Business Associations

Chapter 3 Handout

Example 1Partnership agreement provides for equal profits and losses

Where a PS is formed, each partner’s capital account is credited for his/her initial investment and the appropriate asset account is debited. If non-cash assets are invested, these assets should be listed at an agreed amount.

Initial contributions:1. Smith$5K (truck)

2. Jones$10K to buy inventory/lease store

3. Williams$0.00 agrees to manage

During year:1. Smithcontributes cash register for $400

$3K profits2. Jonesw/draws $500 for personal reasons

3. Williamsmanaged

Interest at end of year:1. Smith$6,400.00

2. Jones$10, 500

3. Williams$1,000.00

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Example 2Partnership agreement provides for equal profits and losses

Morrison is a proprietor in a small merchandising business. He decides to form a partnership with Kathy in which Kathy will become an equal partner and share profits and losses equally. Morrison contributes his sole proprietorship business to the partnership as follows:

Sole Proprietorship:

Morrison

Cash$10,000

Accounts Receivable $5,000

Merchandise Inventory$20,000

Equipment$15,000

Allowance for doubtful accounts$1,000

Notes Payable$9,000

Morrison, Capital$40,000

If Kathy is to contribute cash to the new partnership, recordation of initial investments would look like this:

(A) Cash$10,000

Accounts Receivable $5,000

Merchandise Inventory$20,000

Equipment$15,000

Allowance for doubtful accounts$1,000

Notes Payable$9,000

Morrison, Capital$40,000

(B) Cash$40,000

Kathy Capital$40,000

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Fixed or capital basisProfits and losses are divided equally in a fixed ration based on capital contributions

Example 3

Perez and Roth have capital balances of 30k and 20k respectively. The net income for the 1st year of operations was 15k. If the partners have decided to share on an equal basis, the journal entry for the allocation of the net income will be:

Expense and Income Summary:15k

Perez, Capital$7,500

Roth, Capital$7,500

If, however, capital investment is to be the determining factor, the entry will run as follows:

Expense and Income Summary:15k

Perez, Capital$9k

[ 30k[60% x 15k]

[30k plus 20k]

Roth, Capital$6k

[ 20k ][40%x 15k]

[30k plus 20k]

Interest basisUnder the interest method, each partner is paid interest on his or her capital investment, and the remaining net income is divided in a fixed ratio. Thus, a partner’s share depends partially on his or her capital investment.

Example 4

Assume each partner is to receive 6% on his or her capital balance, the remaining net income to be shared equally. The entry would be:

Expense and Income Summary:15k

Perez, Capital$7,800

Roth, Capital$7,200

The computation being:

PerezRothTotal

Interest on investment1,800 (30kx.06)1,200 (20kx.06)3,000

Balance6,000 6,00012,000

15,000

Salary basis

The partners may agree to give recognition to contribution in the form of services, while the remaining net income may be divided equally or in a fixed ration. These “salaries” are treated as “withdrawels” and are not charged as an expense of the business.

Example 5

Assume that the PS of Perez and Roth agree that a yearly salary allowance of $4k will be given to Perez and $3k to Roth, the balance to be divided equally. The entry would be:

Expense and Income Summary:15k

Perez, Capital$8,000

Roth, Capital$7,000

The computation being:

PerezRothTotal

Salary4,0003,0007,000

Balance4,000 4,0008,000

8,0007,00015,000

Salary plus interest basis

Under the salary plus interest basis, services rendered to the business and capital contribution jointly determine the income division. Each partner gets a salary, and, at the same time, interest on capital. If any balance remains, it is divided in an agreed ratio.

Example 6

Perez and Roth decide to allow a credit of 6% interest on capital balances, respective salalries of 4k and 3k, and equal division of any remainder. The entry would be:

Expense and Income Summary:15k

Perez, Capital$8,300

Roth, Capital$6,700

The computation being:

PerezRothTotal

Interest$1,800$1,200$3,000

Salary$4,000$3,000$7,000

$5,800$4,200$10,000

Balance$2,500 $2,500$5,000

8,3006,70015,000

Dividing a negative balance

If the income of the business does not exceed the total of the allowances to the partners, the balance remaining is negative and is divided among the partners equally as though it were a loss.

Example 7

Perez and Roth decide to allow a credit of 6% on capital balances, respective salaries of $8k and$6k respectively, and equal division of the remainder. The entry would be:

Expense and Income Summary:15k

Perez, Capital$8,800

Roth, Capital$6,200

The computation being:

PerezRothTotal

Interest$1,800$1,200$3,000

Salary$8,000$6,000$14,000

$9,800$7,200$17,000

Balance-$1,000 -$1,000-$2,000

8,8006,20015,000

If in the partnership of Perez and Roth a $15k loss has occurred (all profits and losses are to be shared equally), the entry to record the loss would be:

Perez, Capital$7,500

Roth, Capital$7,500

Expense and Income Summary:15k

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