Accounting for Partnerships and Limited Liability Companies

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12
Accounting for Partnerships and Limited Liability
Companies
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After studying this chapter, you should be able
to

1. Describe the basic characteristics of
   proprietorships, partnerships, and limited
   liability companies.

1. Describe and illustrate the accounting for
   forming a partnership and for dividing the net
   income and net loss of a partnership.

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After studying this chapter, you should be able
to

1. Describe and illustrate the accounting for
   partner admission and withdrawal.

1. Describe and illustrate the accounting for
   liquidating a partnership.
2. Prepare the statement of partnership equity.

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12-1
Objective 1
Describe the basic characteristics of
proprietorships, partnerships, and limited
liability companies.
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12-1
Proprietorship
A proprietorship is a business enterprise owned
by a single individual.

• Advantages
• Simple to form
• Ability to be ones own boss

• Disadvantages
• Difficulty in raising large amounts of capital
• Unlimited liability

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12-1
Partnership
A partnership is an association of two or more
individuals who own and manage a business for
profit.
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Characteristics of Partnerships
Voluntary Association
Limited Life
Partnership Agreement
Taxation
Unlimited Liability
Mutual Agency
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12-1
Partnership
A partnership is an association of two or more
individuals who own and manage a business for
profit.

• Advantages
• More financial resources than a proprietorship
• Additional management skills

• Disadvantages
• Limited life
• Unlimited liability
• Co-ownership of partnership property
• Mutual agency

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12-1
Partnership

• An important right of partners is to participate
  in the income of the partnership.

• A partnership, like a proprietorship, is a
  nontaxable entity.
• A partnership is created by a contract, known as
  the partnership agreement or articles of
  partnership.

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12-1
Limited Partnership
A variant of the regular partnership is a limited
partnership. This form of partnership allows
partners who are not involved in the operations
of the partnership to retain limited liability.
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12-1
Limited Liability Companies

• Combines the advantages of the corporate and
  partnership forms.

• LLCs must file articles of organization with
  state governmental authorities.
• Owners are termed members rather than
  partners.
• Members must create an operating agreement.

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(Continued)
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12-1
Limited Liability Companies

• An LLC may elect to be treated as a partnership
  for tax purposes.

• Most operating agreements specify continuity of
  life for the LLC, even when a member withdraws.
• Members may elect operating the LLC as a
  member-managed entity.
• An LLC provides limited liability for the members.

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Organizations with Partnership Characteristics
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Choosing a Business Form
Many factors should be considered when choosing
the proper business form.
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12-1
Characteristics of Proprietorships, Partnerships,
and Limited Liability companies
2
Ease of Formation
Proprietorship Simple
Partnership Moderate
LLC Moderate
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12-1
Characteristics of Proprietorships, Partnerships,
and Limited Liability companies
2
Legal Liability
Proprietorship No limitation
Partnership No limitation
LLC Limited liability
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12-1
Characteristics of Proprietorships, Partnerships,
and Limited Liability companies
2
Taxation
Proprietorship Nontaxable
Partnership Nontaxable
LLC Nontaxable
Pass-through entity Pass-through entity by
election
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12-1
Characteristics of Proprietorships, Partnerships,
and Limited Liability companies
2
Limitation on Life of Entity
Proprietorship Yes
Partnership Yes
LLC No
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12-1
Characteristics of Proprietorships, Partnerships,
and Limited Liability companies
2
Access to Capital
Proprietorship Limited
Partnership Limited
LLC Average
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12-2
Objective 2
Describe and illustrate the accounting for
forming a partnership and for dividing the net
income and net loss of a partnership.
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Organizing a Partnership
Partners can invest both assets and liabilities
in the partnership.
Assets and liabilities are recorded at an
agreed-upon value, normally fair market value.
Contributions increase the partners capital
account.
Withdrawals decrease the partners capital
account.
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12-2
Forming a Partnership
Joseph Stevens and Earl Foster agree to combine
their hardware businesses in a partnership. Each
is to contribute certain amounts of cash and
other assets. They also agree that the
partnership is to assume the liabilities of the
separate businesses.
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Stevens Transfer of Assets, Liability, and Equity
Apr. 1 Cash 7 200 00 Accounts Receivable 16
300 00 Merchandise Inventory 28 700 00
Store Equipment 5 400 00 Office Equipment 1
500 00
Allowance for Doubtful Accounts 1 500 00 Accounts
Payable 2 600 00 Joseph Stevens, Capital 55 000 00
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12-2
A similar entry would record the assets
contributed and the liabilities transferred by
Foster. In each entry, the noncash assets are
recorded at values agreed upon by the partners.
These values normally represent current market
values.
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12-2
Reese Howell contributed equipment, inventory,
and 34,000 cash to a partnership. The equipment
had a book value of 23,000 and market value of
29,000. The inventory had a book value of
60,000, but only had a market value of 15,000,
due to obsolescence. The partnership also
assumed a 12,000 note payable owed by Howell
that was used originally to purchase the
equipment. Provide the journal entry for Howells
contribution to the partnership.
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12-2
Cash 34,000 Inventory 15,000 Equipment 29,000 Not
es Payable 12,000 Reese Howell, Capital 66,000
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For Practice PE 12-1A, PE 12-1B
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Dividing Income or Loss

