ch12

CHAPTER 12
ACCOUNTING FOR PARTNERSHIPS
LEARNING OBJECTIVES
1. DISCUSS AND ACCOUNT FOR THE FORMATION OF A

PARTNERSHIP.
2. EXPLAIN HOW TO ACCOUNT FOR NET INCOME OR

NET LOSS OF A PARTNERSHIP.
3. EXPLAIN HOW TO ACOUNT FOR THE LIQUIDATION OF

A PARTNERSHIP.
*4. PREPARE JOURNAL ENTRIES WHEN A NEW

PARTNER IS EITHER ADMITTED OR WITHDRAWS.
Copyright © 2015 John Wiley & Sons, Inc. Weygandt, Accounting Principles, 12/e, Instructor’s Manual (For Instructor Use Only) 12-1
CHAPTER REVIEW
Partnership Form of Organization
1. A partnership is an association of two or more persons to carry on as co-owners of
a business for a profit.
Characteristics of Partnerships
2. The principal characteristics of the partnership form of business organization are
(a) association of individuals, (b) mutual agency, (c) limited life, (d) unlimited liability, and
(e) co-ownership of property.
3. The association of individuals in a partnership may be based on as simple an act as a handshake;
however, it is preferable to state the agreement in writing.
a. A partnership is a legal entity for certain purposes.
b. A partnership is an accounting entity for financial reporting purposes.
c. Net income of a partnership is not taxed as a separate entity.
4. Mutual agency means that each partner acts on behalf of the partnership when engaging in
partnership business, and the act of any partner is binding on all other partners. This is true even
when partners act beyond the scope of their authority, so long as the act appears to be appropriate
for the partnership.
5. Partnerships have a limited life. Partnership dissolution occurs whenever a partner withdraws or
a new partner is admitted.
6. Each partner has unlimited liability.
a. Each partner is personally and individually liable for all partnership liabilities.
b. Creditors’ claims attach first to partnership assets and then to the personal resources of any
partner, irrespective of that partner’s capital equity in the company.
7. Partnership assets are co-owned by the partners. Once assets have been invested in the
partnership they are owned jointly by all the partners.
Advantages and Disadvantages

8. Organizations with partnership characteristics include limited partnerships, limited liability partner-
ships, limited liability companies, and S corporations.
9. The major advantages of a partnership are:
a. Combining skills and resources of two or more individuals.
b. Ease of formation.
c. Freedom from governmental regulations and restrictions.
d. Ease of decision-making.
10. The major disadvantages of a partnership are
a. mutual agency.
b. limited life.
c. unlimited liability.
Limited Partnerships
11. Under limited partnerships, the liability of a limited partner is limited to the partners’ capital
equity. However, there must always be at least one partner with unlimited liability, often referred to
as the general partner.
Limited Liability Partnership
12. Professionals such as lawyers, doctors, and accountants can be protected from malpractice or
negligence claims of other partners by forming a limited liability partnership.
Limited Liability Companies

13. A new hybrid form of business organization with certain features like a corporation and others like
a limited partnership is a limited liability company.
The Partnership Agreement

14. The written contract, often referred to as the partnership agreement, contains such basic infor-
mation as the name and principal location of the firm, the purpose of the business, and the date of
inception.
Forming a Partnership
15. (L.O. 1) In the formation of a partnership, each partner’s initial investment in a partnership
should be recorded at the fair value of the assets at the date of their transfer to the partnership.
Dividing Net Income or Net Loss

16. (L.O. 2) Partnership net income or net loss is shared equally unless the partnership contract
specifically indicates otherwise.
a. A partner’s share of net income or net loss is recognized in the accounts through closing
entries.
b. Closing entries for a partnership are identical to the entries made for a proprietorship, except
for the use of multiple capital and drawing accounts.
17. The various income ratios that may be used include:
a. A fixed ratio, expressed as a proportion (6:4), a percentage (70% and 30%), or a fraction (2/3
and 1/3).
b. A ratio based either on capital balances at the beginning of the year or on average capital
balances during the year.
c. Salaries to partners and the remainder on a fixed ratio.
d. Interest on partners’ capitals and the remainder on a fixed ratio.
e. Salaries to partners, interest on partners’ capitals, and the remainder on a fixed ratio.
The objective is to reach agreement on a basis that will equitably reflect the differences among
partners in terms of their capital investment and service to the partnership.
18. Provisions for salaries and interest must be applied before the remainder of net income or net loss
is allocated on the specified fixed ratio. Detailed information concerning the division of net income
or net loss should be shown at the bottom of the partnership’s income statement.
Partnership Financial Statements

