REVIEW OF CHAPTER 13  

Partnership Form of Organization

1.     (S.O. 1) The Uniform Partnership Act provides the basic rules for the formation and operation of partnerships in more than 90% of the states.  The Act defines a partnership as "an association of two or more persons to carry on as co-owners of a business for a profit."

Characteristics of Partnerships

2.     The principal characteristics of the partnership form of business organization are (a) association of individuals, (b) mutual agency, (c) limited life, (d) unlimited liability, and (e) co-ownership of property.

3.     The association of individuals in a partnership may be based on as simple an act as a handshake, however, it is preferable to state the agreement in writing.

a.     A partnership is a legal entity for certain purposes.

b.     A partnership is an accounting entity for financial reporting purposes.

c.     Net income of a partnership is not taxed as a separate entity.

4.     Mutual agency means that each partner acts on behalf of the partnership when engaging in partnership business, and the act of any partner is binding on all other partners.

5.   Partnerships have a limited life. Partnership dissolution occurs whenever a partner withdraws or a new partner is admitted.

6.     Each partner has unlimited liability.

        a.     Each partner is personally and individually liable for all partnership liabilities.

         b.        Creditors' claims attach first to partnership assets and then to the personal resources of any partner, irrespective of that partner's capital equity in the company.

         c.        Under limited partnerships, the liability of a limited partner is limited to the partners' capital equity.  However, there must always be at least one partner with unlimited liability, often referred to as the general partner.

7.        Partnership assets are co-owned by the partners.  Once assets have been invested in the partnership they are owned jointly by all the partners.

Advantages and Disadvantages

8.        Organizations with partnership characteristics include limited partnerships, limited liability partnerships, limited liability companies, and S corporations.

9.     The major advantages of a partnership are:

        a.        Combining skills and resources of two or more individuals.

        b.     Ease of formation.

        c.        Freedom from governmental regulations and restrictions.

        d.     Ease of decision making.

10.     The major disadvantages of a partnership are (a) mutual agency, (b) limited life, and (c) unlimited liability.

The Partnership Agreement

11.     The written contract often referred to as the partnership agreement, contains such basic information as the name and principal location of the firm, the purpose of the business, and the date of inception.

Forming a Partnership

12.     (S.O. 2)  In the formation of a partnership, each partner's initial investment in a partnership should be recorded at the fair market value of the assets at the date of their transfer to the partnership.

Dividing Net Income or Net Loss

13.     (S.O. 3)  Partnership net income or net loss is shared equally unless the partnership contract specifically indicates otherwise.

a.     A partner's share of net income or net loss is recognized in the accounts through closing entries.

b.        Closing entries for a partnership are identical to the entries made for a proprietorship, except for the use of multiple capital and drawing accounts.

14.     The various income ratios that may be used include:

a.     A fixed ratio, expressed as a proportion (6:4), a percentage (70% and 30%), or a fraction (2/3 and 1/3).

b.     A ratio based either on capital balances at the beginning of the year or on average capital balances during the year.

c.        Salaries to partners and the remainder on a fixed ratio.

d.        Interest on partners' capitals and the remainder on a fixed ratio.

e.        Salaries to partners, interest on partners' capitals, and the remainder on a fixed ratio.

         The objective is to reach agreement on a basis that will equitably reflect the differences among partners in terms of their capital investment and service to the partnership.

15.     Provisions for salaries and interest must be applied before the remainder of net income or net loss is allocated on the specified fixed ratio.  Detailed information concerning the division of net income or net loss should be shown at the bottom of the income statement.

Partnership Financial Statements

16.     (S.O. 4)  The financial statements of a partnership are similar to a proprietorship.  The differences are generally related to the fact that a number of owners are involved in a partnership.  The income statement for a partnership is identical to the income statement for  a proprietorship except for the division of net income.

17.     The owners' equity statement for a partnership is called the partners capital statement.  It explains the changes in each partners' equity during an accounting period.  Changes in capital may result from additional capital investment, drawings, and net income or net loss.

Admission of a Partner

18.     (S.O. 5)  A new partner may be admitted either by (1) purchasing the interest of one or more existing partners, or (2) investing assets in the partnership.  The former affects only partners' capital accounts whereas the latter increases both net assets and total capital of the partnership.