• In the absence of an agreement, the Uniform
  Partnership Act says that the income or loss is
  shared equally by the partners.Three frequently
  used methods to divide income or loss are
• A stated ratio
• The ratio of capital balances
• Salary and interest allowances and any remainder
  in a fixed ratio.

Lets look at each of these methods!
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Allocation on Stated Ratios
Greene and Redd agree to a three-fourths,
one-fourth allocation of partnership income and
loss, respectively. For 2008, net income is
60,000.
Prepare the closing entry for Income Summary that
will allocate the income to the partners based on
their agreement.
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Allocation on Stated Ratios
Greene and Redd agree to a three-fourths,
one-fourth allocation of partnership income and
loss, respectively. For 2008, net income is
60,000.
Greene 60,000 (3/4) 45,000 Redd 60,000
(1/4) 15,000
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Allocation on Capital Balances
Greenes capital balance is 80,000 and Redds
capital balance is 40,000. The partnership
agreement calls for income or loss to be
allocated based on the relative capital balances.
Net income for 2008 is 60,000.
Prepare the closing entry for Income Summary that
will allocate the income to the partners based on
their agreement.
31
Allocation on Capital Balances
Greenes capital balance is 80,000 and Redds
capital balance is 40,000. The partnership
agreement calls for income or loss to be
allocated based on the relative capital balances.
Net income for 2008 is 60,000.
Greene 60,000 (80,000/120,000)
40,000 Redd 60,000 (40,000/120,000)
20,000
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Allocation on Services, Capital, and Stated Ratios

• Greene and Redds partnership agreement contains
  the following information
• Greene receives 15,000 and Redd receives 10,000
  as annual salaries.
• Each partner is allowed an annual interest
  allowance of 5 on the beginning-of-year capital
  balance.
• Any remaining balance of income or loss is
  allocated equally.
• Net income for 2008 is 60,000.
• What amount of the net income will be allocated
  to each partner based on their agreement?

