Dire Dawa University, College of Business and Economics: Department of Accounting & Finance Principles of Accounting II

Dire Dawa University, College of Business and
Economics
Department of Accounting & Finance
Principles of Accounting II
Chapter 4
Accounting for
Partnership
Chapter
12-1
Study Objectives
1. Identify the characteristics of the partnership form

of business organization.
2. Explain the accounting entries for the formation of a
partnership.
3. Identify the bases for dividing net income or net
loss.
4. Describe the form and content of partnership
financial statements.
5. Explain the effects of the entries to record the
liquidation of a partnership.
Chapter
12-2
Accounting for Partnerships
Partnership Basic
Liquidation of a
Form of Partnership
Partnership
Organization Accounting
Characteristics Forming a No capital

Organizations partnership deficiency
with partnership Dividing net Capital
characteristics income / loss deficiency
Advantages / Financial
disadvantages statements
Partnership Admission &
agreement Withdrawal
Chapter
12-3
Partnership Form of Organization
A partnership is an association of two or more

persons to carry on as co-owners of a business
for profit.
Type of Business:
Small retail, service, or manufacturing companies.
Accountants, lawyers, and doctors.
Chapter
12-4
Characteristics of Partnerships
Association of Individuals
Legal entity.
Accounting entity.
Net income not taxed as a separate entity.
Mutual Agency
Act of any partner is binding on all other
partners, so long as the act appears to be
appropriate for the partnership.
Chapter
12-5
Limited Life
Dissolution occurs whenever a partner withdraws
or a new partner is admitted.
Dissolution does not mean the business ends.
Unlimited Liability
Each partner is personally and individually liable
for all partnership liabilities.
Chapter
12-6
Co-ownership of Property
Each partner has a claim on total assets.
This claim does not attach to specific assets.
All net income or net loss is shared equally by the
partners, unless otherwise stated in the
partnership agreement.
Chapter
12-7
Partnership Form of Organization
Discussion Question
Q1 The characteristics of a partnership include
the following: (a) association of individuals, (b)
limited life, and (c) co-ownership of property.
Explain each of these terms.
Chapter
12-8
Organizations with Partnership Characteristics
Special forms of business organizations are often

used to provide protection from unlimited liability.
Special partnership forms are:

1. Limited Partnerships,
2. Limited Liability Partnerships, and
3. Limited Liability Companies.
Chapter
12-9
Organizations with
Partnership Characteristics
Regular Partnership
Major Advantages Major Disadvantages

Simple and Owners (partners)
inexpensive to create personally liable for
and operate. business debts.
Chapter
12-10
Organizations with
Major Advantages “Ltd.,” or “LP”

Limited partners have
limited personal liability Major Disadvantages
for business debts as long
General partners
as they do not participate
personally liable for
in management.
business debts.
General partners can
More expensive to create
raise cash without
than regular partnership.
involving outside investors
in management of Suitable for companies
business. that invest in real estate.
Chapter
12-11
Organizations with
Major Advantages “LLP”

Mostly of interest to
partners in old-line Major Disadvantages
professions such as law,
Unlike a limited liability
medicine, and accounting.
company, partners remain
Owners (partners) are personally liable for many
not personally liable for types of obligations owed
the malpractice of other to business creditors,
partners. lenders, and landlords.
Often limited to a short
list of professions.
Chapter
12-12
Organizations with
Major Advantages “LLC”

Owners have limited
personal liability for Major Disadvantages
business debts even if
More expensive to create
they participate in
than regular partnership.
management.
Chapter
12-13
Question
All of the following are characteristics of
partnerships except:
a. co-ownership of property.
b. mutual agency.
c. limited life.
d. limited liability.
Chapter
12-14
Discussion Question
Q12-3 Brent Houghton and Dick Kreibach are
considering a business venture. They ask you to
explain the advantages and disadvantages of the
partnership form of organization.
Chapter
12-15
Question
Under which of the following business organization
forms do limited partners have little, if any, active
role in the management of the business?
a. Limited liability partnership.
b. Limited partnership.
c. Limited liability companies.
d. None of the above.
Chapter
12-16
Partnership Agreement
Should specify relationships among the partners:
1. Names and capital contributions of partners.
2. Rights and duties of partners.
3. Basis for sharing net income or net loss.
4. Provision for withdrawals of assets.
5. Procedures for submitting disputes to arbitration.
6. Procedures for the withdrawal or addition of a partner.
7. Rights and duties of surviving partners in the event of a
partner’s death.
Chapter
12-17
Forming a Partnership
Partner’s initial investment should be recorded at the
fair market value of the assets at the date of their
transfer to the partnership.
E-2 Meissner, Cohen, and Hughes are forming a partnership.

