Accounting for Partnerships and Limited Liability Companies

Accounting for Partnerships and Limited Liability Companies
12 Accounting for Partnerships and Limited Liability Companies

Describe the nature of the adjusting process.
Learning Objective 1 Learning Objective 1 Accounting for Partnerships and Limited Liability Companies 3-1 3-1 After studying this chapter, you should be able to: 1 Describe the characteristics of proprietorships, partnerships, and limited liability companies. Insert Chapter Objectives Describe the nature of the adjusting process. Describe the nature of the adjusting process. 2 Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership. 3 Describe and illustrate the accounting for partnership admission and withdrawal. 9-2 12-2

Accounting for Partnerships and Limited Liability Companies (continued)
4 Describe and illustrate the accounting for liquidating a partnership. 5 Prepare the statement of partnership equity. 12-3

1 Describe the characteristics of proprietorships, partnerships, and limited liability companies. 12-4

Four Most Common Legal Forms of Business
1 Four Most Common Legal Forms of Business Proprietorship Corporation Partnership Limited liability company

A proprietorship is a company owned by a single individual.
1 Proprietorship A proprietorship is a company owned by a single individual. Lawyers Architects Realtors Physicians

Characteristics of a Proprietorship
1 Characteristics of a Proprietorship Simple to form No limitation on legal liability Not taxable Limited life Limited ability to raise capital (funds)

1 Partnership A partnership is an association of two or more individuals who own and manage a company for profit. Less widely used than proprietorships.

Characteristics of a Partnership
1 Characteristics of a Partnership Moderate to form No limitation on legal liability Not taxable Limited life Limited ability to raise capital (funds) (continued)

Characteristics of a Partnership (continued)
1 Characteristics of a Partnership (continued) Co-ownership of partnership property Mutual agency Participation in income

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.

Limited Liability Companies
1 Limited Liability Companies A limited liability company (LLC) is a form of legal entity that provides limited liability to its owners, but is treated as a partnership for tax purposes.

Characteristics of a Limited Liability Partnership
1 Characteristics of a Limited Liability Partnership Moderate to form Limited legal liability Not taxable Unlimited life Moderate ability to raise capital (funds)

Proprietorship Simple Partnership Moderate LLC Moderate
1 Characteristics of Proprietorships, Partnerships, and Limited Liability Companies Exhibit 1 Ease of Formation Proprietorship Simple Partnership Moderate LLC Moderate (continued)

Proprietorship No limitation Partnership No limitation
Characteristics of Proprietorships, Partnerships, and Limited Liability Companies (continued) Exhibit 1 Legal Liability Proprietorship No limitation Partnership No limitation LLC Limited liability (continued)

Proprietorship Nontaxable* Partnership Nontaxable* LLC Nontaxable**
1 Characteristics of Proprietorships, Partnerships, and Limited Liability Companies (continued) Exhibit 1 Taxation Proprietorship Nontaxable* Partnership Nontaxable* LLC Nontaxable** *Pass-through entity **Pass-through entity by election (continued)

Limitation on Life of Entity
1 Characteristics of Proprietorships, Partnerships, and Limited Liability Companies (continued) Exhibit 1 Limitation on Life of Entity Proprietorship Limited Partnership Limited LLC Unlimited (continued)

Proprietorship Limited Partnership Limited LLC Moderate
1 Characteristics of Proprietorships, Partnerships, and Limited Liability Companies (concluded) Exhibit 1 Access to Capital Proprietorship Limited Partnership Limited LLC Moderate

2 Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership. 12-19

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.

2 The entry to record the assets and liabilities contributed by Stevens is as follows:

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.

2 If a limited liability company is formed the following entry is made:

2 Example Exercise 12-1 Journalize Partner’s Original Investment
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. 12-24

2 Cash………………………………. 34,000 Inventory………………………….. 15,000
Example Exercise 12-1 (continued) 2 Follow My Example 12-1 Cash………………………………. 34,000 Inventory………………………….. 15,000 Equipment………………………… 29,000 Notes Payable…………………. 12,000 Reese Howell, Capital………… 66,000 For Practice: PE 12-1A, PE 12-1B 12-25

Dividing Income—Services of Partners
2 Dividing Income—Services 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.

