Partnerships & LLC
BY RACHELLE AGATHA, CPA, MBA
Slides by Rachelle Agatha, CPA,
with excerpts from Warren, Reeve, Duchac
Objectives:
1. Describe the basic 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.
2
Objectives:
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.
3
Objective 1
Describe the basic
characteristics of
proprietorships,
partnerships, and
limited liability
companies.
4
Proprietorship
A proprietorship is a business
enterprise owned by a single
individual.
Disadvantages
• Difficulty in raising large
amounts of capital
• Unlimited liability
Advantages
• Simple to form
• Ability to be one’s own boss
5
Partnership
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
6
Partnership
 An important right of partners is to
participate in the income of the
partnership.
 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.
7
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.
8
Limited Liability Companies




Combines the advantages of the corporate and
partnership forms.
LLCs must file “articles of organization” with state
governmental authorities.
Owners are termed “members” rather than “partners.”
Members must create an operating agreement.
(Continued)
9
Limited Liability Companies

An LLC may elect to be treated as a partnership for tax
purposes.

Most operating agreements specify continuity of life
for the LLC, even when a member withdraws.
Members may elect operating the LLC as a “membermanaged” entity.
An LLC provides limited liability for the members.


10
Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
Ease of Formation
Proprietorship Simple
Partnership
Moderate
LLC
Moderate
11
Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
Legal Liability
Proprietorship No limitation
Partnership
No limitation
LLC
Limited liability
12
Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
Taxation
Proprietorship Nontaxable*
Partnership
Nontaxable*
LLC
Nontaxable**
*Pass-through entity
**Pass-through entity by
election
13
Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
Limitation on Life of Entity
Proprietorship
Partnership
LLC
Yes
Yes
No
14
Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
Access to Capital
Proprietorship Limited
Partnership
Limited
LLC
Average
15
Objective 2
Describe and illustrate
the accounting for
forming a partnership
and for dividing the net
income and net loss of
a partnership.
16
Forming a Partnership
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.
17
Stevens’ Transfer of Assets, Liability, and Equity
Apr. 1 Cash
Accounts Receivable
Merchandise Inventory
Store Equipment
Office Equipment
Allowance for Doubtful Accounts
Accounts Payable
Joseph Stevens, Capital
18
7 200
16 300
28 700
5 400
1 500
00
00
00
00
00
1 500 00
2 600 00
55 000 00
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.
19
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.
20
Cash
Inventory
Equipment
Notes Payable
Reese Howell, Capital
34,000
15,000
29,000
12,000
66,000
21
Dividing Income—Services of
Partners
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.
22
Division of Net Income
J. Stone C. Mills
Total
Annual salary allowance $60,000 $48,000 $108,000
Remaining income
21,000
21,000 42,000
Division of net income
$81,000
$69,000 $150,000
to journal entry (Slide 24)
23
The entry for dividing net income is as follows:
Dec. 31 Income Summary
Jennifer Stone, Capital
Crystal Mills, Capital
150 000 00
81 000 00
69 000 00
24
Dividing Income—Services of
Partners and Investments
The partnership agreement for Stone and Mills
divides income as follows:
1. Monthly salary allowance of $5,000 for Stone
and $4,000 for Mills.
2. Interest of 12% on each partner’s capital balance
on January 1.
3. If there is any remaining net income, it is to be
divided equally between the partners.
25
Division of Net Income
Net income of $150,000 is divided.
Salary allowance
Interest allowance
J. Stone C. Mills
Total
$60,000 $48,000
$108,000
19,200 14,400
33,600
26
Division of Net Income
Net income of $150,000 is divided.
Salary allowance
Interest allowance
J. Stone
$60,000
19,200
C. Mills
Total
$48,000 $108,000
14,400
33,600
12% x Stone’s
capital account
balance on Jan. 1
of $160,000
27
Division of Net Income
Net income of $150,000 is divided.
Salary allowance
Interest allowance
J. Stone
$60,000
19,200
C. Mills
Total
$48,000 $108,000
14,400
33,600
12% x Mills’
capital account
balance on Jan. 1
of $120,000
28
Division of Net Income
Net income of $150,000 is divided.
Salary allowance
Interest allowance
Remaining income
Division of net income
J. Stone
$60,000
19,200
4,200
$83,400
C. Mills
Total
$48,000 $108,000
14,400
33,600
4,200
8,400
$66,600 $150,000
29
The entry for dividing net income is as follows:
Dec. 31 Income Summary
Jennifer Stone, Capital
Crystal Mills, Capital
150 000 00
83 400 00
66 600 00
30
LLC Alternative
The entry for dividing net income is as follows:
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.
31
Dividing Income—Allowances
Exceed Net Income
Assume the same facts as
before except that the net
income is only $100,000.
