Partnerships and LLCs Accounting

Chapter 13
Partnerships and Limited
Liability Corporations
Accounting, 21st Edition
Warren Reeve Fess
PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
© Copyright 2004 South-Western, a division
of Thomson Learning. All rights reserved.
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1. Describe the basic characteristics of
proprietorships, corporations,
partnerships, and limited liability
corporation.
2. Describe and illustrate the equity
reporting for proprietorships, corporations,
partnerships, and limited liability
corporations.
3. Describe and illustrate the accounting for
forming a partnership.
Objectives
After studying this
chapter, you should
be able to:

4. Describe and illustrate the accounting
for dividing the net income and net loss
of a partnership.
Objectives
for the dissolution of a partnership.
for liquidation of a partnership.
7. Describe the lifecycle of a business,
including the role of venture capitalists,
initial public offerings, and
underwriters.

Alternative Forms of Business Entities
Advantages
• Ease in organizing
• Low cost of
organizing
Disadvantages
• Difficulty in raising
large amounts of
capital
• Unlimited liability
Joe’s
Review of Chapter 1
A proprietorship is
owned by one
individual.

A corporation is
organized under
state or federal
statutes as a separate
legal entity.
Advantages
• The ability to obtain large
amounts of resources by
issuing stocks
• Limited liability for the
owners
Disadvantages
• Double taxation
• More complexity
and regulations
J & M, Inc.

J & M, Inc.
A business may organize
as an S Corporation. The
IRS allows income to pass
through the S Corporation
to the individual
stockholder without the
corporation having to pay
tax on the income.

A partnership is an
association of two
or more individuals.
Advantages
• More financial
resources than a
proprietorship
• Additional
management skills
Joe and Marty’s

Disadvantages
• Limited life
• Unlimited liability
• Co-ownership of
partnership property
• Mutual agency
Joe and Marty’s
A partnership is an
association of two
or more individuals.

An important right of
partners is to participate in
the income of the
partnership.

Each partner must
report their share of
partnership income
on their personal
tax returns.

A partnership is created
by a contract, known as
the partnership
agreement or articles of
partnership.

A variant of the
regular partnership
is a limited
partnership.
This form of partnership
allows partners that are
not involved in the
operations of the
partnership to retain
limited liability.

Limited Liability Corporations
 Combines the advantages of the corporate and
partnership forms.
 Owners are termed “members” rather than
“partners.”
 Members must create an operating agreement.
 LLC may elect to be treated as a partnership for
tax purposes.
Continued

Limited Liability Corporations
 Unless specified in the operating agreement,
LLCs have a limited life.
 Members may elect operating the LLC as a
“member managed” entity.
 LLC provides limited liability for the members.
 LLCs must file “articles of organization” with
state governmental authorities.

Comparison of Alternate
Entity Characteristics
Ease of Formation
Proprietorship Simple
Corporation Complex
Partnership Simple
LLC Moderate

Legal Liability
Proprietorship No limitation
Corporation Limited liability
Partnership No limitation
LLC Limited liability

Taxation
Proprietorship Nontaxable entity
Corporation Taxable entity
Partnership Nontaxable entity
LLC Nontaxable entity by election

Limitation on Life of Entity
Proprietorship Yes
Corporation No
Partnership Yes
LLC Yes

Ease of Raising Capital
Proprietorship Difficult
Corporation Easier
Partnership Moderate
LLC Moderate

Equity Reporting for
Alternative Entity Forms
Proprietorships
 Proprietorships use a capital account to
record investments by the owner of the
business.
 Withdrawals by the owner are recorded
in the owner’s drawing account.

Proprietorships
Greene Landscapes
Statement of Owner’s Equity
For the year ended December 31, 2006
Duncan Greene, capital, Dec. 31, 2005 $345,000
Net income $79,000
Less withdrawals 35,000
Increase in owner’s equity 44,000
Duncan Greene, capital, Dec. 31, 2006 $389,000

Corporations
 Investments by stockholders in the
business use capital stock accounts,
such as Common Stock and Preferred
Stock.
 Dividends to owners (stockholders) are
recorded by a debit to Retained
Earnings.

Corporations

Partnerships and Limited Liability Corporations
 Investments and withdrawals for
partnerships is similar to proprietorships,
except there is a capital and drawing
account for each partner.
 Limited liability corporations are similar
to a partnership except that each owner is
referred to as “member.”

Equity Reporting for Alternative
Entity Forms
Partnerships

Forming a Partnership
Joseph Stevens and Earl Foster agree to combine
their hardware businesses in a partnership. They
agree that the partnership is to assume the
liabilities of the separate businesses.
Apr. 1 Cash 7 200 00
Accounts Receivable 16 300 00
Merchandise Inventory 28 700 00
Store Equipment 5 400 00
Office Equipment 1 500 00
Allowance for Doubtful Accounts 1 500 00
Accounts Payable 2 600 00
Joseph Stevens, Capital 55 000 00
Stevens’ Transfer of Assets, Liability, and Equity

A similar entry would be made
for the assets, liabilities, and
equity of Earl Foster.

