Accounting for Partnerships and Limited Liability Companies

1. Accounting for Partnerships and Limited Liability Companies Chapter 12

2. 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.

3. Learning Objective 1 Describe the characteristics of proprietorships, partnerships, and limited liability companies

4. Four Most Common Legal Forms of Business • Proprietorship • Corporation • Partnership • Limited Liability Company

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

6. 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)

7. 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.

8. Partnerships • No limitation on legal liability • Not taxable • Limited life • Limited ability to raise capital (funds)

9. 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

10. 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)

11. Comparing Proprietorships, Partnerships, and Limited Liability Companies

12. Comparing Proprietorships, Partnerships, and Limited Liability Companies

13. Comparing Proprietorships, Partnerships, and Limited Liability Companies

14. Learning Objective 2 Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership

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

16. Forming a Partnership • The entry to record the assets and liabilities contributed by Stevens is as follows: • The noncash assets are normally recorded at current market value.

17. Forming a Partnership • If a limited liability company is formed, the following entry is made:

18. Dividing Income—Services of Partners • 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.

19. J. Stone C. Mills Total 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

20. Division of net income$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

21. Division of net income$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

22. Dividing Income—Services of Partners and Investments • 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

23. $5,000 x 12 $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

24. Dividing Income—Services of Partners and Investments • 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.

25. 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. 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

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

27. Dividing Income—Allowances Exceed Net Income • 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).

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

29. Net income $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

30. Dividing Income—Allowances Exceed Net Income

31. Learning Objective 3 Describe and illustrate the accounting for partner admission and withdrawal

32. Admitting a Partner • 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

33. Admitting a Partner

34. Purchasing an Interest from Existing Partners • 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.

35. Purchasing an Interest from Existing Partners • The only entry required in the partnership accounts is as follows: • For a limited liability company, the following entry is required:

36. Purchasing an Interest from Existing Partners • The effect of the transaction on the partnership accounts is shown in the following diagram.

37. 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.

38. Contributing Assets to a Partnership • The entry to record this transaction is as follows: • For a limited liability company, the following entry is required:

39. Contributing Assets to a Partnership • The effect of the transaction on the partnership accounts is shown in the following diagram.

40. Revaluation of Assets • 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.

41. Revaluation of Assets • 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.

42. Revaluation of Assets • The entry to record this transaction is as follows: • For a limited liability company, the following entry is required:

43. Partner Bonuses

44. Partner Bonuses • 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.

45. Partner Bonuses • 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.

46. Partner Bonuses

47. Partner Bonuses • The entry to record this transaction is as follows: • For a limited liability company, the following entry is required:

48. Partner Bonuses • 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.

49. Partner Bonuses

50. Partner Bonuses • The entry to record this transaction is as follows: • For a limited liability company, the following entry is required: