Advanced Chapter 14 - Partnerships Formation and Operation

Bonus allocation for dissolution

Attributed to either remaining partners or withdrawing partner

Two methods used to establish capital accounts:

Bonus Method and Goodwill Method

Methods used to for dissolution

Bonus, Goodwill, or Hybrid

Variation of allocation possibility

Consideration based on interest and compensation allowance for hours worked or level of partner's business expertise - Income includes interest based on beginning balance and compensation allowance - remaining profit/loss is allocated based on %

Bonus = **applies whether purchase of percentage, cash contribution, or hybrid method

Difference between the amount credited to the new owner and the amount contributed

Reclassification Entry - Goodwill Method (1) purchase ownership percentage from current partner

Dr. A, B, C Capital for % new interest * capital balances Cr. New, Capital for % new interest * implied value

Bonus Method JE for admission of a new partner (1) purchase ownership percentage from current partner

Dr. A, Cap Dr. B, Cap Dr. C, Cap Cr. New, Cap - percent = for amount determined to be allocated - credit = % interest allocated * total debits

Reclassification Entry - Goodwill Method (2) contribution made to partnership

Dr. Cash Cr. New, Cap (cash amount)

Hybrid method JE (reallocation):

Dr. Cash Cr. New, Cap (new % * total implied value) Cr. A, Cap (profit loss % * bonus) Cr. B, Cap (profit loss % * bonus)

Bonus Method JE for admission of a new partner (2) contribution made to partnership

Dr. Cash (amount donated) Cr. New, Cap (% gained * total capital after contribution) Cr. A, Cap (profit loss % * bonus) Cr. B, Cap (profit loss % * bonus)

Goodwill Method - Recognize Goodwill - Withdrawing

Dr. Goodwill Cr. A, Cap (profit loss % * goodwill) Cr. B, Cap (") Cr. C, Cap (")

Goodwill entry for admission of a new partner (2) contribution made to partnership

Dr. Goodwill Cr. A, Cap (profit loss % * goodwill) Cr. B, Cap (profit loss % * goodwill)

Goodwill entry for admission of a new partner (1) purchase ownership percentage from current partner

Dr. Goodwill Cr. Capital accounts for each partner - allocation percent based on profit/loss ratio

Assignment of Income JE

Dr. Income Summary Cr. A, Capital Cr. B, Capital Cr. C, Capital

Goodwill Method - Revaluation of Land - Withdrawing

Dr. Land Cr. A, Cap (profit loss % * revaluation) Cr. B, Cap (") Cr. C, Cap (")

Hybrid Method - Withdrawing

Dr. Land Cr. A, Cap (profit loss % * revaluation) Cr. B, Cap (") Cr. C, Cap (")

Hybrid method JE (revaluation):

Dr. Land Cr. A, Cap (profit loss % * revaluation) Cr. B, Cap (profit loss % * revaluation)

Bonus Method - Withdrawing

Dr. Withdrawing Partner (capital balance) Dr. A, Cap (5/8 * extra FV) Dr. B, Cap (3/8 * extra FV) Cr. Cash (full amount of debits)

Goodwill Method - Pay Withdrawing Partner - Withdrawing

Dr. Withdrawing Partner, Cap Cr. Cash (amount paid)

Assets contributed are reported at ________

Fair Value - because partnerships can be viewed as a separate entity because it has legal ownership of its assets and can initiate lawsuits BUT: - an argument can be made that it should be reported at Book Value because it is an arm's-length transaction (but that would be unfair to the partner with appreciated property)

Goodwill = (1) purchase ownership percentage from current partner

Implied Value - Book Value

Goodwill = (2) contribution made to partnership

Implied Value - NEW Book Value after contribution

Admission through purchase of a current interest is common when:

In businesses that rely on capital rather than expertise

Articles of Partnership

Legal document that forms central governance for the partnership's operations - accounting guidance

Capital Bonus (bonus method)

Only debit cash and increase capital accounts by specified percentage of that cash = amount allocated to partner > cash contributed

Recording additional capital contributions

Record as increment in partner's capital based on fair value

Recording withdrawals

Recorded initially in separate drawing account that is closed at year-end: Dr. A, Drawing Dr. B, Drawing Cr. Cash Large withdrawals (i.e. reduced investment) are allowed by prior approval by other partners

"Bonus method" - Admission of a new partner (1) purchase ownership percentage from current partner

Retain book value of partnership assets - business not involved directly and current partners just transfer some interest a new one - should the dissolved partnership be considered the same entity as the newly formed one?