Assume that instead of forming a partnership, the
two men formed a limited liability corporation.
Apr. 1 Cash 7 200 00
Accounts Receivable 16 300 00
Merchandise Inventory 28 700 00
Store Equipment 5 400 00
Office Equipment 1 500 00
Allowance for Doubtful Accounts 1 500 00
Accounts Payable 2 600 00
Joseph Stevens, Member Equity 55 000 00
Stevens’ Transfer of Assets, Liability, and Equity

Dividing Income
Services of Partners
The partnership agreement of Jennifer Stone and
Crystal Mills provides for Stone to have an annual
salary allowance of $30,000 and Mills is to receive
$24,000. Any net income is to be divided equally.
The firm had a net income of $75,000.
J. Stone C. Mills Total
Salary allowance $30,000 $24,000 $54,000
Remaining income 10,500 10,500 21,000
Division of net income $40,500 $34,500 $75,000

Dividing Income
Dec. 31 Income Summary 75 000 00
Jennifer Stone, Capital 40 500 00
Crystal Mills, Capital 34 500 00

Dividing Income
LLC Alternative
Jennifer Stone, Member Equity 40 500 00
Crystal Mills, Member Equity 34 500 00

Dividing Income
Services of Partners and Investments
The partnership agreement of Jennifer Stone and
Crystal Mills provides for Stone to have an
annual salary allowance of $30,000 and Mills is
to receive $24,000. Interest of 12% is provided
on each partner’s capital balance on January 1.
Any net income is to be divided equally. The
firm had a net income of $75,000.

Dividing Income
Services of Partners and Investments
Interest allowance 9,600 7,200 16,800
$80,000 x
12%
$60,000 x
12%
Remaining income 2,100 2,100 4,200

Dividing Income
Jennifer Stone, Capital 41 700 00
Crystal Mills, Capital 33 300 00

Dividing Income
LLC Alternative
Jennifer Stone, Member Equity 41 700 00
Crystal Mills, Member Equity 33 300 00

Dividing Income
Allowances Exceed Net Income
Assume the same facts as before except that
the net income is only $50,000.
Interest allowance 9,600 7,200 16,800
Total $39,600 $31,200 $70,800
Deduct excess equally 10,400 10,400 20,800

Partnership Dissolution
Admitting a Partner
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 partners by:

Purchasing an Interest in a Partnership
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
June 1 Tom Andrews, Capital 10 000 00
Nathan Bell, Capital 10 000 00
Joe Canter, Capital 20 000 00
For a LLC, members’ equity accounts would
have been used rather than capital accounts.

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.

Contributing Assets to a Partnership
June 1 Cash 20 000 00
Sharon Nelson, Capital 20 000 00
For a LLC, Sharon Nelson, Member Equity
would have been credited.

Revaluation of Assets
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.

June 1 Merchandise Inventory 3 000 00
Donald Lewis, Capital 1 500 00
Gerald Morton, Capital 1 500 00
Because the LLC alternative follows a pattern
of replacing “Capital” with “Member Equity,”
the LLC entry will not be shown again.
Revaluation of Assets

Partner Bonuses
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 a fair
market values and the resulting capital
balances for Jenkins and Kramer are
$30,000 and $24,000, respectively.

Partner Bonuses
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.

Partner Bonuses from New Partner
Equity of Jenkins $20,000
Equity of Kramer 24,000
Diaz’s Contribution 31,000
Total equity after admitting Diaz $75,000
Diaz’s interest (1/3 x $75,000) $25,000
Diaz’s contribution $31,000
Diaz’s equity after admission 25,000
Bonus paid to Jenkins and Kramer $ 6,000

Partner Bonuses
Mar. 1 Cash 31 000 00
Alex Diaz, Capital 25 000 00
Marsha Jenkins, Capital 3 000 00
Helen Kramer, Capital 3 000 00
$6000 ÷ 2

Partner Bonuses
After adjusting the market values, the
capital balance of Janice Cowen is
$580,000 and the capital balance of Steve
Dodd is $40,000. Ellen Chua receives a
one-fourth interest in the partnership for a
contribution of $30,000. Before admitting
Chua, Cowen and Dodd shared net income
using a 2 to 1 ratio.

