Chapter One

Accounting for Partnerships

1.1 Partnership Businesses: An Overview
1.1.1) Definition and Types of Partnership
Partnership is defined semantically in a different ways in different acts of different nations. But
the basic concept is, in all the definitions, the same. Partnership is defined as an association two
or more persons to carry on, as co-owners, a business for profit. In this definition, the term
person includes individuals and other partnerships, and sometimes corporations may be partners.
There are three types of partnership business: General Partnership, Limited Partnership and
Limited Liability Partnership.

A. General Partnership (GP) - the general partnership refers to a firm in which all the partners
are responsible for liabilities of the firm and all have authority to act for the firm. All partners
also participate in the operation and management of the business.
General Partnership consists of partners who are personally, jointly, severally and fully liable as
between themselves and to the partnership for the firm’s undertakings. Any provision to the
contrary in the partnership agreement shall be of no effect with regard to third parties (Art.280,
Commercial Code of Ethiopia)

B. Limited Partnership (LP) - is a type of partnership designed primarily for individuals who
want the tax benefits of a partnership but who do not wish to work in a partnership. In such
organizations, a number of limited partners invest money as owners but are not allowed to
participate in the management of the company. These partners can still incur a loss on their
investment, but the amount of the loss is restricted to the amount of investment, which has been
contributed by limited partners. To protect the creditors of a limited partnership, one or more
general partners must be designated to assume responsibility for all obligations created in the
name of the business. The balance sheet shows both general partner’s capital and limited
partner’s capital separately.

A limited Partnership comprises two types of partners: general partners in full liable personally,
jointly and severally and limited partners who are only liable to the extent of their contributions
(Article 296, Commercial Code of Ethiopia)

C. Limited Liability Partnership (LLP) - the limited liability partnership has most of the same
characteristics of a general partnership except that the liability of the partners is significantly
reduced. Partners may lose their investment in the business and are also responsible for the
contractual debts of the business. The advantage is created in connection with any liability
resulting from damages. In such cases, the partners are only responsible for their own acts or
omissions plus the acts and omissions of individuals under their supervision. Example one
partner in the HH Audit Firm would not be held liable for a poor audit performed by another
partner.

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1.1.2) Partnership Contracts
Partnership can be formed through oral agreement, implied agreement, or written agreement.
The written agreement of a partnership business is called Deed of Partnership or Articles of
Partnership or Partnership Contract. The most important terms in a partnership contract for a
limited liability partnership are the following:
 The date of formation, name of partners, name of partnership, business location, etc
 The assets to be invested by each partners
 The authority of each partners and rights & duties of each partner
 Profit sharing ratio
 The accounting period to be used
 The drawing allowed to the partners and penalties for excess drawing
 Insurance on the lives of partners
 Provision for arbitration of disputes and liquidation of the partnership

The accounting principles for partnership may come from the nature of the business, legal acts
regarding partnership (e.g. Commercial Code of Ethiopia), and accounting concepts and
principles developed for partnership, tax laws, partnership contract (deed), etc. For example,
partnership may use cash method of accounting (cash basis of accounting) as they mostly
provide professional services on cash basis. In addition to this, the nature of the partnership
business may also affect the application of the accounting principle Going Concern as a
partnership is dissolved when there is change in partners. An asset of a partnership firm is also
protected as per Principles of Asset Protection.

1.1.3) Characteristics of Partnership

The basic characteristics of partnership include and are discussed as follows:
 Ease of Formation - only an oral agreement is necessary to create a legally binding
partnership. It may also be created by written contract between persons, or may be implied by
their conduct. But incorporation requires large cost and the filing of a formal application.
 Limited Life - a partnership may be ended by the death, retirement, bankruptcy, or
incapacity of a partner. The admission of a new partner to the partnership legally ends the former
partnership and establishes a new one.
 Mutual Agency - each partner has the authority to act for the partnership and to enter into
contract on its behalf. But, acts beyond the normal scope of business operations do not bind the
partnership unless specific authority has been given to the partner to enter into such transactions.
 Unlimited Liability - the liability is not limited to the business. If the partnership is unable
to pay its liability, the partners are personally liable. Creditors having difficulty in collecting cash
on matured liability from the partnership will be likely to turn to those partners who have other
financial resources.
 Co-ownership of partnership assets and Earnings - when individuals invest assets in a
partnership, they retain no claim to those specific assets but acquire an ownership equity in all
assets of the partnership. That is, every member of a partnership has ownership equity in
partnership.
 Participation in Earnings - participation in earnings and losses is one of the tests of the
existence of a partnership.
 Better resources and skills - resources and skills contributed by two or more persons are
better that those contributed a single person

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 Single Taxation – a partnership is taxed only once

1.1.4) Choosing Between Partnership and Corporation

One of the most important considerations in choosing between a Limited Liability Partnership
(LLP) and the corporate form of business organizations is the income tax status of the enterprise
and of its owners’. An LLP pays no income tax, but it is required to file an annual information
return showing its revenue and expenses, the amount of its net income, and the division of the net
income among the partners. The partners report their respective shares of the ordinary net
income from the partnership and such items as dividends and charitable contributions in their
individual income tax returns, regardless of whether they received more or less than this amount
of cash from the partnership during the year. A corporation is separate legal entity subject to a
corporate income tax. The net income, when and if distributed to stockholders’ as dividends, also
is taxable income of stockholders.

Example 1.1: assume that a business earns Br 100. After paying any income taxes, the reminder
is immediately conveyed to its owners. A tax rate of 30% is assumed for both individuals and
corporations.

Partnership Corporation
Income before income taxes...................................... Br 100 Br 100
...................................................................................
Income taxes paid by business (30%)....................... 0 (30)
Income distributed to owners.................................... Br 100 Br 70
Income taxes paid by owners (30%)......................... (30) (21)
Expendable (Disposable) income .............................Br 70 Br 49

The advantage of single taxation has led some larger companies in recent years to convert to the
partnership form to maximize after-tax returns to investors. Limited liability partnership may be
incorporated as S Corporation to retain the advantages of limited liability but at the same time
elect to be taxed as a partnership.

Income tax rates and regulations are subject to frequent changes, and new interpretations of tax
laws often arise. The tax status of the owners also is likely to change from year to year. For these
reasons, management of a business enterprise should review the tax implications of the limited
liability partnership and corporate forms of organization so that the enterprise may adapt most
successfully to the income tax environment.

The burden of taxation is not the only factor influencing a choice between the Limited Liability
Partnership and the corporate form of organization. Perhaps the factor that most often tips the
scales in favor of incorporation is the opportunity for obtaining larger amounts of capital. When
ownership may be divided into shares of capital stock, readily transferable, and offering the
advantages inherent in the separation of ownership and management. Another reason for
choosing the corporate form of organization is the limited liability of all stockholders for unpaid
debts of the corporation.

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1.2) Accounting for Formation of a Partnership
Accounting for formation and operation of a partnership involves some transactions between the
partnership and the partners and follows some end of the year procedures, which are as follows:
 Recording initial investment by the partners (tangible and intangible contributions)
 Recording additional contributions by the partners
 Withdrawal by the partners
 Loan transactions
 Allocation of income and losses and Preparation of financial statements
The transaction between the firm and the partnership are accounted for in Owners’ Equity
Accounts.

1.2.1) Owners’ Equity Accounts

Accounting for a partnership differs from accounting for a single proprietorship or a corporation
with respect to sharing of net income and losses and maintenance of the partners’ ledger
accounts. Although it might be possible to maintain partnership accounting records with only one
ledger account, the usual practice is to maintain three types of accounts. These are:
1. Partner Capital Account
2. Partner Drawing Account
3. Loan to Partner Account and Loan from Partner Account

1.2.2) Recording Initial Capital Contribution (Investment) Made by the Partners

Partner’s Capital Account
The original investment by each partner is recorded by debiting the assets invested, crediting any
liabilities assumed by the partnership, and crediting the partners’ capital account with the current
fair value of the net assets (asset minus liabilities) invested. Subsequent to the original
investment, the partners’ equity is increased by additional investment and by a share of net
income; the partners’ equity is decreased by withdrawal of cash or other assets and by a share of
net losses. Another possible source of increase or decrease in partners’ ownership equity results
from changes in ownership.

Valuation of Investments by Partners

The investment by a partner in the firm often includes assets other than cash. It is imperative that
the partners agree on the current fair value of non monetary assets at the time of the investment is
made and that the assets be recognized in the accounting records at such values. Any gains or
losses resulting from the disposal of such assets during the operation of the partnership, or at the
time of liquidation, generally are divided according to the plan for sharing net income or losses.
Therefore, equitable treatment of the individual partners requires a starting point of current fair
values recorded for all non-cash assets invested in the firm. Thus, partnership gains or losses
from disposal of non-cash assets invested by the partners will be measured by the difference
between the disposal price and the current fair value of the assets when invested by partners,
adjusted for any depreciation or amortization of the date of disposal.

Tangible Contributions
Example 1.2: Assume that Carter and Green form a business to be operated as a partnership.
Carter contributes Br 50,000 in cash whereas Green invests Br 20,000 photographic equipment
with fair value of Br 25,000

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 Cash ..........................................................................
5000
0
Equipment ................................................................2500
0
Carter, Capital ................................................ 50000
Green, Capital ................................................. 25000
Note: Although partners have contributed inventory, land, and a building, cash, the partner holds
no further right to these individual assets; they rather belong to the partnership. It does not
constitute a specific claim.

Intangible Contributions
The contribution made by one or more of the partners may go beyond assets and liabilities in
forming a partnership. A partner may contribute a particular line of expertise, artistic talent, etc.
These attributes, as well as many others, are frequently valuable to a partnership as cash and
fixed assets. Hence, formal accounting recognition of such special contributions may be
appropriately included as a provision of any partnership agreement. There are two methods for
treatment of intangible contributions in accounting records:
 The Bonus Method
 The Goodwill Method

The Bonus Method recognizes only the assets that are physically transferred to the business. The
Goodwill Method is based on the assumption that an implied value can be calculated
mathematically and recorded for any intangible contribution.

Example 1.3: James and Joyce planned to open an advertising agency named JJ Advertising
and decide to organize the endeavor as a partnership. James contributes cash of Br 90,000
whereas Joyce Br 30,000. Joyce is a graphic artist, a skill that is valuable to this business. In the
Articles of Partnership, the partners agree to start the business with equal capital balance. Thus, it
is recorded as follows by Bonus Method & Goodwill Method.
Bonus Method Goodwill Method
Total Investment = 90,000 + 30,000 James’ Capital........................................... 90,000
Total Investment = 120,000 Joyce Capital (should be).......................... 90,000
Equal Share = 120,000 /2 = 60,000 Total Capital..............................................180,000
Less: Total Investment..............................120,000
Goodwill (Implied)................................... 60,000
Journal Entry: Journal Entry:
Cash......................................
120,00 Cash...............................................120,000
0
James Capital............ 60,000 Goodwill....................................... 60,000
Joyce Capital............. 60,000 James Capital.......................... 90,000
Joyce Capital........................... 90,000

Comparison of Methods
Both approaches achieve the intent of partnership agreement: equal capital balances are recorded
despite a difference in the partner’s cash contributions. Although nothing prohibits the use of
either technique, the recognition of goodwill poses definite theoretical problems. Goodwill is

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recorded only as a result of acquisition by the reporting entity. Thus, goodwill in a partnership
should be viewed with a strong degree of skepticism.

