This document describes accounting for partnerships and limited liability companies. It discusses the basic characteristics of proprietorships, partnerships, and LLCs. It also describes how to record the formation of a partnership by contributing assets, how to divide partnership net income and losses, how to account for admitting or withdrawing a partner, and how to liquidate a partnership. The objectives are to describe these topics and illustrate them with journal entries.

1. Accounting for Partnerships and Limited Liability Companies 12 0

2. Describe the basic characteristics of proprietorships, partnerships, and limited liability companies. Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership. After studying this chapter, you should be able to: 0

3. Describe and illustrate the accounting for partner admission and withdrawal. Describe and illustrate the accounting for liquidating a partnership. Prepare the statement of partnership equity. After studying this chapter, you should be able to: 0

4. Describe the basic characteristics of proprietorships, partnerships, and limited liability companies. Objective 1 12-1 0

5. Advantages Simple to form Ability to be one’s own boss Disadvantages Difficulty in raising large amounts of capital Unlimited liability 12-1 A proprietorship is a business enterprise owned by a single individual. Proprietorship 0

6. A partnership is an association of two or more individuals who own and manage a business for profit. Advantages More financial resources than a proprietorship Additional management skills Disadvantages Limited life Unlimited liability Co-ownership of partnership property Mutual agency 12-1 Partnership 0

7. An important right of partners is to participate in the income of the partnership. 12-1 A partnership, like a proprietorship, is a nontaxable entity . A partnership is created by a contract, known as the partnership agreement or articles of partnership . Partnership 0

8. 12-1 Limited Partnership A variant of the regular partnership is a limited partnership . This form of partnership allows partners who are not involved in the operations of the partnership to retain limited liability. 0

9. 9 Combines the advantages of the corporate and partnership forms. 12-1 Limited Liability Companies LLCs must file “articles of organization” with state governmental authorities. Owners are termed “members” rather than “partners.” Members must create an operating agreement . (Continued) 0

10. An LLC may elect to be treated as a partnership for tax purposes. 12-1 Limited Liability Companies Most operating agreements specify continuity of life for the LLC, even when a member withdraws. Members may elect operating the LLC as a “member-managed” entity. An LLC provides limited liability for the members. 0

11. 11 Ease of Formation Proprietorship Simple Partnership Moderate LLC Moderate Characteristics of Proprietorships, Partnerships, and Limited Liability companies 12-1 2 0

12. 12 12-1 Legal Liability Proprietorship No limitation Partnership No limitation LLC Limited liability Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2 0

13. 13 12-1 Taxation Proprietorship Nontaxable* Partnership Nontaxable* LLC Nontaxable** *Pass-through entity **Pass-through entity by election Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2 0

14. 14 12-1 Limitation on Life of Entity Proprietorship Yes Partnership Yes LLC No Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2 0

15. 15 12-1 Access to Capital Proprietorship Limited Partnership Limited LLC Average Characteristics of Proprietorships, Partnerships, and Limited Liability companies 2 0

16. Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership. Objective 2 12-2 0

17. Forming a Partnership 12-2 Joseph Stevens and Earl Foster agree to combine their hardware businesses in a partnership. Each is to contribute certain amounts of cash and other assets. They also agree that the partnership is to assume the liabilities of the separate businesses. 0

18. 18 Stevens’ Transfer of Assets, Liability, and Equity 12-2 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 0

19. A similar entry would record the assets contributed and the liabilities transferred by Foster. In each entry, the noncash assets are recorded at values agreed upon by the partners. These values normally represent current market values. 12-2 0

20. 20 12-2 Reese Howell contributed equipment, inventory, and $34,000 cash to a partnership. The equipment had a book value of $23,000 and market value of $29,000. The inventory had a book value of $60,000, but only had a market value of $15,000, due to obsolescence. The partnership also assumed a $12,000 note payable owed by Howell that was used originally to purchase the equipment. Provide the journal entry for Howell’s contribution to the partnership. 0 Example Exercise 12-1

21. 21 For Practice: PE 12-1A, PE 12-1B 12-2 Cash 34,000 Inventory 15,000 Equipment 29,000 Notes Payable 12,000 Reese Howell, Capital 66,000 0 Follow My Example 12-1

