Unit 8. Accounting For Partnerships
Unit 8. Accounting For Partnerships
Unit 8. Accounting For Partnerships
Contents
8.0 Aims & Objectives
8.1 Introduction
8.2 Partnership And Their Characteristics
8.3 Advantages And Disadvantages of A Partnership
8.4 Recording The Formation of A Partnership
8.5 Division of Partnership Income And Losses
8.6 Financial Statements For A Partnership
8.7 Dissolution of A Partnership
8.7.1. Admission of A New Partner
8.7.2. Withdrawal of A Partner
8.8 Liquidation of A Partnership
8.9 Summary
8.10 Answers To Check Your Progress
8.11 Model Examination Questions
8.12 Reference Books
8.13 Glossary
The unit aims at discussing the accounting for partnerships such as recording investments,
computing each partner’s share of income or losses using different techniques, and recording
them to the respective capital accounts. Also, the accounting implications of dissolution and
liquidation of a partnership will be described. Having studied and worked through this chapter
you would be able to:
In your previous course you have studied the three most dominant forms of business
organization: sole proprietorship, partnership, and corporation. For accounting purposes, each
form should be viewed as an economic unit separate from its owners, though legally only the
corporation is considered separate from its owners. In the previous section you have also studied
the basic accounting principles and practices used in accounting for a sole proprietorship form of
business organization. The accounting for corporate form of businesses will be explained in the
next unit. Therefore, the main focus of this chapter is to acquaint the learns with the basics of
accounting for partnerships. As will be explained later in this section, the same accounting
principles that are used in accounting for a sole proprietorship are applied in partnership form of
businesses. However, there are accounting practices that are unique to partnerships. These
unique accounting features relate to the partners’ capital and drawing accounts, division of
income (or loss), and changes in ownership of the partnership.
The partnership agreement should specify the name location, and purpose of the business; the
capital contributions and duties of each partner; the methods of income and loss division; the
rights of each partner upon liquidation (winding up) of a partnership, etc.
The partnership agreement should be in writing to avoid any misunderstandings about the
formation, operation, and liquidation of a partnership.
Characteristics of a partnership
For purposes of accounting, partnerships are treated as separate economic entities. The next
paragraphs describe some of the important features of a partnership.
A) Voluntary Association
A partnership is a voluntary association of individuals rather than a legal entity in itself.
Therefore, a partner is responsible under the law for his or her partner’s business actions with in
the scope of the partnership. A partner also has unlimited liability for the debts of the
partnership. Because of these potential liabilities, an individual must be allowed to choose the
people who join the partnership.
B) Limited Life
Because a partnership is formed by the consent of two or more partners, it has a limited life.
This means that, anything that ends the contract dissolves the partnership.
A partnership can be dissolved when (1) a new partner is admitted; (2) a partner withdraws,
retires, dies or becomes bankrupt. At this point, the remaining partners should sign a new
contractual agreement to continue the affairs of the business. In place of the old partnership a
new partnership is formed. Thus, a partnership is said to have a limited life.
C) Unlimited Liability
Each partner is liable for all the debts of the partnership. When and if the partnership fails to pay
its debts, creditors can seize (take) each partner’s personal assets to satisfy their claims.
Therefore, partnerships creditors claims are not limited to the assets of the business, but is
extends to the personal property of the partners. Each partner, then, could be required by law to
pay all the obligations (debts) of the partnership.
Suppose, for example, the liabilities of ABC company (a partnership business) as of a certain
date is birr 600,000, however, the total properties (assets) of ABC company could only be sold
for birr 450,000. Thus, to settle creditors claims fully, the house or personal assets of the partners
may have to be sold.
D) Mutual Agency
Each partner is an agent of the partnership within the scope of the business. This means that
partner’s act to any contract is binding on the remaining partners as long as it is with in the
apparent scope of the business’ operations.
For example, a partner in a public accounting firm can bind the partnership through the delivery
of accounting services. redundent. But this partner cannot bind the partnership to a contract for
delivering (or providing) cars because it is out of the scope of the business.
Advantages:
A partnership form of business ownership has the following advantages:
1. Easy and inexpensive to form than a corporation. A partnership is easy to form. It only
requires the consent of two or more parties. Two or more competent persons simply agree to
be partners in some common business purpose.
2. Advantageous to raise a large amount of capital and managerial skill (talent) than a sole
proprietorship. Because a partnership is formed by two or more persons, it is possible to
raise a large amount of capital and managerial skill than a single owner.
3. Not subject to separate taxation as a case in a corporation because each partner reports
his/her own share of partnership income and is individually taxed, and
Disadvantages
2. Disadvantageous if each partner does not exercise his/her good judgment because one
partner’s act can bind a partnership into a contract.
