©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin Chapter 2 Partnership Organization and Operation

2 Partnership is Association of two or more persons to carry on, as co-owners, a business for profit

3 Liabilities Under LLP. Individual Partner is Liable for his own actions and for the actions of partnership employees under his supervision. The LLP as whole however is responsible for the actions of all partners and employees.

4 Characteristics of a limited liability partnership Ease of formation Limited life Mutual agency Co-ownership of partnership assets and earnings

5 LLP v/s Corporation LLP No Income Tax File Information Return Partners reports their share as ordinary net income and liable to pay tax. Corporation Subject to Income Tax Distribution of Income also taxable in hands of Stockholders. A Subchapter S corporation may elect to be treated as a partnership for income tax purposes.

6 LLP is separate Legal Entity Because It may own property May enter into contracts Be sued or bring suit against others

7 Professional corporations May be established in the fields of law, medicine, and public accounting.

8 LLP CONTRACT An Agreement that will establish many issues that arise Disputes between partners not referenced in contract can be resolved: - Arbitration - In court

9 LLP contract should include 1. Date of formation and planned duration of the partnership, names of the partners, and name and business activities of the partnership. 2. Assets to be invested by each partner and the procedures for valuing noncash assets invested. 3. Authority of each partner and the rights and duties of each. 4. The accounting period to be used, the nature of accounting records, and financial statements. 5. The plan for sharing net income and losses. 6. Salaries and drawings allowed to partners and any penalties for excessive withdrawals. 7. Insurance on the lives of partners, with the partnership or surviving partners named as beneficiaries. 8. Provisions for arbitration of disputes.

10 Income-sharing Plans for LLP (if no explicit plan for sharing earnings, the law requires equal division) 1. Equally, or in some other ratio. 2. In the ratio of the partners' capital account balances on a specific date, or in the ratio of average capital account balances during the year. 3. Allowing interest on partners' capital account balances and dividing the remaining net income or loss in a specified ratio. 4. Allowing salaries to partners and dividing the resultant net income or loss in a stated ratio. 5. Bonus to managing partner based on income. 6. Allowing salaries and interest on capital account balances, and dividing the remaining net income or loss in a stated ratio.

11 Ledger Accounts for each partner Capital Accounts Drawing or Personal Accounts Accounts for loans to and from Partners

12 CAPITAL ACCOUNT INCREASED BY FAIR VAUE OF NET ASSET INVESTED SHARE OF NET INCOME Decreased BY: WITHDRAWL OF CASH SHARE OF NET LOSS

13 LOANS TO/FROM PARTNERS PARTNER LOANS MONEY TO PARTNERSHIP; EVIDIENCED BY PROMISSARY NOTE Classified as Non-Current LOANS RECEIVABLE CLASSIFIED ACCORDING MATURITY; CURRENT VS NON-CURRENT

14 DRAWING ACCOUNT WITHDRAWING OF CASH OR OTHER ASSETS BY PARTNERS IN ANTICIPATION OF NET INOME OR DRAWINS THAT ARE SALARY

15 Financial Statement of LLP Income Statement Statement of Partners’ Capital Balance Sheet

16 Rectification of Net Income of Prior Period Errors in the measurement of partnership net income or loss for prior accounting periods must be analyzed The income-sharing ratio is changed or when a change in partners takes place. Capital account balances are restated based on each partner's share of the corrected net income for each period.

17 Change in ownership of LLP Operations of a limited liability partnership generally are not interrupted by a change in partners; Changes result when: Partner is admitted to the firm, Partner retires from the partnership Partner dies

18 New Partner by Acquisition of all or part of the interest of one or more of the existing partners Investment of assets in the partnership

19 Bonus or Goodwill at the time of new admission To Existing Partner (for the privilege of becoming a member of a firm with high earning power ) The new partner may invest an amount that is larger than the new partner's percentage share of net assets, thus requiring the recognition of a bonus or goodwill to the existing partners. To New Partner (if the new partner has unusual ability or invests the net assets of a business enterprise of superior earning power in the partnership) The new partner may invest an amount that is less than his or her percentage share of net assets, thus requiring the recognition of a bonus or goodwill to the new partner

20 Record of Goodwill New partner invests an amount larger than the carrying amount of the equity in net assets acquired, the transaction generally is recorded by the bonus method because the implied goodwill was not paid for by the partnership Restatement of assets to current fair value before a new partner is admitted to a limited liability partnership may be the most convenient method of achieving equity among the partners

21 Retirement of Partner Computation of Settlement Price Bonus to Retiring Partner Bonus to Continuing Partner

22 Retiring Partner A retiring partner may sell his or her equity in the partnership, to an existing partner, or to a new partner If the amount received by a retiring partner differs from the carrying amount of his or her equity, the difference generally is recorded as a bonus, either to the retiring partner or to the remaining partners

23 Death of Partner LLP contract often provide for life insurance policies on each other’s lives for settlement of estate of a deceased partner Buy-sell agreement may be formed

24 Formation of LP Formation of LP is evidenced by a certificate filed with the county recorder of principal place of business Certificate includes a number of items in addition to those found in the typical contract of a limited liability partnership Membership is offered to prospective limited partners in units The membership units offered to prospective limited partners may have to be registered with the Securities and Exchange Commission (SEC) SEC has provided guidance for such registration (In Industry Guide 5)

25 Limited Partnership (LP) is different from LLP There must be at least one general partner Limited partner have no obligation for unpaid liabilities of LP Limited partner can not participate in management of of LP Limited partner may not provide services as their investment Last name of limited partner may not appear in the name of LP