19. The financial statements of a partnership are similar to a proprietorship. The differences are
generally related to the fact that a number of owners are involved in a partnership. The income
statement for a partnership is identical to the income statement for a proprietorship except for the
division of net income.
20. The owners’ equity statement for a partnership is called the partners’ capital statement. It explains
the changes in each partners’ equity during an accounting period. Changes in capital may result
from additional capital investment, drawings, and net income or net loss.
Liquidation of a Partnership
21. (L.O. 3) The liquidation of a partnership terminates the business. In a liquidation, it is
necessary to:
a. Sell noncash assets for cash and recognize a gain or loss on realization. The journal entry to
record this will include a debit to Cash for the amount received from the sale, debits to any
contra-asset accounts, a debit for the loss on realization/or a credit for the gain on realization
and credits to all asset accounts.
b. Allocate gain/loss on realization to the partners based on their income ratios. The journal entry
to record this will include a debit to Gain on Realization and credits to each partner’s capital
account or debits to each partner’s capital account and a credit to Loss on Realization.
c. Pay partnership liabilities in cash. The journal entry to record this will include debits to all
liability accounts and a credit to Cash.
d. Distribute remaining cash to partners on the basis of their remaining capital balances. The
journal entry to record this will include debits to each partner’s capital account and a credit to
Cash.
Each of the steps must be performed in sequence.
22. The liquidation of a partnership may result in no capital deficiency (all partners have credit
balances in their capital accounts) or in a capital deficiency (at least one partner’s capital account
has a debit balance.)
23. A schedule of cash payments may be used to determine the distribution of cash to each partner.
24. When there is a capital deficiency, the partner with the deficiency may pay the amount owed and
the deficiency is eliminated.
25. If a partner with a capital deficiency is unable to pay the amount owed to the partnership, the
partners with credit balances must absorb the loss as follows:
a. The cash distributed to each partner is the difference between the partner’s present capital
balance and the loss that the partner may have to absorb if the capital deficiency is not paid.
b. The allocation of the deficiency is made on the income ratios that exist between the partners
with credit balances. The allocation is journalized and posted.
Admission of a Partner
*26. (L.O. 4) A new partner may be admitted either by (1) purchasing the interest of one or more
existing partners, or (2) investing assets in the partnership. The former affects only partners’ capital
accounts whereas the latter increases both net assets and total capital of the partnership.
*27. When a new partner is admitted by purchase of an interest,
a. The transaction is a personal one between one or more existing partners and the new partner.
b. Any money or other consideration exchanged is the property of the participants and not the
property of the partnership.
c. Each partner’s capital account is debited for the ownership claims that have been relinquished,
and the new partner’s capital account is credited with the capital equity purchased.
d. Total assets, total liabilities, and total capital remain unchanged.
*28. When a new partner is admitted by the investment of assets, both the total net assets and the
total capital of the partnership increase. This is done by debiting Cash and crediting the new
partner’s capital account. When the capital credit does not equal the investment of assets in
the partnership, the difference is considered a bonus either to the existing partners or the new
partner.
*29. A bonus to old partners results when the new partner’s capital credit on the date of admittance
is less than the new partner’s investment in the firm. The procedure for determining the new
partner’s capital credit and the bonus to the old partners is as follows:
a. Determine the total capital of the new partnership by adding the new partner’s investment to
the total capital of the old partnership.
b. Determine the new partner’s capital credit by multiplying the total capital of the new partnership
by the new partner’s ownership interest.
c. Determine the amount of bonus by subtracting the new partner’s capital credit from the new
partner’s investment.
d. Allocate the bonus to the old partners on the basis of their income ratios.
*30. A bonus to a new partner results when the new partner’s capital credit is greater than the
partner’s investment of assets in the firm. The bonus results in a decrease in the capital balances
of the old partners based on their income ratios before admission of the new partner.
Withdrawal of a Partner
*31. As in the case of the admission of a partner, the withdrawal of a partner legally dissolves the
partnership. The withdrawal of a partner may be accomplished by (a) payment from partners’
personal assets or (b) payment from partnership assets. The former affects only the partners’
capital accounts, whereas the latter decreases total net assets and total capital of the partnership.
*32. The withdrawal of a partner when payment is made from partners’ personal assets is the direct
opposite of admitting a new partner who purchases a partner’s interest.
a. Payment from partners’ personal assets is a personal transaction between the partners.
b. Partnership assets are not involved and total capital does not change.
c. The effect on the partnership is limited to a realignment of the partners’ capital balances.
*33. Using partnership assets to pay for a withdrawing partner’s interest is the reverse of admitting a
partner through the investment of assets in the partnership.
a. Payment from partnership assets is a transaction that involves the partnership.
b. Both partnership net assets and total capitals are decreased.
c. Asset revaluations should not be recorded.
*34. When the partnership assets paid are in excess of the withdrawing partner’s capital interest,
a bonus to the retiring partner results. The bonus is deducted from the remaining partners’
capital balances on the basis of their income ratios at the time of the withdrawal.
*35. When the partnership assets paid are less than the withdrawing partner’s capital interest, a bonus
to the remaining partners results. The bonus is allocated to the capital accounts of the remaining
partners on the basis of their income ratios.
Death of a Partner
*36. The death of a partner dissolves the partnership, but provision generally is made for the surviving
partners to continue operations. When a partner dies it is necessary to determine the partner’s
equity at the date of death.
LECTURE OUTLINE
A. Characteristics of Partnerships.
1. A partnership is an association of two or more persons to carry on as

