Kế toán, kiểm toán - Chapter fourteen: Partnerships: formation and operation

Chapter FourteenPartnerships: Formation and OperationCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.PartnershipsA partnership is defined as “an association of two or more persons to carry on a business as co-owners for profit.” (Section 6 of Uniform Partnership Act).14-2The IRS projects that by 2016, nearly 4.7 million partnership U.S. income tax returns will be filed, compared to 8.1 million corporation income tax returns. (Source: www.irs.gov)Learning Objective 14-1Explain the advantages anddisadvantages of the partnershipversus the corporate formof business.14-3Partnership AdvantagesAdvantages: Flexibility in defining relationships Profits and losses, and management operating decisions, shared independent of ownership percentages.Ease of formation and dissolution.Taxes “flow-through” to the partners.Disadvantages:Unlimited liability incurred by each partner (they are “jointly and severally” liable).Mutual agency (each partner has right to incur liabilities in the name of the partnership).Inability to participate in various corporate tax benefits14-4Alternative Legal Forms - Subchapter S CorporationLegal characteristics of a corporation.Ownership limited to 100 stockholders.Owners limited to individuals, estates, and certain tax-exempt entities and trusts (no corporate owners allowed).Profit passes to owners as a partnership.14-5Alternative Legal Forms Limited partners not allowed to participate in management.Losses are restricted for limited partners to the amount invested.Must have one or more general partners who assume responsibility for all obligations.Limited Partnership (LP)Owners: Risk their own investments.Are responsible for contractual debts of the business.Are liable only for their own acts and omissions, and those of individuals they directly supervise. Limited Liability Partnership (LLP)14-6Alternative Legal Forms – Limited Liability Company (LLC)LLC’s are a new type of organization for U.S. They have long been used in Europe and other areas. They are classified as partnerships for tax purposes. In contrast to Sub Chapter S Corporations, the number of owners is not usually restricted.Owners only risk their own investments.14-7Partnerships - Capital AccountsThe equity section of a partnership consists of capital balances for each partner.Profits/losses for each period are allocated to each partner’s capital account.Withdrawals by partners reduce their capital accounts.14-8Learning Objective 14-2Describe the purpose of thearticles of partnership and listspecific items that should beincluded in this agreement.14-9Articles of PartnershipThe Uniform Partnership Act establishes standards and rules for partnerships but a written agreement will supersede the UPA standards.Articles of partnership should always clearly describe the:• Name and address of each partner.• Business location.• Nature of the business.• Rights and responsibilities of each partner.• Initial contribution to be made by each partner and the method to be used for valuation. 14-10Articles of PartnershipArticles of partnership should always clearly describe the:Specific method by which profits and losses are to be allocated.Periodic withdrawal of assets by each partner.Procedure for admitting new partners.Method for arbitrating partnership disputes.Life insurance provisions enabling remaining partners to acquire the interest of any deceased partner.Method for settling a partner’s share in the business upon withdrawal, retirement, or death.14-11Learning Objective 14-3Prepare the journal entryto record the initial capitalinvestment made by a partner.14-12Accounting for Capital ContributionsAssume that Carter and Green form a business to be operated as a partnership. Carter contributes$50,000 in cash and Green invests $20,000. The initial journal entry to record the creation of the partnership:14-13Accounting for Capital ContributionsIf one or more of the partners transfers noncash assets, fair value is used to record the assets. Assume that Carter invests $50,000 in cash to begin the previously discussed partnership and Green contributes the following assets14-14Accounting for Capital ContributionsGreen’s building is encumbered by a $23,600 mortgage that the partnership has agreed to assume. Green’s net investment is equal to $43,400 ($67,000 less $23,600). The following journal entry records the formation of the partnership created by these contributions14-15Learning Objective 14-4Use both the bonus methodand the goodwill methodto record a partner’s capitalinvestment.14-16Accounting for Capital ContributionsContributed intangible assets require special consideration .Contributions made by one or more of the partners may go beyond assets and liabilities, for example, a particular line of expertise or established clientele. Use either the Bonus Method or Goodwill Method for recording contributed intangible assets.14-17Intangible Contributions - ExampleJames and Joyce open an advertising agency and organize as a partnership. James contributes cash of $70,000, and Joyce invests only $10,000. Joyce, however, is an accomplished graphic artist, a skill that is considered especially valuable to this business.James and Joyce have contributed a total of $80,000 in identifiable assets to their partnership and have decided on equal capital balances.14-18Intangible Contributions - Bonus Method ExampleThe bonus method simply splits the $80,000 capital evenly between the two partners. Joyce received a capital bonus of $30,000 (the $40,000 recorded capital balance in excess of the $10,000 cash contribution) from James in recognition of her artistic abilities she contributed.14-19Intangible Contributions - Goodwill Method ExampleThe goodwill method is based on the assumption that an implied value can be calculated mathematically and recorded for any intangible contribution made by a partner. In the present illustration, Joyce invested $10,000 cash, $60,000 less than James, but receives an equal amount of capital according to the partnership agreement.14-20Intangible Contributions - Goodwill Method ExampleJoyce’s artistic talent has an apparent value of $60,000, a figure that should be included as part of this partner’s capital investment. If not recorded, Joyce’s primary contribution to the business is ignored completely within the accounting records.14-21Learning Objective 14-5Demonstrate the impact thatthe allocation of partnershipincome has on the partners’individual capital balances.14-22Allocation of Income Partnership revenues and expenses must be closed out at the end of each fiscal period and the net income allocated to each partners’ capital account. A method must be devised for assignment of income.Articles of partnership should