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Accounting for
Partnerships and
Limited Liability
Companies
12
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After studying this chapter, you should
be able to:
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.
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After studying this chapter, you should
be able to:
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.
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Objective 1
12-1
Describe the basic
characteristics of
proprietorships,
partnerships, and limited
liability companies.
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Proprietorship
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12-1
A proprietorship is a business
enterprise owned by a single individual.
Advantages
Disadvantages
• Simple to form
• Difficulty in raising
large amounts of capital
• Ability to be one’s own
boss
• Unlimited liability
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Partnership
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12-1
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
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•
•
•
Disadvantages
Limited life
Unlimited liability
Co-ownership of
partnership property
Mutual agency
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Partnership
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12-1
 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.
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Limited Partnership
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12-1
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.
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Limited Liability Companies
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
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)
12-1
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Limited Liability Companies
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
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 “member-managed” entity.
An LLC provides limited liability for the
members.


12-1
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Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
12-1
Ease of Formation
Proprietorship
Partnership
LLC
Simple
Moderate
Moderate
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Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
12-1
Legal Liability
Proprietorship
Partnership
LLC
No limitation
No limitation
Limited liability
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Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
12-1
Taxation
Proprietorship
Partnership
LLC
Nontaxable*
Nontaxable*
Nontaxable**
*Pass-through entity
**Pass-through entity by election
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Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
12-1
Limitation on Life of Entity
Proprietorship
Partnership
LLC
Yes
Yes
No
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Characteristics of
Proprietorships, Partnerships,
and Limited Liability companies
12-1
Access to Capital
Proprietorship
Partnership
LLC
Limited
Limited
Average
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Objective 2
12-2
Describe and illustrate the
accounting for forming a
partnership and for dividing
the net income and net loss
of a partnership.
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Forming a Partnership
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12-2
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.
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12-2
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
7 200
16 300
28 700
5 400
1 500
00
00
00
00
00
1 500 00
2 600 00
55 000 00
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12-2
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.
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12-2
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Example Exercise 12-1
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.
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12-2
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Follow My Example 12-1
Cash
Inventory
Equipment
Notes Payable
Reese Howell, Capital
For Practice: PE 12-1A, PE 12-1B
34,000
15,000
29,000
12,000
66,000
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Dividing Income—Services of
Partners
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12-2
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.
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Division of Net Income
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J. Stone
Annual salary allowance $60,000
Remaining income
21,000
C. Mills Total
$48,000 $108,000
21,000
42,000
Division of net income
$69,000 $150,000
$81,000
12-2
to journal entry
(Slide 24)
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12-2
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
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Dividing Income—Services of
Partners and Investments
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12-2
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.
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Division of Net Income
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12-2
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
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Division of Net Income
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12-2
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
12% x Stone’s
capital account
balance on Jan. 1 of
$160,000
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Division of Net Income
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12-2
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
12% x Mills’
capital account
balance on Jan. 1 of
$120,000
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Division of Net Income
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12-2
Net income of $150,000 is divided.
J. Stone C. Mills Total
Salary allowance
$60,000 $48,000 $108,000
Interest allowance
19,200
14,400
33,600
Remaining income
4,200
4,200
8,400
Division of net income $83,400 $66,600 $150,000
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12-2
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
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LLC Alternative
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12-2
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.
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Dividing Income—Allowances
Exceed Net Income
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12-2
Assume the same facts as
before except that the net
income is only $100,000.
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Division of Net Income
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12-2
Net income of $100,000 is divided.
Salary allowance
Interest allowance
Total
J. Stone C. Mills Total
$60,000 $48,000 $108,000
19,200
14,400
33,600
$79,200 $62,400 $141,600
This amount exceeds net
income by $41,600.
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Division of Net Income
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12-2
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
Net income
$58,400
20,800 <41,600>
$41,600 $100,000
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12-2
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Example Exercise 12-2
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?
