F5 - M4 - Partnerships Flashcards
What are the two ways a partner can be admitted?
They can either buy the interest of an existing partner, and take their place. This has no accounting impact since it is an exchange between them. Also, they need approval from the other partners.
They can invest into the partnership and become a partner. This has an accounting impact and what the lectures will be covering.
What are the three ways to account for an investment into a partnership, and what do they mean?
Exact method - The purchase price can be equal to the book value.
Bonus Method - The purchase price can be less to the book value.
Goodwill method - The purchase price can be more to the book value.
What is the formula to calculate a partners capital account, when they contribute to become a partner?
Fair value of the asset they contributed - present value of the liabilities assumed.
How does the exact method work?
This is where a partner buys into a another partnership, but this does change the percentage but not the amount of each partners account contributed.
So for example, lets say there are three partners that each own 20,000, 30,000, and 50,000. The total of these capital accounts is 100,000. If you want to be a partner in the exact method, you just have to pay the amount 1/3 of a partner would since there are three partners. 100,000/3 is 33,333. The new partner would pay this amount, become a partner, and the new capital account would be 133,333, but each partner keeps their total capital amount.
How does the bonus method work?
Under this method, either the amount paid is more or less than the book value.
Existing partner - When the new partner pays more than net book value, bonus will be credited to the existing partners.
New partner - When the new partner pays less than net book value, bonus will be credited to the new partner.
So lets say you give 20,000 to become a new partner, where the partnership has two partners. The total capital account will the capital account of those two partners plus 20,000. You take that total capital amount divided by the 3 new partners, and compare that to what the new partner paid. If it is more, then the gain would increase the existing partners capital accounts. If it is less, than the existing partners would have their capital accounts decreased to increase the new partner.
How does the goodwill method work?
This is where you compare the imputed net assets to the actual net assets, and the difference is goodwill. That goodwill is allocated among the existing partners as an increase in their capital account.
So if a new partner pays 35,000 for their interest and there are already two partners that own 20,000 each, the implied interest is 35,000*3 which is 105,000. That is what we think it should be valued since the partner paid 35,000. The actual is 75,000 (35+20+20). The difference between 105-75= 30,000. That is the amount of goodwill and will be allocated among the existing partners based on their ownership percentage.
When distributing income and loss among partners, what are the two ways this is done?
Either the income or loss is distributed among the the partnership agreement that they have in writing.
If that is not there, then it is based on their ownership percentages, or their capital account percentages.
What is normally deducted prior to the distribution of profit and loss?
You normally deduct guaranteed payments such as interest on capital, salaries, bonuses.
What are the two methods that can be used for the withdrawal of a partner?
Bonus - This is where when a partner leaves, you have to pay the partner their capital amount, and if you pay more or less, you have to allocate that amount among the other active partners.
Goodwill - This is where you raise everyone’s capital account by the amount of the goodwill. Then after you do that, you pay of the exiting partner with cash.
What is the three step process for liquidating a partnership?
Disposing of the assets and collecting cash
Paying off all liabilities to creditors
Distributing the remainder (if any) to the partners
What is capital deficiency for a partner?
This is when a partner has a negative capital account. In partnerships you cannot have a negative account so there are a few ways to offset this.
- If the partnership has a loan account for that partner (partnership owes that partner the money), the partnership has a legal right to use that loan amount to offset that partners deficiency. So if they are negative -10,000 in capital, and the loan the partnership owes is 20,000, they can use 10,000 of that to bring the capital account to zero.
- If there is still a deficiency, then the remaining partners have to absorb that deficiency in their capital accounts.
For partner liquidation, is it important that no partner is either underpaid or overpaid? How do you combat this?
Yes that is correct. so if one partner cannot cover due to their capital account, then the rich partners have to cover for that partner and are paid first.
What would be the journal entry to pay off a with drawling partner if the amount paid to them is greater than their capital account under the bonus method?
If you pay more than the capital account, then the other partners have to eat that cost with their account. So let’s say they paid 120,000 when the partner had 100,000. This is what the entry would be. Note that A and B partners are 50/50 and X partner is leaving.
DR A partner - 10,000
DR B partner - 10,000
DR X partner - 100,000
CR Cash - 120,000
What would be the journal entry to pay off a with drawling partner if the amount paid to them is greater than their capital account under the goodwill method?
This method is different from the bonus method because under the bonus method, you decrease everyone’s capital account based on the buyout of the partner. In good will, you raise everyone’s account based on the goodwill, then you create a separate entry to pay of the leaving partner with no adjustment to the other partners, see below:
DR Goodwill
CR A partner
CR B partner
CR X partner
DR X partner
CR Cash
