Accounting for partnerships and limited liability companies
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Accounting for Partnerships and Limited Liability Companies. Chapter 12. Learning Objectives. Describe the characteristics of proprietorships, partnerships, and limited liability companies.

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Learning objectives
Learning Objectives

  • Describe the characteristics of proprietorships, partnerships, and limited liability companies.

  • Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership.

  • Describe and illustrate the accounting for partner admission and withdrawal.

  • Describe and illustrate the accounting for liquidating a partnership.

  • Prepare the statement of partnership equity.

  • Analyze and interpret employee efficiency.


Learning objective
Learning Objective

1

Describe the characteristics of proprietorships, partnerships, and limited liability companies


Four most common legal forms of business
Four Most Common Legal Forms of Business

  • Proprietorship

  • Corporation

  • Partnership

  • Limited Liability Company


Proprietorship
Proprietorship

  • A proprietorship is a company owned by a single individual.

    • Lawyers

    • Architects

    • Realtors

    • Physicians


Proprietorships
Proprietorships

  • Characteristics of proprietorships include the following:

    • Simple to form

    • No limitation on legal liability

    • Not taxable

    • Limited life

    • Limited ability to raise capital (funds)


Partnerships
Partnerships

  • A partnership is an association of two or more persons who own and manage a business for profit. Characteristics of a partnership include the following:

    • Moderately complex to form

      • A partnership requires a partnership agreement, sometimes called the articles of partnership, which includes matters such as amounts to be invested, limits on withdrawals, distributions of income and losses, and admission and withdrawal of partners.


Partnerships1
Partnerships

  • No limitation on legal liability

  • Not taxable

  • Limited life

  • Limited ability to raise capital (funds)


Partnerships2
Partnerships

  • In addition to the characteristics listed on the previous slides, some unique aspects of partnerships are:

    • Co-ownership of partnership property

    • Mutual agency

    • Participation in income


Limited liability companies
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 include:

    • Moderately complex to form

    • Limited legal liability

    • Not taxable

    • Unlimited life

    • Moderate ability to raise capital (funds)





Learning objective1
Learning Objective Liability Companies

2

Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership


Forming a partnership
Forming a Partnership Liability Companies

  • Joseph Stevens and Earl Foster, owners of competing hardware stores, agree to combine their businesses in a partnership. Stevens agrees to contribute the following:


Forming a partnership1
Forming a Partnership Liability Companies

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

  • The noncash assets are normally recorded at current market value.


Forming a partnership2
Forming a Partnership Liability Companies

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


Dividing income services of partners
Dividing Income—Services of Partners Liability Companies

  • The partnership agreement of Jennifer Stone and Crystal Mills provides for Stone to receive a monthly salary allowance of $5,000 ($60,000 annually) and Mills to receive $4,000 a month ($48,000 annually). If there is any remaining net income, it is to be divided equally.

Income and losses of the partnership would have been divided equally if no partnership agreement existed or if the partnership agreement did not specify how the division was to occur.


Dividing income services of partners1

J. Stone C. Mills Total Liability Companies

Annual salary allowance$60,000 $48,000 $108,000

Dividing Income—Services of Partners

  • The firm had net income of $150,000 for the year. Stone shared the net income as calculated below.

12 x Stone’s monthly salary allowance

12 x Mill’s monthly salary allowance


Dividing income services of partners2

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

Dividing Income—Services of Partners

  • The firm had net income of $150,000 for the year. Stone shared the net income as calculated below.

J. Stone C. Mills Total

Annual salary allowance $60,000 $48,000 $108,000

Remaining income 21,000 21,000 42,000


Dividing income services of partners3

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

Dividing Income—Services of Partners

  • The firm had net income of $150,000 for the year. Stone shared the net income as calculated below.

J. Stone C. Mills Total

Annual salary allowance $60,000 $48,000 $108,000

Remaining income 21,000 21,000 42,000


Dividing income services of partners and investments
Dividing Income—Services of Partners and Investments Liability Companies

  • The partnership agreement for Stone and Mills divides income as follows:

    • Partner salary allowances: $5,000 monthly for Stone and $4,000 monthly for Mills

    • Interest of 12% on each partner’s capital balance as of January 1

    • Any remaining income divided equally


Dividing income services of partners and investments1

$5,000 x 12 Liability Companies

$4,000 x 12

Dividing Income—Services of Partners and Investments

  • Each partner’s annual salary allowance is calculated.

J. Stone C. Mills Total

Salary allowance $60,000 $48,000 $108,000


Dividing income services of partners and investments2
Dividing Income—Services of Partners and Investments Liability Companies

  • 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

12% x Stone’s capital account balance of $160,000 on Jan. 1.

12% x Mill’s capital account balance of $120,000 on Jan. 1.


