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BY R A C H E L L E A G AT H A , C PA , M B A
Partnerships & LLC
Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac
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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.
Objectives:
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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.
Objectives:
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Describe the basic characteristics of proprietorships,
partnerships, and limited liability
companies.
Objective 1
Objective 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
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
Partnership
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An important right of partners is to participate in the income of the partnership.
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.
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.
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 limitationLLC Limited liability
Characteristics of Proprietorships, Partnerships, and Limited Liability companies
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Taxation
Proprietorship Nontaxable*Partnership Nontaxable*LLC Nontaxable**
*Pass-through entity**Pass-through entity by election
Characteristics of Proprietorships, Partnerships, and Limited Liability companies
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Limitation on Life of EntityProprietorship YesPartnership YesLLC No
Characteristics of Proprietorships, Partnerships, and Limited Liability companies
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Access to Capital
Proprietorship LimitedPartnership LimitedLLC Average
Characteristics of Proprietorships, Partnerships, and Limited Liability companies
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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.
Objective 2
Objective 2
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Forming a Partnership
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
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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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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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
42,000Division of net income $81,000 $69,000
$150,000
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 00Jennifer Stone, Capital 81 000
00Crystal 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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Division of Net Income
Salary allowance $60,000 $48,000 $108,000Interest allowance 19,200 14,400 33,600
Net income of $150,000 is divided.
J. Stone C. Mills Total
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Division of Net Income
Salary allowance $60,000 $48,000 $108,000Interest allowance 19,200 14,400 33,600
12% x Stone’s capital account balance on Jan. 1 of $160,000
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.
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Division of Net Income
J. Stone C. Mills TotalSalary allowance $60,000 $48,000
$108,000Interest allowance 19,200 14,400 33,600
12% x Mills’ capital account balance on Jan. 1 of $120,000
12% x Mills’ capital account balance on Jan. 1 of $120,000
Net income of $150,000 is divided.
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Division of Net Income
J. Stone C. Mills TotalSalary allowance $60,000 $48,000
$108,000Interest allowance 19,200 14,400 33,600Remaining income 4,200 4,200 8,400
Division of net income $83,400 $66,600 $150,000
Net income of $150,000 is divided.
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The entry for dividing net income is as follows:
Dec. 31 Income Summary 150 000 00Jennifer Stone, Capital 83 400
00
Crystal Mills, Capital 66 600 00
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The entry for dividing net income is as follows:
Dec. 31 Income Summary 150 000 00
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.
Dividing Income—Allowances Exceed Net Income
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Division of Net Income
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
Net income of $100,000 is divided.
This amount exceeds net income
by $41,600.
This amount exceeds net income
by $41,600.
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Division of Net Income
J. Stone C. Mills TotalSalary allowance $60,000 $48,000$108,000
Interest 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
Net income of $100,000 is divided.
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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.
Objective 3
Objective 3
12-3
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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:
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.
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 00Nathan 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 Equity10 000 00Nathan Bell, Member Equity10 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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June 1 Cash 20 000 00Sharon 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 00Sharon 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.
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June 1 Merchandise Inventory3 000 00 Donald Lewis, Capital1 500 00Gerald 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.
The revaluation is recorded as follows:
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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/3²$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.
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:
$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.
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:
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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
The entry to record the bonus and admission of Chou to the partnership is as follows:
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The entry to record the bonus and admission of Chou to the partnership is as follows:
June 1 Cash 30 000 00
Janice Cowen, Capital 5 000 00
Steve Dodd, Capital 2 500 00
Ellen Chou, Capital37 500 00
2/3 x $7,500
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The entry to record the bonus and admission of Chou to the partnership is as follows:
June 1 Cash 30 000 00
Janice Cowen, Capital 5 000 00
Steve Dodd, Capital 2 500 00
Ellen Chou, Capital37 500 00
1/3 x $7,500
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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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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.
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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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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Equity of Lowman $45,000Conrad contribution 26,000Total equity after admitting Conrad$71,000Conrad’s equity interest x 30%Conrad’s equity after admission$21,300Conrad’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.
Objective 4
Objective 4
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When a partnership goes out of business,
the winding-up process is called the
liquidation of a partnership.
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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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
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.
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
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
Step 2: Division of gain
Entries to Record the Steps in the Liquidation Process
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Liabilities 9 000 00
Cash9 000 00
Step 3: Payment of liabilities
Entries to Record the Steps in the Liquidation Process
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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
Step 4: Distribution of cash to partners
Entries to Record the Steps in the Liquidation Process
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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.
Loss on Realization
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Cash 44 000 00
Loss on Realization 20 000 00
Noncash Assets64 000 00
Step 1: Sale of assets
Entries to Record the Steps in the Liquidation Process
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Loss on Realization
$20,000 loss
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Jean Farley, Capital 10 000 00
Brad Greene, Capital 6 000 00
Alice Hall, Capital 4 000 00
Loss on Realization20 000 00
Step 2: Division of loss
Entries to Record the Steps in the Liquidation Process
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Liabilities 9 000 00
Cash9 000 00
Step 3: Payment of liabilities
Entries to Record the Steps in the Liquidation Process
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Jean Farley, Capital 12 000 00
Brad Greene, Capital 16 000 00
Alice Hall, Capital 18 000 00
Cash46 000 00
Step 4: Distribution of cash to partners:
Entries to Record the Steps in the Liquidation Process
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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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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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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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Loss on Realization—Capital Deficiency
Farley’s contribution
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Cash 10 000 00
Loss on Realization 54 000 00
Noncash Assets64 000 00
Step 1: Sale of assets
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Joan Farley, Capital 27 000 00
Brad Greene, Capital 16 200 00
Alice Hall, Capital 10 800 00
Loss on Realization54 000 00
Step: Payment of liabilities
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Step 3: Payment of liabilities
Liabilities 9 000 00
Cash9 000 00
91
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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Loss on Realization—Capital Deficiency
The remaining cash is distributed. Greene receives $5,800 and Hall receives $11,200.
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Brad Greene, Capital 5 800 00
Alice Hall, Capital 11 200 00
Cash17 000 00
Distribution of cash to partners:
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Prior to liquidating their partnership, Short and Bain had capital accounts of $20,000 and $80,000, respectively. The partnership assets were sold for $40,000. The partnership had no liabilities. Short and Bain share income and losses equally.
a. Determine the amount of Short’s deficiencyb. Determine the amount distributed to Bain
assuming Short is unable to satisfy the deficiency.
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a. Short’s equity prior to liquidation$ 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) 30,000Short’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.
Objective 5
Objective 5
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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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Statement of Partnership Equity
Summary Partnerships & LLC’s
Forming a partnership
Dividing income
Admitting partner
Liquidating partnership
Partnership equity &
Statements
