1. Click to edit Master title style 1 1 1 12 Accounting for Partnerships and Limited Liability Companies

2. Click to edit Master title style 2 2 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. After studying this chapter, you should be able to:

3. Click to edit Master title style 3 3 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. After studying this chapter, you should be able to:

4. Click to edit Master title style 4 4 4 Describe the basic characteristics of proprietorships, partnerships, and limited liability companies. Objective 1 12-1

5. Click to edit Master title style 5 5 5 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

6. Click to edit Master title style 6 6 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 12-1 Partnership

7. Click to edit Master title style 7 7 7  An important right of partners is to participate in the income of the partnership. 12-1  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. Click to edit Master title style 8 8 8 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.

9. Click to edit Master title style 9 9 9 9  Combines the advantages of the corporate and partnership forms. 12-1 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. Click to edit Master title style 10  An LLC may elect to be treated as a partnership for tax purposes. 12-1 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. Click to edit Master title style 11 Ease of Formation ProprietorshipSimple PartnershipModerate LLCModerate Characteristics of Proprietorships, Partnerships, and Limited Liability companies 12-1 2

12. Click to edit Master title style 12 12-1 Legal Liability ProprietorshipNo limitation PartnershipNo limitation LLCLimited liability Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2

13. Click to edit Master title style 13 12-1 Taxation ProprietorshipNontaxable* PartnershipNontaxable* LLCNontaxable** *Pass-through entity **Pass-through entity by election Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2

14. Click to edit Master title style 14 12-1 Limitation on Life of Entity ProprietorshipYes PartnershipYes LLCNo Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2

15. Click to edit Master title style 15 12-1 Access to Capital ProprietorshipLimited PartnershipLimited LLCAverage Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2

16. 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 2 12-2

17. 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.

18. Click to edit Master title style 18 Stevens’ Transfer of Assets, Liability, and Equity 12-2 Apr.1Cash7 200 00 Accounts Receivable16 300 00 Merchandise Inventory28 700 00 Store Equipment5 400 00 Office Equipment1 500 00 Allowance for Doubtful Accounts1 500 00 Accounts Payable2 600 00 Joseph Stevens, Capital55 000 00

19. 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

20. Click to edit Master title style 20 Example Exercise 12-1 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 Howell’s contribution to the partnership.

21. Click to edit Master title style 21 For Practice: PE 12-1A, PE 12-1B Follow My Example 12-1 12-2 Cash34,000 Inventory15,000 Equipment29,000 Notes Payable12,000 Reese Howell, Capital66,000

22. 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

23. 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$150,000 12-2 Division of Net Income to journal entry (Slide 24)

24. Click to edit Master title style 24 12-2 The entry for dividing net income is as follows: Dec. 31Income Summary150 000 00 Jennifer Stone, Capital81 000 00 Crystal Mills, Capital69 000 00

25. Click to edit Master title style 25 12-2 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. Click to edit Master title style 26 Division of Net Income Salary allowance$60,000$48,000$108,000 Interest allowance19,20014,40033,600 12-2 Net income of $150,000 is divided. J. Stone C. Mills Total

27. Click to edit Master title style 27 Division of Net Income Salary allowance$60,000$48,000$108,000 Interest allowance19,20014,40033,600 12-2 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. 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 allowance19,20014,40033,600 12-2 12% x Mills’ capital account balance on Jan. 1 of $120,000 Net income of $150,000 is divided.

29. 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.

30. Click to edit Master title style 30 12-2 The entry for dividing net income is as follows: Dec. 31Income Summary150 000 00 Jennifer Stone, Capital83 400 00 Crystal Mills, Capital66 600 00

31. Click to edit Master title style 31 12-2 The entry for dividing net income is as follows: Dec. 31Income Summary150 000 00 Jennifer Stone, Member Equity83 400 00 Crystal Mills, Member Equity66 600 00 LLC Alternative Note the use of “Member Equity” instead of “Capital” for LLC.

