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Appendix D

Appendix D. Reporting and Analyzing Partnerships. Conceptual Chapter Objectives. C1: Identify characteristics of partnerships and similar organizations. Analytical Chapter Objectives. A1: Compute partner return on equity and use it to evaluate partnership performance.

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Appendix D

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  1. Appendix D Reporting and Analyzing Partnerships

  2. Conceptual Chapter Objectives C1: Identifycharacteristics of partnerships and similar organizations

  3. Analytical Chapter Objectives A1: Compute partner return on equity and use it to evaluate partnership performance

  4. Procedural Chapter Objectives P1: Prepare entries for partnership formation P2: Allocate and record income and loss among partners P3: Account for the admission and withdrawal of partners P4: Prepare entries for partnership liquidation

  5. Partnership Form of Organization C1 Voluntary Association Limited Life Partnership Agreement Taxation Mutual Agency Unlimited Liability Co-Ownership of Property

  6. Limited Partnerships(LP) Limited Liability Partnerships(LLP) Limited Liability Corporations(LLC) • General partners assume management duties and unlimited liability for partnership debts. • Limited partners have no personal liability beyond invested amounts. • Protects innocent partners from malpractice or negligence claims. • Most states hold all partners personally liable for partnership debts. • Owners have same limited liability feature as owners of a corporation. • A limited liability corporation typically has a limited life. Organizations with Partnership Characteristics C1

  7. Choosing a Business Form C1 Many factors should be considered when choosing the proper business form.

  8. Organizing a Partnership P1 Partners can invest both assets and liabilities in the partnership. Assets and liabilities are recorded at an agreed-upon value, normally fair market value. Asset contributions increase the partner’s capital account. Withdrawals from the partnership decrease the partner’s capital account.

  9. On 2/15/08, Smith and Jones form a partnership. Smith contributes $80,000 cash. Jones contributes land valued at $40,000. Organizing a Partnership P1

  10. Dividing Income or Loss P2 Partners are not employees of the partnership but are its owners. This means there are no salaries reported as expense on the income statement. Profits or losses of the partnership are divided on some agreed upon ratio. Three frequently used methods to divide income or loss are allocation on: • Stated ratios. • Capital balances. • Services, capital and stated ratios.

  11. $60,000 × ¾ = $45,000 Allocation Based on Stated Ratios P2 Smith and Jones agree to divide profits or losses ¾for Smith and ¼ for Jones. For 2008, the partnership reported net income of $60,000.

  12. Allocation Based on Capital Balances P2 Smith’s capital balance, before division of profits or losses is $80,000 and Jones’s capital balance is $40,000. The partnership agreement calls for income or loss to be allocated based on the relative capital balances. Net income for 2008 is $60,000.

  13. Allocation Based on Capital Balances P2 Smith’s capital balance, before division of profits or losses is $80,000 and Jones’s capital balance is $40,000. The partnership agreement calls for income or loss to be allocated based on the relative capital balances. Net income for 2008 is $60,000.

  14. Allocation Based on Services, Capital, and Stated Ratios P2 Smith and Jones have a partnership agreement with the following conditions: • Smith receives $15,000 and Jones receives $10,000 as annual salaries. • Each partner is allowed an annual interest allowance of 5% on the beginning-of-year capital balance. • Any remaining balance of income or loss is allocated equally. Net income for 2008 is $60,000.

  15. $80,000 × 5% = $4,000 $29,000 × ½ = $14,500 Allocation Based on Services, Capital, and Stated Ratios P2

  16. Partnership Financial Statements P2 Assume that during 2008, Smith withdrew $5,000 cash from the partnership and Jones withdrew $1,000.

  17. Allocation Based on Services, Capital, and Stated Ratios P2 Smith and Jones have a partnership agreement with the following conditions: • Smith receives $15,000 and Jones receives $10,000 as annual salaries. • Each partner is allowed an annual interest allowance of 5% on the beginning-of-year capital balance. • Any remaining balance of income or loss is allocated equally. Net income for 2008 is $30,000.

  18. ($1,000) × ½ = $500 Allocation on Services, Capital, and Stated Ratios P2

  19. Admission and Withdrawal of Partners P3 • When the makeup of the partnership changes, the partnership is dissolved. • A new partnership may be immediately formed. • New partner acquires partnership interest by: • Purchasing it from the other partners, or • Investing assets in the partnership.

