Click to edit Master title style Accounting for Partnerships and Limited Liability Companies

Click to edit Master title style 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. After studying this chapter, you should be able to:

Click to edit Master title style 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. After studying this chapter, you should be able to:

Click to edit Master title style Describe the basic characteristics of proprietorships, partnerships, and limited liability companies. Objective

Click to edit Master title style Advantages Simple to form Ability to be one’s own boss Disadvantages Difficulty in raising large amounts of capital Unlimited liability 12-1 A proprietorship is a business enterprise owned by a single individual. Proprietorship

Click to edit Master title style 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 12-1 Partnership

Click to edit Master title style  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

Click to edit Master title style 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.

Click to edit Master title style  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)

Click to edit Master title style 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.

Click to edit Master title style 11 Ease of Formation ProprietorshipSimple PartnershipModerate LLCModerate Characteristics of Proprietorships, Partnerships, and Limited Liability companies

Click to edit Master title style Legal Liability ProprietorshipNo limitation PartnershipNo limitation LLCLimited liability Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2

Click to edit Master title style Taxation ProprietorshipNontaxable* PartnershipNontaxable* LLCNontaxable** *Pass-through entity **Pass-through entity by election Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2

Click to edit Master title style Limitation on Life of Entity ProprietorshipYes PartnershipYes LLCNo Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2

Click to edit Master title style Access to Capital ProprietorshipLimited PartnershipLimited LLCAverage Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2

Click to edit Master title style 16 Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership. Objective

Click to edit Master title style 17 Forming a Partnership 12-2 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.

Click to edit Master title style 18 Stevens’ Transfer of Assets, Liability, and Equity 12-2 Apr.1Cash Accounts Receivable Merchandise Inventory Store Equipment Office Equipment Allowance for Doubtful Accounts Accounts Payable Joseph Stevens, Capital

Click to edit Master title style 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. 12-2

Click to edit Master title style 20 Example Exercise 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.

Click to edit Master title style 21 For Practice: PE 12-1A, PE 12-1B Follow My Example Cash34,000 Inventory15,000 Equipment29,000 Notes Payable12,000 Reese Howell, Capital66,000

Click to edit Master title style 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 12-2

Click to edit Master title style 23 J. Stone C. Mills Total Annual salary allowance$60,000$48,000$108,000 Remaining income21,00021,00042,000 Division of net income$81,000$69,000$150, Division of Net Income to journal entry (Slide 24)

Click to edit Master title style The entry for dividing net income is as follows: Dec. 31Income Summary Jennifer Stone, Capital Crystal Mills, Capital

Click to edit Master title style 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.

Click to edit Master title style 26 Division of Net Income Salary allowance$60,000$48,000$108,000 Interest allowance19,20014,40033, Net income of $150,000 is divided. J. Stone C. Mills Total

Click to edit Master title style 27 Division of Net Income Salary allowance$60,000$48,000$108,000 Interest allowance19,20014,40033, % x Stone’s capital account balance on Jan. 1 of $160,000 J. Stone C. Mills Total Net income of $150,000 is divided.

Click to edit Master title style 28 Division of Net Income J. Stone C. Mills Total Salary allowance$60,000$48,000$108,000 Interest allowance19,20014,40033, % x Mills’ capital account balance on Jan. 1 of $120,000 Net income of $150,000 is divided.

Click to edit Master title style 29 Division of Net Income 12-2 J. Stone C. Mills Total Salary allowance$60,000$48,000$108,000 Interest allowance19,20014,40033,600 Remaining income4,2004,2008,400 Division of net income$83,400$66,600$150,000 Net income of $150,000 is divided.

Click to edit Master title style The entry for dividing net income is as follows: Dec. 31Income Summary Jennifer Stone, Capital Crystal Mills, Capital

Click to edit Master title style 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.

Click to edit Master title style 32 Assume the same facts as before except that the net income is only $100, Dividing Income—Allowances Exceed Net Income

Click to edit Master title style 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.

Click to edit Master title style 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.

Click to edit Master title style 35 Example Exercise 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?