co-owners of a business for profit.
2. The principal characteristics of partnerships are:
a. Association of individuals. A partnership is a legal entity that can own

property and can sue or be sued. A partnership is also an accounting
entity.
b. Mutual agency. Each partner acts on behalf of the partnership when

engaging in partnership business. The act of any partner is binding
on all other partners, even when partners act beyond the scope of
their authority, so long as the act appears to be appropriate for the
partnership.
c. Limited life. Corporations have unlimited life, but partnerships do not.

A partnership may be ended voluntarily any time through the
acceptance of a new partner or the withdrawal of a partner.
Partnership dissolution occurs whenever a partner withdraws or a
new partner is admitted.
d. Unlimited liability. Each partner is personally and individually liable

for all partnership liabilities. Creditors’ claims attach first to partnership
assets. If these are insufficient, the claims then attach to the personal
resources of any partner, irrespective of that partner’s equity in the
partnership.
e. Co-ownership of property. Partners jointly own partnership assets. If

the partnership is dissolved, each partner has a claim on total assets
equal to the balance in his/her respective capital account.
B. Organizations with Partnership Characteristics.
1. Special forms of business organizations with partnership characteristics

are often used to provide protection from unlimited liability for people
who want to work together in some activity.
2. The special partnership forms are:
a. Limited partnership. One or more partners have unlimited liability

and one or more partners have limited liability for the debts of the
firm. Those with limited liability are responsible for partnership
debts up to the limit of their investment in the firm.
b. Limited liability partnership (LLP). The LLP is designed to protect

innocent professionals (lawyers, doctors) from malpractice or
negligence claims resulting from the acts of another partner.
c. Limited liability companies (LLC). The LLC is a hybrid form of

business organization with certain features like a corporation and
others like a limited partnership. The owners (members) have
limited liability like owners of a corporation.
ACCOUNTING ACROSS THE ORGANIZATION
Whenever a group of individuals wants to form a partnership, the limited liability

