9/25/21, 2:21 PM Module 6: Interactive Lecture

ACT506

Advanced Accounting II
Module 6: Partnerships
In this module, starting with Chapter 15, we cover the nature of the partnership, followed by the accounting used for the
formation and operation of the partnership and well as the allocation of profits or losses to the partners. Next, we cover the
accounting for changes in the membership of partnerships under various scenarios. Then, in Chapter 16, we discuss
partnership liquidations, including lump-sum and installment liquidations.

Learning Outcomes

1. Assess the nature and regulation of partnerships.

2. Analyze the differences among different types of partnerships.
3. Formulate calculations and journal entries for formation, operation, and allocations of partnership profits and losses
including changes in partnership ownership structures.
4. Explain terms associated with partnership liquidations.
5. Demonstrate calculations related to lump-sum and installment partnership liquidations.

https://csuglobal.instructure.com/courses/49918/modules/items/2306333 1/13
For Your Success & Readings
In this module, you closely examine the accounting for partnerships, including their formation, operation, and changes in
membership along the way. This module also covers the accounting for liquidation of a partnership under a variety of
scenarios.

Be sure to read the required readings and watch the videos within the interactive lecture. Note that the presentations require
Mozilla Firefox for proper viewing. They do not play correctly in other browsers. The videos are located under the Course
Information section of Canvas in a file called Video Resources.

The materials in Chapters 15 and 16 continues to cover the topics and learning outcomes introduced in Module 5. It is highly
recommended that you read both chapters early in the week. Consider reviewing the recommended readings as well. Like in
previous modules, your Critical Thinking Assignment includes an Assignment in McGraw-Hill Connect and a related Writing
Assignment. Additionally, review the instructions and refer to the Grading Rubric for how your instructor will grade your
performance in Connect and on the Writing Assignment.

A reminder about the additional LearnSmart resources available to you in Connect for each chapter being covered in this
Module from your course textbook (eText).

Use the Check Your Understanding questions to test your understanding of the information presented.

This week is the second of two Live Classroom opportunities. This is a chance to interact in real time with your instructor and
other students and get procedural and/or content related questions answered. While attendance is optional, you might find it
very helpful to be able to speak to your instructor and hear explanations of course concepts, as well as some guidance on
assignments and the Portfolio Project. Make sure you know when the live session is scheduled and make an effort to attend.

As always, be sure to get in touch with your instructor right away if you have questions or run into problems with the course.

Required

Chapter 15 and 16 in Advanced Financial Accounting

Recommended

PowerPoint Presentations for Chapter 15 (https://frostlor-cdn-prod.courses.csuglobal.edu/lor/resources/src/4ad66198-

74d6-3290-89e5-4c89b55f21b5/ACT506Mod06PowerPointCh15.pptx) and Chapter 16
(https://frostlor-cdn- prod.courses.csuglobal.edu/lor/resources/src/3fdb6f2f-a95b-3565-8a60-
b0f50a0be171/ACT506Mod06PowerPointCh16.pptx)
Lee, N., & Hales, E. (2002) Partnership accounting
(http://www.pearsoned.ca/highered/divisions/virtual_tours/lee/sample.pdf). In Accounting. Pearson Education Canada.
http://www.pearsoned.ca/highered/divisions/virtual_tours/lee/sample.pdf

Read pages 376-400

Important Note Regarding Interactive Lecture Videos for This Module. For some of the concepts included in the Interactive
Lecture materials, you can find a series of videos included in Canvas called Video Resources located under Course
Information where the course syllabus is located. We recommend that you review these videos as required for certain topics
that you may find particularly challenging or interesting.
1. Nature and Regulation of Partnerships

. . . the association of two or more persons to carry on as co-owners of a business for

profit forms a partnership . . .

Uniform Partnership Act of 1997

Partnerships are relatively easy to form and have distinct advantages. First, when a group of individuals starts a business,
there are most likely more skills and talents available. Second, risk is shared, and that means there is less risk for each
individual. Third, a group of people is more likely to bring a larger network of potential investors into the partnership for
raising funds and equity capital.

Some key factors to understand about partnerships:

A partnership is a legal entity.