1.2.3) Recording Additional Capital Contributions

Additional Capital Contribution is also recorded in the same manner as initial contributions by
increasing capital account. Subsequent to the formation of a partnership, the owners may choose
to contribute additional capital amounts. These investments can be made to stimulate expansion
or to assist the business in overcoming working capital shortage or other problems. Regardless of
the reason, the contribution is again recorded as an increment in the partner’s capital account
based on fair market value.

1.2.4) Withdrawal by the Partners and Partner’s Drawing Account

Drawing (withdrawals of cash or other assets) by partners in anticipation of net income or
drawings that are considered salary allowances are recorded by debits to the drawing accounts.
However, a large withdrawal that is considered a permanent reduction in the ownership equity of
a partner is debited directly to the partner’s capital account. The withdrawals are recorded
initially in a separate drawing account that is closed into the individual partner’s capital account
at year end.

Example 1.4: Record the drawing of two partners assuming that James and Joyce withdrew Br
1,200 and Br 1,500.

James Drawing .................................................... 1,200

Joyce Drawing ..................................................... 1,500
Cash ...................................................... 2,700

1.2.5) Loan Transactions and Loan to and Loan from Partners account (Loan
Account)
A partner may receive cash from the limited liability partnership with the intention of repaying
this amount. Such a transaction may be debited to the “Loan to Partner’s Account” rather than to
the partner’s drawing account. Loan to Partner is receivable from the partner. Conversely, a
partner can make a cash payment to the partnership that is considered a loan rather than an
increase in partner’s capital account balance. This is recorded by a credit to “Loans from
Partner’s Account” rather than an increase in partner’s capital account and generally is
accompanied by the issuance of a promissory note. Loan from Partner’s Account is a liability
payable to partners. Loans to Partners accounts are displayed as assets in the partnership balance
sheet and loans from partners are displayed as liabilities. The classification of these items as
current or long-tem generally depends on the maturity date, although these related party
transactions may result in noncurrent classification of the partner’s loans, regardless of maturity
dates. If a substantial unsecured loan has been made by a partnership to a partner and repayment
appears doubtful, it is appropriate to offset the receivable against the partner’s capital account
balance. If this is not done, partnership total assets and total partners’ equity may be misleading.
In any event, the disclosure principle requires separate listing of Loan to Partner, Loan from
Partner and Partner’s Capital accounts.

Loan to Partner.................................................
xxxxx

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 Cash...................................................... xxxxx
Cash..................................................................
xxxxx
Loan from Partner............................................xxxxx

1.3) Accounting for Operation of a Partnership

1.3.1) Financial Statements of a Partnership Business
Financial statements for a Partnership include:
 Income statement
 Statement of Partners’ Capital (Partners’ Capital Statement)
 Balance Sheet
 Statement of cash flows

Income Statement
Explanation of the division of net income among partners may be included in the partnership’s
income statement or in a note to the financial statements. This information is referred to as the
division of net income section of the income statement.

Example 1.5: A&B Partnership has sales of Br 300,000; cost of goods sold of Br 180,000; and
operating expenses of Br 90,000 for the year ending December 31, 2005. Required: prepare
income statement showing division of net income section assuming profit or loss sharing
percentages 47% and 53% to Partner A and B, respectively.

A&B Partnership
Income Statement
For the Year ended Dec. 31, 2005
Sales.....................................................................................................Br 300,000
Cost of Goods Sold ............................................................................. (180,000)
Gross Profit or Sales............................................................................Br 120,000
Operating Expenses............................................................................. (90,000)
Net Income........................................................................................... Br 30,000
Division of Income:
Partner A.............................................................................................. 14,100
Partner B.............................................................................................. 15,900
Total Net Income................................................................................. 30,000

 Note: Prior Period Adjustments – that is the correction of prior years’ income becomes
particularly important when the profit sharing ratio has been changed.

Example 1.6: Assume that Challa, Elias, and HAILU form a partnership by investing cash of Br
120,000, Br 90,000 and Br 75,000, respectively. The profit and loss sharing ratio is 3:4:3 and
each partner is allowed to withdraw Br 10,000 according to Articles of Partnership. At the end of
first year of operation, the partnership reports net income of Br 60,000. Record the foregoing
transactions and prepare statement of Partners’ Capital
 Initial Investment (Initial Contribution of Capital)

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 Cash................................................................ 285,000
Challa, Capital...................................... 75,000
Elias, Capital........................................ 90,000
HAILE, Capital.................................... 120,000
 Withdrawals by Partners
Elias, Drawing................................................ 10,000
Challa, Drawing............................................. 10,000
HAILE, Drawing............................................ 10,000
Cash...................................................... 30,000
 Allocation of Income and Closing Income Summery Account
Allocation of Income:
 Challa = 60,000 @ 30% = 24,000
 Elias = 60,000 @ 40% = 18,000
 HAILE = 60,000 @ 30% = 18,000

Closing Income Summary Account:

Income Summary................................................. 60,000
Challa, Capital............................................. 18,000
Elias, Capital............................................... 24,000
HAILE, Capital........................................... 18,000

 Closing Drawing Account

Challa, Capital.............................................................
10,000
Elias, Capital................................................................
10,000
HAILE, Capital............................................................
10,000
Challa, Drawing............................................. 10,000
Elias, Drawing................................................ 10,000
HAILE, Drawing............................................ 10,000
 Statement of Partners’ Capital
HAILE, Elias, and Challa Partnership
Statement of Partners’ Capital
For the year ending December 31, Year 1
Challa Elias HAILE Total
Capital Capital Capital Capital
Capital Balance, 120,000 90,000 75,000 285,000
Beginning
Allocation of Net Income 18,000 24,000 18,000 60,000
Less: Drawings 10,000 10,000 10,000 10,000
Capital Balance, Year End 128,000 104,000 83,000 315,00

1.3.2) Allocation of Income and Losses

At the end of each fiscal period, partnership revenues and expenses are closed out with the
resulting net income or loss being reclassified to the partners’ capital accounts. Since a separate

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equity balance is maintained for each partner, a method must be devised for this assignment of
annual income. The procedure of income allocation should always be stipulated in the Articles of
partnership. If no arrangement has been specified, partnership law normally holds that all
partners share equally in any income or loss earned by the business.
Allocation Techniques:
 Equal division of earnings, or in some other ratio
 Division of earnings in the ratio of partners’ capital account balances
 Allowing interest on partners’ capitals account balances with remaining net income or
loss divided equally or in a specified ratio
 Salary allowances with remaining net income or loss divided equally or in a specified
ratio
 Salaries to partners with interest on capitals and remaining income equally or in some
ratio
 Bonus to managing partner based on income & remaining income equally
 Interest on Beginning Capital, Compensation (Salary Allowance), Bonus, and
Remaining Income equally or in specified ratio, etc

Illustration on Division of earnings in the ratio of partners’ capital account balances

Division of partnership earnings in proportion to the capital invested by each partner is most
likely to be found in limited liability partnerships in which substantial investment is the principal
ingredient for success. To avoid controversy, it is essential that the partnership contract specify
whether the income-sharing ratio is based on:
 The original capital investment
 The capital account balance at the beginning of each year
 The average capital balances during the year
 The capital balances at end of each year (before distribution of income)
Example 1.7: HUSSEN and HASSEN established a partnership named HH Limited Liability
Partnership. HUSSEN invested Br 320,000 on January 1, 2004 and an additional investment of
Br 100,000 on April 1, 2004. He also withdrew Br 70,000 on July 1, 2004. HASSEN invested Br
480,000 on January 1, 2004 and withdrew 100,000 on July 1, 2004 and made an additional
investment of Br 40,000 on October 1, 2004. Determine the share of net income that must be
allocated to the two partners assuming a total net income of Br 200,000 based on the original
capital investment and average capital account balances
Division of Income in the ratio of original capital investment
HUSSEN................................................................................ 320,000
HASSEN................................................................................ 480,000
Total Original Investment...................................................... 800,000
HUSSEN = Br 200,000 @ 320,000 / 800,000 =.................... Br 80,000
HASSEN = Br 200,000 @ 480,000 / 800,000 =.................... Br 120,000
In the ratio of average capital account balances
The average capital account balances to the nearest month and the division of net income for
HUSSEN and HASSEN for 2004 are as follows:
 () in Capital Fraction of Average
Partner Date
Capital Balance Year Unchanged Capital
HUSSEN Jan. 1 -0- 320,000 3/12 80,000
April 1 100,000 420,000 3/12 105,000

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 July 1 (70,000) 350,000 6/12 175,000
Average Capital Balance of HUSSEN......................................................... 360,000
......................................................................................................................
......................................................................................................................
HASSEN Jan. 1 -0- 480,000 6/12 240,000
July 1 (100,000) 380,000 3/12 95,000
Oct. 1 40,000 420,000 3/12 105,000
Average Capital Balance HASSEN............................................................. 440,000
Division of Income in the ratio of average capital account
HUSSEN........................................................................................ 360,000
HASSEN........................................................................................ 440,000
Total Original Investment.............................................................. 800,000
HUSSEN = Br 200,000 @ 360,000 / 800,000 =........................... Br 90,000
HASSEN = Br 200,000 @ 440,000 / 800,000 =........................... Br 110,000

1. Bonus to managing partner based on income

Example 1.8: Determine the amount of bonus to the managing partner assuming that the partner
is entitled to 25% bonus on after bonus income and before bonus income is Br 30,000.
 Let Y= Income after Bonus
 25% Y = Bonus
 Bonus + Income after Bonus = Income before Bonus
 25% Y + Y = Br 30,000
 1.25Y = Br 30,000
 Y = Br 24,000
 Bonus = 25% @ 24,000 = Br 6,000

Exercise 1.1:
Southwestern Coffee Producers LLP
Adjusted Trial Balance
December 31, 2005
Debit Credit
Cash .......................................................................................125,000
Trade Accounts Receivable...................................................102,000
Allowance for doubtful accounts........................................... 6,500
Inventories..............................................................................97,500
Plant Assets............................................................................
1,200,000
Accumulated Depreciation..................................................... 100,000
Notes Payable......................................................................... 100,000
Trade Accounts Payable........................................................ 22,000
Accrued liabilities.................................................................. 33,000
Lemma, Capital...................................................................... 500,000
Lemma, Drawing...................................................................60,000
Zeberga, Capital..................................................................... 300,000
Zeberga, Drawing..................................................................60,000
Waktola, Capital.................................................................... 200,000

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 Waktola, Drawing..................................................................60,000
Net sales................................................................................. 1,308,000
Cost of Goods Sold................................................................690,000
Operating Expenses...............................................................175,000
Total.......................................................................................
2,569,500 2,569,500

Instruction: Assuming income sharing ratio of 5:3:2, showing the required closing entries and
prepare the following financial statements:
 Income Statement showing loss or income division section
 Statement of Partners’ Capital
 Balance Sheet

Partnerships Dissolution and Liquidation

1) Accounting for Dissolution a Partnership (Changes in Partners’ Composition)
Regardless of the nature or the frequency of the event, any alteration in the specific individuals
composing a partnership automatically leads to legal dissolution. The partnership is legally
terminated though an actual termination is not occurred. Before trying to summarize
accounting principles applicable to dissolution of a partnership, the wide rang of business
activities or events to which the dissolution may be applied should be considered. The term
dissolution may be used to describe events ranging from a minor change of ownership interest
not affecting operations of the partnership to a decision by the partners to terminate the
partnership. But in many instances, the breakup is merely a prerequisite to the formation of a
new partnership. This indicates that the main reason for dissolution is changes in partnership
personnel (partners). It is a legal form of winding up or termination of a partnership, but the
business may continue as going concern.