32
Division of Net Income
Net income of $100,000 is divided.
Salary allowance
Interest allowance
Total
J. Stone
$60,000
19,200
$79,200
C. Mills
Total
$48,000 $108,000
14,400
33,600
$62,400 $141,600
This amount exceeds
net income by
$41,600.
33
Division of Net Income
Net income of $100,000 is divided.
J. Stone C. Mills
Total
$60,000 $48,000 $108,000
19,200 14,400
33,600
$79,200 $62,400 $141,600
Salary allowance
Interest allowance
Total
Deduct excess of
allowance over income 20,800 20,800 <41,600>
Net income
$58,400 $41,600 $100,000
34
Steve Prince and Chelsy Bennick formed a
partnership, dividing income as follows:
1. Annual salary allowance to Prince of $42,000.
2. Interest of 9% on each partner’s capital balance on
January 1.
3. 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?
35
Monthly salary
Interest (9% x $20,000)
Remaining income
Total distributed to Prince
$ 42,000
1,800
91,350*
$135,150
*($240,000 – $42,000 – $1,800 – $13,500) x
50%
36
12-3
Objective 3
Describe and
illustrate the
accounting for
partner
admission and
withdrawal.
37
Admitting a Partner
A person may be admitted to a
partnership only with the consent of
all the current partners by:
1. Purchasing an interest from one or more of
the current partners.
2. Contributing assets to the partnership.
38
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.
39
The only entry required in the partnership accounts is as
follows:
June 1 Tom Andrews, Capital
Nathan Bell, Capital
Joe Canter, Capital
00
10 000 00
10 000 00
20 000
40
The effect of the transaction on the partnership
accounts is presented in the following diagram:
Partnership
Accounts
Andrew, Capital
50,000
10,000
Bell, Capital
10,000
50,000
Carter, Capital
20,000
41
LLC Alternative
June 1 Tom Andrew, Member Equity 10 000 00
Nathan Bell, Member Equity
10 000 00
Joe Canter, Member Equity
00
20 000
42
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.
43
The entry to record this transaction is as follows:
June 1 Cash
Sharon Nelson, Capital
00
20 000 00
20 000
44
The effect of the transaction on the partnership
accounts is presented in the following diagram:
Partnership
Accounts
Net Assets
60,000
20,000
Lewis, Capital
35,000
Morton, Capital
Nelson, Capital
20,000
25,000
45
LLC Alternative
June 1 Cash
20 000 00
Sharon Nelson, Member Equity
20 000 00
46
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.
47
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.
48
The revaluation is recorded as follows:
June 1 Merchandise Inventory
Donald Lewis, Capital
Gerald Morton, Capital
3 000 00
1 500 00
1 500 00
Because the LLC alternative follows a
pattern of replacing “Capital” with “Member
Equity,” the LLC entry will not be shown
again.
49
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.
a. Provide the journal entry for the revaluation of
land.
b. Provide the journal entry to admit Nelson.
50
a.
Land
Lynne Lawrence, Capital
Tim Kerry, Capital
60,000
20,000¹
40,000²
¹$60,000 x l/3
²$60,000 x 2/3
b. Cash
Blake Nelson, Capital
45,000
45,000
51
52
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 current
market values and the resulting capital
balances for Jenkins and Kramer are
$20,000 and $24,000, respectively.
53
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.
54
Equity of Jenkins
Equity of Kramer
Diaz’s Contribution
Total equity after admitting Diaz
Diaz’s interest (1/3 x $75,000)
Diaz’s contribution
Diaz’s equity after admission
Bonus paid to Jenkins and Kramer
$20,000
24,000
31,000
$75,000
$25,000
$31,000
25,000
$ 6,000
55
The entry to record the admission of Diaz to the
partnership is as follows:
Mar. 1 Cash
Alex Diaz, Capital
31 000 00
25 000 00
Marsha Jenkins, Capital
3 000 00
Helen Kramer, Capital
3 000 00
$6,000/2
56
Adjusting for New Partner’s
Unique Qualities or Skills
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.
57
The bonus is computed as follows:
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
58
The entry to record the bonus and admission of
Chou to the partnership is as follows:
June 1 Cash
30 000 00
Janice Cowen, Capital
5 000 00
Steve Dodd, Capital
2 500 00
Ellen Chou, Capital
37 500 00
59
The entry to record the bonus and admission of
Chou to the partnership is as follows:
June 1 Cash
30 000 00
Janice Cowen,2/3
Capital
x $7,500
5 000 00
Steve Dodd, Capital
2 500 00
Ellen Chou, Capital
37 500 00
60
The entry to record the bonus and admission of
Chou to the partnership is as follows:
June 1 Cash
30 000 00
Janice Cowen, Capital
5 000 00
Steve Dodd, Capital
1/3 x $7,500
2 500 00
Ellen Chou, Capital
37 500 00
61
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.
