 Hello and this lecture will discuss partnerships and adding a new partner Objectives 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. All right, so we're gonna take a look at this through a Problem, we're gonna have a trial balance here a simplified trial balance with a beginning balance an ending balance We're gonna 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 You know if 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 child balance That has had the income statement closed out to the capital accounts Also note that we have debits represented by non-bracketed 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 income 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 then when we think about the partnership and added a new partnership that we consider the fact that The equity accounts are equal to the assets minus the liabilities 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 will be our here so we have the MD and L partners share income and loss at a Three to five ratio. We're gonna first discuss what that means What is a three to five ratio and then we're gonna add the new partnership the new partnership? Partner is gonna be on the books or interest the company at a 25% interest That interest is what is agreed on between the partner The new partner and the existing partners they come to an agreement of a 25% interest in exchange for 140,000 of that the new partner will be giving to the partnership. So the partnerships gonna receive 140,000 the partnership is then going to give a 25% interest to the new partner new partner being our existing partners being MB and L So first let's think about what this means. What does it mean to have a? 325 ratio that's the current ratio before the new partner comes in so before our comes in We've got our three partners With a three to five ratio on the income and lost 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 for thinking about It's it's easier to think about ratio sometimes than percentages However, because ratios can can be more specific in some cases if it's not an even percentage Number therefore if we see something like this, which says two colon I mean three colon two colon five then we could calculate this something like this ends calculation would then be the three divided by and then there's three plus two plus five is ten divided by ten or Point three or remove the decimal place of two places over 30 percent And then we have the same for B So B has two out of the three plus two plus five So we're gonna say the two out of ten and that is the two move the decimal place over the twenty percent And then of course L The final one will do it out here And we'll say five out of the three plus two plus five ten if we move the place decimal place over fifty percent So we're having a three thirty twenty fifty this happened to be even so we could have expressed it as thirty twenty fifty ratio which of course adds up to a hundred But it 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 gonna add it up three plus two plus five is ten So it's three out of a ten two out of ten five out of ten That's how you come up with your percent. It's also a bit smaller or you know It 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 count 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 happening 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 very gonna 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 counts 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 gonna 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 gonna come on the books for 140,000 therefore we ask our normal question is cash going to be affected in this transaction Yeah, the partnerships going to receive 140,000 therefore cash is going to go up cash as a debit balance represented by the fact that it does not have brackets It's gonna 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 gonna debit cash that's gonna increase the cash account So we know that much and we know that the new partner is gonna come on the books He's partner are in this case and they're the new partner So we would think that obviously the nuke 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 gonna credit the capital account. However, we're not gonna credit it for 140,000 necessarily in this case. We're gonna credit it for 170 That's kind of the part of the problem. So we'll explain why we got that 170 And then we've got this difference that we're gonna 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 is not gonna 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 them book value 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 the company Theoretic value that the partners 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 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 so now of course cash is going to go up by 140. Therefore assets minus liabilities is going to be what it was 540 plus the new 140 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 and we decided that we were going to give a 25 percent interest of the book value of the partnership for $140,000 therefore we're going to take 25 percent of the 680 That's how much we're going to allocate to our and of course the 680,000 times 25 percent will give us the 170 that we talked about over here. So here's the 170. That's what the new partners going to be on the books for Even though the partner only gave us 140 and what you might be thinking now as well Why would the existing partners agree to this? This doesn't make any sense if the book value the partnership assets minus liabilities is worth 170 why would we allow our to be included in the partnership when they only give us 140 and the reason for that there could be different reasons for 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 are on board are willing to give up a 170% interest even though they're only receiving 140 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 minus the 140 which it will be 30 and How are we going to allocate that out? Well, we're going to have to reduce the other Company the other owners the other owners capital accounts the other partners capital accounts I should say so we're gonna have to debit them so that 30,000 Now the question is well, how much are we going to debit? MB and L in order to of 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 We look at that calculation. What we're saying is the new partner was put on the books or Take it. We can look at it either way. We could say the new partner was on the books for 140 That's how much they paid and we put them on the books or 170 Therefore, we have a difference of this 30,000. We're gonna break that difference out between 30 percent to M So times point three gives us 9,000. So that's where this 9,000 is if we take this 30 We take the 30,000 times the point two 20% we get the 6,000 and then of course if we take the 30,000 times the point five That'll give us the 15 the 9 plus the 6 plus the 15 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 to L. So that's 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 travel. I'm gonna post this journal entry. So Here's the 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 expected to do What do we expect it to do? We expect it to create an Indian capital account after we post this journal entry of our 170 and then M 142 to B 182 and L 249 6 thereby giving us a capital count 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 gonna debit cash cash as a debit balance We're gonna make it go up by doing the same thing to it. Therefore cash went up to the 690,000 and then we put R on the books. So here's R on the books We're gonna credit over the 170,000 so we're gonna 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 ML and MB 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 is gonna have to eat or reduce their capital account to 142 to so it was going to receive the 151 that was the value and it went down. So then B is gonna get the 6000 So B has a credit balance of 124 to we're bringing the balance down by the 6000 to 118 to and then L here has