CHAPTER 4

Accounting for
partnerships
Partnership: definition
Partnership is defined as:
◦ an association of two or more persons
◦ to carry on business
◦ as co-owners
◦ for a profit .
Partnership Act (agreement) is:
◦ The relationship that ‘ exist between persons
carrying on a business in common, with a view to
profit ’
Partnership agreement
Partnership agreement ( Articles of co-
partnership )
◦ written contract (voluntary) that consists
 Names and capital contributions of the partners.
 Rights and duties of partners.
 Basis for sharing net income or net loss.
 Provision for withdrawals of assets.
 Procedures for submitting disputes to arbitration.
 Procedures for the withdrawal or addition of a
partner.
CHARACTERISTICS OF PARTNERSHIPS

Principal characteristics of a partnership

are:
 Ease of formation
 Association of individuals
 Mutual agency
 Limited life
 Unlimited liability
 Co-ownership of property
 Non-taxability
 PARTNERSHIP
PARTNERSHIP CHARACTERISTICS
CHARACTERISTICS

Association of Individuals

Partnership Form of
Business
Organization
Co-ownership of
Mutual Agency Property

Unlimited Liability Limited Life

Advantages of partnership
Advantages
Pooling of resources
Low cost
Formed at little or no cost
Subject to little regulation
Not Taxable
A partnership combines of the partners
CAPITAL TALENT EXPERIENCE
Disadvantages of partnership
The disadvantages are:
◦ Unlimited liability
◦ Limited life
◦ Mutual agency
◦ Difficulty to raise large amount of
money
◦ Ownership is not easily transferred
◦ Lack of freedom of action
Accounting for partnership
Accounting for a Partnership deals with:
◦ Formation
◦ Distribution of profits and
Drawings
◦ Change in partnership members
◦ Liquidation
FORMING A PARTNERSHIP
Initial investment
recorded at the fair market value of the assets at the
date of their transfer to the partnership
values assigned is amount agreed by all of the
partners
Liabilities may be contributed by partners
An item contributed by a partner becomes
partnership property/liability
Once partnership has been formed
Accounting is similar to accounting for transactions
of any other type of business organization
FORMING A PARTNERSHIP
Receivables are recorded at face amount, with a
credit to the allowance for doubtful
(uncollectible)
Accumulated depreciation is not recognized
for old plant assets.
The equity (Capital) of every partner must
show the net assets i.e. total assets minus
liabilities contributed to the partnerships, then
after it shows additional investments and
withdrawals made by the partners.
FORMING A PARTNERSHIP
Example : assume that Rita and Katherine
agreed on January 1, 2012 to form a
partnership named RK partnership.
◦ Rita invested Br 8,000 Cash, Br 35,000 furniture,
Br 12,000 merchandise and Br 15,000 notes
payable is assumed by the partnership which is
related to Rita.
◦ Katherine invested Br 30,000 Cash and Br
20,000 accounts receivable with the provision for
uncollectible accounts of Br 8,000.
Required: Record the investment by the two
owners
Dividing net income or net loss
◦ Partnership net income or net loss
 Shared equally unless the partnership contract
indicates otherwise
 partner’s share of net income or net loss is
recognized in the accounts through closing entries
◦ Factors to be considered in income division:
 Services performed
 Capital invested
 Business risk assumed
 Diving
Diving net
net income
income or
or net
net loss
loss
The following are typical of the ratios that may
be used:
1.A fixed ratio, expressed as a proportion (2:1), a
percentage (67% and 33%), or a fraction (2/3
and 1/3).
2.A ratio based on either capital balances at the
beginning of the year or on average capital
balances during the year.
3.Salaries to partners and the remainder in a
fixed ratio.
4.Interest on partners’ capital balances and the
remainder in a fixed ratio.
5.Salaries to partners, interest on partners’
capital balances, and the remainder in a fixed
ratio.
Dividing net income or net
loss
Each partner’s share of income (loss) is
recognized by Closing entries.
◦ After closing revenues and expenses,
 Debit ( credit ) Income Summary for its
balance and credit ( debit ) each partner’s
capital account for his or her share of net
income ( net loss ).
 The drawing made by each partner is also
closed to the respective capital account
Diving net income or net loss
 Example 5.2: assume that RK partnership earned net
income of $ 80,000 for the first year of its operation (in
2012).
Instruction: prepare a schedule of income division and
record it assuming that the articles of partnership
specify
◦ Fixed ratio ratio of 60 % and 40 % for Rita and Katherine
◦ Income ratio based on beginning capital balance
◦ Monthly salary allowances of Br 2,500 and Br 1,500,
respectively with the balance of the Net Income to be
divided equally
◦ Monthly salary allowances of Br 2,500 for Rita and Br
1,500 for Katherine, interest allowance of 10 % on
beginning capital and remaining balance of the Net
Income to be divided equally
Statement of partners’ capital
Shows the change in capital balance of each
partner during a particular period
Each partner’s capital account will change
by:
The additional investment made by the partner
The partner’s share of net income or loss
The drawing made by the partner
The balance sheet for a partnership is the
same as for a proprietorship except in the
owners’ equity section .
 The capital balances of the partners are
shown in the balance sheet
Exercise
 Helena and Meron agreed to form a partnership. Helena
contributed Br. 200,000 in cash, and Myron contributed
assets with a fair market value of Br. 400,000. The
partnership, in its initial year, reported net income of Br.
120,000. Required: Prepare the journal entry to
distribute the income to the partners under condition that
Helena and Meron:
◦ Failed to include stated ratio.
◦ Agreed to share income and losses in 3:2 ratios.
◦ Agreed to share income and losses based on their original investments.
◦ Agreed to share income and losses by allowing 10 percent interest on
their original investments and sharing any remainder equally.
◦ Agreed to share NI/NL by allowing 10% interest on their capital
investment, $40,000 salary allowance each & the remainder equally.
Dissolution of Partnership
Dissolution of a partnership occurs
whenever there is change in the original
association of partners.
The admission on new partner/s; the death
of existing partner/s or withdrawals of
existing partner resulted in dissolution of a
partnership.
Dissolution of a partnership does not
necessarily mean winding up the affairs of
the business
 Admission of a Partner/s
 There are two procedures
1. By Purchase of a Capital Interest
 New partner admitted to the partnership by purchasing an
equity interest from existing partners
 Neither the total asset nor the total owner’s equity of the
partnership will be affected.
 The only entry needed is to transfer the owner’s equity
from the capital accounts of the selling partner/s to the
incoming partner.
It is personal transaction b/n incoming and
selling partners
Admission of a Partner/s
Example : Getahun, Tibebu, and Abraham
were operating a partnership called GTA
Partnership. Asfaw purchased 20% Capital
Interest of Getahun at Br 20,000, ¼ Capital
interest of Tibebu at Br 30,000 and 30% capital
interest of Abraham at Br 40,000. The capital
of Getahun, Tibebu and Abraham is Br 50,000,
Br 80,000 and Br 70,000, respectively.
Instruction: record the transaction to transfer
the capital interest from the current partners to
the incoming partner
Admission of a Partner/s
2. Admission By Contribution of Asset
Instead of buying an interest from the
existing partners, the incoming partner/s may
contribute assets to the partnership.
In this procedure both the total asset and the
total owner’s equity of the firm increased.
The contribution of assets is recorded as in
the same way of recording investment.
In the admission of new partner, there are
two methods used for recording premium given
to either party (Goodwill method and bonus
method).
 Cont’d Admission of a Partner/s

