Chapter 2 accounting for partnerships

Chapter Accounting for Partnerships: Organization and Operation All examples are from textbook by Larsen ACCT 501 Objectives of the Chapter To learn the accounting and reporting for limited liability partnerships (LLPs) including: a the organization, b the income-sharing plans, c the financial statements, and d the changes in ownership ■ To learn the accounting for limited partnerships ■ Partnerships: Organization and Operation Partnerships ■ The Uniform Partnership Act defines a partnership as: "an association of two or more persons to carry on, as co-owners, a business for profit" ■ Partnerships generally are associated with the practice of law, medicine, public accounting and other professions, and also with small business enterprises Partnerships: Organization and Operation Partnerships (contd.) ■ ■ General partnership: in which all partners have unlimited personal liability for debts of the partnership Limited liability partnerships (LLPs): individual partners of LLPs are personally responsible for their own actions and for the actions of employees under their supervision Partnerships: Organization and Operation Partnerships (contd.) ■ ■ The LLPs as a whole, like a general partnership, is responsible for the actions of all partners and employees Since the LLPs are the prevalent form of partnerships and the issues of organization, income-sharing plans and changes in ownership of LLPs are similar to those of general partnerships, LLPs are discussed in this chapter Partnerships: Organization and Operation Organization of a Limited Liability Partnership (LLP)  Basic Characteristics of the LLP: Ease of Formation Limited Life Mutual Agency Co-Ownership of Partnership Assets and Earnings Partnerships: Organization and Operation Major Differences between an LLP and a Corporation Characteristics of a corporation: Separated legal entity from its owners: it can buy, sell and own properties Limited liability for stockholders Continuous existence Ease of transfer of ownership Ease of capital generation Partnerships: Organization and Operation Major Differences between an LLP and a Corporation (contd.) Centralized authority and responsibility to the President, not to numerous owners Professional management Corporation taxes (double taxation) Separation of ownership and management: principal & agent conflicts 10 Government regulations Partnerships: Organization and Operation Taxation of LLP ■ ■ An LLP pays no income tax LLP is only required to file an annual information return showing its revenue and expenses, the amount of its net income and the division of the net income among the partners Partnerships: Organization and Operation Taxation of LLP ■ The partners of LLP report their shares of the ordinary net income from the partnership and dividends and charitable contributions in their individual income tax returns, regardless of whether they received more of less than this amount of cash from the LLP Partnerships: Organization and Operation 10 Retirement of a Partner- Bonus to Retiring Partner (example) Lund, Capital Jorb, Capital ($10,000 X 1/2) Kent, Capital ($10,000 X 1/2) Cash 60,000 5,000 5,000 70,000 To record payment to retiring partner Lund, including a bonus of $10,000 Partnerships: Organization and Operation 88 Retirement of a Partner- Bonus to Retiring Partner (example) This bonus method illustrated above is appropriate whenever the settlement exceeds the capital account balance of the retiring partner  The agreement for settlement may not use the term goodwill  Partnerships: Organization and Operation 89 Retirement of a Partner- Bonus to Continuing Partner (example)  Assume that the three partners, Noll, Merz and Park share net income/loss equally  Each has a capital balance of $60,000  Noll retires from the partnership and receives $50,000  The journal entry to record Noll's retirement is as follows: Partnerships: Organization and Operation 90 Retirement of a Partner- Bonus to Continuing Partner (example) Noll, Capital 60,000 Cash Merz, Capital ($10,000 X 1/2) Park, Capital ($10,000 X 1/2) 50,000 5,000 5,000 To record retirement of Partner Noll for an amount less than carrying amount of Noll’s equity, with a bonus to continuing partners Partnerships: Organization and Operation 91 Limited Partnerships   The legal provisions governing limited partnerships are provided by the Uniform Limited Partnership Act The important features of