Partnership accounting tutorial
A partnership is a business entity with two or more owners joined to do business together. Partnerships require different accounting procedures for formation, withdrawal, profits and losses, and liquidation.
There are three ways to account for partnership admissions: bonus, goodwill and exact methods. Partners may only use one method when admitting a partner. The method used depends on if the partners elect to grant a bonus, goodwill or neither.
Use the bonus method when the purchase price of a partnership interest is more or less than the new partner's capital account and the partners elect not to use goodwill. For the bonus method, add the total capital accounts to the amount paid by the new partner for an interest in the partnership. Multiply the sum by the new percentage of ownership the new partner has to obtain the partner's interest. The amount paid above or below the partner's interest is paid as a bonus. So if the total old capital accounts were £32,500 and a partner paid £19,500 for a 30% interest, take £32,500 and add it to £19,500 for £52,000. Multiply £52,000 by 30% to calculate the new partner's capital account's valued of £16,250. The £3,250 difference between the capital account and the amount paid is treated as a bonus to the other partners.
The goodwill method implies the value of the new partner's capital account; any remainder of the purchase price not used in the new partner's capital account is distributed as goodwill to the other partners. With the goodwill method, a total capital account is implied by multiplying the amount a partner paid for an interest by the inverse of the per cent of control he received. So if a new partner paid £19,500 for a 1/3 interest, multiply £19,500 by 3, to arrive at £58,500 as the implied value of the partnership capital account. Then subtract the total old capital accounts plus the cash paid by the new partner from the implied value to arrive at goodwill. If the old partnership had £26,000 in old capital accounts, the goodwill in the example would be £13,000, ($90,000 - £26,000 - £19,500). Goodwill is then distributed among the partners.
The exact method uses the purchase price as the new partner's capital account value, no goodwill or bonus is distributed. So, if a partner buys a percentage of ownership, say 25%, in the partnership, then to find the new partner's capital account value, divide the sum of the old capital accounts by (1-the new percentage interest). If before the new partner, partners total equity was £130,000, the new total capital interest is £173,332 ($200,000/.75). The new partner's capital account is £43,332 ($266,666 - £130,000)
Profits and Losses
Partners share profits evenly absent a partnership agreement. Partners share losses according to how the partners share profits.
Withdrawal of a Partner
Account for the withdrawal of a partner with either the bonus method or goodwill method. The bonus method first revalues all assets to fair value, then pays off the exiting partner the value of his capital account. The goodwill method first revalues all assets to fair value, then records goodwill as the difference between the partner's payout and the partner's capital account.
Liquidation of a Partnership
Liquidate partnership assets first to any creditors, then to the partner for an amount equal to their capital account.