CPA, MBA BY RACHELLE AGATHA, CPA, MBA Partnerships & LLC Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac

2 1. Describe the basic characteristics of proprietorships, partnerships, and limited liability companies. 2. Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership. Objectives:

3 3. Describe and illustrate the accounting for partner admission and withdrawal. 4. Describe and illustrate the accounting for liquidating a partnership. 5. Prepare the statement of partnership equity. Objectives:

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

5 Advantages Simple to form Ability to be one’s own boss Disadvantages Difficulty in raising large amounts of capital Unlimited liability A proprietorship is a business enterprise owned by a single individual. Proprietorship

6 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 Partnership

7  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. Partnership

8 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.

9  Combines the advantages of the corporate and partnership forms. Limited Liability Companies  LLCs must file “articles of organization” with state governmental authorities.  Owners are termed “members” rather than “partners.”  Members must create an operating agreement. (Continued)

10  An LLC may elect to be treated as a partnership for tax purposes. Limited Liability Companies  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.

11 Ease of Formation ProprietorshipSimple PartnershipModerate LLCModerate Characteristics of Proprietorships, Partnerships, and Limited Liability companies

12 Legal Liability ProprietorshipNo limitation PartnershipNo limitation LLCLimited liability Characteristics of Proprietorships, Partnerships, and Limited Liability companies

13 Taxation ProprietorshipNontaxable* PartnershipNontaxable* LLCNontaxable** *Pass-through entity **Pass-through entity by election Characteristics of Proprietorships, Partnerships, and Limited Liability companies

14 Limitation on Life of Entity Proprietorship Yes Partnership Yes LLC No Characteristics of Proprietorships, Partnerships, and Limited Liability companies

15 Access to Capital ProprietorshipLimited PartnershipLimited LLCAverage Characteristics of Proprietorships, Partnerships, and Limited Liability companies

16 Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership. Objective 2

17 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.

18 Stevens’ Transfer of Assets, Liability, and Equity Apr.1Cash Accounts Receivable Merchandise Inventory Store Equipment Office Equipment Allowance for Doubtful Accounts Accounts Payable Joseph Stevens, Capital

19 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.

20 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 Howell’s contribution to the partnership.

21 Cash34,000 Inventory15,000 Equipment29,000 Notes Payable12,000 Reese Howell, Capital66,000

22 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. Dividing Income—Services of Partners

23 J. Stone C. Mills Total Annual salary allowance $60,000 $48,000 $108,000 Remaining income 21,000 21,000 42,000 Division of net income $81,000 $69,000 $150,000 Division of Net Income to journal entry (Slide 24)

24 The entry for dividing net income is as follows: Dec. 31Income Summary Jennifer Stone, Capital Crystal Mills, Capital

25 Dividing Income—Services 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 partner’s capital balance on January 1. 3.If there is any remaining net income, it is to be divided equally between the partners.

26 Division of Net Income Salary allowance$60,000 $48,000 $108,000 Interest allowance19,20014,400 33,600 Net income of $150,000 is divided. J. Stone C. Mills Total

27 Division of Net Income Salary allowance$60,000 $48,000 $108,000 Interest allowance19,200 14,400 33,600 12% x Stone’s capital account balance on Jan. 1 of $160,000 J. Stone C. Mills Total Net income of $150,000 is divided.

28 Division of Net Income J. Stone C. Mills Total Salary allowance$60,000 $48,000 $108,000 Interest allowance19,200 14,400 33,600 12% x Mills’ capital account balance on Jan. 1 of $120,000 Net income of $150,000 is divided.

29 Division of Net Income J. Stone C. Mills Total Salary allowance$60,000 $48,000 $108,000 Interest allowance19,200 14,400 33,600 Remaining income4,200 4,200 8,400 Division of net income $83,400 $66,600 $150,000 Net income of $150,000 is divided.

30 The entry for dividing net income is as follows: Dec. 31Income Summary Jennifer Stone, Capital Crystal Mills, Capital

31 The entry for dividing net income is as follows: Dec. 31Income Summary Jennifer Stone, Member Equity Crystal Mills, Member Equity LLC Alternative Note the use of “Member Equity” instead of “Capital” for LLC.

32 Assume the same facts as before except that the net income is only $100,000. Dividing Income—Allowances Exceed Net Income

33 Division of Net Income 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 Net income of $100,000 is divided. This amount exceeds net income by $41,600.

