Chapter 15

Chapter 15

PARTNERSHIPS - FORMATION, OPERATIONS, AND
CHANGES IN OWNERSHIP INTERESTS

Answers to Questions

1 Noncash investments of partners should be recorded at their fair
values in order to provide equitable treatment to the individual
partners. The recording of noncash assets at less than fair value will
result in allocating the amount of understatement between the partners
in their relative profit and loss sharing ratios as the undervalued
assets are used for partnership business or when they are sold by the
partnership.

2 Conceptually, there is no difference between the drawings and the
withdrawals of partners since both represent disinvestments of
resources from the partnership entity. From a practical viewpoint, the
distinction between withdrawals and drawings may be important because
allowable drawings are not usually deducted in determining the amount
of partnership capital to be used for purposes of dividing profits
among the partners. Since withdrawals are deducted, the distinction
can affect the division of profits and losses.

3 In the absence of an agreement for dividing profits, an equal
division among the partners is required by the Uniform Partnership
Act. The agreement also applies to losses. And it applies irrespective
of the relative investments by the partners.

4 Salary and interest allowances are included in some partnership
agreements in order to reward partners for the time and effort that
they devote to partnership business (salary allowances) and for
capital investments (interest allowances) that they make in the
business.

5 Salary allowances to partners are not expenses of a partnership.
Rather, they are a means of recognizing the efforts of individual
partners in the division of partnership income.

6 When profits are divided in the ratio of capital balances, capital
balances should be computed on the basis of weighted average capital
balances in the absence of evidence that another interpretation of
capital balances is intended by the partners.

7 An individual partner may have a loss from his share of partnership
operating activities even though the partnership has income. This
situation results if priority allocations to other partners exceed
partnership net income. For example, if net income for the A and B
Partnership is $5,000 and profits are divided equally after a salary
allowance of $8,000 to A, A will have partnership income of $6,500 and
B will have a partnership loss of $1,500.

8 Partnership dissolution under the Uniform Partnership Act is the
change in the relation of the partners caused by any partner ceasing
to be associated in the carrying on of the business, as distinguished
from the winding up of the business. Thus, the assignment of a
partnership interest to a third party by one of the partners does not,
by itself, dissolve the partnership because the assignee does not
become a partner unless accepted as a partner by the continuing
partners.

9 The sale of a partnership interest to a third party dissolves the old
partnership if the continuing partners accept the third party
purchaser as their partner. In this case, the relation among the
partners is changed and a new partnership agreement is necessary.

10 A partnership is both a legal entity and a business entity. The
partnership as a legal entity is dissolved by the death or retirement
of a partner as provided by the Uniform Partnership Act. But the
partnership as a business entity continues until the business entity
is liquidated, irrespective of the changes in the interests held by
individual partners.

11 When a new partner acquires an interest by purchase from existing
partners, the partnership receives no new assets because the payment
for the new partner's interest is distributed to the old partners.
Alternatively, an investment in a partnership increases the net assets
of the partnership. This difference is important in accounting for the
admission of a new partner.

12 The admission of a new partner may be recorded by the goodwill
approach (or revaluation approach) or by the bonus approach (or
nonrevaluation approach).

13 The goodwill procedure for recording the admission of a new partner
is best described as a revaluation approach because identifiable
assets and liabilities that are over or undervalued are adjusted to
their fair values before the unidentifiable asset goodwill is
recorded. For example, if a new partner's investment reflects the fact
that land owned by the old partnership is undervalued, it would be
misleading to record the amount of revaluation as goodwill, rather
than as a revaluation of the land account.

14 A bonus procedure for recording an investment in a partnership
involves adjusting the partnership capital account to the extent
necessary to meet the new partnership agreement without a revaluation
of the assets and liabilities of the old partnership.
If a new partner receives a capital credit in excess of his or
her investment, the excess is a bonus to the new partner. A bonus to a
new partner is charged against the old partners' capital balances in
relation to their old profit sharing ratios.
If a new partner's investment exceeds his or her capital
credit, the excess is a bonus to the old partners. A bonus to the old
partners is credited to the old partners' capital balances in
accordance with the old partners' profit sharing ratios.

15 The amounts received by the individual partners in final liquidation
will be the same under the bonus and goodwill procedures provided that
the relative profit and loss sharing ratios of the old partners remain
unchanged in the new partnership and that the new partners' capital
interest and profit and loss sharing ratio are aligned.

16 Parts a and b assume that the partnership assets are to be revalued
upon the admission of Bob into the partnership.
Goodwill would be recorded if identifiable assets and liabilities are
equal to their fair values and
1. $10,000 25% > $10,000 + old capital; or
2. Old capital 75% > $10,000 + old capital; or
3. An independent assessment of earning power or other factors
indicate goodwill.
Old partnership assets would be written down if
1. $10,000 25% < $10,000 + old capital; or
2. Old capital 75% < $10,000 + old capital; or
3. An independent assessment of earning power or other factors
indicate that partnership assets are overvalued.
Parts c and d assume that partnership assets are not to be
revalued upon the admission of Bob into the partnership. A bonus to
the old partners would be recorded if 25% ($10,000 + old capital) is
less than $10,000. A bonus to Bob would be recorded if 25% ($10,000 +
old capital) is greater than $10,000.

SOLUTIONS TO EXERCISES

Solution E15-1

If the partners' contributions were erroneously recorded at cost rather
than fair market value, the account balances would be:

| |Cash |$ 30,000 |
| |Delivery equipment | 40,000 |
| |Furniture inventory | 60,000 |
| | |$130,000 |
| |Lamb capital |$ 70,000 |
| |Carson capital | 60,000 |
| | |$130,000 |

Inequity is calculated as follows:

| | 60% to | 40% to | |
| | Carson | Lamb | Total |
|Carson's appreciation ($30,000) |$18,000 |$12,000 |$ 30,000 |
|Lamb's depreciation ($10,000) | (6,000) | (4,000) | (10,000) |
| | 12,000 | 8,000 | 20,000 |
|Actual appreciation | 30,000 |(10,000) | 20,000 |
|Inequity |(18,000) | 18,000 | 0 |


Solution E15-2

Computation of Beverly's bonus:

Let B = bonus
B = 10% ($506,000 - B)
B = $50,600 - .1B
1.1B = $50,600
B = $46,000

Schedule to Allocate Partnership Income

| | | Arnold | Beverly | Carolyn |
|Net income to distribute |$506,000 | | | |
|Bonus to Beverly | (46,000) | |$ 46,000 | |
|Remainder to divide | 460,000 | | | |
|Divided 40:40:20 |(460,000) |$184,000 | 184,000 |$ 92,000 |
|Income allocation | 0 |$184,000 |$230,000 |$ 92,000 |

Solution E15-3

Schedule to Allocate Partnership Income for 2006

| |Balance | Cari | Helen |Brandie |
|Income to distribute |$14,000 | | | |
|Salary allocation |(21,000) |$ --- |$ 9,000 |$12,000 |
|Interest on capital* |(26,000) | 10,500 | 8,000 | 7,500 |
|Loss to divide