Click to edit Master title style 36 For Practice: PE 12-2A, PE 12-2B Follow My Example 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%

Click to edit Master title style 37 Describe and illustrate the accounting for partner admission and withdrawal. Objective

Click to edit Master title style 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: 12-3 Admitting a Partner

Click to edit Master title style 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

Click to edit Master title style The only entry required in the partnership accounts is as follows: June 1Tom Andrews, Capital Nathan Bell, Capital Joe Canter, Capital

Click to edit Master title style 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 41

Click to edit Master title style LLC Alternative June 1Tom Andrew, Member Equity Nathan Bell, Member Equity Joe Canter, Member Equity

Click to edit Master title style 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.

Click to edit Master title style June 1Cash Sharon Nelson, Capital The entry to record this transaction is as follows:

Click to edit Master title style 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

Click to edit Master title style LLC Alternative June 1Cash Sharon Nelson, Member Equity

Click to edit Master title style 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.

Click to edit Master title style 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. 12-3

Click to edit Master title style 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:

Click to edit Master title style 50 Example Exercise 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.

Click to edit Master title style 51 For Practice: PE 12-3A, PE 12-3B Follow My Example 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

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Click to edit Master title style 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

Click to edit Master title style 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. 12-3

Click to edit Master title style 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,

Click to edit Master title style 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: 12-3 $6,000/2

Click to edit Master title style 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

Click to edit Master title style 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: 12-3

Click to edit Master title style 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:

Click to edit Master title style 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

Click to edit Master title style 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

Click to edit Master title style 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.

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

Click to edit Master title style 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.

Click to edit Master title style 65 Example Exercise 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.

Click to edit Master title style 66 For Practice: PE 12-4A, PE 12-4B Follow My Example 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

Click to edit Master title style 67 Describe and illustrate the accounting for liquidating a partnership. Objective

Click to edit Master title style 68 When a partnership goes out of business, the winding-up process is called the liquidation of a partnership Liquidating Partnerships

Click to edit Master title style 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.

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Click to edit Master title style 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, 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.

Click to edit Master title style 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

Click to edit Master title style Gain on Realization $8,000 gain

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

Click to edit Master title style 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

Click to edit Master title style 76 Liabilities Cash Step 3: Payment of liabilities Entries to Record the Steps in the Liquidation Process

Click to edit Master title style 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

Click to edit Master title style 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

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

Click to edit Master title style Loss on Realization 80 $20,000 loss

Click to edit Master title style 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

Click to edit Master title style 82 Liabilities Cash Step 3: Payment of liabilities Entries to Record the Steps in the Liquidation Process

Click to edit Master title style 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

Click to edit Master title style 84 Example Exercise 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.

Click to edit Master title style 85 For Practice: PE 12-5A, PE 12-5B Follow My Example 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

Click to edit Master title style 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.

Click to edit Master title style Loss on Realization— Capital Deficiency Farley’s contribution

Click to edit Master title style Cash Loss on Realization Noncash Assets Step 1: Sale of assets

Click to edit Master title style 89 Joan Farley, Capital Brad Greene, Capital Alice Hall, Capital Loss on Realization Step: Payment of liabilities 12-4

Click to edit Master title style 90 Step 3: Payment of liabilities 12-4 Liabilities Cash

Click to edit Master title style 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.

Click to edit Master title style Loss on Realization— Capital Deficiency The remaining cash is distributed. Greene receives $5,800 and Hall receives $11,200.

Click to edit Master title style 93 Brad Greene, Capital Alice Hall, Capital Cash Distribution of cash to partners:

Click to edit Master title style 94 Example Exercise 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.

Click to edit Master title style 95 For Practice: PE 12-6A, PE 12-6B Follow My Example 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.

Click to edit Master title style 96 Prepare the statement of partnership equity. Objective

Click to edit Master title style Statement of Partnership Equity The change in the owners’ capital accounts for a period of time is reported in a statement of partnership equity.

Click to edit Master title style Statement of Partnership Equity

Click to edit Master title style 99 Financial Analysis and Interpretation Washburn & Lovett, CPA’s had the following information for the last two years: Revenues$220,000,000$180,000,000 Number of employees1,6001,500 Revenue per employee, 2008 = $220,000,000 1,600 = $137,500 Revenue per employee, 2007 = $180,000,000 1,500 = $120,

Click to edit Master title style 100 Financial Analysis and Interpretation 12-5 The revenues per employee showed improvement in 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.