stipulate an established procedure.If no arrangement is specified, state partnership laws dictate that all partners receive an equal allocation of income or loss. 14-23Allocation of Income -- ExampleAssume that Tinker, Evers, and Chance form a partnership by investing cash of $120,000, $90,000, and $75,000, respectively.Evers will be allotted 40 % of all profits and losses because of previous business experience. Tinker and Chance are to divide the remaining 60 % equally. This agreement also stipulates that each partner is allowed to withdraw $10,000 in cash annually from the business.Net income for the period is $60,000.14-24Allocation of IncomeExample14-25Learning Objective 14-6Allocate income to partnerswhen interest and/or salaryfactors are included.14-26Allocation of IncomeThe allocation of income is not necessarily based on the relative capital balances.It is a separately negotiated item.Allocated compensationBonusesRemaining incomeInterest on beginning capital balancesItems to be allocated:14-27Alternative Technique-1Assume the original facts for the Tinkers, Evers, and Chance partnership except an articles of partnership agreement credits each partner annually for interest equal to 10 % of that partner’s beginning capital balance for the year. Evers and Chance will also be allotted $15,000 each as a compensation allowance in recognition of their participation in daily operations.Any remaining profit or loss will be split 4:3:3, with the largest share going to Evers because of the work experience that this partner brings to the business.14-28Alternative Technique- 114-29Alternative Techniques- The assignment process is merely a series of mechanical steps reflecting the change in each partner’s capital balance resulting from the provisions of the partnership agreement. The number of different allocation procedures that could be employed is limited solely by the partners’ imagination. Although interest, compensation allowances, and various ratios are the predominant factors encountered in practice, numerous other possibilities exist. 14-30Learning Objective 14-7Explain the meaning ofpartnership dissolution andunderstand that a dissolution will often have little or no effect on the operations of thepartnership business.14-31Legal DissolutionAny alteration in the specific individuals composing a partnership results in “legal dissolution”DeparturesRetirement DeathAdmission (including promotion) of a New PartnerImmediate formation of a new partnership as business continuesNew partner acquires partnership interest by: Purchasing it from the other partners, or making a contribution to the partnership.14-32Learning Objective 14-8Prepare journal entries torecord the acquisition by anew partner of either all or aportion of a current partner’sinterest.14-33These two rights can be sold (unless restricted by the articles of partnership).This right cannot be sold without the other partners’ approval.Admission of a New Partner - The Rights of a PartnerAn individual partner’s ownership rights include:The right to co-ownership in the business property.The right to share in profits and losses as specified in the partnership agreementThe right to participate in the management of the business.14-34Admission of a New Partner - Purchase of a Current InterestA new partner can purchase partnership interest directly from the existing partners.The cash goes to the partners, not the partnership.Two methods are available to account for the transfer of ownership:Book Value ApproachGoodwill (Revaluation) Approach14-35Admission of a New Partner - Purchase of a Current InterestAssume Scott, Thompson, and York formed a partnership, and subsequently, York decides to leave the partnership. He offers to sell his interest to Morgan. Although York may transfer the right of property ownership as well as the specified share of future profits and losses, the partnership does not automatically admit Morgan. York legally remains a partner until such time as both Scott and Thompson agree to allow Morgan to participate in the management of the business.14-36Admission of a New PartnerPurchase of a Current InterestBook Value Approach Instead of York selling his interest to Morgan, each of these three partners elects to transfer a 20 percent interest to Morgan for a total payment of $30,000 in a simple capital reclassification. The money is paid directly to the owners.14-37Admission of a New Partner - Purchase of a Current InterestGoodwill Approach Scott, Thompson, and York is transferring all assets and liabilities to the partnership of Scott, Thompson, York, and Morgan. The goodwill method recognizes the transaction as occurring between two separate reporting entities that necessitates the complete revaluation of all assets and liabilities.14-38Learning Objective 14-9Prepare journal entries torecord a new partner’s admission by a contribution made directly to the partnership.14-39Admission of a New Partner - Contribution to the PartnershipThe new partner can also gain partnership interest by contributing cash to the partnership.Remember that the new cash will increase the partnership’s net assets.Two methods are:Bonus ApproachGoodwill Approach14-40Admission of a New Partner - Contribution to the PartnershipAn outsider may be admitted to a partnership by contributing directly to the business. Assume King and Wilson maintain a partnership and presently report capital balances of $80,000 and $20,000, respectively. According to the articles of partnership, King is entitled to 60 % of all profits and losses with the remaining 40% credited each year to Wilson. Goldman can enter the partnership for $20,000 cash with the money going into the business. Goldman receives an initial 10 percent interest in partnership property.14-41Admission of a New Partner - Contribution to the PartnershipBonus Credited to Original PartnersGoodwill Credited to Original Partners14-42Admission of a New Partner - Contribution to the PartnershipHybrid Method 14-43Admission of a New Partner - Contribution to the PartnershipBonus or Goodwill Credited to New Partner14-44Learning Objective 14-10Prepare journal entries torecord the withdrawal of acurrent partner.14-45Withdrawal of a Partner The Withdrawing Partner is paid out in accordance with the Partnership Agreement. Using the Bonus Method, any amount paid in excess of that partner’s capital account is allocated against the remaining partners’ capital accounts. Using the Goodwill Method, the books are first adjusted to FMV, with a proportion of the increase allocated to each partner’s account. The withdrawing partner is then paid based on the balance in the individual capital account.14-46Withdrawal of a Partner Goodwill Method AppliedBonus Method Applied14-47Withdrawal of a Partner Hybrid Method Applied14-48