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Principles of Accounting, Volume 1: Financial Accounting

15.4 Prepare Journal Entries to Record the Admission and Withdrawal of a Partner

Principles of Accounting, Volume 1: Financial Accounting15.4 Prepare Journal Entries to Record the Admission and Withdrawal of a Partner
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  1. Preface
  2. 1 Role of Accounting in Society
    1. Why It Matters
    2. 1.1 Explain the Importance of Accounting and Distinguish between Financial and Managerial Accounting
    3. 1.2 Identify Users of Accounting Information and How They Apply Information
    4. 1.3 Describe Typical Accounting Activities and the Role Accountants Play in Identifying, Recording, and Reporting Financial Activities
    5. 1.4 Explain Why Accounting Is Important to Business Stakeholders
    6. 1.5 Describe the Varied Career Paths Open to Individuals with an Accounting Education
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
  3. 2 Introduction to Financial Statements
    1. Why It Matters
    2. 2.1 Describe the Income Statement, Statement of Owner’s Equity, Balance Sheet, and Statement of Cash Flows, and How They Interrelate
    3. 2.2 Define, Explain, and Provide Examples of Current and Noncurrent Assets, Current and Noncurrent Liabilities, Equity, Revenues, and Expenses
    4. 2.3 Prepare an Income Statement, Statement of Owner’s Equity, and Balance Sheet
    5. Key Terms
    6. Summary
    7. Multiple Choice
    8. Questions
    9. Exercise Set A
    10. Exercise Set B
    11. Problem Set A
    12. Problem Set B
    13. Thought Provokers
  4. 3 Analyzing and Recording Transactions
    1. Why It Matters
    2. 3.1 Describe Principles, Assumptions, and Concepts of Accounting and Their Relationship to Financial Statements
    3. 3.2 Define and Describe the Expanded Accounting Equation and Its Relationship to Analyzing Transactions
    4. 3.3 Define and Describe the Initial Steps in the Accounting Cycle
    5. 3.4 Analyze Business Transactions Using the Accounting Equation and Show the Impact of Business Transactions on Financial Statements
    6. 3.5 Use Journal Entries to Record Transactions and Post to T-Accounts
    7. 3.6 Prepare a Trial Balance
    8. Key Terms
    9. Summary
    10. Multiple Choice
    11. Questions
    12. Exercise Set A
    13. Exercise Set B
    14. Problem Set A
    15. Problem Set B
    16. Thought Provokers
  5. 4 The Adjustment Process
    1. Why It Matters
    2. 4.1 Explain the Concepts and Guidelines Affecting Adjusting Entries
    3. 4.2 Discuss the Adjustment Process and Illustrate Common Types of Adjusting Entries
    4. 4.3 Record and Post the Common Types of Adjusting Entries
    5. 4.4 Use the Ledger Balances to Prepare an Adjusted Trial Balance
    6. 4.5 Prepare Financial Statements Using the Adjusted Trial Balance
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  6. 5 Completing the Accounting Cycle
    1. Why It Matters
    2. 5.1 Describe and Prepare Closing Entries for a Business
    3. 5.2 Prepare a Post-Closing Trial Balance
    4. 5.3 Apply the Results from the Adjusted Trial Balance to Compute Current Ratio and Working Capital Balance, and Explain How These Measures Represent Liquidity
    5. 5.4 Appendix: Complete a Comprehensive Accounting Cycle for a Business
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  7. 6 Merchandising Transactions
    1. Why It Matters
    2. 6.1 Compare and Contrast Merchandising versus Service Activities and Transactions
    3. 6.2 Compare and Contrast Perpetual versus Periodic Inventory Systems
    4. 6.3 Analyze and Record Transactions for Merchandise Purchases Using the Perpetual Inventory System
    5. 6.4 Analyze and Record Transactions for the Sale of Merchandise Using the Perpetual Inventory System
    6. 6.5 Discuss and Record Transactions Applying the Two Commonly Used Freight-In Methods
    7. 6.6 Describe and Prepare Multi-Step and Simple Income Statements for Merchandising Companies
    8. 6.7 Appendix: Analyze and Record Transactions for Merchandise Purchases and Sales Using the Periodic Inventory System
    9. Key Terms
    10. Summary
    11. Multiple Choice
    12. Questions
    13. Exercise Set A
    14. Exercise Set B
    15. Problem Set A
    16. Problem Set B
    17. Thought Provokers
  8. 7 Accounting Information Systems
    1. Why It Matters
    2. 7.1 Define and Describe the Components of an Accounting Information System
    3. 7.2 Describe and Explain the Purpose of Special Journals and Their Importance to Stakeholders
    4. 7.3 Analyze and Journalize Transactions Using Special Journals
    5. 7.4 Prepare a Subsidiary Ledger
    6. 7.5 Describe Career Paths Open to Individuals with a Joint Education in Accounting and Information Systems
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  9. 8 Fraud, Internal Controls, and Cash
    1. Why It Matters
    2. 8.1 Analyze Fraud in the Accounting Workplace
    3. 8.2 Define and Explain Internal Controls and Their Purpose within an Organization
    4. 8.3 Describe Internal Controls within an Organization
    5. 8.4 Define the Purpose and Use of a Petty Cash Fund, and Prepare Petty Cash Journal Entries
    6. 8.5 Discuss Management Responsibilities for Maintaining Internal Controls within an Organization
