Intermediate Accounting 1 Chapter 2 PDF

Intermediate accounting 1 Chapter 2 Accounting for Partnership Formation  12 - 2 Chapter 2 Learning Objectives 1. Understand how to record initial investments in a partnership. Explain the treatment of ca...

Intermediate accounting 1 Chapter 2 Accounting for Partnership Formation  12 - 2 Chapter 2 Learning Objectives 1. Understand how to record initial investments in a partnership. Explain the treatment of cash and non-cash, a sole proprietorship contributions 2. Record journal entries for withdrawals. 3. Calculate and record interest on partner withdrawals. 4. Record journal entries for loans by partner. 2  12 - 3 Partnership Formation ❑ All contributions made by partners, whether cash or non- cash, become assets of the partnership and are recorded in each partner’s capital account. On 1/11, Ahmed and Rana decide to form a partnership. Ahmed contributes EGP 15,000 in cash, and Rana contributes EGP 25,000 in cash. 1/11 Cash 15000 Ahmed, Capital 15000 1/11 Cash 25000 Rana, Capital 25000 These journal entries record the cash contributions made by both partners and reflect their ownership in the business through their capital accounts. 3  12 - 4 Contribution of Non-Cash Assets (Fixed Assets) ❑ Fixed assets such as machinery, buildings, or equipment are valued at fair market value (FMV) upon contribution. ❑ Fair market value is the current value of the asset, based on what it would sell for today under normal conditions. ❑ Recording non-cash assets at FMV ensures fairness and accuracy when establishing each partner’s capital account.  12 - 5 Example – Contribution of Machinery Partner A contributes a piece of machinery that was originally purchased for EGP 50,000 five years ago. However, the current fair market value of the machinery is EGP 40,000 due to depreciation and market changes. Machinery (Fixed Asset) 40000 Partner A, Capital 40000 Note: Although the machinery originally cost EGP 50,000, it is recorded at its current market value of EGP 40,000. This ensures the asset's current worth is reflected in Partner A’s capital account. 5  12 - 6 Example – Contribution of a Building Partner B contributes a building to the partnership. The building’s original purchase price was EGP 320,000, but its fair market value at the time of contribution is EGP 300,000. Building (Fixed Asset) 300000 Partner B, Capital 300000 Note: Explanation: The building is recorded at its current fair market value of EGP 300,000, ensuring an accurate representation of Partner B’s contribution to the partnership. 6  12 - 7 Contribution of Accounts Receivable ❑ Accounts receivable represent amounts owed to the business by customers. ❑ When a partner contributes receivables ✓ the partnership records the full value of the receivables (debit) ✓ the partnership may need to account for any potential uncollectible amounts through an allowance for doubtful debts. (credit) ✓ Partner’s capital account is credited by the net value  12 - 8 Example – Contribution of Accounts Receivable Partner A contributes EGP 50,000 in accounts receivable to the partnership, but it is estimated that EGP 5,000 of these receivables may not be collected. Accounts Receivable 50000 Allowance for Doubtful Debts 5000 Partner A, Capital 45000 Note: The full amount of the receivables is recorded, but an allowance for doubtful debts is created to account for the EGP 5,000 that may not be collected. Partner A’s capital account is credited with the net value of EGP 45,000 8  12 - 9 Exercise – Recording Partner Contributions 1. Partner A contributes EGP 100,000 in cash. 2. Partner B contributes equipment that originally cost EGP 60,000 but has a fair market value of EGP 50,000. 