Recognition of admission of new partner

Goodwill attributable either to the old partnership or the
incoming partner will be recognized.
Therefore, total asset increase by amount of investment
by the new partner plus amount of goodwill.
Illustration: Assume that instead of purchasing
ownership right from the existing partners, Sister Helen
invested cash of Br. 80,000 into the partnership. In this
case both partnership assets and total owners’ equity are
increase. The journal entry must record such an investment
and the increase in partnership assets. Consider the
following scenarios as an example:
 Cont’d
 Neither Bonus nor Goodwill. Sister Helen receives a
50% ownership right in the partnership. Assume also that
Dr. Talky and Dr. Mama’s capital balance was Br.
25,000 and Br. 55,000 respectively. Dr. Talky and Dr.
Mama share income in a ratio of 2:1 respectively.
 Bonus to the Existing Partners. Sister Helen receives a
one –fourth ownership right upon admission. Assume
everything else as above. In this case Sister Helen’s
capital account would be Credited for birr 40,000 i.e.,
(Birr 55,000+ Birr 25,000 + Birr 80,000)X ¼. The
difference Br. 40,000, (80,000 – 40,000) would be shared
between the remaining two partners with the income-
sharing ratio.
Cont’d
 Goodwill to old Partners. On April 1, the
partnerships of Giddy and Helen admit Jamal, who is
to contribute cash of Birr 15,000 and machinery with
current market price of Birr 25,000. The Capital
balances of Giddy and Helen after assets are adjusted
to CM price are Birr 50,000 and Birr 64,000,
respectively. The partners agree, however, that the
partnership is worth Birr 130,000 considering Good
Will to the partnerships. The old partners have been
sharing income in the ratio of 2:3. a) Record the
journal entries on April 1, to record/admission of the
new partner. b) What is the interest of each partner’s
capital balance over the total partnerships equity?
Cont’d
Goodwill to New Partner. Ababa and
Berkeley are partners with capital balance
of Birr 20,000 and 60,000 respectively.
Chili is admitted on Jan. 1 by investing
Birr. 15,000. If the old partners agree to
recognize Birr 5000 of goodwill
attributable to chili his special skill. a)
Record the entry; b) Determine the
interest of each partners over the total OE
Withdrawal of a Partner

