Chapter One

Partnerships
DEFINED .......................................................................................................................................................... 1-1

AGREEMENTS ................................................................................................................................................ 1-1

DIVISION OF PROFITS .................................................................................................................................. 1-1

ADMISSION OF A PARTNER ........................................................................................................................ 1-1

PURCHASE OF AN INTEREST ...................................................................................................................... 1-1
Payment to an Existing Partner
Payment to More Than One Partner

INVESTMENT IN A PARTNERSHIP BY CONTRIBUTION TO THE
FIRM'S CAPITAL ............................................................................................................................................. 1-3
No Goodwill or Bonus
Goodwill Recognized to Old Partners
Bonus Allowed to Old Partners
Goodwill Allowed to New Partner
Bonus Allowed to New Partner

DIVISION OF PROFITS .................................................................................................................................. 1-4
Interest on Capital
Partners' Salaries

RETIREMENT OF A PARTNER ..................................................................................................................... 1-4
Goodwill Recorded
Implied Bonus or Goodwill

DISSOLUTION AND LIQUIDATION ............................................................................................................ 1-5
Causes of Dissolution
Liquidation

LIQUIDATION IN INSTALLMENTS ............................................................................................................. 1-6

CASH DISTRIBUTION PLANS ...................................................................................................................... 1-7

INCORPORATION OF A PARTNERSHIP ..................................................................................................... 1-9

BONUS COMPUTATIONS ............................................................................................................................. 1-9

IFRS.1-10


Chapter One
Partnerships
DEFINED
"Association of two or more persons to carry on, as co-owners, a business for profit."

AGREEMENTS
Can be expressed (oral or written contract) or implied (actions).
Should be in writing for protection of partners. The agreement governs the formation, operation, distribution of
ncome or loss, and dissolution of the partnership. i

DIVISION OF PROFITS
Profits can be shared in any way agreeable to the partners.
If the agreement is silent, the law assumes that profits and losses will be shared equally.
Amount of capital contributed has no effect on profit division unless specified in the agreement.

ADMISSION OF PARTNER
Admission or withdrawal of a partner generally dissolves the partnership and brings into being a new
partnership.
New articles of partnership should be drawn up.
A new partner can purchase an interest or invest in the partnership.

Care should be taken to distinguish between a purchase of an interest and the investment in a partnership. The
difference is critical to the proper procedure to follow in partnership problems.
1. Purchase of interest. Example: A purchases interest of X in XYZ partnership or part of interest of XYZ in
XYZ partnership. The amount A paid for his interest is outside the partnership and not recorded in the books.
2. Investment. Example: A invests $10,000 in XYZ partnership, thereby increasing the capital of the partnership.

PURCHASE OF AN INTEREST
1. Payment to an existing partner
No cash transaction is to be entered on the books in the purchase of an interest. X, Y, and Z have capitals of
$10,000, $15,000 and $20,000 respectively. Z sells half of his capital interest to P for the sum of $12,000.

Entry: Z, Capital $10,000
P, Capital $10,000

Transaction is between Z and P as to amount and Z has merely transferred one-half of his interest to P.

2. Payment to more than one partner
Purchase at book value: P purchases a one-fourth interest for $11,250.

Entry: X, Capital $2,500 (25% $10,000)
Y, Capital $3,750 (25% $15,000)
Z, Capital $5,000 (25% $20,000)
P, Capital $11,250

Purchase at more than book value: Where purchase is at more than book value, goodwill may or may not be
recognized.


1-1
Example: P pays $15,000 for a one-fourth interest and XYZ share profits on a 4:3:3 basis.
a. Goodwill not recognized. Transfer of capital same as above. The existing partners will divide the $15,000 cash
on some agreed basis or as follows:

X(40) Y(30) Z(30) Total
For Capital $2,500 $3,750 $5,000 $11,250
Amount in Excess of Capital
in P&L Ratio 1,500 1,125 1,125 3,750
$4,000 $4,875 $6,125 $15,000

b. Goodwill recognized. If P is willing to pay $15,000 for a one-fourth interest, the implied value of the
partnership is $60,000 ($15,000 4). Goodwill must be placed on the books prior to the admission of P to bring
total capital to $60,000.

