Chapter 2: Partnerships
What assumptions are made prior to making a cash distribution to the partners?
(1) All noncash assets will be complete losses; (2) All liabilities will be paid; (3) All deficit partners will be written off. These assumptions allow the computation of "safe" balances.
What are the steps involved in creating a predistribution plan?
(1) Calculate maximum loss on any assets and allocate losses and expenses among partners; (2) Determine maximum loss absorption: Capital Balance / P/L interest; (3) Identify partner with minimum loss absorption; (4) Zero out their capital and allocate loss among other partners according to their P/L interest; (5) Repeat steps using new P/L ratio between existing partners until only one remains;
What must the accountant record in the termination of a partnership?
(1) Conversion of assets to cash; (2) Allocation of the resulting gains/losses; (3) Payment of liabilities and expenses; (4) Any remaining unpaid debts to be settled; (5) Distribution of remaining assets to partners based on their final capital balances
Steps in calculating the allocation of potential loss?
(1) Find the P/L ratio between existing partners; (2) Multiply maximum possible loss by each partners individual ratio; (3) Subtract allocated loss amount from their capital balance. The remaining amount is a "safe" balance
Liability of Partners to 3d Parties
*Agency principles apply Rule: Partners are liable for the usual partnership activity, are bound to torts committed in the scope of the partnership business, partnership is bound by contracts entered into as usual partnership activity
Phases of Dissolution in order
-Dissolution, Winding Up, Termination,
What is a schedule of liquidation?
A periodic report summarizing liquidation transactions as they occur. Some frequently disclosed events include: transactions to date, property still held, liabilities awaiting payment, current cash and capital balances. It is constructed by listing the assets and liabilities horizontally and changes vertically
What is a predistribution plan?
A plan used to guide the distribution of cash resulting from the liquidation process.
Salary (Partnership)
Absent an agreement partners get no salary
Management (Partnership)
Absent an agreement, each partner is entitled to equal control, one partner=one vote.
Partnership Share of Profits/Losses
Absent an agreement, profits/losses are shared equally. Exception: Winding up compensation, see below
At what point in the termination process are accounts payable paid off?
After all assets are sold.
Revalued figure
Balance sheet prepared after the new partnership agreement, the assets and liabilities are recorded at ____________. (Original value, Realisable value, Revalued fugire, Current cost)
Wrongful Dissolution (Partnership)
Breach of PS agreement, if PS is for a definite term or particular undertaking, then partner breaches the agreement when she walks away. Exception: AT WILL, if the PS is at will the partner can walk away at any time, indicated by no specification of terms or undertaking.
Consequences for Dissociating Partners
Business stays open- If PS continues in business, then must buyout disassociating partner based on either liquidation or going concept value, whichever is greater. Business closes: Partner who wrongfully dissociates gets no wind-up compensation.
How are gains and losses from a termination allocated among partners?
By the profit/loss ratio
Limited Liability Company
Combines the corporate benefit of limited liability for the owners with the benefit of partnership taxation, including the single level of tax and special allocations of income, losses and cash flows. Owners are technically considered to be members rather than partners and are generally permitted to participate in management of the entity.
General Partnership
Consists of two or more partners who are general partners and who may participate in management of the entity; no limited partners.
Consequences for Partnership w/ Dissociating Partners
Disassociated partner retinas the ability to bind the partnership for one year after disassociation →Can be avoided by notifying the creditors and notifying the state department to put all creditors on notice.
Liquidating distributions - inventory
Distributions of inventory in exchange for all/part of partnership interest results in a gain if the FMV exceeds 120% of the partner's AB in the inventory or and is ordinary income.
LLC Priority Of Distribution
Each level of priority must be satisfied before reaching the next: 1. Pay Creditors (First Priority) Two Types: -Outside Creditor (Outside the Comp who delivers goods to the comp) -Inside Creditor: Partner who loans money to the partnership 2. Pay Capitol Contributions (Second Priority) Any money paid by partners to the PS must be repaid 3. Partners share any remaining profits after the first two levels are satisfied -Each partner must be rapid his loans and capital contribution plus that partners share of the profits or minus that partners share of the losses.
LLC Vote
Each member is entitled to a vote, a vote that is weighed in proportion to the member's current percentage. Majority vote is required: 3 members of LLC would need 2 votes to act.
Partnership Funds/Property
If PS money was used to buy the property, then it becomes PS Property. Property purchased with PS assets is presumed to be PS although the presumption is rebuttable.
Unrealized receivables
If a partner receives money or property in exchange for any part of a partnerships interest, any share of unrealized receivables/inventory results in ordinary income/loss.
LLC Powers
If management is vested in members, individual members have apparent authority to bind the company contractually. The operating agreement may NOT: -Unreasonably restrict the right to information -Unreasonably reduce the duty of care -Eliminate the duty of loyalty or obligation of good faith and fair dealing -Vary the right to expel a right of member specified by statute -Vary requirements to wind up LLC business in cases specific by statute -Restrict rights to a person other than a member or transferee's distributional interest.
Partnership Assets vs. Personal Property of Partners
In conflict, focus on who's funds were used...
How is a partner's loan balance handled? (On the Liab/Equity side)
Loans to partners rank behind obligations to outside creditors but ahead of partner's capital balances in order of payment. Typically, loans are merged in with the partner's capital account balance at the beginning of liquidation
Liquidating distributions - loss
Loss is realized when money and the FMV of property distributed are less than the AB of the partnership interest.
LLC Limited Liability
Managers may be liable for acts or omission that are criminal or made in bad faith or in conciseness disregard of corporation's interest.
