Accounting for Partnerships - Midterm Revision PDF

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Accounting for Partnerships – Midterm Revision First: Theoretical Part (A) Forms of business organizations: There are three forms of business organizations: 1. Sole Proprietorship: It refers to a business that is owned and operated by one person (proprietor). 2. Partnership: It refers to a business that is owned and operated by two or more persons (partners). 3. Corporation: It refers to a business that is owned by shareholder.

(B) Forms of Partnerships: There are three forms of partnerships: 1. The General Partnership:  It includes only general partners.  Each general partner has unlimited liability for the debts of the partnership.  Each general partner has the power or the authority to sign contracts on behalf of the partnership and each general is responsible for his or her actions and the actions of other partners. This is known as “the mutual agency concept” where each general partner has the full authority of the owner. 2. The Limited Partnership:  It includes one or more general partners and one or more limited partners.  Limited partners have limited liability and do not participate in management.  In limited partnerships, the concepts of unlimited liability and mutual agency apply only to the general partners. 3. The limited Liability Partnership:  Each partner in the limited liability partnership has unlimited liability for his own activities but not for the actions of other partners.  The limited liability partnership is most suitable for groups of independent professionals such as engineering firms, auditing firms, lawyers firms .. etc.

(C) Advantages of a Partnership: 1. Formation is relatively easier and less expensive than to form or organize a corporation. 2. To bring together sufficient capital. 3. To combine special skills.

(D) Disadvantages of a Partnership: 1. Limited uncertain life. 2. Unlimited liability and mutual agency with regard to general partners. 3. A partnership is less efficient in raising funds than corporations.

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(E) Characteristics of Partnerships: 1. 2. 3. 4. 5. 6. 7. 8.

Relative ease of formation. A partnerships is not a separate legal entity but a separate accounting entity. Income is taxable to partners (partners pay taxes not the partnership) Limited and uncertain life. Unlimited liabilities and mutual agency with regard to general partners. Limited liabilities with regard to limited partners. General partners are owners and managers. Limited partners are owners but not managers.

Note:  Partnership is not separate legal entity from its owner. This means that in the eye of the law the partnership and the partners are considered the same legal entity.  Partnership has a separate accounting entity from its owners. This means that from accounting perspective, we should separate the partnership from its partners.

(F) Comparative Features Main Features (1) Legal Status (2) Accounting Status (3) Tax Status (4) Liability of Owners (5) Management

Sole Proprietorship Not a Separate legal entity Separate entity Owner is taxed Personal unlimited liability Owners

General Partnership Not a Separate legal entity Separate entity Partners are taxed Personal unlimited liability Every general partner

(6) Continuity

Limited Life

Limited Life

Corporations a Separate legal entity Separate entity Corporations are taxed No Personal unlimited liability (limited liability) Hired professional management Indefinite Life

(G) The Partnership Contract: At the formation of partnership, the partners write an agreement (also called articles of the partnership). The contract agreement include the following points: 1. The name, location, objectives and length of time. 2. The identification of partners and their duties. 3. Partners’ initial capitals. 4. Provisions for sharing profits and losses. 5. Procedures for admitting a new partner. 6. Provisions to deal with the withdrawal or the death of the partners. 7. Provisions for termination or liquidation of the partnership. Notes: 



Any cash withdrawals by any partner under any title are recorded by debiting the Partner, Drawing account. In other words, any cash drawings as salary allowances to partners, as interest allowances on partner’s capital, and as bonuses to partners .. etc, are all recorded as Drawing not as an expense. Profit or loss is divided according to partnership agreement. If there is no agreement, profit or loss is to be shared equally.

Note (on formation):  

Under bonus and goodwill method, only one entry should to be made While under the other two ways, number of entries to be made equal to the number of partners or can be combined in one entry only (in other words, 2 entries or 1 entry). 2

True or False questions: 1. 2. 3. 4.

Partnerships are not separate legal entities but are accounting entities. As co-owners, the limited partners are not entitled to manage the partnership. The term “mutual agency” describes the right of any general partner to bind the partnership to contracts. The unlimited personal liability for business debts is the most important disadvantage of the general partnership. 5. The amount of cash that a partner withdraws from the partnership may be greater or less than the partner’s share in net income. 6. The income statement of a partnership should not include among expenses the total amount of partners’ drawings. 7. Partners’ capital accounts should not be closed in the periodic closing process of accounts unless the partnership is to be subject to liquidation. 8. The use of partnership funds to pay personal debts of partners should be recorded by debiting their drawing accounts. 9. A liability to a partner for funds loaned to the partnership has no priority over liabilities to outside creditors. 10. Any partner can enter into a contract on behalf of a general partnership without a majority vote of all general partners. 11. The unique characteristics of a limited partnership is that the liability of some of the partners for losses incurred by the business is limited to the amount of their investments. 12. Title to the assets of a partnership is held by partnership. 13. A limited liability partnership is most suitable for a group of professional auditors of accounts. 14. Two partners from a partnership without any written agreement and without any discussion as to how profits and losses should be divided. Under these circumstances, profits and losses must be shared equally. 15. Although a partnership operates at a profit, it is possible that one partner’s share of this profit will be a loss, resulting in a debit to the partner’s capital account. 16. The monthly salary to each partner is not a method to determine how much each partner can withdrew each month. 17. If a partnership pays for a partner’s salary, the amount should not be combined with the partnership’s salaries in the income statement accounts. 18. The general partnership is an accounting entity in which each partner is personally liable for all debts of this entity. 19. Partnerships are not separate legal entities, like sole proprietorship. 20. In a general partnership, only a majority of partners need to have unlimited liability to partnership creditors. 21. Partners are owners and also hired employees if they are active in the business of their partnership. 22. The partner’s drawing account is not debited if he or she makes his or her mortgage payment by writing a check from the partnership’s checking account. 23. Two expenses normally found in the income statements of a partnership, are salaries to partners and interest to partners’ capitals. 24. No partner can enter into a contract on behalf of a partnership without a majority vote of all of the partners. 25. Owners of sole proprietorship and general partnerships are personally liable for the debts of the business. 26. One partner in a firm can obligate the firm to buy goods or services without the consent of other partners. 27. When a partner contributes noncash assets to a partnership, the assets are valued at their fair market values. 3

