Chapter 5
Chapter 5
Chapter 5
Chapter 5
ACCOUNTING FOR PARTNERSHIP
4.1 Introduction
A business can be organized in the form of a sole proprietorship, a partnership firm or a company. In
doing business sometimes a single person might have the necessary intelligent and the resources that
are needed and therefore he would have carried on his business as an individual. Such cases are
however so rarely practical in life. Due to this then almost every businessman needs help from others
in business, which requires huge resources for the ongoing expansion programs. One of the inevitable
ways to overcome intellectual and resource constraint is to form partnership by joining hands with
person(s) who can complement the efforts by bringing in the necessary intellectual as well as financial
capital. This chapter is devoted to the basic aspects of partnership accounting.
Towards properly comprehending basic accounting concepts in relation to partnership are discussed
herewith. Owing the fact that the basic accounting procedure is similar in to other forms of
organizations it is on certain special features in the accounts of a partnership firm are dealt in detail.
The special features relate to the distribution of profits, the maintenance of capital accounts and the
adjustments required when the firm is reconstituted. In this chapter, we shall study the nature of
partnership and discuss the basic aspects of partnership accounts like preparation of capital accounts,
distribution of profits amongst partners and change in the profit-sharing ratio of the existing partners
along with preparation of Profit and Loss Account and Balance Sheet of the partnership firm. At the
end of the chapter problems are annexed so that you might be able to exercise concepts you have
learned.
The sole proprietorship has its limitations such as limited capital, limited managerial ability and
limited risk-bearing capacity. Hence, when a business expands or when it is to be set up on a scale,
which needs more capital and involves more risk, two or more persons join hands to run it. They agree
to share the capital, the management, the risk and profits of the business. Such mutual economic
relationship based on a written or an oral agreement amongst these persons is termed as 'partnership'.
The persons who have entered into partnership are individually known as 'partners' and collectively as
'firm'. A partnership is, then, an association of two or more persons to carry on as co-owners of a
business for profit.
4.2 Basics of Partnership- Common Characteristics:
The following are a common characteristic that hallmarks partnership from other formations:
Mutual Agency-the action of any partner is binding on all other partners when the partner is
engaging in partnership business. The firm's business may be carried on by all the partners or
any one of them acting for all. This means that partnership is based on the concept of mutual
agency relationship. A partner is both an agent (he can, by his acts, bind the other partners) and
a principal (he is bound by the acts of other partners). The implication of this is that partner
binds others and others bind him in the same way. Further implication of this is that each
partner is entitled to participate in the conduct of business affairs and act for and on behalf of
the firm.
Limited Life-the partnership is dissolved whenever a new partner is admitted to the
partnership or an old partner withdraws from the partnership.
Unlimited Liability-each partner is personally liable for the liabilities of the partnership if the
partnership assets are insufficient to settle the liabilities of the partnership.
Co-ownership of Property-partnership assets are owned jointly by all the partners
Participation in Income-net income and loss are distributed among partners according to their
agreement. The agreement should be to share the profits of the business. If some persons join
hands to carry on some charitable activity, it will not be termed as partnership. Of course, the
Cash 100,000
Inventory 100,000
Equipment 180,000
Building 600,000
Mortgage Payable 480,000
A, Capital 100,000
B, Capital (180,000 + (600,000 – 480,000)) 300,000
C, Capital 100,000
ST partnership
Statement of Owner’s equity
For the year ended Dec. 31, 2010
A B Total
Capital, beginning of 2005 472,500 107,500 580,000
Add. Additional investment during 2005 7,500 12,500 20,000
Subtotal 480,000 120,000 600,000
Net Income for the year 57,000 33,000 90,000
Subtotal 537,000 153,000 690,000
Loss: Withdrawals during the year (20,000) (10,000) (30,000)
Capital, Dec. 31, 2005 517,000 143,000 660,000
Changes in Ownership
Since a change in ownership creates a new partnership, the assets and liabilities of the old partnership
should be revalued to reflect fair market value at the date of change in ownership. The change in
ownership might result out of the following reasons. The common causes of dissolutions are admission
of new partners, death, bankruptcy or withdrawal of a partner. It has to be remembered however
dissolution of the partnership is not necessarily followed by the winding up of the affairs of the
business.
Investment in Partnership
Investment in partnership occurs when the new partner gains admission to the partnership by investing
assets directly into the partnership or purchase of an interest from one or more of the current partners.
In case where admission of partnership is by contribution of assets, the assets and liabilities invested in
the partnership should be recorded at their fair market value at the date of investment in the
partnership, and the new partner's capital account is credited for his capital interest multiplied by the
recorded value of the net assets of the partnership after the investment of the new partner with the
difference, if any, between the recorded value of the net assets invested by the new partner and the
amount recorded in his capital account (bonus payment) allocated to the old partners on the basis of
their profit and loss sharing ratios before the investment of the new partner
Illustration 6: Asset contributed is equal to capital contributed
A and B are partners with profit and loss sharing ratios of 25% and 75%, respectively, and capital
balances of 130,000 and 70,000, respectively; C invested 50,000 in cash for a 20% capital interest in
the partnership.
Required: Pass the necessary journal entries to record the investment.
C = 20% x (130,000 + 70,000 + C)
C = 50,000
Cash 50,000
C, Capital (20% x (200,000 + 50,000)) 50,000
Illustration 7: A and B are partners with profit and loss sharing ratios of 25% and 75%, respectively,
and capital balances of 130,000 and 70,000, respectively; C invested 60,000 in cash for a 20% capital
interest in the partnership; C agreed that the partnership had goodwill of 40,000.
Required: Show the necessary journal entries to record the investment.
C = 20% x (130,000 + 70,000 + 40,000 + C)
C = 60,000
Cash 60,000
C, Capital (20% x (200,000 + 60,000)) 52,000
A, Capital (25% x (60,000 - 52,000)) 2,000
B, Capital (75% x 8,000) 6,000
Solution
Total Owner’s Equity before Admission (50,000 + 64,000) 114,000
Revaluation of the partnerships 130,000
Goodwill attributable to the old partners 16,000
a) (1) Good will 16,000
A’s, Capital (2/5x16, 000) 6,400
B’s, Capital (3/5x16, 000) 9,600
Loss Allocation:
A = 20% x (160,000 – 270,000) = (22,000)
B = 60% x (160,000 – 270,000) = (66,000)
C = 20% x (160,000 – 270,000) = (22,000)
Illustration 18:
A, B, and C are partners with profit and loss sharing ratios of 20%, 60%, and 20%, respectively; the
partnership balance sheet consisted of cash of $20,000, non-cash assets of $270,000, liabilities of
$40,000, and capital balances of $140,000 for A, $60,000 for B, and $50,000 for C; the partnership
was liquidated by selling the non-cash assets for $160,000; the partner B is personally insolvent.
Required: Show the Liquidation Process and Allocation of the Loss on the Realization.
Non-cash A B C
_ Cash_ _Assets Liab. Capital Capital Capital
20,000 270,000 40,000 140,000 60,000 50,000
160,000 (270,000) _ (22,000) (66,000) (22,000)