3. Limited life. Partnerships are subject to possible termination due to many uncontrollable
circumstances such as the death of a partner.
4. The transfer of ownership from one partner to another person is difficult unless the
remaining partners approve of this
8.4 RECORDING THE FORMATION OF A PARTNERSHIP
A separate capital account is maintained for each partner in a partnership. Each partner’s capital
account is credited for the value of their investment upon formation of the partnership.
Illustration
Dr. Teklay and Dr.Mamo decided to form a partnership business, which would provide medical
services. They have been in business separately before they form the partnership. The
partnership assumed the liabilities of their separate business. The assets were valued and
recorded at their current fair market value.
Shown below are the assets contributed and the liabilities assumed by the partnership at their fair
market value.
A partnership’s income and losses can be distributed according to whatever method the partners
specifies in the partnership agreement. The agreement should be specific and clear, to avoid
later disputes.
If a partnership agreement does not mention the distribution of income and losses, the law
requires that they be shared equally by all partners. Also, if a partnership agreement specifies
only the distribution of income, but is silent as to losses, the law requires that losses be
distributed in the same ratio as income.
(1) return to the partners for the use of their capital – called interest on partners’ capital,
(2) compensation for direct services the partners have rendered – called partners’ salaries,
and
(3) other income for any special characteristics individual partners may bring to the
partnership or risks they may take.
The breakdown of total income into its three components helps clarify how much each partner
has contributed to the firm.
Income can be shared among the partners in one of the following ways:
2. Net Income divided by allowing interest on the capital investments, salaries, or both with
the remaining net income divided in an agreed ratio.
Example
Assume that Dr. Teklay and Dr. Mamo partnership had a net income of Birr 60,000
1. A. Assume that the articles of a partnership provides equal share of Net Income or
Loss.
- In this case the capital accounts of each partner will be credited for Birr. 30,000
Income Summary-------------------------------60,000
Dr. Teklay capital-----------------------------------30,000
Dr. Mamo capital------------------------------------30,000
B. Net income is divided in ratio of 3.2 to Dr. teklay and Dr. Mamo respectively.
- Income summary-------------------------------------60,000
Dr. Teklay capital (3/5 X 60,000) --------------------------36,000
Dr. Mamo capital (2/5 X 60,000) ---------------------------24,000
C. Net income is divided in a ratio of partners’ capital account balances at the beginning
of the fiscal period.
166400
Dr. Mamo capital
[ 203200
×60 , 000 ] ------------------------------ 49,134
Journal entry
Income summary ---------------------------- 60,000
Dr. Teklay capital ---------------------------- 29,260
Dr. Mamo capital ---------------------------- 30,740
1. Assume the same agreement as in number “2” above but the net income for the year was
Birr. 10,000. Determine the amount to be distributed to each partner and record the
distribution in journal entry form
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The income statement of a sole proprietorship and that of a partnership are the same. At the end
of the period a statement of partners’ capital is prepared which summarizes the effect of
transactions on the capital account balances of each partner. The statement of owners equity for
Teklay and Mamo using assumed data and the income division shown above is illustrated below:
Dr. Teklay and Dr Mamo
Statement of partners’ Capital
For the year Ended Dec, 31, 2002
NB- The balance sheet of a partnership is different from that of a sole proprietorship only
in the owner’s equity section. In the partnership business since two or more persons
owns the business, there are two or more capital accounts whereas for a sole
proprietorship there will always be one capital account.
1. Hilina and Meron agreed to form a partnership. Hilina contributed Br. 200,000 in cash ,
and Meron contributed assets with a fair market value of Br. 400,000. The partnership, in its
initial year, reported net income of Br. 120,000.
Prepare the journal entry to distribute the first year’s income to the partners under each of the
following condition.
Hilina and Meron failed to include stated ratio in the partnership agreement.
Hilina and Meron agreed to share income and losses in a 3:2 ratio.
Hilina and Meron agreed to share income and losses in the ratio of their original
investments.
Hilina and Meron agreed to share income and losses by allowing 10 percent
interest on their original investments and sharing any remainder equally
2. What accounts are debited and credited to record the division of net income at the end of
the fiscal period?
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3. What accounts are debited and credited to record the division of net loss among the
partners’ at the end of the fiscal period?
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8.7 DISSOLUTION OF A PARTNERSHIP
The remaining partners can act for the partnership in finishing the affairs of the business
or in forming a new partnership that will be a new accounting entity.
Dissolving the old partnership and creating a new one require the consent of all the old partners
and the ratification of a new partnership agreement.
