Click To Edit Master Title Style: Accounting For Partnerships and Limited Liability Companies

1
CHAPTER
Click to edit Master
Accounting fortitle style
12 Partnerships and Limited
Liability Companies
Accounting
27e
human/iStock/360/Getty Images
Warren
Reeve 1
Duchac
2
Click to edit Master title style

After studying this chapter, you should
be able to:
1. Describe the basic characteristics of
proprietorships, partnerships, and
limited liability companies.
2. Describe and illustrate the accounting
for forming a partnership and for
dividing the net income and net loss
of a partnership.
2
3

After studying this chapter, you should
be able to:
for partner admission and withdrawal.
for liquidating a partnership.
5. Prepare the statement of partnership
equity.
3
4
12-1
Objective
Objective 11
Describe the basic
characteristics of
proprietorships,
partnerships, and limited
liability companies.
4
5
Proprietorships, Partnerships, and

Limited Liability Companies
• The four most common legal forms for
organizing and operating a business are as
follows:
– Proprietorship
– Corporation
– Partnership
– Limited liability company
5
©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Proprietorships, Partnerships, and Limited Liability
Companies
Proprietorship Partnership
Most common legal
forms for organizing
and operating a
business
Limited liability
Corporation
company
© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
7
12-1
Proprietorship
A proprietorship is a business
enterprise owned by a single individual.
Most common are professional service
providers, such as lawyers, architects,
realtors, and physicians
7
8
12-1
Click to edit
Proprietorship
Advantages
Master title style
Disadvantages
• Simple to form • Difficulty in raising
• There are no legal large amounts of
restrictions or forms to file.
capital
• Ability to be one’s own
• Unlimited liability
boss • The owner is
• Not taxable personally liable for
• For federal income tax
any debts or legal
purposes, a proprietorship is
not taxed. Instead, the
claims against the
proprietorship’s income or business.
loss is “passed through” to • Limited life
the owner’s individual 8
income tax return.
9
12-1
Partnership
A partnership is an association of
two or more individuals who own
and manage a business for profit.
Partnerships are less widely used

than proprietorships.
9
10
12-1
Partnership
A partnership is an association of
two or more individuals who own
and manage a business for profit.
Advantages Disadvantages
• More financial • Limited life
resources than a • Unlimited liability
proprietorship • Co-ownership of
• Additional partnership property
management skills • Mutual agency
10
11
Characteristics of Partnerships
Voluntary
Voluntary
Association Limited
Limited
Association Partnership Life
Partnership Life
Agreement
Agreement
Taxation
Taxation
Mutual
Mutual Unlimited
Unlimited
Agency
Agency Liability
Liability 11
12
12-1
Partnership
 An important right of partners is to

participate in the income of the
partnership.
 A partnership, like a proprietorship, is a
nontaxable entity.
 A partnership is created by a contract,
known as the partnership agreement or
articles of partnership.
12
13
Partnerships
(slide 2 of 3)
• Characteristics of a partnership include the following:
– Moderately complex to form
• A partnership is often formed with a partnership agreement.
– A partnership agreement includes matters such as amounts to be invested, limits on
withdrawals, distributions of income and losses, and admission and withdrawal of
partners.
– No limitation on legal liability
• The partners are personally liable for any debts or legal claims against the partnership.
– Not taxable
• For federal income tax purposes, a partnership is not taxed. Instead, the proprietorship’s income
or loss is “passed through” to the partners’ individual income tax returns.
– Limited life
• When the owner dies or retires, the partnership ceases to exist.
– Limited ability to raise capital (funds)
• The ability to raise capital (funds) for the partnership is limited to what the partners can provide
from personal resources or through borrowing.
13
14
Limited
Click Liability
to edit Master Companies
title style
(slide 1 of 2)
• A limited liability company (LLC) is a form
of legal entity that provides limited liability to
its owners but is treated as a partnership for
tax purposes.
• The LLC organizational form is popular for
small businesses.
14
Limited Liability Companies (1 of 3)
• Form of legal entity that provides

limited liability to its owners
• Treated as a partnership for tax
purposes
• LLC organizational form is popular for
small businesses
© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
16
12-1
 Combines the advantages of the corporate

and partnership forms.
 LLCs must file “articles of organization”
with state governmental authorities.
 Owners are termed “members” rather than
“partners.”
 Members must create an operating
agreement.
(Continued) 16
9
17
12-1
 An LLC may elect to be treated as a

