UNIT 5: Partnership Organization And Operation

5.1 INTRODUCTION

Partnership is another form of organization, in addition to sole proprietorship and corporation.

Partnerships are common in retail establishments and in small scale manufacturing companies.
Similarly, if you enter a profession such as accounting, law, or medicine, you may find it
desirable to form a partnership with other professionals in your field. In this chapter, we will
discuss the essential features of partnerships, and explain the major issues in accounting for
partnerships.

5.2 DEFINITION AND CHARACTERISTICS OF A PARTNERSHIP

Definition of a partnership

Partnership is an association of two or more persons to carry, as co-owners, a business for profit.
In a partnership, there are at least two persons. The assets of the partnership are owned jointly by
the owners. The owners in a partnership are called partners. The partners share the profit or loss
of the partnership depending on their agreement.

Characteristics of a Partnership

Partnerships have several characteristics that have accounting implications. The principal
characteristics of the partnership form of business organization are described below:

a. Limited Life
A partnership has limited life. Its continuance as a going concern rests in the partnership
contract. A partnership may be ended voluntarily at any time through the acceptance of a new
partner into the firm or the withdrawal of the partner. A partnership may be ended in voluntarily
by the death or incapacity of a partner. In short, any change in the member of partners, regardless
of the cause, affects the dissolution of the partnership. Dissolution thus refers to changes in
ownership in the partnership. Dissolution does not necessarily mean that the business ends. If the
remaining partners agree, operations can continue without interruption by forming a new
partnership.
b. Unlimited Liability
Each partner is personally and individually liable for all partnership liabilities. The claims of the
creditors attach first to partnership assets and then to personal assets of any partner, regardless of
that partner’s equity in the company.

c. Voluntary Association of Individuals

A partnership is a voluntary association of two or more individuals based on a legally binding
contract. The contract may be written, oral, or implied. A partnership may be divided into two;
namely, general partnership and limited partnership. General partnership is a partnership in
which each partner is individually liable to creditors for the debts incurred by the partnership. In
a general partnership, individual partner should contribute from his/her personal assets if the
partnership becomes insolvent (unable to pay its debt). On the other hand, limited partnership is
a partnership in which the liability of some partners is limited to the amount of capital
investment. The remaining partners are general partners (partners who have unlimited liability).
However, a limited partnership must have at least one general partner who has unlimited
liability.

d. Mutual Agency
Mutual agency means that each partner acts on behalf of the partnership when engaging in
partnership business. The act of any partner is binding on all other partners, even when partners
act beyond the scope of their authority, as long as the act appears to be appropriate for the
partnership. Because of mutual agency, an individual should be extremely cautious in selecting
partners.

e. Nontaxable entity
The income of a partnership is not taxed as a separate entity. However, a partnership is required
to file an information tax return showing partnership net income and each partner’s share of net
income. Each partners’ share is taxable at personal tax rates, regardless of the amount of net
income withdrawn from the business during the year.

f. Co-ownership of Property
Partnership assets are co-owned by the partners. Once assets have been invested in the
partnership, they are owned jointly by all the partners. Moreover, if the partnership is terminated,
the assets do not legally revert to the original contributor. Each partner has a claim on total assets
equal to the balance in his/her respective capital account. This claim does not attach to specific
assets that an individual partner may have contributed to the firm.

Check your progress 5-1

1. A partnership may have only one partner. Do you agree?

2. The owner in a partnership is called --------------------.
3. List the principal characteristics of a partnership.
4. What are the two types of partnerships?

5.3 ADVANTAGES AND DISADVANTAGES OF A PARTNERSHIP

The advantages of a partnership include:

o A partnership is relatively easy and inexpensive to establish. It is relatively free
from government regulations and restrictions. (case of formation).
o A partnership enables to bring more capital, more skills, and more experience as
compared to sole proprietorship.
o The combined income taxes paid by the individual partners may be lower than the
income taxes that would be paid by a corporation.
o Decisions can be made quickly on substantial matters affecting the firm, whereas
in a corporation, formal meetings with the board of directors are often needed.
(i.e. ease of decision making)

Even though partnership has many advantages, it is not without limitations. Thus, the main
disadvantages (limitations) of a partnership include:
 Partnership has limited life.
 Partnership has unlimited liabilities.
 One partner can bind a partnership to contracts (i.e. mutual agency).
 Raising large amount of capital is more difficult for a partnership than for a
corporation.
Deciding Between Limited Liability Partnership (LLP) and corporation

1. Income status of the enterprise and of its owners.

owners. An LLP pays no income tax but is
required to file an annual information return showing its revenue and expenses, the
amount of its net income and division of the net income among the partners. A
corporation is a separate legal entity subject to a corporate income the amount of net
income distributed to shareholders in the form of dividend is taxable income to
shareholder.
2. Opportunity for obtaining large amount of capital.
capital. Corporations have better
opportunity than partnership in terms of raising larger amount of capital.

5.4 THE PARTNERSHIP AGREEMENT

A partnership is created by a contract expressing the voluntary agreement of two or more

individuals. Partnership may be formed in written, oral, or implied. If the partnership is formed
in writing, the contract is called partnership agreement, or articles of co-partnership. The articles
of co-partnership include such basic information as:

 The principal and location of the firm.

 The purpose of the business.
 Date of establishment.
 Names and capital contributions of partners.
 Rights and duties of partners.
 Basis for sharing net income or net loss.
 Provision for the withdrawal of assets.
 Procedures for submitting disputes to arbitration.
 Procedures for the withdrawal or addition of a partner.
 Rights and duties of surviving partners in the event of a partner’s death.
5.5 PARTNERSHIP FORMATION

Most of the day-to-day accounting for a partnership is the same as the accounting for any other
form of business organization. For example, the chart of accounts, with the exception of drawing
and capital accounts for each partner, does not differ from the chart of accounts of a similar
business conducted by a single owner. Transactions that are peculiar (unique) to partnership
organizations are:
 Formation of a partnership
 Income distribution
 Dissolution
 Liquidation

This topic deals with how to record the initial investments of each partner in the accounting
records of the partnership. The investment of each partner is separately recorded in a partnership.
Those assets, which are contributed by the partner, are debited to the proper asset accounts.
These assets should be recorded at their fair market value at the date of their transfer to the
partnership. All partners must agree to the values assigned to assets. Similarly, if liabilities are
assumed by the partnership, the appropriate liability accounts are credited. Then, the difference
between the assets and liabilities (net amount) should be credited to partner’s capital account.

To illustrate, assume that Lemma and Kassa established a partnership, called LK partnership on
October 10,2003. Lemma contributed cash of Br. 50,000, and Kassa contributed equipment,
which was purchased 4 years ago for Br. 70,000. The partners agreed that the market value of
this equipment is Br. 40,000. The entry to record the investment of each partner is shown below:

To record Lemma’s investment:

Cash……………………………………… 50,000
Lemma, capital…………………………….. 50,000

To record Kassa’s investment

Equipment……………………………….. 40,000
Kassa, capital………………………………. 40,000
Note that the original cost of the equipment (Br. 70,000) is no more relevant for the partnership
because the equipment should be recorded at its current market value.

