Chapter- 5

Accounting
for Part-
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 Meaning of Partnership
−Partnership is an association of two or
more persons to carry on as co-owners a
business for profit
−Partnership originates from a contract
entered between partners
−The contract could be written, oral or
implied by acts of partners
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 Types of partnership
1.General partnership
– Is one in which all of the partners have the
ability to actively manage or control the
business
– This means that every owner has author-
ity to make decisions about how the
business will run.
– In general partnerships, partners manage
the business and assume responsibility for
the partnership’s debts
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2. Limited partnership
– Have both general and limited partners
– There are at least one general & one lim-
ited partner
– Limited partners only serve as investors
for the partnership
– Typically, a limited partner does not have
decision-making rights
– They get ownership but don’t have as
many risks and responsibilities as a
general partner
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3. Limited liability partnership (LLP): is
a type of partnership where owners
aren’t held personally responsible for
the business’s debts or other part-
ners’ actions

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 Characteristics of partnership
– Ease of formation
– Voluntary association
– Articles of partnership
– Mutual agency
– Unlimited liability
– Co-ownership of property
– Income participation
– Limited life
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 Advantages and Disadvantages of the
Partnership
Advantages
– Capitalization
– Combined experience and talent
– Ease of formation
– Cost of organization
– Tax advantages (single tax)
– Less government supervision
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 Disadvantages
– Loss of freedom
– Limited life
– Unlimited Liability
– Mutual Agency
– Division of authority

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 Partnership Agreement
• In Ethiopia, legal provisions on partnership require the following
points be covered in partnership agreement:-
– The date of formation of partnership and the duration of the con-
tract
– The names and addresses of the partners, and the name and na-
ture of the partnership
– The assets to be invested by each partner
– The right and duties of each partner
– The accounting period to be used, the nature of accounting
records, financial statements and audits by certified public accoun-
tants.
– The plan for sharing net income or loss,
– The salaries and drawing allowed to partners
– Provision for the arbitration of disputes and the liquidation of the
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partnership at the end of the specified term of the contract or9 at
Partnership Formation / Recording In-
vestments
•When a partnership is formed, a journal
entry is made to record the assets con-
tributed by each partner and the liabili-
ties of each partner that are assumed by
the partnership
•A separate entry is made for the invest-
ment of each partner in a partnership.
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Example
On April 1 of the current year, Fassil and
Selamawit agreed to combine their exist-
ing business and form a partnership. The
partners are to contribute the assets of
their previous business. It is agreed that
the liabilities of the proprietorships will
be assumed by the partnership. The con-
tribution made by each partner is as fol-
lows.
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 Amount
Asset contributed Fassil
Selamawit
Cash 3,500 5,700
Accounts Receivable 7,600 4,200
Merchandise inventory 15,900
11,000
Supplies 700 300
Equipment 8,500 -
Building -
55,000
Land -
16,000
Liability
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The journal entries to open the accounts of the
partnership are:
April 1. Cash 3,500
Account Receivable 7,600
Merchandise inventory 15,900
Supplies 700
Equipment 8,500
Account payable
3,100
Fassil, capital
33,100
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(To record the investment13
April 1. Cash 5,700
Account Receivable 4,200
Merchandise Inventory 11,000
Supplies 3,00
Building 55,000
Land 16.000
Notes payable
19,600
Selamawit, capital
72,600
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Methods to divide income or lose use:
1.Income Division: Services of part-
ners
Salary Allowance
•Articles of partnership often provide for
the division of a portion of net income to
the partners in the form of a salary al-
lowance taking into account the ability
and amount of time devoted to the busi-
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• Example
• Assume that the articles of partnership
of Alem and Tesfaye provide for
monthly salary allowance or $ 24,000
and $ 36,000 respectively, with the bal-
ance of the net income to be divided
equally. The net income for the year is
$ 90,000. The division of the $ 90,000
net income is a follows. Net income to
divide $90,000
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 Division of net income
Alem Tesfaye
Total
Salary Allowance $ 24,000 $ 36,000
$ 60,000
Remaining income 15,000 15,000
30,000
Partners shares $ 39,000 $
51,000 $ 90,000
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• The division of net income is recorded
as a closing entry, regardless of
whether the partners actually withdraw
the amounts of their salary allowances.
• The entry for the division of net income
is as follows.
Dec 31 Income Summary 90,000
Alem, capital 39,000
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Tesfaye, capital 51,000
18
2. Income Division: services of part-
ners and investment
• Partners may agree that the most equi-
table plan of dividing income is to pro-
vide for:
– Salary allowance and
– Interest on capital investments.
– Any remaining net income is then divided
as agreed.
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Example
Assume that the partnership agreement for Alem and
Tesfaye divides income as follows.
1.Monthly salary allowances of $ 24,000 for Alem
and $ 36,000 for Tesfaye.
2.Interest of 10% on each partner’s capital balance
on January 1.
3.Any remaining net income divided equally between
the partners.
•Alem had a credit balance of $ 70,000 in her capital
account on January 1 of the current fiscal year, and
Tesfaye had a credit balance of $ 90,000 in his capi-
tal account.
•The $ 90,000 net income for the year is divided in
the following schedule.
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Net income
$ 90,000
Division of net income
Alem Tesfaye
Total
Annual salary allowance $ 24,000 $ 36,000 $
60,000
Interest allowance 7,000 9,000
16,000
Remaining income 7,000 7,000
14,000
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For the above example, the entry to close
the income summary account is shown
below.
Dec 31. Income summary $
90,000
Alem, capital
38,000
Tesfaye, capital
52,000
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Income Division: Allowances Exceed Net
Income
•In the examples so far, the net income
has exceeded the total of the salary and
interest allowances. If the net income is
less than the total of the allowances, the
remaining balance will be a negative
amount. This amount must be divided
among the partners as though it were a
net loss.
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• Example:
Assume the same salary and interest al-
lowances as in the above example, but
assume that the net income is $
50,000. Alem Tesfaye Total
Annual salary allowance $ 24.000 $ 36.000 $ 60.000
Interest allowance 7.000 9.000 16.000
Total $ 31.000 $ 45.000 $ 76.000
Excess of allowances over income (13.000) (13.000) (26.000)
Net income $ 18.000 $ 32.000 $ 50.000

