Accounting for Partnerships and Limited Liability Companies

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Accounting for

Accounting for

Partnerships and

Partnerships and

Limited Liability

Limited Liability

CompaniesCompanies

Chapter 12Chapter 12Chapter 12Chapter 12

Learning ObjectivesLearning Objectives

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

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

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

4.4. Describe and illustrate the accounting for Describe and illustrate the accounting for liquidating a partnership.liquidating a partnership.

5.5. Prepare the statement of partnership equity.Prepare the statement of partnership equity.

6.6. Analyze and interpret employee efficiency.Analyze and interpret employee efficiency.


Learning Learning Objective

ObjectiveDescribe the characteristics of

Describe the characteristics of

proprietorships, partnerships,

proprietorships, partnerships,

and limited liability companies

and limited liability companies

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Four Most Common Legal Forms of Four Most Common Legal Forms of BusinessBusiness

o ProprietorshipProprietorship

o CorporationCorporation

o PartnershipPartnership

o Limited Liability CompanyLimited Liability Company

ProprietorshipProprietorship

o A proprietorship is a company owned by a A proprietorship is a company owned by a single individual.single individual. LawyersLawyers

ArchitectsArchitects

RealtorsRealtors

PhysiciansPhysicians

ProprietorshipsProprietorships

o Characteristics of proprietorships include Characteristics of proprietorships include the following:the following: Simple to formSimple to form

No limitation on legal liabilityNo limitation on legal liability

Not taxableNot taxable

Limited lifeLimited life

Limited ability to raise capital (funds)Limited ability to raise capital (funds)

PartnershipsPartnerships

o A partnership is an association of two or A partnership is an association of two or more persons who own and manage a more persons who own and manage a business for profit. Characteristics of a business for profit. Characteristics of a partnership include the following:partnership include the following: Moderately complex to formModerately complex to form

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


No limitation on legal liabilityNo limitation on legal liability


Limited lifeLimited life

Limited ability to raise capital (funds)Limited ability to raise capital (funds)


o In addition to the characteristics listed on In addition to the characteristics listed on the previous slides, some unique aspects the previous slides, some unique aspects of partnerships are:of partnerships are: Co-ownership of partnership propertyCo-ownership of partnership property

Mutual agencyMutual agency

Participation in income Participation in income

Limited Liability CompaniesLimited Liability Companies

o A A limited liability company (LLC) limited liability company (LLC) is a form is a form of legal entity that provides limited liability of legal entity that provides limited liability to its owners, but is treated as a to its owners, but is treated as a partnership for tax purposes. partnership for tax purposes. Characteristics include:Characteristics include: Moderately complex to formModerately complex to form

Limited legal liabilityLimited legal liability


Unlimited lifeUnlimited life

Moderate ability to raise capital (funds)Moderate ability to raise capital (funds)

COMPARING COMPARING PROPRIETORSHIPPROPRIETORSHIP

S, S, PARTNERSHIPS, PARTNERSHIPS,

AND LIMITED AND LIMITED LIABILITY LIABILITY

COMPANIESCOMPANIES



ObjectiveDescribe and illustrate the

Describe and illustrate the

accounting for forming a partnership

accounting for forming a partnership

and for dividing the net income and

and for dividing the net income and

net loss of a partnership

net loss of a partnership

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Forming a PartnershipForming a Partnership

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


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

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


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

Dividing Income—Services of PartnersDividing Income—Services of Partners

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

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.

J. Stone C. Mills Total

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

12 x Stone’s monthly salary

allowance

12 x Mill’s monthly salary

allowance


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


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

Remaining income 21,000 21,00042,000

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


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

Dividing Income—Services of Partners and Dividing Income—Services of Partners and InvestmentsInvestments

o The partnership agreement for Stone and The partnership agreement for Stone and Mills divides income as follows:Mills divides income as follows: Partner salary allowances: $5,000 monthly for Partner salary allowances: $5,000 monthly for

Stone and $4,000 monthly for MillsStone and $4,000 monthly for Mills

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

Any remaining income divided equallyAny remaining income divided equally


$5,000 x 12 $4,000 x 12

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


o Each partner’s annual salary allowance is Each partner’s annual salary allowance is calculated. calculated.


