1.PRESENTATION ONGENERAL LEDGER&TRAIL BALANCEPrepared byHASHIBUL HASANh.hashibul@yahoo.com

2. General ledgerHASHIBUL HASAN DEPARTMENT OF CSEDAFFODIL INTERNATIONAL UNIVERSITY DHAKA,BANGLADESH 3. DefinitionThe General Ledger contains all of the balance sheetDAFFODIL INTERNATIONAL UNIVERSITYaccounts of an accounting system. The balance sheet DEPARTMENT OF CSE DHAKA,BANGLADESHHASHIBUL HASANaccounts are the assets, liabilities, and fund balanceaccounts of the school district. Values in General Ledger areexpressed as debits or credits. 4. The ledger page is actually a T-account in a more detailed format. It has theaccount title and its corresponding account number on top. It also has twosides, namely, the debit side and the credit side. Each T-account or ledgeraccount has the following columns. Date (debit side)- the date of the debit entry is entered in thiscolumn.DAFFODIL INTERNATIONAL UNIVERSITY Explanation (debit side)- A brief explanation of the debit entry isentered in this column. DEPARTMENT OF CSE DHAKA,BANGLADESHHASHIBUL HASAN F or folio (debit side)- The journal page number from where thedebit entry was taken is entered in this column. Debit- The amount of the debit entry is entered in this column. Date (credit side) - the date of the credit entry is entered in thiscolumn. Explanation (credit side) - A brief explanation of the credit entryis entered in this column. F or folio (credit side)- The journal page number from where thecredit entry was taken is entered in this column. Credit - The amount of the credit entry is entered in this column 5. An example of a page from a ledger is as follows:-Accounts receivableAccount No: 2001 DateExplanationF Debit DateExplanation FCreditDAFFODIL INTERNATIONAL UNIVERSITY 2008 2008 DEPARTMENT OF CSE DHAKA,BANGLADESHHASHIBUL HASANSept-29 Service on credit 1 50, 000.00 Sept. 30Collection 1 20,000.00 10Collection 1 30,000.0050,000.00Balance0.0 6. The posting procedure Step 1- Locate the account title used by the journal entry in the general ledger. Step 2- Determine if the journal entry is a debit entry or a credit. If it is a debit entry, it should beposted on the debit side of the located ledger account. If it is credit entry, it should be posted on thecredit side of the located ledger account. Step 3- Record the date of the journal entry in the date column. If the posting is to be done on afresh page, write the year on the first line. Then write the month and day of the journal entry on thesecond line. For succeeding entries, only the day of the journal entry should be written. The monthDAFFODIL INTERNATIONAL UNIVERSITYshould be written only if it is different from the month of the last entry made. DEPARTMENT OF CSE DHAKA,BANGLADESH Step 4- Write a brief explanation of the journal entry in the explanation column. It should be on theHASHIBUL HASANsame line as that of the date. Step 5- Write the amount of the journal entry in the amount column. It should be on the same line asthat of the date and explanation. Step 6- In the folio column, write the page number of the general journal page that contains theposted journal entry. It should be on the same line as that of the date, the explanation, and theamount. Step 7- In the folio column of the general journal, write the account number of the page number ofthe ledger account in which the journal entry was posted. The account number of the page numbershould be on the same line as of the journal entry. Step 8- Do not leave a blank line between entries in the general ledger. 7. Explain With A Example :-HASHIBUL HASAN DEPARTMENT OF CSEDAFFODIL INTERNATIONAL UNIVERSITY DHAKA,BANGLADESH 8. Selected transaction for tina cordero company during its first month in business are presenter below :-st. 1. Invested $10000 cash in the businessSept. 5. Purchased equipment for $12000 paying $5000 in cash and the balance on account.Sept.25. Paid $3000 cash on balance owed for equipment.Sept.30. Withdrew $500 cash for personal use.General Journal General Ledger >>EquipmentDateAccount Title &Ref Debit Credit Date ExplanationReDebitCredit Balance Description fSept-1 Cash 10,000 Sept.5 J112,00012,000Tina 10,000Cordero,capitalGeneral Ledger >>Account PayableDAFFODIL INTERNATIONAL UNIVERSITY 5Equipment 12,000 Cash 5,000 DateExplanation Ref DebitCredit Balance DEPARTMENT OF CSE DHAKA,BANGLADESHHASHIBUL HASAN Account Payable7,000 Sept.5J1 7,0007,00025 Account Payable 3,00025 J13,000 4,000 Cash 3,00030 Drawings 500General Ledger >>Tina Cordero,capitalCash500DateExplanationRefDebitCredit BalanceGeneral Ledger>>cashSept.1 J110,000 10,000 DateExplanation RefDebit Credit Balance Sept.1J110,000 10,000General Ledge >>Tina Cordero,drawing5J1 5,0005,00025 J1 3,0002,000DateExplanation Ref DebitCredit Balance30 J1 5001,500 Sept.30 J1 500 500 9. TRAIL BALANCEHASHIBUL HASAN DEPARTMENT OF CSEDAFFODIL INTERNATIONAL UNIVERSITY DHAKA,BANGLADESH 10. Trial BalanceTrial Balance Calculation A basic rule of double-entry accountingAccountDebits Creditsis that for every credit there must bean equal debit amount. From this Account 1 xxxx.xxconcept, one can say that the sum of Account 2 xxxx.xx DAFFODIL INTERNATIONAL UNIVERSITYall debits must equal the sum of allcredits in the accounting system. If Account 3 xxxx.xxDEPARTMENT OF CSEDHAKA,BANGLADESHdebits do not equal credits, then an HASHIBUL HASAN .error has been made. The trialbalance is a tool for detecting such .errors.. Account 4 xxxx.xx The trial balance is calculated bysumming the balances of all the ledger Account 5 xxxx.xxaccounts. The account balances are Account 6 xxxx.xxused because the balancesummarizes the net effect of all of the.debits and credits in an account. To .calculate the trial balance, construct a .table in the following format : Total xxxx.xx xxxx.xx 11. Steps to Prepare the Trial Balance For each ledger account Cash, Accounts Payable, etc. totalyour credits and debits. If the credit total is larger, subtract the debit total from the credit total to DAFFODIL INTERNATIONAL UNIVERSITYget your ledger account total which goes in the credit column of the trialDEPARTMENT OF CSEDHAKA,BANGLADESHbalance HASHIBUL HASAN If the debit total is larger, subtract the credit total from the debit total toget your ledger account total which goes in the debit column of the trialbalance Put the ledger account total in the credit or debit column of your trialbalance (as identified above). When you have debit or credit totals for each ledger account, add allof your credit totals to get a credit grand total. Add all of your debit totals to get a debit grand total. This is your trialbalance. 12. Unbalanced Trial BalanceIf you have an unbalanced trial balance, then you have an errorsomewhere in the accounting process. Examples of problems that canunbalance a trial balance include: DAFFODIL INTERNATIONAL UNIVERSITYDEPARTMENT OF CSEDHAKA,BANGLADESH Adding the debits and credits for the trial balance incorrectly; HASHIBUL HASAN Forgetting to include a ledger account balance on the trial balance; Putting the ledger account balances in the wrong debit/creditcolumn in the trial balance; Writing the wrong ledger account balances in the trial balancecolumns; Miscalculating the ledger account totals; Posting a journal entry incorrectly to the general ledger, whetherusing the wrong number or getting your debits/credits mixed up; Making an error in your journal entry, whether using the wrongnumber or forgetting part of a compound journal entry. 13. Balanced Trial Balance If all of your journal entries were posted properly (and error-free) in thegeneral ledger, your debit grand total and credit grand total should balance,and you can move on in the accounting cycle. If the debit and credit grandtotals do not balance, then you have an error to find somewhere in yourDAFFODIL INTERNATIONAL UNIVERSITYtransaction posting process (journal to general ledger to trial balance). DEPARTMENT OF CSE DHAKA,BANGLADESHHASHIBUL HASAN Its possible to have a posting error even if the debits and credits dobalance, but that will get found and solved later in the accounting cycle.Examples of problems that would not show up in the trial balance include: * Putting the credit amount in the debit column and the debit amount in the credit column for a particular transaction; * Recording a transaction in an incorrect account; * Forgetting to record a journal entry as a general ledger transaction; * Neglecting to make a journal entry at all. 14. LIMITATIONS OF A TRIAL BALANCE A trial balance does not prove that all transactions have beenrecorded or that the ledger is correct. Numerous errors may exist even though the trial balance columnsagree. The trial balance may balance even when:DAFFODIL INTERNATIONAL UNIVERSITY* a transaction is not journalized, DEPARTMENT OF CSE DHAKA,BANGLADESHHASHIBUL HASAN* a correct journal entry is not posted,* a journal entry is posted twice,* incorrect accounts are used in journalizing or posting,* offsetting errors are made in recording the amount of the transaction. 