Journal Entries for Partnerships

Investing in a partnership

Partners (or owners) can invest cash or other assets in their business.  They
can even transfer a note or mortgage to the business if one is associated with
an asset the owner is giving the business.  Assets contributed to the business
are recorded at the fair market value.  Anytime a partner invests in the
business the partner receives capital or ownership in the partnership.  You will
have one capital account and one withdrawal (or drawing) account for each
partner.

To illustrate, Sam Sun and Ron Rain decided to form a partnership.  Sam
contributes $100,000 cash to the partnership.  Ron is going to give $25,000
cash and an automobile with a market value of $30,000.  Ron is also going to
transfer the $20,000 note on the automobile to the business.  The journal
entries would be:

Account

Cash       

    S. Sun, Capital

To record cash contribution by owner

Cash            25,00

Automobile            30,00

    Note Payable

    R. Rain, Capital (25,000 + 30,000 – 20,000)

To record assets and note contributed by owner

The entries could be separated as illustrated or it could be combined into one

entry with a debit to cash for $125,000 ($100,000 from Sam and $25,000 from
Ron) and the other debits and credits remaining as illustrated.  Either way is
acceptable.  Since the note will be paid by the partnership, it is recorded as a
liability for the partnership and reduces the capital balance of Ron Rain.

Partners can take money out of the business whenever they want.  Partners
are typically not considered employees of the company and may not get
paychecks.  When the partners take money out of the business, it is recorded
in the Withdrawals or Drawing account.  Remember, this is a contra-equity
account since the owners are reducing the value of their ownership by taking
money out of the company.

To illustrate, Sam Sun wants to go on a beach vacation and decides to take

$8,000 out of the business.  Ron Rain wants to go to Scotland and will take
$15,000 out of the business.  The journal entries would be:

Account Debit

S. Sun, Withdrawal              8,000

    Cash

To record cash withdrawn by owner

R. Rain, Withdrawal            15,000

    Cash

To record cash withdrawn by owner

Just as in the previous example, the entries could also be combined into one
entry with the credit to cash $23,000 ($8,000 from Sam + $15,000 from Ron)
and the debits as listed above instead.

Income Allocation

Once net income is calculated from the income statement (revenues –

expenses), net income or loss is allocated or divided between the partners
and closed to their individual capital accounts.  The partners should agree
upon an allocation method when they form the partnership.  The partners can
divide income or loss anyway they want but the 3 most common ways are:
 1. Agreed upon percentages:  Each partner receives a previously agreed
upon percentage.  For example, Sam Sun will get 60% and Ron Rain will
get 40%.  To allocate income, net income or loss is multiplied by the
percent agreed upon.
2. Percentage of capital:  Each partner receives a percentage of capital
calculated as Partner Capital / Total capital for all partners.   Using Sam
and Ron, Sam has capital of $100,000 and Ron has capital of $35,000
for a total partnership capital of $135,000 (100,000 + 35,000).  Sam’s
percentage of capital would be 74% (100,000 / 135,000) and Ron’s
percentage would be 26% (35,000 / 135,000).  To allocate income, the
percent of capital is multiplied by the net income or loss for the period.
3. Salaries, Interest, Agreed upon percent:  Since owners are not
employees and typically do not get paychecks, they should still be
compensated for work they do for the business.  In this method, we start
with net income and give salaries out to the partners, then we calculate
an interest amount based on their investment in the business, and any
remainder is allocated using set percentages.  This is by far the most
confusing so a video example would be helpful.

Note:  The video shows a sharing ratio of 3:1.  To use this in calculations, you
will add the numbers presented together (3 + 1 = 4) and divide each number
of the sharing ratio by this total to get a percentage.  The sharing ratio of 3:1
means 75% ( 3/4) and 25% ( 1/4).

The journal entries to close net income or loss and allocate to the partners  for
each of the scenarios presented in the video would be (remember, revenues
and expenses are closed into income summary first and then net income or
loss is closed into the capital accounts):

Account

Income Summary

    Partner A, Capital

    Partner B, Capital

To record allocation of $70,000 net income to partners.

Income Summary
     Partner A, Capital

    Partner B, Capital

To record allocation of $30,000 net income to partners.

Partner A, Capital

    Partner B, Capital

    Income Summary

To record allocation of $10,000 net LOSS to partners.

If the partners cannot or do not decide how income will be allocated, allocate it
equally between the partners (for 4 partners divide net income by 4; for 3
partners divide net income by 3, etc.).

Liquidation of a Partnership

Sometimes things do not go as well as planned in a business and it may be

necessary to go out of business.  When a partnership goes out of business,
the following items must be completed:

 All closing entries should be completed including allocating any net

income or loss to the partners.
 Any non-cash assets should be sold for cash and any gain or loss from
the sale would be allocated to the partners.
 Any liabilities should be paid.
 Any remaining cash is allocated to the partners based on the capital
balance in each partner’s account (note:  this is not an allocated figure
but the actual capital balance for each partner after the other
transactions).

Here is a good (but long) video demonstrating the liquidation process and the
journal entries required.
 Partnership accounting
October 19, 2017

The accounting for a partnership  is essentially the same as is used for a sole
proprietorship , except that there are more owners. In essence, a separate account tracks
each partner's investment, distributions, and share of gains and losses.

Overview of the Partnership Structure

A partnership is a type of business organizational structure where the owners have

unlimited personal liability for the business. The owners share in the profits (and losses)
generated by the business. There may also be limited partners  in the business who do not
engage in day-to-day decision making, and whose losses are limited to the amount of
their investments in it; in this case, a general partner  runs the business on a day-to-day
basis.