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12-2
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Follow My Example 12-2
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%
For Practice: PE 12-2A, PE 12-2B
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Objective 3
12-3
Describe and illustrate
the accounting for
partner admission
and withdrawal.
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Admitting a Partner
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12-3
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.
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Purchasing an Interest in a
Partnership
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12-3
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.
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12-3
The only entry required in the partnership
accounts is as follows:
June 1 Tom Andrews, Capital
Nathan Bell, Capital
Joe Canter, Capital
10 000 00
10 000 00
20 000 00
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12-3
The effect of the transaction on the partnership
accounts is presented in the following diagram:
Partnership Accounts
Andrew, Capital
50,000
10,000
Carter, Capital
20,000
Bell, Capital
10,000
50,000
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LLC Alternative
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June 1 Tom Andrew, Member Equity
Nathan Bell, Member Equity
Joe Canter, Member Equity
12-3
10 000 00
10 000 00
20 000 00
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Contributing Assets to a
Partnership
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12-3
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.
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12-3
The entry to record this transaction is as follows:
June 1 Cash
Sharon Nelson, Capital
20 000 00
20 000 00
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12-3
The effect of the transaction on the partnership
accounts is presented in the following diagram:
Partnership Accounts
Net Assets
60,000
20,000
Nelson, Capital
20,000
Lewis, Capital
35,000
Morton, Capital
25,000
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LLC Alternative
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June 1 Cash
Sharon Nelson, Member Equity
12-3
20 000 00
20 000 00
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Revaluation of Assets
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12-3
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.
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12-3
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.
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12-3
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.
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12-3
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Example Exercise 12-3
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.
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12-3
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Follow My Example 12-3
a. Land
60,000
Lynne Lawrence, Capital
20,000¹
Tim Kerry, Capital
40,000²
¹$60,000 x l/3
²$60,000 x 2/3
b. Cash
Blake Nelson, Capital
For Practice: PE 12-3A, PE 12-3B
45,000
45,000
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12-3
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Partner Bonuses
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12-3
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.
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12-3
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.
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Equity of Jenkins
Equity of Kramer
Diaz’s Contribution
Total equity after admitting Diaz
Diaz’s interest (1/3 x $75,000)
$20,000
24,000
31,000
$75,000
$25,000
Diaz’s contribution
Diaz’s equity after admission
Bonus paid to Jenkins and Kramer
$31,000
25,000
$ 6,000
12-3
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12-3
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
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Adjusting for New Partner’s
Unique Qualities or Skills
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12-3
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.
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12-3
The bonus is computed as follows:
Equity of Cowen
Equity of Dodd
Chou’s Contribution
Total equity after admitting Chou
Chou’s equity interest after admission
Chou’s equity after admission
Chou’s contribution
Bonus paid to Chou
$ 80,000
40,000
30,000
$150,000
x 25%
$ 37,500
30,000
$ 7,500
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12-3
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
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12-3
The entry to record the bonus and admission of
Chou to the partnership is as follows:
June
1 Cash
2/3 x
$7,500
Steve Dodd, Capital
Janice Cowen, Capital
Ellen Chou, Capital
30 000 00
5 000 00
2 500 00
37 500 00
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12-3
The entry to record the bonus and admission of
Chou to the partnership is as follows:
June
1 Cash
Janice Cowen, Capital
1/3
x
Steve Dodd, Capital
$7,500
Ellen Chou, Capital
30 000 00
5 000 00
2 500 00
37 500 00
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Withdrawal of a Partner
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12-3
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.
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12-3
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.
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12-3
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.
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12-3
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Example Exercise 12-4
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.
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12-3
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Follow My Example 12-4
Equity of Lowman
Conrad contribution
Total equity after admitting Conrad
Conrad’s equity interest
Conrad’s equity after admission
$45,000
26,000
$71,000
x 30%
$21,300
Conrad’s contribution
Conrad’s equity after admission
Bonus paid to Lowman
$26,000
21,300
$ 4,700
For Practice: PE 12-4A, PE 12-4B
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Objective 4
12-4
Describe and illustrate
the accounting for
liquidating a
partnership.