partnership for tax purposes.
 Most operating agreements specify
continuity of life for the LLC, even when
a member withdraws.
 Members may elect operating the LLC as
a “member-managed” entity.
 An LLC provides limited liability for the
members.
17
18
Limited
Click Liability
title style
(slide 2 of 2)
• Characteristics of an LLC include the following:
– Not taxable
• An LLC may elect to be treated as a partnership for tax purposes.
Thus, income passes through the LLC and is taxed on the
individual members’ tax returns.
– Unlimited life
• Most LLC operating agreements specify continuity of life for the
LLC, even when a member withdraws or new members join the
LLC.
– Moderate ability to raise capital (funds)
• Because of their limited liability, LLCs are attractive to many
investors, thus allowing for greater access to capital (funds) than is
normally the case in a partnership. 18
19
Limited
Click Liability
title style
(slide 2 of 2)
• Characteristics of an LLC include the following:
– Moderately complex to form
• An LLC requires an agreement among the owners, who
are called members.
– The operating agreement includes matters such as
amounts to be invested, limits on withdrawals,
distributions of income and losses, and admission
and withdrawal of partners.
– Limited legal liability
• Only the members’ investments in the company are
subject to claims of creditors. 19
20
12-1
Click2 to edit Master title style
Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
Ease of Formation
Proprietorship Simple
Partnership Moderate
LLC Moderate
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11
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12-1
Characteristics of
Legal Liability
Proprietorship No limitation
Partnership No limitation
LLC Limited liability
21
12
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12-1
Characteristics of
Limitation on Life of Entity

Proprietorship Yes
Partnership Yes
LLC No
22
14
23
12-1
Characteristics of
Taxation
Proprietorship Nontaxable*
Partnership Nontaxable*
LLC Nontaxable**
*Pass-through entity
**Pass-through entity by election
23
13
24
12-1
Characteristics of
Access to Capital
Proprietorship Limited
Partnership Limited
LLC Average
24
15
25
Characteristics of
Proprietorships,
Partnerships,
title style
and
25
26
Organizations with Partnership

Characteristics
Limited
Limited Limited
Limited
Limited
Limited Liability
Liability Liability
Liability
Partnerships
Partnerships Partnerships
Partnerships Corporations
Corporations
•• General
Generalpartners
partners •• Protects
Protectsinnocent
innocent •• Owners
Ownershave
havesame
same
assume
assumemanagement
management partners
partnersfrom
from limited
limitedliability
liabilityfeature
feature
duties
dutiesand
andunlimited
unlimited malpractice
malpracticeoror as
asowners
ownersof ofaa
liability
liabilityfor
forpartnership
partnership negligence
negligenceclaims.
claims. corporation.
corporation.
debts.
debts.
•• Limited
Limitedpartners
partnershave
have •• Most
Moststates
stateshold
holdall
all •• AAlimited
limitedliability
liability
no
nopersonal
personalliability
liability partners
partnerspersonally
personally corporation
corporationtypically
typically
beyond
beyondinvested
invested liable
liablefor
forpartnership
partnership 26
has
has a limitedlife.
a limited life.
amounts.
amounts. debts.
debts.
27
12-1
Limited Partnership
A variant of the regular

partnership is a limited
partnership. This form of
partnership allows partners who
are not involved in the
operations of the partnership to
retain limited liability.
27
28
Click
Choosing
to edita Master
Business
title
Form
style
Proprietorship Partnership LLP LLC S Corp. Corporatio
Business entity yes yes yes yes yes yes
Legal entity no no no yes yes yes
Limited liability no no limited* yes yes yes
Business taxed no no no no no yes
One owner allowed yes no no yes yes yes
*A partner's personal liability for LLP debts is lim ited. Most LLPs carry insurance to protect against
m alpractice.
Many
Many factors
factors should
should be
be
considered
considered when
when
choosing
choosing the
the proper
proper
business
business form.
form.
28
29
12-2
Objective
Objective 22
Describe and illustrate the
accounting for forming a
partnership and for dividing
the net income and net loss
of a partnership.
29
30

Organizing title style
a Partnership
Partners
Partners can
can invest
invest both
both assets
assets and
and liabilities
liabilities in
in the
the
partnership.
partnership.
Assets
Assets and
and liabilities
liabilities are
are recorded
recorded at
at an
an agreed-upon
agreed-upon
value,
value, normally
normally fairfair market
market value.
value.
Contributions
Contributions increase
increase the
the partner’s
partner’s capital
capital account.
account.
Withdrawals
Withdrawals decrease
decrease the
the partner’s
partner’s
capital
capital account.
account. 30
31
12-2
Forming a Partnership
Joseph Stevens and Earl Foster agree to

combine their hardware businesses in a
partnership. Each is to contribute certain
amounts of cash and other assets. They
also agree that the partnership is to assume
the liabilities of the separate businesses.
31
32
Forming
Click to editaMaster
Partnership
title style
• Stevens agrees to contribute the following:
• Cash $ 7,200
• Accounts Receivable 16,300
• Merchandise Inventory
28,700
• Store equipment 5,400
• Office equipment 2,500
• Allowance for doubtful accounts 1,500
32
• Accounts payable 2,600

33
12-2
Stevens’ Transfer of Assets, Liability, and Equity
Apr. 1 Cash 7 200 00

Accounts Receivable 16 300 00
Merchandise Inventory 28 700 00
Store Equipment 5 400 00
Office Equipment 1 500 00
Allowance for Doubtful Accounts
1 500 00
Accounts Payable
2 600 00
Joseph Stevens, Capital 33
18
55 000 00
34
12-2
A similar entry would record the assets
contributed and the liabilities
transferred by Foster. In each entry, the
noncash assets are recorded at values
agreed upon by the partners. These
values normally represent current
market values.
34
35
Change From Sole Proprietorship

to Partnership
• Assume that E and F form a partnership. F is to invest cash of $25,000. E has been operating a business that
is to carried on by the new partnership. Just before the partnership is formed, balance sheet is drawn up for
E’s business is as follows:
• Assets Liabilities and Capital