32. Click to edit Master title style 32 Assume the same facts as before except that the net income is only $100,000. 12-2 Dividing Income—Allowances Exceed Net Income

33. Click to edit Master title style 33 12-2 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. Click to edit Master title style 34 12-2 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. Click to edit Master title style 35 Example Exercise 12-2 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 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. Click to edit Master title style 36 For Practice: PE 12-2A, PE 12-2B Follow My Example 12-2 12-2 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. Click to edit Master title style 37 Describe and illustrate the accounting for partner admission and withdrawal. Objective 3 12-3

38. 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

39. 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. 12-3 Purchasing an Interest in a Partnership

40. Click to edit Master title style 40 12-3 The only entry required in the partnership accounts is as follows: June 1Tom Andrews, Capital10 000 00 Nathan Bell, Capital10 000 00 Joe Canter, Capital20 000 00

41. Click to edit Master title style 41 12-3 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

42. Click to edit Master title style 42 12-3 LLC Alternative June 1Tom Andrew, Member Equity10 000 00 Nathan Bell, Member Equity10 000 00 Joe Canter, Member Equity20 000 00

43. Click to edit Master title style 43 12-3 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. Click to edit Master title style 44 12-3 June 1Cash20 000 00 Sharon Nelson, Capital20 000 00 The entry to record this transaction is as follows:

45. Click to edit Master title style 45 12-3 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. Click to edit Master title style 46 12-3 LLC Alternative June 1Cash20 000 00 Sharon Nelson, Member Equity20 000 00 46

47. Click to edit Master title style 47 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.

48. 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

49. Click to edit Master title style 49 June 1Merchandise Inventory3 000 00 Donald Lewis, Capital1 500 00 Gerald Morton, Capital1 500 00 Because the LLC alternative follows a pattern of replacing “Capital” with “Member Equity,” the LLC entry will not be shown again. 12-3 The revaluation is recorded as follows:

50. Click to edit Master title style 50 Example Exercise 12-3 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 1:2 ratio. a.Provide the journal entry for the revaluation of land. b.Provide the journal entry to admit Nelson.

51. Click to edit Master title style 51 For Practice: PE 12-3A, PE 12-3B Follow My Example 12-3 12-3 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. Click to edit Master title style 52 12-3 52

53. 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. 12-3 Partner Bonuses

54. 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

55. 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$31,000 Diaz’s equity after admission 25,000 Bonus paid to Jenkins and Kramer$ 6,000 12-3

56. Click to edit Master title style 56 Mar.1Cash31 000 00 Alex Diaz, Capital25 000 00 Marsha Jenkins, Capital3 000 00 Helen Kramer, Capital3 000 00 The entry to record the admission of Diaz to the partnership is as follows: 12-3 $6,000/2

57. 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. 12-3 Adjusting for New Partner’s Unique Qualities or Skills

58. 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

59. Click to edit Master title style 59 June1Cash30 000 00 Janice Cowen, Capital5 000 00 Steve Dodd, Capital2 500 00 Ellen Chou, Capital37 500 00 12-3 The entry to record the bonus and admission of Chou to the partnership is as follows:

60. Click to edit Master title style 60 12-3 The entry to record the bonus and admission of Chou to the partnership is as follows: June1Cash30 000 00 Janice Cowen, Capital5 000 00 Steve Dodd, Capital2 500 00 Ellen Chou, Capital37 500 00 2/3 x $7,500

61. Click to edit Master title style 61 12-3 The entry to record the bonus and admission of Chou to the partnership is as follows: June1Cash30 000 00 Janice Cowen, Capital5 000 00 Steve Dodd, Capital2 500 00 Ellen Chou, Capital37 500 00 1/3 x $7,500

62. Click to edit Master title style 62 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.

63. Click to edit Master title style 63 12-3 The following entry is required to record Z selling his interest to Y. June1Z, Capital30 000 00 Y, Capital30 000 00 Transfer ownership from Z to Y. 63 The amount paid to Y by Z has no impact on the partnership’s accounting records.

64. Click to edit Master title style 64 12-3 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. Click to edit Master title style 65 Example Exercise 12-4 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.