In many partnerships, capital transactions are limited almost exclusively to contributions,

drawings, and profit and loss allocations. Normally, though, over any extended period, changes
occur in the members who make up a partnership. Employees may be promoted into the
partnership or new owners may be brought in from outside the organization to add capital or
expertise to the business. Current partners eventually retire, die or simply elect to leave the
partnership.

 Accountants are concerned with the economic substance of a transaction rather than with its
legal form. Therefore, they must evaluate all the circumstances of the individual case to
determine how a change in partners should be recorded. Although a general partnership is
ended in a legal sense when a partner withdraws or a new partner is admitted, the partnership
continues with little outward evidence of change. In current accounting practice, a partner’s
interest often is viewed as a share in the partnership that may be transferred, much as shares
of a corporation’s capital stock are transferred between stockholders, without disturbing the
continuity of the partnership. For example, if a partner of a Consultancy Firm retires or a new
partner is admitted to the firm, the contract for the change in ownership should be planned

11
 carefully to avoid distressing client relationships and any condition that affect the continuity
of the firm. In a large CPA firm with hundreds of partners, the decision to promote an
employee to the rank of partner generally is made by a committee of partners rather than by
action of all partners.

Changes in ownership of a general partnership raise a number of accounting & management

issues. Among these issues are the setting of firms for admission of a new partner, the possible
revaluation of existing partnership assets, the development of a new plan for the division of net
income or loss, and the determination of the amount to be paid to a retiring partner.

Conditions for Dissolutions (Change in Partnership Personnel)

 Admission of new partner
 Withdrawal of a partner
 Retirement of partner
 Death of partner, etc

1.4.1) Admission of New Partner

One of the most prevalent changes in the make-up of a partnership is the addition of a new
partner. An employee may have worked for years to gain this opportunity or a prospective
partner might offer new investment capital or business experience necessary for future business
success. An individual can gain admittance to a partnership in one of the two ways:
 By purchasing an ownership interest from a current partner or
 By contributing assets directly to the business

In recording either type of transaction, the accountant has the option, once again, of retaining the
book value of all partnership assets and liabilities (Bonus Method) or revaluing these accounts to
their present market values (The Goodwill Method). Although both are acceptable, the decision
as to a theoretical preference between the Bonus (Book Value Approach) and Goodwill
(Revaluation Approach) Methods hinges on one single question: should the dissolved
partnership and the newly formed partnership be viewed as two separate reporting entities?
/;;
If the new partnership is merely an extension of the old, no basis exists for restatement. The
transfer of ownership is only a change in a legal sense and has no direct impact on business
assets and liabilities. However, if the continuation of the business represents a legitimate transfer
of property from one partnership to another, revaluation of all accounts and recognition of
goodwill can be justified.

A. Admission of New Partners through Acquisition of a Current Interest

If a new partner acquires an interest from one or more of the existing partners, the event is
recorded by establishing a capital account for the new partner and decreasing the capital account
balances of the selling partners by the same amount. No assets are received by the partnership;
the transfer of assets is a private transaction between two or more partners. In making a transfer
of ownership of interest, a partner can actually convey only three rights;
 The right of co-ownership in the business property
 The right to share in profits and losses as specified in the articles of partnership.
 The right to participate in the management of the business

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Example 1.9: Assume the following information is available relating to the partnership of Scott,
Thomas, and York
Capital Balance Profit and Loss Ratio

Partner
Scott Br 50,000 20%
Thomas 30,000 50%
York 20,000 30%
Total Capital Br 100,000 100%

Each of the three partners elects to transfer a 20% interest to Morgan for a total payment of Br
30,000. Instruction: Record the Admission Mr. Morgan under Book Value Approach (Bonus
Approach)
Scott, Capital (20%)...............................................................
10,000
York, Capital (20%)...............................................................
6,000
Thomas, Capital (20%).......................................................... 4,000
Morgan, Capital (20%)....................................... 20,000

An alternative for recording this acquisition by Morgan relies on a different perspective of the
new partner’s admission. Legally, the partnership of Scott, Thomas, and York is transferring all
assets and liabilities to the partnership of Scott, Thompson, York and Morgan. Therefore,
according to the logic underlying the goodwill method, a transaction is occurring between two
separate reporting entities, an event that necessitates the complete revaluation of all assets and
liabilities.

Goodwill Method (Revaluation Approach)

Since Morgan is paying Br 30,000 for a 20% interest in the partnership, the implied value of the
business as a whole is Br 150,000 (Br 30,000/20%). The Book Value is only Br 100,000; thus,
Br 50,000 upward revaluation is indicated. This adjustment is reflected by restating specific
partnership asset and liability accounts to market value with any remaining balance being
recorded as goodwill. After the implied value of the partnership is established, the
reclassification can be recorded on the new capital balance.

Recognition of Goodwill:
Goodwill (or Specific accounts)....................................................
50,000

13
 Scott, Capital....................................................................... 10,000
York, Capital....................................................................... 25,000
Thomas, Capital................................................................... 15,000
Transfer of Capital Interest:
Scott, Capital..........................................................................
12,000
York, Capital..........................................................................
11,000
Thomas, Capital..................................................................... 7,000
Morgan, Capital.................................................. 30,000

B. Admission of a New Partner by a Contribution Made to the Partnership

It is an investment made in the Partnership by new partner. A new partner may gain admission
by investing assets in the partnership, thus increasing the total assets and partners’ capital of the
partnership, because an outsider is admitted to the partnership by contributing cash or other
assets directly to business rather than to the partners.

Example 1.10: Assume that ZELEKE and SOLOMON maintain a partnership and presently
report capital balances of Br 80,000 and Br 20,000, respectively. According to the Articles of
partnership, ZELEKE and SOLOMON are entitled to 60% and 40% of profit and loss,
respectively. ADANE is allowed to enter partnership for a payment of Br 20,000 with this
money going into the business receiving an initial 10 percent interest in partnership property.
Record the admission of ADANE under both the Bonus and Goodwill method

 Bonus Credited to Original (Existing) Partners

The Bonus (or no revaluation) method maintains the same recorded value for all partnership
assets and liabilities despite ADANE’s admittance. The capital balance of this new partner is
simply set at the appropriate 10 percent level based on the Book Value of the partnership taken
as a whole (after payment is recorded).
Book Value of ZS partnership............................................... 100,000
Investment by newly admitted partner................................... 20,000
Total capital...........................................................................120,000
10 percent interest of newly admitted partner........................ 12,000
Bonus to Existing Partners
Invest by new partner.............................................................20,000
Less: Capital interest..............................................................12,000
Bonus to ZELEKE (60%)....................................4,800
Bonus to SOLOMON (40%)...............................3,200
Total....................................................................................... 8,000
Journal Entry
Cash........................................................................................
20,00
0
ZELEKE, Capital........................................................ 4,800
SOLOMON, Capital.................................................... 3,200
ADANE, Capital.......................................................... 12,000

 Goodwill Credited to Existing Partners

14
The goodwill method views the partner’s payment as evidence that the partnership as a whole
possesses an actual vale of Br 200,000 (Br 20,000/10%). Since, even with the new partner’s
investment, only Br 120,000 in Net Assets is being reported, a valuation adjustment of Br
80,000 is implied. The Br 80,000 figure might reflect the need to revalue specific accounts such
as inventory or equipment, although the entire amount, or some portion, may simply be recorded
as goodwill.

Recognizing Goodwill:
Goodwill (or Specific Accounts)...............................
80,000
ZELEKE, Capital (60%..................................... 48,000
SOLOMON, Capital (40%)............................... 32,000

Recording the Investment:

Cash...........................................................................
20,000
ADANE, Capital................................................ 20,000

Assuming the Bonus or Goodwill was accrued to the existing partners, the Comparison of Bonus
Method and Goodwill Method is as follows:
Bonus Method Goodwill Method
Assets les liability..................................... Br100,000 Br100,000
New partner’s contribution....................... 20,000 20,000
Goodwill.................................................... 0 80,000
Total.......................................................... Br120,000 Br 200,000
New Partner’s Capital (10%).................... 12,000 20,000

 Hybrid Method of Recording Admission of New Partner

Under the Hybrid Method, identifiable assets (such as land) are revalued but no goodwill is
recognized.

Example 1.11: Assume that asset minus liabilities of SOLOMON & ZELEKE partnerships have
a Book Value of Br 100,000 as stated earlier. Also assume that a piece of land held by business
is actually worth Br 30,000 more than its currently recorded book value. Thus, the identifiable
assets of the partnership are worth Br 130,000. ADANE pays Br 20,000 for a 10 percent interest.
Revaluation of Land:
Land.................................................................................
30,000
ZELEKE, Capital (60%)......................................... 18,000
SOLOMON, Capital (40%).................................... 12,000

Recording the Admission of the new partner

The admission of ADANE and the payment brings the total capital balance to Br 150,000.
Because ADANE is acquiring a 10 percent interest, and thus his capital balance is Br 15,000
[10% @ (100,000 (book value) + 30,000 (land revaluation) + 20,000 (new investment)]. The Br
5,000 extra payment (Br 20,000 – Br 15,000) is a bonus attributed to the original partners.

Cash.....................................................................
20,000

15
 ZELEKE, Capital (60%)............................. 3,000
SOLOMON, Capital (40%)........................ 2,000
ADANE, Capital......................................... 15,000

 Bonus or Goodwill Credited to New Partner (Incoming Partner)

The incoming partner may contribute some attribute other than tangible assets to the partnership.
Therefore, the Articles of partnership may be written to credit the new partner rather than the
original partners, with either a bonus or goodwill. Because of an excellent professional
reputation, valuable business contacts, or myriad other possible factors, the new incoming
partner may be able to negotiate a beginning capital balance in excess of the cash contribution.
This same circumstance may also result if the business is desperate for new capital and is willing
to offer favorable terms as an enticement to the potential partner.