• Cash $16,200 Liabilities
• Accounts Receivable $20,000 Accounts Payable $24,000
• Less: allowance 1,200 18,800 Owner’s Equity
• Merchandise Inventory 21,400
• Supplies 1,600 E, Capital 40,400
• Furniture and Fixture $12,000
• Less: Accumulated
• Depreciation 5,600 6,400
• Total Liabilities & _______
• Total assets $64,400 Owner’s Equity $64,400
• ======== =======
• 35
11-35
Copyright ©2012
Agreement Between E and F 36

E shall withdraw the cash and that the partnership shall take
over the remaining assets and assume the liabilities.
 Accounts receivable: Bad accounts of $1,000 are to be
written off: a 4% allowance for bad debts is to be recognized
on remaining accounts.
 Merchandise Inventory: The present market value appraised
is $26,600.
 Furniture and Fixture: Replacement value is $15,000, but the
asset is assessed to be 50% depreciated and has a sound
value $7,500
 Goodwill: E is to allowed credit for goodwill of $10,000 that
is considered to be related to his business 36
11-36
Copyright ©2012
37
E’s books are retained

Click to edit Master title
Allowance for Bad Debts 440
style
Merchandise Inventory 5,200
Accumulated Depreciation 5,600
Goodwill 10,000
1
Accounts Receivable 1,000
Furniture and Fixtures 4,500
E, Capital
E, Capital 16,200 15,740
Cash 16,200
Cash 25,000
F, Capital 25,00037
16-37
Copyright ©2012
38
New books are opened for

Click partnership
to edit Master title style
Accounts Receivable 19,000
Merchandise Inventory 26,600
Supplies 1,600
Furniture and Fixtures 7,500
Goodwill 10,000
1
Allowance for Bad Debts 760
Accounts Payable 24,000
E, Capital 39,940
Cash 25,000
F, Capital 25,00038
16-38
Copyright ©2012
39
12-2

Example Exercise 12-1
Reese Howell contributed equipment, inventory, and

$34,000 cash to a partnership. The equipment had a book
value of $23,000 and market value of $29,000. The
inventory had a book value of $60,000, but only had a
market value of $15,000, due to obsolescence. The
partnership also assumed a $12,000 note payable owed by
Howell that was used originally to purchase the equipment.
Provide the journal entry for Howell’s contribution to the
partnership.
39
20
40
12-2

Follow My Example 12-1
Cash 34,000
Inventory 15,000
Equipment 29,000
Notes Payable 12,000
Reese Howell, Capital 66,000
For Practice: PE 12-1A, PE 12-1B 40

21
41
Dividing Partnership
Click toIncome
edit Master title style
or Loss
Partners are not employees of
partnership but are its owners. No
salaries reported as expense on the
income statement. Profits or losses of
the partnership are divided on some
agreed upon ratio.
41
© McGraw-Hill Education 41
Learning Objective P2: Allocate and record income and loss among partners.
42
Click
Dividing
to editIncome
Master or
title
Loss
style
• In the absence of an agreement, the
Uniform Partnership Act says that
the income or loss is shared equally
by the partners.
Three frequently used methods to
divide income or loss are:
– A stated ratio
– The ratio of capital balances
– Salary and interest allowances and any
remainder in a fixed ratio.
Let’s look at each
of these methods!
42
43
Click
Allocation
to editon
Master
Statedtitle
Ratios
style
Greene and Redd agree to a three-fourths, one-
fourth allocation of partnership income and loss,
respectively. For 2008, net income is $60,000.
GENERAL JOURNAL Page 34

Date Description PR Debit Credit
Prepare the closing entry for Income Summary

that will allocate the income to the partners based
on their agreement. 43
44
Click
Allocation
to editon
Master
Statedtitle
Ratios
style
Greene and Redd agree to a three-fourths, one-
fourth allocation of partnership income and loss,
respectively. For 2008, net income is $60,000.

Income Summary 60,000
Greene, Capital 45,000
Redd, Capital 44
15,000
Greene: $60,000 (3/4) = $45,000
Redd: $60,000 (1/4) = $15,000
45
Allocation
Click to edit
onMaster
Capitaltitle
Balances
style
Greene’s capital balance is $80,000 and Redd’s capital
balance is $40,000. The partnership agreement calls
for income or loss to be allocated based on the
relative capital balances. Net income for 2008 is
$60,000.

Prepare the closing entry for Income Summary

that will allocate the income to the partners based
on their agreement. 45
46
Allocation
Click to edit
onMaster
Capitaltitle
Balances
style
Greene’s capital balance is $80,000 and Redd’s capital
balance is $40,000. The partnership agreement calls
for income or loss to be allocated based on the
relative capital balances. Net income for 2008 is
$60,000.

