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Unformatted text preview: Chapter 14 - Partnerships: Formation and Operation CHAPTER 14 PARTNERSHIPS: FORMATION AND OPERATION Chapter Outline I. Business organizations that are formed legally as partnerships, although they are not always as visible as corporations, still proliferate throughout this country especially in the legal, medical, and accounting professions. A. Advantages of the partnership format include ease of creation and the absence of the double taxation effect inherent to the income earned by a corporation and distributed to its owners. B. Partnerships, however, rarely grow to a significant size (when compared with large corporate organizations) primarily because of the unlimited liability being assumed by each general partner. C. Alternative legal formats have been created over the years to combine the benefits of corporations and partnerships such as S corporations, limited liability partnerships, and limited liability companies. II. Partnership accounting and the capital accounts A. The distinctive aspects of partnership accounting center on the capital accounts maintained for each individual partner. B. The basis of accounting for these capital balances is the Articles of Partnership agreement which establishes provisions for initial investments, withdrawals, admission of a new partner, retirement of a partner, etc. C. The actual contribution made by the partners to the business should be recorded at fair market value. A problem arises, however, when a contribution is truly intangible such as a particular expertise or an established client base. 1. In the bonus method, only identifiable assets are valued and recorded. The capital account balances are then aligned to indicate the percentage of the actual contributions being made by each partner. 2. In the goodwill method, the amount being contributed and the corresponding percentage of the initial capital balance are used to calculate the value of the business and the presence of goodwill, a figure which is physically recorded as an intangible asset. III. Partnership income allocation A. At the end of each fiscal period, the revenue and expense accounts must be closed out with the resulting income figure being assigned to the individual capital accounts. B. The method of allocating income to the capital accounts should be established within the Articles of Partnership. 1. The partners can simply assume an equal division of profits and losses. 14-1 Chapter 14 - Partnerships: Formation and Operation 2. The partners, however, can select any method that is designed to arrive at an equitable allocation. Such factors as the amounts of capital invested, the time worked in the business, and the degree of business expertise may all serve to influence the assignment of income....
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