  20. Admission of a Partner P3 Purchase of Partnership Interest • A new partner can purchase partnership interest directly from the existing partners. • The cash goes to the partners, not to the partnership. • To become a partner, the new partner must be accepted by the current partners.

  21. Purchase of Partnership Interest P3 On January 2, 2009, Jones agrees to sell Johnson $10,000 of her partnership interest for $25,000 cash. Smith agrees with this. arrangement.

  22. Investing Assets in a Partnership P3 • The new partner can gain partnership interest by contributing assets to the partnership. • The new assets will increase the partnership’s net assets. • After admission, both assets and equity will increase.

  23. Investing Assets in a Partnership P3 On January 2, 2009, Smith and Jones agree to accept Johnson as a partner upon his investment of $30,000 cash in the partnership.

  24. When the current value of a partnership is greater than the recorded amounts of equity, the old partners usually require a new partner to pay a bonus when joining. Bonus to Old Partners The partnership may grant a bonus to a new partner if the business is in need of cash or if the new partner has exceptional talents. Bonus to New Partners Bonus to Old or New Partners P3

  25. Bonus to Old Partners P3 On January 2, 2009, Smith and Jones agree to accept Johnson as a partner upon his investment of $60,000 cash in the partnership. Johnson is to receive a 20% ownership interest in the new partnership. Any bonus is attributable to the existing partners and is shared equally.

  26. $60,000 - $46,800 = $13,200 × ½ = $6,600 Bonus to Old Partners P3 On January 2, 2009, Smith and Jones agree to accept Johnson as a partner upon his investment of $60,000 cash in the partnership. Johnson is to receive a 20% ownership interest in the new partnership. Any bonus is attributable to the existing partners and is shared equally.

  27. Bonus to New Partner P3 On January 2, 2009, Smith and Jones agree to accept Johnson as a partner upon his investment of $60,000 cash in the partnership. Johnson is to receive a 30% ownership interest in the new partnership. Any bonus is attributable to the new partner and is shared equally by the existing partners.

  28. $70,200 - $60,000 = $10,200 × ½ = $5,100 Bonus to New Partner P3 On January 2, 2009, Smith and Jones agree to accept Johnson as a partner upon his investment of $60,000 cash in the partnership. Johnson is to receive a 30% ownership interest in the new partnership. Any bonus is attributable to the new partner and is shared equally by the existing partners.

  29. Withdrawal of a Partner P3 A partner can withdraw in two ways: • The partner can sell his/her partnership interest to another person. • The partnership can distribute cash and/or other assets to the withdrawing partner.

  30. $65,500 - $50,000 = $15,500 × ½ = $7,750 Withdrawal of a Partner P3 Jones has a capital balance of $65,500. She decides to withdraw from the partnership of Smith, Jones, and Johnson for $50,000 cash. Any bonus is attributable to the remaining partners and is divided equally.

  31. Liquidation of a Partnership P4 • When a partnership is dissolved, four steps are required: • Noncash assets are sold for cash and a gain or loss on liquidations is recorded. • Gain or loss on liquidation is allocated to partners using their income-and-loss ratio. • Liabilities are paid or settled. • Any remaining cash is distributed to partners based on their capital balances.

  32. No Capital Deficiency P4 No capital deficiency means that all partners have a zero or credit balance in their capital accounts. Smith, Jones, and Johnson agree to dissolve their partnership. They sell all of their assets for a net gain of $10,000. Profits and losses are shared as follows: Smith, ½; Jones, ¼; and Johnson, ¼.

  33. Capital Deficiency P4 Capital deficiency means that at least one partner has a debit balance in his/her capital account. A partner with a deficit must, if possible, cover the deficit by paying cash into the partnership. Smith, Jones, and Johnson agree to dissolve their partnership. They sell all of their assets for a net loss of $10,000. Profits and losses are shared as follows: Smith, ½; Jones, ¼; and Johnson, ¼.

  34. Capital Deficiency P4 Any partner’s unpaid deficiency is absorbed by the remaining partners with credit balances in accordance with the partnership agreement.

  35. Death of a Partner P4 • A partner’s death dissolves a partnership. • A deceased partner’s estate is entitled to receive the equity. • This usually requires closing the books to determine the net income or loss at the date of death and also recording market values for assets and liabilities.

  36. Partner returnon equity Partner net incomeAverage partner equity = Partner Return on Equity A4

  37. End of Appendix D

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