same with the OLD PARTNER thus increasing the TAC more than the TCC
TCC TAC Total
Aimee 60 60 -
Ronald 20 60 40
Total 80 120 40
BONUS METHOD
The capital credit of the NEW PARTNER should be the same with the OLD PARTNER HOWEVER total TAC is the same as TCC
TCC TAC Total
Aimee 60 40 (20)
Ronald 20 40 20
Total 80 80 -
*Under the bonus meth od, assets are not revalued, instead adjustments are made to partnership capital accounts, unidentifiable assets a
not recognized.

Computation for depreciable asset when FMV is not given:

Contri. Of Partners with complete asset valuation Pxxx

Net Adjustment to FV xxx
Total xxx
Multiply by contribution ratio 5/4 (5-complete / 4 - partners not given)
FV of other partner xxx (representing total contribution)
Less: other partner contri (xxx)
FV of Fixed Asset by other Partner - Not complete xxx
FV of Fixed Asset of Partner - Complete xxx
Total Depreciable Asset xxx

Partners Contribution Ratio = Total Contributed Contribution

Interest Ratio/Capital Credits = Total Agreed Contribution

FAIR MARKET VALUES MEANS

Cash Selling Price of the asset
Second hand value of the asset
Cash Transaction of the same/similar asset
Quoted Market prices & independent appraisals

As a general guideline, what is to be recorded as a credit to partner's capital is the fair value of the net assets contributed.

Admission of New Partner

Problem Scenario 1: New Partner offered to join for a 20% interest in the firm. How much cash should he contribute?

TCC of OLD PARTNER/Agreed Remaining Interest (basis 100%) 1,621,910

100%-20%=80% [(614,476 + 683,052)/80%]
Agreed Interest of NEW PARTNER X 20%
Cash to be contributed by NEW PARTNER 324,382

Follow up question:
After NEW PARTNER's admission, the P & L sharing ratio was agreed to be 40:40:20 based on capital credits. How much should
the cash settlement be between OLD PARTNER

Cash Settlement means amounts to be contributed between OLD PARTNER in order to align with the agreed capital credits.
*bayaran between sa kanila
OLD PARTNER1 OLD PARTNER2
Capital Bals after New Partner's Admission 614, 476 683,052
NEW capital ratio @ 40% each (1,621,910) 648,764 648,764
Cash Settlement bet OLD PARTNER's 34,288 (34,388)

Parnership Operation
Profit & Loss Agreement, Total number of shares subscribed
No P & L Agreement = Divided equally
Interest - Net Profit, Net Loss, Assumed to be per annum basis
Bonus - If result of operation is Profit, not given, in the event of loss
Bonus is computed if:
NI > S + I Compute
NI = S + I NIL

1. Allocation of Net Income

Net Income: 572,000
Schedule of Allocation
Aimee Ronald Total
Salaries 72,000 72,000 144,000
Interest 66,750 45,000 111,750
Bonus 28,750 0 28,750
Balance Figure 172,500 115,000 287,500
Total 340,000 232,000 572,000

*Salaries
Given: Salaries of 6,000 per month to each partner
6,000 x 12 = 72,000

*Interest
Given: Interest of 6% is allowed on the average capital balance

a. Compute the Partners Average Capital Balance

Aimee 900,000 x 1/12 = 75,000 On Jan 1 contributing cash of 900,000 (Jan-Feb = 1 month)
1,200,000 x 6/12 = 600,000 On Feb 1 contributed additional cash of 300,000 (Feb-Jul = 6 months)
1,050,000 x 5/12 = 437,500 On Aug 1 has permanent withdrawal (Jul-Dec = 5 months)
1,112500 x 6% = 66,750

Ronald 600,000 x 4/12 = 200,000 On Jan 1 contributing cash of 600,000 (Jan-May = 4 months)
800,000 x 6/12 = 400,000 On Feb 1 contributed machinery of 200,000 (May-Oct = 6 months)
900,000 x 2/12 = 150,000 On Aug 1 has permanent withdrawal (Nov-Dec = 2 months)
750,000 x 6% = 45,000

