 Hello, in this lecture, we're going to talk about partnerships and we're going to talk about the selling of a partnership interest. We will be able to describe the process of selling a partnership interest, create the journal entry to record the sale of a partnership interest, define the effect of journal entry to sell a partnership interest on the trial balance accounts, and explain the effect on the capital accounts of selling a partnership interest. So we're going to do this by looking at a problem. We're going to look through the problem, post the transaction, see what happens to the capital accounts in terms of both a trial balance as well as a format of just a worksheet type of format. This is going to be our simplified accounts that we will be looking at. Only asset that we will have will be cash. Only liability accounts payable. And then we will have our capital accounts. This is where we will be focusing on. And then we have the income statement down here. Note that nothing is in the income statement. The income statement has been closed out. You can think of this as a post closing trial balance or just basically the balance sheet accounts being represented here. We also have the accounting equation assets equal liabilities and owner's equity. Also note that we have the debits represented with non-racketed or positive numbers and credits represented with bracketed or negative numbers. This gives us an easy balancing process in that we see this zero down here represents the fact that the assets minus the liabilities equals zero. Therefore the assets equal the liabilities and we can shorten our debits and credit columns and have a quick worksheet to see what the transactions will do to our trial balance accounts in this way. Clearly, net income is zero at this point because the revenue and expense accounts have been closed out to the capital account balances. So what we have are the three partners MB&L represented here in these capital accounts are going to share their profit and loss at a three to five ratio. We're going to say that B will be selling their capital account interest to N. So here's B, here's capital account interest, here's N, that's who B is going to sell their capital account interest to after the transaction was approved by the other two partners for cash of 120,000. Now one of the tricky things when we think about selling a partnership interest is that who are the two parties in the agreement is the first question we need to ask. In this case, the partnership is actually not in the transaction. The transaction is between B and the new partner N, meaning that there is $120,000 changing hands here if going from one account to another, but it's not going to the partnership account. Therefore, the partnership is getting nothing. So when we ask our question in terms of is cash affected in terms of the partnership, in this case, no, it's not affected. The agreement, the deal is between B and N. B says, hey, you know what? I have a partnership interest. It has a book value of 124.2. What does that mean? Well, the assets amounts to 550 minus the liabilities of 10 mean that we have 540 broken out book value of the company and B owns or is owed 124.2. That's the value of the company that is owned or the partnership that is owned by B at this time. B says to N, hey, I'll sell you this partnership interest worth of book value of 124.2.4. You giving me cash of 120,000. You're not going to receive anything. However, the other two partners do have to agree to this, that the other two partners are not forced to take on N as a new partner just because B wants to sell the partnership interest. The other two partners do have to agree to the terms and if they do agree, then B and N can have this transaction and make this transaction happen. So first let's talk about what this ratio means, the three to five. So when we think about a partnership interest, if there's two partners, the most common partnership interest would be what, a 50-50 or 60-40, something like that. We will often represent the partnership interest in a ratio format like a three to five for various reasons. One, it's a little bit shorter and two, if the ratio is not even, then it's more specific to have a ratio rather than represented as percentages. So if we were to look at this, then M's capital count is going to be 30% calculated as three divided by three plus two plus five is 10, so three over 10. So that's how you calculate that, 0.3 moved to decimal place, two places over 30%. Then we have of course B, so if we take a look at B, we do the same thing, B is the two. So we're going to take the two divided by three plus two plus five or 10 and that gives us the 0.2 moved to decimal two places over 20%, 20%. And yes, we'll do this one more time for L, L has a partnership interest of five. So we're going to take the five out of the three plus two plus five, 10 and that gives us the 0.5 or 50%. If we add up the 30, the 20, the 50, we add up to of course the 100%. So whenever you see the ratios breaking out, if you see any ratio broken out like is three colon two colon five, you add them up three plus two plus five is 10, three over 10, two over 10, five over 10, and that will give you your ratio breakout. Now if we look at the capital accounts, then we have 151.2, 124.2, 264.6 adds up to 510. Note that those are just the same capital account balances that would be represented on the trial balance. So here they are on the trial balance from MB and L. You could have problems that would represent this in terms of a table, could have problems represented in terms of a trial balance. I really like seeing it in terms of trial balance because as accountants and bookkeepers we're often going to be using trial balances and it could help to see it in that format. But it's also very helpful to see it in terms of a table. Note that the assets minus the liabilities equals these capital account balances. Also note that these capital account balances are not necessarily in proportion of 30-20-50 of the 540. A lot of people will think that that should be the case, not the case normally. The 30-20-50 represents how we allocate net income, doesn't have anything to do with the actual ratio of account balances in the capital accounts between the partnerships. And being is because these accounts only represent to income and loss allocations general and depending on the terms of the partnership agreement. And that means that we could