28. Title to the assets of a partnership is held by the partners. 29. The term “Unlimited Liability” describes the right of any general partner to bind the partnerships to contract. 30. Partners drawing and capital accounts are closed in the closing process for a partnership. 31. Partners could receive a bonus on net profit in case of net loss. 32. No bonus on sales revenue will be given to any partner in case of net loss. 33. The assets which are contributed on formation should equal to these book values if only book value don’t differ from fair value. 34. At formation, accountants record accumulated depreciation on trucks. 35. The entry to record the formation may include prepaid expenses among credit balances and accrued expenses among debit balances. 36. There are 3 ways to record the formation of partnerships. 37. If a bonus method is used to record the initial formation of a new partnership, a bonus account shouldn’t appear. 38. In the entry to record drawings of partners, cash is credited. 39. If a partner presents a loan to the partnership, the loan appears as a debit. 40. The interest on partner’s loan is an expense. 41. The interest on partner’s capital is an expense. 42. The partnership is an accounting entity but is not a legal entity. 43. Partnership take only one form which is general partnership. 44. Limited partnerships include only limited partners. 45. General partnership includes only general partners. 46. Each general partner has the right or the authority to sign contracts on behalf of the partnership. 47. The concept of "mutual agency" is the right which is not given to limited partners. 48. At the initial formation of the new partnership of “Seleem Brothers”, “S.Seleem” had no economic resources, but his expected general performance was highly appreciated. To equalize initial capitals of all partners including “S.Seleem”, the goodwill method should only be used at formation. 49. At least two general entries should be made, if the goodwill method is used to equalize initial capitals of all partners. 50. If the bonus is to be used to equalize the initial capitals of all partners, then each partner's initial capital is the result of dividing the number of all the partners by the total of their net investment. 51. One single journal entry should be made if the bonus method is to be used to equalize initial capitals of the partners. 52. One single journal entry can be prepared to record the formation of the new partnership, if all partners agreed that each partner should receive an initial capital equals to the net assets he/she invested in the new partnership. 53. One single journal entry should be prepared to record the formation of the new partnership, if all partners agreed that each partner should receive an initial capital equals to the net assets he/she invested in the new partnership. 54. The general partner "M.Sheeka" requested doubling his salary because of his effort contributed to the "Mixed Club" partnership. Although the partnership showed a record of continuous monthly losses, this request was approved and the new salary was paid and properly recorded in books after altering the partnership agreement. 55. At the end of every fiscal year, the income summary account should be closed regardless of the orders or the instructions given by the partners on how to deal with their shares in the net income. 56. If no mention of how to share the income of partnership is written in its agreement, profits and losses are assumed to be divided equally.

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57. To share net profits of a partnership, a bonus on sales revenue can be allowed to a partner even if the accounting period has ended up by a net loss. 58. The contract of the “Art & Engineering” partnership was adjusted to give partner “A. Gogo” an additional bonus of 10% on net income after all bonuses. Although the current year of the partnership ended-up by a net loss, this additional bonus must be given at the end of the current year. 59. The interest allowances of the partners on their capitals at the end of every fiscal year are computed after allocating the annual net income to the capital accounts of the partners. 60. When sharing net income of a partnership, all allowances and bonuses to partners should not be recorded in books as expenses. 61. Although a partnership operates at a profit, it is possible that one partner's share of this profit will be a loss, resulting in a debit to the partner's capital account. 62. Using the goodwill method at the initial formation date will result in a higher total assets than other methods. Solution Question No 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

True or False True True True True True True True True True True True True True True True True True True True False

21.

False

22.

False

23.

False

24.

False

25. 26. 27. 28. 29.

True True True False False

Correction

In a general partnership, all partners have unlimited liability to partnership creditors. Partners are owners and also hired employees regardless of whether they are active in the business of their partnership or not. The partner’s drawing account is debited if he or she makes his or her mortgage payment by writing a check from the partnership’s checking account. salaries to partners are considered as drawings while interest to partners’ capitals is considered as allocation of net income. General partners can enter into a contract on behalf of a partnership without a majority vote of all of the partners due to mutual agency concept.

