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CHAPTER 1 : FORMATION AND OPERATIONPLURARITY OF CAPITAL ACCOUNT AND DRAWING ACCOUNTS:CAPITAL ACCOUNTDRAWING ACCOUNTPARTNERSHIP FORMATION Contribute cash, property and industry  Asset : Debited (asset account), Credited (capital account)  Liabilities : present value  Cash – Face value  Non-Cash ...

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CHAPTER 1 : FORMATION AND OPERATION PLURARITY OF CAPITAL ACCOUNT AND DRAWING ACCOUNTS: CAPITAL ACCOUNT 1. Permanent withdrawal (decrease) of capital 2. Share in partnership loss from operations 3. Debit balance of drawing account closed to capital

1. Original investment by a partner 2. Share in partnership profits from operations 3. Additional investment by a partner

DRAWING ACCOUNT

1. Personal withdrawal by a partner in anticipation of profits (Temporary withdrawal of Capital) 2. Share in partnership loss from operations (this may be debited directly to capital)

1. Share in partnership profits from operations (this may be credited directly to capital)

PARTNERSHIP FORMATION      

Contribute cash, property and industry Asset : Debited (asset account), Credited (capital account) Liabilities : present value Cash – Face value Non-Cash – Agrees values, Fair market value Service – memorandum entry

The capital account of each partner reflects all of the activity of an individual partner, contribution, withdrawals, and the distributive share of net income (loss). In some cases, a drawing account is used as a clearing account for each partner’s transactions with only the net effect of each period’s activity shown I the capital account.

The adjustment of books of new partnership is through capital accounts. The capital account is credited for the increases in the value of net assets and is debited for decreases in the value of the net assets (asset and liabilities). To close the balance accounts of the partner that are not to be used by the partnership, all accounts with debited balances are credited and vice versa. The excess of the capital credited to any sole proprietorship over the agreed value or fair market value of the net assets acquired by the partnership is treated as goodwill. The adjustment of goodwill increases the capital of the sole proprietor CAPITAL SHARE AND CAPITAL CONTRIBUTION The capital share of each partner is the percentage of equity that each of them will gave in the net asset of the newly formed partnership.  Proportionate to his/her capital contribution  Not proportionate to their capital contribute (or contribute expertise) Allowing Bonus on initial investment.  Net assets = total assets – total liabilities LOAN RECEIVABLE AND LOAN PAYABLE A loan from a partner is shown as loan payable (partner to partnership) on the partnership books, similar to any other loan. Unless all partners agree otherwise; the partnership is obligated to pay to the individual partner interest (expense in income statement) on the loan. Loan receivable from the partner (partnership to partner), again unless otherwise agreed by the partners, the loan bears interest (income in income statement).

PARNERSHIP OPERATIONS AND DISTRIBUTION OF PROFITS AND LOSSES Accounting for partnership operations is essentially the same as accounting for the operations of any other form of business organization. CLOSING ENTRIES OF PARTNERSHIP

1. All revenue and nominal account with credit balance are debited and income summary is credited. 2. Income summary is debited and all expense and other nominal accounts with debit balances are credited. 3. The balance of the income summary account (profit or loss) is transferred to either the drawing accounts or capital accounts. 4. The balance of the drawing of each partner is transferred to his/her capital account.

ORDER OF PROFIT SHAING PROVISION: bonus, salaries, interest, and remainder. The bonus is computed on the basis of partnership profit as the concept of “partnership net profit” is generally understood in accounting practice. Partners may, however intend for salary and interest allowances to be deducted in determining the base for computing the bonus. In such case, no bonus is allowed if there is insufficient profit after distribution of salaries and interest.

The balance of the income summary account is transferred to the drawing accounts of the partners if the partner intention is to keep the capital account intact for investment or permanent withdrawals of capital. A credit balance in income summary account represents a profit and its balance is transferred to the drawing accounts of the partners based on their P & L sharing ratio.

ORDER OF PRIORITY PROVISION: the partners may agree not to use a residual sharing ratio in the event profits did not exceed the total of the salary and interest allowances. In this case, the partners must agree on the priority of the various features. If the partnership agreement gives salary allowances priority over interest on capital balances, then profit would first apply to salaries and the balance would be divided in to the ratio of interest allowances and vice versa.

DISTRIBUTION OF PROFITS AND LOSSES

SPECIAL PROFIT ALLOCATION METHODS

1. Services rendered by the partners to the partnership – salaries 2. Amount of capital contributed by the partners – interest 3. Entrepreneurial ability or managerial skills – bonus

Most public accounting firms distribute profits on the basis of partnership “units”. A new partner acquires a certain number of units and additional units are assigned by firm wide compensation committee based on:  Obtaining new client, providing the firm with specific areas of industrial expertise, serving as a managing partner of a local office, or accepting a variety of other responsibilities.

P & L division: Percentage, Fraction, Decimal, Ratio METHODS OF DISTRIBUTING PROFITS BASED ON PARTNERSHIP AGREEMENT 1. Equally 2. Arbitrary ratio (percentage, decimal, fraction, ratio) 3. Capital ratio (original, beg, end, average) note: in computing average cap ratio, if the problem is in sentence or t-account (x the given month up to December), if the problem is in capital account (x the given month up to the next given month). Be careful with date! 1 not include, 30/31 include in counting.

4. Interest 5. Salaries 6. Bonus to managing partner - (if there is profit) a. Before deducting bonus and tax (B = BR x I) b. After deducting bonus but before deducting tax (B = BR x I – B) c. Before deducting bonus but after deducting tax (B = BR x I – T) d. After deducting bonus and after deducting tax (B = BR x I – B – T/S)

Many partnerships use profit and loss sharing formula that gives some weight to specific performance of each partner. Some of these performance methods are the ff: chargeable hours, total billings, promotional and civic activities. Other partnerships devise profit distribution plans that reflect the earnings of the partnership. Other criteria may include number or size of clients, years of service within the firm, or the partner’s position within the firm. CORRECTION IN NET PROFIT FOR OMISSIONS PRIOR TO DISTRIBUTION

ERRORS

AND

The errors may also affect the computation or a prior period’s profit. The central issue, however, is whether the correction would affect the profit of the current year (the year in

which the error is discovered) or the profit of the prior year (the year in which the error occurred). When the error is corrected as adjustment to prior year’s profit, the allocation of profit for the prior year should be recalculated based on the corrected profit and the profit-and-loss sharing agreement in effect during the prior period. When the error is corrected as adjustment to current year’s profit only, the adjustment is allocated among capital accounts based on the corrected current year’s profit and the profit and loss sharing agreement. The required corrections to profit are summarized as follows: Correction to profit of current year for errors made in: Prior year Current year 1. Unrecorded prepaid expenses + 2. Unrecorded accrued expenses + 3. Unrecorded accrued income + 4. Unrecorded unearned income + 5. Overstatement of inventories + 6. Understatement of inventories + 7. Overstatement of purchases + 8. Understatement of purchases + 9. Overstatement of depreciation none + 10. Understatement of depreciation none CAPITAL RATIO ADJUSTED TO PROFIT AND LOSS RATIO While it is usual that capital ratios do not equal profit and loss ratios, partners may decide to bring their capita balances into their profit and loss ratio. 1. By payments outside of the firm among the partners and where the total firm capital is to remain the same. 2. By lowest possible additional cash investment in the firm. Higher than capital contribution 3. By lowest possible additional investment or cash withdrawal from the firm by the partners. Lower than capital contribution...