a limited partnership are the following: There must be at least one general partner Limited partners have no obligation for unpaid liabilities of the limited partnership; only general partners have such liability Partnerships: Organization and Operation 92 Limited Partnerships (contd.) Limited partners have no participation in the management of the partnership Limited partners may invest only cash or other assets in a limited partnership; they may not provide services as their investment The surname of a limited partner may not appear in the name of the partnership Partnerships: Organization and Operation 93 Limited Partnerships (contd.) The formation of a limited partnership is evidenced by a certificate filed with the county recorder of the principal place of business of the limited partnership Partnerships: Organization and Operation 94 Limited Partnerships (contd.)  Membership in a limited partnership is offered to limited partners in units subject to the Securities Act of 1933  Thus, unless exempt by the provisions of that Act, a limited partnership must file a registration statement for the offered units with the SEC and file reports with the SEC Partnerships: Organization and Operation 95 Accounting for Limited Partnerships  The accounting for limited partnerships parallels that accounting for LLPs  However, limited partners not have periodic drawings debited to Drawing ledger account  In Staff Accounting Bulletin 40, the SEC requires the equity section of a limited partnership balance sheet specify amounts for each ownership class (i.e., the general partner versus the limited partners) Partnerships: Organization and Operation 96 Financial Statements for Limited Partnerships  Assume that Wesley Randall formed Randall Company, a limited partnership that was exempt from the registration requirements of the Securities Act of 1933 on 1/2/1999  Wesley Randall, the general partner, acquired 30 units at $1,000 a unit, and 30 limited partners acquired a total of 570 units at $1,000  The certificate for Randall Company provided Partnerships: Organization and Operation 97 Financial Statements for Limited Partnerships (contd.)   The certificate for Randall Company provided that limited partners might withdraw their net equity only on 12/31 of each year Randall was authorized to withdrew $500 a month at his discretion, but he had no drawings during 1999 Partnerships: Organization and Operation 98 Financial Statements for Limited Partnerships (contd.)   Randall Company had a net income of $90,000 for 1999 and on 12/31/99, two limited partners withdrew their entire equity interest of 40 units The following condensed financial statements incorporate the foregoing assumptions and comply with the provisions of Staff Accounting Bulletin 40: Partnerships: Organization and Operation 99 Income Statement of Randall Company –a Limited Partnerships for the Year Ended 12/31/99 Revenue Costs and expenses Net income Division of net income ($150* per unit $400,000 310,000 $ 90,000 based on 600 weighted average units outstanding): To general partner (30 units) $4,500 To limited partners (570 units) Total 85,500 $90,000 *$90,000 / 600 units outstanding throughout 1999=$150 Partnerships: Organization and Operation 100 Statement of Partners' Capital for Year Ended 12/31/1999 General Partner Limited Partners Initial investments, beginning of year Add: Net income Subtotals Less: Redemption of units Partners’ capital, end of year Combined Units Amount Units Amount Units Amount 30 $30,000 570 $570,000 600 $600,000 4,500 30 $34,500 85,500 570 $655,500 40 46,000 90,000 600 $690,000 40 46,000 30 $34,500 530 $609,500 560 $644,000 Partnerships: Organization and Operation 101 Balance Sheet, 12/31/99 Assets Liabilities & Partners’ Capital Current assets Other assets $240,000 Current liabilities 760,000 Long-term debt Total Liabilities Partners’ capital ($1,150* per unit based on 560 units outstanding): General partner Limited partners Total $1,000,000 Total liabilities assets & partners’ capital *$644,000 / 560 = $1,150 $100,000 256,000 $356,000 $34,500 609,500 Partnerships: Organization and Operation 644,000 $1,000,000 102 [...]