Goodwill $15,000 ($60,000 $45,000 XYZ total capital)
X, Capital $6,000 ($15,000 40%)
Y, Capital 4,500 ($15,000 30%)
Z, Capital 4,500 ($15,000 30%)

To recognize goodwill and increase total capital to $60,000.

(1) X, Capital $4,000
(2) Y, Capital 4,875
(3) Z, Capital 6,125
P, Capital $15,000

(1) $16,000 1/4 (2) $19,500 1/4 (3) $24,500 1/4
To record transfer of capital to P.

Purchase at less than book value: P pays $10,000 for a one-fourth interest.

a. No adjustment of the old partner's capital account. The same journal entry as in #2 above will be recorded
since P will receive $11,250 in capital for $10,000. The existing partners will divide the $10,000 cash on some
agreed basis or as follows:

X(40) Y(30) Z(30) Total
Capital $2,500 $3,750 $5,000 $11,250
Loss: $11,250 10,000 in P&L ratio (500) (375) (375) (1,250)
Division of Cash $2,000 $3,375 $4,625 $10,000

b. Adjustment of old partner's capital account: In this situation the partners are giving recognition to the loss in
value of their interest. Total capital is reduced to $40,000 implied value ($10,000 4), with the resulting asset
write-down of $5,000.

X(40) Y(30) Z(30) P Total
Original Capitals $10,000 $15,000 $20,000 $45,000
Asset write-down
$45,000 $40,000 in P&L ratio (2,000) (1,500) (1,500) (5,000)
8,000 13,500 18,500 40,000
Capital transfers (2,000) (3,375) (4,625) 10,000 --
$ 6,000 $10,125 $13,875 $10,000 $40,000


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INVESTMENT IN A PARTNERSHIP BY CONTRIBUTION
TO THE FIRM'S CAPITAL
Asset values may be adjusted before admission of any new partner(s). An investment may result in the following:
Recognition of either goodwill or bonus to the old partners.
Goodwill is placed on the books before admission of a new partner.
Bonus--part of the capital contributed is credited to the account of the old partners.
Recognition to the incoming partner in the form of either goodwill or bonus.

1. No goodwill or bonus.
A and B have capitals of $10,000 and $20,000 respectively, share profits and losses equally, and C is to be admitted
to the firm by making a contribution to the firm's capital. C is to invest $10,000.

Entry: Cash $10,000
C, Capital $10,000

Note that C's profit sharing ratio is not determined by the amount of capital contributed, but must result from
agreement with the original partners.

2. Goodwill recognized to old partners
C is to invest $12,000 for a one-fourth interest. Analysis: Implied value is $48,000 (4 $12,000). C's contribution
plus A and B's capital equals $42,000; therefore, $6,000 in goodwill must be added to total capital.

Entries: Goodwill $6,000
A, Capital $3,000
B, Capital 3,000
Cash 12,000
C, Capital $12,000

3. Bonus allowed to old partners
C is to invest $18,000; capital of A and B plus C's contribution equals $48,000. Since C is contributing $18,000 but
is to receive only a one-fourth interest of $12,000 (1/4 $48,000), a bonus of $6,000 is given to A and B.

Entry: Cash $18,000
A, Capital $ 3,000
B, Capital 3,000
C, Capital 12,000

Note that in bonus situations total capital equals the old capital plus the partner's contribution.

4. Goodwill allowed to new partner
C is to invest $9,000 of miscellaneous business assets and agreed total capital is to be $40,000.

Entry: Goodwill $1,000 ($40,000 $30,000 $9,000)
Misc. Assets 9,000
C, Capital $10,000 (1/4 40,000)

5. Bonus allowed to new partner
C is to invest $9,000; a bonus is allowed to C.

Entry: Cash $9,000
A, Capital 375
B, Capital 375
C, Capital $9,750 (1/4 39,000)

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DIVISION OF PROFITS
Division of profits is governed by the partnership agreement. Profits may be divided:
1. Equally
2. On some other fractional basis
3. In capital ratio
4. On average capital ratio
5. By allowing interest on capitals and dividing remainder, and
6. By allowing salaries to the partners and dividing remaining profit.