Income Summary 60,000
Greene, Capital 40,000
Redd, Capital 46
20,000
Greene: $60,000 ($80,000/$120,000) = $40,000
Redd: $60,000 ($40,000/$120,000) = $20,000
47
Allocation on Services, Capital,

and Stated Ratios
Greene and Redd’s partnership agreement contains the
following information:
• Greene receives $15,000 and Redd receives $10,000 as
annual salaries.
• Each partner is allowed an annual interest allowance of
5% on the beginning-of-year capital balance.
• Any remaining balance of income or loss is allocated
equally.
Net income for 2008 is $60,000.
What amount of the net income will be allocated to each
47
partner based
on their agreement?
48
Allocation on Services, Capital,

and Stated Ratios
Greene Redd Total
Net income $ 60,000
Salaries $ 15,000 $ 10,000 25,000
Interest 4,000 2,000 6,000
Remainder 29,000
Equal allocation of remainder 14,500 14,500 29,000
Balance of net income $ -
Income of each partner $ 33,500 $ 26,500
If the allowances exceed net income, the deficit would be

allocated equally, just as the excess is in the example
48
above.
49
12-2
Dividing Income—Services of
Partners
The partnership agreement of Jennifer

Stone and Crystal Mills provides for Stone
to receive a monthly allowance of $5,000
($60,000 annually) and Mills is to receive
$4,000 a month ($48,000 annually). If
there is any remaining net income, it is to
be divided equally. The firm had a net
income of $150,000 for the year.
49
50
12-2
Division of Net Income
J. Stone C. Mills Total

Annual salary allowance $60,000 $48,000
$108,000
Remaining
Division of income
net income 21,000
$81,00021,000 42,000
$69,000
$150,000
to journal entry
(Slide 24)
50
23
51
12-2
The entry for dividing net income is as follows:
Dec. 31 Income Summary 150 000 00

Jennifer Stone, Capital 81 000 00
Crystal Mills, Capital 69 000 00
51
24
52
12-2
Dividing Income—Services of
Partners and Investments
The partnership agreement for Stone and Mills

divides income as follows:
1. Monthly salary allowance of $5,000 for Stone
and $4,000 for Mills.
2. Interest of 12% on each partner’s capital
balance on January 1.
3. If there is any remaining net income, it is to be
divided equally between the partners.
52
53
12-2
Net income of $150,000 is divided.

Salary allowance $60,000 $48,000 $108,000
Interest allowance 19,200 14,400 33,600
53
26
54
12-2

12%
12%xxStone’s
Stone’s
capital
capitalaccount
account
balance
balanceononJan.
Jan.11
of
of$160,000
$160,000
54
27
55
12-2

12%
12%xxMills’
Mills’
capital
capitalaccount
account
balance
balanceononJan.
Jan.11
of
of$120,000
$120,000
55
28
56
12-2

Remaining income 4,200 4,200 8,400
Division of net income $83,400 $66,600 $150,000
56
29
57
12-2

Jennifer Stone, Capital 83 400 00
Crystal Mills, Capital 66 600 00
57
30
58
12-2
LLC Alternative

Jennifer Stone, Member Equity 83 400 00
Crystal Mills, Member Equity 66 600 00
Note the use of “Member Equity”

instead of “Capital” for LLC. 58
31
59
12-2
Dividing Income—Allowances
Exceed Net Income
Assume the same facts as

before except that the net
income is only $100,000.
59
60
12-2

Total $79,200 $62,400 $141,600
This
Thisamount
amountexceeds
exceedsnet
net
income
incomeby
by$41,600.
$41,600.
60
33
61
12-2

Total $79,200 $62,400 $141,600
Deduct excess of
allowance over income 20,800 20,800 <41,600>
Net income $58,400 $41,600 $100,000
61
34
62
12-2

Steve Prince and Chelsy Bennick formed a partnership,
dividing income as follows:
1. Annual salary allowance to Prince of $42,000.
2. Interest of 9% on each partner’s capital balance on
January 1.
3. Any remaining net income divided equally.
Prince and Bennick had $20,000 and $150,000 in their
January 1 capital balances, respectively. Net income for the
year was $240,000.
How much net income should be distributed to Prince?
62
35
63
12-2

Monthly salary $ 42,000

Interest (9% x $20,000) 1,800
Remaining income 91,350*
Total distributed to Prince $135,150
*($240,000 – $42,000 – $1,800 – $13,500) x 50%

36
64
12-3
Objective
Objective 33
Describe and illustrate
the accounting for
partner admission
and withdrawal.
64
65
Click
Admission
to edit Master
of a Partner
title style
•• When
Whenthethemakeup
makeupof ofthe
thepartnership
partnership
changes,
changes,the
thepartnership
partnershipisisdissolved.
dissolved.
•• AAnew
newpartnership
partnershipmay
maybe beimmediately
immediately
formed.
formed.
•• New
Newpartner
partneracquires
acquirespartnership
partnershipinterest
interest
by:
by:
–– Purchasing
Purchasingititfrom
fromthe
theother
otherpartners,
partners,
or
or
–– Investing
Investingassets
assetsininthe
thepartnership.
partnership.
65
66
Purchase
Click to edit
of Partnership
Master titleInterest
style
•• AAnew
new partner
partner can
can purchase
purchase
partnership
partnership interest
interest directly
directly
from
from the
the existing
existing partners.
partners.
–– The
The cash
cash goes
goes to
to the
the partners,
partners,
not
not to
to the
the partnership.
partnership.
•• To
To become
become aa partner,
partner, the
the
new
new partner
partner must
must be
be
accepted
accepted by
by the
the current
current
partners.
partners. 66
67
12-3
Admitting a Partner
A person may be admitted to a partnership

only with the consent of all the current
partners by:
1. Purchasing an interest from one or more
of the current partners.
2. Contributing assets to the partnership.
67
68
Two Methods for Admitting a

