ACC 4100 Chapter 14 - Partnerships: Formation & Operation

Calculations under the Goodwill Method of Recording Admission by a Contribution Made to the Partnership

Implied Value of Business = Purchase Price / Interest % Book Value = Total Capital Balances after new Partner Goodwill = Implied Value of Business - Book Value

Calculations under the Goodwill (Revaluation) Method of Recording Admission through Purchase of a Current Interest

Implied Value of Business = Purchase Price / Interest % Book Value = Total Capital Balances before New Partner Goodwill = Implied Value of Business - Book Value

Perhaps the most severe disadvantage of partnerships is the __________ that each partner automatically incurs.

unlimited liability Partnership laws specifies that any partner can be held personally liable for all debts of the business.

Limited Liability Partnership (LLP)

Significantly reduces partners' liability. Partners may incur a loss on their investment and are responsible for contractual debts of the business. In the case of *liabilities resulting from damages*, partners are responsible *only for their own acts* or *omissions plus the acts and omissions of individuals under their supervision.*

DISSOLUTION - Admission of a New Partner

An individual can gain admittance to a partnership in one of two ways: (1) by purchasing an ownership interest from a *current partner* or (2) by contributing assets directly to the business

Hybrid Method of Recording Admission of New Partner

Identifiable assets are revalued, but no goodwill is recognized.

Mutual Agency

Legal term which refers to the right that each partner has to incur liabilities in the name of the partnership.

Because income is taxable to the partners as the business earns it, any __________ can be used to reduce...

operating losses; their personal taxable income directly.

If the continuation of the business represents a legitimate transfer of property from one partnership to another...

revaluation of all accounts and recognition of goodwill can be justified.

ACCOUNTING FOR PARTNERSHIP DISSOLUTION

Any alteration in the specific individuals composing a partnership automatically leads to a legal dissolution. In many instances, the breakup is merely a prerequisite to the formation of a new partnership. Dissolution can conversely be a preliminary step in the termination and liquidation of the business (to be discussed in Chapter 15)

JE to Record Current FV of Asset in Preparation of New Partner under *Hybrid Method*

Asset Undervalued: Debit to Asset [for amount undervalued by] Credit to Jack, Capital [P/L% * undervaluation] Credit to Rose, Capital [P/L% * undervaluation] Asset Overvalued: Debit to Jack, Capital [P/L% * overvaluation] Debit to Rose, Capital [P/L% * overvaluation] Credit to Asset [for amount overvalued by]

Bonus Method of Recording Contribution of Intangible Assets

Assumes that a specialization does not constitute a recordable partnership asset with a measurable cost. Recognizes only the assets that are physically transferred to the business (such as cash, patents, and inventory).

Only a(n) __________ is necessary to create a legally binding partnership.

oral agreement;

Limited Liability Company (LLC)

Classified as a partnership for tax and court purposes. Similar to Subchapter S, but the number of owners is not usually restricted.

JE to Record Intangibles Contributed to the Formation of a New Partnership under the *Goodwill Method*

Debit to Cash and/or Asset [at FV] Debit to Goodwill Credit to Jack, Capital Credit to Rose, Capital Goodwill is recognized in contrast to a capital bonus being credited to the partners' accounts under the bonus method.

JE to Recognize Goodwill and Revaluation of Assets and Liabilities Based on Value of Business Implied by New Partner's Purchase Price

Debit to Goodwill Credit to Jack, Capital [P/L% * Goodwill] Credit to Rose, Capital [P/L% * Goodwill]

JE to Reclassify Capital to Reflect New Partner's Acquisition under *Goodwill Method*

Debit to Jack, Capital [New% * Jack's Capital after GW] Debit to Rose, Capital [New% * Rose's Capital after GW] Credit to Dawson, Capital [New% * Total Capital after GW]

JE to Reclassify Capital to Reflect New Partner's Acquisition under *Book Value Method*

Debit to Jack, Capital [New% * Jack's Capital] Debit to Rose, Capital [New% * Rose's Capital] Credit to Dawson, Capital [New% * Total Capital] *Money paid directly to partners*

2017 Tax Cuts & Jobs Act

Eligible taxpayers, including those with partnership income, may be entitled to a deduction of up to 20% of qualified income from domestic "pass-through" businesses. Partnerships (along with other tax entities) must be considered *a qualified trade or business* for their owners to benefit from the 20% deduction.

If the new partnership is merely an extension of the old...

no basis exists for restatement. The transfer of ownership is a change only in a legal sense and has no direct impact on business assets and liabilities.

For tax purposes, ownership of a partnership is labeled as __________ unless the partner materially participates in the actual business activities.

passive activity *Passive activity loss serve only to offset other passive activity profits.*

In making a transfer of ownership, a partner can actually convey only three rights, the first (two) of which every partner has the power to sell or assign at any time (unless restricted by the articles of partnership)

1. The right of co-ownership in the business property. [This right justifies the partner's periodic drawings from the business as well as the distribution settlement paid at liquidation or at the time of a partner's withdrawal. 2. The right to share in profits and losses as specified in the articles of partnership. 3 . The right to participate in the management of the business.

ALTERNATIVE LEGAL FORMS

A number of alternative types of organizations have developed with a common purpose to limit the owners' personal liability while providing the tax benefits of a partnership.

Goodwill Method of Recording Contribution of Intangible Assets

Assumes that an implied value can be calculated mathematically and recorded for any intangible contribution made by a partner. Argues that a specialization has an apparent value of that in excess of the tangible contribution of the partner contributing an intangible asset or specialization.

