Question

The choosen Company is AMAZON.

Partnership: The company is considering forming a partnership and wants to be sure it understands the key issues regarding partnership formation, income distribution, and liquidation.

A. Explain the process and methods used to account for partnership formation. How do these methods impact the firm’s balance sheet?

B. Illustrate how the company could split profits and losses.

C. Describe what happens if the partnership doesn’t do well and the company has to dissolve it, or one of the partners becomes insolvent.

D. Illustrate the dissolution process by creating a hypothetical cash distribution schedule. Ensure all information is entered accurately.

Answer 1

A. Explain the process and methods used to account for partnership formation. How do these methods impact the firm’s balance sheet?

Answer : Accounting methods used for partnership formation.

1. Partner Investment: A partner’s investment of assets to obtain a partnership capital interest can be accounted for using the exact, bonus or goodwill method. Under the exact method, the partner’s investment is equal to the book value of the capital interest purchased. Under the bonus method, any difference between the partner’s investment and the book value of the interest is distributed as a “bonus” to the old partners or new partner. If the investment amount is larger than the book value of the interest, the bonus is allocated to the old partners; if the investment amount is less than book value, the bonus is allocated to the new partner.
2. Distribution of profit and loss: A partnership’s profits and losses can be split equally among all partners or according to a partnership agreement. For example, partners Joe, Jhon and Curly have a partnership agreement that states profits and losses are shared 70:20:10. In the absence of an agreement, it is assumed that division of profits and losses are equal among all partners. Any guaranteed payments, such as salaries, are deducted before any profit or loss amounts are allocated to each partner. Unless the agreement states otherwise, these payments must be paid and may increase a partnership loss.
3. Partner withdrawal: Accounting for the withdrawal of a partner follows the same methods used for a partner investment. If the exact method is used, the partner’s capital balance is the pay off amount. Under the bonus method, assets used to pay off the withdrawing partner are adjusted to fair market value. The difference between the re-valued assets and the withdrawing partner’s capital balance is allocated to the remaining partners based on their profit and loss ratios. Under the goodwill method, the assets are also revalued and “goodwill” is allocated to all partners according to their profit and loss ratios.
4. Partnership liquidation: When a partnership is liquidated, all liabilities must be paid off and losses must be accounted for before any remaining capital is distributed to the partners. If one of the partners has a capital deficiency, the negative balance can be offset against the partner’s loan account, if one is available. A negative capital balance can also be absorbed by the remaining partners, according to their profit and loss ratios.

B. Illustrate how the company could split profits and losses.

Answer : Deciding how to split profits will affect what kind of company you will create. The partnership agreement that you enter into will formally document the terms of the arrangement. This is used for auditing purposes or if there is ever a dispute between partners. Even if you’re going into business with friends or family you should still keep it professional and set up a formal partnership agreement.

This should be a written document that details all the relevant information and how certain situations will be addressed:

• How much of the company does each partner own? What is the exact breakdown of authority?
• What are the specific terms of your profit share agreement? The written agreement should detail them exactly.
• How is each partner contributing? If someone is investing their own money, say how much and how often. If one partner gets a bigger share because of their special expertise, detail what the expertise is and how much bigger the share is.
• Which decisions can partners make independently, and what must be referred to the group?
• Who can be a partner or company shareholder? Consider eligibility and the process of adding or removing partners.
• What happens if a partner dies, retires, disappears, becomes disabled or is otherwise absent?
• What happens to a partner’s equity if they leave? Are the other partners required to purchase those shares?

C.   Describe what happens if the partnership doesn’t do well and the company has to dissolve it, or one of the partners becomes insolvent.

Answer:   When the relation between partners comes to an end resulting in the breakdown of the business, it is referred to as dissolution of a firm. Here, the partnership firm is wound-up and the accounts are settled. When a new partner is admitted or when an existing partner becomes insolvent or leaves the partnership, dissolution of partnership is said to take place. Irrespective of the change in the partners’ composition, the remaining partners decide to continue the business. To put in other words, since there takes place a change in the partners, the partnership that existed among the partners just before the change is said to be dissolved. In place of the old partnership, new partnership is formed. The relation between partners is revised. However, a point worth noting here is that the new firm takes the assets and liabilities of the old firm. Also, dissolution of partnership does not contribute to any break in the business. Also, the assets are sold, liabilities are paid for and all the claims of the partners are discharged.

D. Illustrate the dissolution process by creating a hypothetical cash distribution schedule. Ensure all information is entered accurately.

Answer:

         Step 1: Sell non cash assets for cash

The non cash assets of 140,000 are sold for 100,000 making a loss on sale of 40,000.

The double entry bookkeeping journal to record the loss on sale of non cash assets would be as follows:

Account	Debit	Credit
Cash	100,000
Non cash assets		140,000
Loss on sale	40,000
Total	140,000	140,000
Liquidation of a Partnership – Sales of non cash assets journal

Step 2: Allocate loss on the sale to each partner using the income ratio

The loss on sale of the non cash assets is then allocated to each partner using the income sharing ratio.

	Partner A	Partner B	Total
Opening balances	50,000	60,000	110,000
Loss on sale	-20,000	-20,000	-40,000
Total	30,000	40,000	70,000
Liquidation of a Partnership – Allocation of Net Loss on Sale

The double entry bookkeeping journal to record the allocation of the loss to each partner would be as follows:

Account	Debit	Credit
Capital – A	20,000
Capital – B	20,000
Loss on sale		40,000
Total	40,000	40,000
Liquidation of a Partnership – Allocation of loss on sale journal

Step 3: Pay any liabilities of the partnership

After the sale of the non cash assets, the cash available to the partnership is the opening balance of 20,000 plus the cash from the disposal of the non cash assets of 100,000 which equals a total of 120,000. This cash is used to settle the liabilities of 50,000 leaving remaining cash of 120,000 – 50,000 = 70,000 to be distributed.

The double entry bookkeeping journal to record the payment of the liabilities would be as follows:

Account	Debit	Credit
Liabilities	50,000
Cash		50,000
Total	50,000	50,000
Liquidation of a Partnership – Payment of liabilities journal

Step 4: Distribute the remaining cash to the partners using the capital ratio.

The remaining cash of 70,000 is paid out to the partners using the capital ratio.

	Partner A	Partner B	Total
Opening balances	30,000	40,000	70,000
Remaining cash	-30,000	-40,000	-70,000
Total	0	0	0
Liquidation of a Partnership – Distribution of remaining cash

The double entry bookkeeping journal to record the distribution of the remaining cash to each partner would be as follows:

Account	Debit	Credit
Capital – A	30,000
Capital – B	40,000
Cash		70,000
Total	70,000	70,000
Liquidation of a Partnership – Distribution of remaining cash journal

The four steps are summarized in the following allocation table.

	Cash	Non Cash	Liabilities	Partner A	Partner B
Opening balances	20,000	140,000	-50,000	50,000	60,000
Sell non cash	100,000	-140,000		-20,000	-20,000
Pay liabilities	-50,000		50,000		0
Remaining cash	-70,000			-30,000	-40,000
Total	0	0	0	0	0
Liquidation of a Partnership – Summary Allocation

After the distribution of the remaining cash and the posting of the journals, the partnership has zero assets and liabilities and can be liquidated.