ca2 chapter 12

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Accounting for Accounting for Partnerships and Partnerships and Limited Liability Limited Liability

CompaniesCompanies

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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:


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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:


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Describe the basic characteristics of proprietorships,

partnerships, and limited liability companies.

Objective 1Objective 1Objective 1Objective 1

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Advantages• Simple to form• Ability to be one’s own

boss

Disadvantages• Difficulty in raising

large amounts of capital

• Unlimited liability

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A proprietorship is a business enterprise owned by a single individual.

Proprietorship


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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

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Partnership


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An important right of partners is to participate in the income of the partnership.

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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


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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.


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Combines the advantages of the corporate and partnership forms.

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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)


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An LLC may elect to be treated as a partnership for tax purposes.

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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.


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Ease of Formation

Proprietorship SimplePartnership Moderate

LLC Moderate

Characteristics of Proprietorships, Partnerships, and Limited Liability companies

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Legal Liability

Proprietorship No limitationPartnership No limitation

LLC Limited liability


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Taxation

Proprietorship Nontaxable*Partnership Nontaxable*

LLC Nontaxable**

*Pass-through entity**Pass-through entity by election


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Limitation on Life of Entity

Proprietorship YesPartnership Yes

LLC No


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Access to Capital

Proprietorship LimitedPartnership Limited

LLC Average


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Describe and illustrate the accounting for forming a

partnership and for dividing the net income and net loss

of a partnership.


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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.


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Stevens’ Transfer of Assets, Liability, and Equity

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Apr. 1 Cash 7 200 00Accounts Receivable 16 300 00 Merchandise Inventory 28 700 00 Store Equipment 5 400 00Office Equipment 1 500 00

Allowance for Doubtful Accounts1 500 00Accounts Payable2 600 00Joseph Stevens, Capital55 000 00


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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.

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Example Exercise 12-1

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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.


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21For Practice: PE 12-1A, PE 12-1B

Follow My Example 12-1

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Cash 34,000Inventory 15,000Equipment 29,000

Notes Payable 12,000Reese Howell, Capital 66,000


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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

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J. Stone C. Mills TotalAnnual salary allowance $60,000 $48,000 $108,000Remaining income 21,000 21,000 42,000

Division of net income $81,000 $69,000$150,000

12-2

Division of Net Income

to journal entry (Slide 24)


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The entry for dividing net income is as follows:

Dec. 31 Income Summary 150 000 00

Jennifer Stone, Capital 81 000 00

Crystal Mills, Capital 69 000 00


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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.


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Salary allowance $60,000 $48,000 $108,000Interest allowance 19,200 14,400 33,600

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Net income of $150,000 is divided.

J. Stone C. Mills Total


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Salary allowance $60,000 $48,000 $108,000Interest allowance 19,200 14,400 33,600

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12% x Stone’s 12% x Stone’s capital account capital account

balance on Jan. 1 balance on Jan. 1 of $160,000of $160,000

12% x Stone’s 12% x Stone’s capital account capital account


J. Stone C. Mills Total



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J. Stone C. Mills TotalSalary allowance $60,000 $48,000 $108,000Interest allowance 19,200 14,400 33,600

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12% x Mills’ 12% x Mills’ capital account capital account


12% x Mills’ 12% x Mills’ capital account capital account




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Division of Net Income 12-2

J. Stone C. Mills TotalSalary allowance $60,000 $48,000 $108,000Interest allowance 19,200 14,400 33,600Remaining income 4,200 4,200 8,400Division of net income $83,400 $66,600 $150,000



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Jennifer Stone, Capital 83 400 00

Crystal Mills, Capital 66 600 00


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Jennifer Stone, Member Equity 83 400 00

Crystal Mills, Member Equity 66 600 00

LLC Alternative

Note the use of “Member Equity” instead of “Capital” for LLC.


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Assume the same facts as before except that the net income is only $100,000.

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Dividing Income—Allowances Exceed Net Income


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J. Stone C. Mills TotalSalary allowance $60,000 $48,000 $108,000Interest allowance 19,200 14,400 33,600 Total $79,200 $62,400 $141,600


This amount exceeds net This amount exceeds net income by $41,600.income by $41,600.

This amount exceeds net This amount exceeds net income by $41,600.income by $41,600.


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J. Stone C. Mills TotalSalary allowance $60,000 $48,000 $108,000Interest allowance 19,200 14,400 33,600 Total $79,200 $62,400 $141,600Deduct excess of

allowance over income 20,800 20,800 <41,600>Net income $58,400 $41,600 $100,000



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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?


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

*($240,000 – $42,000 – $1,800 – $13,500) x 50%


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Describe and illustrate the accounting for partner admission and withdrawal.


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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


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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.

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Purchasing an Interest in a Partnership


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The only entry required in the partnership accounts is as follows:

June 1 Tom Andrews, Capital 10 000 00

Nathan Bell, Capital 10 000 00

Joe Canter, Capital 20 000 00


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

Partnership Accounts

Andrew, Capital10,000

Bell, Capital10,000

50,000

50,000

Carter, Capital 20,000

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LLC Alternative

June 1 Tom Andrew, Member Equity 10 000 00

Nathan Bell, Member Equity 10 000 00

Joe Canter, Member Equity 20 000 00


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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.