*Bonus
Given: Bonus to Aimee of 10% of net income after partners salaries, interest and bonus
= 10% (NI - S-I-B)
= 10% (572,000 - 144,000 - 111,750 - B)
= 10% (316,250 - B)
= 31,625 - .10B
= 1.10B = 31,625
= 31,625 / 1.10 = 28,750

*Balance Figure
Given: Balance to be divided in the ratio of 6:4 to Aimee and Ronald respectively

2. Statement of Partners Capital Balances

Aimee Ronald Total
Initial Capital 900,000 600,000 1,500,000
Additional Invsmt 300,000 300,000 600,000
Permanent Withdrawal (150,000) - (150,000)
Temporary Drawings (24,000) (24,000) (48,000)
Subtotals 1,026,000 876,000 1,902,000
Share of NI 340,000 232,000 572,000
Ending Capital 1,366,000 1,108,000 2,474,000

Additional: Assuming that partners have decided to report partners' interest and salaries as OPERATING EXP
in the Income Statement and modified its P&L agreement as follows:
a. Bonus to Aimee of 10% of Net Income AFTER BONUS
b. Balance to be divided in the ratio of 6:4 to Aimee and Ronald respectively

Aimee Ronald Total

Initial Capital 900,000 600,000 1,500,000
Additional Invsmt 300,000 300,000 600,000
Aimee Ronald Total
Initial Capital 900,000 600,000 1,500,000
Additional Invsmt 300,000 300,000 600,000
Permanent Withdrawal (150,000) - (150,000)
Temporary Drawings (24,000) (24,000) (48,000)
Subtotals 1,026,000 876,000 1,902,000
Share of NI 201,250 115,000 316,250
Ending Capital 1,366,000 1,108,000 2,474,000
Schedule of Allocation
Aimee Ronald Total
Bonus 28,750 0 28,750
Balance Figure 172,500 115,000 287,500
Total 201,250 115,000 316,250

NI = 572,000 = 111,750 - 144,000

Partners Dissolution
1. Admission of a New Partner
a. Purchase of Interest - More than Book Value (Others: at BV, less than BV)
Given: Lilia purchases 1 /3 interest from the old partners paying 97,500 (vs. 90,000 = Julia 180 + Karla 90/3

Julia Karla Lilia Total

Opening Balance 180,000 90,000 - 270,000
Purchase of Interest (60,000) (30,000) 90,000 -
Ending Cap Bal. 120,000 60,000 90,000 270,000

Computation of Gain:

Julia Karla Total

Book Value 60,000 30,000 90,000
Gain 4,500 3,000 7,500
64,500 33,000 97,500 Amount Paid

2. Admission by Investment of additional Asset

a. No Bonus recognized
Given: Lilia invests P 90,000 for 1/4 interest in the partnership

IR Partners TAC TCC DIFF

3/4 Julia 180,000 180,000 -
Karla 90,000 90,000 -
1/4 Lilia 90,000 90,000 -
Total 360,000 360,000

JE:
Cash 90,000
Lilia, Capital 90,000

b. Bonus granted to OLD partners

Given: Lilia invests P 100,000 for 1/4 interest in the partnership

IR Partners TAC TCC DIFF

3/4 Julia 184,500 180,000 4,500
Karla 93,500 90,000 3,000
1/4 Lilia 92,500 100,000 (7500)
Total 370,000 370,000

First: Compute the share of the new partner using the agreed rate
Second: Get the difference of TAC and TCC, any diff will represent Bonus to be allocated based on old partners P & L ratio
JE:
Cash 100,000
Julia, Capital 4,500
Karla, Capital 3,000
Lilia, Capital 92,500

c. Bonus granted to NEW partners

Given: Lilia invests P 80,000 for a 1/4 interest in equity

IR Partners TAC TCC DIFF

3/4 Julia 175,500 180,000 (4,500)
Karla 87,000 90,000 (3,500)
1/4 Lilia 87,500 80,000 7500
Total 350,000 350,000

3. Partners Withdrawal
*Certain Asset is to be taken by the retiring partners and a note for the interest balance
a. The amount of the asset should always on its FV.
Carrying Amount - FV = Basis for sharing (reduction on capital bals.)
b. Computation of the amount that will get by the retiring partner:
Current Capital Bal (Retiring Partner) - Share on the adj. On FV of asset acquired - FV of the asset received