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Allocation on Services, Capital, and Stated Ratios
If the allowances exceed net income, the deficit
would be allocated equally, just as the excess is
in the example above.
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12-2
Dividing IncomeServices of Partners
The partnership agreement of Jennifer Stone and
Crystal Mills provides for Stone to receive a
monthly allowance of 5,000 (60,000 annually)
and Mills is to receive 4,000 a month (48,000
annually). If there is any remaining net income,
it is to be divided equally. The firm had a net
income of 150,000 for the year.
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Division of Net Income
J. Stone C. Mills Total
Annual salary allowance 60,000 48,000 108,000 R
emaining income 21,000 21,000 42,000
to journal entry (Slide 24)
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The entry for dividing net income is as follows
Dec. 31 Income Summary 150 000 00 Jennifer
Stone, Capital 81 000 00 Crystal Mills,
Capital 69 000 00
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Dividing IncomeServices of Partners and
Investments
The partnership agreement for Stone and Mills
divides income as follows

1. Monthly salary allowance of 5,000 for Stone and
   4,000 for Mills.
2. Interest of 12 on each partners capital balance
   on January 1.
3. If there is any remaining net income, it is to be
   divided equally between the partners.

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Division of Net Income
Net income of 150,000 is divided.
J. Stone C. Mills Total
Salary allowance 60,000 48,000 108,000 Interest
allowance 19,200 14,400 33,600
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12-2
Division of Net Income
Net income of 150,000 is divided.
J. Stone C. Mills Total
Salary allowance 60,000 48,000 108,000 Interest
allowance 19,200 14,400 33,600
12 x Stones capital account balance on Jan. 1
of 160,000
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12-2
Division of Net Income
Net income of 150,000 is divided.
J. Stone C. Mills Total
Salary allowance 60,000 48,000 108,000 Interest
allowance 19,200 14,400 33,600
12 x Mills capital account balance on Jan. 1 of
120,000
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12-2
Division of Net Income
Net income of 150,000 is divided.
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12-2
The entry for dividing net income is as follows
Dec. 31 Income Summary 150 000 00 Jennifer
Stone, Capital 83 400 00 Crystal Mills,
Capital 66 600 00
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LLC Alternative
The entry for dividing net income is as follows
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12-2
Dividing IncomeAllowances Exceed Net Income
Assume the same facts as before except that the
net income is only 100,000.
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Division of Net Income
Net income of 100,000 is divided.
J. Stone C. Mills Total
Salary allowance 60,000 48,000 108,000 Interest
allowance 19,200 14,400 33,600
Total 79,200 62,400 141,600
This amount exceeds net income by 41,600.
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12-2
Division of Net Income
Net income of 100,000 is divided.
J. Stone C. Mills Total
Salary allowance 60,000 48,000 108,000 Interest
allowance 19,200 14,400 33,600
Total 79,200 62,400 141,600 Deduct excess of
allowance over income 20,800 20,800
lt41,600gt
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12-2
Steve Prince and Chelsy Bennick formed a
partnership, dividing income as follows

1. Annual salary allowance to Prince of 42,000.
2. Interest of 9 on each partners capital balance
   on January 1.
3. Any remaining net income divided equally.

Prince and Bennick had 20,000 and 150,000 in
their January 1 capital balances, respectively.
Net income for the year was 240,000. How much
net income should be distributed to Prince?
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12-2
36
For Practice PE 12-2A, PE 12-2B
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12-3
Objective 3
Describe and illustrate the accounting for
partner admission and withdrawal.
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Admission of a Partner

• When the makeup of the partnership changes, the
  partnership is dissolved.
• A new partnership may be immediately formed.
• New partner acquires partnership interest by
• Purchasing it from the other partners, or
• Investing assets in the partnership.

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Purchase of Partnership Interest

• A new partner can purchase partnership interest
  directly from the existing partners.
• The cash goes to the partners, not to the
  partnership.
• To become a partner, the new partner must be
  accepted by the current partners.

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12-3
Admitting a Partner
A person may be admitted to a partnership only
with the consent of all the current partners by
1. Purchasing an interest from one or more of the
current partners. 2. Contributing assets to the
partnership.
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Purchase of Partnership Interest

• Redd agrees to sell Blue 10,000 of her
  partnership interest for 25,000.

