Limited and general partnerships
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Explores the differences between types of partnerships.
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Limited and general partnerships
- 1. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 12 Accounting for Partnerships
- 2. 12 - 2 Partnership Form of Organization Partnership Agreement Partnership Agreement Voluntary Association Voluntary Association Limited Life Limited Life TaxationTaxation Unlimited Liability Unlimited Liability Mutual Agency Mutual Agency Co-Ownership of Property Co-Ownership of Property C 1
- 3. 12 - 3 Organizations with Partnership Characteristics Limited Partnerships (LP) Limited Partnerships (LP) • General partners assume management duties and unlimited liability for partnership debts. • Limited partners have no personal liability beyond invested amounts. • General partners assume management duties and unlimited liability for partnership debts. • Limited partners have no personal liability beyond invested amounts. Limited Liability Partnerships (LLP) Limited Liability Partnerships (LLP) • Protects innocent partners from malpractice or negligence claims. • Most states hold all partners personally liable for partnership debts. • Protects innocent partners from malpractice or negligence claims. • Most states hold all partners personally liable for partnership debts. Limited Liability Corporations (LLC) Limited Liability Corporations (LLC) • Owners have same limited liability feature as owners of a corporation. • A limited liability corporation typically has a limited life. • Owners have same limited liability feature as owners of a corporation. • A limited liability corporation typically has a limited life. C 1
- 4. 12 - 4 Choosing a Business Form Many factors should be considered whenMany factors should be considered when choosing the proper business form.choosing the proper business form. Many factors should be considered whenMany factors should be considered when choosing the proper business form.choosing the proper business form. C 1
- 5. 12 - 5 Organizing a Partnership Partners can invest both assets and liabilities in the partnership. Partners can invest both assets and liabilities in the partnership. Assets and liabilities are recorded at an agreed- upon value, normally fair market value. Assets and liabilities are recorded at an agreed- upon value, normally fair market value. Asset contributions increase the partner’s capital account. Asset contributions increase the partner’s capital account. Withdrawals from the partnership decrease the partner’s capital account. Withdrawals from the partnership decrease the partner’s capital account. P 1
- 6. 12 - 6 Organizing a Partnership In accounting for partnerships:In accounting for partnerships: 1.1.Partners’ withdrawals are debited to their own separatePartners’ withdrawals are debited to their own separate withdrawals account.withdrawals account. 2.2.Partners’ capital accounts are credited (or debited) forPartners’ capital accounts are credited (or debited) for their shares of net income (or net loss) when closing thetheir shares of net income (or net loss) when closing the accounts at the end of the period.accounts at the end of the period. 3.3.Each partner’s withdrawal account is closed to thatEach partner’s withdrawal account is closed to that partner’s capital account. Separate capital and withdrawalspartner’s capital account. Separate capital and withdrawals accounts are kept for each partner.accounts are kept for each partner. In accounting for partnerships:In accounting for partnerships: 1.1.Partners’ withdrawals are debited to their own separatePartners’ withdrawals are debited to their own separate withdrawals account.withdrawals account. 2.2.Partners’ capital accounts are credited (or debited) forPartners’ capital accounts are credited (or debited) for their shares of net income (or net loss) when closing thetheir shares of net income (or net loss) when closing the accounts at the end of the period.accounts at the end of the period. 3.3.Each partner’s withdrawal account is closed to thatEach partner’s withdrawal account is closed to that partner’s capital account. Separate capital and withdrawalspartner’s capital account. Separate capital and withdrawals accounts are kept for each partner.accounts are kept for each partner. P 1
- 7. 12 - 7 Organizing a Partnership On 1/11, Kayla Zayn and Hector Perez organize a partnership called BOARDS. Zayn’s initial investment is $7,000 cash, $33,000 in boarding facilities, and a note payable for $10,000 on the boarding facilities. Perez’s initial investment is $10,000 cash. Jan 11 Cash 7,000 Boarding Facilities 33,000 Notes Payable 10,000 K. Zayn, Capital 30,000 To record Zayn's initial investment. Jan 11 Cash 10,000 H. Perez, Capital 10,000 To record Perez's initial investment. P 1