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The entry to close the income summary
account
Dec 31 Income summary 50,000
Alem, capital
18,000
Tesfaye, capital
32,000

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Partnership Dissolution
When a partnership dissolves, its affairs are not
necessarily windup. When a partner is added or
a partner withdraws, the old partnership ends.
Stills, the business can continue to operate as
a new partnership among the remaining partners.
Admission of a partner
There are two ways a new partner is admitted to
a partnership with the consent of all the cur-
rent partners.
1.Purchasing an interest from one or more of
the current partners.
2.Contributing/investing partners’ cash or
other
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assets to the partnership. 26
1. Purchasing an interest in a part-
nership
– The purchase of partnership inter-
est is a personal transaction be-
tween one or more current partners
and the new partner
– The capital interest of the incoming
partner is reallocated and obtained
from current partner
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• Example
• Assume that partners Abraham and
Kebede have capital balance of $ 100,000
and $ 75,000 respectively.
• On September1, Abraham sells one-half
of his interest for $60,000 and Kebede
sells one-fifth of his equity for $ 20,000 to
Nardos.
• The exchange of cash is not a partnership
transaction and thus is not recorded by
the partnership.
• The only entry required in the partnership
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Sept 1. Abraham capital 50,000
Kebede, capital 15,000
Nardos, capital
65,000