Suppose, for example, Sister Helen joins the partnership of Dr. Teklay and Dr. Mamo by buying
ownership right of Br. 8000 from Dr. Mamo. The entry to record the admission of Sister Helen
and the transfer of the ownership right from the capital account of Dr. Mamo to the capital
account of Sister Helen in the partnership books shown below
Journal entry
Dr. Mamo---------------------------------- 8,000
Sr. Helen --------------------------------------8,000
The price that sister Helen paid to Dr. Momo can be more or less than Br. 8,000 but that is
irrelevant as it wouldn’t be reflected in the record (books) of the partnership.
Journal Entry
Sister Helen’s capital account would be credited for Br. 80,000 i.e., (55,000 + 25,000 + 80,000)
X ½.
Cash------------------------------------------80,000
Sister Helen, Capital------------------------80,000
2- 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 ie, (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.
Journal entry
Cash----------------------------80,000
Helen capital ------------------------40,000
Dr. Teklay capital --------------------- 26,667
Dr. Mamo capital --------------------- 13,333
Dr. Mamo withdraws from the partnership because of a disagreement. He sells his Br. 38,333
ownership right to Dr. Teklay.
Journal entry
Dr. Mamo Capital----------------------------- 38,333
Dr. Teklay Capital ----------------------------- 38,333
The amount paid by Dr. Teklay is not recorded on the partnership books, because the transaction
involves no flow of assets to or from the partnership.
Example:
a. Assume Dr. Mamo 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:
Journal entry
b. Assume Dr. Mamo 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 income- sharing ratio.
(Assume a 3:2:1 income-sharing ratio between Dr Teklay Dr. Mamo and Sister Helen
respectively).
Journal entry
Dr. Mamo capital ------------------------------50,000
Sister Helen capital ---------------------------- 1,500
Dr. Teklay capital ------------------------------ 4,500
Cash ----------------------------------------------------56,000
The Birr 6,000 excess is shared on the basis of a 3:1 ratio, i.e., Dr. Teklay would be charged
for 6,000 X c/4 = birr 4500, and Sister Helan would be charged for
Birr 6000 X ¼= Birr 1500.
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2. In January 19X1, Sisay Hailu and Gelane Jalene agreed to produce and sell Soaps. Sisay
contributed br. 240,000 in cash to the business. Gelane contributed the building and
equipment, valued at Br. 220,000 and Birr. 140,000, respectively. The partnership had an
income of Birr 84,000 during 19X1 but was less successful during 19X2, when income was
only Br. 40,000.
(a) Prepare the journal entry to record the investment of both partners in the
partnership
(b) Determine the share of income for each partner in 19X1 under each of the
following conditions:
3. Nadew, Tezera, and Woliyi have equity in a partnership of Birr 80,000, Birr 80,000, and
Birr 120,000, respectively, and they share income and losses in a ratio of 20%, 20%, and
60%. The partners have agreed to admit Equbay to the partnership.
Instruction:
Instruction: prepare journal entries to record the admission of Equbay to the partnership under
the following conditions:
(a) Equbay invests Birr 50,000 for 20% interest in the partnership, and a bonus is
recorded for the original partners.
(b) Equbay invests Birr 60,000 for a 40% interest in the partnership, and a bonus is
recorded for Equbay.
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.
Liquidation is a special form of dissolution. When a partnership is liquidated, the business will
not continue.
The partnership agreement should indicate the procedures to be followed incase of liquidation.
Usually, the books (records) are adjusted and closed, with the income or loss distributed to the
partners and the assets are sold.
The sale of the assets at the time of liquidation of a partnership is known as realization.
As the assets of the business are sold, any gain or loss should be distributed to the partners
according to the income and loss sharing ratio.
As cash is realized, it must be applied first to outside creditors. Finally, the remaining cash is
distributed to the partners in accordance with the balance of their capital accounts.
Illustration
The partnership of Resom, Sultan, and Tassew is liquidated on September 1,2002. The income
and loss sharing ratio of the partners is: Resom 40%, Sultan 35%, and Tassew 25%. After
discontinuing the ordinary business operations of their partnership and closing the accounts, the
following summary of a trial balance is prepared:
R, S And T
Trial Balance
Septamber 1, 2002
Debit Credit
Cash 10,000
Other assets 90.000
Liabilities 10,000
R. Capital 30,000
S. Capital 30,000
T. Capital ________ 30,000
Total 100,000 100,000
Based on the information on the trial balance, accounting for liquidation of R,S,
R,S, and T
partnership will be illustrated using different selling prices for the non cash assets.