A new partnership agreement must be prepared that
identifies the allowances and profit sharing
basis.
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12-3
Purchasing an Interest in a Partnership
Partners Tom Andrews and Nathan Bell have capital
balances of 50,000 each. On June 1, each sells
one-fifth of his equity to Joe Canter for 10,000
in cash.
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12-3
The only entry required in the partnership
accounts is as follows
June 1 Tom Andrews, Capital 10 000 00 Nathan
Bell, Capital 10 000 00 Joe Canter, Capital 20
000 00
40
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12-3
The effect of the transaction on the partnership
accounts is presented in the following diagram
Partnership Accounts
Andrew, Capital
50,000
10,000
Carter, Capital
20,000
Bell, Capital
10,000
50,000
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12-3
LLC Alternative
June 1 Tom Andrew, Member Equity 10 000
00 Nathan Bell, Member Equity 10 000 00 Joe
Canter, Member Equity 20 000 00
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Contributing Assets to a Partnership
Partners Donald Lewis and Gerald Morton have
capital balances of 35,000 and 25,000,
respectively. On June 1, Sharon Nelson joins the
partnership by permission and makes an investment
of 20,000 cash.
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12-3
The entry to record this transaction is as
follows
June 1 Cash 20 000 00 Sharon Nelson,
Capital 20 000 00
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12-3
The effect of the transaction on the partnership
accounts is presented in the following diagram
Partnership Accounts
Net Assets
60,000
Nelson, Capital
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12-3
LLC Alternative
June 1 Cash 20 000 00 Sharon Nelson, Member
Equity 20 000 00
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12-3
Revaluation of Assets
If the asset accounts do not reflect approximate
current market values when a new partner is
admitted, the accounts should be adjusted
(increased or decreased) before the new partner
is admitted.
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12-3
Partners Donald Lewis and Gerald Morton have
capital balances of 35,000 and 25,000,
respectively. The balance in Merchandise
Inventory is 14,000 and the current replacement
value is 17,000. The partners share net income
equally.
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The revaluation is recorded as follows
June 1 Merchandise Inventory 3 000 00
Donald Lewis, Capital 1 500 00 Gerald Morton,
Capital 1 500 00
Because the LLC alternative follows a pattern of
replacing Capital with Member Equity, the LLC
entry will not be shown again.
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12-3
Blake Nelson invested 45,000 in the Lawrence
Kerry partnership for ownership equity of
45,000. Prior to the investment land was
revalued to a market value of 260,000 from a
book value of 200,000. Lynne Lawrence and Tim
Kerry share net income in a 12 ratio.

1. Provide the journal entry for the revaluation of
   land.
2. Provide the journal entry to admit Nelson.

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12-3

• Cash 45,000
• Blake Nelson, Capital 45,000

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For Practice PE 12-3A, PE 12-3B
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68
Bonus to Old or New Partners
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12-3
Partner Bonuses
On March 1, the partnership of Marsha Jenkins and
Helen Kramer admit Alex Diaz as a new partner.
The assets of the old partnership are adjusted to
current market values and the resulting capital
balances for Jenkins and Kramer are 20,000 and
24,000, respectively.
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Jenkins and Kramer agree to admit Diaz as a
partner for 31,000. In return, Diaz will
receive a one-third equity in the partnership and
will share income and losses equally with Jenkins
and Kramer.
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12-3
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12-3
The entry to record the admission of Diaz to the
partnership is as follows
Mar. 1 Cash 31 000 00
Alex Diaz, Capital 25 000 00 Marsha Jenkins,
Capital 3 000 00 Helen Kramer, Capital 3 000 00
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12-3
Adjusting for New Partners Unique Qualities or
Skills
After adjusting the market values, the capital
balance of Janice Cowen is 80,000 and the
capital balance of Steve Dodd is 40,000. Ellen
Chou receives a one-fourth interest in the
partnership for a contribution of 30,000.
Before admitting Chou, Cowen and Dodd shared net
income using a 21 ratio.
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12-3
The bonus is computed as follows
Equity of Cowen 80,000 Equity of
Dodd 40,000 Chous Contribution 30,000 Total
equity after admitting Chou 150,000 Chous
equity interest after admission x 25 Chous
equity after admission 37,500 Chous
contribution 30,000 Bonus paid to Chou
7,500
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12-3
The entry to record the bonus and admission of
Chou to the partnership is as follows
June 1 Cash 30 000 00 Janice Cowen, Capital 5
000 00 Steve Dodd, Capital 2 500 00
Ellen Chou, Capital 37 500 00
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The entry to record the bonus and admission of
Chou to the partnership is as follows
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12-3
The entry to record the bonus and admission of
Chou to the partnership is as follows
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Withdrawal of a Partner

