zChap. 15 Partnerships: Formation, Operation, and Dissolution
steps for Goodwill Method
1) Find Capital Balance of new Partner 2) Find Implied Value of the new Parntership 3) Find Implied Goodwill 4) Allocate the Goodwill to existing partners based on Income sharing and update capital balances of partners 5) Allocate the % of each exisiting partners new capital balance to the new partner
Steps to using Goodwill Approach: Investment > Book Value
1) Find Net assets after the contribution 2) Find Implied Value of partnership = [investment/ % going to partner] 3) Find Implied Goodwill [Implied Value - New Net Assets] 4) Record Goodwill with a debit and allocate the goodwill among the existing partners based on their shares 5) Cash contribution is debited to cash and credit to new partner's capital balance
Steps to using Goodwill Approach: Investment < Book Value
1) Net Assets after Contribution 2) Implied Value of new Partner [Current Net Assets of partners/ % share of partners less share of new partner] 3) Implied Goodwill of new Partner [New net assets - Implied value of new partner] 4) Dr. Cash and Goodwill, credit Capital account of new partner
Other major characteristics of partnerships
1) Partnership Agreement 2) Partnership as a separate entity 3) Partner as an agent of the partnership 4) Statement of partnership authority 5) Partner's liability is joint and several 6) Partner's rights and duties 7) Partner's transferable interest in the partnership 8) Partner's dissociation
Partner's liability is joint and several
all partners are liable jointly and severally for obligations of the partnership unless otherwise provided by law
Partnership
an association of two or more persons who are co-owners of a business and share profits and losses agreed upon -easy to form and allows several individuals to combine their talents and skills in a particular business venture
Statement of partnership authority
describes the partnership and identifies the specific authority of partners to transact specific types of business on behalf of the partnership -filed with secretary of state
In order to carry on as co-owners........
each partner has the apparent authority, unless restricted by the partnership agreement, to act as an agent of the partnership for the transactions in the ordinary course of business
Limited Partnership (LP)
has at least one general partner and one or more limited partners -General partner is personally liable for the partnership's obligations and has management responsibility -Limited partners are liable only to the extent of their capital contributions; no management authority
Limited Liability Limited Partnership (LLLP)
limited partnership may elect to become a LLLP; each partner is liable only for the business obligations of the partnership not for acts of wrongdoing
Partner's Dissociation
the partner can no longer act on the firm's behalf
Business for profit
the partnership must attempt to make a profit; therefore, not-for-profit entities, such as fraternal groups, may not organize as partnerships
Dissociation of a partner
the retirement or withdrawal of a partner from a partnership - can be do to death or required by law -doesn't necessarily mean that the business is over -partnership can purchase the dissociated partner's interest at a buy out price -partners who simply wish to leave may be liable to the partnership for damages caused by a wrongful dissociation
Goodwill Method (Revaluation Method)
Non-GAAP -Record the tangible assets contributed -record contributed intangible asset as the difference between the contributed tangible assets and the implied value of the partnership
Why do partnerships have more flexibility to select accounting methods than Corporations?
Partnerships do not issue stock, so accounting information are mostly useful for internal purposes and do not require GAAP methods -if they do choose to provide external information, they need to use GAAP methods
deficiencies
a partner's capital account with a debit balance usually resulting from the partner's shares of losses and withdrawals exceeds their capital contribution and share of profits
Partnership as a separate entity
a partnership is a separate business entity distinct from its partners -entity concept: partnership can sue or be sued and its property belongs to partnership, not to the individual partners
Partner's rights and duties
each partner is to have a capital account showing the amount of his or her contributions to the partnership, net of any liabilities, and the partner's share of the partnership profits/losses, less any distributions -partners are entitled to equal shares or profits/losses -new partners can be admitted with consent of the other partners -right to access records and books -has a duty to act on behalf of the partnership in good faith and fair dealing
Why is proper accounting important in a partnership
even though there are no shareholders to report to, as a partner, you are concerned over -fair contribution of effort across partners -potential litigation resulting from joint & several liability -fair distribution of resources to partners (esp. you)
Drawing Accounts
used to record periodic withdrawals and is then closed to the partner's capital account at the end of the period -noncash drawings are valued at their at their market value
Capital accounts
used to record the initial investment of a partner, any subsequent capital contributions, profit or loss distributions, and any withdrawals of capital by the partner -deficiencies usually eliminated by additional capital contributions
To the extent possible limitation
when a "limit" provision exists, the next lower level method of sharing can be reached if and only if there is still unallocated profit remaining after dealing with the current level
Buyout < Price Capital credit
can result if liquidation values of net assets are less than their book value or if dissociating partner wants to leave badly -partnership should evaluate its net assets to determine impairments or write-downs -if no revaluation is necessary, the difference is distributed as a capital adjustment to remaining partners in their respective profit ratios
International Financial Reporting Standards for small and medium size enterprises (IFRS SMEs)
defined as those entities that 1) do not have public accountability (no stock) 2) publish general-purpose financial statements for external users
Limited Liability Partnerships (LLP)
each partner has some degree of liability shield -no general or limited liability partners so each partner has the rights and duties of a general partner but limited legal liability -not personally liable for partnership obligations (some states vary)
Non cash drawings should be valued at their ________
market values at the date of the withdrawal
Partner's transferable interest in the partnership
partner is not co-owner of any partnership property, the only transferable interest of a partner is his or her share of the profits and losses of the partnership and the right to receive distributions, including any liquidating distribution
Buyout > Partner's capital credit
payments above dissociating partner's capital credit is a capital adjustment to the partner from the capital accounts of the remaining partners
The purchase of an interest from one or more of a partnership's existing partners is a .....
