Part 1: Formation of Partnerships
Introduction
A partnership is a business arrangement where two or more individuals share ownership. Each partner contributes resources, shares in the profits and losses, and has joint decision-making authority. This tutorial covers the accounting aspects of forming a partnership, including initial contributions, profit and loss sharing, and journal entries.
Formation of a Partnership
When a partnership is formed, each partner contributes assets to the partnership. These contributions can be in the form of cash, non-cash assets, or liabilities assumed by the partnership.
Example 1: Initial Contributions
Let’s consider the formation of a partnership between Alice and Bob. Alice contributes $50,000 in cash, and Bob contributes a piece of equipment worth $70,000.
Journal Entry:
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|--------------------------------|-----------|------------
YYYY-MM-DD | Cash | 50,000 |
| Equipment | 70,000 |
| Alice, Capital | | 50,000
| Bob, Capital | | 70,000In this example, the partnership records the cash contributed by Alice and the equipment contributed by Bob as assets. The respective capital accounts for Alice and Bob are credited to reflect their ownership interests.
Profit and Loss Sharing
Partnership agreements typically include provisions for sharing profits and losses. These provisions can be based on the ratio of initial contributions, a fixed ratio, or another agreed-upon method.
Example 2: Profit Sharing Ratio
Assume Alice and Bob agree to share profits and losses in a 3:2 ratio. This means that for every $5 of profit, Alice receives $3, and Bob receives $2.
If the partnership earns a profit of $10,000 in the first year, the allocation would be:
- Alice: ( \frac{3}{5} \times 10,000 = 6,000 )
- Bob: ( \frac{2}{5} \times 10,000 = 4,000 )
Journal Entry:
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|--------------------------------|-----------|------------
YYYY-MM-DD | Income Summary | 10,000 |
| Alice, Capital | | 6,000
| Bob, Capital | | 4,000This entry closes the Income Summary account and distributes the profit to the partners’ capital accounts based on the agreed ratio.
Drawings
Partners may withdraw cash or other assets from the partnership for personal use. These withdrawals are called drawings and are recorded in separate drawings accounts for each partner.
Example 3: Partner Drawings
Suppose Alice withdraws $2,000 and Bob withdraws $1,500 during the year.
Journal Entry:
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|---------------------------------|-----------|------------
YYYY-MM-DD | Alice, Drawings | 2,000 |
| Bob, Drawings | 1,500 |
| Cash | | 3,500The drawings accounts are debited to reflect the amounts withdrawn by the partners, and the Cash account is credited to reduce the partnership’s cash balance.
Part 2: Changes in Partnership
Admission of a New Partner
When a new partner is admitted to the partnership, they may contribute cash or other assets. The new partner’s capital account is credited for their contribution, and existing partners’ capital accounts may be adjusted if there is a revaluation of assets.
Example 4: New Partner Admission
Charlie is admitted to the partnership with a cash contribution of $30,000. The new profit-sharing ratio is agreed to be 3:2:1 for Alice, Bob, and Charlie, respectively.
Journal Entry:
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|--------------------------------|-----------|------------
YYYY-MM-DD | Cash | 30,000 |
| Charlie, Capital | | 30,000Revaluation of Assets
When a new partner is admitted, the partnership may revalue its assets to reflect their current market values. Any increase or decrease in asset values is allocated to the existing partners’ capital accounts based on the old profit-sharing ratio.
Example 5: Asset Revaluation
Before admitting Charlie, the partnership revalues its equipment from $70,000 to $90,000. The old profit-sharing ratio is 3:2 for Alice and Bob.
Journal Entry:
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|--------------------------------|-----------|------------
YYYY-MM-DD | Equipment | 20,000 |
| Alice, Capital | | 12,000
| Bob, Capital | | 8,000Withdrawal of a Partner
When a partner withdraws from the partnership, the partnership may pay the withdrawing partner in cash or other assets. The partner’s capital account is debited, and the assets given to the partner are credited.
Example 6: Partner Withdrawal
Bob decides to withdraw from the partnership. The partnership agrees to pay Bob $40,000 in cash for his capital balance.
Journal Entry:
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|--------------------------------|-----------|------------
YYYY-MM-DD | Bob, Capital | 40,000 |
| Cash | | 40,000Part 3: Dissolution of Partnerships
Introduction
A partnership is dissolved when it ceases operations, and its assets are liquidated to pay off liabilities and distribute any remaining assets to the partners.
Liquidation Process
The liquidation process involves selling the partnership’s assets, paying off liabilities, and distributing any remaining cash or assets to the partners according to their capital account balances.
Example 7: Liquidation
Assume the partnership has the following balances before liquidation:
- Cash: $10,000
- Accounts Receivable: $20,000
- Equipment: $50,000
- Accounts Payable: $15,000
- Alice, Capital: $40,000
- Bob, Capital: $25,000
The partnership sells the accounts receivable for $18,000 and the equipment for $45,000. The accounts payable are paid off in full.
Journal Entries:
- Sale of Accounts Receivable:
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|--------------------------------|-----------|------------
YYYY-MM-DD | Cash | 18,000 |
| Accounts Receivable | | 20,000
| Loss on Sale of Receivables | | 2,000- Sale of Equipment:
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|--------------------------------|-----------|------------
YYYY-MM-DD | Cash | 45,000 |
| Equipment | | 50,000
| Loss on Sale of Equipment | | 5,000- Payment of Accounts Payable:
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|--------------------------------|-----------|------------
YYYY-MM-DD | Accounts Payable | 15,000 |
| Cash | | 15,000- Distribution of Remaining Cash to Partners:
After the sales and payments, the partnership has $58,000 in cash ($10,000 initial + $18,000 from receivables + $45,000 from equipment – $15,000 for payables). The total capital balance for Alice and Bob is $65,000 ($40,000 + $25,000), but the partnership has $58,000 in cash available. The loss on sale of assets ($7,000) is allocated to the partners’ capital accounts based on the profit-sharing ratio.
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|--------------------------------|-----------|------------
YYYY-MM-DD | Alice, Capital | 4,200 |
| Bob, Capital | 2,800 |
| Loss on Sale of Assets | | 7,000Finally, the remaining cash is distributed to the partners:
Date | Account Titles and Explanation | Debit ($) | Credit ($)
-----------|--------------------------------|-----------|------------
YYYY-MM-DD | Alice, Capital | 35,800 |
| Bob, Capital | 22,200 |
| Cash | | 58,000Final Thoughts …
Accounting for partnerships involves tracking each partner’s contributions, withdrawals, and share of profits and losses. Changes in the partnership, such as the admission or withdrawal of partners, and the dissolution process require careful attention to ensure accurate financial records. By following the principles and examples provided in this tutorial, you can manage partnership accounting effectively.