• A partner can withdraw in two ways
• The partner can sell his/her partnership interest
  to another person.
• The partnership can distribute cash and/or other
  assets to the withdrawing partner.

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Withdrawal of a Partner
Redd has a capital balance of 65,500. She
decides to withdraw from the partnership and
takes cash equal to her equity.
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12-3
Withdrawal of a Partner
On June 1, the partnership of X, Y, and Z have
capital balances of 50,000, 80,000, and
30,000, respectively. Z decides to retire from
the partnership and sells his interest to Y for
35,000.
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12-3
If Z had sold his interest directly to the
partnership, both the assets and the owners
equity of the partnership would have been reduced.
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12-3
Lowman has a capital balance of 45,000 after
adjusting assets to fair market value. Conrad
contributes 26,000 to receive a 30 interest in
a new partnership with Lowman.
Determine the amount and recipient of the partner
bonus.
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12-3
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For Practice PE 12-4A, PE 12-4B
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12-4
Objective 4
Describe and illustrate the accounting for
liquidating a partnership.
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12-4
Liquidating Partnerships
When a partnership goes out of business, the
winding-up process is called the liquidation of a
partnership.
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12-4
Liquidation Process

1. Sell the partnership assets. This step is called
   realization.

1. Distribute any gains or losses from realization
   to the partners based upon their income-sharing
   ratio.
2. Pay the claims of creditors using the cash from
   step 1 realization.
3. After satisfying the creditors, distribute the
   remaining cash to the partners based on the
   balances in their capital accounts.

