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balance during the year.
3. Partners may receive a guaranteed salary, and the remaining profit or loss is allocated on a fixed ratio.
4. Income can be allocated based on the proportion of interest in the capital account. If one partner has a
capital account that equates to 75% of capital, that partner would take 75% of the income.
5. Some combination of all or some of the above methods.
A fixed ratio is the easiest approach because it is the most straightforward. As an example, assume that Jeffers
and Singh are partners. Each contributed the same amount of capital. However, Jeffers works full time for the
partnership and Singh works part time. As a result, the partners agree to a fixed ratio of 0.75:0.25 to share the
net income.
Selecting a ratio based on capital balances may be the most logical basis when the capital investment is the
most important factor to a partnership. These types of ratios are also appropriate when the partners hire
managers to run the partnership in their place and do not take an active role in daily operations. The last three
approaches on the list recognize differences among partners based upon factors such as time spent on the
business or funds invested in it.
Salaries and interest paid to partners are considered expenses of the partnership and therefore deducted
prior to income distribution. Partners are not considered employees or creditors of the partnership, but these
transactions affect their capital accounts and the net income of the partnership.
Let’s return to the partnership with Dale and Ciara to see how income and salaries can affect the split of net
income (Figure 15.3). Acorn Lawn & Hardscapes reports net income of $68,000. The partnership agreement
has defined an income sharing ratio, which provides for salaries of $15,000 to Dale and $10,000 to Ciara. They
will share in the net income on a 50:50 basis. The calculation for income sharing between the partners is as
follows:
Figure 15.3 Income Allocation for Acorn Lawn & Hardscapes. (attribution: Copyright Rice University,
OpenStax, under CC BY-NC-SA 4.0 license)
Now, consider the same scenario for Acorn Lawn & Hardscapes, but instead of net income, they realize a net
loss of $32,000. The salaries for Dale and Ciara remain the same. Also, the distribution process for allocating a
loss is the same as the allocation process for distributing a gain, as demonstrated above. The partners will
share in the net loss on a 50:50 basis. The calculation for the sharing of the loss between the partners is shown
in Figure 15.4
936 Chapter 15 Partnership Accounting
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Figure 15.4 Loss sharing Allocation for Acorn Lawn & Hardscapes. (attribution: Copyright Rice University,
OpenStax, under CC BY-NC-SA 4.0 license)
C O N C E P T S I N P R A C T I C E
Spidell and Diaz: A Partnership
For several years, Theo Spidell has operated a consulting company as a sole proprietor. On January 1,
2017 he formed a partnership with Juanita Diaz called Insect Management.
The facts are as follows:
• Spidell was to transfer the cash, accounts receivable, furniture and equipment, and all the liabilities
of the sole proprietorship in return for 60% of the partnership capital.
• The fair market value in the relevant accounts of the sole proprietorship at the close of business on
December 31, 2016 are shown in Figure 15.5.
Figure 15.5 Fair Market Values of Sole Proprietorship. (attribution: Copyright Rice University,
OpenStax, under CC BY-NC-SA 4.0 license)
• In exchange for 40% of the partnership, Diaz will invest $130,667 in cash.
• Each partner will be paid a salary – Spidell $3,000 per month and Diaz $2,000 per month.
• The partnership’s net income for 2016 was $300,000. The partnership agreement dictates an
income-sharing ratio.
• Assume that all allocations are 60% Spidell and 40% Diaz.
Record the following transactions as journal entries in the partnership’s records.
A. Receipt of assets and liabilities from Spidell
B. Investment of cash by Diaz
C. Profit or loss allocation including salary allowances and the closing balance in the Income Section
account
Chapter 15 Partnership Accounting 937
15.4 Prepare Journal Entries to Record the Admission and Withdrawal of a
Partner
So far we have demonstrated how to create a partnership, distribute the income or loss, and calculate income
distributed at the end of the year after salaries have been paid. Acorn Lawn & Hardscapes has been doing well,
but what if the opportunity arises to add another partner to handle more business? Or what happens if one
partner wants to leave the partnership or sell his or her interest to someone else? This section will discuss
those situations.
Admission of New Partner
There are two ways for a new partner to join a partnership. In both, a new partnership agreement should be
drawn up because the existing partnership will come to an end.
1. The new partner can invest cash or other assets into an existing partnership while the current partners
remain in the partnership.
2. The new partner can purchase all or part of the interest of a current partner, making payment directly to
the partner and not to the partnership. If the new partner buys an existing partner’s entire interest, the
existing partner leaves the partnership.