LLC Formation
One or more organizers have to file articles of incorporation in their respectable state. (Delaware is more pop) Articles must STATE: LLC Name, location of principal's office, the name and address of registered agents, and whether it will be managed by a member or manager.
Partnership Liability for Winding Up
PS and all general Partners retain liability on all new business transactions UNTIL a notice of dissolution has been given to actual and potential creditors and a filing notice of dissolution with the department of state.
When do partners get Compensation?
Partners receive comp for winding up
Termination of a partnership
Partnerships terminate when the operations cease or when 50% or more of the partnerships interests are sold/exchanged within a 12 month period.
Liquidating distributions
Payments to a retired partner are treated as a distributive share of partnership income, amounts received are treated as capital gain to the extent the money received exceeds AB of the partner.
Winding Up (Partnership)
Period between dissolution and termination in which the remaining partners liquidate partnership assets to satisfy PS creditors
Nominal
Profit and Loss Adjustment account is a ___________ account.
Creditors of Partnerships
Rule: Creditors must exhaust from partnership resources before going directly to partner. If partner is held liable, then partner is entitled to indemnification from partnership and possibility of contribution from other partners once partnership runs dry.
Outgoing Partners Liability for Debts
Rule: Outgoing Partners remain liable to all future creditors: Exception: the outgoing partner can file a notice of withdraw and give notice all know and potential future creditors and file a statement of dissolution with the Dept of State (effective 90 days after filing)
Joint & Several Liability (Partnership)
Rule: Partners are Joint & Several liable for debts of the partnership
Preexisting Debt (Partnership)
Rule: incoming partners not liable for preexisting debts or creditors. Only new debts and creditors incurred while there. Exception: Any capitol contribution by an incoming partner may be used to pay preexisting debts.
Sale of partnership interest
Sale of partnership interest is generally recognized as a capital gain or loss and the amount realized includes the relief of any liabilities assumed by the buyer.
Combined Concepts
Some rules governing the formation, operations and liquidation of a partnership contain a blend of the entity and aggregate concepts.
What happens when a partner has a deficit at the end of liquidation?
They are required to convey funds to the partnership to zero out their balance. Partnership records may then be closed out.
LLC Finance
Three General Rules: 1. Profits are shared by members as provided by the articles of incorporation 2. No distribution may be made if the LLC would be insolvent after the distribution 3. Except in dissolution or other specified events, return of member's capital contribution requires unanimous consent of all members and amendment of the articles
Entity Concept
Treats partners and partnerships as separate units and gives the partnership its own tax "personality" by (1) requiring a partnership to file an information tax return and (2) treating partners as separate and distinct from the partnership in certain transactions between a partner and the entity.
What is Marshaling of Assets?
Under the Uniform Partnership Act, it is the priority ranking of creditors having claims against partners. (1) Debts owed to separate creditors; (2) Debts owed to partnership creditors; (3) Debts owed to other partners. Other partners can sue, but they are last in line.
When can personal creditors claim partnership balances?
When: (1) Payment of all partnership debts is assured; AND (2) The insolvent partner has a positive capital balance. However, even in this circumstance, personal creditors cannot receive more than the total of that partner's capital balance.
Cash/ Bank account
Which account is credited when goodwill is withdrawn by old partners?
Old Partners capital account
Which account is credited while goodwill is received in cash from new partner?
New partner's capital account
Which account is debited when goodwill is not brought in cash?
Goodwill account
Which account is debited when goodwill is raised by firm?
New ratio
Which ratio is used for writing-off goodwill after admission of new partner?
How do you show the absorption of the deficit of an insolvent partner?
Zero out the deficit balance of the insolvent partner, and share the loss among the remaining partners according to their P/L ratio.
Limited Partnership
a partnership with at least one general partner and one or more limited partners. General Partners are often corporations or LLCs.
Partnership
an association of two or more person transacting business together FOR PROFIT—if no profit, no partnership.
Dissolution (Partnership)
deals with the whole partnership winding down, occurs upon any material change (death, withdraw, insolvency of any general partner)
LLC Agency Authority
depends on manager or member →If nothing else is said, the manager is the agent and LLC is the principal
LLC Dissolution
events for Dissolution: -Upon expiration of a period of dissolution -Unanimous consent of all members, -Any event in the articles, -No more members, -When a court orders dissolution
Formation (Partnership)
no formalities are required, you may file a registration statement with the sec of state **Share of profits=Prima Facie evidence of Partnership, IF YOU MEET requirements of 202(a), even if you didn't want to form partnership, you have.
Partnership Dissolution
occurs when partner seizes to be associated with PS: 4 Types: -Express -Expollison, death, or incapacity -Appoint of a receiver -Distribution of all partners assets
Partnership agreement
should explain the rights and obligations of the partners; the allocation of income, deductions, and cash flow; initial and future capital contribution requirements; conditions for terminating the partnership; and other matters.
Termination (Partnership)
the real end of partnership
Aggregate (or conduit) Concept
treats the partnership as a channel through which income, credits, deductions, and other items flow to the partners. The partnership is regarded as a collection of taxpayers joined in an agency relationship. Tax is imposed on the partners rather than the partnership.
Why a LLC?
→Fed Tax benefit of PS (no corporate tax), retain the ability to be taxed as a PS, members interest in a LLC is only transferable with majority consent of LLC members, Members can manage or delegate management by electing someone to, Member and managers are usually not personally liable for company debts, Can be dissolved by unanimous written consent of all members or upon death, retirement, resignation, expulsion, or bankruptcy of any member.