2 Division of Net Income 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

Dividing Income—Services of Partners and Investments
2 Dividing Income—Services of Partners and Investments The partnership agreement for Stone and Mills divides income as follows: Monthly salary allowance of $5,000 for Stone and $4,000 for Mills. Interest of 12% on each partner’s capital balance on January 1. If there is any remaining net income, it is to be divided equally between the partners.

Each partners’ annual salary is calculated.
2 Each partners’ annual salary is calculated. J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 $5,000 × 12 $4,000 × 12

12% × Stone’s capital account balance on Jan. 1 of $160,000
Interest on each partner’s January 1 capital balance is determined. J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 Interest allowance 19,200 12% × Stone’s capital account balance on Jan. 1 of $160,000

12% × Mill’s capital account balance on Jan. 1 of $120,000
Interest on each partner’s January 1 capital balance is determined. J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 Interest allowance 19,200 14,400 12% × Mill’s capital account balance on Jan. 1 of $120,000

Interest on each partner’s January 1 capital balance is determined.
2 Interest on each partner’s January 1 capital balance is determined. J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 Interest allowance 19,200 14,400 33,600

The remaining income is divided equally.
2 The remaining income is divided equally. J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 Interest allowance 19,200 14,400 33,600 Remaining income 4,200 4,200 8,400 Net income $83,400 $66,600 $150,000

Dividing Income—Allowances Exceed Net Income
2 Dividing Income—Allowances Exceed Net Income Assume the same facts as before except that the net income is only $100,000. In this case, the total of the allowance exceeds the net income by $41,600 ($100,000 – $141,600).

This amount exceeds net income by $41,600.
2 Net income of $100,000 is divided. J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 Interest allowance 19, , ,600 Total $79,200 $62,400 $141,600 This amount exceeds net income by $41,600.

Net income of $100,000 is divided.
2 Net income of $100,000 is divided. J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 Interest allowance 19, , ,600 Total $79,200 $62,400 $141,600 Deduct excess of allowance over income 20, ,800 <41,600> Net income $58,400 $41,600 $100,000

2 Example Exercise 12-2 Dividing Partnership Net Income
Steve Prince and Chelsy Bernard formed a partnership, dividing income as follows: Annual salary allowance to Prince of $42,000. Interest of 9% on each partner’s capital balance on January 1. Any remaining net income divided equally. Prince and Bernard 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? 12-39

2 Follow My Example 12-2 Monthly salary $ 42,000
Example Exercise 12-2 (continued) 2 Follow My Example 12-2 Monthly salary $ 42,000 Interest (9% × $20,000) 1,800 Remaining income ,350* Total distributed to Prince $135,150 *[$240,000 – $42,000 – $1,800 – $13,500 ($150,000 × 9%)] × 50% For Practice: PE 12-2A, PE 12-2B 12-40

3 Describe and illustrate the accounting for partner admission and withdrawal. 12-41

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

3 Exhibit 2 Two Methods of Admitting a Partner (continued)

Two Methods of Admitting a Partner (continued)
Exhibit 2

Purchasing an Interest in a Partnership
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.

The only entry required in the partnership accounts is as follows:
3 The only entry required in the partnership accounts is as follows: For a limited liability company, the following entry is required: Tom Andrews, Member Equity 10,000 Nathan Bell, Member Equity 10,000 Joe Canter, Member Equity 20,000

3 The effect of the transaction on the partnership accounts is presented in the following diagram:

Contributing Assets to a Partnership
3 Contributing Assets to a Partnership Partners Tom Andrews and Nathan Bell each have capital balances of $50,000. On June 1, Joe Canter contributes $20,000 cash to Bring It Consulting for ownership equity of $20,000.

3 The entry to record this transaction is as follows: For a limited liability company, the following entry is required:

3 The effect of the transaction on the partnership accounts is presented in the following diagram:

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.