Meissner is transferring $50,000 of cash to the
partnership. Cohen is transferring land worth $15,000 and a
small building worth $80,000. Hughes transfers cash of
$9,000, accounts receivable of $32,000 and equipment
worth $19,000. The partnership expects to collect $29,000
of the accounts receivable.
Instructions: Prepare the journal entries to record each of
the partners’ investments.
Chapter
12-18
E-2 Meissner is transferring $50,000 of cash to the

partnership. Prepare the entry.
Cash 50,000
Meissner, Capital
Cohen is50,000
transferring land worth $15,000 and a small
building worth $80,000. Prepare the entry.
Land 15,000
Building 80,000
Cohen, Capital
Chapter
12-19 95,000
E-2 Hughes transfers cash of $9,000, accounts

receivable of $32,000 and equipment worth $19,000.
The partnership expects to collect $29,000 of the
accounts receivable. Prepare the entry.
Cash 9,000
Accounts receivable 32,000
Equipment 19,000
Allowance for doubtful accounts
Hughes, Capital
3,000
57,000
Chapter
12-20
Question
When a partner invests noncash assets in a
partnership, the assets should be recorded at their:
a. book value.
b. carrying value.
c. fair market value.
d. original cost.
Chapter
12-21
Dividing Income
Services of Partners
The partnership agreement of Jennifer Stone and
Crystal Mills provides for Stone to have an annual
salary allowance of $30,000 and Mills is to receive
$24,000. Any net income is to be divided equally.
The firm had a net income of $75,000.
J. Stone C. Mills Total
Salary allowance $30,000 $24,000 $54,000
Remaining income 10,500 10,500 21,000
Division of net income $40,500 $34,500 $75,000
Chapter
12-22
Dividing Income
Dec. 31 Income Summary 75 000 00

Jennifer Stone, Capital
40 500 00
Crystal Mills, Capital
34 500 00
Chapter
12-23
Dividing Income
LLC Alternative

Jennifer Stone, Member Equity
40 500 00
Crystal Mills, Member Equity
34 500 00
Chapter
12-24
Dividing Income
Services of Partners and Investments
The partnership agreement of Jennifer Stone and

Crystal Mills provides for Stone to have an
annual salary allowance of $30,000 and Mills is
to receive $24,000. Interest of 12% is provided
on each partner’s capital balance on January 1
which is $80,000 for Stone and $60,000 for
Mills. Any net income is to be divided equally.
The firm had a net income of $75,000.
Chapter
12-25
Dividing Income
Services of Partners and Investments
Interest allowance 9,600 7,200 16,800
Remaining income 2,100 2,100 4,200
Division of net income $80,000
$41,700x $60,000
$33,300x $75,000
12% 12%
Chapter
12-26
Dividing Income

Jennifer Stone, Capital
41 700 00
Crystal Mills, Capital
33 300 00
Chapter
12-27
Dividing Income
Allowances Exceed Net Income
Assume the same facts as before except that

the net income is only $50,000.
Interest allowance 9,600 7,200 16,800
Total $39,600 $31,200 $70,800
Deduct excess equally 10,400 10,400 20,800
Division of net income $29,200 $20,800 $50,000
Chapter
12-28
Partnership Dissolution
Admitting a Partner
A person may be admitted to a partnership

only with the consent of all partners by:
1. Purchasing an interest from one or more of
the current partners.
2. Contributing assets to the partnership.
Chapter
12-29
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.
Chapter
12-30
Purchasing an Interest in a Partnership
June 1 Tom Andrews, Capital 10 000 00

Nathan Bell, Capital 10 000 00
Joe Canter, Capital
20 000 00
Chapter
12-31
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.
Chapter
12-32
Contributing Assets to a Partnership
June 1 Cash 20 000 00