    7. 8.6 Define the Purpose of a Bank Reconciliation, and Prepare a Bank Reconciliation and Its Associated Journal Entries
    8. 8.7 Describe Fraud in Financial Statements and Sarbanes-Oxley Act Requirements
    9. Key Terms
    10. Summary
    11. Multiple Choice
    12. Questions
    13. Exercise Set A
    14. Exercise Set B
    15. Problem Set A
    16. Problem Set B
    17. Thought Provokers
  10. 9 Accounting for Receivables
    1. Why It Matters
    2. 9.1 Explain the Revenue Recognition Principle and How It Relates to Current and Future Sales and Purchase Transactions
    3. 9.2 Account for Uncollectible Accounts Using the Balance Sheet and Income Statement Approaches
    4. 9.3 Determine the Efficiency of Receivables Management Using Financial Ratios
    5. 9.4 Discuss the Role of Accounting for Receivables in Earnings Management
    6. 9.5 Apply Revenue Recognition Principles to Long-Term Projects
    7. 9.6 Explain How Notes Receivable and Accounts Receivable Differ
    8. 9.7 Appendix: Comprehensive Example of Bad Debt Estimation
    9. Key Terms
    10. Summary
    11. Multiple Choice
    12. Questions
    13. Exercise Set A
    14. Exercise Set B
    15. Problem Set A
    16. Problem Set B
    17. Thought Provokers
  11. 10 Inventory
    1. Why It Matters
    2. 10.1 Describe and Demonstrate the Basic Inventory Valuation Methods and Their Cost Flow Assumptions
    3. 10.2 Calculate the Cost of Goods Sold and Ending Inventory Using the Periodic Method
    4. 10.3 Calculate the Cost of Goods Sold and Ending Inventory Using the Perpetual Method
    5. 10.4 Explain and Demonstrate the Impact of Inventory Valuation Errors on the Income Statement and Balance Sheet
    6. 10.5 Examine the Efficiency of Inventory Management Using Financial Ratios
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  12. 11 Long-Term Assets
    1. Why It Matters
    2. 11.1 Distinguish between Tangible and Intangible Assets
    3. 11.2 Analyze and Classify Capitalized Costs versus Expenses
    4. 11.3 Explain and Apply Depreciation Methods to Allocate Capitalized Costs
    5. 11.4 Describe Accounting for Intangible Assets and Record Related Transactions
    6. 11.5 Describe Some Special Issues in Accounting for Long-Term Assets
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  13. 12 Current Liabilities
    1. Why It Matters
    2. 12.1 Identify and Describe Current Liabilities
    3. 12.2 Analyze, Journalize, and Report Current Liabilities
    4. 12.3 Define and Apply Accounting Treatment for Contingent Liabilities
    5. 12.4 Prepare Journal Entries to Record Short-Term Notes Payable
    6. 12.5 Record Transactions Incurred in Preparing Payroll
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  14. 13 Long-Term Liabilities
    1. Why It Matters
    2. 13.1 Explain the Pricing of Long-Term Liabilities
    3. 13.2 Compute Amortization of Long-Term Liabilities Using the Effective-Interest Method
    4. 13.3 Prepare Journal Entries to Reflect the Life Cycle of Bonds
    5. 13.4 Appendix: Special Topics Related to Long-Term Liabilities
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  15. 14 Corporation Accounting
    1. Why It Matters
    2. 14.1 Explain the Process of Securing Equity Financing through the Issuance of Stock
    3. 14.2 Analyze and Record Transactions for the Issuance and Repurchase of Stock
    4. 14.3 Record Transactions and the Effects on Financial Statements for Cash Dividends, Property Dividends, Stock Dividends, and Stock Splits
    5. 14.4 Compare and Contrast Owners’ Equity versus Retained Earnings
    6. 14.5 Discuss the Applicability of Earnings per Share as a Method to Measure Performance
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  16. 15 Partnership Accounting
    1. Why It Matters
    2. 15.1 Describe the Advantages and Disadvantages of Organizing as a Partnership
    3. 15.2 Describe How a Partnership Is Created, Including the Associated Journal Entries
    4. 15.3 Compute and Allocate Partners’ Share of Income and Loss
    5. 15.4 Prepare Journal Entries to Record the Admission and Withdrawal of a Partner
    6. 15.5 Discuss and Record Entries for the Dissolution of a Partnership
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  17. 16 Statement of Cash Flows
    1. Why It Matters
    2. 16.1 Explain the Purpose of the Statement of Cash Flows
    3. 16.2 Differentiate between Operating, Investing, and Financing Activities
    4. 16.3 Prepare the Statement of Cash Flows Using the Indirect Method
    5. 16.4 Prepare the Completed Statement of Cash Flows Using the Indirect Method
    6. 16.5 Use Information from the Statement of Cash Flows to Prepare Ratios to Assess Liquidity and Solvency
    7. 16.6 Appendix: Prepare a Completed Statement of Cash Flows Using the Direct Method
    8. Key Terms
    9. Summary
    10. Multiple Choice
    11. Questions
    12. Exercise Set A
    13. Exercise Set B
    14. Problem Set A
    15. Problem Set B
    16. Thought Provokers
  18. Financial Statement Analysis
  19. Time Value of Money
  20. Suggested Resources
  21. Answer Key
    1. Chapter 1
    2. Chapter 2
    3. Chapter 3
    4. Chapter 4
    5. Chapter 5
    6. Chapter 6
    7. Chapter 7
    8. Chapter 8
    9. Chapter 9
    10. Chapter 10
    11. Chapter 11
    12. Chapter 12
    13. Chapter 13
    14. Chapter 14
    15. Chapter 15
    16. Chapter 16
  22. Index