15. Accounting Principles, 7th Edition Weygandt Kieso Kimmel Chapter 2The Recording Process Prepared by Naomi KarolinskiMonroe Community CollegeandMarianne BradfordBryant CollegeJohn Wiley & Sons, Inc. 2005 16. CHAPTER 2 THE RECORDINGPROCESSAfter studying this chapter, you should be able to:1 Explain what an account is and how ithelps in the recording process2 Define debits and credits and explainhow they are used to record businesstransactions3 Identify the basic steps in the recordingprocess4 Explain what a journal is and how ithelps in the recording process 17. CHAPTER 2 THE RECORDING After studying PROCESSthis chapter, you should be able to:5 Explain what a ledger is and how it helpsin the recording process6 Explain what posting is and how it helpsin the recording process7 Prepare a trial balance and explain itspurpose 18. THE ACCOUNTSTUDY OBJECTIVE 1 An account is an individualaccounting record of increasesand decreases in a specific asset,liability, or owners equity item. There are separate accounts forthe items we used in transactionssuch as cash, salaries expense,accounts payable, etc. 19. BASIC FORM OF ACCOUNTSTUDY OBJECTIVE 2The simplest form an account consists of1 the title of the account2 a left or debit side3 a right or credit side The alignment of these parts resembles theletter T = T account Title of AccountLeft or debit sideRight or credit sideDebit balance Credit balance 20. DEBITS AND CREDITS Debit indicates left and Credit indicates right Recording $s on the left side of an account isdebiting the account Recording $s on the right side is crediting theaccount If the total of debit amounts is bigger than credits,the account has a debit balance If the total of credit amounts is bigger than debits,the account has a credit balance 21. TABULAR SUMMARYCOMPARED TO ACCOUNT FORM 22. DEBITING AN ACCOUNT Cash DebitsCredits15,000Example: The owner makes an initialinvestment of $15,000 to startthe business. Cash is debitedas the owners Capital iscredited. 23. CREDITING AN ACCOUNT CashDebits Credits7,000Example: Monthly rent of $7,000 is paid. Cash is credited as RentExpense is debited. 24. DEBITING / CREDITING ANACCOUNTCash Debits Credits15,000 7,0008,000Example: Cash is debited for $15,000 and credited for $7,000, leaving a debit balance of $8,000. 25. DOUBLE-ENTRY SYSTEMequaldebits and credits made accounts for each transactiontotal debits always equal the total creditsaccounting equation always stays in balanceAssetsLiabilitiesEquity 26. DEBIT AND CREDIT EFFECTS ASSETS AND LIABILITIESDebits Credits Increase assetsDecrease assets Decrease liabilities Increase liabilities 27. NORMAL BALANCEeveryaccount has adesignated normal balance. It is either a debit or credit.accountsrarely have anabnormal balance. 28. NORMAL BALANCES ASSETS AND LIABILITIES AssetsIncrease DecreaseNormalLiabilitiesBalanceDecrease Debit Increase Credit Normal Balance 29. DEBIT AND CREDIT EFFECTS OWNERS CAPITALDebits CreditsDecrease owners capital Increase owners capital 30. NORMAL BALANCE OWNERSCAPITALOwners Capital DecreaseIncrease Normal BalanceDebit Credit 31. DEBIT AND CREDIT EFFECTS OWNERS DRAWING DebitsCredits Increase owners drawingDecrease ownersdrawingRemember, Drawing is a contra-account an account that isbackwards from the account it accompanies (the Capitalaccount). 32. NORMAL BALANCE OWNERS DRAWINGOwners DrawingDecreaseIncrease Normal Balance DebitCredit 33. DEBIT AND CREDIT EFFECTS REVENUES AND EXPENSES Debits Credits Decrease revenues Increase revenues Increase expenses Decrease expenses 34. NORMAL BALANCES REVENUES AND EXPENSES RevenuesDecrease Increase Normal Balance ExpensesIncrease Debit DecreaseCreditNormalBalance 35. EXPANDED BASIC EQUATION AND DEBIT/CREDIT RULESAND EFFECTS Asset= Liabilities + Owners Equity sOwnersOwners Assets = Liabilities +-CapitalDrawingDr. Cr. Dr. Cr. Dr.Cr. Dr. Cr. + - - + -+ + -+ Revenues - ExpensesDr.Cr. Dr. Cr. -+ +- 36. Which of the following is not true of theterms debit and credit.a. They can be abbreviated as Dr. and Cr.b. They can be interpreted to mean increase and decrease.c. They can be used to describe the balance of an account.d. They can be interpreted to mean left and right.Chapter 2 37. THE RECORDINGPROCESS STUDY OBJECTIVE 31 analyze each transaction (+, -)2 enter transaction in a journal3 transfer journal information toledger accounts 38. THE JOURNALSTUDY OBJECTIVE 4 Transactions Are initially recorded in chronological order before they are transferred to the ledger accounts.Ageneral journal has 1 spaces for dates 2 account titles and explanations 3 references 4 two amount columns 39. THE JOURNALA journal makes several contributions torecording process:1 discloses in one place the complete effect of atransaction2 provides a chronological record of transactions3 helps to prevent or locate errors as debit andcredit amounts for each entry can be compared 40. JOURNALIZING Enteringtransaction data in the journalis known as journalizing. Separate journal entries are made foreach transaction. A complete entry consists of:1 the date of the transaction,2 the accounts and amounts to bedebited and credited,3 a brief explanation of transaction. 41. TECHNIQUE OF JOURNALIZINGThe date of the transaction is entered into thedate column.GENERAL JOURNALJ1 DateAccount Titles and ExplanationRef. DebitCredit 2005Sept. 1 Cash15,000R. Neal, Capital 15,000 (Invested cash in business)1 Computer Equipment 7,000Cash7,000(Purchased equipment forcash) 42. TECHNIQUE OF JOURNALIZINGThe debit account title is entered at the extremeleft margin of the Account Titles and Explanationcolumn. The credit account title is indented onthe next line.GENERAL JOURNALJ1 DateAccount Titles and ExplanationRef. DebitCredit 2005Sept. 1 Cash15,000R. Neal, Capital 15,000 (Invested cash in business)1 Computer Equipment 7,000Cash7,000(Purchased equipment forcash) 43. TECHNIQUE OFJOURNALIZINGThe amounts for the debits are recorded in theDebit column and the amounts for the creditsare recorded in the Credit column. 44. TECHNIQUE OFJOURNALIZINGA brief explanation of the transaction is given. 45. TECHNIQUE OFJOURNALIZINGA space is left between journal entries. Theblank space separates individual journal entriesand makes the entire journal easier to read. GENERAL JOURNAL J1 DateAccount Titles and ExplanationRef. DebitCredit 2005Sept. 1 Cash15,000R. Neal, Capital 15,000 (Invested cash in business)1 Computer Equipment 7,000Cash7,000(Purchased equipment forcash) 46. TECHNIQUE OF JOURNALIZINGThe column entitled Ref. is left blank at the timejournal entry is made and is used later when thejournal entries are transferred to the ledgeraccounts. 47. SIMPLE AND COMPOUNDJOURNAL ENTRIESIf an entry involves only two accounts, one debitand one credit, it is considered a simple entry. 48. COMPOUND JOURNAL ENTRYWhen three or more accounts are required inone journal entry, the entry is referred to as acompound entry.123 49. COMPOUND JOURNALENTRYThis is the wrong format; all debits must be listedbefore the credits are listed. 50. THE LEDGER STUDY OBJECTIVE 5A Group of accounts maintained by acompany is called the ledger.A general ledger contains all theassets, liabilities, and ownersequity accounts 51. POSTING A JOURNAL ENTRYSTUDY OBJECTIVE 6 In the ledger, enter in the appropriate columns of the account(s) debited the date, journal page, and debit amount shown in the journal. 52. POSTING A JOURNAL ENTRY In the ledger, enter in the appropriate columns of the account(s) debited the date, journal page, and debit amount shown in the journal. 53. POSTING A JOURNALENTRYIn the reference column of the journal, write the accountnumber to which the debit amount was posted. 54. POSTING A JOURNALENTRYGENERAL LEDGER CASH NO. 10 DateExplanationRef.Debit Credit Balance 2005Sept. 1J1 15,000 15,000In the ledger, enter in the appropriate columns of the account(s) credited the date, journal page, andcredit amount shown in the journal. 55. POSTING A JOURNALENTRYIn the reference column of the journal, write the account number to which thecredit amount was posted. 56. CHART OF ACCOUNTSA Chart of Accounts lists the accounts and theaccount numbers which identify their location inthe ledger. 57. INVESTMENT OF CASH BY OWNER October 1, C.R. Byrd invests $10,000 cash in anTransactionadvertising business known as: The Pioneer Advertising Agency. Basic The asset Cash is increased $10,000Analysis Owners equity, C. R. Byrd, Capital is increased $10,000. Debits increase assets: debit Cash $10,000.Debit-Credit Credits increase owners equity: credit C.R. Byrd, AnalysisCapital $10,000. 58. PURCHASE OF OFFICE EQUIPMENTJOURNAL ENTRYPOSTING 59. RECEIPT OF CASH FORFUTURE SERVICE October 2, a $1,200 cash advance is received from aTransactionclient, for advertising services expected to be completed by December 31. Asset Cash is increased $1,200 Liability Unearned Fees is increased $1,200 Basic Service has not been rendered yet.Analysis Liabilities often have the word payable in their title, Unearned fees are a liability. Debits increase assets: debit Cash $1,200.Debit-Credit Credits increase liabilities: credit Unearned Fees Analysis$1,200. 