Chapter 12

One method of dividing partnership income would include:

1. Partner salary allowances 2. Interest on capital investments 3. Any remaining income equally

Steps in liquidating a partnership

1. Sale of assets 2. Division of gain or loss 3. Payment of liabilities 4. Distribution to partners

Revaluation of Assets

Before a new partner is admitted, the balances of a partnership's asset accounts should be stated at current values. If necessary, the accounts should be adjusted. Any net adjustment (increase or decrease) in asset values is divided among the capital accounts of the existing partners, similar to the division of income. Failure to adjust the partnership accounts for current values before admitting a new partner may result in the new partner sharing in asset gains or losses that occurred prior to their admission to the partnership. An alternative approach uses a temporary account called Asset Revaluation when a revaluation occurs during the period.

Unique aspects of partnerships

Co-ownership of partnership property Mutual agency Participation in income

Proprietorships

Company owned by single individual Most common are professional service providers such as lawyers, architects, realtors, and physicians

Mutual agency

Each partner is an agent of the partnership and may act on behalf of the entire partnership. Thus, any liabilities created by one partner become liabilities of all the partners.

Limited liability companies

Form of legal entity that provides limited liability to its owners Treated as a partnership for tax purposes LLC organizational form is popular for small businesses

Allowances exceed net income

In some cases, the net income may be less than the total of the allowances. In this case, the remaining net income to divide is a negative amount. This negative amount is divided among the partners as though it were a net loss.

Partnership agreement

Includes parts such as amounts to be invested, limits on withdrawals, and distributions of income and losses, and admission and withdrawals of partners.

Dividing Income

Income or loss of the partnership are divided as specified in the partnership agreement. If there is no specification or agreement, income and losses are divided equally.

Admitting a Partner: Contributing Assets to a Partnership

When a new partner is admitted by contributing assets to the partnership, the total assets and the total owners' equity of the partnership are increased. This is because the transaction is between the new partner and the partnership.

Admitting a partner

When a new partner is admitted by purchasing an interest from one or more of the existing partners, the total assets and the total owners' equity of the partnership are not affected. The capital (equity) of the new partner is recorded by transferring capital (equity) from the existing partners. When a new partner is admitted by contributing assets to the partnership, the total assets and the total owners' equity of the partnership are increased. The capital (equity) of the new partner is recorded as the amount of assets contributed to the partnership by the new partner.

Admitting a Partner: Purchasing an Interest from Existing Partners

When a new partner is admitted by purchasing an interest from one or more of the existing partners, the transaction is between the new and existing partners acting as individuals. The admission of the new partner is recorded by transferring owners' equity amounts from the capital accounts of the selling partners to the capital account of the new partner.

Death of a partner

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. The asset accounts should also be adjusted to current values and the amount of any adjustment divided among the capital accounts of the partners. After the income is divided and any assets revalued, an entry is recorded to close the deceased partner's capital account. The entry debits the deceased partner's capital account for its balance and credits a liability account, which is payable to the deceased's estate.

Liquidating partnerships

When a partnership goes out of business, it sells the assets, pays the creditors, and distributes the remaining cash or other assets to the partners. This winding-up process is called the liquidation of the partnership. When the partnership goes out of business and the normal operations are discontinued, the accounts should be adjusted and closed.

The assets contributed by a partner are debited to the partnership _____ acounts.

asset

The only accounts remaining open after a partnership goes out of business are the:

asset, contra asset, liability, and owners' equity accounts

If any liabilities are assumed by the partnership, the partnership liability accounts are (debited or credited).

credited

Capital also means

funds

LLC operating agreement includes

matters such as amounts to be invested, limits on withdrawals, distributions of income and losses, and admission and withdrawal of members.