19.     When a net partner is admitted by purchase of an interest,

         a.     The transaction is a personal one between one or more existing partners and the new partner.

         b.     Any money or other consideration exchanged is the property of the participants and not the property of the partnership.

         c.     Each partner's capital account is debited for the ownership claims that have been relinquished, and the new partner's capital account is credited with the capital equity purchased.

         d.     Total assets, total liabilities, and total capital remain unchanged.

20.     When a new partner is admitted by the investment of assets, both the total net assets and the total capital of the partnership increase.  This is done by debiting Cash and crediting the new partner's capital account.  When the capital credit does not equal the investment of assets in the partnership, the difference is considered a bonus either to the existing partners or the new partner.

21.     A bonus to old partners results when the new partner's capital credit on the date of admittance is less than the new partner's investment in the firm.  The procedure for determining the new partner's capital credit and the bonus to the old partners is as follows:

         a.        Determine the total capital of the new partnership by adding the new partner's investment to the total capital of the old partnership.

         b.        Determine the new partner's capital credit by multiplying the total capital of the new partnership by the new partner's ownership interest.

         c.        Determine the amount of bonus by subtracting the new partner's capital credit from the new partner's investment.

         d.        Allocate the bonus to the old partners on the basis of their income ratios.

22.     A bonus to a new partner results when the new partner's capital credit is greater than the partner's investment of assets in the firm.  The bonus results in a decrease in the capital balances of the old partners based on their income ratios before admission of the new partner.

Withdrawal of a Partner

23.     (S.O. 6)  As in the case of the admission of a partner, the withdrawal of a partner legally dissolves the partnership.  The withdrawal of a partner may be accomplished by (a) payment from partners' personal assets or (b) payment from partnership assets.  The former affects only the partners' capital accounts, whereas the latter decreases total net assets and total capital of the partnership.

24.     The withdrawal of a partner when payment is made from partners' personal assets is the direct opposite of admitting a new partner who purchases a partner's interest.

         a.        Payment from partners' personal assets is a personal transaction between the partners.

         b.        Partnership assets are not involved and total capital does not change.

         c.     The effect on the partnership is limited to a realignment of the partners' capital balances.

25.     Using partnership assets to pay for a withdrawing partner's interest is the reverse of admitting a partner through the investment of assets in the partnership.

         a.        Payment from partnership assets is a transaction that involves the partnership.

         b.     Both partnership net assets and total capitals are decreased.

         c.        Asset reevaluations should not be recorded.

26.     When the partnership assets paid are in excess of the withdrawing partner's capital interest, a bonus to the retiring partner results.  The bonus is deducted from the remaining partners' capital balances on the basis of their income ratios at the time of the withdrawal.

27.     When the partnership assets paid are less than the withdrawing partner's capital interest, a bonus to the remaining partners results.  The bonus is allocated to the capital accounts of the remaining partners on the basis of their income ratios.

Death of a Partner

28.     The death of a partner dissolves the partnership, but provision generally is made for the surviving partners to continue operations.   When a partner dies it is necessary to determine the partner's equity at the date of death.

Liquidation of a Partnership

29.     (S.O. 7)  The liquidation of a partnership terminates the business.  In a liquidation, it is necessary to:

         a.     Sell noncash assets for cash and recognize a gain or loss on realization.

         b.        Allocate gain/loss on realization to the partners based on their income ratios.

         c.     Pay partnership liabilities in cash.

         d.        Distribute remaining cash to partners on the basis of their remaining capital balances.

Each of the steps must be performed in sequence.

30.     The liquidation of a partnership may result in no capital deficiency (all partners have credit balances in their capital accounts) or in a capital deficiency (at least one partner's capital account has a debit balance.)

31.     A schedule of cash payments may be used to determine the distribution of cash to each partner.

32.     When there is a capital deficiency, the partners with the deficiency may pay the amount owed and the deficiency is eliminated.

33.     If a partner with a capital deficiency is unable to pay the amount owed to the partnership, the partners with credit balances must absorb the loss as follows:

         a.     The cash distributed to each partner is the difference between the partner's present capital balance and the loss that the partner may have to absorb if the capital deficiency is not paid.

         b.     The allocation of the deficiency is made on the income ratios that exist between the partners with credit balances.  The allocation is journalized and posted.