have invested different amounts and partners could have drawn out different amounts. So these capital accounts basically represent the amount that a partner could theoretically draw out of the company. Alright so then if we go on here we're going to look at our journal entry to record this transaction. So what is happening is that B is going to leave the partnership. So if we think through this, we're going to think through it well, is cash affected? In this case we're saying no, cash isn't affected. It's not affected even though cash did exchange hands. However, the cash didn't go to or from the partnership. The cash went from N, the new partner, to B personally. Not B as part of the partnership, but B's pocket. However, no cash went to the partnership. What did happen is B's giving up their capital account. So B's on the books, B's gone, B's leaving, B's leaving town. He's not going to be here anymore. We need to say, hey B's on the books at 124.2, B's gone now. Their partnership interest needs to be zero. Therefore, the capital account balance has a credit balance. We need to make it go down. We're going to do the opposite thing to it, which in this case would be a debit. So we know we're going to debit this capital account which will bring it down to zero. Then we have to credit something. What are we going to credit? We're crediting the new person coming on the books, the new person N. So N will be credited for the 124.2. N is going to be on the books zero up to buy 124.2 to 124.2. So it's a pretty straightforward journal entry. The question though that people are going to have is they're going to say, well wait a second. What about the 120 up here? If N paid 120, shouldn't their capital account go up by 120? Why is it going up by 124.2? And the reason is because remember the agreement was between N and B. So N said, hey I'm going to give you my share of the partnership interest. The partnership my share of the 550 minus the 10 is 124.2. And I will sell that to you N for $120,000. So you might be asking well why would B sell their partnership interest which has a book value of the 510 assets minus the 10 of 124.2 and only receive 120,000. And there could be multiple reasons for that. Maybe the value of the assets are not fair market value as is negotiated between the two partners. The B needs to leave quickly and needs to make the transaction happen. Very rarely will those two things match. So just be aware that if the sale is between an existing partner and a new partner then we need to take the current partner off the books at whatever they're on the books for and then put the new partner on the books for whatever the old partner was on the books for. No cash is affected in the partnership because the cash went into the pocket of the partner not the bank account of the partnership. So if we were to look at this in terms of a slightly different way we can look at it what if B sells the capital interest to the partnership for cash. So now B is saying hey I'm going to take off I need to leave and I want to sell my partnership interest to the partnership. So now the other two partners M and B are going to basically buy out I mean M and L are basically going to buy out B in this case. So that's going to be the arrangement of the agreement B is going to be going to sell the capital accounts to the partners for cash of 200,000. So is cash going to be affected? Yeah so we're going to think about this first I want to think about the types the part of the journal tree that we can do then we'll run into a problem and then we'll do some calculations to adjust for that problem. So first we're going to say is cash affected and we're going to say yeah cash is going to go down because the partnership is paying B for B's interest. So the partnership is saying hey B we're going to give you 200,000 for your cap your capital account interest therefore we're going to take cash down cash is going to bounce into the opposite thing to it which is a credit by the amounts paid and then we know that B needs to be off the books B's on the books for 124.2 B's no longer with us therefore B should not have any amount in their capital accounts therefore that's a credit we need to make it go down by doing the opposite thing to it which would be a debit of the 124.2. So now the partnership paid 200 B's going to be off the books at 124.2 we have a difference here so we have a difference and that's going to be a debit that debit's going to have to be divided in some way between M and L now you might be saying well once again well if B has a 124.2 interest in the partnership why is it that the partners would pay 200,000 to pay off the capital account balance and again there could be multiple reasons it could be that there's some kind of goodwill in the partnership that's not being reported in the books some type of intangible assets it could be that they really want to let B go and they're willing to pay more in order to do that so there could be multiple reasons for that but once again that's an agreement between the partnership in this case and B so those things will very rarely match now we need to figure out how to allocate that difference how to allocate that plug so we have our MB and L which is a 30-20-50 ratio that we discussed before between the three to five 30% 20% 50% here's the same capital accounts so here's the capital accounts here here's the capital accounts represented in terms of a table book value of the company 540 that's equivalent to the assets cash less the liabilities representing the accounts payable in this case and then the new income and loss ratio so now we have to say well B is gone therefore we can't allocate between M and L between a 30-50 because it needs to add up to 100 or 1 so we need to come up with a new ratio so if we look at this we have if we had a 3-2-5 ratio and now the 2 is gone we can think of it as a 3-5 ratio so if we think about our new ratio then we could think that we have a 3 out of a 3 plus 5 is 8 divided by 8 so our new ratio would be 0.375 or 37.5% for M and then if we think about L L have 5 over the 3 plus 5 or 8 so we can say that we have a 0.625 or a 62.5 so our new ratio that we're going to allocate this amount by this difference by will be the 37.5 and the 20 and the 62.5 so now we're going to allocate this difference so that difference being the 200,000 cash received minus the capital account to take them off the books 124.2 and that's the 75.8 and we're going to allocate times the 0.375 to M and that's going to give us the 284.25 and then we'll do the same thing over here of course the difference will be the other but we'll do the calculations which we'll find that 75.8 times the 0.625 that gives us the 47.375 and of course the 284.25 plus the 47.375 equals the 75.800 so we're going to allocate the plug the 75.800 in the in 284.25 and 47.375 M and L respectively if we look at the journal entry then it would look like this we're going to debit ends capital account 284.25 and debit L's capital account 47.375 and we'll see what the effect on the trial balance will be this time all right so here's the same journal entry we have and this is our chart of accounts and of course here's that table that we are looking at let's see what would happen if we posted this transaction what would happen to the capital accounts does it do what we expected to do what do we expect it to do we expect the ending capital accounts to be M 122.775 B is going to be gone L is going to be at 272.217.225 to give us a total capital account or book value of 340 all right so B's capital account we're going to debit for the 124.2 so here's B has a credit we're doing the opposite thing to it debiting it making it go down to zero cash cash is going to go down so cash has a debit balance we're doing the opposite thing to it crediting it cash in the partnership will go down to 350 and M has a credit balance in the capital account we're doing the opposite thing to it debiting the capital account making it go down to 122.775 and L has a credit in the capital account like all capital accounts and it goes down because we're doing the opposite thing to it which is a debit 2.217.275 so note that the new capital accounts are still equal to book value of the company so the assets of 350 000 minus the liabilities of 10 000 still add up to the M and L's capital accounts at this time all right so now we're going to do the same thing however this time we're going to have B sells the capital part ship interest to the partnership however they're only going to pay 50 000 this time so same idea except the exchange will be the 50 000 so is cash affected yeah it's going to go down by the 50 000 in this case so if we take a look at that then let's go through the journal entry see what we can do where we run into a problem then do the calculation so cash is cash affected yeah it's going down we the partnerships paying B for the partnership interest cash has a debit balance we're going to do the opposite thing to it which in this case would be a credit we're going to take B off the books B has a credit balance in the capital account we need to make it go down therefore we're going to do the opposite thing to it which in this case would be a debit now the debits do not equal the credits we need more credits in this case and the credits are going to go to M and L the other two partners and we have to figure out how to break it out between those two partners remember we have our ratios here so we have M 30 20 and 50 percent broken out between a three to five ratio and we have our capital account balances represent at 151 to 124 to and 264 six which are represented in the trial balance up here if we're then going to break out our our ratio then it's going to be looking like this same calculation we did last time if we're saying three and the two is gone now so we're dividing by three plus five so divided by eight so that's where we come up with the 37.5 and the five over divided by eight which is the three plus the five because the two is gone that's where we get the 62.5 and so now then we have our difference of 74 to so where does the 74 to come from we bees going off the books at 124 to and cash is going to be affected by 50 and that's the 74 to if we multiply that times the 0.375 0.375 that's what's going to give us the 27 825 which is going to be allocated to m and of course l will receive the difference let's do that calculation however which is the 74 200 times the 0.625 and that gives us the 46 375 so that's how we're going to break out this 74 200 that's the plug that we need up here so our new capital account balances then would be the 179 25 which of course is the beginning balance plus the 27 825 and the 264 600 plus the 46 375 giving us the 3 10 975 which will give us a total capital count balance of 490 so if we see that in terms of the journal entry we're going to credit or increase the capital count balance for m 27 825 and we're going to credit l the 46 375 all right so if we take a look at the effect of this transaction on the trial balance then we'll see if it does what we expect it to do what do we expect it to do we expect m's capital account balance to end at 179 025 b to be off the books because we have now sold these partnership and they're not with us anymore and then l's going to be at a capital account balance of 3 10 975 giving us a total capital count balance which is equivalent to the book value of the company assets minus liabilities of 490 000 all right so we're going to debit b's capital accounts so here's b again on the books at 427 2 has a credit balance we're doing the opposite thing to it bring b off the books by debiting it bringing the balance down to zero so b is off the books cash cash is being bathed by the partnership to the partner of b in order to buy b's capital account interest therefore cash is a debit balance we're making it go down by doing the opposite thing to it which is a credit bringing it down from 550 to 500 then m uh m has a credit here so here is m credit balance in the capital accounts like all capital accounts have and we are going to credit it making it go up because we're doing the same thing to it from 151 200 by 27 825 to 179 0 25 and then l we're going to credit l so here's l's capital account balance has a credit balance in it we are going to credit it bringing it up to 3 10 975 we now have a b off the books we have m and l on the books and we see that the cash minus or the assets minus the liabilities equals the new capital account balances between the only two partners left being m and l at this time so we are now able to describe the process of selling a partnership interest create the journal entries to record the sale of a partnership interest define the effect of the journal entry to sell a partnership interest on the trial balance accounts and explain the effect on the capital accounts of selling a partnership interest