60. RECEIPT OF CASH FORFUTURE SERVICEJOURNAL ENTRYPOSTING 61. PAYMENT OF MONTHLY RENT October 3, office rent for October is paid in cash,Transaction$900. Basic The expense Rent is increased $900Analysis Payment pertains only to the current month Asset Cash is decreased $900.Debit-Credit Debits increase expenses: debit Rent Expense $900. AnalysisCredits decrease assets: credit Cash $900. 62. PAYMENT OF MONTHLY RENTJOURNAL ENTRYPOSTING 63. PAYMENT FOR INSURANCE October 4, $600 Paid one-year insurance policy- Transaction expires next year on September 30. -Asset Prepaid Insurance increases $600 -Payment extends to more than the current month Basic -Asset Cash is decreased $600.Analysis -Payments of expenses benefiting more than one period are prepaid expenses or prepayments.Debit-Credit Debits increase assets: debit Prepaid Insurance Analysis$600. Credits decrease assets: credit Cash $600. 64. PAYMENT FORINSURANCEJOURNAL ENTRYPOSTING Prepaid Insurance 130Oct. 4600 65. PURCHASE OFSUPPLIES ON CREDIT October 5, an estimated 3-month supply ofTransactionadvertising materials is purchased on account from Aero Supply for $2,500. Basic The asset Advertising Supplies is increased $2,500;Analysis the liability Accounts Payable is increased $2,500. Debits increase assets: debit Advertising SuppliesDebit-Credit $2,500. Credits increase liabilities: credit AnalysisAccounts Payable $2,500. 66. PURCHASE OF SUPPLIES ON CREDITJOURNAL ENTRYPOSTING 67. HIRING OF EMPLOYEES October 9, hire four employees to begin work on October 15. Each employee is to receive a weeklyTransactionsalary of $500 for a 5-day work week, payable every 2 weeks -- first payment made on October 26. A business transaction has not occurred only an Basic agreement between the employer and theAnalysis employees to enter into a business transaction beginning on October 15.Debit-Credit A debit-credit analysis is not needed because there is Analysisno accounting entry. 68. WITHDRAWAL OF CASH BY OWNER October 20, C. R. Byrd withdraws $500 cash forTransactionpersonal use. Basic The owners equity account C. R. Byrd, Drawing isAnalysis increased $50 The asset Cash is decreased $500. Debits increase drawings: debit C. R. Byrd,Debit-Credit Drawing $500. Credits decrease assets: credit AnalysisCash $500. 69. WITHDRAWAL OF CASH BY OWNERJOURNAL ENTRYPOSTING 70. PAYMENT OF SALARIES October 26, employee salaries of $4,000 are owedTransactionand paid in cash. (See October 9 transaction.) Basic The expense account Salaries Expense is increasedAnalysis $4,000; the asset Cash is decreased $4,000.Debit-Credit Debits increase expenses: debit Salaries Expense Analysis$4,000. Credits decrease assets: credit Cash $4,000. 71. PAYMENT OF SALARIESJOURNAL ENTRYPOSTINGSalaries Expense 726Oct. 264,000 72. RECEIPT OF CASH FOR FEES EARNEDOctober 31, received $10,000 in cash from Copa TransactionCompany for advertising services rendered inOctober.Basic The asset Cash is increased $10,000; the revenue Analysis Fees Earned is increased $10,000. Debit-Credit Debits increase assets: debit Cash $10,000. CreditsAnalysisincrease revenues: credit Fees Earned $10,000. 73. RECEIPT OF CASH FOR FEES EARNED JOURNAL ENTRYPOSTING 74. THE TRIAL BALANCESTUDY OBJECTIVE 7 The trial balance is a list of accounts and their balances at a given time. Theprimary purpose of a trial balance is to prove debits = credits after posting. Ifdebits and credits do not agree, the trial balance can be used to uncover errors in journalizing and posting. 75. THE TRIAL BALANCEThe Steps in preparing the Trial Balance are:1. List the account titles and balances2. Total the debit and credit columns3. Prove the equality of the two columns 76. A TRIAL BALANCEThe total debitsmust equal thetotal credits. 77. LIMITATIONS OF A TRIAL BALANCEA trial balance does not prove all transactions have been recorded or the ledger is correct. Numerouserrors may exist even though the trial balance columns agree. For example, the trial balance may balance even when: a transaction is not journalized a correct journal entry is not posted a journal entry is posted twice incorrect accounts used in journalizing or posting offsetting errors are made in recording 78. Which one of the following represents the expandedbasic accounting equation?a. Assets = Liabilities + Owners Capital + Owners Drawings Revenue - Expenses.b. Assets + Owners Drawings + Expenses = Liabilities + Owners Capital + Revenue.c. Assets Liabilities Owners Drawings = Owners Capital + Revenue Expenses.d. Assets = Revenue + Expenses Liabilities.Chapter 2 79. Stockholders Equity Fundamentals of CorporateFinance by Robert Parrino and David S.KidwellJohn Wiley & Sons, Inc.. (c) 2009.Copying Prohibited 80. Fundamentals of Corporate Financeby Robert Parrino and David S. KidwellJohn Wiley & Sons, Inc.. (c) 2010. CopyingProhibited.Reprinted for Sai Chakrala, Bank ofAmericaReprinted with permission as asubscription benefit of Books24x7, 81. Learning Objectives Explain the advantages and disadvantages of acorporation Measure the effect of issuing stock on acompanys financial position Describe how treasury stock transactions affecta company Account for dividends and measure their impacton a company Use different stock values in decision making Evaluate a companys return on assets andreturn on common equity 82. Characteristics of Corporate Form Separate legal entity Continuous life and transferability ofownership Limited liability for stockholders Separation of ownership and management Corporate taxation income is taxed atthe corporate level; dividends are taxed atthe shareholder level Government regulation 83. Organizing a Corporation Obtain a charter from the state Bylaws Stockholders elect Board of Directors Board of Directors sets policy andappoints officers Board elects a chairperson Board selects the president 84. Stockholders Rights Vote one vote for each share of stock Dividends right to participate in dividenddistributions Liquidation right to receive proportionateshare of assets remaining after creditorshave been paid Preemption right to maintain onesproportionate share of ownership in thecorporation 85. Stockholders Equity Paid-in capital (contributed capital) Retained earnings Classes of stock Common and Preferred Par or No-Par 86. Issuing StockIssue 6.2 million shares of $10 par value stock at par. Cash62,000,000 Common Stock 62,000,000 To issue common stockIssue 6.2 million shares of $0.01 par value stock at $10 pershare. Cash62,000,000 Common Stock 62,000 Paid-in Capital in Excess of Par Common (6,200,000 x 9.99) 61,938,000 To issue common stock 87. Issuing StockIssue 3,000 shares of no-par stock for $20 per share. Cash 60,000 Common Stock 60,000 To issue common stockIssued 3,000 shares of no-par stock with a stated value of $1for $20 per share Cash 60,000 Common Stock (3,000 x $1 stated value)3,000 Paid-in Capital in Excess of Stated Value Common (3,000 x 19)57,000 To issue common stock 88. Common Stock Issued for Other Assets Value the exchange at the current marketvalue of the assets received.Issued 15,000 shares of $1 par common for equipment worth$4,000 and a building worth $120,000.Equipment 4,000Building 120,000 Common Stock (15,000 x $1 par)15,000 Paid-in Capital in Excess of Par Common (124,000 15,000)109,000To issue common stock 89. Ethical Issues When shares are issued for assets otherthan cash, care should be taken to notover-value those assets and thus inflatevalues on the balance sheet. 90. Treasury Stock A companys own stock that it has issuedand later reacquired is treasury stock. Reasons companies have treasury stock to use for employee stock purchase plans to increase net assets by buying shares at alow price and selling at a higher price to avoid takeover by outside parties Treasury Stock is a contra stockholdersequity account 91. Preferred Stock Entries are similar to entries for commonstock. Paid-in Capital in Excess of Par Preferred is a separate equity account. 92. Treasury StockPurchased shares of treasury stock for $19,000. Treasury Stock 19,000Cash19,000To purchase treasury stockSold treasury stock for $25,000 that was previouslypurchased for $19,000. Cash25,000Treasury Stock19,000Paid-in Capital in from Treasury Stock 6,000 Sold treasury stock 93. Other Stock-Related Issues If treasury stock is sold below its cost,retained earnings is debited for thedifference between cost and selling price. Stock retirement involves purchasingstock and removing it from issued status. To retire stock, remove the stock account,any related paid-in capital accounts, andincrease cash. 94. Dividends To pay dividends, a company must have enough retained earnings to declare thedividend enough cash to pay the dividend Relevant dates related to dividends Declaration date Date of record Payment date 95. DividendsDeclaration date a liability is created. Retained Earnings 50,000Dividends Payable 50,000 Declared a cash dividendDate of record no entry requiredDate of payment a liability is settled Dividends Payable 50,000Cash50,000 Paid cash dividend 96. Computing Dividends Dividends on preferred stock are either percentage rate dollar amount Preferred stock may be cumulative (dividends in arrears must be paidbefore other stockholders receive a dividend) non-cumulative dividends not paid in oneyear are not made up later. 