personal transaction between the incoming partner and the selling partner -only entry required on partnership books is to transfer an amount from the selling partner's capital account to the new partner capital's account
New partner acquires partnership interest by.....
purchasing it from the other partners OR Making a contribution to the partnership
Preselected ratios
results from negotiations between partners -ratios may be based on the percentage of total partnership capital, time, and effort invested in the entity, or a variety of other factors
Why use Goodwill Method?
so that if there were a gain or loss, the new partner admitted would not be affected by G/L
association of two or more persons
the "persons" may be individuals, corporations or other partnerships
Partnership Agreement
the Uniform Partnership Act of 1997 (UPA) governs in those partnership relations that are not specifically presented in the partnership agreement -several provisions of UPA aren't waivable by partnership agreement
Partnership should include the following items.....
-name of partnership and name of its partners -type of business to be conducted and the duration of the partnership agreement -the initial capital contribution of each partner and the method by which to account for future capital contributions -a complete specification of the profit/loss distribution, including salaries, interest on capital balances, bonuses, limits on withdrawals in anticipation of profits, and the percentages used to distribute any residual profit or loss -procedures used for changes in partnerships, such as admission of new partners and the retirement of a partner -other aspects of operations the partners decide on, such as each partner's management rights and the election procedures and accounting methods to use
Steps to using Bonus Approach when Investment>Book Value
1) Calculate net assets when you include new partner's investment 2) Using new net assets, calculate the credit to capital balance of new partner 3) Allocate the remaining amounts to existing partners (credit their capital accounts)
Steps for Bonus Method
1) [Record value of prior partnership] * [% share going to new partner] = capital balance of new partner 2) transfer amounts from old partners capital balances
Two ways to account for Capital Contributions
Bonus Method Goodwill Method
Journal Entry for recording buyout price = partner's capital
DR. dissociating partner's capital account CR. Cash for same amount
When Partnership forms: If the partners each contribute cash......
Dr. Cash Cr. Capital-Partner A Cr. Capital-Partner B
Journal Entry to record a loan agreement with Partner A
Dr. Cash Cr. Loan Payable to Partner A
When Partnership forms: If partners contribute cash or other assets....
Dr. Cash and contributed assets @FMV Cr. Capital-Partner A Cr. Capital-Partner B
Journal Entry for a cash withdrawal
Dr. Drawing-Partner A Cr. Cash
JE to record interest on loan agreement to Partner A
Dr. Operating Expense Cr. Cash/Int Payable
Loan accounts
a loan from a partner is shown as a payable on the partnership's books -unless all partners agree otherwise, the partnership is obligated to pay interest on the loan
Admitting New partner: Contribution to the partnership
a new partner can gain partnership by contributing cash to the PARTNERSHIP. -this will increase the partnership's net assets
Possible methods to account for contributions to the partnership
-Bonus Approach -Goodwill Approach -Asset Revaluation Approach
Finding Implied Goodwill
Implied Value of Partnership - BV of Current Net Assets
Bonus Method
Increases partnership's capital for the capital amount the new partner invests (GAAP) -Record the tangible assets contributed -adjust the partner capital balances to the relative value of the intangible asset
Implied Value of new partnership
Investment of new partner/% share going to new partner
If a partnership lends money to a partner, how would it be accounted for?
It would be recorded as a Loan Receivable from the partner and a credit to cash; likewise interest is obligated to be paid and Interest Revenue would be recorded.
Types of Limited Partnerships
Limited Partnership Limited Liability Partnerships Limited Liability Limited Partnership
How do you achieve proper accounting?
-meticulous detail in partnership agreement -knowledge of Uniform Partnership Act of 1997 -Focus on your interests (and understanding of other's interests) when deciding/negotiating accounting methods (aided by knowledge of US GAAP)
Reasons why a new partner would pay more for their share than what they're getting in their beginning capital balance account?
-Could be an unrecognized Goodwill -Could be undervalued tangible assets
What helps with determining the fair distribution of resources among partners?
-Proper valuation of and accounting for partnership's formation -Proper accounting for partnership's operations -Proper year end accounting for partnership's profit/loss and capital distributions
Possible ways to share profits and losses
-Ratios -Salary allowances and ratios -imputed interest on capital, salary allowances, and ratios -capital balances only -performance methods
3 types of Partners' Accounts
-capital account -a drawing account (a temporary contra capital account) -a loan account (usually earns interest-a partnership expense)
Advantages of a partnership?
-easy to form -allows several individuals to combine their talents and skills in a particular business venture -can be a formal or informal agreement; however a written agreement should be created to avoid problems in the future -Single Taxation
A partner is dissociated from any of the following reasons
-he/she gives notice to the partnerships of their will to withdraw as a partner -the firm expels them from the firm in accordance with the partnership agreement,typically for violating some part of the partnership agreement or his or her continuance becomes unlawful -one of several judicial determinations occurs (committing a material breach or conduct resulting in adverse effects) -the partner becomes a debtor in bankruptcy -the partner dies