Partner
68
69
ClickAdmitting
to edit(slide
Master a Partner
2 of 2)
title style
• When a new partner is admitted by purchasing
an interest from one or more of the existing
partners, the total assets and the total owners’
equity of the partnership are not affected. The
capital (equity) of the new partner is recorded
by transferring capital (equity) from the
existing partners.
69
70
ClickAdmitting
to edit(slide
Master a Partner
2 of 2)
title style
• When a new partner is admitted by
contributing assets to the partnership, the total
assets and the total owners’ equity of the
partnership are increased. The capital (equity)
of the new partner is recorded as the amount of
assets contributed to the partnership by the new
partner.
70
71
Admitting a Partner: Purchasing

an Interest from Existing Partners
(slide 1 of 5)
• When a new partner is admitted by purchasing

an interest from one or more of the existing
partners, the transaction is between the new
and existing partners acting as individuals.
• The admission of the new partner is recorded
by transferring owners’ equity amounts from
the capital accounts of the selling partners to
71
the capital account of the new partner.
72
Purchase of Partnership Interest

Redd agrees to sell Blue $10,000 of her
partnership interest for $25,000.
Greene Redd Blue Total
Capital balances before new partner $ 108,500 $ 65,500 $ - $ 174,000
Allocation to new partner (10,000) 10,000 -
Capital balances after new partner $ 108,500 $ 55,500 $ 10,000 $ 174,000

Redd, Capital 10,000
Blue, Capital 10,000
A new partnership agreement must be prepared that 72

identifies the allowances and profit sharing basis.
73
12-3
Purchasing an Interest in a
Partnership
Partners Tom Andrews and Nathan

Bell have capital balances of
$50,000 each. On June 1, each
sells one-fifth of his equity to Joe
Canter for $10,000 in cash.
73
74
12-3
The only entry required in the partnership
accounts is as follows:
June 1 Tom Andrews, Capital 10 000 00

Nathan Bell, Capital 10 000 00
Joe Canter, Capital 20 000 00
74
40
75
12-3
The effect of the transaction on the partnership
accounts is presented in the following diagram:
Partnership Accounts
Andrew, Capital
10,000 50,000
Carter, Capital
20,000
Bell, Capital
10,000 50,000
75
41
76
12-3
LLC Alternative
June 1 Tom Andrew, Member Equity 10 000 00

Nathan Bell, Member Equity 10 000 00
Joe Canter, Member Equity 20 000 00
76
42
77
12-3
Contributing Assets to a
Partnership
Partners Donald Lewis and Gerald

Morton have capital balances of
$35,000 and $25,000, respectively. On
June 1, Sharon Nelson joins the
partnership by permission and makes an
investment of $20,000 cash.
77
78
12-3
The entry to record this transaction is as follows:
June 1 Cash 20 000 00

Sharon Nelson, Capital 20 000 00
78
44
79
12-3
The effect of the transaction on the partnership
accounts is presented in the following diagram:
Partnership Accounts
Net Assets Lewis, Capital
60,000 35,000
20,000
Nelson, Capital Morton, Capital
20,000 25,000
79
45
80
12-3
LLC Alternative
June 1 Cash 20 000 00

Sharon Nelson, Member Equity 20 000 00
80
46
81
Revaluation
Click to edit(slide
Master of Assets
title style
1 of 6)
• Before a new partner is admitted, the balances
of a partnership’s asset accounts should be
stated at current values. If necessary, the
accounts should be adjusted.
– Any net adjustment (increase or decrease) in asset
values is divided among the capital accounts of the
existing partners, similar to the division of income.
81
82
Revaluation
Click to edit(slide
Master of Assets
title style
1 of 6)
– Failure to adjust the partnership accounts for
current values before admission of a new partner
may result in the new partner sharing in asset gains
or losses that arose in prior periods.
82
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12-3
Revaluation of Assets
If the asset accounts do not reflect

approximate current market values
when a new partner is admitted, the
accounts should be adjusted
(increased or decreased) before the
new partner is admitted.
83
84
12-3
Partners Donald Lewis and Gerald
Morton have capital balances of
$35,000 and $25,000, respectively.
The balance in Merchandise
Inventory is $14,000 and the current
replacement value is $17,000. The
partners share net income equally.
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85
12-3
The revaluation is recorded as follows:
June 1 Merchandise Inventory 3 000 00

Donald Lewis, Capital
1 500 00
Gerald Morton, Capital
1 500 00
Because the LLC alternative follows a pattern of

replacing “Capital” with “Member Equity,” the
LLC entry will not be shown again.
85
49
86
12-3