4. Incorporation of a Partnership

Partnership Liquidation
1. Lump sum Distribution
a. Deficient Partne(s) are solvent

Distribution of cash
2. Installment Distribution

Asset Contribution Adjustment

Deduction: A/R uncollectibles, Inventories worthless, Asset written off, under depreciated asset, Expenses not recorded (Accrued Expense
Net (Debit)Credit adjustment - referring to capital account
Total liabilities of partners = Unadjusted Liabilities - Accrued Expense
Total Asset of partners = Unadjusted Asset - or + Adjustments excluding Accrued Expense
Total Partnership Income after deducting Salaries and Interest:
AA RR Total
Salaries 60,000 30,000 90,000
Interest 30,000 12,000 42,000
Bal of residual profit 60,000 150,000 60,000 / 40%
..............................................................282,000

Partnership Net Income (loss):

Sales
Less: Cost of Good Sold
Operating Expense
Interest Expense (paid to bank)
Note: Salary allocation to partners (P & L sharing plan) & Partner's withdrawal NOT INCLUDED

Computation of Net Income after salaries and bonus formula:

Bonus = 10% (NI-Salaries-Bonus)
15,000 = .10 [NI -(100,000 + 25,000) - 15,000]
15,000 = .10 [NI- 140,000]
15,000 = .10 NI -14,000
29,000/.1 = NI
NI = 290,000

1. Compute first the difference between the alternative salaries = placed under bonus
2. If the other partners will received a bonus: include this in the amt of bonus

Partner's Net Income Allocation: Net Income 500,000 before any allocation
First, XX to receive 10% of net income up to 200,000 and 20% over 200,000:
200,000 x 10% =20,000 ; 300,000 x 20% = 60,000
Second, YY and ZZ each are to receive 5% of the remaining income over 300,000
500,000 - 20,000 - 60,000 - 300,000 =120,000 ; 120,000 x 5% = 6,000 each
The balance of income is to be allocated equally among the three partners
500,000 - 20,000 - 60,000 - 6,000 - 6,000 =408,000 ; 408,000 / 3 =136,000
Amount to be allocated to XX: 20,000 + 60,000 + 136,000 = 216,000

Weighted Average Capital:

Details: Balance, January 1 420,000
Additional Investment, July 1 120,000
Withdrawal, August 1 (45,000)
 Balance, December 31 495,000

Computation
January 1 - July 1: 420,000 x 6 months = 2,520,000
July 1 - August 1 : 540,000 x 1 months = 540,000
August 1 - December 1: 495,000 x 6 months = 2,475,000

....................................................................5,535,000
Divide by 12 months
......................................................................461,250
Multiply by: Interest rate per year 10%
Amount of interest per year 46,125

Partner's Capital Account Change: Partnership sustained a 99,000 loss before interest and salaries to partners

AA BB CC TOTAL
Interest on Ave. Capital
AA: 360,000 x 10% 36,000
BB: 180,000 X 10% 18,000
CC: 120,000 X 10% 12,000 66,000
Salaries 90,000 60,000 150,000
Balance or Residual Equity (105,000) (105,000) (105,000) (315,000) SQUEEZE
Increase (Decrease) 21,000 (87,000) (3,000) (99,000) ---GIVEN (net loss)
Partner's Interest_Weighted Average (Average Capitals)

Partnership agreement provides that interest at 10% per year is to be credited to each partner on the basis of weighted-average
capital balances. A summary of Simm's capital acct for the year-ended December 31, 2014 is as follows:

Balance, January 1 140,000

Additional Investment, July 1 40,000

Withdrawal, August 1 (15,000)
Balance, December 31 165,000

Partner's Capital Balance_Weighted Average

Partner contributed P50,000 of capital into existing partnership on March 1, 2014, said partner contributed another P20,000. On Sept
1, 2014, he withdrew of P15,000 from the partnership. Withdrawal in excess of P10,000 are charged to partner's capital account

Partnership agreement should provide how invested capital is to be determined. Since each partner's equity is a combination of
capital and drawing account balances, partner's drawings may be offset against their respective capital account for purposes of
allocating income based on invested capital
However an agreement may also provide that only withdrawals more than a certail limit are to be viewed as offset against capital
balances.
P7
P8
P11
P12
P13
P15

P17

P19

P20
P21
General Theory:

Profits might be divided in one of the ff ways/component of formula used to

distribute income.