The Internal Revenue Service (IRS) views partnerships as a conduit only, not separable from its partners. The IRS has
established specific tax rules for partnerships which differ from the rules for corporations. Note that while the focus of your
textbook is on Generally Accepted Accounting Principles (GAAP) for partnerships, you can find a brief discussion on the
IRS aspects of a partnership in Appendix 15A.
Partnerships can use the accrual basis, cash basis, or modified cash basis of accounting. The choice of accounting methods
generally reflects the information needs of the individual partners.
Deviations from GAAP exist in practice. These deviations, however, are generally related to the specific needs of the
partners in the partnerships.

Click through to learn about other major characteristics of partnerships include as described in Christensen, Cottrell, and
Budd (2019):
Partnership agreement.

Most partnerships start with a partnership agreement.

Partnership as a separate entity.

Since the partnership is a legal entity, the partnership itself can sue or be sued, and the property of the partnership belongs to
the partnership and not to any individual partner.

Partner as agent.

Each partner acts as an agent of the partnership.

Statement of partnership authority.

Each partnership files a statement of partnership authority with its respective Secretary of State, defining in detail what each
partner can and cannot do on behalf of the partnership.

Partner’s liability is joint and several.

All partners are liable for the partnership.

Partner’s rights and duties.

Each partner has a capital account. Each partner is entitled to an equal or agreed upon share of the partnership’s profits or
losses. No new partners can be admitted without the consent of all the partners. Each partner has the right to access the
partnership’s books and records. Each partner has a fiduciary duty to act on behalf of the partnership in good faith.

Partner’s transferable interest in the partnership.

Each partner has a transferable interest in the partnership. This means that the only transferable interest of a partner is his or
her share of the profits and losses of the partnership, including the right to receive any distributions including any liquidating
distribution. A partner may not transfer any rights of management or authority. A partner’s individual creditors cannot attach
to any of the partnership’s assets, but a partner’s personal creditors may obtain a legal judgement to attach to a partner’s
transferable interest.

Partner’s disassociation.

Once a partner is disassociated from the partnership, the partner can no longer act on the partnership’s behalf. Acts of
disassociation include:
9/25/21, 2:21 PM Module 6: Interactive Lecture

Giving notice to the partnership of the express will to withdraw as a partner

The partnership expels the partner in accordance with the partnership agreement
The partner commits a material breach of the partnership agreement
The partner becomes a debtor in bankruptcy
The partner becomes deceased (pp. 761-762).

The legal regulation of partnerships is covered in the Uniform Partnership Act of 1997 (UPA 1997) which has been adopted in
most states. Read more about this in the following sections in Chapter 15 of the textbook: Legal Regulations of Partnerships,
Definition of a Partnership, and Formation of a Partnership.

So, now that you have some background regarding the nature of partnerships, let’s review the different types of partnerships
that can be formed legally.
2. Different Types of Partnerships

Many people view the potential for personal liability as a disadvantage of the general partnership form of business. For this
reason, they may choose to become limited partners. There are three types of limited partnerships:

Limited Partnerships (LPs)

Limited Liability Partnerships (LLPs)
Limited Liability Limited Partnerships (LLLPs)

The variation in the degree of liability shield provided to the partners differs significantly for each of these partnerships. See
Types of Limited Partnerships in Chapter 15 for details.

Next, let’s discuss the accounting issues related to partnership formation, operations, and the changes in ownership structure.
3. Partnership Formation; Operation; Allocations of Profits and Losses; and Changes in Ownership
Structures
Partnership Formation and Operation

A few basics are important to emphasize in the accounting for the formation of a partnership as described in Chapter 15,
Illustration of Accounting for Partnership Formation.

Following ASC 820 (https://asc.fasb.org/imageRoot/00/7534500.pdf), contributed assets by the partners to a newly

formed partnership should be valued at their fair values.
The capital balance for each partner when the partnership is formed is determined by the proportionate share of each
partner’s capital contribution. The partners, however, may agree to any proportional division of the capital when the
partnership is formed. This could be done, for example, to reflect one of the partners’ specific business expertise or other
relevant experience.