97. Stock Dividend A proportional distribution by a corporationof its own stock to the stockholders Increase stock account and decreaseretained earnings. Total equity is unchanged, and assets andliabilities are unaffected. Reasons for stock dividends: to conserve cash to reduce the per-share market price of thestock 98. Stock Dividend Small stock dividend (less that 25%)reduces retained earnings for the currentmarket value of the stock Large stock dividend (greater than 25%)reduces retained earnings for par value ofthe stock. 99. Stock Dividend10% stock dividend declared when 20,000,000 shares ofcommon stock are outstanding. Market price of the stock is$15. 20,000,000 shares of common outstandingx .10 stock dividendx $15 market value per share of commonRetained Earnings30,000,000 Common Stock 20,000 Paid-in Capital in Excess of Par Common29,980,000Distributed a 10% stock dividend20,000,000 x 0.10 x $.01 parvalue per share 100. Stock Split An increase in the number of authorized,issued, and outstanding shares of stock,coupled with a proportionate reduction inthe stocks par value. Total equity does not change. Only parvalue, number of shares issued, andnumber of shares authorized are affected. 101. Chapter 10 Partnerships: Formation, Operation and Basis Corporations, Partnerships, Estates & Trusts 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 101 102. Partnership Definition An association of two or more persons to carry on a trade or business Contribute money, property, labor Expect to share in profit and losses For tax purposes, includes: SyndicateJoint venture, etc 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 102 103. Entities Taxed as Partnerships (slide 1 of 4) General partnership Consists of at least 2 partners Partners are jointly and severally liable Creditors can collect from both partnership and partners personal assets General partners assets are at risk for malpractice of other partners even though not personally involved 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 103 104. Entities Taxed as Partnerships (slide 2 of 4) Limited liability partnership (LLP) An LLP partner is not personally liable formalpractice committed by other partners Popular organizational form for large accountingfirms 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 104 105. Entities Taxed as Partnerships (slide 3 of 4) Limited partnership Has at least one general partner One or more limited partners Only general partner(s) are personally liable tocreditors Limited partners loss is limited to equity investment 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 105 106. Entities Taxed as Partnerships (slide 4 of 4) Limited liability company (LLC) Combines the corporate benefit of limited liabilitywith benefits of partnership taxation Unlike corporations, income is subject to tax only once Special allocations of income, losses, and cash flow are available Owners are members, not partners, but ifproperly structured will receive partnership taxtreatment 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 106 107. Check-The-Box Regs (slide 1 of 2) Allows most unincorporated entities to select their federal tax status If 2 or more owners, can choose to be treated as: Partnership, or Corporation Permits some flexibility Not all entities have a choice e.g., New publicly traded partnerships must be taxed as corporations 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 107 108. Check-The-Box Regs (slide 2 of 2) Some entities can be excluded from partnership treatment if organized for: Investment (not active trade or business) Joint production, extraction, or use of property Underwriting, selling, or distributing a specificsecurity Owners simply report their share of operations on their own tax return 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 108 109. Partnership Taxation(slide 1 of 3) Partnership is not a taxable entity Flow through entity Income taxed to owners, not entity Partners report their share of partnership income or loss on their own tax return 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 109 110. Partnership Taxation(slide 2 of 3) Generally, the calculation of partnership income is a 2-step approach Step 1: Net ordinary income and expensesrelated to the trade or business of thepartnership Step 2: Segregate and report separatelysome partnership items If an item of income, expense, gain or loss might affect any 2partners tax liabilities differently, it is separately stated e.g., Charitable contributions 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 110 111. Partnership Taxation(slide 3 of 3) Electing large partnerships can net some items that would otherwise be separately stated Must have at least 100 partners and electsimplified reporting procedures Such partnerships separately report less than adozen categories of items to their partners e.g., Combine interest, nonqualifying dividends, and royalty income into one amount, and report the net amount to partners 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 111 112. Partnership Reporting Partnership files Form 1065 On page 1 of Form 1065, partnership reports ordinaryincome or loss from its trade or business activities Schedule K accumulates information to be reported topartners Provides ordinary income (loss) and separately stated items in total Each partner (and the IRS) receives a Schedule K-1 Reports each partners share of ordinary income (loss) and separately stated items 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 112 113. Conceptual Basis for Partnership Taxation (slide 1 of 2) Involves 2 legal concepts: Aggregate (or conduit) conceptTreatspartnership as a channel with income, expense,gains, etc. flowing through to partners Concept is reflected by the imposition of tax on the partners, not the partnership 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 113 114. Conceptual Basis for Partnership Taxation (slide 2 of 2) Involves 2 legal concepts (contd): Entity conceptTreats partners and partnershipsas separate and is reflected by: Partnership requirement to file its own information return Treating partners as separate from the partnership in certain transactions between the two 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 114 115. Partners Ownership Interest Each owner normally has a: Capital interest Measured by capital sharing ratio Partners percentage ownership of capital Profits (loss) interest Partners % allocation of partnership ordinary income (loss) and separately stated items Certain items may be specially allocated Specified in the partnership agreement 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 115 116. Inside and Outside Bases Inside basis Refers to adjusted basis of each partnership asset Each partner owns a share of the partnershipsinside basis for all its assets Outside basis Represents each partners basis in the partnershipinterest All partners should maintain a record of theirrespective outside bases 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 116 117. Basis Issues(slide 1 of 3) Partners outside basis is adjusted for income and losses that flow through from partnership This ensures that partnership income is only taxed once 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 117 118. Basis Issues(slide 2 of 3) Partners basis is important for determining: Deductibility of partnership losses Tax treatment of partnership distributions Calculating gain or loss on the partnersdisposition of the partnership interest 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 118 119. Basis Issues(slide 3 of 3) Partners capital account balance is usually not a good measure of a partners adjusted basis in a partnership interest for several reasons e.g., Basis includes partners share of partnership liabilities; Capital account does not 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 119 120. Partnership Formation Transaction 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 120 121. Tax Consequences of Partnership Formation (slide 1 of 2) Usually, no gain or loss is recognized by a partner or partnership on the contribution of money or property in exchange for a partnership interest Gain (loss) is deferred until taxable disposition of: Property by partnership, or Partnership interest by partner 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 121 