Blake Nelson invested $45,000 in the Lawrence & Kerry

partnership for ownership equity of $45,000. Prior to the
investment land was revalued to a market value of $260,000
from a book value of $200,000. Lynne Lawrence and Tim
Kerry share net income in a 1:2 ratio.
a. Provide the journal entry for the revaluation of land.
b. Provide the journal entry to admit Nelson.
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50
87
12-3

a. Land 60,000
Lynne Lawrence, Capital 20,000¹
Tim Kerry, Capital 40,000²
¹$60,000 x l/3
²$60,000 x 2/3
b. Cash 45,000
Blake Nelson, Capital 45,000

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88
Bonus or Goodwill on Initial Investment

Partner initial investments may not represent
ownership percentage. Partners may bring
 Individual talent
 Business connections
 Customer base
 Intellectual know-how
Partners choose method to record their capital
 Bonus method
 Adjustment within the capital accounts
 Goodwill method
88
 Goodwill is recorded on the books
16-88
Copyright ©2012
89
Click toPartner
edit(slide Bonuses
Master
2 of 2)
title style
• Existing partners receive a bonus when the
ownership interest received by the new partner
is less than the amount paid.
• In contrast, the new partner receives a bonus
when the ownership interest received by the
new partner is greater than the amount paid.
89
90
12-3
90
52
91
Bonus
Click totoedit
OldMaster
or Newtitle
Partners
style
When the current value of a partnership is
greater than the recorded amounts of
Bonus to Old equity, the old partners usually require a
Partners new partner to pay a bonus when joining.
The partnership may grant a bonus to a

Bonus to New new partner if the business is in need of
Partners cash or if the new partner has exceptional
talents.
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12-3
Partner Bonuses
On March 1, the partnership of Marsha

Jenkins and Helen Kramer admit Alex Diaz
as a new partner. The assets of the old
partnership are adjusted to current market
values and the resulting capital balances for
Jenkins and Kramer are $20,000 and
$24,000, respectively.
92
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12-3
Jenkins and Kramer agree to admit
Diaz as a partner for $31,000. In
return, Diaz will receive a one-third
equity in the partnership and will
share income and losses equally with
Jenkins and Kramer.
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12-3
Equity of Jenkins $20,000
Equity of Kramer 24,000
Diaz’s Contribution 31,000
Total equity after admitting Diaz $75,000
Diaz’s interest (1/3 x $75,000) $25,000
Diaz’s contribution $31,000

Diaz’s equity after admission 25,000
Bonus paid to Jenkins and Kramer $ 6,000
94
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12-3
The entry to record the admission of Diaz to
the partnership is as follows:
Mar. 1 Cash 31 000 00
Alex Diaz, Capital
25 000 00
Marsha Jenkins, Capital
3 000 00
Helen Kramer, Capital
3 000 00
$6,000/2
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12-3
Adjusting for New Partner’s
Unique Qualities or Skills
After adjusting the market values, the

capital balance of Janice Cowen is
$80,000 and the capital balance of Steve
Dodd is $40,000. Ellen Chou receives a
one-fourth interest in the partnership for
a contribution of $30,000. Before
admitting Chou, Cowen and Dodd
shared net income using a 2:1 ratio.
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12-3
The bonus is computed as follows:
Equity of Cowen $ 80,000
Equity of Dodd 40,000
Chou’s Contribution 30,000
Total equity after admitting Chou $150,000
Chou’s equity interest after admission x 25%
Chou’s equity after admission $ 37,500
Chou’s contribution 30,000
Bonus paid to Chou $ 7,500
97
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12-3
The entry to record the bonus and admission of
Chou to the partnership is as follows:
June 1 Cash 30 000 00

Janice Cowen, Capital 5 000 00
Steve Dodd, Capital 2 500 00
Ellen Chou, Capital
37 500 00
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99
12-3
June 1 Cash 30 000 00

2/3 x
$7,500
Steve Dodd, Capital 2 500 00
Ellen Chou, Capital
37 500 00
99
60
100
12-3
June 1 Cash 30 000 00

Steve Dodd, Capital1/3 x 2 500 00
$7,500
Ellen Chou, Capital
37 500 00
100
61
101
Click
Withdrawal
to edit Master
of a Partner
title style
A
Apartner
partner can
can withdraw
withdraw in
in
two
two ways:
ways:
•• The
The partner
partner can
can sell
sell his/her
his/her
partnership
partnership interest
interest to
to another
another
person.
person.
•• The
The partnership
partnership can
can distribute
distribute
cash
cash and/or
and/or other
other assets
assets to
to the
the
withdrawing
withdrawing partner.
partner. 101
102
Withdrawal
Click to edit(slide of a Partner
Master title style
1 of 3)
• A partner may retire or withdraw from a
partnership. In such cases, the withdrawing
partner’s interest is normally sold to the:
– Existing partners or
– Partnership
102
103
Withdrawal
Master title style
2 of 3)
• If the existing partners purchase the
withdrawing partner’s interest, the purchase
and sale of the partnership interest is between
the partners as individuals.
• The only entry on the partnership’s records is
to debit the capital account of the partner
withdrawing and to credit the capital account
of the partner or partners buying the additional
interest. 103
104
Withdrawal
Master title style
3 of 3)
• If the partnership purchases the withdrawing partner’s interest,
the assets and the owners’ equity of the partnership are reduced
by the purchase price.
– Before the purchase, the asset accounts should be adjusted to current
values. The net amount of any adjustment should be divided among the
capital accounts of the partners according to their income-sharing ratio.
• The entry to record the purchase debits the capital account of
the withdrawing partner and credits Cash for the amount of the
purchase.
– If not enough partnership cash is available to pay the withdrawing
partner, a liability may be created (credited) for the amount owed the
withdrawing partner.
104
105
Click
Withdrawal
to edit Master
of a Partner
title style
Redd has a capital balance of $65,500. She decides to withdraw
from the partnership and takes cash equal to her equity.