62
The following entry is required to record Z selling his
interest to Y.
June 1 Z, Capital
Y, Capital
Transfer ownership
30 000 00
30 000 00
from Z to Y.
The amount paid to Y by Z has no impact on the partnership’s accounting
records.
63
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.
64
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.
65
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
Conrad’s equity after admission
Bonus paid to Lowman
$26,000
21,300
$ 4,700
66
Objective 4
Describe and
illustrate the
accounting for
liquidating a
partnership.
67
Liquidating Partnerships
When a partnership goes
out of business, the
winding-up process is
called the liquidation of
a partnership.
68
Liquidation Process
1. Sell the partnership assets. This step is
called realization.
2. Distribute any gains or losses from
realization to the partners based upon
their income-sharing ratio.
3. Pay the claims of creditors using the cash
from step 1 realization.
4. After satisfying the creditors, distribute
the remaining cash to the partners based
on the balances in their capital accounts.
69
70
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.
Cash
Noncash Assets
Liabilities
Jean Farley, Capital
Brad Greene, Capital
Alice Hall, Capital
Total
$11,000
64,000
$ 9,000
22,000
22,000
22,000
$75,000 $75,000
71
Liquidation Process
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.
72
Gain on Realization
$8,000 gain
73
Entries to Record the Steps in the
Liquidation Process
Step 1: Sale of assets
Cash
Noncash Assets
Gain on Realization
72 000 00
64 000 00
8 000 00
74
Entries to Record the Steps in the
Liquidation Process
Step 2: Division of gain
Gain on Realization
Jean Farley, Capital
8 000 00
4 000 00
Brad Greene, Capital
2 400 00
Alice Hall, Capital
1 600 00
75
75
Entries to Record the Steps in the
Liquidation Process
Step 3: Payment of liabilities
Liabilities
9 000 00
Cash
9 000 00
76
Entries to Record the Steps in the
Liquidation Process
Step 4: Distribution of cash to partners
Jean Farley, Capital
26 000 00
Brad Greene, Capital
24 400 00
Alice Hall, Capital
23 600 00
Cash
74 000 00
77
Loss on Realization
Farley, Greene, and Hall sell
all noncash assets for
$44,000. A loss of $20,000
($64,000 – $44,000) is
realized.
78
Entries to Record the Steps in the
Liquidation Process
Step 1: Sale of assets
Cash
44 000 00
Loss on Realization
20 000 00
Noncash Assets
64 000 00
79
Loss on Realization
$20,000 loss
80
Entries to Record the Steps in the
Liquidation Process
Step 2: Division of loss
Jean Farley, Capital
10 000 00
Brad Greene, Capital
6 000 00
Alice Hall, Capital
4 000 00
Loss on Realization
20 000 00
81
Entries to Record the Steps in the
Liquidation Process
Step 3: Payment of liabilities
Liabilities
9 000 00
Cash
9 000 00
82
Entries to Record the Steps in the
Liquidation Process
Step 4: Distribution of cash to partners:
Jean Farley, Capital
12 000 00
Brad Greene, Capital
16 000 00
Alice Hall, Capital
18 000 00
Cash
46 000 00
83
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.
84
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
85
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.
86
Loss on Realization—
Capital Deficiency
Farley’s
contribution
87
Step 1: Sale of assets
Cash
10 000 00
Loss on Realization
54 000 00
Noncash Assets
64 000 00
88
Step: Payment of liabilities
Joan Farley, Capital
27 000 00
Brad Greene, Capital
16 200 00
Alice Hall, Capital
10 800 00
Loss on Realization
54 000 00
89
Step 3: Payment of liabilities
Liabilities
9 000 00
Cash
9 000 00
90
Receipt of deficiency
Cash
Jean Farley, Capital
5 000 00
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.
91
Loss on Realization—
Capital Deficiency
The remaining cash is distributed. Greene
receives $5,800 and Hall receives $11,200.
92
Distribution of cash to partners:
Brad Greene, Capital
5 800 00
Alice Hall, Capital
11 200 00
Cash
17 000 00
93
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.
a. Determine the amount of Short’s deficiency
b. Determine the amount distributed to Bain assuming
Short is unable to satisfy the deficiency.
94
a. 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.
95
Objective 5
Prepare the
statement of
partnership
equity.
96
Statement of Partnership Equity
12-5
The change in the owners’
capital accounts for a period
of time is reported in a
statement of
partnership equity.
97
Statement of
Partnership Equity
98
Summary
 Partnerships & LLC’s
 Forming a partnership
 Dividing income
 Admitting partner
 Liquidating partnership
 Partnership equity & Statements