Sharon Nelson, Capital
20 000 00
Chapter
12-33
Revaluation of Assets
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.
Chapter
12-34
Revaluation of Assets
June 1 Merchandise Inventory 3 000 00
Donald Lewis, Capital
1 500 00
Gerald Morton, Capital
1 500 00
Chapter
12-35
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 a fair
market values and the resulting capital
balances for Jenkins and Kramer are
$20,000 and $24,000, respectively.
Chapter
12-36
Partner Bonuses
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.
Chapter
12-37
Partner Bonuses from New Partner
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
Chapter
12-38
Partner Bonuses
Mar. 1 Cash 31 000 00

Alex Diaz, Capital
25 000 00
Marsha Jenkins, Capital
3 000 00
Helen Kramer, Capital
3 000 00 $6000 ÷ 2
Chapter
12-39
Partner Bonuses
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 Chua receives a
one-fourth interest in the partnership for a
contribution of $30,000. Before admitting
Chua, Cowen and Dodd shared net
income using a 2 to 1 ratio.
Chapter
12-40
Partner Bonuses to New Partner
Equity of Cowen $ 80,000
Equity of Dodd 40,000
Chua’s Contribution 30,000
Total equity after admitting Chua $150,000
Chua’s interest (1/4 x $150,000) $ 37,500
Chua’s contribution $30,000

Chua’s equity after admission 37,500
Bonus paid to Chua $ 7,500
Chapter
12-41
Partner Bonuses
Mar. 1 Cash 30 000 00

2/3 x
Janice Cowen, Capital $7,500 5 000 00
1/3 x
Steve Dodd, Capital 2 500 00
$7,500
Ellen Chua, Capital
37 500 00
Chapter
12-42
Liquidating Partnerships
When a partnership goes out of
business, the winding-up
process is called the liquidation
of a partnership.
Chapter
12-43
The sale of the assets is

called realization.
Chapter
12-44
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
Chapter
12-45
Gain on Realization
Between April 10 and April 30, 2006,

Farley, Greene, and Hall sell all
noncash assets for $72,000.
Chapter
12-46
Noncash
Cash Assets Liabilities
Balance before realization $11,000 $64,000 $9,000
Sale of assets and division
of gain +72,000 -64,000 —
Left side of statement
Chapter
12-47
Farley Greene Hall
Capital Capital Capital
of gain +4,000 +2,400 +1,600
$8,000 $8,000 $8,000

gain x .50 gain x .30 gain x .20
Right side of statement

Chapter
12-48
Noncash
Balance before realization$11,000 $64,000 $9,000
of gain +72,000 –64,000 —
Balance after realization $83,000 $0 $9,000

Chapter
12-49
Farley Greene Hall
of gain +4,000 +2,400 +1,600
Balance after realization $26,000 $24,400 $23,600

Chapter
12-50
Gain on Realization
The partnership’s liabilities are

paid, $9,000.
Chapter
12-51
Noncash
of gain +72,000 –64,000 —
Balance after realization $83,000 $ 0 $9,000
Payment of liabilities –9,000 — –9,000

Chapter
12-52
Noncash
of gain +72,000 –64,000 —
Balance after payment $74,000 $ 0 $ 0

Chapter
12-53
Gain on Realization
The remaining cash, $74,000,

is paid to each partner in
accordance with the partner’s
capital balance.
Chapter
12-54
Noncash
of gain +72,000 –64,000 —
Partners’ cash distributed –74,000 — —
Final balances $ 0 $ 0 $ 0
Chapter
12-55
Farley Greene Hall
of gain +4,000 +2,400 +1,600
Payment of liabilities — — —
Balance after payment $26,000 $24,400 $23,600
Partners’ cash distributed –26,000 –24,400 –23,600
Chapter
12-56
Sale of Assets
Apr. 30 Cash 72 000 00

Noncash Assets
64 000 00
Gain on Realization
8 000 00
Chapter
12-57
Division of Gain
Apr. 30 Gain on Realization 8 000 00

Jean Farley, Capital
4 000 00
Brad Greene, Capital
2 400 00
Alice Hall, Capital
1 600 00
Chapter
12-58
Payment of Liabilities
Apr. 30 Liabilities 9 000 00