... Interest on average capital account balances: Alb: $475,000X0.15 Bay: $775,000X0.15 Subtotal Remainder ($300,000$187,500) divided equally Total Bay $71 ,25 0 Combined 56 ,25 0 $71 ,25 0 116 ,25 0 $187,500 1 12, 500 $ 127 ,500 $1 72, 500 $300,000 $116 ,25 0 56 ,25 0 Partnerships: Organization and Operation 35 Interest on Partner's Capital account balances with Remaining Divided in Specified Ratio (condt.) ■ ■ The provision... Operation 22 Income-Sharing Plans for LLP Partners can agree on any type of income sharing plan regardless of the amount of their respective capital investment ■ The Uniform Partnership Act states that if partners fail to specify a plan for sharing net income/loss, it is assumed that they intend to share equally ■ Partnerships: Organization and Operation 23 Income-Sharing Plans for LLP (contd.) ■ 1 2 3 The... be invested by each partner, the procedure for valuing noncash investments, and the penalties for a partner's failure to invest and maintain the agreed amount of capital Partnerships: Organization and Operation 14 The Partnership Contract (contd.) 3 4 5 The authority, the rights and the duties of each partner The accounting period to be used, the nature of accounting records, financial statements and... plans Partnerships: Organization and Operation 15 The Partnership Contract (contd.) 6 The drawings allowed to each partner 7 Insurance on the lives of partners 8 Provision for arbitration of disputes 9 Provision for liquidation of the partnership at the end of the term specified in the contract or at the death or retirement of a partner Partnerships: Organization and Operation 16 Ledger Accounts for. .. retirement of a partner Partnerships: Organization and Operation 16 Ledger Accounts for Partners ■ 1 2 3 The following three types of accounts are used in LLPs for each partner: Capital accounts Drawing accounts Accounts for loans to and from partners Partnerships: Organization and Operation 17 Ledger Accounts for Partners (contd.) ■ The original investment from partner is recorded as: Assets (based on current... much business and accounting entities as are corporations Partnerships: Organization and Operation 11 Is the LLP a Separate Entity ? (contd) ■ ■ LLPs typically are guided by long-range plans not likely to be affected by the admission or departure of a single partner The accounting policies of LLPs should reflect the fact that the partnership is an accounting entity apart from its owners Partnerships: Organization... Operation 25 Income-Sharing Plans for LLPExamples Alb & Bay LLP had a net income of $300,000 for the year ended 12/ 31/99, the first year of operation The partnership contract provides that each partner may withdraw $5,000 cash on the last day of each month Both partners did so during 1999 All other withdrawals, investments and net income/loss are entered directly in the capital account  Partnerships: ... Partnerships: Organization and Operation 26 Income-Sharing Plans for LLPExamples (contd.) Alb invested $4,000,000 on 1/1/99 and an additional $100,000 on 4/1 Bay invested $800,000 on 1/1/ and withdrew $50,000 on 7/1 These transactions and events are summarized in the following ledger accounts:  Partnerships: Organization and Operation 27 Income-Sharing Plans for LLPExamples (contd.) Alb, Capital 400,000…1/1... apart from its owners Partnerships: Organization and Operation 12 The Partnership Contract ■ ■ A good business practice requires the partnership contract in writing The followings are a few important points to be covered in a written contract for a LLP: Partnerships: Organization and Operation 13 The Partnership Contract (contd.) 1 2 The formation date and the planned duration of the partnership; the... a specified ratio Partnerships: Organization and Operation 24 Income-Sharing Plans for LLP (contd.) 4 5 6 Allowing salaries to partners and dividing the remaining net income/loss in a specified ratio Bonus to managing partner based on income Allowing salaries to partners, allowing interest on capital account balances, and dividing the remaining net income/loss in a specified ratio Partnerships: Organization ... and d the changes in ownership ■ To learn the accounting for limited partnerships ■ Partnerships: Organization and Operation Partnerships ■ The Uniform Partnership Act defines a partnership as:... income/loss in a specified ratio Partnerships: Organization and Operation 25 Income-Sharing Plans for LLPExamples Alb & Bay LLP had a net income of $300,000 for the year ended 12/ 31/99, the first year... a business for profit" ■ Partnerships generally are associated with the practice of law, medicine, public accounting and other professions, and also with small business enterprises Partnerships: