Partnerships and Limited Liability Companies

Partner Admission and Withdrawal

Elements of Partner Admission

A new partner can be admitted to an existing partnership by purchasing the existing interest of a current partner or by contributing new assets to the partnership.
Many partnership agreements have special clauses that explain the procedures for adding a new partner or withdrawing an existing partner. These clauses allow the company to continue its operations without the need to form a new partnership or a new agreement. The two ways of admitting a new partner are by purchasing the current interest of an existing partner or by contributing new assets to the partnership. For example, Andy Potts and Samantha Stevenson are partners, and they both sell one-fourth of their partnership equity to Kim Foxx for $20,000 in cash, so that Kim now owns 25% of the company as a new partner. In the event that a new partner purchases the interest of an existing partner, there is no change in the assets of the partnership. However, when a new partner contributes additional assets to the partnership, the assets of the partnership increase.

Purchasing Interest from Existing Partner

When the partnership interest of an existing partner is purchased by a new partner, the current interest is transferred to the new partner. As noted, partners Andy Potts and Samantha Stevenson both sell one-fourth of their partnership equity of ABC Company to Kim Foxx for $20,000 in cash. The total assets of the partnership on January 1 were $100,000, and the total liabilities were $25,000, making the total net asset $75,000 ($100,000 – $25,000). Andy Potts's capital balance is $30,000, which is a 40% interest in the company, and Samantha Stevenson's capital balance is $45,000, which is a 60% interest in the company. The transaction is between all three partners; however, the only entry that is required by the partnership is to record the transfer of equity or capital from Andy and Samantha to Kim.

Transfer of Equity between Multiple Partners Journal Entries

Date Description Debit Credit
Jan. 1 Andy Potts, Capital (Member's Equity) $7,500
Samantha Stevenson, Capital (Member's Equity) $11,250
Kim Foxx, Capital (Member's Equity) $18,750
To record the transfer of equity between the existing partners and the new partner

By giving up one-fourth, or 25%, of their partnership interest, Andy and Samantha are providing Kim with an interest equal to $18,750. In turn, the capital balances of all the partners are now different.

Capital Balances of Multiple Partners Entries

A. Potts S. Stevenson K. Foxx Total
Capital before new partner $30,000 $45,000 $0 $75,000
Adjustment to capital from journal entry ($7,500) ($11,250) $18,750 $0
Capital after new partner $22,500 $33,750 $18,750 $75,000
New Partnership percentages 30% 45% 25%

Because of the inclusion of Kim as a partner of ABC Company, Andy's partnership interest decreased from 40% to 30%, and Samantha's decreased from 60% to 45%. However, Kim's interest is now 25%. The total equity, or capital, of the business remained the same. Regardless, the division of the income is still determined based on the existing partnership agreement or a new partnership agreement.

It is important to note that the journal entry was not affected by the amount that Kim paid to Andy and Samantha for the partnership interest. Even if Kim had paid $30,000, the journal entry would have been the same. The main thing to consider is the amount of interest in the company that she is purchasing.

Contributing Assets to the Partnership

When a new partner joins the partnership by contributing assets, the total assets and equity of the organization are increased because a new partner usually contributes assets, such as cash, in order to become part of the company. For example, Kim Foxx contributes $25,000 cash to join ABC Company as a new partner.

Contributing Assets by New Partner Journal Entry

Date Description Debit Credit
Jan. 1 Cash $25,000
Kim Foxx, Capital (Member's Equity) $25,000
To record the contribution of assets by a new partner

In this scenario, the capital balances of existing partners Andy and Samantha do not change.

New Partnership Percentages

A. Potts S. Stevenson K. Foxx Total
Capital before new partner $30,000 $45,000 $0 $75,000
Adjustment to capital from journal entry $0 $0 $25,000 $25,000
Capital after new partner $30,000 $45,000 $25,000 $100,000
New Partnership percentages 30% 45% 25%

In this scenario, the total equity or capital of the business increased with the additional assets brought into the organization by Kim.

Revaluation of Assets

When a new partner is admitted into the partnership, the balances of the partnership's asset accounts should be restated at current values. Any changes to these accounts are divided between the current partner capital accounts. For example, the current balance of inventory of ABC Company is $10,000, but the current market value is $15,000. If partners Andy and Samantha share income equally, there is a revaluation of assets with each partner credited $2,500.

Revaluation of Inventory Journal Entry

Date Description Debit Credit
Jan. 1 Inventory $5,000
Andy Potts, Capital (Member's Equity) $2,500
Samantha Stevenson, Capital (Member's Equity) $2,500
To record the revaluation of inventory

If the asset being revalued is a fixed asset, the accumulated depreciation is removed, and the asset is revalued at its current value. For example, the company has machinery worth $20,000 with accumulated depreciation of $5,000. At the time of a new partnership with Kim, the machine was valued at $13,000. The $2,000 ($15,000 book value minus $13,000 market value) decrease in valuation is recorded and debited between Andy and Samantha.