company is usually the popular choice. One other form of business organization
is a subchapter S corporation, but it is losing its popularity.
Why do you think that the use of the limited liability company is gaining in
popularity?
Answer: The LLC is gaining in popularity because owners in such companies

have limited liability for business debts even if they participate in
management. As a result, the LLC form has a distinct advantage over
regular partnerships. In addition, the other limited type partnerships are
restrictive as to their use.
C. Advantages and Disadvantages of Partnerships.
1. Advantages of partnerships are:
a. Combining skills and resources of two or more individuals.
b. Ease of formation and freedom from governmental regulations and

restrictions.
c. Ease of decision-making.
2. Major disadvantages of a partnership are:
a. Mutual agency.
b. Limited life.
c. Unlimited liability.
D. The Partnership Agreement.
1. The partnership contract, called the partnership agreement, or articles of

co-partnership, contains such basic information as the name and principal
location of the firm, the purpose of the business, and date of inception.
2. The partnership agreement should specify relationships among the

partners, such as rights and duties of partners, provision for withdrawals
of assets, and procedures for the withdrawal or addition of a partner.
ACCOUNTING ACROSS THE ORGANIZATION
What should you do when you and your business partner do not agree on things,
to the point where you are no longer on speaking terms? Unfortunately, in many
instances the partners do everything they can to undermine the other partner,
eventually destroying the business.
How can partnership conflicts be minimized and more easily resolved?
Answer: First, it is important to develop a business plan that all parties agree to.
Second, it is vital to have a well-thought-out partnership agreement.
Third, it can be useful to set up a board of mutually agreed upon and
respected advisors to consult when making critical decisions.
E. Forming a Partnership.
1. Each partner’s initial investment in a partnership is entered in the partnership

records. The partnership should record these investments at the fair
value of the assets at the date of their transfer to the partnership.
2. All partners must agree to the values assigned.
3. After formation of the partnership, the accounting for transactions is

similar to any other type of business organization.
F. Dividing Net Income or Net Loss.
1. Partners equally share partnership net income or net loss unless the
partnership contract indicates otherwise.
2. The same basis of division usually applies to both net income and net
loss, and is referred to as the income ratio, or the profit and loss (P&L)
ratio.
3. Typical income ratios are:
a. A fixed ratio, expressed as a proportion, a percentage, or a fraction.
b. A ratio based either on capital balances at the beginning of the year

or on average capital balances during the year.
c. Salaries to partners and the remainder on a fixed ratio.
d. Interest on partners’ capital balances and the remainder on a fixed

ratio.
e. Salaries to partners, interest on partners’ capital, and the remainder

on a fixed ratio.
4. The objective is to settle on a basis that will equitably reflect the partners’
capital investment and service to the partnership.
G. Partnership Financial Statements.
1. The financial statements of a partnership are similar to those of a pro-

prietorship.
2. The partnership’s income statement shows the division of net income at

the bottom of the income statement.
3. The owners’ equity statement is called the partners’ capital statement. It

explains the changes in each partner’s capital account and in total
partnership capital during the year.
4. The partnership reports each partner’s capital balance on the balance

sheet.
H. Liquidation of a Partnership.
1. Liquidation may result from the sale of the business by mutual agreement
of the partners, from the death of a partner, or from bankruptcy.
2. To liquidate a partnership, it is necessary to:

a. Sell noncash assets for cash and recognize a gain (loss) on
realization.
b. Allocate any gain (loss) on realization to the partners based on their
income ratios.
c. Pay partnership liabilities in cash.
d. Distribute remaining cash to the partners on the basis of their capital
balances.
3. Each of the steps must be performed in sequence because the partner-

ship must pay creditors before partners receive any cash distributions.
4. A cash payments schedule is sometimes prepared to determine the distri-