After each partner’s investment is recorded properly, the capital of the partnership can be
determined. For the example under question, total capital of the partnership is computed as
follows:
Lemma, capital……………………………. 50,000
Kassa, capital……………………………… 40,000
Total capital………………………. 90,000

A balance sheet can also be prepared for the partnership after recording the partner’s
investments. Notes the following balance sheet for the partnership being described:

LK Partnership
Balance Sheet
October 10,2003
Assets Liabilities and Capital
Capital
Cash 50,000 Lemma, capital 50,000
Equipment 40,000 Kassa, capital 40,000
Total Assets 90,000 Total liab. &capital 90,000

At this time, LK partnership has no liability. No partner’s liability was transferred to the
partnership.

Example
Assume that Mamo and Worku agree to combine their sole proprietorships to start a partnership
named MW partnership. On November 2, 2003 their investments in the partnership are as
follows:

Items Book Value Market Value

Mamo Worku Mamo Worku
Cash Br. 7,000 8,000 Br. 7,000 Br. 8,000
Office Equipment 6,000 5,000
Accumulated Depreciation (2,000)
Accounts Receivable 3,000 3,000
 Allowance for Doubtful (800) (1,100)
Accounts
Total Br. 11,000 Br. 10,200 Br. 12,000 Br. 9,900

Besides the partnership agreed to assume the liabilities (accounts payable) of former sole
proprietorship, owned by Mamo, amounted to Br. 4,000.

Required
a. Prepare the entry to record the partner’s investments
b. Prepare the balance sheet for the new partnership on November 2, 2003.

Solution
a) Investment of Mamo:
Mamo:
Cash………………………………………… 7,000
Office equipment……………………………. 5,000
Accounts payable……………………………… 4,000
Mamo, capital…………………………………. 8,000

Investment of Worku:
Worku:
Cash…………………………………………….. 8,000
Accounts Receivable…………………………….. 3,000
Allowance for Doubtful Accounts………………………. 1,100
Worku, capital…………………………………………… 9,900

b) Balance Sheet
MW Partnership
Balance Sheet
November 2,2003
Assets
Cash (7,000 + 8,000) Br. 15,000
Accounts Receivable 3,000
 Less: Allowance for Doubtful 1,100 1,900
Accounts
Office equipment 5,000
Total assets 21,900
Liabilities and Capital
Accounts payable 4,000
Capital:
Mamo, capital 8,000
Worku, capital 9,900
Total capital 17,900
Total liabilities and capital 21,900
Note that both the original cost and the accumulated depreciation of the equipment are not
recorded by the partnership. The equipment is recorded at its market value (i.e. Br. 5,000). Since
the equipment has not been used by the partnership, there can be no accumulated depreciation. In
contrast, the gross claims on customers ((Br. 3,000) are carried forward to the partnership, and
the allowance for doubtful accounts is adjusted to Br. 1,100 instead of Br. 800. The difference
between Br. 3,000 and its related allowance for doubtful account is equal cash net realizable
value. i.e. the net amount that is expected to be received from customers on accounts receivable
of Br. 3,000.

After the partnership has been formed, the accounting for its transactions is similar to accounting
for transactions of any other type of business organization. The steps described in the accounting
cycle are equally applicable to a partnership. i.e.
 Journalize transactions
 Posting to accounts in the ledger
 Trail balance Preparation
 Worksheet Preparation
 Preparation of financial statements
 Journalizing and posting adjusting entries
 Journalizing and posting closing entries
 Post-closing trial balance preparation.

Ledger Accounts for partners

In accounting for partnership, there are three types of accounts for partners. There are
1. Capital Accounts
 2. Drawing or Personal Accounts
3. Accounts for loans to and from partners
To explain Accounts for loans to and from partners, a partner may receive cash from the
partnership with the intention of repaying it. Such transaction is recorded in partnership accounts
as follows:

Loans Receivable from partners ***

Cash ***

On the other hand, a partner may make a cash payment to the partnership that is considered a
loan rather than an increase in the partner’s capital account balance. Such transaction is recorded
as follows:

Cash ***
Loans payable to partners ***

Loans Receivable from Partners is an asset while Loans Payable to Partners is a liability.

Check your progress

1. How should a partner’s initial investment of non-cash assets be valued?

2. What are the transactions that are unique to partnership form of organization?
3. Suppose that Bacha and Chaltu decide to organize the partnership called BC partnership.
Bacha invests Br. 20,000 cash, and Chaltu contributes Br. 15,000 and equipment having a
book value of Br. 4,000. Prepare the entry to record the investment of each partner,
assuming that the equipment has a fair market value of Br. 4,500.

5.6 DIVISION OF NET INCOME OR NET LOSS

The partnership agreement should specify the basis for sharing net income or net loss. If the
partnership agreement failed to specify the basis of sharing net income or net loss, partnership
net income or net loss is shared equally. In other words, if the partnership agreement is silent as
to the manner in which net income or net loss is shared, the amount of net income or net loss is
shared equally. The same basis of division is usually applied to both net income and net loss.

The following are typical schemes (plans) that may be used to share net income or net loss.
1. A fixed ratio, expressed as a proportion (6:4, a percentage 60% and 40%) or a fraction
(2/3 and 1/3).
1/3).

Example
Suppose that TR partnership has net income of Br. 30,000 for 2002. The partners Tesfa, and
Rahel, agreed to share net income using a proportion of 6:4.

Required
a. Compute the share of net income for each partner.
b. Prepare the entry to record the share of net income.

Solution
a. Share of Net Income
Tesfa = 30,00 X 6/10 = Br. 18,000
Rahel = 30,000 X 4/10 = Br. 12,000
b. After the net income is shared between the partners, the share of each partner should be
recorded in the capital account of each partner. This is done to increase the balance of the
partner’s capital account. This entry is in essence, a closing entry and it is made as follows:

Income summary……………………………………………. 30,000

Tesfa, capital………………………………………………… 18,000
Rahel, capital………………………………………………… 12,000

The capital account of each partner is credited for the share of net income. If the amount is net
loss, the partner’s capital account is debited for the share. Income summary account is debited
because share of partnership net income is closed after revenues and expenses are closed.

That is, the following closing entries are made before net income or net loss is closed. These
are:-
i. Debit each revenue account for its balance and credit income summary for total revenues.
ii. Debit income summary for total expenses and credit each expense account for its balance.
After entry No.( I) and entry No.( ii) are posted, income summary account may have debit or
credit balance.
It will have credit balance if total revenues are greater than total expenses. Income summary
account will have debit balance if total expenses are greater than total revenues. A debit balance
in income summary account represents net loss.

Therefore, closing the share of net income/net loss by the partners is done after revenues and
expenses are closed to income summary account.