Revaluation of Machinery Journal Entry

Date Description Debit Credit
Jan. 1 Accumulated Depreciation $5,000
Andy Potts, Capital (Member's Equity) $1,000
Samantha Stevenson, Capital (Member's Equity) $1,000
Machinery $7,000
To record the revaluation of machinery

Revaluing the assets of the organization is important to prevent the new partner from sharing in the gains and losses of assets that were on the books prior to their admission into the partnership.

Partner Bonuses

When a new partner joins the partnership, they may pay the existing partners a bonus, or in some cases existing partners may pay the new partner a bonus for joining the partnership. These bonuses are usually the result of future income-generating potential of the new or existing partners. A great example is an affiliation with a well-known brand or person. Simply being affiliated with a well-known sports figure or other celebrity can help the partnership's profits increase significantly in a given period. In the event that the new partner's ownership interest is less than the amount paid, the existing partners receive a bonus. If the new partner's ownership interest is more than the amount paid, the new partner receives the bonus.

For example, partner Andy Potts's capital balance is $30,000, and partner Samantha Stevenson's capital balance is $45,000. The total equity of the partnership before admitting new partner Kim is $75,000. Andy and Samantha agree to let Kim into the partnership for $42,000, and in return they will allow her to have one-third of the equity in the partnership.

Partner Bonuses Entry

Andy Potts, Capital $30,000
Samantha Stevenson, Capital $45,000
Kim Foxx, Contribution $42,000
Total equity after admitting Kim $117,000
Kim's equity after admission x 1/3
Kim Foxx, Capital $39,000
Kim Foxx, Contribution $42,000
Kim Foxx, Capital $39,000
Bonus Paid to Andy and Samantha $3,000

The $3,000 bonus Kim pays is captured in Andy's and Samantha's capital accounts. Assuming that they share income equally, the journal entry would reflect the split.

Recording Bonus to Existing Partners Journal Entry

Date Description Debit Credit
Jan. 1 Cash $42,000
Andy Potts, Capital (Member's Equity) $1,500
Samantha Stevenson, Capital (Member's Equity) $1,500
Kim Foxx, Capital (Member's Equity) $39,000
To record bonus to existing partners

Assume the same previous information, except Kim contributes only $33,000 in cash to the partnership. There would be a $3,000 bonus paid to Kim.

Bonus to New Partner

Andy Potts, Capital $30,000
Samantha Stevenson, Capital $45,000
Kim Foxx, Contribution $33,000
Total equity after admitting Kim $108,000
Kim's equity after admission x 1/3
Kim Foxx, Capital $36,000
Kim Foxx, Capital $36,000
Kim Foxx, Contribution $33,000
Bonus Paid to Kim $3,000

The $3,000 bonus is paid to Kim and is deducted from the capital accounts of Andy and Samantha. Once again, assuming that they share income equally, the journal entry would reflect the division.

Bonus to New Partner Journal Entry

Date Description Debit Credit
Jan. 1 Cash $33,000
Andy Potts, Capital (Member's Equity) $1,500
Samantha Stevenson, Capital (Member's Equity) $1,500
Kim Foxx, Capital (Member's Equity) $36,000
To record bonus to new partner

Overview of Partner Withdrawal

A current partner can withdraw from the partnership, and his or her current interest can be sold to the existing partners or to the partnership itself.

In the event that a partner decides to retire or withdraw from the partnership, his or her interest can be sold. If the interest is sold to the existing partner(s), the purchase and sale of the interest are between the partners as individuals, not as an organization. Therefore, the only entry that is required is to debit the capital account of the partner who is withdrawing and credit the capital account of the partner or partners purchasing the additional interest. For example, Kim Foxx is moving to another city and must exit the partnership. Partner Andy Potts, as an individual, buys Kim's interest for $33,000. So, Kim's capital account is debited $33,000, and Andy Potts's capital account is credited $33,000. However, if the partnership purchases the exiting partner's interest, the assets and equity of the partnership are reduced by the purchase price. Before the purchase, the existing assets are revalued to reflect the current market values. This will allow the adjustments to be fairly divided up between the partners' capital accounts.

If a partner dies, the current partnership accounts should be closed on the date of death, and net income should be determined and distributed to the partner capital accounts at that time. The assets should then be adjusted to the current market value, and any revaluations should be divided between the partners based on their income-sharing ratios. After these entries are completed, a final journal entry should be recorded to close the capital account of the deceased partner. The entry includes a debit to the deceased partner's account and a credit to a liability that will be payable to the estate of the deceased. The remaining partners can then continue the business or liquidate it.