Partnerships

When an existing partnership admits a new partner, the purchase price paid (ie, contribution received) does not always equal the book value (BV) of the capital account purchased.

Accounting for the admission depends on which of three methods is used: bonus, exact, or goodwill.

If the bonus method is used to record the admission and the purchase price is more than the BV of the new partner's capital account, a bonus is paid to the old partners; if it is less, a bonus is paid to the new partner.

Allocation of any bonus is based on the old profit and loss ratio of the existing partners.

On the date of contribution, each partner's capital account (ie, equity) is credited for the fair value (FV) of the assets (original cost and carrying values are irrelevant).

An exception to the FV treatment occurs if a noncash asset (eg, a building) contributed is subject to a liability (eg, a mortgage) that is assumed by the partnership. In this case, the contributing partner's capital account is credited for the FV of the noncash asset less the present value of the liability.

if the partners agree to divide the initial capital equally, but all the partners do not contribute equal amounts, the difference must be addressed.

For example, one partner may have essential skill sets but lacks sufficient assets to contribute. Similar to admitting a new partner to an existing P/S, the bonus method can be used to account for the difference.

The liquidation process begins with selling the noncash assets and allocating any gain or loss on the sale to the partners based on their profit ratios. After the partnership's debts are satisfied, the remaining cash is distributed to the partners based on their updated capital accounts.

If a partner owes money to the partnership (eg, a loan) and does not repay it, the unpaid balance reduces the amount of cash distributed to that partner.

When forming a partnership, each partner contributes cash and/or assets in exchange for an interest in the partnership. Each partner's capital account is credited for the fair value of the assets contributed.

If an asset is subject to a liability that the partnership assumes, the fair value is reduced by the present value of the liability.

Partners are allocated a portion of the partnership's net income/loss in accordance with the partnership agreement. The allocation may include salary and/or interest allowances that are considered before dividing the net income/loss.

If the allowances exceed net income, the resulting loss is divided according to the loss ratios.

The bonus method requires a revised allocation of capital balances for both the new partner and the old partners based on the difference between the BV of the capital account purchased and the new partner's contribution (ie, the purchase price).

If the contribution is more than the BV of the new partner's capital account, a bonus is paid to the old partners; if it is less, a bonus is paid to the new partner. The old profit and loss ratio is used to allocate the bonus.

When a new partner is admitted to a partnership, the purchase price of the capital account may differ from its book value. If the goodwill method is used, the total value of the partnership is implied by the new partner's contribution.

If the existing partners' capital accounts do not equal their pro rata share of the implied book value, goodwill is recorded for the difference.

When forming a partnership (P/S), each partner contributes cash and/or other assets in exchange for an interest in the P/S. On the date of contribution, each partner's capital account (ie, equity) is credited for the fair value of the assets.

In general, the amount of each partner's capital account (ie, ownership) does not have to be equal (eg, 70% and 30% ownership).

Red and White formed a partnership in Year 2. The partnership agreement provides for annual salary allowances of $55,000 for Red and $45,000 for White. The partners share profits equally and losses in a 60/40 ratio. The partnership had earnings of $80,000 for Year 3 before any allowance to partners. What amount of these earnings should be credited to each partner's capital account?

Red = $43,000 White = $37,000

Partners are allocated a portion of the partnership's net income/loss in accordance with the partnership agreement.

Special allocations and allowances are considered before dividing the net income/loss. If the allocations and allowances exceed net income, the resulting loss is divided according to the partners' stated ratios.

When property other than cash is contributed to a partnership, the contributing partner's capital account should be credited for the fair value of the property at the date of contribution.

The amount will be reduced by any obligations assumed by the partnership, such as a mortgage on a building.

When a partner retires, the partnership's assets and liabilities are revalued at fair value to determine the current value of the partner's interest. Under the bonus method, if the retiring partner receives more than the balance in their capital account, the excess is a bonus from the remaining partners.

The capital balances of the remaining partners are reduced according to their new profit and loss percentages.

The partner who contributed more is considered to have paid a bonus to any partner making a lower contribution, resulting in equal capital accounts.

The difference is not treated as a debit to an unidentifiable asset, but as an additional credit to the capital account of the partner(s) receiving the bonus (ie, reduce the capital of the partner[s] paying the bonus and increase the capital of the partner[s] receiving the bonus)

The goodwill method is based on the total value of the partnership implied by the new partner's contribution (investment divided by share of new partner). If the existing partners' capital accounts do not equal their pro rata share of the implied BV, goodwill is recorded for the difference.

The old partners' capital balances are increased by the goodwill according to their old profit ratios.

When forming a partnership, if the partners agree to divide initial capital equally, but all the partners do not contribute equal amounts, the difference is considered a bonus.

Under the bonus approach, no asset is debited for the difference. Instead, the partner(s) receiving the bonus has an increased credit to its capital account.

The contributing partner's capital account is credited for the fair value of the noncash asset

less the present value of the liability assumed.