2.. A ratio based on capital balances at the beginning of the period.

period.
Partners may agree to share income or loss on the ratio of their beginning capital balance.

To illustrate, suppose that R and S have beginning capital balances of Br. 45,000 and Br. 55,000
respectively. The net income of the partnership is Br. 20,000 for year 2002. Partners agreed to
share income on the basis of capital balances at the beginning of 2002.
Based on the above data, the share of net income for each partner can be computed.
a. Partners share income as follows:
R = 45,000 X 20,000 = Br. 9,000
100,000
S = 55,000 X 20,000 = Br. 11,000
100,000

The denominator 45,000/100,000 is obtained by adding beginning capital balances of all

partners. In the example above, the denominator (Br. 100,000) is the sum of R capital and S
capital. The numerator represents the beginning capital balance of the partner for whom we are
computing the share of net income.

The entry to record the share of net income is shown below:

Income summary………………………………………………. 20,000
S. Capital………………………………………………………………. 9,000
R. Capital……………………………………………………………… 11,000

3. Salaries to partners and the remainder on some basis

As a means of recognizing differences in ability and amount of time devoted to the business,
articles of partnership often provide for the division of a portion of net income to the partners in
the form of salary allowance. The articles may also provide for withdrawals of cash by the
partners in lieu (instead of) salary payments. Therefore, a clear distinction must be made between
the division of net income (which is credited to the capital account) and payments to the partners
(which are debited to the drawing accounts)

Example
Assume that the articles of partnership of Hanna and Sosina provide for monthly salary
allowances of Br. 500 and Br. 600 respectively. The net income for the year is Br. 60,000. The
remaining net income is divided equally.

Required
a. Compute the share of net income for each partner.
b. Prepare the entry to close the share of net income.

Solution
a. Annual Salary:
Hanna = 500 X 12 = Br. 6,000
Sosina = 600 X 12 = Br. 7,200

Division of Net Income:

Tota
Hanna Sosina l
Salary allowance 6,000 7,2000 13,200
Remaining Income 23,400 23,400 46,800
Net Income 29,400 30,600 60,000

b. Closing entry:
Income summary…………………………………………………. 60,000
Hanna, capital……………………………………………………. 29,400
Sosina, capital…………………………………………….……….. 30,600
4. Interest on partner’s capital and the remainder on some basis.
This scheme is used by the partners when one partner contributed large portion of capital than
the other. In order to recognize differences in capital investments, interest may be allowed on
capital as a means of dividing net income or net loss.

To illustrate, assume that Haile and Getachew have beginning capital balances of Br. 40,000 and
Br. 70,000 respectively. The partnership agreement states that the partners are allowed interest at
10% on beginning capital balances. The remaining net income is to be shared equally. Assume
further that the company generated net income of Br. 18,000 in the year.

The division of income is shown below:

Interest allowances:
Haile = 40,000 X 10% X 1= 4,000
Getachew = 70,000 X 10% X 1 = 7,000
Division of net income:
Hai
le Getachew Total
Interest allowance 4,000 7,000 11,000
Remaining income 3,500 3,500 7,000
Net income 7,500 10,500 18,000

Closing entry for income division is presented below::

Income summary………………………………………………….. 18,000
Haile, capital…………………………………………………………..7,500
Getachew, capital…………………………………………………….10,500

5. Salaries to partners, interest on partners’ capital, and the remainder on some basis.
Partners may agree that the most equitable plan of income sharing is to allow salaries based on
the services rendered and also to allow interest on the capital investments. The remainder is then
shared in an arbitrary ratio.

Example
Assume that Serkalem and Ayantu are partners in the SA partnership. The partnership agreement
provides for:
- Annual salary allowances of Br. 5,000 to Serkalem and Br. 9,000 to Ayantu.
- Interest allowances of 10% on capital balances at the beginning of the year.
- The remainder equally.
Capital balances on January 1 were Serkalem, Br. 24,000, and Ayantu, Br. 20,000. In 2002,
partnership net income is Br. 25,000.

Required
a. Compute the division of net income
b. Prepare the entry to record the division of net income.

Solution
a. Interest allowances:
Serkalem = 24,000 X 10% = 2,400
Ayantu = 20,000 X 10% = 2,000
Division of Net Income:
Serkale Ayan Tota
m tu l
Interest 2,400 2,000 4,400
Allowance
Salary Allowance 5,000 9,000 14,000
Remaining 3,300 3,300 6,600
Income
Net Income 10,700 14,300 25,000
b. Closing entry:
Income summary…………………………………. 25,000
Serkalem, capital…………………………………………………10,700
Ayantu, capital……………………………………………………14,300

Sometimes the sum of interest allowance and salary allowance may exceed the amount of net
income. For example, consider the above example and assume that net income is Br. 15,000
instead of Br. 25,000. The net income will be shared as follows:

Division of Net Income

Serkal Ayant Tot
em u al
Interest allowance 2,400 2,000 4,400
Salary allowance 5,000 9,000 14,000
Total allowances 7,400 11,000 18,400
Excess of allowances over (1,700) (1,700) (3,400)
income
Net Income 5,700 9,300 15,000

6. Equally
If each of the partner is to contribute equal services and amounts of capital, an equal sharing in
partnership net income would be equitable. That is, partners may agree to share income or loss
equally.
Example
Suppose that Sara and Tsige have capital balance of Br. 50,000 each in the partnership of SATE
partnership. Sara and Tsige have the same qualifications and contribute equal service to the
company. The net income for the year is B r. 3,000. Compute the division of net income if they
agreed to share income equally.
equally

Solution
Division of net income:
Sara = 3000/2= 1,500
Tsige = 3000/2 = 1,500

6. Income Sharing based on bonus to managing partner

A specified percentage of income may be provided to the managing partner in the form of bonus.
The partnership contract should state clearly whether the percentage is applied to net income
before deducting bonus, or net income after bonus.

To illustrate, assume that A is a managing director in AB partnership which is owned by A and B

. Net income for the year is Br. 40000. The partnership agreement states that net income is to be
shared based on bonus and the remaining equally. The director is allowed 20% bonus.

If the percentage is applied to income after tax, the amount of bonus to A and income sharing is
shown below:

Bonus = 40,000 ╳ 20% = 8000

A B Total

Bonus 8,000 ___ 8,000

Remaining income 16,000 16,000 32,000
Net income 24,000 16,000 40,000
On the other hand, if the percentage is applied to net income before bonus, the amount of bonus
is shown below:

Bonus + NI after bonus= Income before bonus

Let X = Net Income After bonus
0.20 ╳ + ╳ = 40,000
 1.20 ╳ = 40,000
╳ = 33,333
Bonus = 0.20 ╳ = 0.20 ╳ 33,333 = 6667

A B Total

Bonus 6667 __ 6667

Remaining income 16,666,50 16,666,50 33,333
Net income 23,333,50 16,666,50 40,000

Check your progress 5-3

1. Suppose that in a partnership of Sara and Mitiku, both partners have equal amount of capital
investments. However, Sara gives more time and service to the partnership than Mitiku. Which
income division scheme do you suggest to the partners?