Dividing income services of partners and investments3
Dividing Income—Services of Partners and Investments Liability Companies

  • At this point, $141,600 of the $150,000 has been assigned. The remaining $8,400 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 services of partners and investments4

J. Stone C. Mills Total Liability Companies

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—Services of Partners and Investments

  • At this point, $141,600 of the $150,000 has been assigned. The remaining $8,400 is divided equally.


Dividing income allowances exceed net income
Dividing Income—Allowances Exceed Net Income Liability Companies

  • Assume the same salary and interest allowances as in the preceding example, but that the net income is only $100,000. In this case, the total of the allowances exceeds the net income by $41,600 ($100,000 - $141,600).


Dividing income allowances exceed net income1
Dividing Income—Allowances Exceed Net Income Liability Companies

  • The division of net income is determined as follows:

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

This amount exceeds net income by $41,600.


Dividing income allowances exceed net income2

Net income Liability Companies$58,400 $41,600 $100,000

Dividing Income—Allowances Exceed Net Income

  • The division of net income is determined as follows:

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 allowances over income 20,800 20,800 41,600



Learning objective2
Learning Objective Liability Companies

3

Describe and illustrate the accounting for partner admission and withdrawal


Admitting a partner
Admitting a Partner Liability Companies

  • A person may be admitted to a partnership by either of the following:

    • Purchasing an interest from one or more of the existing partners

    • Contributing assets to the partnership


Admitting a partner1
Admitting a Partner Liability Companies


Purchasing an interest from existing partners
Purchasing an Interest from Existing Partners Liability Companies

  • On June 1, Tom Andrews and Nathan Bell each sell one-fifth of their partnership equity of Bring It Consulting to Joe Canter for $10,000 in cash. On June 1, the partnership has net assets of $100,000, and both existing partners have capital balances of $50,000 each.


Purchasing an interest from existing partners1
Purchasing an Interest from Existing Partners Liability Companies

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

  • For a limited liability company, the following entry is required:


Purchasing an interest from existing partners2
Purchasing an Interest from Existing Partners Liability Companies

  • The effect of the transaction on the partnership accounts is shown in the following diagram.


Contributing assets to a partnership
Contributing Assets to a Partnership Liability Companies

  • 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.


Contributing assets to a partnership1
Contributing Assets to a Partnership Liability Companies

  • The entry to record this transaction is as follows:

  • For a limited liability company, the following entry is required:


Contributing assets to a partnership2
Contributing Assets to a Partnership Liability Companies

  • The effect of the transaction on the partnership accounts is shown in the following diagram.


Revaluation of assets
Revaluation of Assets Liability Companies

  • If the partnership’s 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.


Revaluation of assets1
Revaluation of Assets Liability Companies

  • 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.


Revaluation of assets2
Revaluation of Assets Liability Companies

  • The entry to record this transaction is as follows:

  • For a limited liability company, the following entry is required:


Partner bonuses
Partner Bonuses Liability Companies


Partner bonuses1
Partner Bonuses Liability Companies

  • On March 1, the partnership of Marsha Jenkins and Helen Kramer admits 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. Jenkins and Kramer share profits and losses equally.


Partner bonuses2
Partner Bonuses Liability Companies

  • Jenkins and Kramer agree to admit Diaz to the partnership 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. Diaz is paying Jenkins and Kramer a $6,000 bonus to join the partnership. The computation is on the next slide.


Partner bonuses3
Partner Bonuses Liability Companies


Partner bonuses4
Partner Bonuses Liability Companies

  • The entry to record this transaction is as follows:

  • For a limited liability company, the following entry is required:


Partner bonuses5
Partner Bonuses Liability Companies

  • After adjusting assets to market values, the capital balance of partner Janice Cowen is $80,000, and the capital balance of partner Steve Dodd is $40,000. Ellen Chou will receive 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. In this case, Cowen and Dodd are paying Chou a $7,500 bonus to join the partnership. The computation is on the next slide.


Partner bonuses6
Partner Bonuses Liability Companies


Partner bonuses7
Partner Bonuses Liability Companies

  • The entry to record this transaction is as follows:

  • For a limited liability company, the following entry is required:


Withdrawal of a partner
Withdrawal of a Partner Liability Companies

  • A partner may retire or withdraw from a partnership. In such cases, the withdrawing partner’s interest is normally sold to the:

    • Existing partners or

    • Partnership


Withdrawal of a partner1
Withdrawal of a Partner Liability Companies

  • If the existing partners purchase the withdrawing partner’s interest, the purchase and sale of the partnership interest is between the partners as individuals. The only entry is:

    • To debit the capital account of the partner withdrawing, and

    • To credit the capital account of the partner or partners buying the additional interest.


Withdrawal of a partner2
Withdrawal of a Partner Liability Companies

  • If the partnership purchases the withdrawing partner’s interest, the assets and the owners’ equity of the partnership are reduced by the purchase price.