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Liquidating Partnerships
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12-4
When a partnership goes out
of business, the winding-up
process is called the
liquidation of a partnership.
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Liquidation Process
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12-4
1. Sell the partnership assets. This step is called
realization.
2. Distribute any gains or losses from realization
to the partners based upon their incomesharing 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.
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12-4
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Liquidation Process
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12-4
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
$75,000
$ 9,000
22,000
22,000
22,000
$75,000
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Liquidation Process
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12-4
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.
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Gain on Realization
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$8,000 gain
12-4
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Entries to Record the Steps in the
Liquidation Process
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12-4
Step 1: Sale of assets
Cash
Noncash Assets
Gain on Realization
72 000 00
64 000 00
8 000 00
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Entries to Record the Steps in the
Liquidation Process
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12-4
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
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Entries to Record the Steps in the
Liquidation Process
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12-4
Step 3: Payment of liabilities
Liabilities
Cash
9 000 00
9 000 00
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Entries to Record the Steps in the
Liquidation Process
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12-4
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
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Loss on Realization
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12-4
Farley, Greene, and Hall sell all
noncash assets for $44,000. A
loss of $20,000 ($64,000 –
$44,000) is realized.
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Entries to Record the Steps in the
Liquidation Process
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12-4
Step 1: Sale of assets
Cash
44 000 00
Loss on Realization
20 000 00
Noncash Assets
64 000 00
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Loss on Realization
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$20,000 loss
12-4
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Entries to Record the Steps in the
Liquidation Process
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12-4
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
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Entries to Record the Steps in the
Liquidation Process
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12-4
Step 3: Payment of liabilities
Liabilities
Cash
9 000 00
9 000 00
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Entries to Record the Steps in the
Liquidation Process
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12-4
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
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12-4
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Example Exercise 12-5
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.
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12-4
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Follow My Example 12-5
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
For Practice: PE 12-5A, PE 12-5B
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Loss on Realization—Capital
Deficiency
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12-4
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.
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Loss on Realization—
Capital Deficiency
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Farley’s contribution
12-4
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12-4
Step 1: Sale of assets
Cash
10 000 00
Loss on Realization
54 000 00
Noncash Assets
64 000 00
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12-4
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
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12-4
Step 3: Payment of liabilities
Liabilities
Cash
9 000 00
9 000 00
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12-4
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.
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Loss on Realization—
Capital Deficiency
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The remaining cash is distributed. Greene
receives $5,800 and Hall receives $11,200.
12-4
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12-4
Distribution of cash to partners:
Brad Greene, Capital
Alice Hall, Capital
Cash
5 800 00
11 200 00
17 000 00
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12-4
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Example Exercise 12-6
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.
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Follow My Example 12-6
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.
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For Practice: PE 12-6A, PE 12-6B
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12-5
Objective 5
Prepare the
statement of
partnership equity.
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Statement of Partnership Equity
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12-5
The change in the owners’
capital accounts for a period of
time is reported in a statement
of partnership equity.
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Statement of
Partnership Equity
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12-5
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12-5
Financial Analysis and Interpretation
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Washburn & Lovett, CPA’s had the following
information for the last two years:
2008
2007
Revenues
$220,000,000 $180,000,000
Number of employees
1,600
1,500
$220,000,000
Revenue per
= $137,500
employee, 2008 =
1,600
$180,000,000
Revenue per
= $120,000
employee, 2007 =
1,500
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Financial Analysis and Interpretation
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12-5
The revenues per employee
showed improvement in 2008.
Thus, each employee is producing
more revenues in 2008, than in
2007, which may indicate
improved productivity. Overall, it
appears the firm is properly
managing the growth in staff.
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