2. A partnership of Tsefaye and Adane generated a net loss of Br. 20,000 in 2002. The
partnership agreement states that income is to be divided on the basis of 60% to Tesfaye and
40% to Adane.

Required
a. Compute the amount of net loss to be divided between the partners.
b. Prepare the entry to record the division of net loss.

3. On January 1, 2002, the capital balances of Nigat and Solomon are Br. 200,000 and Br.
300,000 respectively in NS partnership. During 2002, the company reported net income of Br.
60,000.
60,000
Assumptions
a. Partners agreed to share income 2/3 to Nigat and 1/3 to Solomon.
b. Partners agreed to share income on the basis of beginning capital balances.
c. The articles of partnership provides for monthly salary allowances of Br. 1,000 to Nigat
and Br.800 to Solomon, and the remainder to be divided equally.
d. The articles of partnership provide interest allowance of 10% of beginning capital
balance, and the remainder to be divided 30% to Nigat and 70% to Solomon.
e.The
e.The articles of partnership provide yearly salary allowance of Br. 15,000 to Nigat, and Br.
12,000 to Solomon; interest of 10% on beginning capital balance, and the remainder
equally.
f. The partners agreed to share income or loss equally.
Required
Compute the division of income/loss to each partner under each of the above assumptions:

Withdrawals in A Partnership
Withdrawal refers to the taking out of cash or other assets by the partner from the partnership. In
a partnership, withdrawal may be made in lieu (instead) of salary allowances, and/or for personal
purposes. Regardless of the purpose for which the asset is withdrawn, the partner’s drawing
account is debited and the asset withdrawn is credited.

Example
Assume that DB partnership is owned and operated by Demeke and Bekele. During the month,
Bekele withdrew cash of Br. 3,000 from the partnership. Prepare the entry to record the
withdrawal.

Solution
The withdrawal is debited to Bekele’s drawing account, and credited to cash, i.e.

Bekele, Drawing…………………………………….. 3,000

Cash………………………………………………………. 3,000

Bekele, drawing account is a temporary capital account. As a result, it is closed to Bekele, capital
at the end of the period. The closing entry is presented below:
Bekele, Capital………………………………………. 3,000
Bekele, Drawing………………………………………… 3,000

Withdrawal decreases the balance of capital. Thus, Bekele’s capital is decreased by Br. 3,000
during the month.

5.7 FINANCIAL STATEMENTS FOR A PARTNERSHIP

The financial statements of a partnership are similar to those of a sole proprietorship. There are
three financial statements for a partnership. These are income statement, capital statement (or
statement of owner’s equity) and balance sheet.

The income statement of partnership similar with that of sole proprietorship except that the
income statement of the partnership discloses the details of the division of net income. The
following is the partial income statement of H and G partnership in which Haile and Getachew
have capital balances of Br. 40,000 and Br. 70,000 respectively. The net income of the
partnership for the year ended December 31, 2002 was Br. 18,000. The partnership agreement
provided interest allowance of 10% on beginning capital balances and the remaining income to
be shared equally.

H and G partnership
Partial Income Statement
For the year ended December 31,2002
Net Income………………………………………………………………………Br. 18,000

Division of Net Income:

Getach
Haile ew Total
Interest allowance Br. 4,000 Br. 7,000 Br. 11,000
Remaining Income 3,500 3,500 7,000
Net Income Br. 7,500 Br. 10,500 Br. 18,000
Therefore, the bottom part of income statement for a partnership includes the manner in which
income or loss was divided.
The capital statement of the partnership is different from sole proprietorship in the sense that
there are more than two owners in a partnership. Capital statement shows or explains the changes
in each partner’s capital account and in total partnership capital during the year. Changes in
capital results from three causes; namely, additional investments, drawing, and net income/net
loss.

To exemplify, assume the data given for H and G partnership and consider the following
additional information:
H Getach
aile ew
Additional Investment Br. 15,000 Br. 16,000
Drawings 8,000 7,500

The capital statement of H and G partnership is shown below:

H and G partnership
Capital Statement
For the year ended December 31, 2002
Hail
e Getachew Total
Capital, January 1 40,000 70,000 110,000
Add: Additional Investment 15,000 16,000 31,000
Net Income 7,500 10,500 18,000
Sub total 62,500 96,500 159,000
Less: Drawings 8,000 7,500 15,500
Capital, December 31 54,500 89,000 143,500
The sources of information for the preparation of capital statement are income statement,
partner’s capital account, and drawing accounts.

The balance sheet for a partnership is the same as that of a sole proprietorship except in the
owner’s equity section. In a partnership, the capital balances of each partner are shown in the
balance sheet. The owner’s equity section for H and G partnership is shown in the following
partial balance sheet.
 H and G partnership
Partial Balance Sheet
December 31,2002

Total Liabilities (assumed amount) Br. 75,000

Owner’s equity (capital)
Haile, capital Br. 54,500
Getachew, capital 89,000
Total owner’s equity 143,500
Total liabilities and owner’s equity Br. 21,500

Check your progress 5-4

In the ABC Company, beginning capital balances on January 1,2003 are Abebe Br. 20,000,
Bekele Br. 60,000 and Chala Br. 35,000. During the year, drawings were Abebe Br. 8,000,
Bekele Br. 12,000, and Chala Br. 10,000. Net income was Br. 40,000. The partners share income
in the ratio of 3:4:3.

Required
a. Compute the division of net income.
b. Prepare capital statement for the year.
c. Prepare the owner’s equity section of the balance sheet at December 31, 2003.

5.8 PARTNERSHIP DISSOLUTION

Partnership type of organization is characterized by limited life. Any change in the members
(ownership) results in the dissolution of the partnership. Factors that result in partnership
dissolution are admission of new partner, withdrawal of the existing partner, death, or
bankruptcy. The winding up of the affairs of the business does not necessarily follow dissolution
of a partnership. When a partnership is dissolved, a new partnership may be formed and the new
article of partnership should be prepared.
The following section describes accounting for the dissolution of a partnership.

5.8.1 Admission of a new partner

An additional person may be admitted to a partnership enterprise only with the consent of all the
current partners. The admission of a new partner results in the legal dissolution of the existing
partnership, and the beginning of a new partnership. However, from an economic standpoint, the
admission of a new partner (or partners) may be of minor significance in the continuity of the
business.

A new partner may be admitted to a partnership in one of the following two ways. These are:-
a. Purchasing the interest of one or more existing partners.
b. Investing assets in the partnership.

5.8.1.1 Admission of a partner by purchasing the existing partner’s interest

The capital interest of the incoming partner is obtained from one or more of the current partners.
The admission of a partner by purchase of an interest in the firm is a personal transaction
between one or more of the existing partners and the new partner. Each party is acting as an
individual separate from the partnership entity. The price paid is negotiated and determined by
the individuals involved. In a purchase of an interest, the partnership is not a participant in the
transaction. No cash is distributed from the partnership. The amount of the purchase price passes
directly from the new partners to partners who are giving up part or all of their ownership claims.
Upon purchase of an interest, the new partner acquired each selling partner’s capital interest, and
income-sharing ratio is decided then.