Under Video Resources, watch the video Accounting for Formation of a Partnership for more information about partnership
formation.

The accounting entry to record the initial capital contributions of two partners on the partnership’s accounting books looks
like the following:

The accounting records will also keep track of the following partner accounts for each partner, separately. These include:

Capital accounts. This is an equity account in the partnership records. It contains the initial and subsequent contributions
by partners to the partnership, in the form of either cash or the market value of other types of assets.
Draw accounts. When a partner withdraws assets from the partnership during the year anticipating a profit distribution by
the partnership. Withdrawing assets is a debit to the partner’s capital account.
Loan accounts. When the partnership borrows money from a partner under a loan agreement. These loans are simply
recorded on the books as loans payable to the partner.

Allocation of Profits and Losses

Under Video Resources, watch this video, Allocating Profit or Loss to Partners, as an introduction to this topic.

In general, most partnerships use one of the following distribution methods for the profit or loss of the partnership:

Preselected ratio. Negotiated up front between the partners

Interest on capital balances. Division of the profits or losses based upon the relative balances the partners have
maintained in their respective capital accounts
Salaries. Paid to all or certain of the partners in an agreed upon distribution agreement
Bonuses. Paid to all or certain of the partners in an agreed upon distribution agreement.

You can find a simple example of each of the above distribution methods in Chapter 15, Accounting for the Operations of
a Partnership. An example illustrating multiple profit allocation bases used to distribute the profits of a partnership to its
partners is found in Multiple Profit Allocation Bases below.
Under Video Resources, Multiple Profit Allocation Bases demonstrates some of the concepts found in this section of the
textbook.

What is the key to the allocation of the partnership’s profits or losses to the partners?

The partnership agreement should specify this allocation in whatever detail is required so that when each partner signs the
partnership agreement, there is an understanding of the following: how the partnership’s profits or losses will be allocated to
each partner; any interest on capital balances; any salaries; any bonuses; and any residual profits left after the above types of
special allocations of the partnership’s profits.

Changes in Ownership Structures

Under Video Resources, you can watch the video New Partner Invests in Partnership as an introduction to this section of the
interactive lecture.

See General Concepts to Account for a Change in Membership in the Partnership in Chapter 15 for a discussion of the
accounting issues surrounding changes in the membership of a partnership. In some cases, a new partner may purchase a
partnership interest in a partnership directly from an existing partner. The textbook illustrates the accounting entries in this
situation. This section of the textbook also shows the accounting entries when the partnership recognizes increases in the
partnership’s net assets before allowing the new partner to acquire the interest of the existing partnerThese two methods are
the revaluation method and the bonus method..

The primary methods for the accounting and recording the admission of a new partner into a partnership are:

The bonus method (following GAAP). Under this method, the partnership records an increase in the partnership’s total
capital only for the fair value of the new partner’s investment.
The revaluation method (not following GAAP). Under this method, the partnership uses the admission of a new partner
as an opportunity to recognize increases in the fair values of the partnership’s existing nonfinancial assets or for recording
previously unrecognized goodwill.

Next, New Partner Invests in Partnership in Chapter 15 describes the accounting when a new partner acquires a share of a
partnership by investing in the existing partnership. Three cases are possible and are described on these pages, when a new
partner invests in an existing partnership. The new partner’s investment:

Equals his or her proportion of the partnership’s book value

Is more than his or her proportion of the partnership’s book value
Is less than his or her proportion of the partnership’s book value.

The accounting for each of these three cases is relatively straight-forward, and the journal entries and the capital balances of
each partner are summarized very nicely in this worksheet also included in Chapter 15 of your textbook:
(Source: Christensen, Cottrell, & Budd, 2019, Figure 16-6)
Summary of Accounting for Investment of New Partner: Journal
Entries and Capital Balances after Admission of New Partner

Under Video Resources, the video Determining a New Partner’s Investment Cost describes in detail the concept behind this
topic discussed in Chapter 15 of your textbook.

Finally, Chapter 15 concludes with an illustration of the accounting when a partner decides to disassociate from an existing
partnership. See Disassociation of a Partner from the Partnership.

