Chapter 10

Partnerships: Formation,
Operation, and Changes in
Membership

McGraw- Copyright 2012 by The McGraw-Hill Companies, Inc. All rights

Learning Objective 1

Understand and explain the

nature and regulation of
partnerships.

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 What is a Partnership?

An association of two or
more persons who
A B
are co-owners of a
business, and
share profits and losses
in an agreed-upon
manner. ABC
Company

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 What is a Person?

An individual
A corporation
Another partnership

T&D
Z Corp
Partnership

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 Partnerships: Pros & Cons

Advantages
Ease of formation
Lack of formality
Single taxation (see following slide)
Disadvantages
Unlimited liability (for general partnerships)
Difficulty in disposing of partnership interests
Mutual agency

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 Partnership Form of Organization: Income Tax
Reporting
Single Taxation of Partnership
Earnings
Partnerships only report their Uncle Sam
earningsthey are not taxed at the
business entity level (as are
corporations).
A B
Partnerships file IRS Form 1065,
which shows the allocation of profits
AB
among partners.
Partnershi
Partners report their share of profits p
on their individual IRS Form 1040
return.
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 Regulation

Each state regulates the partnerships

that are formed in it.
Most states begin with a model act and
then modifies it to fit that states
business culture and history.
Most have now adopted the Uniform
Partnership Act of 1997 (UPA 1997) as
their model act.

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 Regulation: The Uniform Partnership Act (UPA)

The UPA 1997 covers:

Relations of partners to one another.
Relations of partners to persons dealing
with the partnership.
Dissolution and winding up of the
partnership.

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 The Partnership Agreement

What is a partnership agreement?

A written expression of what the
partners have agreed to.
Examples of areas addressed:
Manner of sharing profits.
Limitations on withdrawals.
Rights of partners.
Settling with withdrawing partners.
Expulsion of partners.
Conflicts of interest.
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Practice Quiz Question #1

Which of the following is not one of

the advantages of general
partnerships?
a. Ease of formation
b. Unlimited liability
c. Lack of formality
d. Single taxation

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Practice Quiz Question #1 Solution

Which of the following is not one of

the advantages of general
partnerships?
a. Ease of formation
b. Unlimited liability
c. Lack of formality
d. Single taxation

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Learning Objective 2

Understand and explain the

differences among different
types of partnerships.

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 Types of Partnerships

General Partnerships
All partners have unlimited liability.
Creditors can go after the personal assets of
any or all of the partners.

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 Types of Partnerships

Limited Partnerships
Limited partners have limited liability to
partnership creditors if the partnership is unable
to pay its debts.
Limited partners risk is limited to their invested
capital.
Thus, personal assets are not at risk.
At least one of the partners must be a general
partner.

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 Types of Partnerships

Limited Liability Partnerships (LLPs)

A partners personal assets are at risk only for
his or her own negligence and wrongdoing,
the negligence and wrongdoing of those under his or
her control, but
not debts.
Since 1993, many accounting firms have changed
from general partnerships to LLPs.

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 Types of Partnerships

Limited Liability Limited Partnerships

(LLLPs)
Like a limited partnership, must have at least one
general partner.
General partners manage the partnership.
Big difference relates to the liability of general
partners:
No personal liability for partnership obligations (like a
limited partner)
Not liable for wrongdoing of other partnersjust
personal decisions and decisions of those supervised
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Practice Quiz Question #2

Which of the following statements is true?

a.The partners in a general partnership have
limited liability.
b.At least two of the partners in a limited
partnership must be general partners.
c.Partners in an LLP are not responsible for
their own actions.
d.Limited liability limited partnerships must
have at least one general partner.

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Practice Quiz Question #2 Solution

Which of the following statements is true?

a.The partners in a general partnership have
limited liability.
b.At least two of the partners in a limited
partnership must be general partners.
c.Partners in an LLP are not responsible for
their own actions.
d.Limited liability limited partnerships must
have at least one general partner.

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Learning Objective 3

Make calculations and journal

entries for the formation of
partnerships.

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 Partners Accounts

Each partner can have

a capital account.
a drawing account (a contra capital
accountclosed out at year-end).
a loan account (loans usually earn
interesta partnership expense).
Partnerships do NOT use a
retained earnings account. DR CR

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 Recording Capital Contributions

Keep it FAIR!
Current Fair Market
Values should be used to
record
noncash assets contributed
to a partnership.
liabilities assumed by a
partnership. ABC
Partnership

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 Partnership Formation Example

Brian and Spencer wish to form the B&S partnership.