- Liabilities……………………….10,000
Cash………………………………..10,000
After the above entries are posted, the partners’ capital accounts shows:
The cash account now shows a balance of Birr 95,000 (10,000 + 95,000 – 10,000). The entry
recorded upon distribution of this cash among the partners would, therefore, be
Journal entry
-Cash --------------------------------------70,000
Loss on realization-----------------------20,00
Other Assets-------------------------------------90,000
After the above entries have been posted; the accounts show cash 70,000 R, cap. Birr22,000
S,cap. Birr 23,000 and T, cap. Birr 25,000. The entry to record the cash distribution to the
partners would, therefore, be as follows:
- Assume the non-cash assets of R,S and T partnership are sold for only Birr
10,200, incurring a loss of Birr 79,800,( Birr 90,000 – Birr 10,200). The entries to record the
division of loss among the partners and the liquidation to this point are shown below:
At this stage of the liquidation the capital accounts of the partners have the following balances
Only Birr 10,200 cash is available (10,000 + 10200 – 10,000) for distribution to S and T while
the combined balances of their capital accounts is Birr 12,120. Therefore, additional Birr 1,920,
(12120 – 10200) is needed which is the amount owed by R to the partnership.
Therefore, either R will have to pay this amount first and the cash will be distributed to S and T,
or S and T will have to share the Birr 1920 loss in their income and loss-sharing ratio of 35:25.
Let’s assume, the loss was distributed since R couldn’t pay the amount immediately.
Journal Entries
S capital (35/60 X 1920) -------------- 1,120.00
T capital (25/60 X 1920) -------------- --800.00
R capital -------------------------------------1,920
To charge R’s capital deficiency to S and T
S, capital -----------------------------------950.00
T, capital -----------------------------------9,250.00
Cash ----------------------------------------------10,200
To record the final cash distribution to partners.
The various entries in the liquidation of R,S, and T partnership are summarized in the following
statement.
R, S, T partnership
Statement of Partnership Liquidation
For period Sept. 1-15,2002
8.9 SUMMARY
A partnership form of business ownership has several characteristics. From among them are:
voluntary association, limited life, unlimited liability, mutual agency, and co- ownership of
partnership property.
The advantages of partnerships include: easy of formation, possible to raise large amount of
capital than a single owner, not subject to separate taxation, and the absence of many restrictive
laws unlike a corporation, etc.
Partnerships have also the following disadvantages: unlimited liability, mutual agency, limited
life, etc.
A partnership income and losses can be distributed according to whatever method the partner
specifies in the partnership agreement. The agreement should be specific and clear, to avoid
later disputes.
If a partnership agreement does not mention the distribution of income and losses, the law
requires that they be shared equally by all partners. If a partnership agreement specifies only the
distribution of income, but is silent as to losses, the law requires that losses be distributed in the
same ratio as income.
The income of a partnership normally has three components: (1) return to the partners for the
use of their capital, (2) compensation for direct services the partners have rendered, and (3) other
income for any special characteristics individual partners may bring to the partnership or risks
they may take.
At the end of each fiscal period financial statements are prepared for a partnership business.
Most of the financial statements of a partnership are the same as that of a sole proprietorship
with the exception of the owners equity section of a balance sheet.
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.
Liquidation is a special from of dissolution. When a partnership is liquidated, the business will
not continue.
A partnership may be liquidated if: (a) the objectives sought in forming the partnership has been
achieved, (b) the time period for which the partnership was formed expires (or ends), (c) newly
enacted laws have made the partnership’s activities illegal, (d) the partnership becomes bankrupt.
The partnership agreement should indicate the procedures to be followed incase of liquidation.
Usually, the records are adjusted and closed, with the income or loss distributed to the partners,
and the assets are sold. The sale of the assets at the time of liquidation of a partnership is known
as realization. As the assets of the business are sold, any gain or loss should be distributed to the
partners according to the income and loss sharing ratio. As cash is realized it must be applied
first to outside creditors. Finally, the remaining cash is distributed to the partners in accordance
with the balance of their capital accounts.
Cash-----------------------------8500
Dr. Teklay capital-------------------------- 4200
Dr. Mamo capital--------------------------- 4300
PART I.
I. Choose The Best Answer:
B) 2:1 D) 1:1
Refer to the following information which is related to XYZ partnership and answer questions 3
and 4.
The capital account and income sharing ratios of the three partners after realization of non – cash
assets and settlement of all liabilities are as follows:
Y (15,000) 3
Z 36,000 3
________ 3. If partner Y is unable to pay any part of his deficiency to the partnership,
how much cash will be given to partner Z from the liquidation?
________ 4. If partner Y pays two – third of the deficiency to the partnership, how much
cash will be given to partner X?
A) Birr 33,000 C) Birr 43,000 E) None of the above.
B) Birr 47,000 D) Birr 45,000
5. Paulos, Kebede, and Abeje are partners sharing income 3:2:1. After
the firm’s loss from liquidation is distributed, Paulos’s capital account has a debit balance of
Birr 30,000. If Paulos is personally bankrupt and unable to pay any of the birr 30,000, how
will the loss be divided between Kebede and Abeje?
Exercise