The accounting and legal issues accompanying a disassociation are totally different from a liquidation of a partnership, which
is covered next.
4. Partnership Liquidations
The Uniform Partnership Act (UPA) of 1997 provides you with a roadmap of the events and processes required to implement a
partnership liquidation. Disassociation, covered previously, is the legal description of a partner’s withdrawal. This includes:

The death of a partner

A partner’s voluntary withdrawal (for example, the retirement of a partner)
Judicial terminations.

A dissolution is the termination of the partnership. Events causing a dissolution and the winding up of a partnership under
Section 801 of the UPA of 1997 include:

A partner notifies the partnership that he or she intends to leave.

The term of the partnership has ended.
An event occurs that renders continuation of the business unlawful.
A judicial determination either renders the partnership economically not viable or impractical.

Sometimes, to summarize the liquidation process and to make sure that each partner is clear on the details, a statement of
partnership realization and liquidation is prepared. This statement describes the conversion of the assets into cash,
how any gains or losses are to be allocated to the partners, and how the cash is to be distributed to the creditors and the
partners.

Watch under Video Resources Realization of Assets to review more information on this topic.

Next, two different types of liquidations will be discussed: lump-sum and installment liquidations.
5. Calculations for Partnership Lump-Sum and Installment Liquidations
Your course textbook contains excellent, step-by-step, illustrations of both lump-sum and installment liquidations of a
partnership is straight-forward. In a lump-sum liquidation, lump-sum payments are made to the partners once the assets are
converted into cash, and the liabilities are paid off. These types of liquidations are normally accomplished in an expedited
manner. In an installment liquidation, the liquidation period involves installment payments to the partners as the partners
require funds for personal purposes. Typically, installment liquidations result because of the time it takes to liquidate the
assets and to maximize the amount realized from their sale. Any liquidation-related expenses incurred by the partnership are
distributed to the partners’ capital accounts in their existing profit and loss distribution ratio for both lump-sum and for
installment liquidations.

Your textbook describes three cases of partnership liquidations most commonly used in situations involving lump-sum
liquidations:

Case 1: The partnership is solvent and there are no deficits in any of the partners’ capital accounts.
Case 2: The partnership is solvent, and a deficit is created in all three partners’ capital accounts (one partner is insolvent;
one partner has the right of setoff, and one partner needs to make a cash contribution). Case 2 is illustrated for you in the
following video: Case 2: Partnership Solvent and Deficit Created in Partner's Capital Account
(https://storage.googleapis.com/asg-material/12e/16.816/presentation.html).
Presentation Transcript (https://frostlor-cdn-prod.courses.csuglobal.edu/lor/resources/src/168b32db-2fcc-377e-ae7d-
a60f0a18339b/ACT506Module6Page5TranscriptCase2PartnershipSolventandDeficitCreatedinPartnerCapitalAccount.docx)
Case 3: This is the same situation as in Case 2 except that the partner with setoff must also make a cash contribution.

This worksheet illustrates an installment liquidation of a partnership through the final cash distribution plan for liquidating
the partnership.

(Source: Christensen, Cottrell, & Budd, 2019, Figure 16-6)

Cash Distribution Plan for Liquidating Partnership

Under Video Resources, Illustration of Installment Liquidation reviews the information presented in Illustration of Cash
Distribution Plan covered in Chapter 16 for an installment liquidation.

Chapter 16 ends with a hypothetical example of a growing partnership which decides to incorporate to have access to
additional equity financing, limit the partner’s personal liability, and to obtain selected tax advantages available under the
corporation form of business. See the example with journal entries in Illustration of Cash Distribution Plan in your textbook.
This example includes the revaluation of all assets and liabilities of the partnership, with any resulting gain or loss distributed
to each partner in their profit and loss-sharing ratios.

Check Your Understanding

These questions are taken from both this interactive lecture and Chapters 15 and 16 in your textbook. Test your
knowledge of what you have learned this week.

Embedded Media Content! Please use a browser to view this content.

References
Christensen, T., Cottrell, D., & Budd, C. (2019). Advanced financial accounting (12th ed.). McGraw Hill.