Note that the selling partner does not have to obtain the approval of the other partners to sell his
or her interest. However, some partnership acts may state that the purchaser does not become a
partner until he/she is accepted into the firm by the continuing partners.

Accounting for the purchase of an interest is straightforward. The only entry needed in the
records of the partnership is the transfer of the proper amounts of owner’s equity from the capital
account of the selling partner to the capital account of the incoming (new) partner. That is, the
capital account is debited for the ownership sold, and the capital account of the incoming partner
is credited for the ownership obtained.
Note that the amount of cash paid to the selling partner may be greater, less than or equal to the
ownership obtained. Regardless of the amount of payment, the capital accounts of the partners
are recorded at the ownership received.
When a new partner is admitted to a partnership by purchasing ownership interest, the total
assets and total capital of the partnership are not changed.

Example
Assume that Kassa and Tollera agreed to sell one third of their interest to Assefa. At the time of
admission of Assefa, each partner has a Br. 48,000 capital balance. Assume that Assefa paid Br.
18,000 each to the selling partners for 1/3 interest acquired.

Required
a. Prepare the entry to record the admission of Assefa.
b. Compute the total capital of the partnership after admission.

Solution
a. Kassa, Captial (48,000 – 16,000) …………………………. 16,000
Tollera, Capital (48,000 X1/3)………………………………16,000
Assefa, capital (48,000 X 1/3 X 2)………………………………..32,000

b. Total Capital
Assefa, Capital…………………………………32,000
Kassa, Capital (48,000 – 16,000)………………32,000
Tolera, cpatial (48,000 – 16,000)………………32,000
16,000)………………32,000
Total capital……………………………………96,000
capital……………………………………96,000

Note that the total capital of the partnership before the admission (48,000 + 48,000 = Br. 96,000)
is the same as after the admission of Assefa (Br. 96,000). Assefa’s ownership interest is one-third
of the selling partner capital balance (Br. 16,000) regardless of the amount of cash he paid. In the
foregoing example, Assefa paid Br. 18,000 to get ownership interest of Br. 16,000. The entry is
the same whether the amount Assefa paid to the selling partner is equal to, greater than, or less
than Br. 16,000. This implies that the amount paid by the buyer has no effect on the entry when
the new partner is admitted to a partnership by purchasing the ownership interest from one or
more of the existing partners.

5.8.1.2 Admission by investment of assets in a partnership

Instead of buying an interest from the current partners, the incoming partner may contribute (or
invest) assets to the partnership. The admission of a new partner by an investment of assets is a
transaction between the new partner and the partnership. In this case, the transaction increases
both the assets and capital of the partnership. The investment by the new partner may be cash,
equipment, furniture, automobile, or other asset. The market value of the asset contributed to the
partnership is debited to the appropriate asset account and credited to capital account of the new
partner.

Example
Assume that Demere and Adugna are partners with capital balances of Br. 40,000 and Br. 55,000
respectively. On December 1, 2003, they agreed to admit Bulcha for cash investment of Br.
30,000, for which he is to receive ownership equity of Br. 30,000.

Required
1. Compute total capital of the partnership before Bulcha’s admission.
2. Prepare the entry to record Bulcha’s admission.
3. Determine total capital of the partnership after admission.

Solution
1. Total capital before Bulcha’s admission:
Demere, capital…………………………………. Br. 40,000
Adugna, capital…………………………………. 55,000
Total capital…………………………… Br. 95,000
2. Entry to record Bulcha’s admission is:
Cash……………………………………….30,000
Bulcha, capital……………………………. 30,000
3. Total partnership capital after Bulcha’s admission:
Demere, capital……………………………………. Br. 40,000
Adugna, capital……………………………………. 55,000
Bulcha, capital…………………………………….. 30,000
Total capital……………………………… Br. 125,000

Note that Bulcha’s cash investment of Br. 30,000 increases the total capital of the partnership by
Br. 30,000 (i.e. 125,000 – 95,000 = 30,000). Total assets of the partnership are also increased by
Br. 30,000. Due to this transaction, the capital balances of the existing partners are not affected.

At the time of admitting new partner by investing assets, the partnership assets should be stated
in terms of their current market values. If the partnership assets are not fairly stated at their
current market value, the capital accounts of the old partners should be adjusted accordingly. The
net increases or decreases in assets of old partnership due to revaluation should be allocated to
old partners capital accounts according to their income-sharing ratio. It is only then that the
investment of new partner should be recorded.

Example
Assume that Adanech and Tigist are partners with capital balances of Br. 70,000 and Br. 50,000
respectively. On December 1,2003, they agreed to admit Kidist for cash contribution of Br.
40,000, for which she is to receive an ownership equity of Br. 40,000. Assume that the balance
of equipment account had been Br. 90,000 before Kidist’s admission and its current market value
is Br. 110,000. Adanech and Tigist share income equally.

Required
a. Determine total capital of the partnership before revaluation.
b. Prepare the entry to record the revaluation of equipment.
c. Compute the capital balance of each partner after revaluation, but before Kidist’s
admission.
d. Prepare the entry to record the admission of Kidist.
e. Determine the partnership’s total capital after the admission of Kidist.

Solution
a. Total capital before revaluation
 Adanech, capital…………………………………………………….. Br. 70,000
Tigist, capital………………………………………………………..
50,000
Total capital………………………………………………. Br. 120,000

b. The entry to record asset revaluation:

Increase in equipment value = 110,000 – 90,000 = 20,000
Share of increase in value of equipment between old partners.
Adanech = 20,000/2 = 10,000
Tigist = 20,000/2 = 10,000
Entry
Equipment ……………………………………………………..20,000
Adanech, capital………………………………………….. 10,000
Tigist, capital……………………………………………… 10,000

If a number of assets are revalued, the adjustments may be debited to a temporary account called
Asset Revaluation. After all adjusting entries are made, the account is closed to the capital
accounts. For the ongoing example, if assets revaluation account is used, the adjusting entry and
closing entry are made as follows:

Adjusting entry
Equipment………………………………………………….20,000
Asset Revaluation………………………………………… 20,000

Closing Entry
Asset Revaluation………………………………………….20,000
Adanech, capital………………………………………… 10,000
Tigist, capital……………………………………………. 10,000

If the current market value of the asset is less than its book value, adjusting entry debits old
partners capital accounts and credits the asset account (if asset revaluation is not used).
 c. Old partners capital balance after revaluation:
Adanech, capital (70,000 + 10,000)…………………….. Br. 80,000
Tigist, capital (50,000 + 10,000)……………………….. 60,000
Total capital……………………………………………. Br. 140,000

d. The entry to record Kidist’s admission:

Cash……………………………………… 40,000
Kidist, capital…………………………………. 40,000

e. Total capital after admission:

Adanech, capital……………………………………….. Br. 80,000
Tigist, capital………………………………………….. 60,000
Kidist, capital………………………………………….. 40,000
Total capital………………………………….. Br. 180,000

Note that the partnership capital is increased by Br. 60,000. Also note that Kidist;s interest in the
partnership is 22% (i.e. 40,000/180,000 = 22%). This does not mean that Kidist will share 22%
of the income of the partnership. It may or may not be equal to the 22% capital interest. Since the
new partnership agreement will be written, a new income-sharing ratio will be agreed upon.

