Admission of a Partner into a Partnership

Admission of a Partner

A new partner is admitted in one of two ways: by purchasing an interest from one or more current partners or by investing cash or other assets in the partnership.

Purchase of Partnership Interest
The purchase of partnership interest is a personal transaction between one or more current partners and the new partner. To become a partner, the current partners must accept the purchaser. Accounting for the purchase of partnership interest involves reallocating current partners’ capital to reflect the transaction. To illustrate, at the end of BOARDS’ first year, H. Perez sells one-half of his partnership interest to Tyrell Rasheed for $18,000. This means that Perez gives up a $13,000 recorded interest ($26,000 × 1/2) in the partnership (see the ending capital balance in Exhibit 12.3). The partnership records this January 4 transaction as follows.




After this entry is posted, BOARDS’ equity shows K. Zayn, Capital; H. Perez, Capital; and T. Rasheed, Capital, and their respective balances of $52,000, $13,000, and $13,000.
 
Two aspects of this transaction are important. First, the partnership does not record the $18,000 Rasheed paid Perez. The partnership’s assets, liabilities, and total equity are unaffected by this transaction among partners. Second, Zayn and Perez must agree that Rasheed is to become a partner. If they agree to accept Rasheed, a new partnership is formed and a new contract with a new income-and-loss-sharing agreement is prepared. If Zayn or Perez refuses to accept Rasheed as a partner, then (under the Uniform Partnership Act) Rasheed gets Perez’s sold share of partnership income and loss. If the partnership is liquidated, Rasheed gets Perez’s sold share of partnership assets. Rasheed gets no voice in managing the company unless Rasheed is admitted as a partner.

Point: Partners’ withdrawals are not constrained by the partnership’s annual income or loss.

Investing Assets in a Partnership
Admitting a partner by accepting assets is a transaction between the new partner and the partnership. The invested assets become partnership property. To illustrate, if Zayn (with a $52,000 interest) and Perez (with a $26,000 interest) agree to accept Rasheed as a partner in BOARDS after an investment of $22,000 cash, this is recorded as follows.




After this entry is posted, both assets (cash) and equity (T. Rasheed, Capital) increase by $22,000. Rasheed now has a 22% equity in the assets of the business, computed as $22,000 divided by the entire partnership equity ($52,000 + $26,000 + $22,000). Rasheed does not necessarily have a right to 22% of income. Dividing income and loss is a separate matter on which partners must agree.





Bonus to old partners.
When the current value of a partnership is greater than the recorded amounts of equity, the partners usually require a new partner to pay a bonus for the privilege of joining. To illustrate, assume that Zayn and Perez agree to accept Rasheed as a partner with a 25% interest in BOARDS if Rasheed invests $42,000. Recall that the partnership’s accounting records show that Zayn’s recorded equity in the business is $52,000 and Perez’s recorded equity is $26,000 (see Exhibit 12.3). Rasheed’s equity is determined as follows.



Although Rasheed invests $42,000, the equity attributed to Rasheed in the new partnership is only $30,000. The $12,000 difference is called a bonus and is allocated to existing partners (Zayn and Perez) according to their income-and-loss-sharing agreement. A bonus is shared in this way because it is viewed as reflecting a higher value of the partnership that is not yet reflected in income. The entry to record this transaction follows.




Bonus to new partner.
Alternatively, existing partners can grant a bonus to a new partner. This usually occurs when they need additional cash or the new partner has exceptional talents. The bonus to the new partner is in the form of a larger share of equity than the amount invested. To illustrate, assume that Zayn and Perez agree to accept Rasheed as a partner with a 25% interest in the partnership, but they require Rasheed to invest only $18,000. Rasheed’s equity is determined as follows.
 


The old partners contribute the $6,000 bonus (computed as $24,000 minus $18,000) to Rasheed according to their income-and-loss-sharing ratio. Moreover, Rasheed’s 25% equity does not necessarily entitle Rasheed to 25% of future income or loss. This is a separate matter for agreement by the partners. The entry to record the admission and investment of Rasheed is