3 Partners Andrews and Bell each have capital balances of $50,000. The balance in Merchandise Inventory is $14,000 and the current replacement value is $17,000. The partners share net income equally.

3 The entry to record this transaction is as follows: For a limited liability company, the following entry is required:

3 Example Exercise 12-3 Revaluing and Contributing Assets to a Partnership 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. Provide the journal entry for the revaluation of land. Provide the journal entry to admit Nelson. 12-54

3 Follow My Example 12-3 Land………………………………….. 60,000
Example Exercise 12-3 (continued) 3 Follow My Example 12-3 Land………………………………….. 60,000 Lynne Lawrence, Capital……… 20,000¹ Tim Kerry, Capital………………. 40,000² ¹$60,000 × 1/3 ²$60,000 × 2/3 Cash………………………………….. 45,000 Blake Nelson, Capital………… ,000 For Practice: PE 12-3A, PE 12-3B 12-55

3 Exhibit 3 Partner Bonuses

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.

3 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.

3 Equity of Jenkins $20,000 Equity of Kramer 24,000
Diaz’s Contribution 31,000 Total equity after admitting Diaz $75,000 Diaz’s interest (1/3 × $75,000) $25,000 Diaz’s contribution $31,000 Diaz’s equity after admission 25,000 Bonus paid to Jenkins and Kramer $ 6,000

The entry to record this transaction is as follows:
3 The entry to record this transaction is as follows: (1/2 of $6,000) (1/2 of $6,000) For a limited liability company, the following entry is required:

Paying the New Partner a Bonus
3 Paying the New Partner a Bonus 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.

3 The bonus is computed as follows: Equity of Cowen $ 80,000
Equity of Dodd 40,000 Chou’s Contribution ,000 Total equity after admitting Chou $150,000 Chou’s equity interest after admission × 25% Chou’s equity after admission $ 37,500 Chou’s contribution 30,000 Bonus paid to Chou $ 7,500

The entry to record this transaction is as follows:
3 The entry to record this transaction is as follows: ¹$7,500 × 2/3 ²$7,500 × 1/3 For a limited liability company, the following entry is required:

3 Example Exercise 12-4 Partner Bonus
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. 12-64

3 Follow My Example 12-4 Equity of Lowman $45,000
Example Exercise 12-4 (continued) 3 Follow My Example 12-4 Equity of Lowman $45,000 Conrad contribution 26,000 Total equity after admitting Conrad $71,000 Conrad’s equity interest × 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 For Practice: PE 12-4A, PE 12-4B 12-65

Withdrawal of a Partner
3 Withdrawal of a Partner If the existing partners purchase the withdrawing partner’s interest, the purchase and sale of the partnership interest is between the parties as individuals.

3 Death of a Partner When a partner dies, the partnership accounts should be closed as of the date of death. The net income for the current period should then be determined and divided among the partners’ capital accounts.

Describe and illustrate the accounting for liquidating a partnership.
4 Describe and illustrate the accounting for liquidating a partnership. 12-68

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

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

4 Exhibit 4 Steps in Liquidating a Partnership

4 Liquidation Process Farley, Green, 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. Cash $11,000 Noncash Assets 64,000 Liabilities $ 9,000 Jean Farley, Capital 22,000 Brad Green, Capital 22,000 Alice Hall, Capital 22,000 Total $75,000 $75,000

4 Gain on Realization Between April 10 and April 30, Farley, Green, and Hall sell all noncash assets for $72,000. Thus, a gain of $8,000 ($72,000 – $64,000) is realized.

4 Statement of Partnership Liquidation: Gain on Realization Exhibit 5

4 Sale of assets (Step 1): For a limited liability company, the following entry is required:

4 Division of the gain (Step 2): For a limited liability company, the following entry is required:

4 Payment of liabilities (Step 3): For a limited liability company, the following entry is required:

4 Distribution of cash to partners (Step 4): For a limited liability company, the following entry is required:

4 Loss on Realization Farley, Green, and Hall sell all noncash assets for $44,000. A loss of $20,000 ($64,000 – $44,000) is realized. The loss is distributed to Farley, Green, and Hall in the income-sharing ratio of 5:3:2.

