1. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Accounting for Partnerships and Limited Liability Companies Chapter 12

2. Learning Objectives 1. Describe the characteristics of proprietorships, partnerships, and limited liability companies. 2. Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership. 3. Describe and illustrate the accounting for partner admission and withdrawal. 4. Describe and illustrate the accounting for liquidating a partnership. 5. Prepare the statement of partnership equity. 6. Analyze and interpret employee efficiency.

3. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Describe the characteristics of proprietorships, partnerships, and limited liability companies 1

4. Four Most Common Legal Forms of Business o Proprietorship o Corporation o Partnership o Limited Liability Company

5. Proprietorship o A proprietorship is a company owned by a single individual.  Lawyers  Architects  Realtors  Physicians

6. Proprietorships o Characteristics of proprietorships include the following:  Simple to form  No limitation on legal liability  Not taxable  Limited life  Limited ability to raise capital (funds)

7. Partnerships o A partnership is an association of two or more persons who own and manage a business for profit. Characteristics of a partnership include the following:  Moderately complex to form A partnership requires a partnership agreement, sometimes called the articles of partnership, which includes matters such as amounts to be invested, limits on withdrawals, distributions of income and losses, and admission and withdrawal of partners. A partnership requires a partnership agreement, sometimes called the articles of partnership, which includes matters such as amounts to be invested, limits on withdrawals, distributions of income and losses, and admission and withdrawal of partners.

8. Partnerships  No limitation on legal liability  Not taxable  Limited life  Limited ability to raise capital (funds)

9. Partnerships o In addition to the characteristics listed on the previous slides, some unique aspects of partnerships are:  Co-ownership of partnership property  Mutual agency  Participation in income

10. Limited Liability Companies o A limited liability company (LLC) is a form of legal entity that provides limited liability to its owners, but is treated as a partnership for tax purposes. Characteristics include:  Moderately complex to form  Limited legal liability  Not taxable  Unlimited life  Moderate ability to raise capital (funds)

11. C OMPARING P ROPRIETORSHIPS, P ARTNERSHIPS, AND L IMITED L IABILITY C OMPANIES

14. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Describe and illustrate the accounting for forming a partnership and for dividing the net income and net loss of a partnership 2

15. Forming a Partnership o Joseph Stevens and Earl Foster, owners of competing hardware stores, agree to combine their businesses in a partnership. Stevens agrees to contribute the following:

16. Forming a Partnership o The entry to record the assets and liabilities contributed by Stevens is as follows: o The noncash assets are normally recorded at current market value.

17. Forming a Partnership o If a limited liability company is formed, the following entry is made:

18. Dividing Income—Services of Partners o The partnership agreement of Jennifer Stone and Crystal Mills provides for Stone to receive a monthly salary allowance of $5,000 ($60,000 annually) and Mills to receive $4,000 a month ($48,000 annually). If there is any remaining net income, it is to be divided equally. Income and losses of the partnership would have been divided equally if no partnership agreement existed or if the partnership agreement did not specify how the division was to occur.

19. J. Stone C. Mills Total Annual salary allowance$60,000$48,000$108,000 12 x Stone’s monthly salary allowance 12 x Mill’s monthly salary allowance Dividing Income—Services of Partners o The firm had net income of $150,000 for the year. Stone shared the net income as calculated below.

20. J. Stone C. Mills Total Annual salary allowance$60,000$48,000$108,000 Remaining income21,00021,00042,000 $81,000$69,000$150,000 Division of net income$81,000$69,000$150,000 Dividing Income—Services of Partners o The firm had net income of $150,000 for the year. Stone shared the net income as calculated below.

21. J. Stone C. Mills Total Annual salary allowance$60,000$48,000$108,000 Remaining income21,00021,00042,000 $81,000$69,000$150,000 Division of net income$81,000$69,000$150,000 Dividing Income—Services of Partners o The firm had net income of $150,000 for the year. Stone shared the net income as calculated below.

22. Dividing Income—Services of Partners and Investments o The partnership agreement for Stone and Mills divides income as follows:  Partner salary allowances: $5,000 monthly for Stone and $4,000 monthly for Mills  Interest of 12% on each partner’s capital balance as of January 1  Any remaining income divided equally

23. J. Stone C. Mills Total $5,000 x 12$4,000 x 12 Salary allowance$60,000$48,000$108,000 Dividing Income—Services of Partners and Investments o Each partner’s annual salary allowance is calculated.