- 8. 12 - 8 Dividing Income or Loss Three frequently used methods to divideThree frequently used methods to divide income or loss are allocation on:income or loss are allocation on: 1.1. Stated ratios.Stated ratios. 2.2. Capital balances.Capital balances. 3.3. Services, capital and stated ratios.Services, capital and stated ratios. Partners are not employees of the partnership but are itsPartners are not employees of the partnership but are its owners. This means there are no salaries reported asowners. This means there are no salaries reported as expense on the income statement. Profits or losses of theexpense on the income statement. Profits or losses of the partnership are divided on some agreed upon ratio.partnership are divided on some agreed upon ratio. P 2
Editor's Notes
- Chapter 12: Accounting for partnerships
- Probably, the first thing new partners should do is prepare a partnership agreement. Without such an agreement, the Uniform Partnership Act will govern many of the key financial questions faced by the partners. A partnership has a limited life. Unless provision is made to the contrary, a partnership ceases to exist upon the death of a partner, the withdrawal of a partner, or the admission of a new partner. In a general partnership, each partner has unlimited liability for the acts of all other partners. Income or loss of the partnership flows through to the individual partners. Income or loss from the partnership is taxed as any other income received by an individual.Let’s look at three special types of partnerships.
- In a limited partnership, one partner is designated as the general partner. The general partner assumes management duties for the entire partnership. Normally, the general partner has unlimited liability and the other partners have no personal liability beyond the amounts invested in the partnership.Partners may form a limited liability partnership, or LLP. An LLP protects innocent partners from malpractice or negligence claims brought against an offending partner. In most states, individual partners are personally liable for the debts of the partnership.Partners may wish to consider forming a limited liability corporation, or LLC. In an LLC, individual owners have limited liability, but the corporation typically has a limited life defined in the agreement.
- This table identifies the major advantages and disadvantages of all the forms of business we have discussed. Obviously, the choice of the proper form of business is important to the success of any operation. It is a good idea to review this table when studying for your next exam.
- When a partnership is formed, each partner may contribute both assets and liabilities to the partnership. Contributed assets increase partner’s capital and liabilities decrease partner’s capital.Assets are normally recorded at fair market value and liabilities are recorded at the amount payable.Each partner may be entitled to withdraw cash or other assets from the partnership. A withdrawal reduces the partner’s capital account.
- In accounting for partnerships, the following additional relations hold true: Partners’ withdrawals are debited to their own separate withdrawals account. Partners’ capital accounts are credited (or debited) for their shares of net income (or net loss) when closing the accounts at the end of the period. Each partner’s withdrawal account is closed to that partner’s capital account. Separate capital and withdrawals accounts are kept for each partner.
- In our example, Kayla Zayn and Hector Perez organize a partnership called BOARDS. Zayn’s initial investment is $7,000 cash, $33,000 in boarding facilities, and a note payable for $10,000 on the boarding facilities. Perez’s initial investment is $10,000 cash. Let’s look at the journal entries required at inception of the partnership.On the books of the partnership, we will debit the asset account Cash for $7,000, and Boarding Facilities for $33,000. We will credit Notes Payable for $10,000 and credit K. Zayn, Capital for $30,000, to admit Kayla to the partnership. Now, let’s prepare the entry to admit Hector Perez to the partnership. For Hector Perez, we will debit Cash for $10,000 and credit H. Perez, Capital for the same amount, to admit Hector to the partnership.
- Partners are not considered employees of the partnership but are owners. There is no salary expense reported on the income statement for distributions to partners. Profits and losses of the partnership are divided among the partners in some agreed upon ratio.Very often partners agree to divide profit and losses on the basis of some stated ratio, on the capital balance of each partner, or on some combination of these amounts.