bution of cash to the partners in the liquidation of a partnership.
5. A partner’s capital deficiency may result from recurring net losses, excessive
drawings, or losses from realization suffered during liquidation.
a. The partner with a capital deficiency is obligated to pay the partnership
the amount owed.
b. If a partner with a capital deficiency is unable to pay the amount owed
to the partnership, the partners with credit capital balances must
absorb the loss on the basis of their income ratios.
*I. Admission of a Partner.
1. The admission of a new partner results in the legal dissolution of the existing
partnership and the beginning of a new one.
2. A new partner may be admitted either by:
a. Purchasing the interest of one or more existing partners. The part-

nership debits each partner’s capital account for the ownership
claims that have been sold, and credits the new partner’s capital
account with the capital equity purchased.
b. Investment of assets in a partnership. When a partner is admitted

by investment, both the total net assets and the total capital change.
When the new partner’s investment differs from the capital equity
acquired, the difference is considered a bonus either to:
(1) The existing (old) partners or
(2) The new partner.
c. The partnership allocates a bonus to the old partners on the basis

of their income ratios before the admission of the new partner.
d. A bonus to a new partner results in a decrease in the capital balances

of the old partners based on their income ratios before the admission
of the new partner.
*J. Withdrawal of a Partner.
1. A partner may withdraw from a partnership voluntarily, by selling his or

her equity in the firm. Or he/she may withdraw involuntarily, by reaching
mandatory retirement age or by dying.
2. The withdrawal of a partner may be accomplished by:
a. Payment from partners’ personal assets, or
b. Payment from partnership assets.
3. The entry to record the withdrawal of a partner when the partners pay
from their personal assets only affects the partners’ capital accounts. It
is the direct opposite of admitting a new partner who purchases a partner’s
interest.
4. Using partnership assets to pay for a withdrawing partner’s interest

decreases both partnership net assets and total capital. In accounting
for a withdrawal by payment from partnership assets:
a. The partnership should not record asset revaluations.
b. The partnership should consider any difference between the amount

paid and the withdrawing partner’s capital balance as a bonus to
the retiring partner or to the remaining partners.
5. A partnership may pay a bonus to a retiring partner when:
a. The fair value of partnership assets is more than their book value,
b. There is unrecorded goodwill resulting from the partnership’s superior

earnings record, or
c. The remaining partners are eager to remove the partner from the firm.
6. The retiring partner may give a bonus to the remaining partners when:
a. Recorded assets are overvalued,
b. The partnership has a poor earnings record, or
c. The partner is eager to leave the partnership.
7. Death of a partner: when a partner dies, it is usually necessary to determine

the partner’s equity at the date of death by:
a. Determining the net income or loss for the year to date,
b. Closing the books,
c. Preparing financial statements.
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. A partner can bind the partnership to outside contracts without receiving permission from
the other partners.
True False
2. In a limited partnership, one or more partners have limited liability for the debts of the
firm.
True False
3. A partner is never liable for more than his or her capital investment in the partnership.
True False
4. In a partnership, when the division of profits and losses is based on salaries, interest,
and a fixed ratio, if the salary and interest allocation exceeds net income, then a net loss
has in fact occurred.
True False
5. A partnership is considered an accounting entity for financial reporting purposes.

True False
6. When the partnership contract does not specify the manner in which net income and net
loss are to be divided, profits and losses are distributed based on the average capital
balances of each partner during the year.
True False
7. The partners’ capital statement explains the changes in each partner’s capital account
and in total partnership capital during the year.
True False
8. Upon the sale of assets in liquidation, gains and losses are always divided equally
among partners.
True False
*9. If a partnership is admitting a new partner to the existing partnership and the existing
partners are to receive a bonus, this bonus would be allocated on the basis of their income
ratios before the admission of the new partner.
True False
*10. Admission of a new partner to the partnership does not result in the dissolution of the
existing partnership.
True False
Multiple Choice
1. Which one of the following is not a feature of partnerships?