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2. Investing/contributing Assets to a part-
nership
• Admitting a partner by accepting as-
sets is a transaction between the new
partner and the partnership. The in-
vested assets become partnership
property.
N.B: In this case, both the assets and
the owner’s equity of the firm in-
crease.
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• Example: -
• Assume that partners Genet (with a $
72,000 capital) and Sisay (with a $
84,000) agreed to accept Nebyat as a
partner with her investment of $ 34,000
on March 1.
• The entry to record Nebiyat’s invest-
ment is:
March 1. Cash 34,000
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Revaluation of Assets
A partnership’s asset account balances should be stated at
current values when a new partner is admitted. The net ad-
justment (increase or decrease) in asset values is divided
among the capital accounts of the existing partners accord-
ing to their income-sharing ratio.
Example:
Assume that in the preceding example for Genet & Sisay
partnership, the balance of the merchandise inventory ac-
count is $25,000 and the current replacement value is $
29,000. Prior to Nebyat’s admission, the revolution would
be recorded as follows, assuming that Genet & Sisay share
net income equally.
March 1. Merchandise Inventory 4,000
10:01 AM Genet, capital 2,000 32
Partner Bonuses
– When a new partner is admitted to a part-
nership, the incoming partner may pay a
bonus to the existing partners for the priv-
ilege of joining the partnership.
– Existing partners can pay a bonus to a new
partner. This usually occurs when they
need additional cash or the new part-
ner has exceptional or special talents &
skill.
– The amount of any bonus paid to the part-
nership is distributed among the partner
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Bonus to old partners
•Assume that on June 1 the partnership of
Ashenafi and Dereje is considering admit-
ting a new partner, Hiwot. After the assets
of the partnership has been adjusted to cur-
rent market values, the capital balance of
Ashenafi is $150,000 and the capital bal-
ance of Dereje $ 30,000.
•Ashenafi and Derege agree to admit Hiwot
to the partnership for $ 80,000. In return,
Hiwot will receive a 25% share in both eq-
uity and partnership income or losses.
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 – Ashenafi $ 150,000
– Dereje
30,000
– Investment of new partner, Hiwot
80,000
– Total partnership equity $
260,000
– Equity of Hiwot (25% of total) $
65,000
– Contribution of Hiwot $
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The bonus is distributed to Ashenafi and
Dereje according to their income-sharing
ratio. Assume that Ashenafi & Dereje share
profits and losses in the ratio of 5:1; the en-
try to record the admission of Hiwot to the
partnership is as follows:
June1. Cash 80,000
Hiwot, capital 65,000
Ashenafi, capital 12,500
Derege, capital
2,500
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Bonus to New partner
The new partner gets a larger share of equity than the
amount invested (contributed).
Example:
Let’s say, from the preceding example, Ashenafi and Dereje agree
to accept Hiwot as a partner with a 25% interest in both the part-
nership’s income or loss and equity, but they require Hiwot to only
invest $ 20,000. Hiwot’s equity is determined as:
Equities of existing partners ( $ 150,000 + $ 30,000) $
180,000
Investment of new partner, Hiwot 20,000
Total partnership equity $
200,000
Equity of Hiwot (25% x $200,000) $ 50,000

10:01 AM Bonus to new partner, (Hiwot) ($50,000-$20,000) = 37 $

The entry to record Hiwot’s investment is
June 1. Cash 20,000
Asenafi, capital ($30,000 x / ) 25,000
5
6

Dereje, capital ($ 30,000x /

1
6) 5,000
Hiwot, capital
50,000
(To record Hiwot’s admission and
bonus)
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Withdrawal of a partner
•There are several ways in which an individ-
ual can withdraw from a partnership. A
partner can:
– Sell his or her interest to another partner or to
an outsider with the consent of the other part-
ners, the transaction is personal.
– Withdraw assets equal to his or her capital
balances (No bonus)
– Withdraw assets that are less than his or her
capital balance (Bonus to remaining partners).
– Withdraw assets that are greater than his or
her capital balance (Bonus to withdrawing
partner).
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1. X capital…………..20,000
Y Capital……….....20,000
(Sell his or her interest to another partner or to an outsider)
2. X Capital……………20,000
Cash………………….20,000
(Withdraw assets equal to his or her capital balance)

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3. X Capital……………20,000
Y Capital………………5,000
Z Capital………………5,000
Cash…………………….10,000
(Withdraw assets that are less than his or her capital balance (Bonus to
remaining partners)

4. X Capital…………………..20,000
Y Capita…………………….5,000
Z Capital……………………5,000
Cash………………………30,000
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Liquidation of a partnership
– Liquidation of a partnership is the process of ending the
business, of selling enough assets to pay the partnership’s
liabilities and distributing any remaining assets among the
partners.
– When a partnership is liquidated, its business is ended.
Four steps are involved:
1.Non-cash assets are sold for cash and a gain or loss
on liquidation is recorded. (Realization)
2.Gain or loss on liquidation is allocated to partners us-
ing their income-and –loss ration.
3.Liabilities are paid.
4.Remaining cash is distributed to partners based on
theirs
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capital balances. 42
Example: -
Assume that Fassil, Tahir, and Kassa share income
and losses in a ratio of 4:4:2 (4/10, 4/10. 2/10). On May
12, 2020 after discontinuing business operations of
the partnership and closing the accounts, the follow-
ing summarized trial balance was prepared.
Cash 3,000
Non-cash Assets 24,000
Liabilities 6,000
Fassil, capital 10,000
Tahir, capital 8,000
Kassa, capital 3,000
Total $ 27,000 $ 27,000
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• Between May 13 and May 31 required sell
all non cash assets of the year 2020, Fas-
sil, Tahir and Kassa based on the above
facts and taking different selling prices for
the non cash assets.
– Prepared a statement of partnership liquida-
tion & make the necessary journal entries to
account for the liquidating process if the non-
cash assets are sold for:
1. $ 29,000, Gain on realization
2. AM
10:01 $ 20,000, Loss on realization 44
1. Gain on Realization
Fassil, Tahir, and Kassa
Statement of partnership Liquidation
For Period May 13, 31, 2020
Assets Capital