22. The partnership agreement of Jennifer Stone and Crystal Mills provides for Stone to receive a monthly allowance of $5,000 ($60,000 annually) and Mills is to receive $4,000 a month ($48,000 annually). If there is any remaining net income, it is to be divided equally. The firm had a net income of $150,000 for the year. Dividing Income—Services of Partners 12-2 0

23. 23 J. Stone C. Mills Total Annual salary allowance $60,000 $48,000 $108,000 Remaining income 21,000 21,000 42,000 12-2 Division of Net Income to journal entry (Slide 24) 0 Division of net income $81,000 $69,000 $150,000

24. 24 12-2 The entry for dividing net income is as follows: Dec. 31 Income Summary 150 000 00 Jennifer Stone, Capital 81 000 00 Crystal Mills, Capital 69 000 00 0

25. 12-2 Dividing Income—Services of Partners and Investments The partnership agreement for Stone and Mills divides income as follows: Monthly salary allowance of $5,000 for Stone and $4,000 for Mills. Interest of 12% on each partner’s capital balance on January 1. If there is any remaining net income, it is to be divided equally between the partners. 0

26. 26 Division of Net Income Salary allowance $60,000 $48,000 $108,000 Interest allowance 19,200 14,400 33,600 12-2 Net income of $150,000 is divided. J. Stone C. Mills Total 0

27. 27 Division of Net Income Salary allowance $60,000 $48,000 $108,000 Interest allowance 19,200 14,400 33,600 12-2 12% x Stone’s capital account balance on Jan. 1 of $160,000 J. Stone C. Mills Total Net income of $150,000 is divided. 0

28. 28 Division of Net Income J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 Interest allowance 19,200 14,400 33,600 12-2 12% x Mills’ capital account balance on Jan. 1 of $120,000 Net income of $150,000 is divided. 0

29. 29 Division of Net Income 12-2 Net income of $150,000 is divided. 0 J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 Interest allowance 19,200 14,400 33,600 Remaining income 4,200 4,200 8,400 Division of net income $83,400 $66,600 $150,000

30. 30 12-2 The entry for dividing net income is as follows: Dec. 31 Income Summary 150 000 00 Jennifer Stone, Capital 83 400 00 Crystal Mills, Capital 66 600 00 0

31. 31 12-2 The entry for dividing net income is as follows: LLC Alternative 0 Dec. 31 Income Summary 150 000 00 Jennifer Stone, Member Equity 83 400 00 Crystal Mills, Member Equity 66 600 00 Note the use of “Member Equity” instead of “Capital” for LLC.

32. Assume the same facts as before except that the net income is only $100,000. 12-2 Dividing Income—Allowances Exceed Net Income 0

33. 33 12-2 Division of Net Income J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 Interest allowance 19,200 14,400 33,600 Total $79,200 $62,400 $141,600 Net income of $100,000 is divided. This amount exceeds net income by $41,600. 0

34. 34 12-2 Division of Net Income J. Stone C. Mills Total Salary allowance $60,000 $48,000 $108,000 Interest allowance 19,200 14,400 33,600 Total $79,200 $62,400 $141,600 Deduct excess of allowance over income 20,800 20,800 <41,600> Net income of $100,000 is divided. 0 Net income $58,400 $41,600 $100,000

35. 35 12-2 Steve Prince and Chelsy Bennick formed a partnership, dividing income as follows: Annual salary allowance to Prince of $42,000. Interest of 9% on each partner’s capital balance on January 1. Any remaining net income divided equally. Prince and Bennick had $20,000 and $150,000 in their January 1 capital balances, respectively. Net income for the year was $240,000. How much net income should be distributed to Prince? 0 Example Exercise 12-2

36. 36 For Practice: PE 12-2A, PE 12-2B 12-2 0 Follow My Example 12-2 Monthly salary $ 42,000 Interest (9% x $20,000) 1,800 Remaining income 91,350 * Total distributed to Prince $135,150 *($240,000 – $42,000 – $1,800 – $13,500) x 50%

37. Describe and illustrate the accounting for partner admission and withdrawal. Objective 3 12-3 0

38. 1. Purchasing an interest from one or more of the current partners. 2. Contributing assets to the partnership. A person may be admitted to a partnership only with the consent of all the current partners by: 12-3 Admitting a Partner 0

39. 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. 12-3 Purchasing an Interest in a Partnership 0