"Goodwill method" - Admission of a new partner (1) purchase ownership percentage from current partner

Revalue assets to present fair value - should the dissolved partnership and newly formed one be considered 2 separate entities? - this method is justified when the continuation of the business represents a legitimate transfer of property from one partnership to another

Hybrid method:

Revalue identifiable assets, but don't record goodwill

Which right has to be consented by all partners?

Right to participate in management (other 2 can be bought/sold any time)

Liquidation

Sell properties, pay debts, distribute remaining assets to partners

___________ replaces Statement of Retained Earnings

Statement of Partner's Capital

Reason for additional capital contributions

Stimulate expansion or overcome working capital shortages

_________ and _________ are two separate decisions

- Assignment of income or loss (after partnership revenues and expenses are closed out) - Setting of withdrawal limits

Importance of Capital Account Balances:

- Totals influence assignment of profits and losses to partners - Balance is one factor in determining final distribution at time of withdrawal or retirement - Ending balance indicates allocation that remains after liquidation of partnership

Bonus Method basics

- artistic ability is not recordable partnership asset with measurable costs - physical contributions determine total partnership capital, but specific balances is a separate process based on the agreement ~capital balances don't correspond with individual investments~

Goodwill Method basics

- calculate and record implied value for intangible contributions made by partner - artistic value has apparent value = cash paid by other partner - cash paid by artistic partner - partnership goodwill has no historical cost like normal goodwill and has no objectively verifiable base - based solely on agreement between partners

Advantages of Partnerhips

- easy to form (only oral agreement needed) - revenues/expenses flow to owners who pay income taxes (not double taxed) - operating losses can offset personal income of the partner (usually passive so limited to passive income)

Limited Partnership (LP)

- partners invest money but can't manage - loss restricted to what was invested - 1+ partners designated to assume liability for all business oblgations

Limited Liability Company (LLC)

- partnership for tax purposes - liability is limited to own investments - number of owners not usually restricted

Limited Liability Partnership (LLP)

- partnership with reduced liability - partners responsible for contractual debts - liability limited to damages from own acts or omissions and those under subervision ~most accounting firms~

Three Rights Conveyed

- right of co-ownership of business property - right to share in profits and losses specified in AOP - right to participate in management

S Corporation

- taxed like a partnership (flow-through) - only 1 class of stock allowed - limited to 100 stockholders - owners must be individuals, estates, types of tax-exempt entities, or types of trusts - limited growth

2 ways to admit a new partner

1) purchasing an ownership percentage from a current partner 2) contributing assets directly to the business

Implied Value - GW Method

= Payment received / % interest earned

Goodwill allocation for dissolution

Allocate to all partners

Hybrid Method - Bonus =

Amount Paid - New Capital Balance ---> distribute to remaining partners based on their new profit/loss percentage

Although the methods of recording a withdrawal change, _____________ is never in dispute

Amount of payment to withdrawing partner Amount = Capital Balance + (profit loss % * change in fair value)

Dissolution

Any alteration in individuals composing the partnership; mainly just a legal change

Admission by Contribution = contributing cash to ________

The business, not the partners

Once assets are contributed by a partner, ________

The partner holds no further right to them (FV of those assets = ownership interest in the business as a whole)

Need to do algebra when.....

There is bonus or goodwill credited to the new partner as well Just credit new partner's account for higher % owned * total new capital ALGEBRA: used to determine goodwill

Disadvantages of Partnerships

Unlimited liability incurred by partners - all debts of the business (mutual agency) - partners can obligate the company for any amount when acting within normal scope of business

Recognition of Goodwill indicates:

Unrecorded gains have accrued to the business during the previous years of operation

Assignment percentages based on:

trying to reward partners for contributions to the firm's success - or assign equally to avoid complication