The new partner’s investment, share of ownership capital, and share of the net income or loss are all
negotiated in the process of developing the new partnership agreement. Based on how a partner is admitted,
oftentimes the admission can create a situation to be illustrated called a bonus to those in the partnership. A
bonus is the difference between the value of a partner’s capital account and the cash payment made at the
time of that partner’s or another partner’s withdrawal.
T H I N K I T T H R O U G H
Sharing Profits and Losses in a Partnership
Michael Wingra has operated a very successful hair salon for the past 7 years. It is almost too successful
because Michael does not have any free time. One of his best customers, Jesse Tyree, would like to get
involved, and they have had several conversations about forming a partnership. They have asked you to
provide some guidance about how to share in the profits and losses.
Michael plans to contribute the assets from his salon, which have been appraised at $500,000.
Jesse will invest cash of $300,000. Michael will work full time at the salon and Jesse will work part time.
Assume the salon will earn a profit of $120,000.
Instructions:
1. What division of profits would you recommend to Michael and Jesse?
2. Using your recommendation, prepare a schedule sharing the net income.
938 Chapter 15 Partnership Accounting
This OpenStax book is available for free at http://cnx.org/content/col25448/1.4
Admission of New Partner—No Bonus
Whenever a new partner is admitted to the partnership, a new capital account must be opened for him or her.
This will allow the partnership to reflect the new members of the partnership.
The purchase of an existing partner’s ownership by a new partner is a personal transaction that involves the
existing partner and the new partner without otherwise affecting the records of the partnership. Accounting
for this method is very straightforward. The only changes that are recorded on the partnership’s books occur
in the two partners’ capital accounts. The existing partner’s capital account is debited and, after being created,
the new partner’s capital account is credited.
To illustrate, Dale decides to sell his interest in Acorn Lawn & Hardscapes to Remi. Since this is a personal
transaction, the only entry Acorn needs to make is to record the transfer of partner interest from Dale to Remi
on its books.
No other entry needs to be made. Note that the entry is a paper transfer—it is to move the balance in the
capital account. The amount paid by Remi to Dale does not affect this entry.
If instead the new partner invests directly into the partnership, the change increasesthe assets of the
partnership as well as the capital accounts. Suppose that, instead of buying Dale’s interest, Remi will join Dale
and Ciara in the partnership. The following journal entry will be made to record the admission of Remi as a
partner in Acorn Lawn & Hardscapes.
Admission of New Partner—Bonus to Old Partners
A bonus to the old partners can come about when the new partner’s investment in the partnership creates an
inequity in the capital of the new partnership, such as when a new partner’s capital account is not
proportionate to that of a previous partner. Because a change in ownership of a partnership produces a new
partnership agreement, a bonus may be used to record the change in the ownership capital to prevent
inequities among the partners.
A bonus to the old partner or partners increases (or credits) their capital balances. The amount of the increase
depends on the income ratio before the new partner’s admission.
As an illustration, Remi is a skilled machine operator who will aid Acorn Lawn & Hardscapes in the building of
larger projects. Assume the following information (Figure 15.6) for the partnership on the day Remi becomes a
partner.
Chapter 15 Partnership Accounting 939
Figure 15.6 Breakdown of Allocation of Bonus to Old Partners. (attribution: Copyright Rice University,
OpenStax, under CC BY-NC-SA 4.0 license)
To allocate the $10,000 bonus to the old partners, Dale and Ciara, make the following calculations:
Dale: ⎛⎝$10,000 × 50%⎞⎠ = $5,000
Ciara: ⎛⎝$10,000 × 50%⎞⎠ = $5,000
The journal entry to record Remi’s admission to the partnership and the allocation of the bonus to Dale and
Ciara is as shown.
Admission of New Partner—Bonus to New Partner
When the new partner’s investment may be less than his or her capital credit, a bonus to the new partner may
be considered. Sometimes the partnership is more interested in the skills the new partner possesses than in
any assets brought to the business. For instance, the new partner may have expertise in a particular field that
would be beneficial to the partnership, or the new partner may be famous and can draw attention to the
partnership as a result. This frequently happens with restaurants; many are named after sports celebrity
partners. A bonus to a newly admitted partner can also occur when the book values of assets currently on the
partnership’s books have a higher value than their fair market values.
A bonus to a new admitted partner decreases (or debits) the capital balances of the old partners. The amount
of the decrease depends on the income ratio defined by the old partnership agreement in place before the
new partner’s admission.
In our landscaping business example, suppose Remi receives a bonus based on his skills as a machine
operator. Assume the following information (Figure 15.7) for the partnership on the day he becomes a partner.
940 Chapter 15 Partnership Accounting
This OpenStax book is available for free at http://cnx.org/content/col25448/1.4
	Chapter 15. Partnership Accounting
	15.4. Prepare Journal Entries to Record the Admission and Withdrawal of a Partner*