 Hello, and this lecture will discuss partnerships and adding a new partner. Object is, we will be able to describe the process of adding a new partner to a partnership, create the journal entries to record the entry of a new partner to a partnership, define the effect of the journal entry to add a new partner on the trial balance accounts as well as explain the effect on capital accounts of adding a new partner to a partnership. Alright, so we're going to take a look at this through a problem. We're going to have a trial balance here, a simplified trial balance with a beginning balance, an ending balance. We're going to have the only asset being cash here. We've got the accounts payable being the only liability. We will be focusing down here in the capital accounts as we add a new partner to the partnership. We have the income statement down at the bottom with the revenue and the expenses. Note there is no revenue and expenses at this time because when we put the new partnership in there, we want to think about at basically a post-closing trial balance that has had the income statement closed out to the capital accounts. Also note that we have debits represented by non-racketed numbers or positive numbers and credits represented by bracket numbers or negative numbers. And therefore we are able to have the debits minus the credits equals zero. So we're able to simplify and have less space to see our balancing process here. Clearly there's no net income on this report because we have closed out the income statement to the capital accounts. We also have our assets equaling our liabilities and our equity. It's important to note that when we think about the partnership and adding a new partnership that we consider the fact that the equity accounts are equal to the assets minus the liabilities. So the 550,000 minus the 10,000 will equal the capital accounts here. So the capital accounts represent of course the book value, the net value, the assets minus the liabilities of the company. We will be adding a new partner to the partnership. It will be a new partner, it will be R here. So we have the MD and L partners share income and loss at a 3 to 5 ratio. We're going to first discuss what that means, what is a 3 to 5 ratio. And then we're going to add the new partnership. The new partnership partner is going to be on the books or into the company at a 25% interest. That interest is what is agreed on between the partner, the new partner and the existing partner. So they come to an agreement of a 25% interest in exchange for 140,000 that the new partner will be giving to the partnership. So the partnership is going to receive 140,000. The partnership is then going to give a 25% interest to the new partner, new partner being R, existing partners being MD and L. So first let's think about what this means. What does it mean to have a 3 to 5 ratio? That's the current ratio before the new partner comes in. So before R comes in, we've got our three partners with a 3 to 5 ratio on the income and loss split. Now when we think about splitting income and loss, if there's two partners, obviously the easiest split would be a 50-50 or 60-40 or some kind of flat ratio. It's easier to think about ratios sometimes than percentages, however, because ratios can be more specific in some cases if it's not an even percentage number. Therefore, if we see something like this, which says 2, 3, 2, 5, then we could calculate this something like this. So B's calculation would then be the 3 divided by, and then there's 3 plus 2 plus 5 is 10 divided by 10, or 0.3, or we move to decimal places 2 places over 30%. And then we have the same for B. So B has 2 out of the 3 plus 2 plus 5, so we're going to say the 2 out of 10. And that is the 2 move to decimal place over the 20%. And then of course L, the final one, we'll do it out here, and we'll say 5 out of the 3 plus 2 plus 5, 10, if we move to decimal place over 50%. So we're having a 30-20-50. This happened to be even, so we could have expressed it as 30-20-50 ratio, which of course adds up to 100. But sometimes it won't be even, so sometimes it's easier to represent, or it's more precise to represent as a ratio. So if you see something represented in that format then, that's how you basically break up. You're going to add it up, 3 plus 2 plus 5 is 10. So it's 3 out of the 10, 2 out of 10, 5 out of 10. That's how you come up with your percentage. It's also a bit smaller or takes up less space to present it in this format as well. Then if we look at the capital accounts, we see the capital accounts here. These are just the accounts that are given in the trial balance. So obviously here is the M's capital account 151.2, here's B's capital account 124.2, and here's L's 264.6. Now, one thing to note that the capital accounts do not match necessarily this ratio. This ratio is having to do with the income and loss distribution. How do we allocate income and loss between the three partners does not have to do with the capital accounts. There's a couple reasons for that. One, they could have put in different amounts when they first enter the partnership. They can also draw out different amounts that aren't in relation to this profit to these ratios. Therefore, it's going to be very rare that the capital accounts are going to coincide with the profit and loss ratios. Just keep that in mind. The profit and loss ratios, these ratios have to do with how they are going to allocate the income and loss that is generated through the partnership to each individual partner does not govern necessarily the amount of money that is drawn out of the partnership and does not govern the ratio that the capital accounts must remain in for the partnership. So now that we have that taken a look at, we can start to work on our journal entry. So the journal entry, we can start thinking about the journal entry and then once we run into a problem, we're going to have to do some calculations. So let's think about the journal entry first, go through our normal steps, then see where the problem happens and do some calculations to figure this out. So we got the new partnership is going to come on the books for $140,000. Therefore, we ask our normal question, is cash going to be affected in this transaction? Yeah, the partnership is going to receive $140,000. Therefore, cash is going to go up. Cash has a debit balance represented by the fact that it does not have brackets. It's going to go up by doing the same thing to it, which in this case would be another debit. So the journal entry is going to start off with a debit to cash. We're going to debit cash, that's going to increase the cash accounts and we know that much. And we know that the new partner is going to come on the books. The partner are in this case, and they're the new partner. So we would think that obviously the new, if they put in $140,000, we would have to credit ours capital account for our coming on to the partnership. And that is true. We are going to credit the capital account. However, we're not going to credit it for $140,000 necessarily. In this case, we're going to credit it for $170,000. That's kind of the part of the problem. So we'll explain why we got that $170,000 and then we've got this difference that we're going to have to deal with as well. So here's the issue. Why, if they gave $140,000, might we credit $170,000? Well, the new partner is not going to be on the books exactly for what was given. We agreed that we were going to give a 25% interest of the partnership for cash of $140,000. So we need to define what a 25% of the partnership is. And the way we do that is we take the book value of the partnership, which is the assets minus the liabilities, which of course also equals the capital accounts. So assets minus liabilities, $550,000 minus the $10,000, $540,000 equals the equity accounts. So here's the equity accounts. If we list those equity accounts here, here they are. We add up to $540,000 assets minus liabilities, book value of the company. Theoretic value that the partner would receive if they liquidated the company and walked away with the cash. Again, that's just a book value, however, probably very accurate in this case because all we have is cash on the book. But if we had other things on the book like equipment, it's not likely that we will sell the equipment for the exact book value. So this is the book value of the partnership, theoretical assets minus liabilities. And then the new partners coming on the books for $140,000. So now of course cash is going to go up by $140,000. Therefore assets minus liabilities is going to be what it was, $540,000 plus the new $140,000 that the new partners coming on the books for. And therefore we now have a book value of assets minus liabilities or a capital account balance that needs to be allocated of $680,000. And we decided that we were going to give a 25% interest of the book value of the partnership for $140,000. Therefore we're going to take 25% of the $680,000. That's how much we're going to allocate to our and of course the $680,000 times 25% will give us the $170,000 that we talked about over here. So here's the $170,000. That's what the new partners going to be on the books for. Even though the partner only gave us $140,000. And what you might be thinking now is, well, why would the existing partners agree to this? This doesn't make any sense. If the book value of the partnership, assets minus the liabilities, is worth $170,000, why would we allow R to be included in the partnership when they only give us $140,000? And the reason for that, there could be different reasons for it, but it might be that R is coming on the books with some intangible assets or maybe R has some particular name recognition which will generate future revenues that are not foreseen in this calculation. And therefore the existing partners in order to get R on board are willing to give up a $170,000 interest even though they're only receiving $140,000. So these two things will not always match. Most of times they will not match. And now we're faced with another problem here, which is that the debits do not equal the credits. We're going to need some more debits of the $170,000 minus the $140,000, which will be $30,000. And how are we going to allocate that out? Well, we're going to have to reduce the other owners, the other owners' capital accounts, the other partners' capital accounts, I should say. So we're going to have to debit them, so that's $30,000. So now the question is, well, how much are we going to debit M, B, and L in order to over the $30,000 that we need? And we will do that in accordance with their profit sharing. So note what we have here. We've got this $30,000. If we look at that calculation, what we're saying is the new partner was put on the books or... We can look at it either way. We can say the new partner was on the books for $140,000. That's how much they paid. And we put them on the books for $170,000. Therefore, we have a difference of this $30,000. We're going to break that difference out between 30% to M. So times 0.3 gives us $9,000. That's where this $9,000 is. If we take this $30,000... We take the $30,000 times the 0.2, 20%. We get the $6,000. And then, of course, if we take the $30,000 times the $0.5, that will give us the $15,000. The $9,000 plus the $6,000 plus the $15,000 add up to the $30,000. Therefore, we will then break out this $30,000 debit over here that is needed between M, B, and L in accordance with the 9, 6, and 15 breakout. Therefore, we have this... Well, this will be the ending capital accounts. So we'll have this breakout. Debit of $9,000 to M, debit of $6,000 to B, and debit of $15,000 to L. We're going to reduce their capital accounts. They are not necessarily happy about this, of course, because now that reduces the book value of the company that is basically owed to them. Let's take a look at what this would look like if we posted this to a trial box. We're going to post this journal entry. So here's what the journal entry would look like and we're posting it in accordance with our worksheet here. Let's post this out and talk through it and see if it does what we expect it to do. What do we expect it to do? We expect it to create an ending capital account after we post this journal entry of R170 and then M142, 2B, 118, 2, and L249, 6, thereby giving us a capital account of 680, which is equivalent to the book value of the company, assets minus liabilities. So here's cash. We're debiting cash and we're going to debit cash. Cash has a debit balance. We're going to make it go up by doing the same thing to it. So we're going to put our credit for cash went up to the 690,000. And then we put R on the book. So here's R on the book. We're going to credit for the 170,000. So we're going to put that down here from zero up in the credit direction to 170,000. New partner on the books for 170. Then we're breaking out that 30,000 in the 9, 6, and 15 to M, L, and M, B, and L, respectively. So we got the 9,000 here. Note that we have a credit balance in the capital account. We're reducing it by doing the opposite thing to it. Therefore, M's going to have to eat or reduce their capital account to 142,2. So it was going to receive the 151. That was the value and it went down. So then B is going to get the 6,000. So B has a credit balance of 124,2. We're bringing the balance down by the 6,000 to 118,2. And then L here has a debit of 15. So they had a 246,6 credit. Minus the 15 brings the balance down. Now you'll note that our ending trial balance here now ties out to our capital account balances over in our worksheet. So a problem could ask this in either of two ways. As an accountant or a bookkeeper, we're often looking at the trial balance and we may want to see stuff, of course, in terms of journal entries. We may very well see this insane information in terms of a table. It's good to be able to understand both ways of seeing this. Also note that once again still, the book value is going to be the 960 minus the 10 will add up to the capital account balances. So now we're going to look at a...