Partnerships, trusts and segment reporting

The course has concentrated on corporations and their investments, but many businesses are organized as partnerships, especially in professional services, and trusts hold assets for beneficiaries in estates, pension plans and investment vehicles. This final lesson covers the accounting that is distinctive to partnerships (formation, sharing profit, changes in partners and liquidation), introduces trusts, and then returns to the Larkspur group to see how segment reporting tells users what a consolidated group is made of. It ends by drawing the course together.

Partnerships

A partnership is an association of two or more persons to carry on as co-owners a business for profit, governed by state partnership statutes (most states have adopted a version of the Revised Uniform Partnership Act) and the partnership agreement. In a general partnership each partner is personally liable for the partnership's debts; in a limited partnership, limited partners' liability is restricted to their investment; and limited liability partnerships and limited liability companies shield owners from many claims. A partnership is not a taxable entity for federal income tax purposes: it files an information return (Form 1065) and gives each partner a Schedule K-1 showing their share of income. Partnerships may use US GAAP or other bases, and the distinctive accounting is in the partners' capital accounts.

Each partner has a capital account, credited with contributions and their share of profit and debited with withdrawals (drawings) and their share of losses. Non-cash contributions are recorded at their fair value at the date of contribution, because the partners have bargained over that value; a partner who contributes land worth $300,000 that cost $120,000 is credited with $300,000. Liabilities assumed by the partnership reduce the contributing partner's credit.

Sharing profit

The partnership agreement sets how profit and losses are shared. Without an agreement, partnership law generally divides them equally. Agreements often recognize differences in what partners contribute: salary allowances for partners who work more, interest on capital for those who invest more, and a residual ratio for whatever remains. Salary allowances and interest are not expenses of the partnership; they are steps in dividing profit, and they apply even if profit is too small to cover them, in which case the shortfall is shared in the residual ratio.

# Dividing partnership profit: salaries, interest on capital, then a residual ratio (illustrative)
partners = {"Ada": {"capital": 200_000, "salary": 60_000, "ratio": 0.40},
            "Ben": {"capital": 150_000, "salary": 40_000, "ratio": 0.30},
            "Cleo": {"capital": 250_000, "salary": 0, "ratio": 0.30}}
rate = 0.05                                   # interest on opening capital
def divide(profit):
    out = {}
    fixed = sum(p["salary"] + rate * p["capital"] for p in partners.values())
    residual = profit - fixed                 # may be negative: shared in the ratio anyway
    for name, p in partners.items():
        out[name] = round(p["salary"] + rate * p["capital"] + residual * p["ratio"])
    return residual, out
for profit in (180_000, 100_000):
    residual, out = divide(profit)
    print(f"Profit {profit:>9,}: residual {residual:>9,.0f}  " + "  ".join(f"{n} {v:,}" for n, v in out.items()))

Profit   180,000: residual    50,000  Ada 90,000  Ben 62,500  Cleo 27,500
Profit   100,000: residual   -30,000  Ada 58,000  Ben 38,500  Cleo 3,500

Admitting and withdrawing partners

A new partner can join in two ways. Buying an interest from an existing partner is a private transaction between them: the partnership simply transfers capital from the seller's account to the buyer's, whatever price is paid. Investing in the partnership increases its assets and total capital. When the new partner pays more than the book value of the interest received, the excess is usually treated as a bonus to the existing partners, credited to their capital in the residual ratio. Some partnerships instead record goodwill implied by the price, but because internally generated goodwill is not recognized under general-purpose accounting standards, the bonus method is more common.

When a partner retires, the partnership pays out the capital balance, usually after revaluing assets to fair value so the retiring partner shares in unrecognized gains. Paying more than the capital balance is a bonus to the retiring partner, charged to the remaining partners in their ratio; paying less is a bonus to the remaining partners.

Liquidation

When a partnership ends, it sells its assets (realization), pays creditors, shares gains and losses on realization in the profit ratio, and distributes remaining cash according to the partners' capital balances, not their profit ratio. If a partner's capital becomes negative, that partner must contribute cash to cover the deficiency; if they cannot, the deficiency is absorbed by the other partners in their relative profit ratio. Because the order and amounts of realization are uncertain, partnerships distributing cash in installments prepare a safe payments schedule that assumes all unsold assets are worthless and no deficient partner will pay, so no partner is paid cash that might later have to be returned.