3. Partner C contributes accounts receivable with a gross value of EGP 40,000, but EGP 5,000 is expected to be uncollectible. Partner A Cash 100000 contribution Partner A, Capital 100000 Partner B Equipment 50000 contribution Partner B, Capital 50000 Partner c Accounts Receivable 40000 contribution Allowance for Doubtful Debts 5000 Partner C, Capital 35000 9  12 - 10 Balance Sheet of the Newly Formed Partnership Assets Current Assets Cash 100,000 Accounts Receivable 40,000 Less: Allowance for Doubtful Debts (5,000) Net Accounts Receivable 35,000 Non-Current Assets Equipment (at Fair Market Value) 50,000 Total Assets 185,000 Equity Partner A, Capital Account 100,000 Partner B, Capital Account 50,000 Partner C, Capital Account 35,000 185,000 Liabilities -- Total Equity and liabilities 185000 10  12 - 11 Converting a Sole Proprietorship into a Partnership ❑ The process involves transferring the assets and liabilities from a sole proprietorship to a partnership. ❑ Assets and liabilities are recorded at their fair market value (FMV). ❑ partner’s capital credited by the net assets transferred to the partnership  12 - 12 Converting a Sole Proprietorship into a Partnership Ahmed converts his business into a partnership with Mohamed. Ahmed’s contributions: Cash EGP 10,000, Equipment EGP 25,000 (FMV), Inventory EGP 15,000, Accounts Payable EGP 5,000. Mohamed’s contributions: Cash EGP 20,000, Land EGP 30,000 (FMV). Cash 10000 Equipment 25000 Inventory 15000 Accounts Payable 5000 Ahmed, Capital 45000 Cash 20000 land 30000 Mohamed, Capital 50000 12 Additional Investments and Withdrawals 13  12 - 14 Additional Investments Partner Rana contributes an additional EGP 10,000 to the partnership after operations have begun. Cash 10000 Rana, Capital 10000 Explanation: Rana’s additional investment increases both the partnership’s cash and her capital account. 14  12 - 15 Withdrawals (drawings) ❑Withdrawals refer to the amounts that partners take from the partnership for personal use. ❑Withdrawals can be in the form of cash or other assets ❑not considered expenses ❑reduce the partner's capital account 15  12 - 16 Irregular Withdrawals ❑Irregular Withdrawals refer to significant or non- recurring amounts withdrawn by a partner from the partnership for personal use. ❑recorded directly in the partner’s capital account, reducing their equity in the partnership. Partner Omar withdraws EGP 8,000 for personal use, which is considered a large and irregular amount compared to his regular withdrawals. Omar Capital 8000 Cash 8000 16  12 - 17 regular withdrawals ❑Regular withdrawals (drawings) are routine amounts partners take for personal use. ❑recorded in a Drawings account. ❑These reduce the partner's capital at year-end Partner A withdraws EGP 5,000 for personal use at the end of each quarter. Partner A, Drawings 5000 Cash 5000 At the end of the accounting period, all drawings accounts are closed into the respective partner’s capital account 5000 x 4 quarters = 20000 Partner A, Capital 20000 Partner A, Drawings 20000 17 Interest on Drawings 18  12 - 19 Interest on Drawings ❑To maintain fairness among partners, interest may be charged on drawings (withdrawals) Partner A withdraws EGP 5,000, and the partnership charges 5% interest on the withdrawal for 6 months. Interest = EGP 5,000 × 5% × 6/12 = EGP 125. Partner A, Capital 125 Interest on Drawings 125 Note: Interest is charged on Partner A’s withdrawal, reducing the capital account by EGP 125. 19 Loans by Partners 20  12 - 21 Loans by Partners ❑Loans provided by partners to the partnership are treated differently from capital contributions. ❑Loans are liabilities and must be repaid, ❑whereas capital contributions represent ownership stakes. ❑Interest on a loan provided by a partner is treated as an expense for the partnership. And recorded on the income statement and reduces net income. 21  12 - 22 Loans by Partners Partner D lends EGP 10,000 to the partnership at an interest rate of 6% per year. Recording the Loan Cash 10000 Loan Payable – Partner D 10000 Interest = EGP 10,000 × 6% = 600. Interest Expense 600 Loan Payable – Partner D 600 Repayment of Loans Loan Payable – Partner D 10600 Cash 10600 The loan is recorded as a liability, and the partnership incurs interest expenses of EGP 600 for one year, which are added to the loan payable 22 balance.  12 - 23 End of Chapter 2 23