Example 1.12: Assume that ZELEKE and SOLOMON maintain a partnership and presently
report capital balances of Br 80,000 and Br 20,000, respectively. According to the Articles of
partnership, ZELEKE and Solomon is entitled to 60% and 40% of profit or loss, respectively.
ADANE is allowed to enter partnership for a payment of Br 20,000 with this money going into
the business receiving an initial 20 percent interest in partnership property. Record the admission
of ADANE under both the Bonus and Goodwill method.

Bonus Method
The Bonus Method sets Adane’s initial capital at Br 24,000 (20% of Br 120,000 Book Value =
Br 100,000 + 20,000)
 20% @ Br 120,000 = Br 24,000
 Bonus = 24,000 – 20,000 = 4,000
Cash...........................................................................................20,000
ZELEKE, Capital (60%Bonus)................................................. 2,400
SOLOMON, Capital (40%Bonus)............................................ 1,600
ADANE, Capital........................................................... 24,000

Goodwill
If goodwill, rather than bonus is attributed to the entering partners, a mathematical problem
arises in determining the implied value of the business as a whole.
ADANE’S Capital = 20% of partnership Capital
 Br 20,000 + Goodwill = 20% (Br 100,000 + Br 20,000 + Goodwill)
 Br 20,000 + Goodwill = Br 20,000 + Br 4,000 + 0.2Goodwill
 Goodwill – 0.2 Goodwill = Br 24,000 – Br 20,000
 0.8 Goodwill = Br 4,000
 Goodwill = Br 5,000
Cash......................................................................... 20,00
0
Goodwill.................................................................. 5,00
0
ADANE, Capital....................................... 25,000

16
1.4.2) Withdrawal by a Partner
Admission of a new partner is not the only method by which a partnership can undergo a change
in composition. Over the life of the business, partners occasionally leave the organization. Death
or retirement can occur, or a partner may simply elect to withdraw from the partnership. The
articles of partnership also can allow for the expulsion of a partner under certain conditions.

Once again, any change in membership legally dissolves the partnership, although the business’s
operations usually continue uninterrupted under the ownership of the remaining partners.
Regardless of the reason for dissolution, some method of establishing an equitable settlement of
the withdrawing partner’s interest in the business is necessary. Often, the partner (the partner’s
state) may simply sell the interest in the business to an outside party with approval, or to one or
more of the remaining partners. As an alternative, cash or other assets can be distributed from the
business as a means of settling a partner’s right of co-ownership. Consequently, life insurance
polices are held by many partnerships solely to provide adequate cash to liquidate a partner’s
interest upon death. Whether withdrawal is caused by death, retirement or some other reason, a
final distribution will not necessarily equal the book value of the partner’s capital account. A
capital account balance is only a record up of historical transactions and rarely represents the true
value interest in a business.

The withdrawal of an individual partner and the resulting distribution of partnership property can
be accounted for by either the bonus (non-revaluation) method or the goodwill (revaluation)
method. A hybrid option is available (revaluation of identifiable assets and bonus). If a bonus is
recorded, the amount can be attributed to either of the parties involved the withdrawing partner
or the remaining partners.

Accounting for Withdrawal of a Partner -Illustration

Example 1.13: Assume that the partnership of DEREJE, SIME and WEYESSA has been in
existence for a number of years. At the present time, the partners have the following capital
balances as well as indicated profit or loss percentages:
Partner Capital Balance Profit Ratio
DEREJE Br70,000 50%
SIME 20,000 30%
WEYESSA 10,000 20%
Total Capital Br100,000 100%

WEYESSA decides to withdraw from the partnership but DEREJE and SIME plan to continue
operating the business. As per the partnership agreement, a final settlement distribution for
WEYESSA is computed based on the following specified provisions.
1. An appraisal will be made by an independent expert to determine the estimated fair
market value of the business
2. Any individual who leaves the partnership to receive cash or other assets equal to the
partner’s current capital balance after recording an appropriate share of any adjustment
indicated by the previous valuation. The allocation of gains and losses is based on the normal
profit and loss ratio.

17
Following WEYESSA’s decision to withdraw from the partn0ership, an immediate appraisal is
made of the business and its property. Total fair market value is estimated at Br 180,000, Br
80,000 in excess of book value. According to this valuation, land held by the partnership is
currently worth Br 50,000 more than its original cost. In addition, Br 30,000 goodwill
attributable to the partnership is created based on the value of the business as a going concern.
Therefore, WEYESSA is paid Br 26,000 on leaving the partnership: the original Br 10,000
capital balance plus a 20% share of the Br 80,000 increment. Recording the transaction under the
Bonus Method, Goodwill Method, and Hybrid Method:

 Bonus Method
The Br 16,000 payment to WEYESSA is recorded as a decrease in the remaining partners’
capital accounts. DEREJE and SIME have been credited with 50% and 30% of all profits and
losses, respectively. This relative ratio is used to allocate the reduction between these two
remaining partners on a 5/8 and 3/8 basis.
Journal Entry:
WEYESSA, Capital.............................................................. 10,000
DEREJE, Capital (5/8 of excess distribution)....................... 10,000
SIME, Capital (3/8 of excess distribution)............................ 6,000
Cash......................................................................... 26,000

 Goodwill Method
Recognition of land value and goodwill
Land.......................................................................................
50,000
Goodwill................................................................................
30,000
DEREJE, Capital (50%).......................................... 40,000
SIME, Capital (30%).............................................. 24,000
WEYESSA, Capital (20%)..................................... 16,000
Cash distribution made to withdrawing Partner
WEYESSA, Capital............................................... 26,000
Cash..................................................... 26,000
.............................................................
The Br 26,000 did not indicate that total capital should be Br 130,000 (Br 26,000/20%). This
computation is appropriate only when (1) a new partner is admitted or (2) the percentage of
capital is the same as the profit and loss ratio.

 Hybrid Method
Revaluations of Asset and liability are still recognized but goodwill is ignored. A bonus must be
recorded to reconcile the partner’s adjusted capital balance with the final distribution. The
distribution is Br 26,000 the difference Br 6,000 is recorded as a bonus taken from the remaining
two partners according to relative profit and loss ratio.
Recognition of Land Value
Land.............................................................................
50,000
DEREJE, Capital (50%)..................................... 25,000
SIME, Capital (30%).......................................... 15,000

18
 WEYESSA, Capital (20%)................................ 10,000

Cash Distribution made to withdrawing partner

DEREJE, Capital (5/8 of Bonus)........................................... 3,750
SIME, Capital (3/8 of Bonus)................................................2,250
WEYESSA, Capital...............................................................
20,000
Cash...................................................................... 26,000

2) Accounting for Liquidation of a Partnership

Throughout any liquidation, both creditors and owners demand continuous information that
enables to monitor and assess their financial risks. This information relates to the following:
 The conversion of partnership assets into cash
 The allocation of the resulting gains and losses
 The payment of liabilities and expenses
 The distribution of any remaining assets to partners based on their final capital
balance

Termination and Liquidation Procedure

The procedures involved in terminating and liquidating a partnership are basically mechanical.
Partnership assets are converted into cash that is used to pay business obligations as well as
liquidation expenses. Any remaining assets are then distributed to individual partners based on
their final capital balances. As no further ledger accounts exist, the partnership’s books are
permanently closed. If each partner has a large enough capital balance to absorb all liquidation
losses, the accountant experiences little difficulty in recording this series of transaction.
Liquidation is classified into two based on the timing of settlement of creditors and partners
account balances:
 Final Stage Liquidation – payments are made to creditors and partners after all
non-cash assets are realized
 Installment Liquidation – payments are made to creditors and partners in
accordance with some reasonable sequence as non-cash assets are realized.

1.5.1) Final Stage Liquidation (Lump-Sum Liquidation)

Example 1.14: Assume that MERGA and HAILU have been operating an art gallery as a
partnership for a number of years. On May 1, 2001, the partners decide to terminate business
activities, liquidate all non-cash assets, and dissolve their partnership. A number of reasons
might exist for such decision – e.g. disagreement, inadequate business profit for investment of
time & capital. The balance sheet is given below:
MERGA AND HAILU Partnership
BALANCE SHEET
MAY 1, 2001

19
 Assets Liabilities and Capital
Cash............................................................
Br 45,000 Liabilities.........................................
Br 32,000
Accounts Receivables................................ 12,000 MERGA, Capital.............................50,000
.........................................................
Inventory.................................................... 22,000 HAILU, Capital...............................38,000
Land, Building & Equipment, net.............. 41,000
Total Assets................................................
Br 120,000 Total Liab.& Capital........................
Br 120,000

The following assumptions are made that the liquidation of MERGA and HAILU Partnership
proceeds in an orderly fashion from June 1, 2001 through October 15, 2001:
 June 1, 2001 - The inventory is sold at auction for Br 15,000. MERGA and HAILU allocate
all profits and losses using 6:4 ratios, respectively.
 July 15, 2001 – from the total accounts receivable, Br 9,000 is collected with the remainder
being written off as bad debts.
 August 20, 2001 – the fixed asset are sold for a total of Br 29,000
 August 25, 2001 – all partnership liabilities are paid
 September 10, 2001 – a total of Br 3,000 liquidation expenses is paid to cover costs such as
accounting and legal fees, commissions incurred in disposing of partnership property
 October 15, 2001 – all remaining cash is distributed to the owners based on their final capital
account balances
Instruction: Record the forgoing transactions and determine partners’ capital balance
June 1, 2001:
Cash............................................................................
15,000
MERGA, Capital (60% of loss).................................4,200
HAILU, Capital (40% of loss)...................................2,800
Inventory........................................................ 22,000

July 15, 2001:

Cash............................................................................9,000
MERGA, Capital (60% of loss)................................. 1,800
HAILU, Capital (40% of loss)...................................1,200
Accounts Receivables.................................... 12,000

August 20, 2001:

Cash............................................................................
29,000
MERGA, Capital (60% of loss).................................7,200
HAILU, Capital (40% of loss)...................................4,800
Land, Building, and Equipment (net)............ 41,000

August 25, 2001:

Liabilities...................................................................
32,000
Cash................................................................ 32,000

September 10, 2001:

MERGA, Capital (60% of loss)................................. 1,800
HAILU, Capital (40% of loss)................................... 1,200
Cash................................................................ 3,000
20
October 15, 2001:
MERGA, Capital (60% of loss)................................. 35,000
HAILU, Capital (40% of loss)................................... 28,000
Cash................................................................ 63,000

MERGA AND HAILU Partnership

Determination of Cash and Capital Account Balances
October 15, 2001
Cash MERGA HAILU
Capital Capital
Beginning Balance................. Br 45,000 Br 50, 000 Br 38,000
Sold inventory........................ 15,000 (4,200) (2,800)
Collected A/Receivable......... 9,000 (1,800) (1,200)
Sold fixed assets..................... 29,000 (7,200 ) (4,800)
Paid Liabilities....................... (32,000) –0– –0–
Paid liquidation expenses....... (3,000) (1,800) (1,200)
Final Totals............................ Br 63,000 Br 35,000 Br 28,000