1. According to ratio - the remainder divided according to the P & l sharing ratio.
2. According to the capital investment of the partner - interest on the average
capital investment

3. According to the labor (or service) rendered by the partners - Salary allocation to
those partners working

*Interest on notes to partner - is a legitimate expense of a partnership

Legitimate Expense of Partnership

1. Salaries for management hired to run the business
2. Depreciation on assets contributed to the partnership by partners
3. Supplies uses in the partner's office
1. The rank order of payments as specified by the Uniform Partnership Act:
Payments to other creditors are ranked ahead of payments to partners with loans to the partnership.
2. Accounting for a deficit balance in a partners capital account during partnership liquidation

If a partner with a negative capital balance is personally insolvent, the negative capital balance may be absorbed by those
partners having a positive capital balance according to the residual profit and loss sharing ratios that apply to those partners
having positive balances.
3. A partnership dissolution differs from a liquidation in that
Payments are made to creditors before partners receive value.
4. Partnership in liquidation has converted all assets into cash and paid all liabilities. According to the Uniform Partnership Act, the order of
payment
Will have amounts owed by partners other than for capital and profits take precedence over amounts due to partners with
respect to their capital accounts.
5. In partnership liquidation, partner salary allocations are disregarded.
6. A simple partnership liquidation requires
Partnership assets to be converted into cash with full payment made to all outside creditors before remaining cash is
distributed to partners in a lump sum payment.
7. In a simple partnership liquidation, the last remaining cash distribution should be made according to the ratio of
the individual partners profit and loss agreement.
8. If conditions produce a debit balance in a partners capital account when liquidation losses are allocated
The partner has an obligation of personal net assets to the other partners.

Partnership Liquidation

1. Book value of the partnership equity

(+)A, Capital
(+)B, Capital
(+)A, Loan Payable
(-)A, Loan Receivable
2. Cash available for distribution to the partners
(+)Cash available as beginning balance
(+)Cash collected from A/R
(+)Non cash asset realized (SOLD)
(-)Liabilities (A/P, N/P)
(-)Contingent Expenses set aside
3. Partner receive from the cash that is available for distribution.

Equities - represents partner capital

 *Partner with Loan receivable should deduct the amount of the loan receivable to reflect the amount of equities
*Partner with Loan Payable should add the amount of the loan payable to reflect the amount of equities
Inventory Loss -represents unsold portion of the realized asset
Contingency Fund - Expenses set aside for contingent expense
Possible Losses on Remaining Asset - Unsold/unrealized Asset
Eliminate Partners Deficit - Partners with Negative balance value should be absorbed by Partners with positive balances according to P&L ratio.

Case 1: One of the partner may sometimes accept certain amount to the asset as deduction solely to his capital
The balance of the asset accepted by the partner should be allocated among partners including the partner who accepts it.

Case 2: The partners agree to liquidate the business and distribute cash when it becomes available. A cash distribution plan for the Lang,
Maas, and Neal partnership will show that cash available, after outside creditors are paid, will initially go to whose Partner:
First: Prepare the vulnerability ranks:
Lang equity ($70,000 - $40,000)/.25 = $120,000 = 1
Maas equity ($80,000 + $50,0000/.25 = $520,000 = 3
Neal equity ($150,000/.5) = $300,000 = 2

4. In a schedule of assumed loss absorptions

The most weak/vulnerable partner is eliminated first.

5. Under the rule of offset, the proper disposition of a partnership loan that was made from a partner who has a debit balance
The loan is written off as a partnership loss if the partner does not have the cash to cover the debit balance.

6. In partnership liquidations, what are safe payments

The amounts of distributions that can be made to the partners with assurance that such amounts will not have to be returned
to the partnership.
7. If all partners are included in the first installment of an installment liquidation, then in future installments
Cash will be distributed according to the residual profit and loss sharing ratio.

