Chapter 13
Partnerships and Limited Liability Corporations
Accounting, 21st Edition
Warren Reeve Fess
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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
5. Describe and illustrate the accounting for the dissolution of a partnership.
6. Describe and illustrate the accounting 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.
Alternative Forms of Business Entities
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.
Alternative Forms of Business Entities
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.
Alternative Forms of Business Entities
A partnership is an association of two or more individuals.
Advantages
More financial resources than a proprietorship
Additional management skills
Joe and Marty’s
Alternative Forms of Business Entities
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.
Alternative Forms of Business Entities
An important right of partners is to participate in the income of the partnership.
Alternative Forms of Business Entities
Each partner must report their share of partnership income on their personal tax returns.
Alternative Forms of Business Entities
A partnership is created by a contract, known as the partnership agreement or articles of partnership.
Alternative Forms of Business Entities
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
Comparison of Alternate Entity Characteristics
Legal Liability
Proprietorship No limitation
Corporation Limited liability
Partnership No limitation
LLC Limited liability
Comparison of Alternate Entity Characteristics
Taxation
Proprietorship Nontaxable entity
Corporation Taxable entity
Partnership Nontaxable entity
LLC Nontaxable entity by election
Comparison of Alternate Entity Characteristics
Limitation on Life of Entity
Proprietorship Yes
Corporation No
Partnership Yes
LLC Yes
Comparison of Alternate Entity Characteristics
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.
Equity Reporting for Alternative Entity Forms
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
Equity Reporting for Alternative Entity Forms
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.
Equity Reporting for Alternative Entity Forms
Corporations
Equity Reporting for Alternative Entity Forms
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
Forming a Partnership
A similar entry would be made for the assets, liabilities, and equity of Earl Foster.
Forming a Partnership
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
Services of Partners
Dec. 31 Income Summary 75 000 00
Jennifer Stone, Capital 40 500 00
Crystal Mills, Capital 34 500 00
Dividing Income
LLC Alternative
Dec. 31 Income Summary 75 000 00
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
J. Stone C. Mills Total
Salary allowance $30,000 $24,000 $54,000
Interest allowance 9,600 7,200 16,800
Division of net income $41,700 $33,300 $75,000
$80,000 x 12%
$60,000 x 12%
Remaining income 2,100 2,100 4,200
Dividing Income
Services of Partners
Dec. 31 Income Summary 75 000 00
Jennifer Stone, Capital 41 700 00
Crystal Mills, Capital 33 300 00
Dividing Income
LLC Alternative
Dec. 31 Income Summary 75 000 00
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.
J. Stone C. Mills Total
Salary allowance $30,000 $24,000 $54,000
Interest allowance 9,600 7,200 16,800
Total $39,600 $31,200 $70,800
Division of net income $29,200 $20,800 $50,000
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:
Partnership Dissolution
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.
Partnership Dissolution
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.
Partnership Dissolution
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.
Partnership Dissolution
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.
Partnership Dissolution
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.
Partnership Dissolution
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
Partnership Dissolution
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.
Partnership Dissolution
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.
Partnership Dissolution
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
Partnership Dissolution
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
Partnership Dissolution
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.
Partnership Dissolution
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
Partnership Dissolution
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 $7,500
2/3 x $7,500
Liquidating Partnerships
When a partnership goes out of business, the winding-up process is called the liquidation of a partnership.
Liquidating Partnerships
The sale of the assets is called realization.
Liquidating Partnerships
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
Liquidating Partnerships
Between April 10 and April 30, 2006, Farley, Greene, and Hall sell all noncash assets for $72,000.
Gain on Realization
Liquidating Partnerships
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 —
Liquidating Partnerships
Balance before realization $22,000 $22,000 $22,000
Right side of statement
Farley Greene Hall
Capital Capital Capital
Sale of assets and division
of gain +4,000 +2,400 +1,600
$8,000 gain x .50
$8,000 gain x .30
$8,000 gain x .20
Liquidating Partnerships
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 —
Balance after realization $83,000 $0 $9,000
Liquidating Partnerships
Balance before realization $22,000 $22,000 $22,000
Right side of statement
Farley Greene Hall
Capital Capital Capital
Sale of assets and division
of gain +4,000 +2,400 +1,600
Balance after realization $26,000 $24,400 $23,600
Liquidating Partnerships
The partnership’s liabilities are paid, $9,000.
Gain on Realization
Liquidating Partnerships
Left side of statement
Noncash
Cash Assets Liabilities
Balance before realization $11,000 $64,000 $9,000
Sale of assets and division
of gain +72,000 –64,000 —
Balance after realization $83,000 $ 0 $9,000
Payment of liabilities –9,000 — –9,000
Liquidating Partnerships
Left side of statement
Noncash
Cash Assets Liabilities
Balance before realization $11,000 $64,000 $9,000
Sale of assets and division
of gain +72,000 –64,000 —
Balance after realization $83,000 $ 0 $9,000
Payment of liabilities –9,000 — –9,000
Balance after payment $74,000 $ 0 $ 0
Liquidating Partnerships
The remaining cash, $74,000, is paid to each partner in accordance with the partner’s capital balance.