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.

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.

Journal entry dated January 1, 2021. Debit Dale, Capital 55,000. Credit Remi, Capital 55,000. Explanation: “To record transfer of partner interest.”

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 increases the 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.

Journal entry dated January 1, 2021. Debit Cash 55,000. Credit Remi, Capital 55,000. Explanation: “To record new partner investment.”

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.

Total capital of Acorn Lawn & Hardscapes $100,000. Investment by new partner, Remi 65,000. Total capital of new partnership 165,000. Remi’s capital credit (one-third of $165,000) 55,000. Total bonus to Dale and Ciara 10,000.
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%)=$5,000Ciara:($10,000×50%)=$5,000Dale:($10,000×50%)=$5,000Ciara:($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.

Journal entry dated January 1, 2021. Debit Cash 65,000. Credit Dale, Capital 5,000; Ciara, Capital 5,000; Remi, Capital 55,000. Explanation: “To record bonus to old partners.”

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.

Total capital of Acorn Lawn & Hardscapes $110,000. Investment by new partner, Remi 40,000. Total capital of new partnership 150,000. Remi’s capital credit (one-third of $150,000) 50,000. Total bonus to Remi 10,000.
Figure 15.7 Breakdown of Allocation of Bonus to New Partner. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

To allocate the $10,000 bonus that each of the old partners will contribute to the new partner, Remi, make the following calculations.

Dale:($10,000×50%)=$5,000Ciara:($10,000×50%)=$5,000Dale:($10,000×50%)=$5,000Ciara:($10,000×50%)=$5,000

The journal entry to record Remi’s admission and the payment of his bonus in the partnership records is as follows:

Journal entry dated January 1, 2021. Debit Cash 40,000; Dale, Capital 5,000; Ciara, Capital 5,000. Credit Remi, Capital 50,000. Explanation: “To record payment of bonus from old partners to new partner.”