JE to Record Properties Contributed to the Formation of a New Partnership

Debit to Asset [at FV] Credit to Payable (if any) [at FV] Credit to Jack, Capital Credit to Rose, Capital

JE to Record Cash Contributed to the Formation of a New Partnership

Debit to Cash Credit to Jack, Capital Credit to Rose, Capital

JE to Record New Partner's Entrance into Partnership with Extra Payment Recorded as *Bonus to the Original Partners*

Debit to Cash [purchase price] Credit to Dawson, Capital [New% * Total Capital after New Partner's Payment] Credit to Jack, Capital [P/L% * (Cash - Dawson, Capital)] Credit to Rose, Capital [P/L% * (Cash - Dawson, Capital)]

JE to Record Entrance of New Partner into Partnership and *Bonus Assigned to Original Partners*

Debit to Cash [purchase price] Credit to Dawson, Capital [New% * Total Capital after Revaluations and New Partner Contribution] Credit to Jack, Capital [P/L% * (Cash - Dawson, Capital)] Credit to Rose, Capital [P/L% * (Cash - Dawson, Capital)]

PARTNERSHIP ACCOUNTING—CAPITAL ACCOUNTS

The stockholders' equity accounts of a corporation do not correspond directly with the capital balances found in a partnership's financial records. Partnerships provide only a limited equity disclosures primarily in the form of individual capital accounts that are accumulated for every partner or every class of partners.

DISSOLUTION - Withdrawal of a Partner

The withdrawal of an individual partner and the resulting distribution of partnership property can, as before, be accounted for by either the bonus (no revaluation) method, the goodwill (revaluation) method, or the hybrid (revaluation w/o goodwill) method.

Book Value Method of Recording Admission through Purchase of a Current Interest

Assumes that the new partner's purchase is carried out between the individual parties, and thus the acquisition has no impact on partnership assets and liabilities. The transfer of ownership requires a simple capital classification without any accompanying revaluation. *Similar to the bonus method for contributions made to the partnership*

Goodwill (Revaluation) Method of Recording Admission through Purchase of a Current Interest

Assumes that the new partner's purchase is occurring between two separate reporting entities, and thus necessitates the complete revaluation of all assets and liabilities.

Bonus or Goodwill Credited to New Partner

Because of an excellent professional reputation, valuable business contacts, or a myriad of other possible factors, the new partner might be able to negotiate a beginning capital balance in excess of the actual cash contribution that the new partner made.

Limited Partnership (LP)

Designed primarily for individuals who want the tax benefits of a partnership but who do not wish to work in a partnership or have unlimited liability. *A number of limited partners invest money as owners but are not allowed to participate in the company's management.* Partners can still incur a loss on their investment, but the amount is restricted to their contribution.

JE to Record New Partner's Entrance into Partnership with Goodwill Attributed to this New Partner

Debit to Cash [purchase price] Debit to Goodwill Credit to Dawson, Capital

JE to Recognize Goodwill Based on Value of Business Implied by New Partner's Purchase Price and Record the New Partner's Admission Into Partnership

Debit to Cash [purchase price] Debit to Goodwill Credit to Dawson, Capital [purchase price] Credit to Jack, Capital [P/L% * Goodwill] Credit to Rose, Capital [P/L% * Goodwill]

JE to Record New Partner's Entrance into Partnership with Reduced Payment Reported as a *Bonus from Original Partners*

Debit to Cash [purchase price] Debit to Jack, Capital [P/L% * (Dawson, Capital - Cash)] Debit to Rose, Capital [P/L% * (Dawson, Capital - Cash)] Credit to Dawson, Capital [New% * Total Capital after New Partner Contribution]

JE to Record Intangibles Contributed to the Formation of a New Partnership under the *Bonus Method*

Debit to Cash and/or Asset [at FV] Credit to Jack, Capital Credit to Rose, Capital A capital bonus will be received by the partner who contributes an intangible such as a specialization in recognition of the intangible contribution.

Uniform Partnership Act (1914, revised 1997)

Establishes uniform standards in areas such as the nature of a partnership, the relationship of the partners to outside parties, and the dissolution of the partnership.

Calculation of Goodwill Attributed to the New [Entering] Partner

Goodwill = (New% * Original Capital before New Partner Contribution) / (100% - New%) - New Partner Contribution

Subchapter S Corporation (S Corporation)

Is created as a corporation but is taxed in virtually the same way as a partnership. *To qualify, the business can have only one class of stock and is limited to 100 stockholders.* All owners must be individuals, estates, certain tax-exempt entities, or certain types of trusts.

Bonus Credited to Original Partners in Admission by a Contribution Made to the Partnership

Maintains the same recorded value for all partnership assets and liabilities despite the new partner's admittance. No need exists to recognize goodwill or revalue any of the assets or liabilities.

Goodwill Credited to Original Partners in Admission by a Contribution Made to the Partnership

Views new partner's payment as evidence that the partnership as a whole possess an actual value of Purchase Price / Interest % (implied value).

Passing income balances through to the individual partners who pay the income taxes avoids __________. A partnership's income is taxed...

double taxation; only at the time that the business initially earns it.

A partnership dissolution is a __________ change; actual operations of the business would probably...

legal; continue unimpeded by this alteration in ownership

In either of the ways that an individual is admitted, the accountant has the option, once again, .......... as in the bonus method, or .......... as in the goodwill method.

to retain the book value of all partnership assets and liabilities; revalue partnership assets and liabilities to their present FV