40. 40 12-3 The only entry required in the partnership accounts is as follows: June 1 Tom Andrews, Capital 10 000 00 Nathan Bell, Capital 10 000 00 Joe Canter, Capital 20 000 00 0

41. 12-3 The effect of the transaction on the partnership accounts is presented in the following diagram: Partnership Accounts Andrew, Capital 10,000 Bell, Capital 10,000 50,000 50,000 Carter, Capital 20,000 41 0

42. 42 12-3 LLC Alternative June 1 Tom Andrew, Member Equity 10 000 00 Nathan Bell, Member Equity 10 000 00 Joe Canter, Member Equity 20 000 00 0

43. 12-3 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. 0

44. 44 12-3 June 1 Cash 20 000 00 Sharon Nelson, Capital 20 000 00 The entry to record this transaction is as follows: 0

45. 45 12-3 The effect of the transaction on the partnership accounts is presented in the following diagram: Partnership Accounts Nelson, Capital Net Assets 60,000 0 Lewis, Capital 35,000 Morton, Capital 25,000 20,000 20,000

46. 12-3 LLC Alternative June 1 Cash 20 000 00 Sharon Nelson, Member Equity 20 000 00 46 0

47. 12-3 Revaluation of Assets If the asset accounts do not reflect approximate current market values when a new partner is admitted, the accounts should be adjusted (increased or decreased) before the new partner is admitted. 0

48. 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. 12-3 0

49. 49 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. 12-3 The revaluation is recorded as follows: 0

50. 50 12-3 Blake Nelson invested $45,000 in the Lawrence & Kerry partnership for ownership equity of $45,000. Prior to the investment land was revalued to a market value of $260,000 from a book value of $200,000. Lynne Lawrence and Tim Kerry share net income in a 1:2 ratio. Provide the journal entry for the revaluation of land. Provide the journal entry to admit Nelson. 0 Example Exercise 12-3

51. 51 For Practice: PE 12-3A, PE 12-3B 12-3 Cash 45,000 Blake Nelson, Capital 45,000 0 Follow My Example 12-3 Land 60,000 Lynne Lawrence, Capital 20,000 ¹ Tim Kerry, Capital 40,000 ² ¹ $60,000 x l/3 ² $60,000 x 2/3

52. 12-3 52 0

53. On March 1, the partnership of Marsha Jenkins and Helen Kramer admit Alex Diaz as a new partner. The assets of the old partnership are adjusted to current market values and the resulting capital balances for Jenkins and Kramer are $20,000 and $24,000, respectively. 12-3 Partner Bonuses 0

54. 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. 12-3 0

55. 55 12-3 0 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

56. 56 Mar. 1 Cash 31 000 00 Alex Diaz, Capital 25 000 00 Marsha Jenkins, Capital 3 000 00 Helen Kramer, Capital 3 000 00 The entry to record the admission of Diaz to the partnership is as follows: 12-3 0 $6,000/ 2

57. After adjusting the market values, the capital balance of Janice Cowen is $80,000 and the capital balance of Steve Dodd is $40,000. Ellen Chou receives a one-fourth interest in the partnership for a contribution of $30,000. Before admitting Chou, Cowen and Dodd shared net income using a 2:1 ratio. 12-3 Adjusting for New Partner’s Unique Qualities or Skills 0

58. 58 Equity of Cowen $ 80,000 Equity of Dodd 40,000 Chou’s Contribution 30,000 Total equity after admitting Chou $150,000 Chou’s equity interest after admission x 25% Chou’s equity after admission $ 37,500 Chou’s contribution 30,000 Bonus paid to Chou $ 7,500 The bonus is computed as follows: 12-3 0

59. 59 June 1 Cash 30 000 00 Janice Cowen, Capital 5 000 00 Steve Dodd, Capital 2 500 00 Ellen Chou, Capital 37 500 00 12-3 The entry to record the bonus and admission of Chou to the partnership is as follows: 0

60. 60 12-3 The entry to record the bonus and admission of Chou to the partnership is as follows: 0 June 1 Cash 30 000 00 Janice Cowen, Capital 5 000 00 Steve Dodd, Capital 2 500 00 Ellen Chou, Capital 37 500 00 2/3 x $7,500