Salary allowance $60,000 $48,000 $108,000Interest allowance 19,200

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.

14,400 33,600


o Interest on each partner’s January 1 Interest on each partner’s January 1 capital balance is determined.capital balance is determined.

Remaining income 4,200 4,200 8,400Net income $83,400$83,400 $66,600$66,600 $150,000$150,000


Salary allowance $60,000 $48,000 $108,000Interest allowance 19,20014,400 33,600


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

Dividing Income—Allowances Exceed Net Dividing Income—Allowances Exceed Net IncomeIncome

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


This amount exceeds net income by

$41,600.

Salary allowance $60,000 $48,000 $108,000Interest allowance 19,200 14,400 33,600 Total $79,200 $62,400 $141,600


o The division of net income is determined The division of net income is determined as follows:as follows:


Salary allowance $60,000 $48,000 $108,000Interest allowance 19,200 14,400 33,600 Total $79,200 $62,400 $141,600Deduct excess of

allowances over income 20,800 20,800 41,600Net income $58,400 $41,600 $100,000


o The division of net income is determined The division of net income is determined as follows:as follows:





accounting for partner admission

accounting for partner admission and withdrawal

and withdrawal

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Admitting a PartnerAdmitting a Partner

o A person may be admitted to a A person may be admitted to a partnership by either of the following:partnership by either of the following: Purchasing an interest from one or more of the Purchasing an interest from one or more of the

existing partnersexisting partners

Contributing assets to the partnershipContributing assets to the partnership

ADMITTING A ADMITTING A PARTNERPARTNER

Purchasing an Interest from Existing Purchasing an Interest from Existing PartnersPartners

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


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

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


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

Contributing Assets to a PartnershipContributing Assets to a Partnership

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


o The entry to record this transaction is as The entry to record this transaction is as follows:follows:



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

Revaluation of AssetsRevaluation of Assets

o If the partnership’s asset accounts do not If the partnership’s asset accounts do not reflect approximate current market values reflect approximate current market values when a new partner is admitted, the when a new partner is admitted, the accounts should be adjusted (increased or accounts should be adjusted (increased or decreased) before the new partner is decreased) before the new partner is admitted.admitted.


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

PARTNER PARTNER BONUSESBONUSES

Partner BonusesPartner Bonuses

o On March 1, the partnership of Marsha On March 1, the partnership of Marsha Jenkins and Helen Kramer admits Alex Jenkins and Helen Kramer admits Alex Diaz as a new partner. The assets of the Diaz as a new partner. The assets of the old partnership are adjusted to current old partnership are adjusted to current market values, and the resulting capital market values, and the resulting capital balances for Jenkins and Kramer are balances for Jenkins and Kramer are $20,000 and $24,000, respectively. Jenkins $20,000 and $24,000, respectively. Jenkins and Kramer share profits and losses and Kramer share profits and losses equally.equally.


o Jenkins and Kramer agree to admit Diaz to Jenkins and Kramer agree to admit Diaz to the partnership for $31,000. In return, the partnership for $31,000. In return, Diaz will receive a Diaz will receive a one-third equity one-third equity in the in the partnership and will share income and partnership and will share income and losses equally with Jenkins and Kramer. losses equally with Jenkins and Kramer. Diaz is paying Jenkins and Kramer a Diaz is paying Jenkins and Kramer a $6,000 bonus to join the partnership. The $6,000 bonus to join the partnership. The computation is on the next slide.computation is on the next slide.


o After adjusting assets to market values, After adjusting assets to market values, the capital balance of partner Janice the capital balance of partner Janice Cowen is $80,000, and the capital balance Cowen is $80,000, and the capital balance of partner Steve Dodd is $40,000. Ellen of partner Steve Dodd is $40,000. Ellen Chou will receive a Chou will receive a one-fourthone-fourth interest in interest in the partnership for a contribution of the partnership for a contribution of $30,000. Before admitting Chou, Cowen $30,000. Before admitting Chou, Cowen and Dodd shared net income using a 2:1 and Dodd shared net income using a 2:1 ratio. In this case, Cowen and Dodd are ratio. In this case, Cowen and Dodd are paying Chou a $7,500 bonus to join the paying Chou a $7,500 bonus to join the partnership. The computation is on the partnership. The computation is on the next slide. next slide.