122. Tax Consequences of Partnership Formation (slide 2 of 2) Partners basis in partnership interest = basis of contributed property If partner contributes capital assets and 1231assets, holding period of partnership interestincludes holding period of assets contributed For other assets including cash, holding periodbegins on date partnership interest is acquired If multiple assets are contributed, partnershipinterest is apportioned and separate holding periodapplies to each portion 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 122 123. WST Partnership FormationExample (slide 1 of 2) William contributes cash Amount$20,000 Sarah contributes land Basis $ 6,000 FMV $20,000 Todd contributes equipment Basis $22,000 FMV $20,000 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 123 124. WST Partnership FormationExample (slide 2 of 2) Gain or loss Basis in PartnershipsPartner RecognizedInterestPropertyBasisWilliam$-0- $20,000$20,000Sarah$-0- $ 6,000$ 6,000Todd $-0- $22,000$22,000Neither the partnership nor any of the partners recognizesgain or loss on the transaction 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 124 125. Exceptions to Tax-Free Treatment on PartnershipFormation (slide 1 of 4) Transfers of appreciated stock to investment partnership Gain will be recognized by contributing partner Prevents multiple investors from diversifying theirportfolios tax-free 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 125 126. Exceptions to Tax-Free Treatment on PartnershipFormation (slide 2 of 4) If transaction is essentially a taxable exchange of properties, gain will be recognized e.g., Individual A contributes land and IndividualB contributes equipment to a new partnership;shortly thereafter, the partnership distributes theland to B and the equipment to A; Partnershipliquidates IRS will disregard transfer to partnership and treatas taxable exchange between A & B 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 126 127. Exceptions to Tax-Free Treatment on PartnershipFormation (slide 3 of 4) Disguised Sale e.g., Partner contributes property to a partnership;Shortly thereafter, partner receives a distributionfrom the partnership Payment may be viewed as a purchase of the property by the partnership 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 127 128. Exceptions to Tax-Free Treatment on PartnershipFormation (slide 4 of 4) Receipt of partnership interest in exchange for services rendered to partnership Services are not treated as property Partner recognizes ordinary compensation income = FMVof partnership interest received Partnership may deduct the amount included in the service partners income if the services are of a deductible nature If the services are not deductible by the partnership, theymust be capitalized to an asset account 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 128 129. Tax Issues Relative to Contributed Property (slide 1 of 3) Contributions of depreciable property and intangible assets Partnership steps into shoes of contributingpartner Continues the same cost recovery and amortization calculations Cannot expense contributed depreciable property under 179 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 129 130. Tax Issues Relative to Contributed Property (slide 2 of 3) Gain or loss is ordinary when partnership disposes of: Contributed unrealized receivables Contributed property that was inventory incontributors hands, if disposed of within 5 yearsof contribution Inventory includes all tangible property except capital assets and real or depreciable business assets 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 130 131. Tax Issues Relative to Contributed Property (slide 3 of 3) If contributed property is disposed of at a loss and the property had a built-in capital loss on the contribution date Loss is treated as a capital loss if disposed ofwithin 5 years of the contribution Capital loss is limited to amount of built-in losson date of contribution 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 131 132. Elections Made by Partnership (slide 1 of 2) Inventory method Accounting method Cash, accrual or hybrid Depreciation method Tax year Organizational cost amortization Start-up expense amortization 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 132 133. Elections Made by Partnership (slide 2 of 2) Optional basis adjustment (754) 179 deduction Nonrecognition treatment for involuntary conversions Election out of partnership rules 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 133 134. Organizational Costs (slide 1 of 2) For organization costs incurred after October 22, 2004, the partnership may elect to deduct up to $5,000 of the costs in year business begins Deductible amount must be reduced by organization coststhat exceed $50,000 Remaining amounts are amortizable over 180 monthsbeginning with month the partnership begins business For organization costs incurred before that date, the taxpayer could elect to amortize the amount over 60 months 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 134 135. Organizational Costs (slide 2 of 2) Organizational costs include costs: Incident to creation of the partnership, chargeable to acapital account, and of a character that, if incident to thecreation of a partnership with an ascertainable life, wouldbe amortized over that life Includes accounting fees and legal fees connected with the partnerships formation Costs incurred for the following items are not organization costs:Acquiring and transferring assets to the partnershipAdmitting and removing partners, other than at formationNegotiating operating contractsSyndication costs 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 135 136. Start-up Costs (slide 1 of 2) Start-up costsinclude operating costs incurred after entity is formed but before it begins business including: Marketing surveys prior to conducting business Pre-operating advertising expenses Costs of establishing an accounting system Costs incurred to train employees before business begins,and Salaries paid to executives and employees before the startof business 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 136 137. Start-up Costs (slide 2 of 2) Partnership may elect to deduct up to $5,000 of start- up costs in the year it begins business Deductible amount must be reduced by start-up costs inexcess of $50,000 Costs that are not deductible under this provision areamortizable over 180 months beginning with the month inwhich the partnership begins business For start-up costs incurred before October 23, 2004, the taxpayer could elect to amortize those costs over 60 months 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 137 138. Method of Accounting (slide 1 of 2) New partnership may adopt cash, accrual or hybrid method Cash method cannot be adopted if partnership: Has one or more C corporation partners Is a tax shelter 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 138 139. Method of Accounting (slide 2 of 2) New partnership may adopt cash, accrual or hybrid method (contd) C Corp partner does not preclude use of cashmethod if: Partnership has average annual gross receipts of $5 million or less for preceding 3 year period C corp partner(s) is a qualified personal service corp, or Partnership is engaged in farming business 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 139 140. Required Taxable Year Partnership must adopt tax year under earliest of following tests met: Majority partners tax year (partners with same taxyear owning >50%) Principal partners tax year (all partners owning5% or more) Least aggregate deferral rule 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 140 141. Least Aggregate Deferral Example (slide 1 of 2) George owns 50% and has June 30 year end Henry owns 50% and has October 31 year end Neither partner owns a majority (>50%) Both are principal partners (5% or more), but do not have same year end Must use least aggregate deferral test to determinerequired taxable year 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 141 142. Least Aggregate Deferral Example (slide 2 of 2) 1. Test June 30 as possible year end:Partner. Year End% Mo. DeferralWeightGeorge June 50% 0 0.0HenryOctober50% 4 2.0Total weighted deferral 2.0 2. Test October 31 as possible year end: GeorgeJune 50% 8 4.0 Henry October50% 0 0.0 Total weighted deferral4.0 June has the least aggregate deferral so it is the tax year for partnership. 