Revenue per employee

measure of the efficiency of the business in generating revenues

The ______ assets are recorded at values agreed upon by the partners. These values are normally based on current _____ values. As a result, the ______ value of the assets contributed by the partners is normally ______ from that recorded by the new partnership.

noncash; market; book; different

The account for an LLC is the same as a _____, except that the terms member and members' _____ are used rather than parter or owners' ____.

partnership; equity; capital

As with other business forms, a partnership makes ____ closing entries at the end of the accounting period.

two The first closing entry closes all revenues and expenses to the partners' equity accounts. Each partner's equity account is credited for the partner's share of net income (or debited for the partner's share of net loss). The second closing entry closes each partner's drawing account to the partner's equity account

Although liquidating refers to the payment of liabilities, the includes the entire _________ process.

winding-up

Revenue per employee formula

Revenue per employee = Revenue ÷ Number of employees

(T/F) In forming a partnership, the investments of each partner are recorded in separate entries

True

(T/F) The partner's capital account is credited for the net amount.

True

Partnerships

Association of two or more persons who own and manage a business for profit Less widely used than proprietorships

Withdrawal of a partner

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 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 on the partnership's records 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. If the partnership purchases the withdrawing partner's interest, the assets and the owners' equity of the partnership are reduced by the purchase price. Before the purchase, the asset accounts should be adjusted to current values. The net amount of any adjustment should be divided among the capital accounts of the partners according to their income-sharing ratio. The entry to record the purchase debits the capital account of the withdrawing partner and credits Cash for the amount of the purchase. If not enough partnership cash is available to pay the withdrawing partner, a liability may be created (credited) for the amount owed the withdrawing partner.

Dividing Income: Services of Partners and Investments

A partnership agreement may divide income based upon interest on capital balances of each partner. In this way, partners with more invested int he partnership are rewarded by receiving more of the partnership income.

Limited liability companies characteristics

Moderately complex to form: an LLC requires an agreement among the owners, who are called members Limited legal liability: only the members' investments in the company are subject to claims of creditors Not taxable: an LLC may elect to be treated as a partnership for tax purposes. Thus, income passes through the LCC and is taxed on the individual members' tax returns. Unlimited life: Most LLC operating agreements specify continuity of life for the LLC, even when a member withdraws or new members join the LLC. Moderate ability to raise capital: Because of their limited liability, LLCs are attractive to many investors, thus allowing for greater access to capital than is normally the case in a partnership

Partnerships Characteristics

Moderately complex to form: often formed with a partnership agreement No limitation on legal liability: the partners are personally liable for any debts or legal claims against the partnership Not taxable: for federal income tax purposes, a partnership is not taxed. Instead, the proprietorship's income or loss is "passed through" to the partners' individual income tax returns. Limited life: When a partner dies or retires, the partnership ceases to exist. Limited ability to raise capital: the ability to raise capital for the partnership is limited to what the partners can provide from personal resources or through borrowing.

Participation in income

Net income and net loss are distributed among the partners according to their partnership agreement If partnership agreement does not provide for distribution of income and losses, then income and losses are divided equally among the partners.

Dividing Income: Services of Partners

One method of dividing partnership income is based on the services provided by each partner to the partnership. These services are often recognized by partner salary allowances.

Proprietoriships characteristics

Simple to form: no legal restrictions or forms to file No limitation on legal liability: owner is personally liable for any debts or legal claims against the business Not taxable: for federal income tax purposes, a proprietorship is not taxed. Instead, the proprietorship's income or loss is "passed through" to the owner's individual income tax return. Limited life: when the owner dies or retires, the proprietorship ceases to exist. Limited ability to raise capital: ability to raise capital is limited to what the owner can provide from personal resources or through borrowing.

Partner salary allowances

Such allowances reflect differences in partners' abilities and time devoted to the partnership Since partners are not employees, such allowances are recorded as divisions of net income and are credited to the partners' capital accounts.

Statement of partnership equity

The changes in partner capital accounts for a period of time are reported in a statement of partnership equity.

Co-ownership of partnership property

The property invested in a partnership by a partner becomes the joint property of all the partners. When a partnership is dissolved, each partner's share of the partnership assets is the balance in their capital account.