34 Division of Net Income 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 Net income$58,400$41,600$100,000 Net income of $100,000 is divided.

35 Steve Prince and Chelsy Bennick formed a partnership, dividing income as follows: 1.Annual salary allowance to Prince of $42, Interest of 9% on each partner’s 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?

36 Monthly salary$ 42,000 Interest (9% x $20,000)1,800 Remaining income 91,350* Total distributed to Prince$135,150 *($240,000 – $42,000 – $1,800 – $13,500) x 50%

37 Describe and illustrate the accounting for partner admission and withdrawal. Objective

38 1.Purchasing an interest from one or more of the current partners. 2.Contributing assets to the partnership. A person may be admitted to a partnership only with the consent of all the current partners by: Admitting a Partner

39 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. Purchasing an Interest in a Partnership

40 The only entry required in the partnership accounts is as follows: June 1Tom Andrews, Capital Nathan Bell, Capital Joe Canter, Capital

41 The effect of the transaction on the partnership accounts is presented in the following diagram: Partnership Accounts Andrew, Capital 10,000 Bell, Capital 10,000 50,000 Carter, Capital 20,000

42 LLC Alternative June 1Tom Andrew, Member Equity Nathan Bell, Member Equity Joe Canter, Member Equity

43 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.

44 June 1Cash Sharon Nelson, Capital The entry to record this transaction is as follows:

45 The effect of the transaction on the partnership accounts is presented in the following diagram: Partnership Accounts Nelson, Capital Lewis, Capital 35,000 Morton, Capital 25,000 Net Assets 60,000 20,000

46 LLC Alternative June 1Cash Sharon Nelson, Member Equity

47 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.

48 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.

49 June 1Merchandise Inventory Donald Lewis, Capital Gerald Morton, Capital Because the LLC alternative follows a pattern of replacing “Capital” with “Member Equity,” the LLC entry will not be shown again. The revaluation is recorded as follows:

50 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 1:2 ratio. a.Provide the journal entry for the revaluation of land. b.Provide the journal entry to admit Nelson.

51 b.Cash45,000 Blake Nelson, Capital45,000 a.Land60,000 Lynne Lawrence, Capital20,000¹ Tim Kerry, Capital40,000² ¹$60,000 x l/3 ²$60,000 x 2/3

52

53 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. Partner Bonuses

54 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.

55 Equity of Jenkins$20,000 Equity of Kramer24,000 Diaz’s Contribution 31,000 Total equity after admitting Diaz$75,000 Diaz’s interest (1/3 x $75,000)$25,000 Diaz’s contribution $31,000 Diaz’s equity after admission 25,000 Bonus paid to Jenkins and Kramer $ 6,000

56 Mar.1Cash Alex Diaz, Capital Marsha Jenkins, Capital Helen Kramer, Capital The entry to record the admission of Diaz to the partnership is as follows: $6,000/2

57 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 2:1 ratio. Adjusting for New Partner’s Unique Qualities or Skills

58 Equity of Cowen$ 80,000 Equity of Dodd40,000 Chou’s Contribution 30,000 Total equity after admitting Chou$150,000 Chou’s equity interest after admission x 25% Chou’s equity after admission$ 37,500 Chou’s contribution 30,000 Bonus paid to Chou$ 7,500 The bonus is computed as follows:

59 June1Cash Janice Cowen, Capital Steve Dodd, Capital Ellen Chou, Capital The entry to record the bonus and admission of Chou to the partnership is as follows:

60 The entry to record the bonus and admission of Chou to the partnership is as follows: June1Cash Janice Cowen, Capital Steve Dodd, Capital Ellen Chou, Capital /3 x $7,500

61 The entry to record the bonus and admission of Chou to the partnership is as follows: June1Cash Janice Cowen, Capital Steve Dodd, Capital Ellen Chou, Capital /3 x $7,500

62 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.

63 The following entry is required to record Z selling his interest to Y. June1Z, Capital Y, Capital Transfer ownership from Z to Y. The amount paid to Y by Z has no impact on the partnership’s accounting records.

64 If Z had sold his interest directly to the partnership, both the assets and the owner’s equity of the partnership would have been reduced.

65 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.

