CHAPTER 5 - PARTNERSHIP FORMULATION, INCOME DIVISION & LIQUIDATION

Partnership: is an association of two or more person to carry on as owners of a business for profit.

The main objective of partnership is to getting advantage of capital, managerial skill, and experience
over the computation.

The need for formulating partnership parities are the intension to get advantage over the competitors
operation in the same business (industry) using combined.

CHARACTERISTICS OF PARTNERSHIP

1) LIMITED LIFE-Any change in the ownership (withdrawal, death or add new partner) will result in
dissolution of partnership.

2) UNLIMITED LIABILITIES-At the event of liquidation if the creditors are not satisfied with assets of the
partnership (or if the partnership became insolvent) members will contribute personal asset to pay the
debit of partnership.

TYPES OF PARTNERSHIP

 General partnership- all members are liable for contributing personal assets.
 Limited partnership- some members will have limited liability but there should at least one
person has unlimited liabilities.

3) ABSENCE OF DOUBLE TAXATION-Members are not expected to pay tax up to the returns (drawing)
obtained from the partnership.

4) MUTUAL AGENCY- The act of one partner binds other members of the partnership.

ADVANTAGE

 Relatively easy and inexpensive to organize, requiring only an agreement between two or more
persons.
 Able to bring together more capital, more managerial skill &more experience than
solepropritership.
 Non taxable entity

DISADVANTAGE

 Its life is limited.

 Unlimited liability.
ACCOUNTING FOR PARTNERSHIP
RECORDING INVESTMENT

A separate entry is made for the investment of each partner in a partnership.

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 CHAPTER 5 - PARTNERSHIP FORMULATION, INCOME DIVISION & LIQUIDATION

Example- assume Mr.’x’ and Mr.’y’ agree to form partnership. Each is contributed certain assets and
assume the separate liability amount,

January / cash------------------------------------7,200

Account receivable-----------------16,300

Merchandise inventory-----------28,700

Store equipment---------------------5,400

Office equipment--------------------1,500

Allowance for doubtful account-------------1,500

Account payable---------------------------------2,600

Mr.’x’, Mr.’y’, capital---------------------------55,000

DIVISION OF NET INCOME AND NET LOSS

Division of net income and net loss could be made by considering partner;

1) Initial capital contribution

2) Time divot ion to the partnership
3) Value of services but, if there is no agreement between partners, the net income/net loss
shared equally.

Example-assume that the partnership ‘A’ & ‘Z’ organized by initial contribution of $40,000 & $60,000
respectively. In the second year earned a net income of $50,000. Present how the net income will be
distributed & prepare the journal entry.

Assumption 1-the partnership agreement allows that each partner to get 10% of his/her initial capital
contribution and the remaining income will be distributed on the ratio of their capital contribution.

Assumption 2-monthly salary allowance for ‘A’ &’Z’ are $1,200 & $1,800 respectively withdrawal at the
end of the year.

Assumption 3-20% of interest on initial capital investment & salary allowance of $1,200 & $1,800 for ‘A’
& ‘Z’ respectively, drawn at the end of each month.

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 CHAPTER 5 - PARTNERSHIP FORMULATION, INCOME DIVISION & LIQUIDATION

PARTNERSHIP DISSOLUTIONS

1) Admission
2) Withdrawal
3) Death
4) Bankruptcy

Dissolution does not mean winding up or discontinuous of operations.

1) Admission of partners-Admission by purchase of interest from one or more existing members.

-Admission by contributing of cash and non- cash asset to the partnership.

Example1. Anderson, Bergamin and Carter have a capital balance of $60,000, $50,000 and$ 90,000 in
ABC partnership respectively. On January 2, 2000 Daniel is accepted as partner by purchasing 10% of
Bergamin and 50% of carter’s capital for $17,000 and $60,000 respectively. Record the admission of
Daniel to the partnership.

Example2-assume in the previous example Daniel is admitted by contributing cash of $17,000 and
merchandise inventory valued at $60,000.

REVALUATION OF ASSETS

It is needed if the book value on the date of admission is different from the market value of the assets.
The net amount of increase and decrease will be charged against the capital balance of existing
partners.

Example: In the above example, the following deviations were found in comparing the balance per
partnership books and market fair value. Assume the income sharing ratio is 30%, 25%and 45%. Record
the revaluation and admission of Daniel to the partnership by contributions cash of $17,000 and
merchandise inventory of $60,000. How much was the book value of the capital before admission?

1) $3000 of the A/R should be written off

2) Balance of supplies is estimated to be $7,000 instead of $5,000
3) Inventories acquired at cost of $62,000 have a current replacement cost of $74,000.
4) Book value of office equipment is decreased by $5,000

GOOD WILL

Can be determined by considering, respectively shares owned by partners and relative bargaining ability
of parties. It can be attributable to both existing and incoming partners.

Example: Mr’H’ is admitted to the partnership of ‘F’ and ‘G’ having an adjusted capital balance of
$ 40,000 and $45,000 respectively by contributing an inventory of $25,000 value. Both parties (existing
and incoming) agreed the value of the business be $105,000.

Record the admission and subsequent events

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Example: assume that athlete Haile G/selassie wants to join an advertising partnership owned by ‘F’ and
‘G’ by contributing cash of $50,000. Haile claimed the capital balance to $120,000. Finally after a serious
of discussion, they reach a consensus to give Haile a capital balance of $100,000. Record the admission
of Haile to the partnership?

LIQUIDATION OF PARTNERSHIP

Liquidation of partnership means discontinuouing or winding up of the partnership.

Example: the partnership john, Kelly and Larson sharing net income and net loss at a ratio of 25%, 35%
and 40% discontinued their operation (business) and closed their accounts. The following are the
summery of account balances after closing necessary accounts is presented, basied on the three
independent partnership liquidation for the period covering July 1-20

Cash-------------------------------------$8,000

Non-cash assets---------------------$60,000

Liabilities---------------------------------------$16,000

John’s capital---------------------------------$23,000

Kelly’s capital---------------------------------$18,200

Larson’s capital------------------------------$10,800

Assumption: 1) if non-cash assets are sold for $68,000.

2) $ 48,000 is realized from sale of assets.

3) Only $ 12,000 is obtained from sale of non-cash assets.

Show the division of cash and non-cash assets and journalize the entry?

Events subsequent to (after) capital deficiency

Three things may occur after the capital deficiency.

1) If capital deficient partner return all the money.

2) If capital deficient partner pay only some part of his deficiency.
3) If capital deficient partner could not return only part of his deficiency (if the capital deficient
partner has a limited liabilities).

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Example: assume Larson in the above example

1) All amount of capital deficient is returned

2) If Larson gave only $6,000 and,

3) If Larson has a limited liabilities

Show the payments of capital deficiency and the journal entry?

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