Title to the assets of a partnership is held by the partnership. The term “Mutual Agency” describes the right of any general partner to bind 5

30.

False

31. 32. 33. 34.

False False True False

35.

False

36. 37. 38. 39. 40. 41.

False False True False True False

42. 43.

True False

44.

False

45. 46. 47. 48.

True True True False

49. 50.

False False

51. 52. 53.

True True False

54. 55. 56. 57. 58. 59.

True True True True False False

60. 61. 62.

True True True

the partnerships to contract. Partners drawing account are closed while capital account is not closed in the closing process for a partnership. No partner receive a bonus on net profit in case of net loss. No bonus on net profit will be given to any partner in case of net loss. At formation, accountants should not record accumulated depreciation on trucks. The entry to record the formation may include prepaid expenses among debit balances and accrued expenses among credit balances. There are 4 ways to record the formation of partnerships. There is no account called bonus. If a partner presents a loan to the partnership, the loan appears as a credit. The interest on partner’s capital Is not an expense but allocation of net income.

There are different forms of partnership which are: (1) General Partnership (2) Limited Partnership (3) Limited liability partnership. Limited partnerships include one or more limited partner and one or more general partner.

To equalize initial capitals of all partners including “S.Seleem”, the goodwill method, bonus method or cash method can be used at formation. Only one journal entry should be made under the goodwill method. If the bonus is to be used to equalize the initial capitals of all partners, then each partner's initial capital is the result of dividing the total of their net investment by the number of all the partners.

One single journal entry or entries can be prepared to record the formation of the new partnership, if all partners agreed that each partner should receive an initial capital equals to the net assets he/she invested in the new partnership.

No bonus on net income is to be given to any partner in case of net loss. The interest allowances of the partners on their capitals at the end of every fiscal year are computed after allocating the annual net income to the capital accounts of the partners.

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Multiple Choice Questions: (1) In a partnership, interest on capital investment is accounted for as (an): a. A return on investment. b. Expense. c. Allocation of net income. d. Reduction of capital. (2) A partnership in which one or more of its partners are general partners and one or more are not is called (an): a. Joint venture. b. General partnership. c. Limited partnership. d. Unlimited partnership. (3) Which of the following is an advantage of a partnership? a. Mutual agency. b. Limited life. c. Unlimited liability. d. None of these. (4) A and B form a partnership and agreed to share profits in 2 to 1 ratio. During the first year of operation, the partnership incurs a L.E 10,000 loss. The partners should share this loss: a. Based on their average capital balances. b. In a 2 to 1 ratio. c. Equally. d. Based on their ending capital balances. (5) Which of the following is not characteristic of a partnership? a. Limited life. b. Mutual agency. c. Limited liability. d. The right to dispose of a partnership interest. (6) The articles of partnership contract need not include which of the following? a. Location of the place of business. b. Allocation of profit/loss. c. Fiscal period of the partnership. d. All of the above should be included. (7) The partnership form of business is: a. An economic entity. b. A separate legal entity. c. Taxable entity. d. None of these. (8) A partner’s drawing account, in substance is a: a. Capital account. b. Contra- capital account. c. Loan account (a loan from the partnership). d. Salary expense account. (9) Which of the following is not a characteristic of a general partnership: a. Each partner has authority to bind the partnership to contracts. b. Relative ease of formation. c. Each partners’ liability is limited to the amount he or she invested. 7

d. Each partner must pay personal income taxes on his or her share of partnerships net income. (10) Which of the following is not a characteristic of a general partnership? a. Mutual agency. b. Unlimited liability for business debts. c. Double taxation. d. Limited life. (11) Which of the following investors do not have unlimited liability for the debts of the business? a. An owner of a sole proprietorship. b. A partner of a general partnership. c. A stockholder of a corporation. d. A general partner of a limited partnership. (12) Which of the following is not true regarding general partnerships? a. Cash withdrawn by a partner is recorded in the partner’s drawing account. b. The individual partners are personally liable for the debts of the partnership. c. The individual partners participate in management only if they are hired by the partnership. d. The individual partners pay income taxes on their share of partnership profits. (13) When a partnership is formed, equity dictates that assets contributed to the partnership be recorded in general journal at their: a. Historical cost. b. Replacement value. c. Current value. d. Book value. (14) Which of the following transactions should not be recorded by debiting partner’s drawing accounts: a. Payment of authorized salary to a partner. b. Use of partnership funds to pay debts of a partner. c. Payment of a partnership liability by a partner out of personal funds. d. Cash collected by a partner on behalf of the firm but retained by the partner personally. (15) Which of the following accounts is not closed in the closing process for a partnership? a. Depreciation expense. b. Income summary c. Partner D, Capital. d. Partner D, Drawing. (16) When partners contribute varying amounts of capital and personal services, their partnership agreement logically should provide for: a. Equal division of profits. b. Bonus to a...