Death of a partner
Death of a Partner Liability Companies

  • 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.


Learning objective3
Learning Objective Liability Companies

4

Describe and illustrate the accounting for liquidating a partnership


Liquidating partnerships
Liquidating Partnerships Liability Companies

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

    • Although liquidation refers to the payment of liabilities, it includes the entire winding-up process.

    • When the partnership goes out of business and the normal operations are discontinued, the accounts should be adjusted and closed.


Liquidating partnerships1
Liquidating Partnerships Liability Companies

The selling of partnership assets is called realization.


Liquidating partnerships2
Liquidating Partnerships Liability Companies

  • In liquidation, cash is distributed to each partner based on his or her final capital balance.


Liquidating partnerships3
Liquidating Partnerships Liability Companies

  • Farley, Green, and Hall decide to liquidate their partnership. On April 9, after discontinuing business operations and closing the accounts, the following trial balance is prepared:


Gain on realization
Gain on Realization Liability Companies

  • Farley, Green, and Hall share income and losses in a ratio of 5:3:2 (50%, 30%, 20%).

  • All noncash assets are sold in a single transaction for $72,000, resulting in a gain of $8,000. Partner capital accounts are credited $4,000, $2,400, and $1,600 to Farley, Green, and Hall, respectively.

  • Creditors are paid $9,000, and the remaining cash of $74,000 is distributed to the partners.

  • A statement of partnership liquidation, which summarizes the liquidation process, is shown in Exhibit 5 on the next slide.


Gain on realization1
Gain on Realization Liability Companies


Gain on realization2
Gain on Realization Liability Companies

Sale of Assets (Step 1)


Gain on realization3
Gain on Realization Liability Companies

Division of Gain (Step 2)


Gain on realization4
Gain on Realization Liability Companies

Payment of Liabilities (Step 3)


Gain on realization5
Gain on Realization Liability Companies

Distribution of Cash to Partners (Step 4)


Loss on realization
Loss on Realization Liability Companies

  • 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.


Loss on realization1
Loss on Realization Liability Companies


Loss on realization2
Loss on Realization Liability Companies

Sale of Assets (Step 1)


Liquidating partnerships4
Liquidating Partnerships Liability Companies

Division of Loss (Step 2)


Liquidating partnerships5
Liquidating Partnerships Liability Companies

Payment of Liabilities (Step 3)


Liquidating partnerships6
Liquidating Partnerships Liability Companies

Distribution of Cash to Partners (Step 4)


Example exercise
Example Exercise Liability Companies


Loss on realization capital deficiency
Loss on Realization—Capital Deficiency Liability Companies

  • The share of a loss on realization may be greater than the balance in a partner’s capital account. The resulting debit balance in the capital account is called a deficiency.


Loss on realization capital deficiency1
Loss on Realization—Capital Deficiency Liability Companies

  • 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.



Loss on realization capital deficiency3
Loss on Realization—Capital Deficiency Liability Companies

Sale of Assets (Step 1)


Loss on realization capital deficiency4
Loss on Realization—Capital Deficiency Liability Companies

Division of Loss (Step 2)


Loss on realization capital deficiency5
Loss on Realization—Capital Deficiency Liability Companies

Payment of Liabilities (Step 3)


Loss on realization capital deficiency6
Loss on Realization—Capital Deficiency Liability Companies

Receipt of Deficiency (Step 4)


Loss on realization capital deficiency7
Loss on Realization—Capital Deficiency Liability Companies

Distribution of Cash to Partners (Step 4)


Partner does not pay deficiency
Partner Does Not Pay Deficiency Liability Companies

  • 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:


Partner does not pay deficiency1
Partner Does Not Pay Deficiency Liability Companies

  • Allocation of deficiency:


Partner does not pay deficiency2
Partner Does Not Pay Deficiency Liability Companies

  • Distribution of cash to partners:


Learning objective4
Learning Objective Liability Companies

5

Prepare the statement of partnership equity


Statement of partnership equity
Statement of Partnership Equity Liability Companies

  • The changes in the partners’ capital accounts for a period of time are reported in a statement of partnership equity.

  • The statement of members’ equity for an LLC is similar to that of a partnership. It reports the changes in member equity for a period.


Statement of partnership equity1
Statement of Partnership Equity Liability Companies


Learning objective5
Learning Objective Liability Companies

6

Analyze and interpret employee efficiency


Revenue per employee

Revenue Liability Companies

Number of Employees

Revenue per Employee =

Revenue per Employee

  • Revenue per employee is a measure of the efficiency of the business in generating revenues.


Revenue per employee1

$220,000,000 Liability Companies

1,600

Revenue per employee, 2015

= $137,500

=

Revenue per employee, 2014

$180,000,000

1,500

=$120,000

=

Revenue per Employee

2015 2014

Revenues $220,000,000 $180,000,000

Number of employees 1,600 1,500