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12-4
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12-4
Liquidation Process
Farley, Greene, and Hall share income and losses
in a ratio of 532. On April 9, after
discontinuing operations, the firm had the
following trial balance.
Cash 11,000 Noncash Assets 64,000 Liabilities
9,000 Jean Farley, Capital 22,000 Brad Greene,
Capital 22,000 Alice Hall, Capital 22,000
Total 75,000 75,000
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Liquidation Process
Between April 10 and April 30, 2006, Farley,
Greene, and Hall sell all noncash assets for
72,000. Thus, a gain of 8,000 (72,000
64,000) is realized.
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12-4
Gain on Realization
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12-4
Entries to Record the Steps in the Liquidation
Process
Step 1 Sale of assets
Cash 72 000 00
Noncash Assets 64 000 00 Gain on Realization 8
000 00
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Entries to Record the Steps in the Liquidation
Process
Step 2 Division of gain
Gain on Realization 8 000 00
Jean Farley, Capital 4 000 00 Brad Greene,
Capital 2 400 00 Alice Hall, Capital 1 600 00
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Entries to Record the Steps in the Liquidation
Process
Step 3 Payment of liabilities
Liabilities 9 000 00
Cash 9 000 00
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12-4
Entries to Record the Steps in the Liquidation
Process
Step 4 Distribution of cash to partners
Jean Farley, Capital 26 000 00 Brad Greene,
Capital 24 400 00 Alice Hall, Capital 23 600 00
Cash 74 000 00
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12-4
Loss on Realization
Farley, Greene, and Hall sell all noncash assets
for 44,000. A loss of 20,000 (64,000
44,000) is realized.
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12-4
Entries to Record the Steps in the Liquidation
Process
Step 1 Sale of assets
Cash 44 000 00 Loss on Realization 20 000 00
Noncash Assets 64 000 00
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12-4
Loss on Realization
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12-4
Entries to Record the Steps in the Liquidation
Process
Step 2 Division of loss
Jean Farley, Capital 10 000 00 Brad Greene,
Capital 6 000 00 Alice Hall, Capital 4 000 00
Loss on Realization 20 000 00
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12-4
Entries to Record the Steps in the Liquidation
Process
Step 3 Payment of liabilities
Liabilities 9 000 00
Cash 9 000 00
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12-4
Entries to Record the Steps in the Liquidation
Process
Step 4 Distribution of cash to partners
Jean Farley, Capital 12 000 00 Brad Greene,
Capital 16 000 00 Alice Hall, Capital 18 000 00
Cash 46 000 00
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12-4
Prior to liquidating their partnership, Todd and
Gentry had capital accounts of 50,000 and
100,000, respectively. The partnership assets
were sold for 220,000. The partnership had
20,000 of liabilities. Todd and Gentry share
income and losses equally. Determine the amount
received by Gentry as a final distribution from
liquidation of the partnership.
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12-4
85
For Practice PE 12-5A, PE 12-5B
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12-4
Loss on RealizationCapital Deficiency
Farley, Green, and Hall sell all of the noncash
assets for 10,000. A loss of 54,000 (64,000
10,000) is realized. The share of the loss
allocated to Farley, 27,000 (50 of 54,000),
exceeds the 22,000 balance in her capital
account. Farley contributes 5,000 to the
partnership.
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12-4
Loss on RealizationCapital Deficiency
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106
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12-4
Step 1 Sale of assets
Cash 10 000 00 Loss on Realization 54 000 00
Noncash Assets 64 000 00
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12-4
Step Payment of liabilities
Joan Farley, Capital 27 000 00 Brad Greene,
Capital 16 200 00 Alice Hall, Capital 10 800 00
Loss on Realization 54 000 00
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12-4
Step 3 Payment of liabilities
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12-4
Receipt of deficiency
Cash 5 000 00
Jean Farley, Capital 5 000 00
Having the partner with a deficiency pay all or
part of the deficiency is not one of the four
liquidation steps, but it should make the other
partners happy.
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12-4
Loss on RealizationCapital Deficiency
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12-4
Distribution of cash to partners
Brad Greene, Capital 5 800 00 Alice Hall,
Capital 11 200 00
Cash 17 000 00
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12-4
Prior to liquidating their partnership, Short and
Bain had capital accounts of 20,000 and 80,000,
respectively. The partnership assets were sold
for 40,000. The partnership had no liabilities.
Short and Bain share income and losses equally.

1. Determine the amount of Shorts deficiency
2. Determine the amount distributed to Bain assuming
   Short is unable to satisfy the deficiency.

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12-4

• Shorts equity prior to liquidation 20,000
• Realization of asset sales 40,000
• Book value of assets 100,000
• Loss on liquidation 60,000
• Shorts share of loss (50 x 60,000)
  30,000
• Shorts deficiency (10,000)

b. 40,000 80,000 30,000 share of loss
10,000. Shorts deficiency also equals the
amount realized from asset sales.
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For Practice PE 12-6A, PE 12-6B
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12-5
Objective 5
Prepare the statement of partnership equity.
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12-5
Statement of Partnership Equity
The change in the owners capital accounts for a
period of time is reported in a statement of
partnership equity.
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12-5
Statement of Partnership Equity
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12-5
Financial Analysis and Interpretation
Washburn Lovett, CPAs had the following
information for the last two years
2008 2007
Revenues 220,000,000 180,000,000 Number of
employees 1,600 1,500
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12-5
Financial Analysis and Interpretation
The revenues per employee showed improvement in
2008. Thus, each employee is producing more
revenues in 2008, than in 2007, which may
indicate improved productivity. Overall, it
appears the firm is properly managing the growth
in staff.