66. Click to edit Master title style 66 For Practice: PE 12-4A, PE 12-4B Follow My Example 12-4 12-3 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. Click to edit Master title style 67 Describe and illustrate the accounting for liquidating a partnership. Objective 4 12-4

68. 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. 12-4 Liquidating Partnerships

69. Click to edit Master title style 69 12-4 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. Click to edit Master title style 70 12-4

71. 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$75,000 12-4 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. 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. 12-4 Liquidation Process

73. Click to edit Master title style 73 12-4 Gain on Realization $8,000 gain

74. Click to edit Master title style 74 Cash72 000 00 Noncash Assets64 000 00 Gain on Realization8 000 00 12-4 Step 1: Sale of assets Entries to Record the Steps in the Liquidation Process

75. Click to edit Master title style 75 Gain on Realization8 000 00 Jean Farley, Capital4 000 00 Brad Greene, Capital2 400 00 Alice Hall, Capital1 600 00 12-4 Step 2: Division of gain Entries to Record the Steps in the Liquidation Process

76. Click to edit Master title style 76 Liabilities9 000 00 Cash9 000 00 12-4 Step 3: Payment of liabilities Entries to Record the Steps in the Liquidation Process

77. Click to edit Master title style 77 Jean Farley, Capital26 000 00 Brad Greene, Capital24 400 00 Alice Hall, Capital23 600 00 Cash74 000 00 12-4 Step 4: Distribution of cash to partners Entries to Record the Steps in the Liquidation Process

78. 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. 12-4 Loss on Realization

79. Click to edit Master title style 79 Cash44 000 00 Loss on Realization20 000 00 Noncash Assets64 000 00 12-4 Step 1: Sale of assets Entries to Record the Steps in the Liquidation Process

80. Click to edit Master title style 80 12-4 Loss on Realization 80 $20,000 loss

81. Click to edit Master title style 81 Jean Farley, Capital10 000 00 Brad Greene, Capital6 000 00 Alice Hall, Capital4 000 00 Loss on Realization20 000 00 12-4 Step 2: Division of loss Entries to Record the Steps in the Liquidation Process

82. Click to edit Master title style 82 Liabilities9 000 00 Cash9 000 00 12-4 Step 3: Payment of liabilities Entries to Record the Steps in the Liquidation Process

83. Click to edit Master title style 83 Jean Farley, Capital12 000 00 Brad Greene, Capital16 000 00 Alice Hall, Capital18 000 00 Cash46 000 00 12-4 Step 4: Distribution of cash to partners: Entries to Record the Steps in the Liquidation Process

84. Click to edit Master title style 84 Example Exercise 12-5 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.

85. Click to edit Master title style 85 For Practice: PE 12-5A, PE 12-5B Follow My Example 12-5 12-4 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. Click to edit Master title style 86 12-4 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.

87. Click to edit Master title style 87 12-4 Loss on Realization— Capital Deficiency Farley’s contribution

88. Click to edit Master title style 88 12-4 Cash10 000 00 Loss on Realization54 000 00 Noncash Assets64 000 00 Step 1: Sale of assets

89. Click to edit Master title style 89 Joan Farley, Capital27 000 00 Brad Greene, Capital16 200 00 Alice Hall, Capital10 800 00 Loss on Realization54 000 00 Step: Payment of liabilities 12-4

90. Click to edit Master title style 90 Step 3: Payment of liabilities 12-4 Liabilities9 000 00 Cash9 000 00

91. Click to edit Master title style 91 12-4 Receipt of deficiency Cash5 000 00 Jean Farley, Capital5 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.

92. Click to edit Master title style 92 12-4 Loss on Realization— Capital Deficiency The remaining cash is distributed. Greene receives $5,800 and Hall receives $11,200.

93. Click to edit Master title style 93 Brad Greene, Capital5 800 00 Alice Hall, Capital11 200 00 Cash17 000 00 12-4 Distribution of cash to partners:

94. Click to edit Master title style 94 Example Exercise 12-6 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. a.Determine the amount of Short’s deficiency b.Determine the amount distributed to Bain assuming Short is unable to satisfy the deficiency.

95. Click to edit Master title style 95 For Practice: PE 12-6A, PE 12-6B Follow My Example 12-6 12-4 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. Click to edit Master title style 96 Prepare the statement of partnership equity. Objective 5 12-5

97. Click to edit Master title style 97 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.

98. Click to edit Master title style 98 12-5 Statement of Partnership Equity

99. Click to edit Master title style 99 Financial Analysis and Interpretation Washburn & Lovett, CPA’s had the following information for the last two years: 20082007 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 = $120,000 12-5

100. Click to edit Master title style 100 Financial Analysis and Interpretation 12-5 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.