Schedule of Liquidation (Statement of Partnership Liquidation)

Liquidation may take a considerable length of time to complete. Thus, there should be a frequent
report summarizing the transactions as they occur. Consequently, a statement (often referred to
as the Schedule of Partnership Liquidation) can be prepared at periodic intervals to disclose:
 Transaction to date
 Property still being held by the partnership
 Liabilities remaining to be paid
 Current cash and capital balances

MERGA AND HAILU Partnership

Statement of Partnership Liquidation
October 15, 2001
Non-Cash Liabilities MERGA HAILU
Cash Assets Capital Capital
Beginning Balance................... 45,000 75,000 32,000 50,000 38,000
Sold inventory......................... 15,000 (22,000) –0– (4,200) (2,800)
Updated Balances.................... 60,000 53,000 32,000 45,800 35,200
Collecting A/Receivable.......... 9,000 (12,000) –0– (1,800) (1,200)
Updated Balances.................... 69,000 41,000 32,000 44,000 34,000
Sold fixed assets...................... 29,000 (41,000) –0– (7,200) (4,800)
Updated Balances.................... 98,000 –0– 32,000 36,800 29,200
Paid Liabilities......................... (32,000) –0– (32,000) –0– –0–
Updated Balances.................... 66,000 0 0 36,800 29,200

21
 Paid liquidation expenses........ (3,000) –0– –0– (1,800) (1,200)
Updated Balances.................... 63,000 0 0 35,000 28,000
Distribution remaining cash.... (63,000) –0– –0– (35,000) (28,000)
Closing Totals.......................... –0– –0– –0– –0– –0–

Settlement of Partners’ Capital Balances: Scenarios of Deficit Capital Balance

1. The Deficit Capital is Entirely Contributed the Partner
Example 1.15: During the liquidation process, the partnership incurred a number of large losses
that have been allocated to the partners’ capital accounts on a 4:4:2 basis, respectively. A portion
of the resulting cash is then used to pay all partnership liabilities and liquidation expenses.
Following these transactions, the following four account balances remain open within the
partnership’s records.
Cash................................................................ 20,000
DUGUMA, Capital........................................ (6,000)
HAGOS, Capital............................................ 15,000
REDIET, Capital............................................ 11,000
Cash collected from partner with deficit capital:
Cash.................................................................................
6,000
DUGUMA, Capital.............................................. 6,000
Distribution of Cash to partners with positive capital:
HAGOS, Capital......................................................... 15,000
REDIET, Capital........................................................ 11,000
Cash............................................................. 26,000
2. The Deficit Capital Is Considered to be Loss to the Remaining Partners
DUGUMA HAGOS REDIET
(40%) (40%) (20%)
Capital balances................................................... (6,000) 15,000 11,000
Allocation of potential loss.................................. _6,000 (4,000) (2,000)
Distribution of safe payment................................ 0 11,000 9,000

HAGOS, Capital.........................................................
11,000
REDIET, Capital........................................................9,000
Cash............................................................. 20,000

After the Br 20,000 cash has been distributed, a few other events can possibly occur. Duguma
and Rediet may be unable to cover any part of the deficit.
Deficit is totally uncollectible
HAGOS, Capital.........................................................
4,000
REDIET, Capital........................................................
2,000
DUGUMA, Capital..................................... 6,000
The Deficit Capital is partly Collectible
DUGUMA manages to contribute Br 4,600 but the final Br 1,400 will never be collected
Cash Collection:
Cash................................................................
4,600
DUGUMA, Capital.............................. 4,600
Distribution of Cash:

22
 HAGOS, Capital.........................................................
3,067
REDIET, Capital........................................................
1,533
Cash...................................................... 4,600
Distribution of the loss:
HAGOS, Capital.........................................................
933
REDIET, Capital........................................................
467
DUGUMA, Capital.............................. 1,400
1.5.2) Installment Liquidation (Installment Payments to Partners)
In final stage partnership liquidations, all partnership non-cash assets were realized and the total
loss from liquidation was divided among the partners before any cash payment were made to
them. However, the liquidation of some partnership may extend over several months. In such
extended liquidations, the partners usually will want to receive cash as it becomes available
rather than waiting until all non-cash assets have been realize. Installment payment to partners
are appropriate if necessary safeguards are used to ensure that all partnership creditors are paid in
full and that no partners are paid more than amount to which they would be entitled after all
losses on realization of assets are known.

Liquidation in installments (Installment Liquidation) is a process of realizing some assets,

paying creditors, paying the remaining available cash to partners, realizing additional assets, and
making additional cash payment to partners. The liquidation continues until all non-cash assets
have been realized and all cash has been distributed to partnership creditors and partners. The
steps are:
 Realizing some assets
 Paying Creditors
 Paying the remaining available cash to partners
 Realizing additional asset
 Making additional payment to creditors,

The circumstances of installment liquidation of partnership vary; consequently, the approach

here is to emphasize the general principles guiding liquidation in installments rather than to
provide illustrations of all possible liquidation situations. Among the variables that cause
partnership liquidations to differ are the sufficiency of each partner’s capital to absorb that
partner’s share of losses from one partner to another because of inability to collect a capital
deficits, the offsetting of loan account balances against capital deficits, and the possible need for
setting aside cash to pay future liquidation costs or unrecorded partnership liabilities.

General Principles Guiding Installment Payments

The critical element in installment liquidations is that the liquidator authorizes cash payments to
partners before all losses that may be incurred in the liquidation are known. If payments are
made to partners and later losses cause deficits in the partner’s capital accounts, the liquidator
will have to request the return of the payments. If the payments cannot be recovered, the
liquidator may be liable to the other partners for the loss caused them by the inappropriate
distribution of cash. Because of this danger, the only safe policy for determining installment cash
payments to partners is under worst-case scenario:

WORST-CASE SCENARIO:

23
 1. Assume a total loss on all remaining non-cash assets, and provide for all possible losses,
including potential liquidations costs and unrecorded liabilities.
2. Assume that any partner with a potential capital deficit will be unable to pay anything to
the partnership; thus, distribute each installment of cash as if no more cash will be
forthcoming, either from realization of assets or from collection of capital deficits from
partners.

Under these assumptions, the liquidator will authorize cash payment to a partner only if that
partner has a capital account credit balance (or in capital and loan accounts combined) in excess
of the amount required to absorb a portion of the maximum possible loss that may be incurred on
liquidation. A partner’s “share of the maximum possible loss” would include any loss that may
result form the inability of partners to pay any potential capital deficits to the partnership.

When installment payments are made according to these rules, the effect will be to bring the
equities of the partners to the income-sharing ratio as quickly as possible. When installment
payment have proceeded to the point that the partner’s capital and loan account balances
(equities) correspond with the income-sharing ratio, all subsequent payment may be made in
that ratio, because each partner’s equity will be sufficient to absorb an appropriate share of the
maximum possible remaining loss.

Determining Appropriate Installment payment to Partners

The amount of cash that may be distributed safely to the partners each month (or at any other
point in time) may be determined by computing the impact on partners’ equities (capital and loan
account balance) of the maximum possible loss on non-cash assets remaining to be realized and
the resultant potential impact on partners’ capital.

Example 1.16: assume that the partners of KASSA, LEMMA & MARU LLP, who share net
income and losses in a 4:3:2: ratio, decide to liquidate the partnership and to distribute cash in
installments. The balance sheet for KASSA, LEMMA & MARU LLP just prior to liquidation on
July 5, 2000, is as follows:
KASSA, LEMMA & MARU LLP
Balance Sheet
July 5, 2000 (In ETB)
Assets: Liabilities and Partners’ Capital
Cash................................................ 8,000 Liabilities........................................... 61,000
Other Assets.................................... 192,000 KASSA, Capital................................ 40,000
LEMMA, Capital.............................. 45,000
______ MARU, Capital................................. 54,000
Total Assets.................................... 200,000 Total Liabilities and Capital............... 200,000

To simplify the illustration, assume that non-cash assets were realized as follows:
Carrying Loss on Cash
Date
Amount of Assets Realization Proceeds
July 31, 2000 Br 62,000 Br 13,500 Br 48,500
August 31, 2000 66,000 36,000 30,000
September 30, 2000 64,000 31,500 32,500

24
 Total Br 192,000 Br 81,000 Br 111,000

Thus, on July 31, 2000, Br 56,500 (Br 8,000 + Br 48,500 = Br 56,500) of cash is available for
distribution. The first claim to the cash is that of partnership creditors; because their claims total
Br 61,000, the entire Br 56,500 available on July 31 is paid to creditors, leaving an unpaid
balance of Br 4,500 (Br 61,000 - Br 56,500 = Br 4,500), and the partners receive nothing on that
date.

On August 31, 2000, Br 30,000 cash is available for distribution: the first Br 4,500 is paid to
creditors, leaving Br 25,500 (Br 30,000 – Br 4,500 = Br 25,500) available for distribution to
partners. Under the Worst Case Scenario described above, the appropriate distribution of the Br
25,500 to partners is determined as follows:

August 31, 2000: Determination of Cash Distribution to Partners

Event and Date KASSA (4) LEMMA (3) MARU (2)
Capital account balance, July 5, 2000 Br 40,000 Br 45,000 Br 54,000
Allocation of Br 13,500 loss on July 31, 2000 &
realization of non-cash assets at Br 48,500 .................................. (6,000) (4,500) (3,000)
Allocation of Br 36,000 loss on August 31, 2000 &
realization of non-cash assets at Br 30,000.................................... (16,000) (12,000) (8,000)
Capital Account Balances, August 31, 2000.................................. 18,000 28,500 43,000
Allocation of maximum potential loss on remaining non-
cash assets (Br 64,000) ................................................................. (28,445) (21,333) (14,222)
Potential capital account balance ..................................................... (10,445) 7,176 28,778
Allocation of maximum potential loss from uncollectibility of 10,445 (6,267) (4,178)
KASSA’s potential capital deficit in the ratio of 3:2 ...................................
Appropriate cash payment to partners, August 31, 2000 ............................. Br 0
Br 900 Br 24,600
The available cash of Br 32,500 on September 30, 2000 is also distributed in a similar way as
shown below:
 KASSA Capital = 18,000 – 0 = 18,000
 LEMMA Capital = 28,500 – 900 = 27,600
 MARU Capital = 43,000 – 24,600 = Br 18,400

Event and Date KASSA LEMMA MARU

(4) (3) (2)
Capital account balance, August 31, 2000.............................
Br 18,000 Br 27,600 Br 18,400
Allocation of Br 31,500 loss on September 30, 2000 &
realization of non-cash assets at Br 32,500...........................(14,000) (10,500) (7,000)
Capital Account Balances, September 30, 2000.................... 4,000 17,100 11,400
Cash payment to partners, September 30, 2000..................... (4,000) (17,100) (11,400)
Final Capital Account Balances, September 30, 2000........... Br 0 Br 900 Br 24,600

Preparation of a Cash Distribution Program

Although the method for determining cash payment to partners illustrated in the foregoing
section is sound, it is somewhat cumbersome. Furthermore, it does not show at the beginning of
the liquidation how cash might be divided among the partners, as it becomes available. For these

25
reasons, it is more efficient to prepare in advance a complete Cash Distribution Program (Plan)
to show how cash may be divided during liquidation. If such a program is prepared, any amount
of cash received from the realization of partnership assets may be paid immediately to
partnership creditors and partners as specified in the program.