If the agreement makes no provision for the division of profit and losses, the law assumes they will be shared
equally.

1. Interest on Capital
Partner cannot claim interest on capital unless provided for in the partnership agreement.
Interest on capital should not be included in income statement as an expense.
Interest paid on partners' loans may be treated as a financial expense.

2. Partners' Salaries: Treated as a division of profits. Allocation of partners' "salaries" may exceed partnership
income and create a loss to be allocated to all partners according to the partnership agreement.

Method of Distribution
Allocate salaries, interest first
Distribute remaining profit (loss) per agreement

Example: A, B, and C agreed to the following distribution of profit:

A B C
Annual salary $10,000 $ 8,000 0
Interest on average capital 0 4% 10%
Remainder 40% 40% 20%
Average capital $50,000 $50,000 $200,000

Profit distribution under three different assumptions:
A B C Total
Interest allocation --0-- $ 2,000 $20,000 $22,000
Salary allowance $10,000 8,000 -0-- 18,000
$10,000 $10,000 $20,000 $40,000
1. Assume $50,000 profit
Remainder ($50,000 $40,000) 4,000 4,000 2,000 10,000
2. Assume $20,000 profit
Remainder ($20,000 $40,000) (8,000) (8,000) (4,000) (20,000)
3. Assume $10,000 loss
Remainder ( $10,000 $40,000) (20,000) (20,000) (10,000) (50,000)


RETIREMENT OF A PARTNER
Adjustment of asset values may be required to determine the fair equity of a retiring partner. This may be necessary
to:
a. Correct improper operating charges of prior periods (bad debts, accruals, depreciation and recognition of
inventories).
b. Give recognition to the existence of goodwill.
c. Give recognition to changes in market values.

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Problem: C is to retire from A, B, C partnership. A goodwill value of $6,000 has been agreed upon.

1. Goodwill recorded on the books for (1) all partners or (2) only the retiring partner.

(1) Goodwill $6,000
A, Capital $2,000
B, Capital 2,000
C, Capital 2,000
(2) Goodwill $2,000
C, Capital $2,000

2. Implied bonus or goodwill
Assume that A, B and C have capitals of $10,000 each and share profits equally. C is to retire and is to be paid
$12,000 from partnership assets. The $2,000 excess of the payment to C over his capital may be recorded as a bonus
or as goodwill.

Bonus A, Capital $ 1,000
B, Capital 1,000
C, Capital 10,000
Cash $12,000

Goodwill: Goodwill $ 2,000
C, Capital $ 2,000
C, Capital 12,000
Cash 12,000


DISSOLUTION AND LIQUIDATION
1. Causes of Dissolution
Dissolution occurs when the existing partnership arrangement is altered for some reason. Liquidation may follow
dissolution but often outsiders would be unaware of the end of one partnership and the start of another.

2. LiquidationTerminating the Affairs of a Business
A. Procedure:
(1) Realization of assetsconvert assets into cash
(2) Division of loss or gain on realization, by charges or credits to partner's capital
(3) Payment of the liabilities
(4) Payment of the partner's interest

B. Order of distribution in liquidation
(1) Outside creditors
(a) Priority claims such as artisans, government, liquidation expenses.
(b) Secured creditors to the extent covered by proceeds from sale of pledged assets. Excess claim treated as
unsecured credit.
(c) Unsecured credit to the extent covered by proceeds from sale of unpledged (or free) assets.
(2) Partners for loan accounts (right of "offset" reserved, however)
(3) Partners' capital

As a practical matter partners' loans and capital are considered as one. Any known gain or loss should be distributed
before any payments are made to partners.

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Problem: A and B have non-cash assets of $40,000, liabilities of $5,000 and capital of $20,000 and $15,000
respectively. Assets are sold for $32,000. Determine amount distributable to A and B in liquidation.