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.142 143. Alternative Tax Years Other alternatives may be available if: Establish to IRSs satisfaction that a businesspurpose exists for another tax year e.g., Natural business year at end of peak season Choose tax year with no more than 3 monthdeferral Partnership must maintain with the IRS a prepaid, non- interest-bearing deposit of estimated deferred taxes Elect a 52- to 53-week taxable year 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 143 144. Measuring Income of Partnership Calculation of partnership income is a 2-step approach Step 1: Net ordinary income and expensesrelated to the trade or business ofthe partnership Step 2: Segregate and report separately some partnership items 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 144 145. Separately Stated Items (slide 1 of 2) If an item of income, expense, gain or loss might affect any 2 partners tax liabilities differently, it is separately stated 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 145 146. Separately Stated Items (slide 2 of 2) Separately stated items fall under the aggregate concept Each partner owns a specific share of each item ofpartnership income, gain, loss or deduction Character is determined at partnership level Taxation is determined at partner level 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 146 147. Examples of Separately Stated Items (slide 1 of 2) Short and long-term capital gains and losses 1231 gains and losses Domestic production activities deduction Charitable contributions Interest income and other portfolio income Expenses related to portfolio income 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 147 148. Examples of Separately Stated Items (slide 2 of 2) Personalty expensed under 179 Special allocations of income or expense AMT preference and adjustment items Passive activity items Self-employment income Foreign taxes paid 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 148 149. Partnership Taxable Income Example (slide 1 of 3)Sales revenue$100,000Salaries 35,000Rent 15,000Utilities 6,000Interest income 1,500Charitable contribution 2,000AMT adjustment for depreciation 3,600Payment of partners medical expenses 4,000 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.149 150. Partnership Taxable Income Example (slide 2 of 3) Partnership ordinary taxable income:Sales revenue $100,000Salaries -35,000Rent -15,000Utilities -6,000Partnership Ordinary Income $ 44,000 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 150 151. Partnership Taxable Income Example (slide 3 of 3) Separately stated items: Interest income$1,500 Charitable contribution 2,000 AMT adjustment for depreciation 3,600 Distribution to partner: Payment of partners medical exp.$4,000 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.151 152. Partnership Allocations (slide 1 of 3) Partnership agreement can provide that a partner share capital, profits, and losses in different ratios e.g., Partnership agreement may provide that apartner has a 30% capital sharing ratio, yet beallocated 40% of the profits and 20% of the losses Such special allocations are permissible if certainrules are followed e.g., Economic effect test 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 152 153. Partnership Allocations (slide 2 of 3) The economic effect test requires that: An allocation must be reflected in a partnerscapital account When partners interest is liquidated, partner mustreceive assets with FMV = the positive balance inthe capital account A partner with a negative capital account mustrestore that account upon liquidation 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 153 154. Partnership Allocations (slide 3 of 3) Precontribution gain or loss Must be allocated to partners taking into account thedifference between basis and FMV of property on date ofcontribution For nondepreciable property this means any built-in gain or loss must be allocated to the contributing partner when disposed of by partnership in taxable transaction For depreciable property, allocations related to the built-in loss can be made only to the contributing partner For allocations to other partners, the partnerships basis in the lossproperty is treated as being the fair market value of the property at thecontribution date 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 154 155. Basis of Partnership Interest (slide 1 of 3) For new partnerships, partners basis usually equals: Adjusted basis of property contributed, plus FMV of any services performed by partner inexchange for partnership interest 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 155 156. Basis of Partnership Interest (slide 2 of 3) For existing partnerships, basis depends on how interest was acquired If purchased from another partner, basis = amountpaid for the interest If acquired by gift, basis = donors basis plus, incertain cases, a portion of the gift tax paid on thetransfer If acquired through inheritance, basis = FMV ondate of death (or alternate valuation date) 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 156 157. Basis of Partnership Interest (slide 3 of 3) A partners basis in partnership interest is adjusted to reflect partnership activity This prevents double taxation of partnershipincome 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 157 158. Basis Example (slide 1 of 2) Pam is a 30% partner in the PDQ partnership Pams beginning basis is $20,000 PDQ reports current income of $50,000 Pam sells her interest for $35,000 at the end of the year 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 158 159. Basis Example (slide 2 of 2)With BasisWithout BasisAdjustmentAdjustment Selling Price(A) $ 35,000 $35,000 Less: Basis in interest Beginning basis 20,00020,000 Share of current income 15,000- 0- . Ending basis (B)35,00020,000 Taxable gain (A)-(B)$ -0-$15,000 If no basis adjustment, Pams $15,000 share of partnershipincome is taxed twice: as ordinary income and as gain onsale of interest 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.159 160. Adjustments to Basis Initial Basis + Partners subsequent contributions to partnership + Partners share of partnership: Debt increase Income items Exempt income items Depletion adjustment Distributions and withdrawals from partnership Partners share of partnership: Debt decreases Nondeductible expenses Deductions and losses 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 160 161. Basis Limitation A partners basis in the partnership interest can never be negative 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 161 162. Partnership Liabilities Affect partners adjusted basis Increase in partners share of liabilities Treated as a cash contribution to the partnership Increases partners adjusted basis Decrease in partners share of liabilities Treated as a cash distribution to the partner Decreases partners adjusted basis 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 162 163. Allocation of Partnership Liabilities Two types of partnership debt Recourse debtAt least one partner is personallyliable Allocate to partners using a Constructive Liquidation Scenario Nonrecourse debtNo partner is personally liable Allocate to partners using a three-tiered allocation 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 163 164. Constructive Liquidation Scenario 1. Partnership assets deemed to be worthless 2. Assets deemed sold at $0; losses determined 3. Losses allocated to partners under partnership agreement 4. Partners with negative capital accounts deemed to contribute cash 5. Deemed contributed cash would repay partnership debt 6. Partnership deemed to liquidate - Partners share of recourse debt = Cash contribution used to repay debt (Step 5) 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 164 165. Nonrecourse Debt Allocation Three step allocation: 1. Minimum Gain allocated under regulations Minimum gain is basically gain which would arise on foreclosure of property 2. Liability = precontribution gain allocated to contributing partner 3. Remaining debt commonly allocated by profit sharing ratios (other allocation methods could be used) 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 165 166. Loss Limitations(slide 1 of 2) Partnership losses flow through to partners for use on their tax returns Amount and nature of losses that may be used bypartners may be limited Three different loss limitations apply Only losses that make it through all three limits are deductible by a partner 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 166 167. Loss Limitations (slide 2 of 2)Section Description704(d)Basis in partnership interest465 At-risk limitation469 Passive loss limitation Limitations are applied successively toamounts which are deductible at all priorlevels 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 167 168. Loss Limitation Example (slide 1 of 2)Megs basis in interest$50,000At-risk amount $35,000Passive income, other sources$25,000Share of partnership losses (passive)$60,000 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 168 169. Loss Limitation Example (slide 2 of 2)Provisions Deductible loss Suspended loss 704(d) $ 50,000 $ 10,000 46535,000 15,000 46925,000*10,000*Amount deducted on tax return: $25,000-passes all three loss limitations 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 169 170. Guaranteed Payments Payment to partner for use of capital or for services provided to