8. Partner considered the most weak/vulnerable as a result of a computation of vulnerability rankings will be the partner with the lowest
vulnerability ranking, who also has the lowest loss absorption potential

9. The rank order is for claims against a bankrupt partner of

I.Those owing to separate creditors
II.Those owing to partnership creditors
III. Those owing to partners by way of contribution

10. Determine how the available cash on January 31, 2006 will be distributed - Cash Distribution Plan
ording to P&L ratio.
Joint Arrangements
Joint Venture

Investment in Joint Operation

Merchandise Contribution Merchandise Withdrawals
Purchases Merchandise Returns
Freight-In/Freight Out Purchase Returns and Allow.
Sales Return and Allow. Purchase Discounts
Sales Discounts Sales
Expenses Other Income
Unsold Merchandise
LOSS PROFIT

Note: Cash not included

Joint Operation Profit (Loss) = May be computed using the balance of the account presented above

Dr Balance: Loss
Cr Balance: Profit
Final Settlement receive by Joint Operators/Venturer computation:
*May be computed using the T-account
*From the point of view of Joint Operators/Venturer, entry in T account should be the reversed of
the Investment in Joint Venture Operation account by their own contribution and expenses as follows

A, Capital
Not applicable on the uncompleted
joint arrangement Unsold Merchandise Merchandise Contribution
Accdg. To sharing Loss Profit

*If the problem state that joint operation accounts has a credit balance of P30,000
meaning to say, this credit balance is representing net of any debit balance therefore
ignoring the item under debit balance (should not be deducted) and to add any UNSOLD
merchandise to get the joint operation profit (Loss)

Asking for Joint Operation Sales:

Credit balance(excluding Cost of Mdse taken) + Debit balance (Mdse Contri, Expenses paid, SRA & D)

Asking for Joint Operation P & L (Credit balance of each Operators entry on a separate book GIVEN):
Credit Balance + Cost of Mdse taken

Salary allowed to one of the operators is considered EXPENSES (DEBIT IN JO)

Mdse Taken over and Unsold Mdse should be debited to the acct of the operator as stated in the problem

19
 Should also consider related Freight on mdse.
Allocation is necessary to add related freight
on the unsold
JA 6
esented above

s as follows

Contribution/Investment
Accdg. To sharing

d, SRA & D)

parate book GIVEN):

in the problem
Important Characteristics of Partnerships
1. Limited Life
A partnership legally ceases to exist
a. upon the withdrawal or death of an existing partner
b. the admission of a new partner
c. the voluntary dissolution of the entity.
2. Mutual Agency
a. Each partner co-owns the assets and liabilities of the partnership.
b. Each partner may act as an agent for the partnership and legally enter into contracts
on its behalf.
3. Unlimited Liability

In case of insolvency, each partner is individually responsible for the liabilities of the
partnership, regardless of the amount of equity that the partner has in the partnership.

This feature is one of the major differences between partnerships and the corporate form
of organization, where shareholders are not personally and the corporate form of
organization, where shareholders are not personally liable for the companys debts.
This major disadvantage of unlimited liability can be circumvented by the formation of a
limited partnership, but the acts that allow this type of partnership require that at least
one partner be a general partner and that the partnership name not contain any of the
names of the limited partners.
4. Income Tax Aspects
Partnerships are not taxed as separate entities; rather, each partner is taxed on his or
her share of the yearly net income whether it has been distributed or not.
This may be viewed as a major disadvantage, and one that could be avoided by using
the corporate form of organization.

Partnership Accounting
Partners Accounts
Partnership accounting records contain three accounts for each partner.
1. Capital account
Records the partners equity investment at any point in time.
It is credited initially with the fair market value of the assets contributed by the partner
at the time of formation of the partnership
Subsequent changes reflect the partners share of net income earned, additional assets
invested, and assets withdrawn.
2. Partners loan account
>Would be used to record amounts borrowed from or loaned to the partner
>Loan accounts are not equity accounts and would therefore appear on the balance
sheet of the partnership as either receivable from or payable to the partner.
3. Drawings account
>Is used to record cash withdrawals in anticipation of yearly profits.
>This account is similar to the dividend account used by corporations
>Is closed to the partners capital accounts at the end of the accounting period.