a. Limited life
b. Limited liability
c. Mutual agency
d. Voluntary association
2. Selling partnership assets and paying the proceeds to creditors and owners refers to
a. dissolution.
b. unlimited liability.
c. mutual agency.
d. liquidation.
3. Partners A and B receive a salary allowance of $63,000 and $81,000, respectively, and
share the remainder equally. If the company earned $90,000 during the period, what is
the effect on A’s capital?
a. $63,000 increase
b. $36,000 decrease
c. $36,000 increase
d. $45,000 increase
*4. A invests $60,000 for a one-fifth interest in a partnership in which the other partners have
capital totaling $180,000 before admitting A. After distribution of the bonus, what would
A’s capital be?
a. $32,000
b. $36,000
c. $60,000
d. $48,000
*5. B invests $120,000 for a 20 percent interest in a partnership that has total capital of $400,000
after admitting B. Which of the following is true?
a. B’s capital is $120,000
b. B’s capital is $56,000
c. B received a bonus of $40,000
d. The original partners received a bonus of $40,000.
ANSWERS TO QUIZ
True/False
1. True 6. False
2. True 7. True
3. False 8. False
4. False *9. True
5. True *10. False
Multiple Choice
1. b.
2. d.
3. c.
*4. d.
*5. d

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CHAPTER 12

ACCOUNTING FOR PARTNERSHIPS

1. DISCUSS AND ACCOUNT FOR THE FORMATION OF A

2. EXPLAIN HOW TO ACCOUNT FOR NET INCOME OR

3. EXPLAIN HOW TO ACOUNT FOR THE LIQUIDATION OF

*4. PREPARE JOURNAL ENTRIES WHEN A NEW

Advantages and Disadvantages

Limited Liability Companies

The Partnership Agreement

Dividing Net Income or Net Loss

Partnership Financial Statements

1. A partnership is an association of two or more persons to carry on as

2. The principal characteristics of partnerships are:

a. Association of individuals. A partnership is a legal entity that can own

b. Mutual agency. Each partner acts on behalf of the partnership when

c. Limited life. Corporations have unlimited life, but partnerships do not.

d. Unlimited liability. Each partner is personally and individually liable

e. Co-ownership of property. Partners jointly own partnership assets. If

B. Organizations with Partnership Characteristics.

1. Special forms of business organizations with partnership characteristics

a. Limited partnership. One or more partners have unlimited liability

b. Limited liability partnership (LLP). The LLP is designed to protect

c. Limited liability companies (LLC). The LLC is a hybrid form of

ACCOUNTING ACROSS THE ORGANIZATION

Whenever a group of individuals wants to form a partnership, the limited liability

Answer: The LLC is gaining in popularity because owners in such companies

1. Advantages of partnerships are:

a. Combining skills and resources of two or more individuals.

b. Ease of formation and freedom from governmental regulations and

2. Major disadvantages of a partnership are:

D. The Partnership Agreement.

1. The partnership contract, called the partnership agreement, or articles of

2. The partnership agreement should specify relationships among the

How can partnership conflicts be minimized and more easily resolved?

1. Each partner’s initial investment in a partnership is entered in the partnership

2. All partners must agree to the values assigned.

3. After formation of the partnership, the accounting for transactions is

F. Dividing Net Income or Net Loss.

3. Typical income ratios are:

a. A fixed ratio, expressed as a proportion, a percentage, or a fraction.

b. A ratio based either on capital balances at the beginning of the year

d. Interest on partners’ capital balances and the remainder on a fixed

e. Salaries to partners, interest on partners’ capital, and the remainder

G. Partnership Financial Statements.

1. The financial statements of a partnership are similar to those of a pro-

2. The partnership’s income statement shows the division of net income at

3. The owners’ equity statement is called the partners’ capital statement. It

4. The partnership reports each partner’s capital balance on the balance

2. To liquidate a partnership, it is necessary to:

3. Each of the steps must be performed in sequence because the partner-

4. A cash payments schedule is sometimes prepared to determine the distri-

*I. Admission of a Partner.

2. A new partner may be admitted either by:

a. Purchasing the interest of one or more existing partners. The part-

b. Investment of assets in a partnership. When a partner is admitted

(2) The new partner.

c. The partnership allocates a bonus to the old partners on the basis

d. A bonus to a new partner results in a decrease in the capital balances

*J. Withdrawal of a Partner.

1. A partner may withdraw from a partnership voluntarily, by selling his or