A and B
Statement of Partnership Liquidation

Assets Partners' Capitals
Cash Non-Cash Liabilities A 50% B 50%
$40,000 $(5,000) $(20,000) $(15,000)
Realization and Loss $32,000 (40,000) ______ 4,000 4,000
$32,000 --0-- $(5,000) $(16,000) $(11,000)
Payment of Liabilities (5,000) 5,000
Payment to Partners (27,000) 16,000 11,000


Problem: Debit balance in partner's capital account. Assets were sold for $50,000.

Assets Partners' Loans Partners' Capitals
Cash Non-Cash Liabilities X Y X 80% Y 20%
--0-- $80,000 $(15,000) $(10,000) $(17,000) $(20,000) $(18,000)
Real. and Loss $50,000 (80,000) ______ ______ ______ 24,000 6,000
50,000 --0-- (15,000) (10,000) (17,000) 4,000 (12,000)
Combine Loan
and Capital Acct. ______ ______ ______ 10,000 17,000 (10,000) (17,000)
50,000 (15,000) --0-- --0-- ( 6,000) (29,000)
Pay Liabilities (15,000) 15,000
Pay Partners (35,000) 6,000 29,000

NOTE: Right of offset exercised. Neither partner would be paid any cash until there is no danger that possible loss
could exceed his capital account and loan account combined.


LIQUIDATION IN INSTALLMENTS -- MAXIMUM POSSIBLE LOSS (MPL)
Where a partnership is liquidated and the full amount to be paid to a partner is determined before any distributions
are made, losses have already been distributed to the partners. In these situations it is assured that no partner will
receive more than he will be entitled to receive. However, where a liquidation occurs in stages and disbursements
are made periodically, there must be assurance that no partner will receive more than he could possibly be entitled
to receive. This can be done by distributing the maximum possible loss to the partners and the remaining capital
balance(s) can safely be paid. The maximum possible loss is the total of the non-cash assets. The procedure to
determine the safe distribution is:

A. Determine the maximum possible loss that the partnership could suffer.
MPL =Total Assets - Cash (or Non-Cash assets)
B. Distribute the MPL to the partners in P and L ratio.
C. The remaining balance is the amount that can be distributed to each partner.
D. Distribute the amount determined in C.
E. The same calculation must be made each time a distribution is made.

NOTE: Remember, MPL's are not actual losses, only theoretical losses; therefore, the determination of MPL should
be done on a separate schedule.


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ABC Partnership has the following balance sheet as of December 31st:

Assets Liabilities and Capital
Cash $ 35,000 Liabilities $ 21,000
Receivables 14,000 Partners' Loans
Other Assets 85,000 A 5,000
C 8,000
Partners' Capital
A 50,000
B 35,000
______ C 15,000
$134,000 $134,000

A, B and C share profits and losses on a 5:3:2 basis. Determine the amount the partner(s) will receive by distributing
the maximum possible loss.

Solution: The maximum possible loss is $99,000 ($14,000 receivables +$85,000 other assets).

A (50%) B (30%) C (20%)
Capital balance $50,000 $35,000 $15,000
Additional loans 5,000 -- 8,000
55,000 35,000 23,000
MPL$99,000 49,500 29,700 19,800
Amount distributed $ 5,500 $ 5,300 $ 3,200

NOTE: The cash to be distributed$14,000is equal to the cash available$35,000less the liabilities of
$21,000.


CASH DISTRIBUTION PLANS
Another method of determining the amount(s) that can be distributed to a partner is by preparation of a cash
distribution plan. An accountant may be asked by a partnership to devise such a plan, if the partnership should
subsequently choose to liquidate, showing how any cash generated by the sale of assets should be distributed. This is
similar to the ordinary procedures in liquidation where, as cash is accumulated, the accountant calculates the
payments which can safely be made to partners in installments. Once the plan is prepared it may be used to
determine all subsequent distributions unless the mix of partners' capital is changed by investment or withdrawal.
The use of MPL and the cash distribution plan is necessary because the partners' capital account ratios differ from
their P and L ratios. The plan will eventually equalize the partners' capital accounts.

The procedure for a plan for distribution of cash is as follows:
1. Add the loan accounts to the partners' capital accounts.
2. Determine the amount of loss which will extinguish the weakest partner's capital balance.
3. Distribute the loss in (2) to all partners. After one partner is eliminated, repeat the same process with the
remaining partners.
4. After all but one of the partners' capital accounts are eliminated, cash distributions are determined by starting
with the remaining partner's final balance (which becomes the first cash distribution) and working
backwards.