Distribution of Income
>Is made in accordance with the partnership agreement.
>An important component of any distribution plan is the profit and loss sharing ratio.
>If the partnership agreement does not contain such a ratio, the acts state that the
ratio is one that will provide an equal distribution to each partner (in the absence of)
>This equal distribution would only be forced on the partners if they disagreed and
referred the matter to the courts.

1. To record the initial investment made by each partner

a. Contribute Cash
Cash 30,000
A capital 20,000

Cash 20,000
B capital 20,000
b. Contribute Assets
Inventory 5,000
Land 22,000
Buildings 23,000
C capital 50,000

2. To record the cash withdrawals made by each partner

A drawing 12,000
B drawing 15,000
C drawing 30,000
Cash 57,000

3. CLOSING ENTRIES: To record the revenues and expenses

a. Revenue & Expense - are closed to an income summary account.

Income Summary XX,XXX

Expenses XX,XXX

Revenue XX,XXX
Income Summary XX,XXX

b. The income summary account - is then closed and the net income allocated in
accordance with the profit and loss sharing ratio

Income summary 70,000

A capital (30% 70,000) 21,000
B capital (20% 70,000) 14,000
C capital (50% 70,000) 35,000

c. Drawing accounts are closed

A capital 12,000
B capital 15,000
C capital 30,000
A drawing 12,000
B drawing 15,000
C capital drawing 30,000
Partnership financial statements

Some Note:
Profit and loss ratios are often used to reflect a combination of time
spent and capital contributed
Partnership agreement may states that an individual partners drawings do not have to
equal his or her share of net income in a particular year.
If partners wish to vary the net income distribution method to better reflect time spent
and capital invested, they can do so by allowing salaries to partners and on capital
balances.interest

Variation: In the last illustration, A, B, and C shared profits and losses in the ratio of
3:2:5.
Addition: the partnership agreement provides for 10 percent
interest on opening capital balances, and for salary allowances of $25,000 to A and
$20,000 each to B and C, with any balance to be distributed in the ratio of 3:2:5.

Computation: Salaries
Just plot the given figures as theirpartnership agreement
Computation: Interest on Capital
Capital Invested:
A Cash Contribution 30,000
B Cash Contribution 20,000
C Asset Contribution 50,000
..100000
Interest = 100,000 x 10% = 10,000
Computation: Residual Income or LOSS in P & L ratio
Net Income 70,000
Salaries (65,000)
Interest on capital (10,000)
Residual Income/Loss (5,000)

>It should be noted that the allocations are made regardless of the size of net income.
>In this example the interest was based on the opening capital. Interest could also be
based on the weighted average capital for the period, or on the ending capital. The
partnership agreement should clearly specify how interest is to be calculated.
Because the amount for interest and salaries is determined by the owners themselves
perhaps without reference to market conditions partnership accounting does not
normally show interest and salaries among expenses. Instead, these components appear
as an allocation of the yearly net income at the bottom of the income statement, as
follows:

Ownership Changes
Accounting involved when ownership in the partnership changes
1. admission of a new partner or because of the
2. retirement of an existing partner.
the old partnership is dissolved and a new partnership is formed.
This factor could provide justification for a revaluation of net assets
Option:
Some accountants feel that a revaluation should take place because legally a new entity
exists.
Other accountants feel that since accounting principles do not allow the revaluation of
the net assets of a corporation every time the composition of the shareholders changes,
the accounting for a partnership should be the same.

*An exception would be the situation where there has been such a change in control that
pushdown accounting would be permitted.

Admission of a New Partner

>requires the unanimous consent of the existing partners.
A new partner could be admitted
a. through the acquisition of a portion of the interests of the existing partners
b. through the investment of additional net assets into the partnership.

Example:

Jill Rain and Cathy Sleet are partners in the Badweather Company and share profits and
losses in the ratio of 7:3. They have agreed to admit Jan Snow as a partner in the
company as at January 1, Year 6; after that date a new profit and loss sharing ratio will be
established. A summarized balance sheet of the company as at December 31, Year 5, is
shown below:
*Details of the assets and liabilities have been omitted in order to focus attention on the
broad accounting concepts involved.