Gain on Realization
Liquidating Partnerships
Left side of statement
Noncash
Cash Assets Liabilities
Balance before realization $11,000 $64,000 $9,000
Sale of assets and division
of gain +72,000 –64,000 —
Balance after realization $83,000 $ 0 $9,000
Payment of liabilities –9,000 — –9,000
Balance after payment $74,000 $ 0 $ 0
Partners’ cash distributed –74,000 — —
Final balances $ 0 $ 0 $ 0
Liquidating Partnerships
Right side of statement
Balance before realization $22,000 $22,000 $22,000
Farley Greene Hall
Capital Capital Capital
Sale of assets and division
of gain +4,000 +2,400 +1,600
Balance after realization $26,000 $24,400 $23,600
Payment of liabilities — — —
Balance after payment $26,000 $24,400 $23,600
Partners’ cash distributed –26,000 –24,400 –23,600
Final balances $ 0 $ 0 $ 0
Liquidating Partnerships
Sale of Assets
Apr. 30 Cash 72 000 00
Noncash Assets 64 000 00
Gain on Realization 8 000 00
Liquidating Partnerships
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
Liquidating Partnerships
Payment of Liabilities
Apr. 30 Liabilities 9 000 00
Cash 9 000 00
Liquidating Partnerships
Distribution of Cash to Partners
Apr. 30 Jean Farley, Capital 26 000 00
Brad Greene, Capital 24 400 00
Alice Hall, Capital 23 600 00
Cash 74 000 00
Liquidating Partnerships
Between April 10 and April 30, 2006, Farley, Greene, and Hall sell all noncash assets for $44,000.
Loss on Realization
Liquidating Partnerships
Balance before realization $11,000 $64,000 $9,000
Left side of statement
Noncash
Cash Assets Liabilities
Sale of assets and division
of loss +44,000 –64,000 —
Liquidating Partnerships
Balance before realization $22,000 $22,000 $22,000
Right side of statement
Farley Greene Hall
Capital Capital Capital
Sale of assets and division
of loss –10,000 –6,000 –4,000
$20,000 loss x .50
$20,000 loss x .30
$20,000 loss x .20
Liquidating Partnerships
Balance before realization $11,000 $64,000 $9,000
Left side of statement
Noncash
Cash Assets Liabilities
Sale of assets and division
of loss +44,000 –64,000 —
Balance after realization $55,000 $0 $9,000
Liquidating Partnerships
Balance before realization $22,000 $22,000 $22,000
Right side of statement
Farley Greene Hall
Capital Capital Capital
Sale of assets and division
of loss –10,000 –6,000 –4,000
Balance after realization $12,000 $16,000 $18,000
Liquidating Partnerships
The liabilities of the partnership are paid, $9,000.
Loss on Realization
Liquidating Partnerships
Left side of statement
Noncash
Cash Assets Liabilities
Balance before realization $11,000 $64,000 $9,000
Sale of assets and division
of loss +44,000 –64,000 —
Balance after realization $55,000 $ 0 $9,000
Payment of liabilities –9,000 — –9,000
Liquidating Partnerships
Left side of statement
Noncash
Cash Assets Liabilities
Balance before realization $11,000 $64,000 $9,000
Sale of assets and division
of loss +44,000 –64,000 —
Balance after realization $55,000 $ 0 $9,000
Payment of liabilities –9,000 — –9,000
Balance after payment $46,000 $ 0 $ 0
Liquidating Partnerships
The remaining cash, $46,000, is paid to each partner in accordance with the partner’s capital balance.
Loss on Realization
Liquidating Partnerships
Left side of statement
Noncash
Cash Assets Liabilities
Balance before realization $11,000 $64,000 $9,000
Sale of assets and division
of loss +44,000 –64,000 —
Balance after realization $55,000 $ 0 $9,000
Payment of liabilities –9,000 — –9,000
Balance after payment $46,000 $ 0 $ 0
Partners’ cash distributed –46,000 — —
Final balances $ 0 $ 0 $ 0
Liquidating Partnerships
Right side of statement
Balance before realization $22,000 $22,000 $22,000
Farley Greene Hall
Capital Capital Capital
Sale of assets and division
of loss –10,000 –6,000 –4,000
Balance after realization $12,000 $16,000 $18,000
Payment of liabilities — — —
Balance after payment $12,000 $16,000 $18,000
Partners’ cash distributed –12,000 –16,000 –18,000
Final balances $ 0 $ 0 $ 0
Liquidating Partnerships
Sale of Assets
Apr. 30 Cash 44 000 00
Loss on Realization 20 000 00
Noncash Assets 64 000 00
Liquidating Partnerships
Division of Loss
Brad Greene, Capital 6 000 00
Alice Hall, Capital 4 000 00
Loss on Realization 20 000 00
Apr. 30 Jean Farley, Capital 10 000 00
Liquidating Partnerships
Payment of Liabilities
Apr. 30 Liabilities 9 000 00
Cash 9 000 00
Liquidating Partnerships
Distribution to Partners
Apr. 30 Jean Farley, Capital 12 000 00
Brad Greene, Capital 16 000 00
Alice Hall, Capital 18 000 00
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
Lifecycle of a Business
Business Stage
Principal Advantage
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
Lifecycle of a Business
Business Stage
Principal Advantage
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.
The End
Chapter 13