61. 61 12-3 The entry to record the bonus and admission of Chou to the partnership is as follows: 0 June 1 Cash 30 000 00 Janice Cowen, Capital 5 000 00 Steve Dodd, Capital 2 500 00 Ellen Chou, Capital 37 500 00 1/3 x $7,500

62. 12-3 Withdrawal of a Partner On June 1, the partnership of X, Y, and Z have capital balances of $50,000, $80,000, and $30,000, respectively. Z decides to retire from the partnership and sells his interest to Y for $35,000. 0

63. 0 12-3 The following entry is required to record Z selling his interest to Y. June 1 Z, Capital 30 000 00 Y, Capital 30 000 00 Transfer ownership from Z to Y. 63 The amount paid to Y by Z has no impact on the partnership’s accounting records.

64. 12-3 If Z had sold his interest directly to the partnership, both the assets and the owner’s equity of the partnership would have been reduced. 0

65. 65 12-3 Lowman has a capital balance of $45,000 after adjusting assets to fair market value. Conrad contributes $26,000 to receive a 30% interest in a new partnership with Lowman. Determine the amount and recipient of the partner bonus. 0 Example Exercise 12-4

66. 66 For Practice: PE 12-4A, PE 12-4B 12-3 0 Follow My Example 12-4 Equity of Lowman $45,000 Conrad contribution 26,000 Total equity after admitting Conrad $71,000 Conrad’s equity interest x 30% Conrad’s equity after admission $21,300 Conrad’s contribution $26,000 Conrad’s equity after admission 21,300 Bonus paid to Lowman $ 4,700

67. Describe and illustrate the accounting for liquidating a partnership. Objective 4 12-4 0

68. When a partnership goes out of business, the winding-up process is called the liquidation of a partnership. 12-4 Liquidating Partnerships 0

69. 12-4 Liquidation Process Sell the partnership assets. This step is called realization . Distribute any gains or losses from realization to the partners based upon their income-sharing ratio. Pay the claims of creditors using the cash from step 1 realization. After satisfying the creditors, distribute the remaining cash to the partners based on the balances in their capital accounts. 0

70. 70 12-4 0

71. 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 12-4 Liquidation Process Farley, Greene, and Hall share income and losses in a ratio of 5:3:2. On April 9, after discontinuing operations, the firm had the following trial balance. 0

72. Between April 10 and April 30, 2006, Farley, Greene, and Hall sell all noncash assets for $72,000. Thus, a gain of $8,000 ($72,000 – $64,000) is realized. 12-4 Liquidation Process 0

73. 73 12-4 Gain on Realization 0 $8,000 gain

74. 74 Cash 72 000 00 Noncash Assets 64 000 00 Gain on Realization 8 000 00 12-4 Step 1: Sale of assets Entries to Record the Steps in the Liquidation Process 0

75. 75 Gain on Realization 8 000 00 Jean Farley, Capital 4 000 00 Brad Greene, Capital 2 400 00 Alice Hall, Capital 1 600 00 12-4 Step 2: Division of gain Entries to Record the Steps in the Liquidation Process 0

76. 76 Liabilities 9 000 00 Cash 9 000 00 12-4 Step 3: Payment of liabilities Entries to Record the Steps in the Liquidation Process 0

77. 77 Jean Farley, Capital 26 000 00 Brad Greene, Capital 24 400 00 Alice Hall, Capital 23 600 00 Cash 74 000 00 12-4 Step 4: Distribution of cash to partners Entries to Record the Steps in the Liquidation Process 0

78. Farley, Greene, and Hall sell all noncash assets for $44,000. A loss of $20,000 ($64,000 – $44,000) is realized. 12-4 Loss on Realization 0

79. 79 Cash 44 000 00 Loss on Realization 20 000 00 Noncash Assets 64 000 00 12-4 Step 1: Sale of assets Entries to Record the Steps in the Liquidation Process 0

80. 12-4 Loss on Realization 80 0 $20,000 loss

81. 81 Jean Farley, Capital 10 000 00 Brad Greene, Capital 6 000 00 Alice Hall, Capital 4 000 00 Loss on Realization 20 000 00 12-4 Step 2: Division of loss Entries to Record the Steps in the Liquidation Process 0

82. 82 Liabilities 9 000 00 Cash 9 000 00 12-4 Step 3: Payment of liabilities Entries to Record the Steps in the Liquidation Process 0

