Chapter 12: Accounting for Partnerships Flashcards
What is a partnership?
An association of individuals who operate a business for a profit
e.g. accounting, advertising, law, medicine
What are characteristics of a partnership?
- 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
What does each partner must do with regards to their profit earnings?
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)
What life does a partnership have?
Partnerships have a limited life. Any change in ownership ends the existing ownership.
How does a partnership dissolution occur?
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
What is mutual agency?
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
What is unlimited liability?
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
What is a limited partnership?
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
1) Those with unlimited liability are…
2) Those with limited liability are…
1) General partners
2) Limited partners
What are limited partners responsible for?
Limited partners are responsible for the debts of the partnership up to the limit of their investment in the partnership
Which type of businesses are limited partnerships normally uses for?
Businesses that offer income tax shelters for investors
e.g. real estate, rental properties, sports venues
What are advantages of partnerships?
- 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
What are disadvantages of partnerships?
- Mutual agency
- Limited life
- Unlimited liability
What is a partnership agreement?
A written contract that expresses the voluntary agreement of two or more individuals in a partnership
Partnership agreements should state…
- 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
The partnership’s initial investments is recorded at…
Fair value of assets contributed as at date of transfer into partnership
Profits and losses are shared….
Equally, unless partnership agreement indicates otherwise
Salaries and interest allowances…
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
What is the purpose of the statement of partner’s equity?
The statement of partner’s equity explains the changes in each partner’s capital account, and in total partnership equity during the year
What does the admission of a partner do to a partnership?
The admission of a partner causes the legal dissolution of the existing partnership and the beginning of a new partnership
How can a new partner be admitted into a partnership?
By purchasing the interest of one or more existing partners, or investing assets in the partnership
When does the admission of a new partner by purchase of a partner’s interest occur?
When a new partner personally purchases an ownership interest from existing partner(s)
What happens when a new partner purchases an existing partner’s ownership interest?
- 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
What happens when a partner invests asses inn a partnership?
Increases both the net assets and the total capital in the partnership
What is a voluntary withdrawal?
When a partner sells their equity in the firm
What is an involuntary withdrawal?
When a partner reaches retirement age, passes away or is expelled
What happens when using partnership assets to pay for a withdrawing partner’s interest?
Both partnership net assets and total capital decrease as a result
What is a partnership liquidation?
Ends both the legal and economic life of the entity
Before liquidation occurs, what must be completed?
The accounting cycle must be completed for the final operating period. Only balance sheet accounts should be open when the liquidation process begins.
What is realization?
The sale of non cash assets for cash
What is a capital deficiency?
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.
What is no capital deficiency?
A credit balance in a partner’s capital account after the allocation of a gain or loss on liquidation of a partnership