Partner Bonuses to New Partner
Equity of Cowen $ 80,000
Equity of Dodd 40,000
Chua’s Contribution 30,000
Total equity after admitting Chua $150,000
Chua’s interest (1/4 x $150,000) $ 37,500
Chua’s contribution $30,000
Chua’s equity after admission 37,500
Bonus paid to Chua $ 7,500

Partner Bonuses
Mar. 1 Cash 30 000 00
Janice Cowen, Capital 5 000 00
Steve Dodd, Capital 2 500 00
Ellen Chua, Capital 37 500 00
1/3 x
$7,50
0
2/3 x
$7,50
0

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

The sale of the assets is
called realization.

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.
Cash $11,000
Noncash Assets 64,000
Liabilities $ 9,000
Jean Farley, Capital 22,000
Brad Greene, Capital 22,000
Alice Hall, Capital 22,000
Total $75,000 $75,000

Between April 10 and April 30, 2006,
Farley, Greene, and Hall sell all
noncash assets for $72,000.
Gain on Realization

Balance before realization $11,000 $64,000 $9,000
Left side of statement
Noncash
Cash Assets Liabilities
Sale of assets and division
of gain +72,000 -64,000 —

Right side of statement
Farley Greene Hall
Capital Capital Capital
of gain +4,000 +2,400 +1,600
$8,000
gain x .50
$8,000
gain x .30
$8,000
gain x .20

Noncash
of gain +72,000 –64,000 —
Balance after realization $83,000 $0 $9,000

Farley Greene Hall
of gain +4,000 +2,400 +1,600
Balance after realization $26,000 $24,400 $23,600

The partnership’s liabilities are
paid, $9,000.
Gain on Realization

Noncash
of gain +72,000 –64,000 —
Balance after realization $83,000 $ 0 $9,000
Payment of liabilities –9,000 — –9,000

Noncash
of gain +72,000 –64,000 —
Balance after payment $74,000 $ 0 $ 0

The remaining cash, $74,000,
is paid to each partner in
accordance with the partner’s
capital balance.
Gain on Realization

Noncash
of gain +72,000 –64,000 —
Partners’ cash distributed –74,000 — —
Final balances $ 0 $ 0 $ 0

Farley Greene Hall
of gain +4,000 +2,400 +1,600
Payment of liabilities — — —
Balance after payment $26,000 $24,400 $23,600
Partners’ cash distributed –26,000 –24,400 –23,600

Sale of Assets
Apr. 30 Cash 72 000 00
Noncash Assets 64 000 00
Gain on Realization 8 000 00

Division of Gain
Apr. 30 Gain on Realization 8 000 00
Jean Farley, Capital 4 000 00
Brad Greene, Capital 2 400 00
Alice Hall, Capital 1 600 00

Payment of Liabilities
Apr. 30 Liabilities 9 000 00
Cash 9 000 00

Distribution of Cash to Partners
Apr. 30 Jean Farley, Capital 26 000 00
Cash 74 000 00

Between April 10 and April 30, 2006,
Farley, Greene, and Hall sell all
noncash assets for $44,000.
Loss on Realization

Noncash
of loss +44,000 –64,000 —

Farley Greene Hall
of loss –10,000 –6,000 –4,000
$20,000
loss x .50
$20,000
loss x .30
$20,000
loss x .20

Noncash
of loss +44,000 –64,000 —
Balance after realization $55,000 $0 $9,000

Farley Greene Hall
of loss –10,000 –6,000 –4,000

The liabilities of the
partnership are paid, $9,000.
Loss on Realization

Noncash
of loss +44,000 –64,000 —

The remaining cash, $46,000,
is paid to each partner in
accordance with the partner’s
capital balance.
Loss on Realization

Noncash
of loss +44,000 –64,000 —
Partners’ cash distributed –46,000 — —

Farley Greene Hall
of loss –10,000 –6,000 –4,000
Payment of liabilities — — —
Balance after payment $12,000 $16,000 $18,000
Partners’ cash distributed –12,000 –16,000 –18,000

Sale of Assets
Apr. 30 Cash 44 000 00
Loss on Realization 20 000 00
Noncash Assets 64 000 00

Division of Loss
Loss on Realization 20 000 00

Distribution to Partners
Cash 46 000 00

Lifecycle of a Business
Business Stage Principal Advantage
Della’s Delights,
Proprietorship
Jeff Jacobi, Proprietor
Form easily: Jacobi forms a
business by obtaining a
local business license and
opening a bank account.
Della’s Delights,
Partnership
Jacobi and Lange,
Partners
Expand capital and
expertise: Jacobi admits a
new partner that contributes
capital and expertise.
Continued

Della’s Delights, LLC Limit legal liability: The
partnership is changed to an
LLC to limit legal liability
of owners.
Della’s Delights, Inc. Simplify raising capital:
The LLC is changed to a
corporation to raise capital
from the public.
Continued

Della’s Delights, Inc. a
division of International
Foods, Inc.
Provide exit: The company
is sold for cash.

A venture capitalist is an
individual or firm that
provides equity financing for
a new company.

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