24. J. Stone C. Mills Total Salary allowance$60,000$48,000$108,000 Interest allowance19,200 12% x Stone’s capital account balance of $160,000 on Jan. 1. 12% x Mill’s capital account balance of $120,000 on Jan. 1. 14,40033,600 Dividing Income—Services of Partners and Investments o Interest on each partner’s January 1 capital balance is determined.

25. Remaining income 4,200 4,200 8,400 $83,400$66,600$150,000 Net income$83,400$66,600$150,000 J. Stone C. Mills Total Salary allowance$60,000$48,000$108,000 Interest allowance19,200 14,40033,600 Dividing Income—Services of Partners and Investments o At this point, $141,600 of the $150,000 has been assigned. The remaining $8,400 is divided equally.

26. Remaining income 4,200 4,200 8,400 $83,400$66,600$150,000 Net income$83,400$66,600$150,000 J. Stone C. Mills Total Salary allowance$60,000$48,000$108,000 Interest allowance19,200 14,40033,600 Dividing Income—Services of Partners and Investments o At this point, $141,600 of the $150,000 has been assigned. The remaining $8,400 is divided equally.

27. Dividing Income—Allowances Exceed Net Income o Assume the same salary and interest allowances as in the preceding example, but that the net income is only $100,000. In this case, the total of the allowances exceeds the net income by $41,600 ($100,000 - $141,600).

28. J. Stone C. Mills Total This amount exceeds net income by $41,600. Salary allowance$60,000$48,000$108,000 Interest allowance 19,200 14,400 33,600 Total$79,200$62,400$141,600 Dividing Income—Allowances Exceed Net Income o The division of net income is determined as follows:

29. 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 allowances over income20,800 20,800 41,600 Net income$58,400$41,600$100,000 Dividing Income—Allowances Exceed Net Income o The division of net income is determined as follows:

30. Dividing Income—Allowances Exceed Net Income

31. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Describe and illustrate the accounting for partner admission and withdrawal 3

32. Admitting a Partner o A person may be admitted to a partnership by either of the following:  Purchasing an interest from one or more of the existing partners  Contributing assets to the partnership

33. A DMITTING A P ARTNER

34. Purchasing an Interest from Existing Partners o On June 1, Tom Andrews and Nathan Bell each sell one-fifth of their partnership equity of Bring It Consulting to Joe Canter for $10,000 in cash. On June 1, the partnership has net assets of $100,000, and both existing partners have capital balances of $50,000 each.

35. Purchasing an Interest from Existing Partners o The only entry required in the partnership accounts is as follows: o For a limited liability company, the following entry is required:

36. Purchasing an Interest from Existing Partners o The effect of the transaction on the partnership accounts is shown in the following diagram.

37. Contributing Assets to a Partnership o Partners Tom Andrews and Nathan Bell each have capital balances of $50,000. On June 1, Joe Canter contributes $20,000 cash to Bring It Consulting for ownership equity of $20,000.

38. Contributing Assets to a Partnership o The entry to record this transaction is as follows: o For a limited liability company, the following entry is required:

39. Contributing Assets to a Partnership o The effect of the transaction on the partnership accounts is shown in the following diagram.

40. Revaluation of Assets o If the partnership’s 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.

41. Revaluation of Assets o Partners Andrews and Bell each have capital balances of $50,000. The balance in Merchandise Inventory is $14,000, and the current replacement value is $17,000. The partners share net income equally.

42. Revaluation of Assets o The entry to record this transaction is as follows: o For a limited liability company, the following entry is required:

43. P ARTNER B ONUSES

44. Partner Bonuses o On March 1, the partnership of Marsha Jenkins and Helen Kramer admits 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. Jenkins and Kramer share profits and losses equally.

45. Partner Bonuses o Jenkins and Kramer agree to admit Diaz to the partnership 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. Diaz is paying Jenkins and Kramer a $6,000 bonus to join the partnership. The computation is on the next slide.

46. Partner Bonuses

47. o The entry to record this transaction is as follows: o For a limited liability company, the following entry is required:

48. Partner Bonuses o After adjusting assets to market values, the capital balance of partner Janice Cowen is $80,000, and the capital balance of partner Steve Dodd is $40,000. Ellen Chou will receive 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. In this case, Cowen and Dodd are paying Chou a $7,500 bonus to join the partnership. The computation is on the next slide.

49. Partner Bonuses

50. o The entry to record this transaction is as follows: o For a limited liability company, the following entry is required:

51. Withdrawal of a Partner o A partner may retire or withdraw from a partnership. In such cases, the withdrawing partner’s interest is normally sold to the:  Existing partners or  Partnership

52. Withdrawal of a Partner o If the existing partners purchase the withdrawing partner’s interest, the purchase and sale of the partnership interest is between the partners as individuals. The only entry is:  To debit the capital account of the partner withdrawing, and  To credit the capital account of the partner or partners buying the additional interest.