it has it 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 it 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 and we also 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 variation of the same problems same exact things can be very similar except for Now we're going to bring a new partner are on the books Same 25% interest that the partnership has agreed the partnership and the new partner have agreed on this and a market environment But the new partner is going to be on the books and give the partnership the 270,000 so now the agreement is that the partnership will give a 25% interest in the partnership in exchange for The new partner are giving the partnership 270,000 so let's see what the journal tree would look like same process I'm going to talk about the journal entry until we hit kind of a problem and then go through our worksheet to see if we Can figure out and fix the problem So first of all of course the question that we always have is the Cash affected in this journal entry of bringing the new partner in and of course. Yes, the cash is going to be effective We're going to receive 270,000 in the partnership therefore cash is a debit balance We're going to make cash go up by doing the same thing to it which in this case would be another debit So we know that's going to be part of the journal tree We can put that lay that out in the front right up front We also know that the new partners going to be be entering the partnerships So the new partner put in 270,000 you would think that of course We would credit the new partner for the investment just like when we create an investment or any time an investment happens You would think we would credit ours capital account, which we will However, we will not credit necessarily for 270 in this case. We're going to credit for 2025 Why that's that's going to be the question. Well, why are we going to do that? How are we going to come up with that? Let's do our worksheet in order to answer that question So what we have here is Our 30 2050 we won't go over calculating those ratios again That's of course the 3 to 5 ratio and we have our capital accounts balances Which will be just these balances here So we've laid these balances out in terms of a table now for the three existing partners before The new partner enters note the capital account balance of 540 is equal to the book value of The company being the assets minus the liabilities assets minus liabilities by 40 That's the book value of the company that is allocated to the partners in this way and note again that The reason we can do this is because we have closed out the revenue and expenses So there's a post closing trial balance. This is basically balance sheet accounts that we're looking at so then The new partner comes on the books and it's going to give the partnership 270,000 therefore The book value the cash is going to go up the assets are going to go up by 270 and the assets minus liabilities Then we'll be at 810,000 that means that our new capital accounts at the end of the day after the transaction has happened needs to be at 810,000 we said that the new partner was going to get a 25% interest of that Therefore if we take that 810 times 25% that's the agreement that we have the new partner is going to be on the books for The 202,000 so that's where this number is coming from So now We that the new partner gave the partnership 270 We're putting the new partner on the books at 2025 and you might be asking well, why would the new partner? Agree to these terms. Why would the new partner? I mean if the assets minus the liabilities equals the value in the company and The new partners only going to receive 2025 of value in the company Why would the new partner then give the company or the partnership? 270,000 and the reason for that might be well, there could be some intangible assets on The books or maybe the books are not valued Exactly at fair market value as is perceived by the individuals in the transaction So maybe the the current partnership has a good name and has good Intangible out of assets being good will or something like that that will Will generate future revenue and therefore the new partner partner are Maybe willing to pay more than what is being allocated to them through the agreement So once again, this these things will very rarely match They could match that would be a very easy journal entry to make but more often than not they won't and the agreement will be Something that will have to differ in this way now, of course the difference being that the debits are greater than the credits We're gonna have to add some credits here. How are we gonna add the credits? Who's gonna receive the credits? Well this time in BNL are gonna receive an increase in their capital accounts because They received more cash than they're allocating to the new partner. So that means that we have this 67.5 difference. So if we look at the calculation here, what is happening is that? We we the new partners is receiving 270,000 in cash and they're giving are a 2025 therefore, we have this 67.5 that we need to allocate to M B and L in accordance with their profit sharing ratios So we got the 67.5. We're gonna multiple times times Point three thirty percent that gives us the twenty thousand two right there And then we're gonna do the same thing here. So we've got the 67.5 Times B's capital account point two profit sharing gives us the thirteen five there And we'll do this one more time And we have L. So we've got the 67.5 times point five for L And that would be the 33 750 therefore This 67.5 will be allocated to M B and L at 20,250,135 and 33 750 respectively If we take a look at the transaction then our trial balance over here We need to then increase the about account balances like so So we will go up obviously r is going to be on the books for the amount allocated to r that 270 That I'm sorry the 2025 That we're putting r on the books for and then we are going to increase the capital account balance from 151 to Plus the 20,000 in this case to the 171 450 we're increasing the capital account balances in terms of a journal entry then To increase the credit balance we will then credit Which of course is also the plug that we need in order to make this reconciled So there's the 22 50 to 13 5 to 33 750 to m b and l respectively Which will increase their capital accounts Let's see what that would look like in terms of the trial balance. So here's that same journal entry Here's that same worksheet Let's see if it does what we expect it to do when we post it to our worksheet here. What do we expect it to do? We expect r m b and l's capital accounts to be 2025 171 450 3 137 7 and 298 350 after we post the journal entry Respectively, so here's the cash cash is going up cash is a debit balance We're making it go up in the debit direction. So it goes from 550 to 820 then we post ours capital accounts. So here's the new partner going from zero, of course up In the credit direction by 202 500 the company now in essence kind of like o's are The 202 500 and then m's capital account is going to go up in the credit direction So with the credit we're doing the same thing to it increase in the capital account from 551 200 up by 20252 171 450 then we've got these capital accounts here. So b has a credit balance of 124 2 We're doing the same thing to it being a credit of 13 5 increasing the capital account to the 137 700 and then l's capital account balance has a credit balance We are going to do the same thing to it increasing that capital account balance from 264 6 by 33 750 to The nine are the 298 350 now, of course the assets the cash minus the liabilities accounts payable Will equal our new capital account balances, which will then add up to The 810 So we are now able to Describe the process of adding a new partner to the partnership create the journal entries to record the entry of a new Partner to a partnership define the effect of journal entry to add a new partner on the trial balance Accounts and explain the effect on the capital accounts of adding a new partner to a partnership