Using the data for KASSA, LEMMA & MARU LLP illustrated above, the following cash
distribution program may be prepared; the working paper supporting the cash distribution
program and an explanation for the preparation of the working paper are also prepared.
KASSA, LEMMA & MARU LLP
Cash Distribution Plan
July 5, 2000
In ETB Creditors KASSA LEMMA MARU
The First 61,000 100% ─ ─ ─
The Next 24,000 ─ ─ ─ 100%
The Next 25,000 ─ ─ 60% 40%
Any cash thereafter ─ 4/9 3/9 2/9

Procedures for developing the working paper are:

1. The “capital account balances before liquidation” represent the equities of the partners in the
partnership, that is, the balance of a partner’s capital account, plus or minus the balance (if
any) of a loan made by a partner to the partnership or a loan made by the partnership to a
partner.
2. The capital account balance before liquidation for each partner is divided by each partner’s
income-sharing ratio to determine the amount of capital per unit (CPU) of income (loss)
sharing for each partner. This procedure is critical because:
 It identifies the partner with the largest capital per unit of income (loss) sharing
who, therefore, will be the first to receive cash
 It facilitates the ranking of partners in the order in which they are entitled to
receive cash, and
 It provides the basis for computing the amount of cash each partner receives at
various stages of liquidation.
Because MARU’s Capital per Unit of income (loss) sharing is the largest (Br 27,000), MARU is
the first partner to receive cash (after all partnership creditors have been paid), followed by
LEMMA and finally by KASSA.
3. MARU receives enough cash to reduce MARU’s capital of Br 27,000 per unit of income
(loss) sharing to Br 15,000, equal to the balance for LEMMA, the second-ranking partner. To
accomplish this, MARU’s capital per unit of income (loss) sharing must be reduced by Br
12,000, and because MARU has two units of income (loss) sharing, MARU receives Br
24,000 (Br 12,000 @ 2 = Br 24,000) before LEMMA receives any cash.
4. At this point, the capital per unit of income (loss) sharing for both LEMMA and MARU is Br
15,000, indicating that they are entitled to receive cash until their capital per unit of income
(loss) sharing is reduced by Br 5,000 to the Br 10,000 balances for KASSA, the lowest-
ranking partner. Because LEMMA has three units and MARU has two units of income (loss)
sharing, LEMMA receives Br 15,000 (Br 5,000 @ 3 = Br 15,000) and MARU receives an
additional Br 10,000 (Br 5,000 @ 2 = Br 10,000) before KASSA receives any cash. After

26
 MARU receives Br 24,000, LEMMA and MARU would share any amount of cash available
to a maximum amount of Br 25,000 in a 3:2 ratios.
5. After LEMMA has received Br 15,000 and MARU has received Br 34,000 (Br 24,000 + Br
10,000 = Br 34,000), the capital per unit of income (loss) sharing is Br 10,000 for each
partner, and any additional cash is paid to the partners in the income-sharing ratio (4:3:2),
because their capital account balances have been reduced to the income-sharing ratio. This is
illustrated below.
KASSA, LEMMA & MARU LLP
Working Paper for Cash Distribution to Partners during Liquidation
July 5, 2000
Event and Date KASSA LEMMA MARU
Capital account balance before liquidation................................................. Br 40,000 Br 45,000 Br 54,000
Income Sharing Ratio.................................................................................. 4 3 2
CPU= Capital account balance before liquidation divided by Income
sharing ratio to determine capital per unit ................................................. Br 10,000 Br 15,000 Br 27,000
Required reduction in CPU of income (loss) sharing for partner
MARU to reduce MARU’s balance to equal the Next largest balance
(for partner LEMMA). This is the amount of the first cash
distribution to a partner per unit of the Partner’s income (loss)
sharing. Because MARU has 2 Units of income (loss) sharing.
MARU receives the first Br 24,000 (Br 12,000 @ 2 = Br 24,000)............
(12,000)
CPU of income (loss) sharing after payment of Br 24,000 to MARU........ Br 10,000 Br 15,000 Br 15,000
Required reduction in CPU of income (loss) sharing for partners
MARU and LEMMA or reduce their balances to equal partner
KASSA’s balance, which is the smallest capital per unit of income
(loss) sharing. The required reduction is multiplied by each partner’s
incoming – sharing ratio to compute the amount of cash to be paid.
Thus, LEMMA receives Br 15,000 (5,000 @ 3 = 15,000) and MARU
receives Br 10,000 (Br 5,000 @ 2 = Br 10,000). .......................................
(5,000) (5,000)
Capital per unit of income (loss) sharing after payment of Br 15,000
to LEMMA and Br 34,000 to MARU. Remaining Cash may be
distributed in income sharing ratio............................................................. 10,000 10,000 10,000

Reduction of Capital Account Balances to Income-Sharing Ratio

KASSA LEMMA MARU
Event and Date (4/9) (3/9) (2/9)
Capital account balance before liquidation........................................ Br40,000 Br45,000 Br54,000
First Payment of Cash to MARU......................................................... (24,000)
Second Payment of Cash to LEMMA and MARU in 3:2 ratio................ (15,000) (10,000)
Capital account balances (Income-sharing ratio) of 4:3:2
after payment of total of Br49,000 to LEMMA and MARU................... Br40,000 Br30,000 Br20,000
4 3 2
Only when installment payment reach the point at which partners’ capital account balance
correspond with the income-sharing ratio may subsequent cash payment be made in that ratio. A
cash distribution program may be used to ascertain an equitable distribution of non-cash assets to
partners. The current fair value of non-cash assets such as marketable securities, inventories, or
equipment distributed to partners is treated as equivalent to cash payments. If a distribution of

27
non-cash assets departs from the cash distribution program by giving one of the partners a large
distribution than that partner is entitled to receive, subsequent distribution should be adjusted to
allow the remaining partners to “make up” the distribution prematurely made to one of the
partners. In such cases, a revised Cash Distribution Program (Cash Distribution Plan) must
be prepared, because the original relationship among the partners’ capital account balances has
been disrupted.

Any losses or gains on the realization of assets during liquidation are allocated to the partners in
the income-sharing ratio, unless the partnership contract specifies another allocation procedure.
Thus, the degree to which the capital account balances do not correspond with the income-
sharing ratio is not altered by such losses or gains. Consequently, losses or gains from the
realization of assets in the course of partnership liquidation do not affect the cash distribution
program prepared prior to the start of liquidation.

Using the cash distribution program, assuming that the realization of other assets by KASSA,
LEMMA & MARU LLP from July 6 through September 30, 2000, the cash available each
month is paid to creditors and partners as summarized below:

KASSA, LEMMA & MARU LLP

Distribution of Cash to Creditors and Partners
July 6 through September 30, 2000
Partners’ Capital
Cash Liabilities KASSA LEMMA MARU
(4/9) (3/9) (2/9)
July 31,2000: *Br56,500 Br56,500
August 31, 2000: 30,000 4,500 Br24,000
9,00 600
September 30, 2000: 32,500 14,100 9,400
4,000 3,000 2,000
Total Br119,000 Br61,000 Br 4,000 Br18,000 Br36,000
*The July 31 cash of Br56,500 includes Br8,000 cash on hand.

The entire cash balance of Br 56,500 available on July 31 is paid to creditors, leaving Br 4,500
in unpaid liabilities. When Br 30,000 becomes available on August 31, Br 4,500 is to be paid to
creditors, leaving Br 25,500 to be paid to the partners according to the cash distribution program.
The program requires MARU to receive 100% of the first Br 24,000 available for distribution to
partners, and for LEMMA and MARU to share the next Br 25,000 in a 3:2 ratio. On August 31
only Br 1,500 (Br 30,000 – Br 4,500 – 24,000 = Br 1,500) is available for payment to LEMMA
and MARU; thus, they receive Br 900 and Br 600, respectively. Of the Br 32,500 available on
September 30, the first Br 23,500 is paid to LEMMA and MARU in a 3:2 ratio, or Br 14,100 and
Br 9,400, respectively, in order to complete the distribution of Br 25,000 to LEMMA and
MARU before KASSA participates; this leaves Br 9,000 (Br 32,500 – Br 23,500 = Br 9,000) to
be distributed to KASSA, LEMMA and MARU in the 4:3:2 income-sharing ratio. The complete
statement of realization and liquidation statement is presented.

28
 KASSA, LEMMA & MARU LLP
Statement of Realization and Liquidation
July 6 through September 30, 2000
Assets Liabiliti Partners Capital
es
Cash Other Liabiliti KASSA LEMMA MARU
Assets es (4/9) (3/9) (2/9)
Balance before liquidation .............................. 8,000 192,000 61,000 40,000 45,000 54,000
July 31: Realization at a loss of 13,500........... 48,500 –62,000 0 –6,000 –4,500 –3,000
Balances.......................................................... 56,500 130,000 61,000 34,000 40,500 51,000
Payment to Creditors.......................................–56,500 0 –56,500 0 –0 0
Balances.......................................................... 0 130,000 4,500 34,000 40,500 51,000
August 31: Realization at a loss of 36,000...... 30,000 –66,000 0 –16,000 –12,000 –8,000
Balances.......................................................... 30,000 64,000 4,500 18,000 28,500 43,000
Payment to Creditors....................................... –4,500 0 –4,500 0 0 0
Balances.......................................................... 25,500 64,000 0 18,000 28,500 43,000
Payment to Partners.........................................–25,500 0 0 0 –900 –24,600
Balances.......................................................... 0 0 0 18,000 27,600 18,400
Sep. 30: Realization at a loss of 31,500........... 32,500 –64,000 0 –14,000 –10,500 –7,000
Balances ......................................................... 32,500 0 0 4,000 17,100 11,400
Payment to Partners.........................................–32,500 0 0 –4,000 –17,100 –11,400
Final Balances................................................. 0 0 0 0 0 0
The journal entries to record the realization of assets and to complete the liquidation of KASSA,
LEMMA, and MARU are as follows:

July 31, 2000: to record realization of assets and division of loss of Br 13,500 loss in 4:3:2 ratio
Cash............................................................................
48,500
KASSA, Capital.........................................................6,000
LEMMA, Capital.......................................................4,500
MARU, Capital..........................................................3,000
Other Assets............................................ 62,000
July 31, 2000: to record payment of liabilities
Liabilities....................................................................
56,500
Cash............................................................. 56,500
August 31, 2000: to record realization of assets and division of Br 36,000 loss in 4:3:2 ratio
Cash............................................................................
30,000
KASSA, Capital......................................................... 16,000
LEMMA, Capital....................................................... 12,000
MARU, Capital..........................................................8,000
Other Assets............................................ 66,000

29
August 31, 2000: to record payment to creditors and first installment to partners
Liabilities....................................................................4,500
LEMMA, Capital....................................................... 900
MARU, Capital.......................................................... 24,600
Cash......................................................... 30,000

September 30, 2000: to record realization of remaining assets and division of Br 31,500 loss
Cash............................................................................
32,500
KASSA, Capital......................................................... 14,000
LEMMA, Capital....................................................... 10,500
MARU, Capital..........................................................7,000
Non-Cash Assets..................................... 64,000
September 30, 2000: to record final installment to partners to complete the liquidation
KASSA, Capital.........................................................4,000
LEMMA, Capital....................................................... 17,100
MARU, Capital.......................................................... 14,400
Cash......................................................... 32,500
Exercise 1.2: In XYZ LLP Partner X, Y and Z has Br 20,000, Br 30,000 and Br 50,000 capital
balance, respectively. The profit or loss sharing ratio is 4:4:2. Required: Prepare a cash
distribution plan assuming liabilities of Br 50,000.

