 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 counts 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 cash that we're going to have, only assets 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 we're going to sell, B's 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 exchanging hands here 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 $124,000. What does that mean? Well, the assets amount 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 $124,000, 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 $124,000, 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 3-2-5 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 3 divided by 3 plus 2 plus 5 is 10, so 3 over 10. So that's how you calculate that, 0.3 moved to decimal place, 2 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 2, so we're going to take the 2 divided by 3 plus 2 plus 5 or 10 and that gives us the 0.2 moved to decimal 2 places over 20%, 20%. And yes, we'll do this one more time for L, L has a partnership interest of 5, so we're going to take the 5 out of the 3 plus 2 plus 5, 10, and that gives us the 0.5 or 50%. If we add up to 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 3, 2, 5, you add them up, 3 plus 2 plus 5 is 10, 3 over 10, 2 over 10, 5 over 10, and that will give you your ratio breakout. Now if we look at the capital counts then, we have 151.2, 124.2, 264.6 adds up to 510. Note that those are just the same capital count 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 count balances. Also note that these capital count 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. The reason 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 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 in the new partner to be personally. Not be as part of the partnership, but B's pocket. 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. Maybe 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.