Withdrawal of a PartnerWithdrawal of a Partner

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

PartnershipPartnership


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

withdrawing, andwithdrawing, and

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


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

Death of a PartnerDeath of a Partner

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





accounting for liquidating a

accounting for liquidating a partnershippartnership

44

Liquidating PartnershipsLiquidating Partnerships

o When a partnership goes out of business, When a partnership goes out of business, the winding-up process is called the the winding-up process is called the liquidationliquidation of the partnership. of the partnership. Although Although liquidationliquidation refers to the payment of refers to the payment of

liabilities, it includes the entire winding-up liabilities, it includes the entire winding-up process.process.

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


The selling of The selling of partnership assets partnership assets

is called is called realization.realization.


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


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

Gain on RealizationGain on Realization

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

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

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

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

GAIN ON GAIN ON REALIZATIONREALIZATION

Sale of Assets (Step 1)Sale of Assets (Step 1)


Division of Gain (Step 2)Division of Gain (Step 2)


Payment of Liabilities (Step 3)Payment of Liabilities (Step 3)


Distribution of Cash to Partners (Step 4)Distribution of Cash to Partners (Step 4)


Loss on RealizationLoss on Realization

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

Division of Loss (Step 2)Division of Loss (Step 2)


EXAMPLE EXAMPLE EXERCISEEXERCISE

Loss on Realization—Capital Loss on Realization—Capital DeficiencyDeficiencyo The share of a loss on realization may be The share of a loss on realization may be

greater than the balance in a partner’s greater than the balance in a partner’s capital account. The resulting debit capital account. The resulting debit balance in the capital account is called a balance in the capital account is called a deficiencydeficiency..

Loss on Realization—Capital Loss on Realization—Capital DeficiencyDeficiencyo Farley, Green, and Hall sell all of the Farley, Green, and Hall sell all of the

noncash assets for $10,000. A loss of noncash assets for $10,000. A loss of $54,000 ($64,000 – $10,000) is realized. $54,000 ($64,000 – $10,000) is realized. The share of the loss allocated to Farley, The share of the loss allocated to Farley, $27,000 (50% of $54,000), exceeds the $27,000 (50% of $54,000), exceeds the $22,000 balance in her capital account. $22,000 balance in her capital account. Farley contributes $5,000 to the Farley contributes $5,000 to the partnership.partnership.

LOSS ON LOSS ON REALIZATION—REALIZATION—

CAPITAL CAPITAL DEFICIENCYDEFICIENCY


Loss on Realization—Capital Loss on Realization—Capital DeficiencyDeficiency

Division of Loss (Step 2)Division of Loss (Step 2)



Receipt of Deficiency (Step 4)Receipt of Deficiency (Step 4)

Partner Does Not Pay DeficiencyPartner Does Not Pay Deficiency

o If Farley does not pay her deficiency, the If Farley does not pay her deficiency, the deficiency would be allocated to Green deficiency would be allocated to Green and Hall based on their income-sharing and Hall based on their income-sharing ratio of 3:2. The remaining cash would be ratio of 3:2. The remaining cash would be distributed to Green and Hall as shown distributed to Green and Hall as shown below:below:


o Allocation of deficiency:Allocation of deficiency:


o Distribution of cash to partners:Distribution of cash to partners:



ObjectivePrepare the statement of

Prepare the statement of partnership equity

partnership equity

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Statement of Partnership EquityStatement of Partnership Equity

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

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

STATEMENT OF STATEMENT OF PARTNERSHIP PARTNERSHIP

EQUITYEQUITY



ObjectiveAnalyze and interpret employee

Analyze and interpret employee efficiencyefficiency

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Revenue per EmployeeRevenue per Employee

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

Revenue per Employee =Revenue

Number of Employees

2015 2014

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

Revenue per employee, 2015 =

$220,000,0001,600

= $137,500

Revenue per employee, 2014 = $180,000,000

1,500= $120,000

Revenue per EmployeeRevenue per Employee


Accounting for

Accounting for

Partnerships and

Partnerships and

Limited Liability

Limited Liability

CompaniesCompanies

The EndThe EndThe EndThe End

Accounting for Partnerships and Limited Liability Companies

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