1.5.3) Marshaling of Assets Doctrine and Liquidation of a Partnership

Personal bankruptcy is not uncommon and raises questions as to the legal right that damaged
partners have to proceed against an insolvent partner. Where a partner has become bankrupt or
his estate is insolvent the claims against his separate property shall rank in the following order:
1. Those owing to separate creditors (personal liabilities)
2. Those owing to partnership creditors (business creditors)
3. Those owing to partners by way of contribution (to other partners as a result of deficit
capital)
This principle is called principle of marshalling of assets. According to the marshaling of
assets doctrine, personal liabilities have first priority. After these claims have been satisfied, the
remaining assets should be used to remunerate any partnership creditors who have sought
recovery directly from the partner.

Example 1.17: Insolvency (Partner is Insolvent)

Balance Sheet
Cash........................................... Br 30,000 Liabilities................................... Br 80,000
Non-cash Assets......................... 150,000 ABLE, Capital (40%)................. 15,000
BAKER, Capital (30%).............. 40,000
CANNON, Capital (20%).......... 30,000
______ DUKE, Capital (10%)................ 15,000
Total Assets............................... 180,000 Total Liabilities and Capital....... 180,000

Additional Information:

30
  BAKER is insolvent & personal creditors file Br 30,000 claim against this partner’s share
of partnership property.
 Non-cash assets are sold for Br 100,000 (the book value is Br 150,000)
 Partnership liabilities of Br 80,000 are then paid
 An additional Br 5,000 should be forthcoming from ABLE to eradicate the single
negative balance. This raises cash to Br 55,000 (30,000 + 20,000 + 5,000). The
liquidation losses reduce Baker’s capital below Br 30,000 therefore; Baker’s creditors
will get only Br 25,000 despite the remaining Br 5,000 debt. No further claim against the
business.

ABLE BAKER CANNON DUKE

(40%) (30%) (20%) (10%)
Beginning Capital..........................................
15,000 40,000 30,000 15,000
Loss on Realization........................................
(20,000 (15,000) (10,000) (5,000)
)
Capital Balances.............................................
(5,000) 25,000 20,000 10,000
Contribution by ABLE................................... 5,000 –0– –0– –0–
Final Capital Balances...................................-0- 25,000 20,000 10,000

Payment of Liabilities:
Liabilities (Partnership Liabilities)...............................80,000
Cash..................................................................... 80,000
Distribution of Cash to Partners:
BAKER, Capital (Creditors of BAKER)......................25,000
CANNON, Capital........................................................20,000
DUKE, Capital..............................................................10,000
Cash.................................................................... 55,000

Example 1.18: Insolvency (Partner is insolvent)

Balance Sheet
Cash...........................................Br 10,000 Liabilities...................................Br 70,000
Non-cash Assets......................... 140,000 MORRIS, Capital (40%)............ 15,000
NEWTON, Capital (20%).......... 10,000
OLSEN, Capital (20%).............. 23,000
PRINCE, Capital (20%)............. 32,000
Total Assets............................... 150,000 Total Liabilities and Capital....... 150,000
 The non-cash assets are sold for a total of Br 80,000 and all liabilities paid

Realization of Non-cash Assets:

Cash...........................................................................80,000
MORRIS, Capital (40%)...........................................24,000
NEWTON, Capital (20%).........................................12,000
OLSEN, Capital (20%)..............................................12,000
PRINCE, Capital (20%)............................................12,000
Non-Cash Assets (Or Specific Accounts)........ 140,000
Payment Liabilities:

31
 Liabilities...................................................................
70,000
Cash................................................................. 70,000

The capital accounts for MORRIS and NEWTON report negative capital balances of Br 9,000
(Br 15,000 – Br 24,000) and Br 2,000 (Br 10,000 – 12,000), respectively.
 NEWTON is personally solvent
 MORRIS’s personal financial condition does not allow him for any further contribution
Absorbing loss from Morris’s Capital deficit:
NEWTON, Capital (1/3)...............................................3,000
OLSEN, Capital (1/3)....................................................3,000
PRINCE, Capital (1/3)..................................................3,000
MORRIS, Capital................................................ 9,000
Newton’s Cash Contribution
Cash ..............................................................................5,000
NEWTON, Capital.............................................. 5,000

Statement of Partners’ Capital balances

Statement of Partners’ Capital balances
Cash MORRIS NEWTON OLSEN PRINCE
Capital Capital Capital Capital
Beginning Balance................. 10,000 15,000 10,000 23,000 32,000
Sold Assets............................. 80,000 (24,000) (12,000) (12,000) (12,000)
Paid Liabilities....................... (70,000) -0- -0- -0- -0-
Insolvency of MORRIS......... -0- 9,000 (3,000) (3,000) (3,000)
Contribution by NEWTON.... 5,000 -0- 5,000 -0- -0-
Closing Balances.................... 25,000 -0- -0- 8,000 17,000

Example 1.19: Insolvency (Partnership is Insolvent)

Liabilities......................................................................Br 20,000
KELLER, Capital.......................................................... (30,000)
LEWIS, Capital............................................................. (5,000)
MORGAN, Capital....................................................... 5,000
NORRIS, Capital.......................................................... 10,000

Additional Information:
 Personal financial condition
KELLER LEWIS MORGAN NORRIS
Capital Capital Capital Capital
Personal Assets...............................25,000 56,000 26,000 150,000
Personal Liabilities.........................45,000 56,000 29,000 60,000
 Keller is personally insolvent thus the deficit is written-off
 Loss or profit is shared equally
Statement of Partners’ Capital balances
KELLER LEWIS MORGAN NORRIS
Capital Capital Capital Capital
Beginning Balance..........................(30,000) (5,000) 5,000 10,000

32
 Capital Contribution........................ 0 0 0 20,000
Written off deficit balance..............30,000 (10,000) (10,000) (10,000)
Closing Balances............................. -0- (15,000) (5,000) 20,000

1.5.4) Right to Offset Doctrine and Liquidation of a Partnership

The uniform partnership, set lists the order for distribution of cash by a liquidating partnership as
1. Payment of creditor in full (partnership creditors)
2. Payment of loans from partners, and
3. Payment of partner’s capital credit balances
The indicated priority of partners’ loans over partners’ capital appears to be a legal fiction. This
rule is nullified for practical purposes by an established legal doctrine called the Right to Offset.
The Right to Offset doctrine stated that if a partner’s capital account has a debit balance (or
even a potential debit balance depending on possible future realization losses, any credit
balance in that partner’s loan account must be offset against the deficit (or potential deficit) in
the capital account. A partner may choose to receive certain non-cash assets, such as computers
or office furniture, in kind, rather than to convert such property to cash. Regardless of whether
non-cash assets are distributed by partners, it is imperative to follow the rule no distribution of
assets must be made to partners until all outside partnership creditors have been paid in full.
There are two groups of creditors; (1) creditors of the partnership and 2) creditors of the partners.
The relative rights of these two groups of creditors are governed by the provisions of the
Uniform Partnership Act (UPA) which was relating to the Marshaling of Assets. These rules
provide that assets of the General Partnership (including partners’ deficits) are first available to
creditors of the partnership and that assets of the partners’ are first available to their creditors.

Example 1.20: AREGA and BELAY have been running a partnership together for a number of
years. The partnership had the following balance sheet on June 30, 200
AREGA and BELAY Partnership
Balance Sheet
June 30, 2000
Cash........................................... Br 10,000 Liabilities...................................Br 20,000
Other Assets............................... 75,000 Loan Payable to AREGA........... 20,000
AREGA, Capital (50%)............. 40,000
BALAY, Capital (50%)............. 5,000
Total Assets............................... 85,000 Total Liabilities and Capital....... 85,000
Instruction: Determine partners’ final capital balances assuming that the assets are sold at Br
35,000 and in accordance with the Right to offset Doctrine.
AREGA and BALAY Partnership
Statement of Partners’ Capital and Cash Balances
June 30, 2000
AREGA BALAY
Cash
Capital Capital
Beginning Balance....................................................
10,000 40,000 5,000
Loan Account ( + Loan from & - Loan to)............... –0– –0– 20,000
Adjusted Capital Balances........................................
10,000 40,000 25,000
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 Assets sold................................................................
35,000 (20,000) (20,000)
Balances....................................................................
45,000 20,000 5,000
Payment of liabilities................................................
20,000 –0– –0–
Final Balances..........................................................
25,000 20,000 5,000

Example 1.21:
RICH, SAND & TOLL Partnership
Balance Sheet
June 30, 2000
Cash........................................... Br 10,000 Liabilities...................................Br 60,000
Loan to Toll............................... 5,000 Loan from Sand......................... 5,000
Other Assets............................... 100,000 Rich, Capital.............................. 5,000
Sand, Capital.............................. 10,000
Toll, Capital............................... 35,000
Total Assets............................... 115,000 Total Liabilities and Capital....... 115,000

Additional Information:
Partner Personal Assets Personal Liabilities
RICH 100,000 25,000
SAND 50,000 50,000
TOLL 40,000 60,000
Instruction: Determine partners’ final capital balances assuming that:
 Other assets are sold for Br 40,000
 Marshalling of assets doctrine
 Right to offset doctrine
 Equal sharing of profit or loss