66 Equity of Lowman$45,000 Conrad contribution 26,000 Total equity after admitting Conrad$71,000 Conrad’s equity interest x 30% Conrad’s equity after admission$21,300 Conrad’s contribution$26,000 Conrad’s equity after admission 21,300 Bonus paid to Lowman$ 4,700

67 Describe and illustrate the accounting for liquidating a partnership. Objective 4

68 When a partnership goes out of business, the winding-up process is called the liquidation of a partnership. Liquidating Partnerships

69 Liquidation Process 1.Sell the partnership assets. This step is called realization. 2.Distribute any gains or losses from realization to the partners based upon their income-sharing ratio. 3.Pay the claims of creditors using the cash from step 1 realization. 4.After satisfying the creditors, distribute the remaining cash to the partners based on the balances in their capital accounts.

70

71 Cash$11,000 Noncash Assets64,000 Liabilities$ 9,000 Jean Farley, Capital22,000 Brad Greene, Capital22,000 Alice Hall, Capital 22,000 Total$75,000$75,000 Liquidation Process Farley, Greene, and Hall share income and losses in a ratio of 5:3:2. On April 9, after discontinuing operations, the firm had the following trial balance.

72 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. Liquidation Process

73 Gain on Realization $8,000 gain

74 Cash Noncash Assets Gain on Realization Step 1: Sale of assets Entries to Record the Steps in the Liquidation Process

75 Gain on Realization Jean Farley, Capital Brad Greene, Capital Alice Hall, Capital Step 2: Division of gain Entries to Record the Steps in the Liquidation Process

76 Liabilities Cash Step 3: Payment of liabilities Entries to Record the Steps in the Liquidation Process

77 Jean Farley, Capital Brad Greene, Capital Alice Hall, Capital Cash Step 4: Distribution of cash to partners Entries to Record the Steps in the Liquidation Process

78 Farley, Greene, and Hall sell all noncash assets for $44,000. A loss of $20,000 ($64,000 – $44,000) is realized. Loss on Realization

79 Cash Loss on Realization Noncash Assets Step 1: Sale of assets Entries to Record the Steps in the Liquidation Process

80 Loss on Realization $20,000 loss

81 Jean Farley, Capital Brad Greene, Capital Alice Hall, Capital Loss on Realization Step 2: Division of loss Entries to Record the Steps in the Liquidation Process

82 Liabilities Cash Step 3: Payment of liabilities Entries to Record the Steps in the Liquidation Process

83 Jean Farley, Capital Brad Greene, Capital Alice Hall, Capital Cash Step 4: Distribution of cash to partners: Entries to Record the Steps in the Liquidation Process

84 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.

85 Gentry’s equity prior to liquidation$100,000 Realization of asset sale$220,000 Book value of assets ($50,000 + $100,000 + $20,000) 170,000 Gain on liquidation$50,000 Gentry’s share of gain (50% x $50,000)25,000 Gentry’s cash distribution$125,000

86 Loss on Realization—Capital 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.

87 Loss on Realization— Capital Deficiency Farley’s contribution

88 Cash Loss on Realization Noncash Assets Step 1: Sale of assets

89 Joan Farley, Capital Brad Greene, Capital Alice Hall, Capital Loss on Realization Step: Payment of liabilities

90 Step 3: Payment of liabilities Liabilities Cash

91 Receipt of deficiency Cash Jean Farley, Capital 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.

92 Loss on Realization— Capital Deficiency The remaining cash is distributed. Greene receives $5,800 and Hall receives $11,200.

93 Brad Greene, Capital Alice Hall, Capital Cash Distribution of cash to partners:

94 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. a.Determine the amount of Short’s deficiency b.Determine the amount distributed to Bain assuming Short is unable to satisfy the deficiency.

95 a.Short’s equity prior to liquidation$ 20,000 Realization of asset sales$ 40,000 Book value of assets 100,000 Loss on liquidation$ 60,000 Short’s share of loss (50% x $60,000) 30,000 Short’s deficiency$(10,000) b. $40,000 $80,000 – $30,000 share of loss – $10,000. Short’s deficiency also equals the amount realized from asset sales.

96 Prepare the statement of partnership equity. Objective 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.

98 Statement of Partnership Equity

Summary  Partnerships & LLC’s  Forming a partnership  Dividing income  Admitting partner  Liquidating partnership  Partnership equity & Statements