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12-3

June 1 Cash 20 000 00

Sharon Nelson, Capital 20 000 00

The entry to record this transaction is as follows:


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

Partnership Accounts

Nelson, Capital

Lewis, Capital35,000

Morton, Capital 25,000

Net Assets60,00020,000

20,000


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LLC Alternative

June 1 Cash 20 000 00

Sharon Nelson, Member Equity 20 000 00

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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.


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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


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June 1 Merchandise Inventory 3 000 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:


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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.


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b. Cash 45,000 Blake Nelson, Capital

45,000

a. Land 60,000 Lynne Lawrence, Capital

20,000¹ Tim Kerry, Capital

40,000²

¹$60,000 x l/3

²$60,000 x 2/3


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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.

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Partner Bonuses


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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.

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Equity of Jenkins $20,000Equity of Kramer 24,000Diaz’s Contribution 31,000Total equity after admitting Diaz $75,000Diaz’s interest (1/3 x $75,000) $25,000

Diaz’s contribution $31,000Diaz’s equity after admission 25,000Bonus paid to Jenkins and Kramer $ 6,000

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Mar. 1 Cash 31 000 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:

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$6,000/2


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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.

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Adjusting for New Partner’s Unique Qualities or Skills


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Equity of Cowen $ 80,000Equity of Dodd 40,000Chou’s Contribution 30,000Total equity after admitting Chou $150,000Chou’s equity interest after admission x 25%Chou’s equity after admission $ 37,500Chou’s contribution 30,000Bonus paid to Chou $ 7,500

The bonus is computed as follows:

12-3


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June 1 Cash 30 000 00

Janice Cowen, Capital 5 000 00

Steve Dodd, Capital 2 500 00

Ellen Chou, Capital37 500 00

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The entry to record the bonus and admission of Chou to the partnership is as follows:


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June 1 Cash 30 000 00




2/3 x 2/3 x $7,500$7,500


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June 1 Cash 30 000 00




1/3 x 1/3 x $7,500$7,500


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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.


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12-3

The following entry is required to record Z selling his interest to Y.

June 1 Z, Capital 30 000 00

Y, Capital30 000 00Transfer ownership

from Z to Y.

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The amount paid to Y by Z has no impact on the partnership’s accounting records.


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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.


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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.


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12-3

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

Conrad’s contribution $26,000Conrad’s equity after admission 21,300Bonus paid to Lowman $ 4,700


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Describe and illustrate the accounting for

liquidating a partnership.


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When a partnership goes out of business, the winding-up

process is called the liquidation of a partnership.

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Liquidating Partnerships


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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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12-4


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Cash $11,000Noncash Assets 64,000Liabilities $ 9,000Jean Farley, Capital 22,000Brad Greene, Capital 22,000Alice Hall, Capital 22,000 Total $75,000 $75,000

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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.


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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.

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Liquidation Process


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Gain on Realization

$8,000 gain


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Cash 72 000 00

Noncash Assets64 000 00

Gain on Realization8 000 00

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Step 1: Sale of assets

Entries to Record the Steps in the Liquidation Process


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Gain on Realization 8 000 00

Jean Farley, Capital4 000 00

Brad Greene, Capital2 400 00

Alice Hall, Capital1 600 00

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Step 2: Division of gain



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Liabilities 9 000 00

Cash9 000 00

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Step 3: Payment of liabilities



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Jean Farley, Capital 26 000 00

Brad Greene, Capital 24 400 00

Alice Hall, Capital 23 600 00

Cash74 000 00

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Step 4: Distribution of cash to partners



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Farley, Greene, and Hall sell all noncash assets for $44,000. A

loss of $20,000 ($64,000 – $44,000) is realized.

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Loss on Realization


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Cash 44 000 00

Loss on Realization 20 000 00


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Loss on Realization

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Loss on Realization20 000 00

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Step 2: Division of loss



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Cash9 000 00

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Cash46 000 00

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Step 4: Distribution of cash to partners:



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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.


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12-4

Gentry’s equity prior to liquidation $100,000Realization of asset sale $220,000Book value of assets ($50,000 +

$100,000 + $20,000) 170,000Gain on liquidation $50,000Gentry’s share of gain (50% x $50,000)

25,000Gentry’s cash distribution $125,000


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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.


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Farley’s contribution


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Cash 10 000 00

Loss on Realization 54 000 00




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Joan Farley, Capital 27 000 00



Loss on Realization54 000 00

Step: Payment of liabilities

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Cash9 000 00


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Receipt of deficiency

Cash 5 000 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.


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The remaining cash is distributed. Greene receives $5,800 and Hall receives $11,200.


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Cash17 000 00

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Distribution of cash to partners:


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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 deficiencyb. Determine the amount distributed to Bain

assuming Short is unable to satisfy the deficiency.


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For Practice: PE 12-6A, PE 12-6B


12-4

a. Short’s equity prior to liquidation$ 20,000

Realization of asset sales $ 40,000Book value of assets 100,000Loss on liquidation $ 60,000Short’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.


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Prepare the statement of

partnership equity.


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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.


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12-5

Statement of Partnership Equity


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Financial Analysis and Interpretation

Washburn & Lovett, CPA’s had the following information for the last two years:

2008 2007Revenues $220,000,000 $180,000,000Number of employees 1,600 1,500

Revenue per employee, 2008 =

$220,000,000

1,600= $137,500

Revenue per employee, 2007 =

$180,000,000

1,500= $120,000

12-5


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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.

ca2 chapter 12

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