# Liquidation: a partner with a capital deficiency who cannot pay (illustrative)
capital = {"Ada": 50_000, "Ben": 30_000, "Cleo": -20_000}   # after realizing assets and paying creditors
ratio = {"Ada": 0.40, "Ben": 0.30, "Cleo": 0.30}
deficit = {n: -c for n, c in capital.items() if c < 0}
solvent = [n for n in capital if capital[n] > 0]
for d, amt in deficit.items():
    share = sum(ratio[n] for n in solvent)
    for n in solvent:
        capital[n] -= amt * ratio[n] / share  # absorbed in the solvent partners' relative ratio
    capital[d] = 0
cash = sum(v for v in capital.values())
for n, v in capital.items():
    print(f"{n:<5} final cash distribution {v:>10,.0f}")
print(f"Cash available {cash:,.0f}")

Ada   final cash distribution     38,571
Ben   final cash distribution     21,429
Cleo  final cash distribution          0
Cash available 60,000

In the program, Cleo's $20,000 deficiency is shared by Ada and Ben in their relative ratio of 40:30, so Ada absorbs $11,429 and Ben $8,571, leaving Ada $38,571 and Ben $21,429 of the $60,000 cash. If Cleo later pays, Ada and Ben recover their shares. Creditors are paid before partners, and personal creditors of a partner have prior claim on that partner's personal assets in many jurisdictions.

Trusts

A trust is a relationship in which a trustee holds property for the benefit of beneficiaries under terms set by the grantor. Accountants meet trusts in estates, family trusts, pension plans and investment funds. A fiduciary accounts to beneficiaries, often distinguishing principal (corpus) from income because the beneficiaries entitled to each may differ; the trust instrument and state law, often based on the Uniform Principal and Income Act or its successor, the Uniform Fiduciary Income and Principal Act, govern that division. Trusts and estates file Form 1041 and are generally taxed on income not distributed to beneficiaries. Real estate investment trusts that meet tax requirements, including distributing at least 90 percent of taxable income, avoid entity-level tax, and their reporting follows US GAAP and SEC rules like other registrants.

Whether a trust is consolidated by someone else is a control question from lesson 9: a sponsor that directs a trust's relevant activities and is exposed to its variable returns may have to consolidate it, as Larkspur did with its receivables trust.

Segment reporting

A consolidated statement adds together businesses with very different prospects. ASC 280 requires public entities to disclose information about their operating segments using the management approach: segments are the components whose operating results are regularly reviewed by the chief operating decision maker (CODM) to allocate resources and assess performance, and the amounts disclosed are those the CODM uses, reconciled to the consolidated totals. Segments may be aggregated if they have similar economic characteristics. A segment is reportable if its revenue (external and intersegment), its absolute profit or loss, or its assets are 10 percent or more of the combined amounts; if reportable segments' external revenue is less than 75 percent of total consolidated revenue, more segments must be reported. ASU 2023-07 added annual and interim disclosure of significant segment expenses regularly provided to the CODM and the CODM's title, and ASU 2024-03 will require disaggregation of certain income statement expense captions for annual periods beginning after 15 December 2026.

# Which operating segments are reportable? The 10% and 75% tests (illustrative, $ thousands)
seg = {"Sensors":  (12_000, 300, 1_900, 16_000),     # external revenue, intersegment revenue, profit, assets
       "Controls": (3_500,  500,   860,  5_800),
       "Optics":   (4_100,    0,   520,  4_000),
       "Service":  (900,      0,   140,    600),
       "Software": (600,    200,  -250,    900)}
rev = sum(e + i for e, i, _, _ in seg.values())
prof = max(sum(p for _, _, p, _ in seg.values() if p > 0), -sum(p for _, _, p, _ in seg.values() if p < 0))
assets = sum(a for *_, a in seg.values())
reportable = []
for name, (e, i, p, a) in seg.items():
    tests = [(e + i) >= 0.1 * rev, abs(p) >= 0.1 * prof, a >= 0.1 * assets]
    if any(tests): reportable.append(name)
    print(f"{name:<9} revenue {(e + i) / rev:5.1%}  profit {abs(p) / prof:5.1%}  assets {a / assets:5.1%}  reportable={any(tests)}")
ext = sum(seg[n][0] for n in reportable) / sum(e for e, *_ in seg.values())
print(f"External revenue of reportable segments: {ext:.1%} (must be at least 75%)")

Sensors   revenue 55.7%  profit 55.6%  assets 58.6%  reportable=True
Controls  revenue 18.1%  profit 25.1%  assets 21.2%  reportable=True
Optics    revenue 18.6%  profit 15.2%  assets 14.7%  reportable=True
Service   revenue  4.1%  profit  4.1%  assets  2.2%  reportable=False
Software  revenue  3.6%  profit  7.3%  assets  3.3%  reportable=False
External revenue of reportable segments: 92.9% (must be at least 75%)

Entity-wide disclosures apply even to an entity with a single segment: revenue by product and service, revenue and non-current assets by geographic area (domestic and all foreign countries, with material individual countries shown separately), and reliance on major customers, being any customer providing 10 percent or more of revenue, with the segment concerned but not the customer's name.

Bringing the course together

The common thread is that the accounting follows the economic relationship: passive investments are measured at fair value, significant influence leads to the equity method, a controlling financial interest leads to consolidation regardless of legal form, and foreign entities are translated or remeasured in a way that reflects how their cash flows affect the parent. Judgments about influence, control and functional currency drive everything else, which is why they receive extensive disclosure. ACCT-470 applies these judgments to complex cases, and ACCT-412 covers public sector and not-for-profit organizations, which have their own standards on controlled and related entities.