83. 83 Jean Farley, Capital 12 000 00 Brad Greene, Capital 16 000 00 Alice Hall, Capital 18 000 00 Cash 46 000 00 12-4 Step 4: Distribution of cash to partners: Entries to Record the Steps in the Liquidation Process 0

84. 84 12-4 Prior to liquidating their partnership, Todd and Gentry had capital accounts of $50,000 and $100,000, respectively. The partnership assets were sold for $220,000. The partnership had $20,000 of liabilities. Todd and Gentry share income and losses equally. Determine the amount received by Gentry as a final distribution from liquidation of the partnership. 0 Example Exercise 12-5

85. 85 For Practice: PE 12-5A, PE 12-5B 12-4 0 Follow My Example 12-5 Gentry’s equity prior to liquidation $100,000 Realization of asset sale $220,000 Book value of assets ($50,000 + $100,000 + $20,000) 170,000 Gain on liquidation $50,000 Gentry’s share of gain (50% x $50,000) 25,000 Gentry’s cash distribution $125,000

86. 12-4 Loss on Realization—Capital Deficiency Farley, Green, and Hall sell all of the noncash assets for $10,000. A loss of $54,000 ($64,000 – $10,000) is realized. The share of the loss allocated to Farley, $27,000 (50% of $54,000), exceeds the $22,000 balance in her capital account. Farley contributes $5,000 to the partnership. 0

87. 87 12-4 Loss on Realization—Capital Deficiency 0 Farley’s contribution

88. 88 12-4 Cash 10 000 00 Loss on Realization 54 000 00 Noncash Assets 64 000 00 Step 1: Sale of assets 0

89. 89 Joan Farley, Capital 27 000 00 Brad Greene, Capital 16 200 00 Alice Hall, Capital 10 800 00 Loss on Realization 54 000 00 Step: Payment of liabilities 12-4 0

90. 90 Step 3: Payment of liabilities 12-4 0 Liabilities 9 000 00 Cash 9 000 00

91. 91 12-4 Receipt of deficiency Cash 5 000 00 Jean Farley, Capital 5 000 00 Having the partner with a deficiency pay all or part of the deficiency is not one of the four liquidation steps, but it should make the other partners happy. 0

92. 92 12-4 Loss on Realization—Capital Deficiency 0 The remaining cash is distributed. Greene receives $5,800 and Hall receives $11,200.

93. 93 Brad Greene, Capital 5 800 00 Alice Hall, Capital 11 200 00 Cash 17 000 00 12-4 Distribution of cash to partners: 0

94. 94 12-4 Prior to liquidating their partnership, Short and Bain had capital accounts of $20,000 and $80,000, respectively. The partnership assets were sold for $40,000. The partnership had no liabilities. Short and Bain share income and losses equally. Determine the amount of Short’s deficiency Determine the amount distributed to Bain assuming Short is unable to satisfy the deficiency. 0 Example Exercise 12-6

95. 95 For Practice: PE 12-6A, PE 12-6B 12-4 Short’s equity prior to liquidation $ 20,000 Realization of asset sales $ 40,000 Book value of assets 100,000 Loss on liquidation $ 60,000 Short’s share of loss (50% x $60,000) 30,000 Short’s deficiency $(10,000) b. $40,000 $80,000 – $30,000 share of loss – $10,000. Short’s deficiency also equals the amount realized from asset sales. 0 Follow My Example 12-6

96. Prepare the statement of partnership equity. Objective 5 12-5 0

97. 12-5 Statement of Partnership Equity The change in the owners’ capital accounts for a period of time is reported in a statement of partnership equity . 0

98. 98 12-5 Statement of Partnership Equity 0

99. 99 Financial Analysis and Interpretation Washburn & Lovett, CPA’s had the following information for the last two years: 2008 2007 Revenues $220,000,000 $180,000,000 Number of employees 1,600 1,500 12-5 0 Revenue per employee, 2008 = $220,000,000 1,600 = $137,500 Revenue per employee, 2007 = $180,000,000 1,500 = $120,000

100. Financial Analysis and Interpretation 12-5 The revenues per employee showed improvement in 2008. Thus, each employee is producing more revenues in 2008, than in 2007, which may indicate improved productivity. Overall, it appears the firm is properly managing the growth in staff. 0