Redd, Capital 65,500
Cash 65,500
105
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12-3
Withdrawal of a Partner
On June 1, the partnership of X, Y,

and Z have capital balances of
$50,000, $80,000, and $30,000,
respectively. Z decides to retire
from the partnership and sells his
interest to Y for $35,000.
106
107
12-3
The following entry is required to record Z selling
his interest to Y.
June 1 Z, Capital 30 000 00
Y, Capital
30 Transfer
000 00 ownership
from Z to Y.
The amount paid to Y by Z has no impact on the

partnership’s accounting records.
107
63
108
12-3
If Z had sold his interest

directly to the partnership, both
the assets and the owner’s
equity of the partnership would
have been reduced.
108
109
12-3

Lowman has a capital balance of $45,000 after

adjusting assets to fair market value. Conrad
contributes $26,000 to receive a 30% interest in a
new partnership with Lowman.
Determine the amount and recipient of the partner
bonus.
109
65
110
12-3

Equity of Lowman $45,000

Conrad contribution 26,000
Total equity after admitting Conrad $71,000
Conrad’s equity interest x 30%
Conrad’s equity after admission $21,300
Conrad’s contribution $26,000

Conrad’s equity after admission 21,300
Bonus paid to Lowman $ 4,700

66
111
12-4
Objective
Objective 44
Describe and illustrate
the accounting for
liquidating a
partnership.
111
112
12-4
Liquidating Partnerships
When a partnership goes out

of business, the winding-up
process is called the
liquidation of a partnership.
112
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12-4
Liquidation Process
1. Sell the partnership assets. This step is called

realization.
2. Distribute any gains or losses from realization
to the partners based upon their income-
sharing ratio.
3. Pay the claims of creditors using the cash from
step 1 realization.
4. After satisfying the creditors, distribute the
remaining cash to the partners based on the
balances in their capital accounts.
113
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12-4
114
70
115
12-4
Liquidation Process
Farley, Greene, and Hall share income and losses

in a ratio of 5:3:2. On April 9, after discontinuing
operations, the firm had the following trial balance.
Cash $11,000
Noncash Assets 64,000
Liabilities $ 9,000
Jean Farley, Capital 22,000
Brad Greene, Capital 22,000
Alice Hall, Capital 22,000
Total $75,000 $75,000
115
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12-4
Liquidation Process
Between April 10 and April 30,

2006, Farley, Greene, and Hall
sell all noncash assets for
$72,000. Thus, a gain of $8,000
($72,000 – $64,000) is realized.
116
117
12-4
Gain on Realization
$8,000 gain 117

73
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12-4
Entries to Record the Steps in the
Liquidation Process
Step 1: Sale of assets
Cash 72 000 00
Noncash Assets
64 000 00
Gain on Realization
8 000 00
118
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12-4
Liquidation Process
Step 2: Division of gain
Gain on Realization 8 000 00

Jean Farley, Capital
4 000 00
Brad Greene, Capital
2 400 00
Alice Hall, Capital
1 600 00
119
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120
12-4
Liquidation Process
Step 3: Payment of liabilities
Liabilities 9 000 00
Cash
9 000 00
120
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12-4
Liquidation Process
Step 4: Distribution of cash to partners
Jean Farley, Capital 26 000 00

Brad Greene, Capital 24 400 00
Alice Hall, Capital 23 600 00
Cash
74 000 00
121
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122
12-4
Loss on Realization
Farley, Greene, and Hall sell all

noncash assets for $44,000. A
loss of $20,000 ($64,000 –
$44,000) is realized.
122
123
12-4
Liquidation Process
Cash 44 000 00
Loss on Realization 20 000 00
Noncash Assets
64 000 00
123
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124
12-4
Loss on Realization
$20,000 loss 124

80
125
12-4
Liquidation Process
Step 2: Division of loss

Loss on Realization
20 000 00
125
81
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12-4
Liquidation Process
Cash
9 000 00
126
82
127
12-4
Liquidation Process
Step 4: Distribution of cash to partners:

Cash
46 000 00
127
83
128
12-4

Prior to liquidating their partnership, Todd and

Gentry had capital accounts of $50,000 and
$100,000, respectively. The partnership assets
were sold for $220,000. The partnership had
$20,000 of liabilities. Todd and Gentry share
income and losses equally. Determine the amount
received by Gentry as a final distribution from
liquidation of the partnership.
128
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129
12-4