partnership May not be determined by reference to partnershipincome Usually expressed as a fixed dollar amount or as a% of capital 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 170 171. Treatment of Guaranteed Payments(slide 1 of 2) May be deducted or capitalized by partnership depending on the nature of the payment Deductible by partnership if meets ordinary andnecessary business expense test May create partnership loss 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 171 172. Treatment of Guaranteed Payments(slide 2 of 2) Includable in income of partner at time partnership deducts Treated as if received on last day of partnership taxyear Character is ordinary income to recipient partner 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 172 173. Other Transactions Between Partner and Partnership (slide 1 of 2) May be treated as if partner were an outsider, for example: Loan transactions Rental payments Sales of property 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 173 174. Other Transactions Between Partner and Partnership (slide 2 of 2) Timing of deduction for payment by an accrual basis partnership to a cash basis partner depends on whether payment is: Guaranteed payment Included in partners income on last day of partnership year when accrued (even if not paid until the next year) Payment to partner treated as an outsider Deduction cannot be claimed until partner includes the amount in income 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 174 175. Sales of Property No loss is recognized on the sale of property between a partnership and a partner who owns > 50% of partnership capital or profits If property is subsequently sold at a gain, thedisallowed loss reduces gain recognized 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 175 176. Partners as Employees A partner usually does not qualify as an employee for tax purpose resulting in the following tax consequences: A partner receiving guaranteed payments from thepartnership is not subject to tax withholding The partnership cannot deduct payments for a partnersfringe benefits A general partners distributive share of ordinarypartnership income and guaranteed payments for servicesare generally subject to the Federal self-employment tax 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 176 177. If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 177 178. Chapter 7 Corporations:Reorganizations Corporations, Partnerships,Estates & Trusts Copyright 2010 Cengage LearningCorporations, Partnerships, Estates & TrustsC7 - 178 179. ReorganizationsIn General Refers to any corporate restructuring that may be tax-free under 368 To qualify, must meet certain general requirements: Must be a plan of reorganization Must meet continuity of interest and continuity of business enterprise tests Must have a sound business purpose Tax-free status can be denied under step transaction doctrineCorporations, Partnerships, Estates & TrustsC7 - 179 180. Summary of Different Types of Reorganizations The term reorganization includes: Statutory merger or consolidation Stock for stock exchange Stock for assets exchange Divisive exchange Recapitalization Change in identity, form, or place of organization Transfers in bankruptcy or receivershipCorporations, Partnerships, Estates & TrustsC7 - 180 181. Tax Free Reorganization Consequences, in General (slide 1 of 3) Consequences to Acquiring Corporation No gain or loss recognized unless it transfers property to the Target corporation as part of the transaction Then gain, but not loss, may be recognized Basis of property received retains basis it had in hands of Target corp plus any gain recognized by the targetCorporations, Partnerships, Estates & TrustsC7 - 181 182. Tax Free Reorganization Consequences, in General (slide 2 of 3) Consequences to Target Corporation No gain or loss unless it retains other property received in the exchange or it distributes its own property to shareholders Other property is defined as anything received other than stock or securities Treated as boot Gain, but not loss, may be recognizedCorporations, Partnerships, Estates & TrustsC7 - 182 183. Tax Free Reorganization Consequences, in General (slide 3 of 3) Consequences to Target or Acquiring Co. Shareholders No gain or loss unless shareholders receive cash or other property in addition to stock Cash or other property is considered boot Gain recognized by the stockholder is the lesser of the boot received or the realized gain Basis of shares received is same as basis of those surrendered, decreased by boot received, increased by gain and dividend income, if any, recognized in the transactionCorporations, Partnerships, Estates & Trusts C7 - 183 184. Type A Reorganization Includes mergers and consolidations Merger is union of two or more corporations One corporation retains it existence and absorbs the others Consolidation occurs when a new corporation is created to take the place of two or more corporationsCorporations, Partnerships, Estates & TrustsC7 - 184 185. Type A Reorganization (slide 1 of 2)Corporations, Partnerships, Estates & Trusts C7 - 185 186. Type A Reorganization (slide 2 of 2)Corporations, Partnerships, Estates & Trusts C7 - 186 187. Type A Reorganization Issues (slide 1 of 2) Advantages: Type A reorganization is flexible Consideration need not be voting stock Money or other property can be transferred without disqualifying the transaction, as long as continuity of interest is met (at least 50% of consideration used in reorganization must be stock)Corporations, Partnerships, Estates & Trusts C7 - 187 188. Type A Reorganization Issues(slide 2 of 2) Disadvantages: Money or other property transferred is boot so some gain may be required to be recognized Shareholders of either entity may dissent; in most states their shares must be redeemed Acquiring entity must assume all liabilities of TargetCorporations, Partnerships, Estates & Trusts C7 - 188 189. Type B Reorganization(Stock-for-Stock Reorganization)Corporations, Partnerships, Estates & Trusts C7 - 189 190. Type B Reorganization Requirements (slide 1 of 4) Corporation acquires stock of Target solely in exchange for its own voting stock (stock for stock) Acquiring corporation must acquire control of Target Control is ownership of at least 80% of all classes of stock of target Acquirer may add shares owned previously with shares acquired in reorganizationCorporations, Partnerships, Estates & Trusts C7 - 190 191. Type B Reorganization Requirements (slide 2 of 4) Acquiring corporation may acquire shares from either: (1) Shareholders of Target, or (2) Directly from Target Exception to the solely for voting stock requirement when shareholders must receive fractional shares May receive cash rather than fractional shares in the acquiring corporationCorporations, Partnerships, Estates & TrustsC7 - 191 192. Type B Reorganization Requirements (slide 3 of 4) Example: Assume Target has 100 shares outstanding: Acquirer may obtain 80 shares from current Target shareholders in exchange for Acquirers voting stock Target may also issue 400 new shares to Acquirer in exchange for Acquirers voting stock (500 shares would be outstanding)Corporations, Partnerships, Estates & TrustsC7 - 192 193. Type B Reorganization Requirements (slide 4 of 4) Consideration paid by Acquirer can only include Acquirers voting stock or transaction does not qualifyCorporations, Partnerships, Estates & Trusts C7 - 193 194. Type C Reorganization (Stock-for-Assets Reorganization)Corporations, Partnerships, Estates & Trusts C7 - 194 195. Type C Reorganization Requirements (slide 1 of 3) A Type C reorganization is essentially an exchange of voting stock for assets followed by liquidation of the target corporation Called a Stock-for-Assets reorganization Transfer is generally between the entities, not the shareholdersCorporations, Partnerships, Estates & Trusts C7 - 195 196. Type C Reorganization Requirements (slide 2 of 3) Consideration paid by Acquirer normally consists only of voting stock However, if at least 80% of FMV of Target is acquired with voting stock, cash or other property can be used for remainder Limitation: liabilities assumed by Acquirer are considered other property if any additional other property is usedCorporations, Partnerships, Estates & Trusts C7 - 196 197. Type C Reorganization Requirements (slide 3 of 3) Substantially all of Targets assets must be transferred to Acquirer There is no statutory definition of substantially all To receive a favorable ruling from the IRS, the target must transfer at least 90% of net asset value or 70% of the gross asset value to the acquiring corporationCorporations, Partnerships, Estates & Trusts C7 - 197 198. Type D Reorganization (slide 1 of 4) Generally a mechanism for corporate division Called a divisive reorganization but can be used to carry out a corporate combination In a Type D acquisitive reorganization Entity transferring