1. Withdrawal by selling to existing partners

One or more of the remaining partners may purchase the
withdrawing partner’s interest.
No change on the partnership assets and total capital
Transfer the capital balance of the withdrawing partner to the
capital balance of the partners purchasing the interest
Example: Dr. Mama withdraws from the partnership because of
a disagreement. He sells his Br. 38,333 ownership right to Dr.
Talky.
Journal entry
Dr. Mama Capital----------------------------- 38,333
Dr. Talky Capital ---------------------------------- 38,333
 Cont’d
2. Withdrawal by payment from partnership assets
Goodwill may be recognized or bonus may be given to
either the withdrawing partner or the existing partners
Both the assets and total capital of the firm will

decrease
Example: 1) Assume Dr. Mama was paid Br. 50,000 cash when he withdraws
from the partnership of T, M &H. The capital balances of each partner were as
follows as of that date:
Dr. Talky capital -----------------------------Br. 100,000
Dr. Mama capital --------------------------- --- 50,000
Sister Helen capital ----------------------------- 35,000
Journal entry
Dr, Mama Capital -------------------------------- 50,000
Cash -----------------------------------------------------------50,000
 Cont’d
2) Assume Dr. Mama was paid Br. 56,000
instead of Br. 50,000, the excess amount of Birr
6,000 is charged to the remaining partner’s
capital accounts based on the incomesharing
ratio. (Assume a 3:2:1 income-sharing ratio
between Dr Talky Dr. Mama and Sister Helen
respectively).
Journal entry
Dr. Mama capital ------------------------------50,000
Sister Helen capital ---------------------------- 1,500
Dr. Talky capital -------------------------------- 4,500
Cash --------------------------------------------56,000
Death of a partner
Dissolves a partnership, according to their
agreement.
In the absence of any contrary agreement,
the accounts should be closed as on the date
of death, and the net income for the
fractional part of the year should be
transferred to the capital accounts.
The balance in the capital accounts of the
deceased partner is then transferred to a
liability account with the deceased’s estate.
-

Liquidation of Partnerships
The process of winding up or terminating the
affairs of the partnership .
When a partnership goes out of the business,
the following activities will occur:
It usually sells the non cash assets. The sale of
the non cash assets is called Realization
Gain or Loss on the Realization is distributed as
per income sharing ratio
Pays the Creditors and
Distributes the remaining cash or other assets to
the partners according to their claims
Cont’d
A partnership may be liquidated if:
The objectives sought in forming the
partnership have been achieved.
The time period for which the partnership
was formed expires (ends)
Newly enacted laws have made the
partnerships activities illegal,
The partnership becomes bankrupt.
Cont’d
Three different realizations in liquidation
a) Grain on realization
b) Loss on realization, no capital
deficiencies
c) Loss on realization, capital deficiency
Journal Entries in liquidation
a) Sale of assets (realization)
b) Division of gain/loss
c) Payment of liabilities
d) Distribution and allocation of cash to
partners.
Liquidation of Partnerships

Example: Melat, Belen and Rekike agreed to

liquidate their partnership named MBR
Partnership. The income sharing ration is 2:3:5,
respectively. After discontinuing the ordinary
business operations of their partnership and
closing the accounts, the following summary of
the general ledger is prepared:
Cash 13,000
Non Cash Assets 62,000
Liabilities 20,000
Melat, Capital 22,000
Belen, Capital 22,000
Rekike, Capital 11,000
Liquidation of Partnerships
Allof the liabilities are paid at one time.
Assuming that the non cash assets are sold:
1. Br 80,000
2. Br 50,000
3. Br 30,000
Instruction: Prepare Statement of
Partnership Liquidation and record the
liquidation assuming that
I. Rekike can pay any of her deficit balance
from her personal assets
II.Rekike cannot pay any of her deficit balance