53. Withdrawal of a Partner o If the partnership purchases the withdrawing partner’s interest, the assets and the owners’ equity of the partnership are reduced by the purchase price.

54. Death of a Partner o When a partner dies, the partnership accounts should be closed as of the date of death. The net income for the current period should then be determined and divided among the partners’ capital accounts.

55. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Describe and illustrate the accounting for liquidating a partnership 4

56. Liquidating Partnerships o When a partnership goes out of business, the winding-up process is called the liquidation of the partnership.  Although liquidation refers to the payment of liabilities, it includes the entire winding-up process.  When the partnership goes out of business and the normal operations are discontinued, the accounts should be adjusted and closed.

57. Liquidating Partnerships The selling of partnership assets is called realization.

58. Liquidating Partnerships o In liquidation, cash is distributed to each partner based on his or her final capital balance.

59. Liquidating Partnerships o Farley, Green, and Hall decide to liquidate their partnership. On April 9, after discontinuing business operations and closing the accounts, the following trial balance is prepared:

60. Gain on Realization o Farley, Green, and Hall share income and losses in a ratio of 5:3:2 (50%, 30%, 20%). o All noncash assets are sold in a single transaction for $72,000, resulting in a gain of $8,000. Partner capital accounts are credited $4,000, $2,400, and $1,600 to Farley, Green, and Hall, respectively. o Creditors are paid $9,000, and the remaining cash of $74,000 is distributed to the partners. o A statement of partnership liquidation, which summarizes the liquidation process, is shown in Exhibit 5 on the next slide.

61. G AIN ON R EALIZATION

62. Sale of Assets (Step 1) Gain on Realization

63. Division of Gain (Step 2) Gain on Realization

64. Payment of Liabilities (Step 3) Gain on Realization

65. Distribution of Cash to Partners (Step 4) Gain on Realization

66. Loss on Realization o Farley, Green, and Hall sell all noncash assets for $44,000. A loss of $20,000 ($64,000 – $44,000) is realized. The loss is distributed to Farley, Green, and Hall in the income-sharing ratio of 5:3:2.

67. Loss on Realization

68. Sale of Assets (Step 1) Loss on Realization

69. Division of Loss (Step 2) Liquidating Partnerships

70. Payment of Liabilities (Step 3) Liquidating Partnerships

71. Distribution of Cash to Partners (Step 4) Liquidating Partnerships

72. E XAMPLE E XERCISE

73. Loss on Realization—Capital Deficiency o The share of a loss on realization may be greater than the balance in a partner’s capital account. The resulting debit balance in the capital account is called a deficiency.

74. Loss on Realization—Capital Deficiency o 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.

75. L OSS ON R EALIZATION — C APITAL D EFICIENCY

76. Sale of Assets (Step 1) Loss on Realization—Capital Deficiency

77. Division of Loss (Step 2) Loss on Realization—Capital Deficiency

78. Payment of Liabilities (Step 3)

79. Loss on Realization—Capital Deficiency Receipt of Deficiency (Step 4)

80. Loss on Realization—Capital Deficiency Distribution of Cash to Partners (Step 4)

81. Partner Does Not Pay Deficiency o If Farley does not pay her deficiency, the deficiency would be allocated to Green and Hall based on their income-sharing ratio of 3:2. The remaining cash would be distributed to Green and Hall as shown below:

82. Partner Does Not Pay Deficiency o Allocation of deficiency:

83. Partner Does Not Pay Deficiency o Distribution of cash to partners:

84. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Prepare the statement of partnership equity 5

85. Statement of Partnership Equity o The changes in the partners’ capital accounts for a period of time are reported in a statement of partnership equity. o The statement of members’ equity for an LLC is similar to that of a partnership. It reports the changes in member equity for a period.

86. S TATEMENT OF P ARTNERSHIP E QUITY

87. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Analyze and interpret employee efficiency 6

88. Revenue per Employee o Revenue per employee is a measure of the efficiency of the business in generating revenues. Revenue per Employee = Revenue Number of Employees

89. 20152014 Revenues$220,000,000$180,000,000 Number of employees1,6001,500 Revenue per employee, 2015 = $220,000,000 1,600 = $137,500 Revenue per employee, 2014 = $180,000,000 1,500 = $120,000 Revenue per Employee

90. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Accounting for Partnerships and Limited Liability Companies The End