Cash 9 000 00
Chapter
12-59
Distribution of Cash to Partners
Apr. 30 Jean Farley, Capital 26 000 00

Brad Greene, Capital 24 400 00
Alice Hall, Capital 23 600 00
Cash 74 000 00
Chapter
12-60
Loss on Realization
Between April 10 and April 30, 2006,

Farley, Greene, and Hall sell all
noncash assets for $44,000.
Chapter
12-61
Noncash
of loss +44,000 –64,000 —

Chapter
12-62
Farley Greene Hall
of loss –10,000 –6,000 –4,000
$20,000 $20,000 $20,000

loss x .50 loss x .30 loss x .20

Chapter
12-63
Noncash
of loss +44,000 –64,000 —
Balance after realization $55,000 $0 $9,000

Chapter
12-64
Farley Greene Hall
of loss –10,000 –6,000 –4,000

Chapter
12-65
Loss on Realization
The liabilities of the

partnership are paid, $9,000.
Chapter
12-66
Noncash
of loss +44,000 –64,000 —

Chapter
12-67
Noncash
of loss +44,000 –64,000 —

Chapter
12-68
Loss on Realization
The remaining cash, $46,000,

is paid to each partner in
accordance with the partner’s
capital balance.
Chapter
12-69
Noncash
of loss +44,000 –64,000 —
Partners’ cash distributed –46,000 — —
Chapter
12-70
Farley Greene Hall
of loss –10,000 –6,000 –4,000
Payment of liabilities — — —
Balance after payment $12,000 $16,000 $18,000
Partners’ cash distributed –12,000 –16,000 –18,000
Chapter
12-71
Sale of Assets
Apr. 30 Cash 44 000 00

Loss on Realization 20 000 00
Noncash Assets
64 000 00
Chapter
12-72
Division of Loss

Loss on Realization
20 000 00
Chapter
12-73
Payment of Liabilities
Apr. 30 Liabilities 9 000 00

Cash 9 000 00
Chapter
12-74
Distribution to Partners

Cash 46 000 00
Chapter
12-75
END
CHAPTER 4
Chapter
12-76

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Dire Dawa University, College of Business and

1. Identify the characteristics of the partnership form

Characteristics Forming a No capital

A partnership is an association of two or more

Special forms of business organizations are often

Special partnership forms are:

Major Advantages Major Disadvantages

Major Advantages “Ltd.,” or “LP”

Major Advantages “LLP”

Major Advantages “LLC”

E-2 Meissner, Cohen, and Hughes are forming a partnership.

E-2 Meissner is transferring $50,000 of cash to the

E-2 Hughes transfers cash of $9,000, accounts

Dec. 31 Income Summary 75 000 00

Dec. 31 Income Summary 75 000 00

The partnership agreement of Jennifer Stone and

Dec. 31 Income Summary 75 000 00

Assume the same facts as before except that

A person may be admitted to a partnership

Partners Tom Andrews and Nathan Bell

June 1 Tom Andrews, Capital 10 000 00

Partners Donald Lewis and Gerald Morton

June 1 Cash 20 000 00

Partners Donald Lewis and Gerald Morton

On March 1, the partnership of Marsha

Jenkins and Kramer agree to admit Diaz

Diaz’s contribution $31,000

Mar. 1 Cash 31 000 00

After adjusting the market values, the

Chua’s contribution $30,000

Mar. 1 Cash 30 000 00

The sale of the assets is

Between April 10 and April 30, 2006,

Left side of statement

$8,000 $8,000 $8,000

Right side of statement

Left side of statement

Right side of statement

The partnership’s liabilities are

Left side of statement

Left side of statement

The remaining cash, $74,000,

Apr. 30 Cash 72 000 00

Apr. 30 Gain on Realization 8 000 00

Apr. 30 Liabilities 9 000 00

Apr. 30 Jean Farley, Capital 26 000 00

Between April 10 and April 30, 2006,

Left side of statement

$20,000 $20,000 $20,000

Right side of statement

Left side of statement

Right side of statement

The liabilities of the

Left side of statement

Left side of statement

The remaining cash, $46,000,

Apr. 30 Cash 44 000 00

Apr. 30 Jean Farley, Capital 10 000 00

Apr. 30 Liabilities 9 000 00