Partnership Change in Ownership: Everything You Need to Know
Having a partnership change in ownership can mean adding or withdrawing partners. Partners can agree to add new partners in two different ways.3 min read
Having a partnership change in ownership can mean adding or withdrawing partners. Partners can agree to add new partners in two different ways. The partner who's new could buy out part or all of the interest of the current partner or partners. The new partner could also invest in the partnership, which would cause an increase in how many partners there are. The partnership will account for these partner changes differently.
Buying Out Existing Partners
Say there are two current partnerships - MJM, which has a capital balance of $70,000, and EAM, which has a capital balance of $50,000. If MJM wants to retire and the partners will have TLM buy out the partnership interest held by MJM, the accounting records for the partnership need to reflect this ownership change. Since TLM is buying all of MJM's interest directly from the company, any cash that MJM gets from TLM will not be recorded on the books.
This is because it's an exchange of an investment by people who have no assets that are being taken or given to the partnership. This means it doesn't matter if TLM pays $50,000 or $100,000 for the new partnership interest that MJM. The partnership simply needs to record the capital accounts change by using MJM's current balance of their capital account.
Investment in the Partnership
If TLM decides to become a third partner and join the current partnership by investing $30,000 cash in it, the partnership needs to record this extra cash and define the new capital account for the partner. The following rules apply:
- How much capital that's recorded for TLM depends on their ownership interest in this partnership.
- Any difference between the cash that's contributed by TLM to the partnership and the ownership interest must be given to the current partners.
- The difference can increase what the current capital account balances are and can be a bonus to current partners to be taken out from the current capital account balances so it will be a bonus to the upcoming partner.
If a 20 percent ownership interest for the partnership is received by TLM for their investment of $30,000, the initial capital account balance needs to be determined by adding this $30,000 to the total capital of the partnership before the investment, and then multiply by 20 percent. This will calculate the ownership interest of TLM. In this case, TLM's capital account will be credited $30,000 and, if they receive a 30 percent interest for their investment of $30,000, the capital account will be credited $45,000.
This $15,000 difference between the original balance of $45,000 and the $30,000 cash investment needs to be deducted from the current partners' capital account balances as defined by their sharing of losses and gains. If there is a 15 percent interest received by TLM in the partnership for an investment of $30,000, the cash account for the partnership will be debited by $30,000 and the capital account for TLM will be credited by $22,500.
The leftover $7,500 will be credited to the other two capital account balances for the remaining partners based off the 60 percent/40 percent ratio for sharing their gains and losses. The capital account balance for MJM will increase by $4,500, and EAM's will increase by $3,000.
Retirement or Withdrawal of a Partner
If a current partner wants to withdraw or retire from a partnership, the partner can choose to be bought out by a current partner or can get assets from the partnership. If the partner decides to purchase a retiring partner's interest, the partnership needs to record an entry, so the capital account balance is closed out and the capital account balance amount is added to the partner who has newly purchased the interest.
If the partnership decides to give their assets to the partner who's retiring in the amount that is the partner's capital account balance, there must be an entry made to decrease the assets and have the capital account balance of the retiring partner be zeroed out. If the retiring partner gets fewer or more assets than the capital account balance of the partner, the difference will be added to or taken from the capital accounts of the partners who are remaining.
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