1. Acquisition of Interest
Assume that Snow will acquire one-half of Sleets capital by making a cash payment
of $18,000 to Sleet. There are two methods that could be used to record this event
Method A
The simplest method available to record the admission of the new partner is to transfer
one-half of Sleets existing capital balance to Snow as follows:

JE:
Sleet capital 15,000
Snow capital 15,000

The companys balance sheet after the admission of Snow is shown below:

Method B
As an alternative, the net assets of the company could be revalued on the basis of the
$18,000 paid for one-half of Sleets capital.
It can be implied that Sleets capital should be $36,000
Sleet's Capital 18,000 x 2 = 36,000 ; bec 18K represents half

Implied Sleet's Capital 36,000

Present Sleet's Capital 30,000
Increased by 6,000

Parnership Agreement: Sleet is entitled to 30 percent of all net asset changes,

6,000 / 30 % = 20,000
total assets should increase by $20,000 (6,000 30 percent) as part of the recording of
the $6,000 increase to Sleets capital.
>Therefore, it can be implied from the $18,000 price paid by Snow that the net assets of
the company are undervalued by $20,000.

>If specific assets cannot be identified as undervalued, the usual procedure is to record
goodwill on the books of the company before recording the transfer of capital

The journal entries are as follows:

Goodwill 20,000
Rain Capital (70% 20,000) 14,000
Sleet capital (30% 20,000) 6,000

Sleet capital 18,000

Snow capital 18,000

2. Admission by Investing Assets

Snow will invest cash into the partnership for 20 percent of capital.
Three situations that vary the amount of cash that Snow invests for this 20 percent
interest.
For example, if Snow is to have 20 percent of capital, the combined capital balances of
Rain and Sleet must equal 80 percent of capital.

A solution can always be reached by using the amounts from columns 2 and 3.
In some situations, a third solution can be reached from the amount in column 1

Solution 1
Assume that Snow will invest $15,000 for 20 percent of capital. Using the prescribed
analysis, we determine the following amounts:

The bonus method - NEW PARTNER

>net assets are not revalued
>a transfer of capital balances between partners is all that is involved.
>With the bonus method, column 3 is used.

Total Capital based on Potential Capital 95,000

(Snow) 20%
Snow Capital 19,000

To arrive at this capital balance, there must be a transfer of a $4,000 from the capitals of
Rain and Sleet to Snow.
This transfer is made by using the profit and loss ratio that existed before the new
partner was admitted.

The journal entry for the admittance of Snow is as follows:

Cash 15,000
Rain capital (70% 4,000) 2,800
Sleet capital (30% 4,000) 1,200
Snow capital 19,000

The balance sheet of the partnership after the admittance of Snow is as follows:

Asset revaluation methods. Ist

Column 2 will always produce an amount that can be used to revalue the net assets of
the existing partnership.

Cash Invested by Snow represents 20% of total Capital

Cash Invested by Snow 15,000

% of total capital 20%
. 75,000

Net Asset or Capital Balances of existing Partn'p 80,000

Capital balances of Rain & Sleet for new % (75,000 X 80%) 60,000
Overvalued by 20,000

this analysis implies that the assets are overvalued by $20,000.

The journal entries to record the revaluation of the net assets of the existing
partnership and the admittance of Snow are:
Rain capital (70% 20,000) 14,000
Sleet capital (30% 20,000) 6,000
Various assets 20,000

Cash 15,000
Snow capital 15,000

>In this case, some identifiable net assets were written down.
>The same result could have been achieved by increasing certain liabilities by $20,000.

The balance sheet after the assets of the existing partnership have been
revalued and Snow has been admitted is as follows:

Asset revaluation methods. 2nd (GOODWILL TO NEW PARTNER)

A second asset revaluation method can evolve from the use of the amount from column
1
We use the net assets being invested by the existing partners ($80,000) to revalue the
assets invested by the new partner.

Net Asset or Capital Balances of existing Partn'p 80,000

% of total capital 20%
. 100,000

Total Capital of new partnershi 100,000

Capital for Snow (80,000 X 20%) 20,000

Capital for Snow (80,000 X 20%) 20,000

Cash Investment of Snow 15,000
Goodwill to Snow 5,000

>Since Snow is investing $15,000 in assets, there is an implication that Snow is bringing
in goodwill of $5,000.