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ILLUSTRATION 1:
The ABCD Partnership is being dissolved. All liabilities have been liquidated. The balance of assets on hand is
being realized gradually. Following are details of partners' accounts:

Capital Account P and L
(Original Investment) Ratio
A $30,000 4
B 36,000 3
C 16,000 2
D 22,000 1

PREPARE a schedule showing how cash payments should be made to the partners as assets are realized.

A (40%) B (30%) C (20%) D (10%)
Capital balance $30,000 $36,000 $16,000 $22,000
Loss (1) $75,000 30,000 22,500 15,000 7,500
--0-- 13,500 1,000 14,500
Loss to eliminate C
$1,000 2/6 =$3,000 1,500 (3/6) 1,000 (2/6) 500 (1/6)
12,000 --0-- 14,000
Loss to eliminate B
$12,000 3/4 =$16,000 12,000 (3/4) 4,000 (1/4)
First cash payment --0-- 10,000

Cash distribution plan-- 1st $10,000 to D
(Liabilities must be Next $16,0003/4 to B; 1/4 to D
paid or cash reserved Next $3,0003/6 to B; 2/6 to C; 1/6 to D
before payments are All remaining cash in P and L ratio
made to partners)

(1) To determine the weakest partner, compare the capital account balance with the P and L ratio. A is weaker than
B because A would be charged with 40% of any loss. A is also weaker than C and D even though A has greater total
apital. Another method of determining the weakest partner is to divide the capital account by the loss ratio. c


30,000
A =
.4
=75,000 loss will eliminate A
36,000
B =
.3
=120,000 loss will eliminate B
16,000
C =
.2
=80,000 loss will eliminate C
22,000
D =
.1
=220,000 loss will eliminate D

We can see from this that D will receive the first cash distribution made to the partners, followed by B, C, and
then A.

(2) After each partner is eliminated, the loss which eliminates the next weakest partner is determined by using the
loss ratio of the remaining partners, or after A is eliminated 3:2:1. Assume that $20,000 in cash is available for
distribution but $5,000 is reserved for payment of liabilities. Following the plan the cash would be distributed as
follows:

1-8
A B C D
To D $10,000 $10,000
To B and D 5,000 $3,750 (3/4) 1,250 (1/4)
$15,000 $3,750 $11,250

Assume that next month $20,000 is to be distributed. The plan would continue at the point reached last month.

A B C D
$16,000 $5,000 = $11,000 $ 8,250 (3/4) $2,750 (1/4)
Next 3,000 1,500 (3/6) $1,000 (2/6) 500 (1/6)
Next 6,000 $2,400 1,800 1,200 600
$20,000 $2,400 $11,550 $2,200 $3,850

Observe that when all partners have received some cash, the capital accounts are in the same percentage as the P and
L ratio and that future distributions can be made in the P and L ratio.


INCORPORATION OF A PARTNERSHIP
Procedures
A. Adjust asset values to bring balances into conformity with values agreed upon for the purpose of transfer to the
corporation. The net effect of these adjustments will be carried to the partners' capital accounts in their respective P
and L ratios.

B. Change from a partnership to corporation is made by debiting the partners' capital accounts and crediting capital
stock account for the shares issued to the partners.


BONUS COMPUTATIONS
Frequently accountants are asked to compute the amount of bonus to be paid a corporate executive, a partner or
employee under a profit sharing plan. The factors which may affect the bonus are:
Net income before tax and/or bonus
Tax rateThe bonus itself affects the tax since the bonus is deductible. The bonus may be computed before or
after the tax depending on the profit sharing arrangement. Partnerships as entities do not pay taxes; however, an
imputed tax rate may be used to compute the bonus.
Bonus percentageMay be before or after bonus and may be applicable to income above a certain amount.

In solving such problems, a good approach is to write the particular problem in equation form with no attempt to
quantify the elements of the equation. Then substitute known quantities in the equation and solve for B (Bonus).