In the case of admission by the investment, further complications occur when the new partner’s
investment differs from the capital equity acquired. When those amounts are not the same, the
difference is considered the bonus either to (1) the existing (old) partners or (2) the new partner.

Bonus to old partners

The existing partners may be unwilling to admit a new partner without receiving a bonus for both
personal and business reasons. In an established firm, existing partners may insist on a bonus as
compensation for the personal scarifies they have made for the company over the years. Two
accounting related factors underline the business reason. These are:
1. Total capital of the partnership equals the book value of the recorded assets of the
partnership. At the time the new partner is admitted, the fair market values of assets such
as land and building may be higher than their book values.
2. When the partnership has been profitable, goodwill exist.
In such cases, the new partner is usually willing to pay the bonus to become a partner. A bonus
to old partners results when the new partner’s capital credit (acquired ownership interest) on the
date of admittance is less than her/his investment in the firm. The bonus results in an increase in
the capital balances of the old partners. The bonus is allocated to them on the basis of income
sharing ratio before the admission of the new partner.

The procedures for determining the ownership of the new partner and the bonus to the old
partners are described below:
Step 1: Determine the total capital of the new partnership by adding the new partner’s investment
to the total capital of the old partnership.
Step 2: Determine the new partner’s ownership interest by multiplying the total capital of the
new partnership by the new partner’s ownership interest percentage.
Step 3: Determine the amount of bonus
New partner’s investment………………………………………………….. xxx
Less: new partner’s ownership interest…………………………………… xxx
Amount of Bonus…………………………………………………………. xxx
Step 4: Allocate the bonus to the old partners on the basis of their income-sharing ratio.

Example
Assume that Hawi and Melat have capital balances of Br. 100,000 and Br. 120,000 respectively
in HAME partnership. Naol acquires a 25% ownership (capital) interest by making cash
investment of Br. 90,000 in the partnership. According to partnership agreement, Hawi and
Melat share income as follows: Hawi, 60%, and Melat, 40%.

Required
1. Compute:
a. The total capital of the new partnership.
b. The ownership interest of Naol.
c. The amount of bonus to old partners.
d. The share of bonus by old partners.
2. Prepare the entry to record the admission of Naol.

Solution
1) (a). Total capital of new partnership before bonus:
Hawi, capital………………………………………. Br. 100,000
Melat, capital……………………………………… 120,000
Naol’s investment………………………………… 90,000
Total ……………………………………. Br. 310,000
(b). Naol’s ownership interest = 310,000 X 25% = Br. 77,500
( c). Bonus = Naol’s investment – Naol’s capital (ownership interest)
= 90,000 – 77,500
= 12,500
(d). Share of bonus:
Hawi = 12,500 X 60% = Br. 7,500
Melat = 12,500 X 40% = 5,000

2) The entry to record the admission of Naol:

Cash………………………………………………… 90,000
Hawi, capital……………………………………….. 7,500
Melat, capital……………………………………….. 5,000
Naol, capital…………………………………………. 77,500

Some organizations refer to record the amount of bonus as goodwill. If this procedure is
followed, the required entries are made as follows:
(1) To record goodwill:
Goodwill………………………………………………….. 12,500
Hawi, capital…………………………………………………. 7,500
Melat, capital………………………………………………… 5,000
 (2) To record Naol’s admission:
Cash …………………………………………………………90,000
Naol, capital………………………………………………… 90,000

Bonus to new partner

If a partnership admits a new partner who is expected to improve the fortunes of the firm, old
partners may agree to give a bonus to new partner. In other words, the new partner possesses
resources or special attributes that are desired by the partnership. A bonus to a new partner
results when the new partner’s ownership equity is greater than his/her investment of assets in
the firm. For example, when bank interest rates are high, the new partner may be able to supply
cash that is urgently needed for expansion or to meet maturing debt. Alternatively, the new
partner may be a recognized expert or authority in a relevant field. For example, an engineering
firm may be willing to give known engineers a bonus to join the firm.

Similarly, the partner of a sporting goods store may offer a bonus to a spots celebrity in order to
add the athlet’s name to the partnership name.

Example
Assume that Helen invests Br. 60,000 in cash for a 30% ownership interest in the Hanna and
Hawi partnership, in which the capital balances of Hanna and Hawi are Br.90,000 and Br.
120,000 respectively. The old partners share income equally.
Required
a. Compute Helen’s capital
b. Prepare the entry to record the admission of Helen.
Solution
a. Helen’s capital:
Total capital of new partnership = 90,000 + 120,000 + 60,000 = 270,000
Helen’s equity = 270,000 x 30% = 81,000

b. Bonus to Helen = 81,000 – 60,000 = Br. 21,000

Allocation of Bonus:
Hanna = 21,000/2 = 10,500
Hawi = 21,000/2 = 10,500
Entry
Cash………………………………………………………………..…. 60,000
Hanna, capital………………………………………………………… 10,500
Hawi, capital…………………………………………………………. 10,500
Helen, capital……………………………………………………..….. 81,000

Check your progress 5-5

1. Assume that Hanna, Hawi, and Helen share income on a 5:3:2 basis. They have capital
balances of Br. 32,000 Br. 24,000, and Br. 21,000 respectively. When Tigist is admitted to the
partnership.

Required:
Prepare the entry to record the admission of Tigist under each of the following independent
assumptions:
a. Purchased one half of Hana’s equity for Br. 18,000.
b. Purchased one-half of Hawi’s equity for Br. 10,000.
c. Purchased one-half o Helen’s equity for Br. 9,000.

2. Assume that Gelena and Lemmesa share income on a 6:4 basis. They have capital balances of
Br. 90,000 and Br. 70,000 respectively, when Bacha is admitted to the partnership.

Required: prepared the entry to record the admission of Bacha under each of the following
independent assumptions:
a) Investment of Br. 80,000 cash for a one-fourth ownership interest with
bonuses to the existing partners.
b) Investment of Br. 40,000 cash for a one-fourth ownership interest with a
bonus to the new partner.

5.8.2 Withdrawal of a partner

A partner may withdraw from a partnership voluntarily by selling his/her equity in the firm, or
involuntarily by reaching mandatory retirement age or dying. Like the admission of a partner, the
withdrawal of a partner legally dissolves the partnership. The legal effects may be recognized in
accounting for a withdrawal by dissolving the firm. However, it is customary to record only the
economic effects. The partnership agreement should specify the terms of the withdrawal.

