Chapter Fourteen - PowerPoint Presentation

Slide1

Chapter Fourteen

Partnerships: Formation and Operation

Copyright © 2015

McGraw-Hill

Education.

All

rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Slide2

Partnerships

A partnership is defined as “an association of two or more persons to carry on a business as co-owners for profit.” (Section 6 of Uniform Partnership Act).

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The IRS projects that by 2016, nearly

4

.7 million partnership U.S. income tax returns will be filed, compared to 8.1 million corporation income tax returns. (Source:

www.irs.gov

)Slide3

Learning Objective 14-1

Explain the advantages and

disadvantages of the partnershipversus the corporate formof business.

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3Slide4

Partnership Advantages

Advantages: Flexibility in defining relationships

Profits and losses, and management operating decisions, shared independent of ownership percentages.Ease of formation and dissolution.Taxes “flow-through” to the partners.

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Disadvantages:

Unlimited liability incurred by each partner (they are “jointly and severally” liable).

Mutual agency (each partner has right to incur liabilities in the name of the partnership).

Inability to participate in various corporate tax benefitsSlide5

Learning Objective 14-2

Describe the purpose of thearticles of partnership and list

specific items that should beincluded in this agreement.

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5Slide6

Articles of Partnership

The Uniform Partnership Act establishes standards and rules for partnerships but a

written agreement will supersede the UPA standards.Articles of partnership should always clearly describe the:• Name and address of each partner.

• Business location.

• Nature of the business.

• Rights and responsibilities of each partner.

• Initial contribution to be made by each partner and the method to be used for valuation.

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6Slide7

Articles of Partnership

Articles of partnership should always clearly describe the:

Specific method by which profits and losses are to be allocated.Periodic withdrawal of assets by each partner.• Procedure for admitting new partners.

• Method for arbitrating partnership disputes.

• Life insurance provisions enabling remaining partners to acquire the interest of any deceased partner.

• Method for settling a partner’s share in the business upon withdrawal, retirement, or death.

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7Slide8

Learning Objective 14-3

Prepare the journal entryto record the initial capital

investment made by a partner.14-

8Slide9

Accounting for Capital Contributions

Assume that Carter and Green form a business to be operated as a partnership. Carter contributes

$50,000 in cash and Green invests $20,000. The initial journal entry to record the creation of the partnership:

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9Slide10

Learning Objective 14-4

Use both the bonus methodand the goodwill method

to record a partner’s capitalinvestment.

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10Slide11

Accounting for Capital Contributions

Contributed intangible assets require special consideration .

Contributions made by one or more of the partners may go beyond assets and liabilities, for example, a particular line of expertise or established clientele.

Use either the Bonus Method or

Goodwill

Method for recording contributed intangible assets.

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Intangible Contributions

The

bonus method splits the capital evenly between the two partners

. The new partner receives a capital bonus in recognition of artistic or other abilities contributed.

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Bonus Method

Goodwill Method

Based on assumption that an implied value can be calculated mathematically and recorded for an intangible contribution made by a partner. Slide13

Learning Objective 14-5

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Demonstrate

the impact that

the allocation of partnership

income has on the partners’

individual capital balances.Slide14

Allocation of Income

Partnership revenues and expenses must be closed out at the end of each fiscal period and the net income allocated to each partners’ capital account. A method must be devised for assignment of income.

Articles of partnership should stipulate an established procedure.If no arrangement is specified, state partnership laws dictate that all partners receive an equal allocation of income or loss. 14-

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Learning Objective 14-6

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15Allocate income to partners

when interest and/or salary

factors are included.Slide16

Allocation of Income

The allocation of income is not necessarily based on the relative capital balances.

It is a separately negotiated item.Allocated compensation

Bonuses

Remaining income

Interest on beginning capital balances

Items to be allocated:

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Alternative Techniques

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The assignment process is a series of mechanical steps reflecting change in each partner’s capital balance resulting from provisions of the partnership agreement. The number of allocation procedures that could be employed is limited solely by the partners’ imagination. Although interest, compensation allowances, and various ratios are the predominant factors encountered in practice, numerous other possibilities exist. Slide18

Learning Objective 14-7

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Explain

the meaning of

partnership dissolution and

understand that a

dissolution will

often have little or

no effect

on the operations of the

partnership business.Slide19

Legal Dissolution

Any alteration in the specific individuals composing a partnership results in “legal dissolution”Departures

Retirement DeathAdmission (including promotion) of a New PartnerImmediate formation of a new partnership as business continues

New

partner acquires partnership interest by:

Purchasing

it from the other partners, or

making

a contribution to the partnership.

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19Slide20

Learning Objective 14-8

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20Prepare journal entries to

record the acquisition by a

new partner of either all or a

portion of a current partner’s

interest.Slide21

Admission of a New Partner -

Purchase of a Current InterestA new partner can purchase partnership interest directly from the existing partners.

The cash goes to the partners, not the partnership.Two methods are available to account for the transfer of ownership:Book Value Approach

Goodwill (Revaluation) Approach

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Admission of a New Partner

Purchase of a Current Interest

Assume Scott, Thompson, and York formed a partnership, and

York leaves

the partnership. He

sells

his interest to Morgan.

Book Value Approach

Each of these three partners elects to transfer a 20 percent interest to Morgan for a total payment of $30,000 in a simple capital reclassification. The money is paid directly to the owners.

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Admission of a New Partner - Purchase of a Current Interest

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Goodwill Approach Scott, Thompson, and York transfer all assets and liabilities to the partnership of Scott, Thompson, York, and Morgan. The goodwill method recognizes the transaction as occurring between two separate reporting entities that necessitates a complete revaluation of all assets and liabilities.Slide24

Learning Objective 14-9

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24Prepare journal entries to

record a new partner’s

admission by

a contribution

made directly

to the

partnership

.Slide25

Admission of a New Partner -

Contribution to the Partnership14-25

An outsider may be admitted to a partnership by contributing directly to the business. Assume King and Wilson maintain a partnership and presently report capital balances of $80,000 and $20,000, respectively. According to the articles of partnership, King is entitled to 60 % of all profits and losses with the remaining 40% credited each year to Wilson. Goldman can enter the partnership for $20,000 cash with the money going into the business. Goldman receives an initial 10 percent interest in partnership property.Slide26

Admission of a New Partner -

Contribution to the PartnershipBonus Credited to Original Partners

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Goodwill Credited to Original PartnersSlide27

Admission of a New Partner -

Contribution to the PartnershipHybrid Method

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Admission of a New Partner -

Contribution to the PartnershipBonus or Goodwill Credited to New Partner

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Learning Objective 14-10

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29Prepare journal entries to

record the withdrawal of a

current partner.Slide30

Withdrawal of a Partner

Goodwill

Method Applied

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Bonus Method AppliedSlide31

Withdrawal of a Partner

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31Hybrid

Method Applied