Gentry’s equity prior to liquidation $100,000

Realization of asset sale $220,000
Book value of assets ($50,000 +
$100,000 + $20,000) 170,000
Gain on liquidation $50,000
Gentry’s share of gain (50% x $50,000)
25,000
Gentry’s cash distribution $125,000

85
130
12-4
Loss on Realization—Capital
Deficiency
Farley, Green, and Hall sell all of the noncash

assets for $10,000. A loss of $54,000
($64,000 – $10,000) is realized. The share of
the loss allocated to Farley, $27,000 (50% of
$54,000), exceeds the $22,000 balance in her
capital account. Farley contributes $5,000 to
the partnership.
130
131
12-4
Loss on Realization—
Capital Deficiency
131
87
Farley’s contribution
132
12-4
Cash 10 000 00
Loss on Realization 54 000 00
Noncash Assets
64 000 00
132
88
133
12-4
Step: Payment of liabilities
Joan Farley, Capital 27 000 00

Loss on Realization
54 000 00
133
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12-4
Cash
9 000 00
134
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12-4
Receipt of deficiency
Cash 5 000 00
Jean Farley, Capital
5 000 00
Having the partner with a deficiency pay all or part of

the deficiency is not one of the four liquidation steps,
but it should make the other partners happy.
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136
12-4
Loss on Realization—
Capital Deficiency
The remaining cash is distributed. Greene 136

92
receives $5,800 and Hall receives $11,200.
137
12-4
Distribution of cash to partners:

Cash
17 000 00
137
93
138
12-4
Click to edit
Master title style
Prior to liquidating their partnership, Short and
Bain had capital accounts of $20,000 and $80,000,
respectively. The partnership assets were sold for
$40,000. The partnership had no liabilities. Short
and Bain share income and losses equally.
a. Determine the amount of Short’s deficiency
b. Determine the amount distributed to Bain
assuming Short is unable to satisfy the
deficiency. 138
94
139
12-4

a. Short’s equity prior to liquidation
$ 20,000
Realization of asset sales $ 40,000
Book value of assets 100,000
Loss on liquidation $ 60,000
Short’s share of loss (50% x $60,000)
30,000
Short’s deficiency $(10,000)
b. $40,000 $80,000 – $30,000 share of loss – $10,000.
Short’s deficiency also equals the amount
realized from asset sales.
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95
For Practice: PE 12-6A, PE 12-6B
140
12-5
Objective
Objective 55
Prepare the
statement of
partnership equity.
140
141
12-5
Statement of Partnership Equity
The change in the owners’

capital accounts for a period of
time is reported in a statement
of partnership equity.
141
142
12-5
Statement of
Partnership Equity
142
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143
12-5
Financial Analysis and Interpretation
Washburn & Lovett, CPA’s had the following

information for the last two years:
2008 2007
Revenues $220,000,000 $180,000,000
Number of employees 1,600 1,500
Revenue per $220,000,000

= $137,500
employee, 2008 = 1,600
Revenue per $180,000,000
= = $120,000
employee, 2007 1,500
143
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144
12-5
Financial Analysis and Interpretation
The revenues per employee

showed improvement in 2008.
Thus, each employee is producing
more revenues in 2008, than in
2007, which may indicate
improved productivity. Overall, it
appears the firm is properly
managing the growth in staff.
144

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1

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Proprietorships, Partnerships, and

Partnerships are less widely used

 An important right of partners is to

• Form of legal entity that provides

 Combines the advantages of the corporate

 An LLC may elect to be treated as a

Limitation on Life of Entity

Organizations with Partnership

A variant of the regular

Click to edit Master

Joseph Stevens and Earl Foster agree to

• Accounts payable 2,600

Apr. 1 Cash 7 200 00

Change From Sole Proprietorship

• Assets Liabilities and Capital

E’s books are retained

New books are opened for

Click to edit Master title style

Reese Howell contributed equipment, inventory, and

Click to edit Master title style

For Practice: PE 12-1A, PE 12-1B 40

GENERAL JOURNAL Page 34

Prepare the closing entry for Income Summary

GENERAL JOURNAL Page 34

GENERAL JOURNAL Page 34

Prepare the closing entry for Income Summary

GENERAL JOURNAL Page 34

Allocation on Services, Capital,

Allocation on Services, Capital,

If the allowances exceed net income, the deficit would be

The partnership agreement of Jennifer

J. Stone C. Mills Total

The entry for dividing net income is as follows:

Dec. 31 Income Summary 150 000 00

The partnership agreement for Stone and Mills

Net income of $150,000 is divided.

Net income of $150,000 is divided.

Net income of $150,000 is divided.

Net income of $150,000 is divided.

The entry for dividing net income is as follows:

Dec. 31 Income Summary 150 000 00

The entry for dividing net income is as follows:

Dec. 31 Income Summary 150 000 00

Note the use of “Member Equity”

Assume the same facts as

Net income of $100,000 is divided.

Net income of $100,000 is divided.

Click to edit Master title style

Click to edit Master title style

Monthly salary $ 42,000

For Practice: PE 12-2A, PE 12-2B 63

A person may be admitted to a partnership

Two Methods for Admitting a

Admitting a Partner: Purchasing

• When a new partner is admitted by purchasing

Purchase of Partnership Interest