Non cash Liabili- Fassil Tahir Kassa

Cash + Assets ties 40% 40% 20%

Balance before realization $3,000 $ 24,000 $ 6,000 $ $ 8,000 $ 3,000

10,000
Sale of assets & division of +29,000 - 24,000 + 2,000 + 2,000 +
gain 1,000
Balance after realization $ 32,000 $0 $6,000 $ $ $ 4,000
12,000 10,000
10:01 AMof liabilities
Payment -6,000 - -6,000 - - 45
-
The entries to record the steps in the liquidating process are as follows:
1. Cash 29,000
Non cash Assets 24,000
Gain on Realization 5,000
(To record selling of assets)
2. Gain on Realization 5,000
Fassil, capital 2,000
Tahir, capital 2,000
Kassa, capital 1,000
(To record Division of gain from sale of assets)
3. Liabilities 6,000
Cash 6,000
(To record Payment of Liabilities)
4. Fassil, capital 12,000
Tahir, capital 10,000
Kassa, capital 4,000
Cash 26,000
(To record Distribution of cash to partners)
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2. Loss of Realization
Fassil, Tahir, and Kassa
Statement of partnership Liquidation
For Period May 13-31, 2020
Assets Capital
Liabilities
Cash + Non cash Fassil Tahir Kassa
+
= 40% 40% 20%
Assets
Balance before realization $3,000 $ 24,000 $ 6,000 $ $ $
10,000 8,000 3,000
Sale of assets & division of +20,000 - 24,000 - - 1,600 - 1,600 - 800
loss
Balance after realization $ 23,000 $0 $6,000 $ 8,400 $ $
6,400 2,200
Payment of liabilities -6,000 - -6,000 - - -
Balance after payment of li- $ 17,000 $0 $0 $ 8,400 $6,400 $
abilities 2,200
Cash distributed to partners -17,000 - - -8,400 -6,400 -
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2,200
The entries to liquidate the partnership are as follows
1. Cash 20,000
Loss on Realization 4,000
Non cash Asets 24,000
(To record Selling of Assets)
2. Fassil, capital 1,600
Tahir, capital 1,600
Kassa, capital 800
Loss of Realization 4,000
(To record loss on realization of assets)
3. Liabilities 6,000
Cash 6,000
(To record Payment of liabilities)
4. Fassil, capital 8,400
Tahir, capital 6,400
Kassa, capital 2,200
Cash 17,000
(To record Distribution of cash to partners)

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1. Loss on Realization- capital Deficiency
Fassil, Tahir, and Kassa
Statement of partnership Liquidation
For Period May 13-31, 2020
Assets Capital
Cash Non cash Liabilities+ Fassil Tahir Kassa
40% 40% 20%
Balance before realization $3,000 $ 24,000 $ 6,000 $ 10,000 $ 8,000 $ 3,000
Sale of assets & division of loss +4,000 - 24,000 ____ - 8,000 - 8,000 - 4,000
Balance after realization $ 7,000 $0 $6,000 $ 2,000 $0 $ (1,000)
Payment of liabilities -6,000 - -6,000 - - -
Balance after payment of liabili- $ 1,000 $0 $0 $ 2,000 $0 $ (1,000)
ties
Receipt of deficiency +1,000 - - - - +1,000
Balances $ 2,000 $0 $0 2,000 $0 $0
Cash distributed to partners -2,000 - - -2,000 - -
Final balance $0 $0 $0 $0 $0 $0
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The entries to record the liquidation are as follows:
1. Cash 4,000
Loss on Realization 20,000
Non cash Assets 24,000
(To record Selling of assets)
2. Fassil, capital 8,000
Tahir, capital 8,000
Kassa, capital 4,000
Loss on Realization 20,000
(To record Division of loss from sale of assets)
3. Liabilities 6,000
Cash 6,000
(To record Payment of liabilities)
4. Cash 1,000
Kassa, capital 1,000
(To record Receipt of cash from deficient partner)
5. Fassil, capital 2,000
Cash 2,000
(To record Distribution of cash to partner)
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