Week 11 Student

8/11/2019 Week 11 Student

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MIT565702

Week 11

Partnerships



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Lecture Objectives

• At the end of this lecture you should be able to:

• Identify a partnership and the major attributes of a

partnership

• Understand the main characteristics of the partnership

structure of business and how to account for partnership

transactions



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What is a partnership

A partnership is defined in the Partnership Act as the

relationship that "subsists between persons carrying on

a business in common with a view to profit'.

Note a written agreement is not necessary to form a

partnership.



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Required attributes

a) There must be an agreement (verbal or written) between two or

more legally competent persons to carry on a business

b) The business must be operated with a view to earning a profit

c) Members must be co-owners of the business.

Co-ownership involves:

• The right of each partner to share in the profits of the business,

• To participate with the other partners in the management of the

business

• To own jointly with the other partners the property of the partnership.

Note: a partnership is not a separate legal entity



Advantages of a partnership

• It permits the pooling of both capital resources and

the multiple skills of the individual partners

• It is easier and less costly to establish than a company

• It is not subject to as much government regulation and

supervision as companies are partners may be able to

operate with more flexibility because they are not

subject to the control of a board of directors

• There may be certain tax advantages



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Characteristics of a Partnership

Mutual agency

Unlimited Liability Each partner is personally liable

for the obligations of the partnership.

Limited Life A partnership is dissolved if one

partner dies or retires, a new partner is admitted of a

partner,

Transfer of Partnership Interest A capital interest in

a partnership is a personal asset of the individual

partner that can be sold. However, the purchaser does

not have the right to participate in management unless

accepted and agreed to by all the other partners.



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Partnership Agreement

A partnership is a voluntary association based on the

contractual agreement between legally competent

people.

The partnership agreement may be verbal, (not

advisable

A partnership agreement covers such things as the

nature, location, and duration of the partnership; how

profits and losses are shared; how the partnership is

operated; the authority of partners in contractualsituations; accounting practices; and dispute resolution.



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Accounting for a Partnership

A partnership is a separate accounting entity distinct

from the partners. The transactions and events that

affect the assets, liabilities and partners' equity

accounts of the partnership are accounted for

separately from the personal activities of the individual

partners.

Separate Capital account and separate Drawings

account are necessary for each partner.



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Income Summary

Expenses 500 Revenues 1000

Profit Distribution 500

Profit Distribution

Capital Account - A 250 Income Summary 500

Capital Account - B 250

Capital Account - Partner A

Drawings Account - A 150 Assets Invested 2000


Drawings Account - Partner A

Assets Withdrawn 100

Personal Expenses Paid 50 Capital Account - A 150

Commonly used methods for accounting for equity in a partnership:

Method 1:

Use of Capital accounts for each partner which record capital contributed and

withdrawn plus each partner's periodic share of profits and/or losses



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Method 2: Capital accounts fixed balances only the capital contributed and

withdrawn. Share of profits and/or losses plus drawings use separate Current

Account

Capital Account – Partner A

Assets Withdrawn 100 Assets Invested 2000

Income Summary

Expenses 500 Revenues 1000


Profit Distribution

Current Account - A 250 Income Summary 500

Current Account - B 250

Drawings Account - Partner A

Personal Expenses Paid 50 Current Account - A 50

Current Account - Partner A

Drawings Account - A 50 Profit Distribution 250



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Date Particulars Dr Cr

Car $x

Cash $xGoodwill $x

Capital Account - Partner A $x

Assets contributed By Partner A

The partnership agreement should specify details agreed of assets contributed or liabilities

taken over and the capital interest each partner is to receive.

The monetary amounts given to assets and liabilities will be the fair value of those assets and

liabilities.

Goodwill. A partner may negotiate a capital interest different from the total of identifiable net

assets contributed. – goodwill due many factors, including customer confidence, qualitymanagement, favourable location, taking over and existing business.

Accounting for the Formation of a Partnership



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•The partners may agree to any method of allocating profit or losses.

•In the absence of an agreement , the Partnership Act provides that profits are to be divided

equally.

•In establishing an equitable allocation of partnership profits and losses, the partners

should consider the:

• the contribution of personal services performed by the partners• A return on the capital provided by the partners

• A return for the business risks assumed by the partners.