The withdrawal of a partner may be accomplished in two ways. These are:-

1. Selling to one or more of the remaining partners.
2. Payment from partnership assets.
Each of these ways of withdrawal will be explained in the following section.

5.8.2.1 Withdrawing by selling to one or more of the remaining partners

In this type of withdrawal, the withdrawing partner sells his/her ownership equity to one or more
of the existing partners. Payment is made to the withdrawing partner from the personal assets of
the buying partners, and not from partnership assets. The withdrawal of a partner when payment
is made from partner’s personal assets is the direct opposite of admitting a new partner who
purchases a partner’s interest. This transaction is a personal transaction between the partners.
Partnership assets are not involved in the withdrawal of the partner. As a result, the total assets
and total capital of the partnership are not changed. A change occurs only in individual partner’s
capital account. The required accounting entry debits the equity of the withdrawing partners, and
the capital account(s) of the buying partner(s). The amount received by the withdrawing partner
does not affect the entry. Whether the amount of cash received by the withdrawing partner is
equal to, less than, or greater than his/her ownership equity, the entry is the same. The entry
required to record the withdrawal is made after all assets are revalued to reflect their current
market value.

Example
Assume that Tsige, Kebede, and Tulu have capital balances of Br. 50,000, Br. 60,000, and Br.
45,000 respectively. Assume further that Kebede decides to withdraw from the partnership, and
Tsige and Tulu agree to buy Kebede’s ownership equity. Each of them agreed to pay Kebede Br.
35,000 in exchange for one-half of Kebede’s ownership interest of Br. 60,000.

Required
a. Compute the total capital before Kebede’s withdrawal
b. Prepare the entry to record Kebede’s withdrawal
c. Determine the capital balance of each partner and total capital after Kebede’s withdrawal.
Solution
a. Total capital before withdrawal:
Tsige, capital…………………………………………. Br. 50,000
Kebede, capital……………………………………….. 60,000
Tulu, capital………………………………………….. 45,000
Total capital………………………………………….. Br. 155,000

b. The entry to record the withdrawal:

Kebede, capital……………………………………… 60,000
Tsige, capital………………………………. 30,000
Tulu, capital……………………………….. 30,000

c. Capital balance of each partner and total capital after withdrawal:

Tsige, capital (50,000 + 30,000) ……………………. Br. 80,000
Tulu, capital (45,000 + 30,000)……………………… 75,000
Total capital…………………………………………. Br. 155,000

Note that the total capital of the partnership remains the same at Br. 155,000. Note also that the
Br. 70,000 paid to Kebede is not recorded. Similarly, Tsige capital is credited only for Br.
30,000, not the Br. 35,000 she paid. Tsige and Tulu will sign new articles of partnership.
partnership

5.8.2.2 Payment from Partnership assets to the Withdrawing partner

Using partnership assets to pay for a withdrawing partner’s equity is the reverse of admitting a
new partner through investment of assets in the partnership. Payment from partnership assets is a
transaction that involves the partnership. Thus, both total assets and total capital of the
partnership are decreased. The withdrawing partner will be settled with the amount equal to
his/her capital balance. This capital balance is determined by revaluing the current market value
of the assets. This is the case when the fair market values of the assets at the time of the partner’s
withdrawal are different from the recorded value of these assets. Any difference between the
current market value and book value of the assets should be divided between (among) the
partners’ capital accounts and adjusting entry is made accordingly.

Example
Assume that Tigist, Tesfa, and Meseret have capital balances of Br. 20,000 Br. 18,000, and Br.
26,000 respectively at the time Tigist decided to withdraw. At the same time, merchandise
inventory with a book value of Br. 5,000 has market value of Br. 7,000. The partnership has paid
Tigist’s interests after adjusting for the difference in merchandise inventory value. The partners
share income on 5:3:2 basis.

Required
1. Prepare adjusting entry to revalue merchandise inventory.
2. Compute each partner’s capital balance.
3. Prepare the entry to record the withdrawal of Tigist.

Solution
1. Merchandise inventory………………………………………….. 2,000
Tigist, capital (2000 X 5/10)………………………………………… 1,000
Tesfa, capital (2000 X 3/10)…………………………………………. 600
Meseret, capital (2000 X 2/10)………………………………………. 400

2. Partners’ capital balances:

Tigist, capital (20,000 + 1,000)………………………21,000
Tesfa, capital (18,000 + 600)………………………18,600
Meseret, capital (18,000 + 400)…………………… 18,400
Total capital…………………………….. 58000

3. The entry to record Tigist’s withdrawal:

Tigist, capital……………………………………. 21,000
Cash………………………………………………… 21,000

After Tigist’s withdrawal, total capital of the partnership is equal to Br. 45,000 (i.e. 18,600 +
26,400 = 45,000)

Check your progress 5-6

 1. Lemma, Amare, and Getu have capital balances of Br. 32,000, Br. 38,000 and Br. 36,000
respectively, and their income sharing ratios are 5:2:3. Amare withdraws from the
partnership under each of the following independent assumptions:
a. Lemma and Getu agree to purchase Amare’s equity by paying Br. 20,000 each
from their personal assets. Each purchaser received 50% of Amare’s equity.
b. Lemma agrees to purchase all of Amare’s equity by paying B r. 42,000 cash from
his personal assets.
c. Getu agrees to purchase all of Amare’s equity by paying Br. 36,000 cash from his
personal assets.
Required
Prepare the entry to record the withdrawal of Amare under each of the above independent
assumption.

2. Assume that Solomon has a capital balance of Br. 45,000 ion S-K-L partnership. He decided
to withdraw from the partnership. The partnership agreed to settle Solomon’s ownership equity
from its assets.
Required
Prepare the entry to record the withdrawal of Solomon.

5.8.3 Death of a Partner

The death of a partner dissolves a partnership. When a partner dies it is necessary to determine
the partner’s at the date of death. This is done by:
1. Determining the net income or net loss for the fractional part of a year.
2. Closing the accounts.
3. Preparing financial statements.
Then the balance in the capital account of the deceased partner is transferred to a liability
account with the deceased’s estate. The surviving partners may continue the business or the
affairs may be wound up. The ownership equity is paid to the deceased person’s heir (s).
Example
Assume that XYZ partnership has three partners; namely X,Y & Z. Their capital balances on
January 1, 2003, the beginning of the fiscal period, are X Br. 12,000, Y Br. 15,000 and 2 Br.
19,000. Partner Y has died on August 30, 2003. Net income for the period between January 1
and August 30,2003 is Br. 8,000. The partners agreed to share income on 4:4:2. Y’s legal heir is
W.

Required
1. Compute the share of net income on August 30.
2. Prepare the entry to record the division of net income.
3. Determine each partner’s capital balance.
4. If W decides to take the ownership equity of Y from the partnership, prepare the entry to
record the payment to W.
5. If W decides to join the partnership in place of Y, prepare the entry to record the
admission of W.