RICH, SAND & TOLL Partnership

Statement of Cash and Partners’ Capital Balances
June 30, 2000
Rich Sand Toll
Cash
Capital Capital Capital
Beginning Balance.............................................. 10,000 5,000 10,000 35,000
± Loan Account.................................................. –0– –0– 5,000 (5,000)
Adjusted Balance................................................ 10,000 5,000 15,000 30,000
Assets sold.......................................................... 40,000 (20,000) (20,000) (20,000)
Balances.............................................................. 50,000 (15,000) (5,000) 10,0000
Writing off Sand’s Capital balances................... –0– (2,500) 5,000 (2,500)
Balances.............................................................. 50,000 (17,500) –0– 7,500
Contribution by Rich.......................................... 17,500 17,500 –0– –0–
Balances.............................................................. 67,500 –0– –0– 7,500
Payment of Liabilities......................................... 60,000 –0– –0– –0–
Balances 7,500 –0– –0– 7,500
Distribution of cash to partners........................... (7,500) –0– –0– (7,500)
Final Balances..................................................... –0– –0– –0– –0–

34
 1.6) Joint Ventures
1.6.1) Characteristics of Joint Ventures
A joint venture differs from a partnership in that it is limited to carrying out a single project, such
as production of a motion picture or construction of building.
A joint venture is an association of two or more than two persons who have combined for the
execution of a specific transaction and divide the profit or loss, therefore, in the agreed ratio.
Example: A and B have undertaken the job of construction of a school building. Such an
association for some specific purpose will be termed as a joint venture and each one of them will
be termed as a co-venturer. The venture will be over as soon as the transaction is over i.e. the
school building is completed. Joint venture agreements can be made for other similar
transactions, e.g,
 Joint consignment of goods
 Underwriting of shares or debentures issued by a company
 Purchasing and selling of a specific property

1.6.2) Joint Ventures versus Partnership

Similarities:
 Both have some business activity whose profit (or loss) is agreed to be shared by two or
more persons
 Both are associations of two or more persons

Differences:
 A partnership covers or is meant to cover a long period whereas a joint venture is
established only for a specific purpose sought to be achieved in a short period.
 Joint ventures are highly risky businesses while partnerships have less risk. This
arises from the nature of operation.
 Huge capital investment is required for joint ventures; whereas small capital
investment is most often sufficient for partnerships

On account of this lesson, joint venture is also sometimes termed as a ‘temporary partnership’.
Historically, joint ventures used to finance the sale or exchange of a cargo of merchandise in a
foreign country. In an area when marine transportation and foreign trade involved many hazards,
individuals (venturers) would bend together to undertake a venture of this type. The capital
required usually was larger than a person could provide, and the risks were too high to be borne
alone. Because of the risks involved and the relatively short duration of the project, no net
income was recognized until the venture was completed. At the end of the voyage, the net
income or net loss was divided among the venturers, and their association was ended.

35
In its traditional form, the accounting for a joint venture did not follow the accrual basis of
accounting. The assumption of continuity was not appropriate; instead of the determination of
net income at regular intervals, the measurement and reporting of net income or loss is usually
postponed to the completion of the venture.

Present-Day Joint Ventures

In today’s business community, joint ventures are less common but still are employed for many
projects such as:
1. The acquisition, development, and sale of real property;
2. Exploration for oil and gas; and
3. Construction of bridges, buildings and dams

Types of Joint Ventures

1. Small Joint Ventures
 No joint venture maintains books of accounts
 Each venturer record their own incomes and expenses in own accounts (venturer’s
account)
 Memorandum account is used to calculate profit or loss
 Profit is taken back to venturer’s account
 A journal entry for cash receipt and payment for equal amount will be made

Example 1.22: Regassa and Daniel buy a used truck and sell it. Regassa pays Br 70,000 for truck
and Br 1,100 for license. Daniel knows the buyer and sells the truck at Br 80,000 after incurring
Br 2,000 on respraying (repainting). Regassa and Daniel agree to share profit and losses equally.

REGASSA Book: JV with DANIEL DANIEL Book: JV with REGASSA

Purchase of Truck 70,000 74,550 Cash from D. Repainting 2,000 80,000 Sale of Truck
License 1,100 Share of Profit 3,450
Share of Profit 3,450 Cash to Regassa 74,550
74,550 74,550 80,000 80,000

Determination of Profit or Loss on Joint Venture’s Operation

No Body’s Book: Memorandum A/c
Purchase of Truck 70,000 80,000 Sale of Truck
License 1,100
Repainting 2,000
Share of Profit 6,900

80,000 80,000

2. Large Joint Ventures

36
Large joint ventures may be corporate or unincorporated. The term corporate joint venture also is
used by many large American corporation to describe oversees operations by a corporation
whose ownership is divide between an American company and a foreign company. A corporate
joint venture and the accounting for such a venture are described in APB opinion No. 18 “the
equity method of accounting for investment in common stock.”

Corporate Joint venture is established as a limited company. It produces its own full set of
accounts. Corporate joint venture “refers to a corporation owned and operated by small group of
business (the “joint venturers”) as a separate and specific business or project for the mutual
benefit of the members of the group. A government may also be a member of the group. The
purpose of a corporate joint venture frequently is to share risks and rewards in developing a new
market, product or technology; to combine complementary knowledge; or to pool resources in
developing production or other facilities. A corporate joint venture also usually provides an
arrangement under which each joint venturer may participate, directly or indirectly in the overall
management of the joint venture. Joint ventures thus have an interest or relationship other than as
passive investors. An entity which is a subsidiary of one of the “joint ventures” is not a corporate
joint venture. The ownership of a corporate joint venture seldom changes, and its stock is usually
not traded publicly. A minority public ownership, however, does not preclude a corporation from
being corporate joint venture.

The APB concludes that the equity method best enables investors in corporate joint ventures to
reflect the underlying nature of their investment in those ventures. Therefore, investors should
account for investments in common stock of corporate joint ventures by the equity method. The
equity method uses the following accounting procedures:
 The cost of acquisition (original investment in common stock) is recorded by
increasing investment account.
 The investor’s investment account is increased as the joint venture earns and
reports income
 The investor’s investment account is decreased whenever dividend is collected
A recent variation of the corporate joint venture is the limited liability company (LLC) joint
venture, which is the version of limited liability partnership. The venturers are responsible for
their own activities.

1.6.3) Accounting for Joint Ventures

1) Accounting for a Corporate Joint Venture (LLC)
The complexity of modern business, the emphasis on good organization and storage internal
control, the importance of income taxes, the extent of government regulation, and the need for
preparation and retention of adequate accounting records are strong equipments for establishing
separate set of accounting records for every corporate joint venture of large size and long
duration.

In the stockholders equity accounts of the joint venture, each venturer’s account is credited for
the amount of cash or non-cash assets invested. The fiscal year of the joint venture may or may
not coincide with the fiscal years of the venturers, but the use of the accrual basis of accounting
and periodic financial statements for the venture permit regular reporting of the share of net
income or loss allocable to each venturer.

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The accounting records of such a corporate joint venture include the usual ledger accounts for
assets, liabilities, stockholders’ equity, revenue, and expenses. The entire accounting process
should conform to GAAP, from the recording of transactions to the preparation of financial
statements.

2) Accounting for an Unincorporated Joint Venture

In unincorporated joint venture, the venture owns an undivided interest in each asset and is
proportionately liable for its share of each liability. Thus, the provision of APB opinion No. 18
(relating to equity method of accounting) may not apply. For example, in some oil and gas
venture accounting, the venture may account in its financial statements for its pro rate of the
assets, liabilities, revenues, and expenses of the venture. Thus, in unincorporated joint venture,
the investors can have the option of using either the equity method of accounting or a
proportionate share method of accounting for the investments.

Example 1.23: Arthur Company and Beatrice Company each invested Br 600,000 and 400,000
interests, respectively for 60% and 40% interest in an unincorporated joint venture named ARBE
on January 2, 2006. The condensed financial statements other than cash flows for ARBE joint
venture for 2006 were as follows.

Income Statement
ABRE Company (A Joint Venture)
Income Statement
For the Year ended December 31, 2006
Revenue..................................................................................Br 2,000,000
Less: Costs and expenses....................................................... 1,500,000
Net Income............................................................................. 500,000
Division of Income:
Arthur Company (60%)......................................................... Br 300,000
Beatrice (40%)....................................................................... 200,000
Total Net Income................................................................... 500,000
Statement of Venturer’s’ Capital
ABRE Company (A Joint Venture)
Statement of Venturers’ Capital
For the Year ended December 31, 2006
Arthur Beatrice
Combined
Company Company
Investment, January 2, 2006..................................................
Br 600,000 Br 400,000 Br 1,000,000
Add: Net Income...................................... 300,000 200,000 500,000
Venturer’s Capital, December 2, 2006..... Br 900,000 Br 600,000 Br 1,500,000

Balance Sheet
ABRE Company (A Joint Venture)
Balance Sheet
December 31, 2006
Assets: Liabilities and Venturers’ Capital:

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 Current Assets...................................Br 1,600,000 Current Liabilities...............................Br 800,000
Other Assets...................................... 2,600,000 Long-term Debt.............................. 1,900,000
Venturers’ Capital:
Arthur Company............900,000
Beatrice Company.........600,000 1,500,000
...............
Total Assets.......................................Br 4,200,000 Total Liabilities and Capital................ Br
4,200,000

Venturers’ Journal Entries under Equity Method

Arthur Company Beatrice Company
January 2, 2006: Recording the Investment January 2, 2006: Recording the Investment
Investment In ARBE Company....... 600,000 Investment In ARBE Company....... 400,000
Cash.................................... 600,000 Cash.................................... 400,000
December 31, 2006: recording share of income December 31, 2006: recording share of income
Investment In ARBE Company....... 300,000 Investment In ARBE Company....... 200,000
Investment Income.............. 300,000 Investment Income.............. 200,000
Proportionate Share Method of Accounting
In addition to the two foregoing journal entries, both Arthur Company and Beatrice Company
prepare the following journal entries for the respective shares of the assets, liabilities, revenue,
and expenses of ARBE Company.

Arthur Company Beatrice Company

January 2, 2006: Recording the Investment January 2, 2006: Recording the Investment
Investment In ARBE Company....... 600,000 Investment In ARBE Company....... 400,000
Cash.................................... 600,000 Cash.................................... 400,000
December 31, 2006: recording share of income December 31, 2006: recording share of income
Investment In ARBE Company....... 300,000 Investment In ARBE Company....... 200,000
Investment Income.............. 300,000 Investment Income.............. 200,000

Proportionate Share of Assets, Liabilities, Revenues, and Cost & Expenses

Arthur Company Beatrice Company
December 31, 2006: Proportionate Share December 31, 2006: Proportionate Share
Current Assets (60%)................. 960,000 Current Assets (40%)................. 640,000
Other Assets (60%).................... 1,560,000 Other Assets (40%).................... 1,040,000
Cost and Expense (60%)............ 900,000 Cost and Expense (40%)............ 600,000
Investment Income..................... 300,000 Investment Income..................... 200,000
Current liabilities (60%)....... 480,000 Current liabilities (40%)....... 320,000
Long-term Debt (60%).......... 1,140,00 Long-term Debt (40%)......... 760,000
0
Revenue (60%)..................... 1,200,00 Revenue (40%)..................... 800,000
0
Investment in ARBE Co....... 900,000 Investment in ARBE Co....... 600,000

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