Some of the more common profit and loss sharing agreements are:

• A fixed ratio

• A ratio based on capital balances

• A fixed ratio established by the partners after allowing for interest on capital

contributions and salaries to partners for services rendered to the partnership.

Allocation of Partnership Profits and Losses



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Admission of a New Partner

The new partner is admitted to the partnership through:

• Purchasing all or part of an interest directly from one or moreexisting partners

A current partner is selling all or part of his or her interest in the

partnership to the incoming partner. The net assets of the partnership

are not changed since this is a personal transaction between

individuals dealing outside the partnership. • Making an investment of assets in the partnership business.

If an investment of assets is made into the partnership, the net assets

and total capital of the firm are increased by the amount of the

investment.

A partner cannot be prevented from selling his or her interest in a

partnership, but no person can be admitted as a partner without the

consent of all existing partners



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Valuation of Net Assets

Generally, whenever there is a change in partners (admission or

retirement) in a partnership, it is necessary to determine the fair

value of the partnership.

Partnership net assets are usually recorded in the partnership

accounts at historical cost (depreciated), not at fair value.• This requires revaluation of all identifiable assets and liabilities

to reflect fair values before the admission or retirement of a

partner.

A major point of disagreement is whether to value theunidentifiable assets, i.e. goodwill that may exist in the

partnership, and to record their fair value.



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When Goodwill is Recorded

The preferred approach is to value all of the partnership's identifiable

assets and liabilities to fair value and to value and record all

unidentifiable assets, e.g. goodwill, and liabilities which have not been previously recorded.

There are arguments for and against recording goodwill on the

admission of a partner:

• Legally a new partnership is created, so goodwill can be seen as

being 'purchased' and thus its recording is acceptable under

accounting standards;

• In substance the partnership operations are not disrupted, so

goodwill is therefore regarded as being 'internally generated

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and thusshould not be recorded under accounting standards.

• Another argument against the recognition and recording of

goodwill is that any valuation of goodwill is subjective.



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b) Valuation Adjustment Summary Account When assets and liabilities are revalued the usual practice is to make adjustments

to each asset and liability account and to credit or debit the various increments or

decrements to a single account which could be called a Valuation Adjustment

Summary account.Date Particulars Dr Cr

Land $x

Buildings $x

Inventory $x

Furniture and Fittings $x

Valuation Adjustment Summary $x

To revalue the assets of the partnership

Valuation Adjustment Summary $x

Capital - Partner A $x

Capital - Partner B$x

To allocate valuation adjustment to partners in profit-sharing

ratio of 3:2.



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Purchasing an interest directly from an existing partner

If an individual buys an interest in a partnership by making

payment directly to the current partners. The only entry required in

the partnership records is to transfer the capital interest acquiredfrom the selling partner to the buying partner.

Purchasing an interest by contributing assets.

When a new partner is admitted to a partnership by a contribution ofassets, the value of assets to be contributed, the amount of goodwill

to be recorded, and the interest acquired by incoming partner are

determined by mutual agreement among the parties concerned.



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There are a number of approaches to effecting and recording the

admission of a new partner to an existing partnership. Whatever

approach is taken, however, there are three distinct steps in the

admission.

These are:

1. Revalue identifiable assets of old partnership to fair values.

2. Determine and record the goodwill of the old partnership.

3. Record the admission of the new partner.

Admission a new partner cont



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a) Value of assets contributed by the incoming partner is equal

to his or her share of the partnership identifiable assets

Since no goodwill is involved, the only general journal entry to

record steps 2 and 3 on the admission of Dart to the new partnership

is:Date Particulars Dr Cr

Cash $x

Capital Account - Partner A $x

Assets contributed By Partner A

b) Value of identifiable assets contributed by the incoming

partner is greater than his or her agreed share of the total

partnership net assets.

Date Particulars Dr Cr

Goodwill $x

Capital Account - Old Partner B $x

Capital Account - Old Partner C $x

Payment for goodwill by incoming partner



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Lecture Outcomes

• You should now be able to:

• Identify a partnership and the major attributes of a

partnership• Understand the main characteristics of the partnership

structure of business and how to account for partnership

transactions



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Homework

Refer Partnership questions on Moodle from Hoggett and Edwards (2009)

ex 8.1, 8.2, 8.4, 8.6, 8.9 and Pb 8.1,8.2 and 8.3

Documents

Week 11 Student