Solution
1. Division of Net Income:
X = 8,000 X 4/10 = 3,200
Y = 8,000 X 4/10 = 3,200
Z = 8,000 X 2/10 = 1,600

2. Entry to record the division of net income:

Income summary……………………………………8,000
summary……………………………………8,000
X, capital………………………………………… 3,200
Y, capital………………………………………… 3,200
Z, capital………………………………………… 1,600

3. Partner’s capital balances:

X, capital = 12,000 + 3,200 = 15,200
Y, capital = 15,000 + 3,200 = 18,200
Z, capital = 19,000 + 1,600 = 20,600

4. Y, capital …………………………………… 18,200

 Cash……………………………………………….. 18,200

5. Y, capital…………………………………….. 18,200
W, Capital………………………………………… 18,200

5.9 SUMMARY

A partnership form of organization is owned and operated by two or more persons for the
purpose of profit. It is characterized by limited life, unlimited liabilities, mutual agency, non
taxability and so on.

Partnership agreement may be in writing, orally, or impliedly. It is generally believed that

partnership agreement should be in writing to avoid minimize potential conflict between the
partners.

There are four unique (peculiar) transactions for partnership, namely, partnership formation,
division of net income, or net loss, partnership dissolution, and partnership liquidation, the first
three are dealt with in this chapter, and partnership liquidation will be addressed in unit six.

The possible means of sharing net income or net loss of the partnership are equally, based on
some fixed rations, based the services of the partners, based the partners’ capital investments of
the partnership liquidation may result due to admission of new partner, withdrawal of partner,
death of partner etc.

A new partner may be admitted to a partnership either by purchasing ownership interest from
one or more of the existing partners, or by investing assets into the partnership. On the other
hand, withdrawal of a partner may take either by selling the ownership interest to one or more of
the remaining partners, or by obtaining payment from the partnership.
5.10 ANSWER TO CHECK YOUR PROGRESS EXERCISES

Check your progress 5-1

1. I do not agree. A partnership should have at least two partners.
2. Partner.
3. Limited life, Association of individuals, unlimited liabilities, mutual agency, nontaxable
entity, and co-ownership of property.
4. General partnership and limited partnership

Check your progress 5-2

1. At fair market value
2. Partnership formation, income distribution, dissolution, and liquidation
3. Bacha’s Investment
Cash……………………………………………………….20,000
Bacha, capital…………………………………………….20,000
Chaltu’s Investment
Cash………………………………………………………15,000
Equipment………………………………………………….4,500
Chaltu, capital…………………………………………..19,500

Check your progress 5-3

1. The one that considers salary allowance
2.
a. Share of net loss:
loss:
Tesfaye = 20,000 X 60%= 12,000 ?????
Adane = 20,000 X 40% = 8,000
b. Tesfaye, capital……………………………………..12,000
Adane, capital……………………………………… 8,000
Income summary…………………………………..20,000
3.
a) Nigat = 2/3 X 60,000 = 40,000
Solomon = 1/3 x 60,000 = 20,000
b) Nigat = 200,000/500,000 X 60,000 = 24,000
 Solomon = 300,000/500,000 X 60,000 = 36,000
c) Salary allowances:
Nigat = 1,000 X 12 = 12,000
Solomon = 800 X 12 = 9,600
Niga Solom Tot
t on al
Salary allowance 12000 9600 21600
Remaining income 19200 19200 38400
Net income 31200 28800 60000
d) Interest allowances:
Nigat = 200,000 X 10% = 20,000
Solomon = 300,000 X 10% = 30,000
Total ………………… 50,000
Remaining income = 60,000 – 50,000 = 10,000
Nigat = 10,000 X 30% = 3,000
Solomon = 10,000 X 70% = 7,000
Division of income to:
Nigat = 20,000 + 3,000 = 23,000
Solomon = 3,000 + 7,000 = 37,000
e)
Nig Solom Tota
at on l
Salary allowance 15,000 12,000 27,000
Interest allowance 20,000 30,000 50,000
Total 35,000 42,000 77,000
Excess of allowances
over
Income (8,500) (8,500) (17,000)
Net income 26,500 33,500 60,000

f.. Division of income

Nigat = 60,000/2 = 30,000
Solomon = 60,000 X ½ = 30,000
Check your progress 5-4
(a) Division of net income:
Abebe = 40,000 X 3/10 =12,000
Bekele = 40,000 X 4/10 = 16,000
Chala = 40,000 X 3/10 = 12,000
(b)
ABC Company
Capital Statement
For the year ended December 31, 2003
Abe Bekel Chal
be e a Total
Capital, January 1 20,000 60,000 35,000 115,000
Add: Net income 12,000 16,000 12,000 40,000
Sub total 32,000 76,000 47,000 155,000
Ded: Drawings 8,000 12,000 10,000 30,000
Capital, December 31 24,000 64,000 37,000 125,000
 ABC Company
Balance Sheet (partial)
December 31,2003
Owner’s Equity:
Abebe, capital 24,000
Bekele, capital 64,000
Chala, capital 37,000
Total capital 125,000
Check your progress 5-5
1. a) Hanna, capital (32,000 X ½ ) ……………………..16,000
Tigist, capital……………………………………..………..16,000

b) Hawi, capital (24,000 X ½) ………………………….12,000

Tigist, capital…………………………………….………..12,000

c) Helen, capital (21,000 X ½) ………………………….10,500

Tigist, capital…………………………………….………..10,500

2. a) Bonus to existing partners:

Total capital (90,000 + 70,000 + 80,000)………..………240,000
Bacha’s equity = 240,000/4 = 60,000
Bonus = 80,000 – 60,000 = 20,000
Share of bonus by the existing partners:
Gelana = 20,000 X 6/10 = 12,000
Lemessa = 20,000 X 4/10 = 8,000
Entry
Cash………………………………………………….80,000
Bacha, capital…………………………………………….60,000
Gelana, capital……………………………………………12,000
Lemmessa, capital……………………………………….. 8,000

b) Bonus to Bacha:
Total capital = 90,000 + 70,000 + 40,000 = 200,000
Bacha’s equity = 200,000 X ¼ = 50,000
Bonus to Bacha = 50,000 – 40,000 = 10,000
Entry
Cash…………………………………………………40,000
Gelana, capital (10,000 X 6/10)…………………….. 6,000
Lemmessa, capital (10,000 X 4/10)…………………. 4,000
Bacha, capital……………………………………………50,000
Check your progress 5-6
1. a) Amare, capital………………………………….38,000
Lemma, capital…………………………………………19,000
Getu, capital……………………………………………19,000

b) Amare, capital…………………………………..38,000
Lemma, capital…………………………………………38,000

c) Amare, capital…………………………………..38,000
Getu, capital……………………………………………38,000

2. Solomon, capital………………………………….45,000
Cash……………………………………………………45,000