Brian contributes land with a book value of $65,000
and a current value of $150,000 and a building with a
book value of $142,000 and a current value of
$175,000. Spencer will contribute cash.
If the partners plan to share profits and losses equally
after the formation of the partnership and assuming
they have agreed to equal capital contributions, how
much cash will Spencer have to contribute to form the
partnership?

$150,000 + $175,000 = $325,000

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 Comprehensive Partnership Creation Problem

The partnerships of Brad & Mike (B&M) and

Austin and Justin (A&J) began business on 1/1/X1;
each partnership owns one retail appliance store. The
two partnerships agree to combine as of 7/1/X8 to
form a new partnership, BAM-J Discount Stores.
REQUIRED
Given the information on the next two slides,
1.Prepare the journal entries to record the initial capital
contribution after considering the effect of this information. Use
separate entries for each of the combining partnerships.
2.Prepare a schedule computing the cash contributed or
withdrawn by each partner to bring the initial capital balances into
the profit and loss sharing ratio.
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 Comprehensive Partnership Creation Problem
1. Profit and loss ratios. The profit and loss sharing ratios for the former partnerships were
40% to Brad and 60% to Mike, and 30% to Austin and 70% to Justin. The profit and loss
sharing ratio for the new partnership is Brad, 20%; Mike, 30%; Austin, 15%; and Justin, 35%.
2. Capital investments. The opening capital investments for the new partnership are to be in
the same ratio as the profit and loss sharing ratios for the new partnership. If necessary,
certain partners may have to contribute additional cash, and others may have to withdraw
cash to bring the capital investments into the proper ratio.
3. Accounts receivable. The partners agreed to set the new partnerships allowance for bad
debts at 3% of the accounts receivable contributed by B&M and 12% of the accounts
receivable contributed by A&J.
4. Inventory. The new partnerships opening inventory is to be valued by the FIFO method.
B&M used the FIFO method to value inventory (which approximates its current value), and
A&J used the LIFO method. The LIFO inventory represents 85% of its FIFO value.
5. Property and equipment. The partners agree that the buildings current value is
approximately 70% of the buildings historical cost, as recorded on each partnerships books.
6. Unpaid liability. After each partnerships books were closed on 6/30/X8, an unrecorded
merchandise purchase of $1,500 by A&J was discovered. The merchandise had been sold by
6/30/X8.
7. The 6/30/X8 postclosing trial balances of the partnerships follow.
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 Comprehensive Partnership Creation Problem
Brad & Mike Trial Austin & Justin Trial
Account
Balance June 30, 20X8 Balance June 30, 20X8
Cash 25,000 22,000
Accounts Receivable 100,000 150,000
Allowance for doubtful accounts 2,000 6,000
Inventory 175,000 119,000
Building & Equipment 105,000 160,000
Accumulated Depreciation 24,000 61,000
Accounts Payable 40,000 60,000
Notes Payable 100,000 120,000
Brad, Capital 95,000
Mike, Capital 144,000
Austin, Capital 65,000
Justin, Capital 139,000
Totals 405,000 405,000 451,000 451,000

1. Prepare the journal entries to record the initial capital contribution after considering the
effect of this information. Use separate entries for each of the combining partnerships.
2. Prepare a schedule computing the cash contributed or withdrawn by each partner to
bring the initial capital balances into the profit and los sharing ratio.

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 Comprehensive Problem Solution
PART 1
Summary of changes to carrying values:

Brad & Mike Austin & Justin

Increase allowance for bad debt $(1,000) $(12,000)
Increase inventory ) 21,000
Increase buildings and equipment (7,500) 13,000)
Increase accounts payable (1,500)
Net increase $(8,500) $20,500)

Allocate to:

Brad (40%) $(3,400) Austin (30%) $6,150

Mike (60%) (5,100) Justin (70%) 14,350
$(8,500) $20,500

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 Comprehensive Problem Solution
PART 1: Summary of changes to carrying values:

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 Comprehensive Problem Solution
Brad & Mike Journal Entry:

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 Comprehensive Problem Solution
Austin & Justin Journal Entry:

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 Comprehensive Problem Solution
PART 2
Brad Mike Austin Justin Total

Profit sharing percentage 20% 30% 15% 35%

Capital balances 91,600 138,900 71,150 153,350 455,000

Capital balances required

using profit and loss 91,000 136,500 68,250 159,250
sharing percentages

Capital contribution or
(600) (2,400) (2,900) 5,900
(withdrawal)

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