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lesson 2 partnership
1. UNIT 1: MODULE 2 Objective 8, 9 PREPARATION OF FINANCIAL STATEMENTS: CHANGES IN OWNERSHIP STRUCTURES
2. The Partnership Agreement To avoid complications in the future, partners in a business venture should make a formal agreement on certain issues, such as: The rational for formation Capital contributions Opportunity cost (interests or penalties) Profit & loss sharing ratios Admission of new partners (goodwill or bonus) Exit of old partners (retirement) Dissolution of the partnership Interest on a partner’s loan to the firm
3. Capital contribution Partners agree on the (total amount of) capital needed to operate the business effectively. The capital is essentially a pooling of the assets and liabilities of the individual partners. The assets and liabilities are generally recorded at their fair values (what they are valued at if sold on the current market) The capital is recorded as a simple journal entry in the (new) business.
4. Opportunity costs Partners should agree on Interest rate (if any) to be given on capital invested before the profits are shared. They should state whether it is the opening, closing or average capital This represents the opportunity benefit for not investing the capital in another project. Interest rate (if any) to be charged on drawings on the capital base before the profits are shared. This represents the opportunity penalty for reducing the capital due to personal reasons.
5. Remunerations Partners should agree on Which partner(s) should be paid a salary [it is usually the general partner(s)] Which partner(s), if any, would receive a bonus Whether on income before the allocations OR on the income after the allocations
6. Profit/loss sharing Partners should agree on how they will share the profits or losses of the business. This might be by fixed ratio OR by the ratio of their capital balances
9. By private interest acquisition Where a direct payment is made to an individual partner It is not recorded on the books calculate the interest acquired from the partner(s) Account for the acquisition by adjusting the capital accounts of the partners [debit OLD partners; credit NEW partner] Adjust the Balance Sheet to reflect the redistribution of the capitals [note] the amount paid does not appear on the books
10. by purchasing interest in the business When an interest stake involves the acquisition /introduction of assets in the business itself one of two methods are used to reflect the change bonus method goodwill method
11. Reflecting the investment by the bonus method Record the investment made by the new partner in the journal Calculate the book value of the business after the investment was made [OLD + NEW capital] Calculate the amount of capital the new partner has actually acquired [new book value * % interest bought] Calculate the bonus resulting from the activity [investment - acquisition] Distribute the bonus to the OLD partners if the bonus is positive credit OLD debit NEW if the bonus is negative debit OLD credit NEW
12. Reflecting the investment by the goodwill method Record the investment made by the new partner in the journal Calculate the implied value of the business base on the investment was made [investment/% interset] Calculate the book value of the business after the investment was made [OLD + investment] Calculate the goodwill resulting from the activity [implied value - book value] Distribute the goodwill to the OLD partners if the bonus is positive credit OLD debit goodwill if the bonus is negative debit OLD Any revaluation in the assets must be shared by OLD
13. Where goodwill is not recorded Sometimes a business [normal practice] may decide to write down acquired goodwill for various reasons. Allocate the goodwill to the OLD partners Write down the goodwill in the new profit sharing ratio Credit the goodwill a/c to write off from books
14. Sharing the profits after the change When the change in the partnership share ratio occurs during its common financial year – the distribution of profits must be time apportioned. Some of the expenses incurred may also be subject to this adjustment [such must be specified under exam rules and conditions] It is useful to use the columns of the profit & loss account to allocate the time-periods; and the profit appropriation.
15. Dissolution of a partnership Partnerships can be dissolved or liquidated for several reasons, ranging from Bankruptcy of a partner Partner misconduct or serious disagreement Death or retirement of a partner Operation has become illegal Operating at a continuous loss
16. The dissolution (liquidation) LIQUIDATION IMMEDIATELY PIECEMEAL ASSETS SOLD AT A GAIN OR LOSS INSOLVENT PARTNERS PARTNERS’ DEBIT BALANCES
18. record entry of new partner’s capital goodwill distributed in capital accounts share revaluation in capital accounts (OLD only) Prepare the T, P& L on time apportioned basis Appropriate the profits on time basis Present partners’ current account (note interest on loan is credited here)