Withdrawal of Partner

Now, let’s explore the opposite situation—when a partner withdraws from a partnership. Partners may withdraw by selling their equity in the business, through retirement, or upon death. The withdrawal of a partner, just like the admission of a new partner, dissolves the partnership, and a new agreement must be reached. As with a new partner, only the economic effect of the change in ownership is reflected on the books.

When existing partners buy out a retiring partner, the case is the opposite of admitting a new partner, but the transaction is similar. The existing partners use personal assets to acquire the withdrawing partner’s equity and, as a result, the partnership’s assets are not affected. The only effect in the partnership’s records is the change in capital accounts. For example, assume that, after much discussion, Dale is ready to retire. Each partner has capital account balances of $60,000. Ciara and Remi agree to pay Dale $30,000 each to close out his partnership account. To record the withdrawal of Dale from the partnership, the journal entry is as follows:

Journal entry dated January 1, 2021. Debit Dale, Capital 60,000. Credit Ciara, Capital 30,000; Remi Capital, 30,000. Explanation: “To record withdrawal of a partner.”

Note that there is no change to the net assets of Acorn Lawn & Hardscapes—only a change in the capital accounts. Ciara and Remi now have to create a new partnership agreement to reflect their new situation.

Partnership Buys Out Withdrawing Partner

When a partnership buys out a withdrawing partner, the terms of the buy-out should follow the partnership agreement. Using partnership assets to pay for a withdrawing partner is the opposite of having a new partner invest in the partnership. In accounting for the withdrawal by payment from partnership assets, the partnership should consider the difference, if any, between the agreed-upon buy-out dollar amount and the balance in the withdrawing partner’s capital account. That difference is a bonus to the retiring partner.

This situation occurs when:

  1. The partnership’s fair market value of assets exceeds the book value.
  2. Goodwill resulting from the partnership has not been accounted for.
  3. The remaining partners urgently want the withdrawing partner to exit or want to show their appreciation of the partner’s contributions.

The partnership debits (or reduces) the bonus from the remaining partners’ capital balances on the basis of their income ratio at the time of the buy-out. To illustrate, Acorn Lawn & Hardscapes is appreciative of the hard work that Dale has put into its success and would like to pay him a bonus. Dale, Ciara, and Remi each have capital account balances of $60,000 at the time of Dale’s retirement. Acorn Lawn & Hardscapes intends to pay Dale $80,000 for his interest. Ciara and Remi will do this as follows:

  1. Calculate the amount of the bonus. This is done by subtracting Dale’s capital account balance from the cash payment: ($80,000 – $60,000) = $20,000.
  2. Allocate the cost of the bonus to the remaining partners on the basis of their income ratio. This calculation comes to $10,000 each for Ciara and Remi ($20,000 × 50%).

The journal entry to record Dale’s retirement from the partnership and the bonus payment to reflect his withdrawal is as shown:

Journal entry dated January 1, 2021. Debit Dale, Capital 60,000; Ciara, Capital 10,000; Remi, Capital 10,000. Credit Cash 80,000. Explanation: “To record retirement of a partner with a bonus payment.”

In some cases, the retiring partner may give a bonus to the remaining partners. This can happen when:

  1. Recorded assets are overvalued.
  2. The partnership is not performing well.
  3. The partner urgently wants to leave the partnership

In these cases, the cash paid by the partnership to the retiring partner is less than the balance in his or her capital account. As a result, the other partners receive a bonus to their capital accounts based on the income-sharing ratio established prior to the withdrawal.

As an example, each of three partners of Acorn Lawn & Hardscapes has a capital balance of $60,000. Dale has another opportunity and is eager to move on. He is willing to accept $50,000 cash in order to retire. The difference between this cash amount and Dale’s capital account is a bonus to the remaining partners. The bonus will be allocated to Ciara and Remi based on the income ratio at the time of Dale’s departure.

The journal entry to record Dale’s withdrawal and the bonus to Ciara and Remi is as shown:

Journal entry dated January 1, 2021. Debit Dale, Capital 60,000. Credit Cash 50,000; Ciara, Capital 5,000; Remi, Capital 5,000. Explanation: “To record withdrawal of a partner and a bonus payment to remaining partners.”

When a partner passes away, the partnership dissolves. Most partnership agreements have provisions for the surviving partners to continue operating the partnership. Typically, a valuation is performed at the date of death, and the remaining partners settle with the deceased partner’s estate either directly with cash or through distribution of the partnership’s assets.

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