4 Statement of Partnership Liquidation: Loss on Realization Exhibit 6

Division of the loss (Step 2):
4 Division of the loss (Step 2): Jean Farley, Member Equity 10,000 Brad Green, Member Equity 6,000 Alice Hall, Member Equity 4,000 Loss on Realization 20,000 For a limited liability company, the following entry is required:

4 Example Exercise 12-5 Liquidating Partnership—Gain
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. 12-85

4 Follow My Example 12-5 Gentry’s equity prior to liquidation $100,000
Example Exercise 12-5 (continued) 4 Follow My Example 12-5 Gentry’s equity prior to liquidation $100,000 Realization of asset sale $220,000 Book value of assets ($50,000 + $100,000 + $20,000) ,000 Gain on liquidation $50,000 Gentry’s share of gain (50% × $50,000) 25,000 Gentry’s cash distribution $125,000 For Practice: PE 12-5A, PE 12-5B 12-86

Loss on Realization—Capital Deficiency
4 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.

4 Statement of Partnership Liquidation: Loss on Realization—Capital Deficiency Exhibit 7

4 Division of the loss (Step 2): For a limited liability company, the following entry is required:

4 Receipt of deficiency (Step 4) For a limited liability company, the following entry is required:

Partner Does Not Pay Deficiency
4 Partner Does Not Pay Deficiency If Farley does not pay her deficiency, the deficiency would be allocated to Green and Hall based on their income-sharing ratio of 3:2. The remaining cash would be distributed to Green and Hall as shown below: Capital Balances Before (Deficiency) Allocated (Deficiency) Capital Balance After Deficiency and Cash Distributed to Partners Farley $ (5,000) $5,000 $ Green 5,800 (3,000)* 2,800 Hall 11,200 (2,000)** 9,200 Total $12,000 $12,000 *$3,000 = [$5,000 × (3/5)] or ($5,000 × 60%) **$2,000 = [$5,000 × (2/5)] or ($5,000 × 40%)

4 Allocation of deficiency: For a limited liability company, the following entry is required:

4 Distribution of cash to partners: For a limited liability company, the following entry is required:

4 Example Exercise 12-6 Liquidating Partnership—Gain
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. Determine the amount of Short’s deficiency. Determine the amount distributed to Bain assuming Short is unable to satisfy the deficiency. 12-97

4 Follow My Example 12-6 Short’s equity prior to liquidation $ 20,000
Example Exercise 12-6 (continued) 4 Follow My Example 12-6 Short’s equity prior to liquidation $ 20,000 Realization of asset sale $ 40,000 Book value of assets 100,000 Loss on liquidation $ 60,000 Short’s share of loss (50% × $60,000) ,000 Short’s deficiency $(10,000) b. $40, $80,000 – $30,000 share of loss – $10,000. Short’s deficiency also equals the amount realized from asset sales. For Practice: PE 12-6A, PE 12-6B 12-98

Prepare the statement of partnership equity.
5 Prepare the statement of partnership equity. 12-99

Statement of Partnership Equity
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.

5 Exhibit 8 Statement of Partnership Equity

Financial Analysis and Interpretation
5 Financial Analysis and Interpretation Washburn & Lovett, CPAs, had the following information for the last two years: Revenues $220,000,000 $180,000,000 Number of employees 1,600 1,500 Revenue per employee, 2011 = $220,000,000 1,600 = $137,500 Revenue per employee, 2010 = $180,000,000 1,500 = $120,000

Financial Analysis and Interpretation
5 Financial Analysis and Interpretation The revenues per employee showed improvement in Thus, each employee is producing more revenues in 2011, than in 2010, which may indicate improved productivity. Overall, it appears the firm is properly managing the growth in staff.

Accounting for Partnerships and Limited Liability Companies

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