Example: A company's bonus plan provides that the company will pay a bonus of one-third of its net income after
taxes each year. Income before taxes and before deducting the bonus for the year is $600,000. The tax rate is 40%.
What amount is the bonus?

Start with a simple expression of the situation
1. Bonus =Bonus Percent Net Income

Now begin to substitute quantities
2. B =33 1/3% (NI Tax Bonus)
3. B =33 1/3% (600,000 .40 [600,000 B] B)

Multiply the factors using the rules of algebra
4. B =33 1/3% (600,000 240,000 +.4B B)
5. B =200,000 80,000 +13 1/3% B 33 1/3% B

1-9
Combine like terms when possible
6. B =$120,000 20% B

Add .2B to both sides of the equation
7. 1.2B =120,000

Divide both sides by 1.2
8. B =100,000

Example:
The Wiley Company provides an incentive compensation plan under which its president is to receive a bonus equal
to 20% of the company's income in excess of $200,000 before deducting income tax but after deducting the bonus.
If income before income tax and bonus is $320,000 and the effective tax rate is 40%, the amount of bonus should be:

Bonus =20% (NI Exclusion Bonus)
B =20% (320,000 200,000 B)
B =20% (120,000 B)
B =24,000 .2B


1.2 B =24,000
B =24,000


1.2
B =20,000


IFRS INTRODUCTION

There are not any IFRS differences in partnerships so it seems to be an appropriate place to talk about the
background for the reasons for accounting differences between countries, the need for IFRS, IFRS as a rule-making
body and the SEC rules for transition to IFRS.

Why do Accounting rules differ internationally?
Historically things like culture, sources of capital, inflation, taxation, the legal system, industry standards and
business complexity have all contributed to difference in accounting rules. For example the shareholders in the US
provide the major source of capital for an entity, but in Germany the banks provide the major source of capital. As a
result the US Standards may be more income statement oriented whereas the standards in Germany may be more
balance sheet oriented. Another example relates to the netting of deferred assets with deferred tax liabilities. The
rule on netting may be determined by the tax laws of the country in which the entity is located.

Why is the US considering IFRS?
The main reason is the lack of comparability between companies located in different countries.

What are IFRS?
IFRS is the abbreviation for International Financial Reporting Standards. The Standards are issued by the
International Accounting Standards Board (IASB) which is located in London. The Board consists of 15 members
(16 by July 1, 2012) chosen from various specified regions of the world to achieve a broad geographic
representation. Nine out of 15 votes are needed to approve a standard.

Convergence
The IASB and the FASB are actively working on the convergence process to make existing standards fully
compatible as soon as practicable.

Theory
In theory, IFRS are more principles-based than the detailed guidance provided by US GAAP (fewer bright lines).
An example of bright lines is the detailed criteria for lease capitalization provided by the 90% of fair value and the
75% of useful life rules.
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SEC RULES FOR TRANSITIONING TO IFRS
The SEC currently requires two years of comparative information. For example, ABC International wants their first
reporting date to be December 31, Year 5. The first transaction date will be J anuary 1, Year 4. On December 31,
Year 5, ABC will report three balance sheets: J anuary 1, Year 4; December 31, Year 4; December 31, Year 5 and
two income statements for years 4 and 5. In its preparation of its J anuary 1, Year 4 initial balance sheet, ABC may
adopt a fresh start approach. This means that ABC is not required to continue with the accounting polices used
under prior GAAP. This is true even if that policy is in compliance with IFRS. For example, if ABC had previously
used the FIFO inventory method, it could switch the weighted average inventory method for its J anuary 1, Year 4
Balance Sheet.




IFRS INTRODUCTION SUMMARY


IFRS US GAAP

Common Terms IFRS
International Finanial
Reporting Standards
FAS
Financial Accounting Standards
Standard Making Board IASB
International Accounting
Standards Board
FASB
Financial Accounting Standards
Board
SEC Transitioning Requirements 3 Balance Sheets
2 Income Statements

Fresh Start
N/A


N/A
Theory Principles-Based More detailed based

Bright lines
Why Switch to IFRS? Comparability between countries NA


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