Partnerships are a common form of organizational structure in businesses that are

oriented toward personal services, such as law firms, auditors, and landscaping.

Accounting for a Partnership

There are several distinct transactions associated with a partnership that are not found in
other types of business organization. These transactions are:

 Contribution of funds. When a partner invests funds in a partnership, the

transaction involves a debit to the cash account and a credit to a separate  capital account .
A capital account records the balance of the investments from and distributions to a
partner. To avoid the commingling of information, it is customary to have a separate
capital account for each partner.
 Contribution of other than funds. When a partner invests some other asset in a
partnership, the transaction involves a debit to whatever asset account most closely
reflects the nature of the contribution, and a credit to the partner's capital account. The
valuation assigned to this transaction is the market value  of the contributed asset.
 Withdrawal of funds. When a partner extracts funds from a business, it involves a
credit to the cash account and a debit to the partner's capital account.
 Withdrawal of assets. When a partner extracts assets other than cash from a
business, it involves a credit to the account in which the asset was recorded, and a debit
to the partner's capital account.
 Allocation of profit or loss.  When a partnership closes its books for an
accounting period, the net profit or loss for the period is summarized in a temporary
equity account called the income summary account . This profit or loss is then allocated
to the capital accounts of each partner based on their proportional ownership interests in
the business. For example, if there is a profit in the income summary account, then the
allocation is a debit to the income summary account and a credit to each capital account.
Conversely, if there is a loss in the income summary account, then the allocation is a
credit to the income summary account and a debit to each capital account.
 Tax reporting. In the United States, a partnership must issue a Schedule K-1 to
each of its partners at the end of its tax year. This schedule contains the amount of profit
or loss allocated to each partner, and which the partners use in their reporting of personal
income earned.

Distributions to partners may be extracted directly from their capital accounts, or they
may first be recorded in a drawing account , which is a temporary account  whose balance
is later shifted into the capital account. The 

Examples

(i) – Appropriations of profit Based on the following information:

 prepare the Partnership Appropriation Account

 calculate each partner’s share of the residual profit and total profit share
 prepare the partners’ current accounts

Amit and Burton are in partnership sharing profits in the ratio 3:2. The
partnership’s profit for the year was $65,460. The partnership agreement
provides for:
 interest to be paid on the partners’ opening capital balances at a rate of
5% per annum
 interest on drawings at a rate of 8% per annum on all drawings during
the year
 partners’ salaries of Amit, $9,000; Burton, $5,000.

At the beginning of the year, the partners’ capital and current account
balances were:

  Capital Current

Amit $120,000 Cr £15,655 Cr

Burton $80,000 Cr $4,137 Dr

During the year, Amit’s drawings were $18,000 and Burton’s drawings were
$31,000.

Solution

 
The closing balances are thus:           

Amit – $38,443 Cr Burton – $10,465 Dr

(ii) – Change in partnership Amit and Binta have been in partnership, sharing

profits and losses in the ratio 4:3. They agreed to admit Chen to the
partnership, with profits and losses being shared between Amit, Binta and
Chen in the ratio 3:2:1. On the date of the change in partnership, the partners’
capital and current account balances were:

  Capital Current

Amit $60,000 Cr £12,800 Cr

Binta $40,000 Cr $9,500 Cr

It was agreed that, at the date of Chen’s admission, the partnership was to be
valued at $164,300.

Step 1 – Calculate goodwill The total book value of the partnership is equal to

the combined value of the partners’ capital and current accounts, or $122,300
($60,000 + $12,800 + $40,000 + $9,500)

The partnership is valued at $164,300.

Therefore, the goodwill is valued at $42,000 ($164,300 – $122,300).

Step 2 – Create goodwill asset in books The goodwill account is created by a

debit entry of $42,000.
This value is credited to the old partners in the old profit and loss sharing ratio
– ie 4/7 (or $24,000) to Amit and 3/7 (or $18,000) to Binta.

Thus, the new capital balances are:           

Amit $84,000 Cr ($60,000 Cr and $24,000 Cr)

Binta $58,000 Cr ($40,000 Cr and $18,000 Cr)

If goodwill is to be carried in the books, no further entries are needed, as the

only change is that a new asset of goodwill has been created, and the capital
balances of the old partners have increased by the same value.

Step 3 – Eliminate goodwill (if required by question) If goodwill is not to be

carried in the books, it is eliminated by a credit entry in the goodwill account,
and debit entries in the partners’ capital accounts, based in the new profit and
loss sharing ratio:

Amit $21,000 ($42,000 x 3/6)

Binta $14,000 ($42,000 x 2/6)

Chen $7,000 ($42,000 x 1/6)

As a result, the new capital balances are:

 Amit $63,000 Cr ($84,000 Cr and $21,000 Dr)

Binta $44,000 Cr ($58,000 Cr and 14,000 Dr)

Chen $7,000 Dr (share of goodwill eliminated)

Step 4 – Contribution of capital by new partner (if required by question) If the

question requires a contribution by any of the partners (or a repayment of
capital) we simply need to follow the normal principles of double-entry
bookkeeping.

For example, the question may require the new partner to contribute cash so
that the opening capital balance is nil.

In this case, a credit of $7,000 is needed in Chen’s capital account, so this is

the amount of cash that must be contributed.

The entries will therefore be:

            Debit  Bank  $7,000                                 Credit Capital – Chen
$7,000   

Table 1 – Summary of entries

* if the interest has been paid to the partner ** if the interest remains
unpaid  † if funds were deposited in the partnership bank account  ‡ if capital
was converted into a loan
Written by a member of the FA2 examining team