Chapter 12: Accounting for Partnerships

Question 1

What is a partnership?

Answer 1

An association of individuals who operate a business for a profit

e.g. accounting, advertising, law, medicine

Question 2

What are characteristics of a partnership?

Answer 2

• A partnership is a legal entity
• A partnership can own property (land, buildings, equipment. ) and can sue or be sued
• A partnership is an accounting entity (personal assets, liabilities, and transactions are excluded from accounting records)
• A partnership a bit taxed as a separate entity

Question 3

What does each partner must do with regards to their profit earnings?

Answer 3

1) File an information tax return that reports partnership’s profit and each partner’s share of the profit

2) Report their share of their profit on their personal income tax returns (taxed at their personal income tax rate)

Question 4

What life does a partnership have?

Answer 4

Partnerships have a limited life. Any change in ownership ends the existing ownership.

Question 5

How does a partnership dissolution occur?

Answer 5

A partnership dissolution occurs when a partner withdraws or a new partner is admitted

NOTE: Operations can continue without any interruption by forming a new partnership, even when partnership is dissolved

Question 6

What is mutual agency?

Answer 6

The action of any partner is binding on all other partners

• If one partner enters into an agreement, provided the act looks appropriate for the partnership, all partners are bound to that agreement

Question 7

What is unlimited liability?

Answer 7

Each partner is liable for all partnership liabilities

• If one partner incurs a liability, the other partners are also responsible for it
• For repayment, creditors have first claims on the partnership assets
• If there are not enough partnership assets for repayments, creditors can make a claim against partner’s personal assets

Question 8

What is a limited partnership?

Answer 8

A partnership in which one or more of the partners have unlimited liability and one or more partners have limited liability for all debts of the partnership

Question 9

1) Those with unlimited liability are…

2) Those with limited liability are…

Answer 9

1) General partners

2) Limited partners

Question 10

What are limited partners responsible for?

Answer 10

Limited partners are responsible for the debts of the partnership up to the limit of their investment in the partnership

Question 11

Which type of businesses are limited partnerships normally uses for?

Answer 11

Businesses that offer income tax shelters for investors

e.g. real estate, rental properties, sports venues

Question 12

What are advantages of partnerships?

Answer 12

• Combines skills and resources of two or more individuals
• Is easily formed
• Has fewer government regulations and restrictions than corporations
• Allows for easier decision-making

Question 13

What are disadvantages of partnerships?

Answer 13

• Mutual agency
• Limited life
• Unlimited liability

Question 14

What is a partnership agreement?

Answer 14

A written contract that expresses the voluntary agreement of two or more individuals in a partnership

Question 15

Partnership agreements should state…

Answer 15

• The names and capital contributions of partners
• Rights and duties of partners
• Basis for sharing profit me loss
• Provisions for withdrawal of assets
• Procedures for submitting disputes to arbitration
• The rights and duties of surging partners if a partner passes away
• Procedures for the liquidation of the partnership

Question 16

The partnership’s initial investments is recorded at…

Answer 16

Fair value of assets contributed as at date of transfer into partnership

Question 17

Profits and losses are shared….

Answer 17

Equally, unless partnership agreement indicates otherwise

Question 18

Salaries and interest allowances…

Answer 18

1) Are allocated first even if greater than profit or if partnership incurred a loss for the year

2) Are not expenses of the partnership - it is only used to divide profit or loss among the partners

3) Are not distributions of cash (or other assets) - drawings by partners are distributions

Question 19

What is the purpose of the statement of partner’s equity?

Answer 19

The statement of partner’s equity explains the changes in each partner’s capital account, and in total partnership equity during the year

Question 20

What does the admission of a partner do to a partnership?

Answer 20

The admission of a partner causes the legal dissolution of the existing partnership and the beginning of a new partnership

Question 21

How can a new partner be admitted into a partnership?

Answer 21

By purchasing the interest of one or more existing partners, or investing assets in the partnership

Question 22

When does the admission of a new partner by purchase of a partner’s interest occur?

Answer 22

When a new partner personally purchases an ownership interest from existing partner(s)

Question 23

What happens when a new partner purchases an existing partner’s ownership interest?

Answer 23

• Individual gains ownership in a partnership without changing the overall capital within the partnership
• No cash is contributed to the partnership
• Partnerships total net assets and total capital does not change when interest is purchased
• Consideration exchanged is personal property of the partners involved and not property of the ownership

Question 24

What happens when a partner invests asses inn a partnership?

Answer 24

Increases both the net assets and the total capital in the partnership

Question 25

What is a voluntary withdrawal?

Answer 25

When a partner sells their equity in the firm

Question 26

What is an involuntary withdrawal?

Answer 26

When a partner reaches retirement age, passes away or is expelled

Question 27

What happens when using partnership assets to pay for a withdrawing partner’s interest?

Answer 27

Both partnership net assets and total capital decrease as a result

Question 28

What is a partnership liquidation?

Answer 28

Ends both the legal and economic life of the entity

Question 29

Before liquidation occurs, what must be completed?

Answer 29

The accounting cycle must be completed for the final operating period. Only balance sheet accounts should be open when the liquidation process begins.

Question 30

What is realization?

Answer 30

The sale of non cash assets for cash

Question 31

What is a capital deficiency?

Answer 31

A debit balance in a partner’s capital account after the allocation of a gain or loss on liquidation of a partnership.
Capital deficiency can be repaid or allocated among remaining partners.

Question 32

What is no capital deficiency?

Answer 32

A credit balance in a partner’s capital account after the allocation of a gain or loss on liquidation of a partnership