The journal entry is as follows:

Cash 15,000
Goodwill 5,000
Snow capital 20,000

The balance sheet after the new partner is admitted is as follows:

Situation 2
In this case we will assume that Snow invests $22,000 for 20 percent of capital. Using
the suggested analysis as a starting point:

The bonus method. - OLD PARTNER

Using column 3, total capital is $102,000, and Snows capital balance is $20,400 (20%
102,000).
There is a capital bonus of $1,600 from Snow to Rain and Sleet.

Capital Invested by Snow 22,000

Share in Capital Balance (102,000 X 20%) 20,400
Bonus to OLD PARTNER 1,600

This is credited to their capital accounts in accordance with their profit and
loss sharing ratio in the following entry:

Cash 22,000
Rain capital (70% 1,600) 1,120
Sleet capital (30% 1,600) 480
Snow capital 20,400

Asset revaluation methods - GOODWILL TO OLD PARTNER

We can always arrive at a feasible solution by using column 2. Here, $22,000 represents
20 percent of total capital, which amounts to

Net Asset or Capital Balances of existing Partn'p 102,000

Total Capital based on New Investment (22,000 20 percent) 110,000
Undervalued by 20,000

If specific assets or liabilities cannot be identified for revaluation, goodwill is

recognized in the existing partnership as follows:

Goodwill 8,000
Rain capital (70% 8,000) 5,600
 Sleet capital (30% 8,000) 2,400

The entry to record the admission of Snow with an investment of $22,000 for
20 percent of capital is as follows:

Cash 22,000
Snow capital 22,000

In this particular situation, a solution cannot be obtained by using column 1. If the capital
of the existing partnership ($80,000) represents 80 percent of total capital, the total
capital must be $100,000 (80,000 80 percent). But Snow is investing $22,000, so the
total capital has to be at least $102,000 (80,000 + 22,000). Therefore, a feasible solution
cannot be arrived at by using column 1.

Situation 3
In this last situation we assume that Snow invests $20,000 for 20 percent of capital.
There is only one way to record this:

Cash 20,000
Snow capital 20,000

The amount invested represents the new partners share of the total assets of the
partnership after her investment; therefore, the bonus and asset revaluation method
cannot be applied.

>Prior to the admission of Snow, Rain and Sleet shared profits and losses in the ration 7:3.
>Now the three partners must agree on a new ratio.
>If Sleet and Rain wish to maintain the same relative ratio with each other, and if Snow
is to have 25 percent of profits and losses, the new ratio should be as follows:

Rain (70% 75%) 52.5%

Sleet (30% 75%) 22.5
Snow 25.0

Retirement of a Partner

The retirement of a partner can also be recorded by bonus and asset revaluation
methods when the amount of assets withdrawn by the retiring partner differs from this
partners capital balance.

Example
Let us return to the Badweather Company and assume that on December 31, Year 10,
Rain retires. With the agreement of the other partners, she is to be paid $80,000 in
cash from the partnership.

The balance sheet of the partnership just prior to Rains retirement is shown below. We
assume that the partners share profits and losses in the ratio 4:3:3.
The bonus method

Rain is to be paid an amount that is $18,000 greater than Rains present capital balance.
A solution to this is to transfer $18,000 in capital to Rain from Sleet and Snow in
proportion to their profit and loss sharing ratio, one to the other.
Then Rains capital balance will equal the cash that she is withdrawing.

The journal entries are as follows:

Sleet capital (50% 18,000) 9,000

Snow capital (50% 18,000) 9,000
Rain capital 18,000

Rain capital 80,000

Cash 80,000

Asset revaluation.
Another acceptable accounting method is to revalue the net assets by such an amount
that Rains capital ends up with a balance of $80,000.
If Rains capital must increase by $18,000, and Rain is entitled to 40 percent of any asset
increases, the total undervaluation of the companys assets is implied to be

18,000 40 percent = $45,000

The journal entries to record the asset revaluation and the payment to Rain
are as follows:

Goodwill 45,000
Rain capital (40% 45,000) 18,000
Sleet capital (30% 45,000) 13,500
Snow capital (30% 45,000) 13,500
Rain capital 80,000
Cash 80,000

In this example, goodwill was created under the assumption that no other assets can be
identified as undervalued.