assets is considered the acquiring corporation Corporation receiving the property is the targetCorporations, Partnerships, Estates & TrustsC7 - 198 199. Type D Reorganization (slide 2 of 4) In an acquisitive Type D reorganization Substantially all of acquiring corps property must be transferred to target corporation The acquiring corp must be in control (at least 50%) of the target Target stock received by the acquiring corp and any remaining assets of acquiring corp must be distributed to its shareholders Acquiring corporation must liquidateCorporations, Partnerships, Estates & Trusts C7 - 199 200. Type D Reorganization (slide 3 of 4) In a divisive Type D reorganization A corporation is divided One or more new corps are formed to receive assets of original corp Original corp must receive stock representing control (80%) of new corps Stock of new corps is then distributed to shareholders of original corpCorporations, Partnerships, Estates & Trusts C7 - 200 201. Type D Reorganization (slide 4 of 4) Three types of divisive Type D reorganizations Spin-Off and Split-Off A new corporation is formed to receive some of the assets of the original corporation in exchange for the new corporations stock Split-Up Two or more corporations are formed to receive substantially all of the assets of the original corporationCorporations, Partnerships, Estates & Trusts C7 - 201 202. Type D Reorganization Spin-Off (slide 1 of 2)Corporations, Partnerships, Estates & Trusts C7 - 202 203. Type D Reorganization Spin-Off (slide 2 of 2)Corporations, Partnerships, Estates & Trusts C7 - 203 204. Type D ReorganizationSplit-Off (slide 1 of 2)Corporations, Partnerships, Estates & Trusts C7 - 204 205. Type D ReorganizationSplit-Off (slide 2 of 2)Corporations, Partnerships, Estates & Trusts C7 - 205 206. Type D Reorganization Split-Up(slide 1 of 2)Corporations, Partnerships, Estates & Trusts C7 - 206 207. Type D Reorganization Split-Up(slide 2 of 2)Corporations, Partnerships, Estates & Trusts C7 - 207 208. Type E Reorganization (slide 1 of 2) Type E reorganization is a recapitalization Involves a major change in character and amount of outstanding stock, securities, or paid-in-capital The following exchanges qualify: Bonds for stock Stock for stock Bonds for bondsCorporations, Partnerships, Estates & Trusts C7 - 208 209. Type E Reorganization (slide 2 of 2) Corporation can exchange its common stock for preferred stock or its preferred stock for common stock tax-free The exchange of bonds for other bonds is tax- free when the debt received has a principal amount that is not more than the surrendered debts principal amountCorporations, Partnerships, Estates & Trusts C7 - 209 210. Type F Reorganization A mere change in identity, form, or place of organization, however effected Restricted to a single operating corporation Tax characteristics of predecessor corp carry over to successor corp Does not jeopardize status of 1244 stock or terminate a valid S corp electionCorporations, Partnerships, Estates & Trusts C7 - 210 211. Type G Reorganization All or part of assets of debtor corp are transferred to an acquiring corp in bankruptcy Debtor corps creditors must receive voting stock of the acquiring corp in exchange for debt representing 80% or more of total FMV of debt of debtor corpCorporations, Partnerships, Estates & Trusts C7 - 211 212. Judicial Doctrines (slide 1 of 2) Besides meeting specific requirements of reorganization, several judicially created doctrines must be met Reorganization must exhibit a sound business purpose Not a well defined test Continuity of interest test IRS deems this test met if shareholders of Target receive stock in Acquirer equal to at least 50% of their prior stock ownership in Target stockCorporations, Partnerships, Estates & Trusts C7 - 212 213. Judicial Doctrines (slide 2 of 2) Continuity of business enterprise test Requires the acquiring corp to either: Continue the Targets historic business, or Use a significant portion of Targets assets in business Step transaction doctrine Ensures that a series of transactions are not used to obtain tax benefits that would be unavailable if the transaction were accomplished in a single step IRS generally views any transactions occurring within one year of reorganization as part of the restructuringCorporations, Partnerships, Estates & TrustsC7 - 213 214. Carryover of CorporateTax Attributes (slide 1 of 4) Assumption of liabilities Acquiring corp either assumes liabilities of Target or takes property subject to liabilities Allowance of Carryovers In Type A, C, acquisitive D, and G reorganizations, the Targets tax attributes are acquired In Type B reorganizations, Target retains its assets and tax attributesCorporations, Partnerships, Estates & TrustsC7 - 214 215. Carryover of CorporateTax Attributes (slide 2 of 4) NOL Carryovers Amount of NOL that can be used in year ownership change occurs is limited to a percentage representing the remaining days in the tax year over the total number of days in the yearCorporations, Partnerships, Estates & Trusts C7 - 215 216. Carryover of CorporateTax Attributes (slide 3 of 4) NOL Carryovers (contd) NOL can be further limited in first and succeedingyears when there is a more than 50-percentage-pointownership change An ownership change takes place on the day (change date) that either an equity structure shift or an owner shift occurs An equity structure shift occurs when a tax-free reorganization causes an owner shift An owner shift is any change in the common stock ownership of shareholders owning at least 5% NOL can be used to the extent of the value of the loss corps stock on the date of the ownership change multiplied by the long-term tax-exempt rateCorporations, Partnerships, Estates & TrustsC7 - 216 217. Carryover of CorporateTax Attributes (slide 4 of 4) Earnings and Profits Positive E & P of acquired corp carries over E & P of a deficit corp are deemed received by acquiring corp as of change date Deficit may only be used to offset E & P accumulated by successor corporation after the change dateCorporations, Partnerships, Estates & TrustsC7 - 217 218. Comparison of Reorganization Types (slide 1 of 5)TypeAdvantages DisadvantagesA. Merger/Consideration State law mayConsolidation need not be give dissentersvoting stockrights or requires/holder mtgs.Up to 50% ofAll liabilities ofconsideration can Target arebe in cashassumed byAcquirerCorporations, Partnerships, Estates & Trusts C7 - 218 219. Comparison of Reorganization Types (slide 2 of 5)Type AdvantagesDisadvantagesB. Stock-for- Stock can be acqd Only voting stock ofStock from shareholdersAcquirer can be used Procedures are notMust have 80% complex control of Target -May have minority after reorg.Corporations, Partnerships, Estates & TrustsC7 - 219 220. Comparison of Reorganization Types (slide 3 of 5)TypeAdvantages DisadvantagesC. Stock-for- Less complex as to Substantially allAssetsstate law than A assets of Target must be transferredCash or property are Liabilities count asOK consideration ifother property for20% or less of FMV 20% test if any otherof propertyconsideration used.transferredTarget must distribute assets recd to s/holdersCorporations, Partnerships, Estates & Trusts C7 - 220 221. Comparison of Reorganization Types (slide 4 of 5)Type AdvantagesD. DivisionPermits corporate division without(generally)tax consequences if no boot is involvedE. Recapitalization Allows for major change in makeupof shareholders equity without gainrecognition requirementCorporations, Partnerships, Estates & TrustsC7 - 221 222. Comparison of Reorganization Types (slide 5 of 5)Type AdvantagesF. Change in form, Survivor is treated as same entityidentity, or place as predecessor; tax attributes ofof organizationpredecessor can be carried back or forwardG. Court approved Creditors can exchange notes forreorganization stock tax-free and state merger laws need not be followedCorporations, Partnerships, Estates & TrustsC7 - 222 223. If you have any comments or suggestions concerning thisPowerPoint Presentation for South-Western FederalTaxation, please contact: Dr. Donald R. Trippeer, CPA trippedr@oneonta.edu SUNY OneontaCorporations, Partnerships, Estates & TrustsC7 - 223 224. REFERENCE LIST (Dr. Donald R. Trippeer, 1. (. (1999)). Partnerships: Formation, Partnerships: Formation, . SOUTH WESTERN FEDERAL: COPARATION PARTNERSHIP. Dr. Donald R. Trippeer, C. (1989). Partnerships: Formation, Operation and Basis. COSMO CITY SOUTH WESREN. HASAN, H. (n.d.). GENERAL LEDGER AND TRAIL BALANCE. Kidwell, b. R. (2009. ). Fundamentals of Corporate Finance. Reprinted for Sai Chakrala, Bank of America: John Wiley & Sons, Inc.. (c) 2010. Copying Prohibited. Kimmel, N. K. (2005). The Recording Process AND Accounting Principles, 7th Edition. Marianne Bradford: Monroe Community College. parakhiya, V. G. (1999). DIVIDEND DECISION. GRAND HOLL. NEWYORK. 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 224