Accounting for Partnerships and Limited Liability Companies

Chapter 12
Student Version
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
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Learning Objective 1

1. Describe the characteristics of proprietorships,

partnerships, and limited liability companies.

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 LO 1
Proprietorships

A proprietorship is a company owned by a

single individual.
Characteristics of proprietorships include the
following:
 Simple to form
 No limitation on legal liability
 Not taxable
 Limited life
 Limited ability to raise capital (funds)
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 LO 1
Partnerships

A partnership is an association of two or

more persons who own and manage a
business for profit. Characteristics of a
partnership include the following:
 No limitation on legal liability
 Not taxable
 Limited life
 Limited ability to raise capital (funds)

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 LO 1
Partnerships

A limited partnership is a unique legal form

that provides partners who are not involved
in the operations of the partnership with
limited liability.
 There must be at least one general
partner who operates the partnership.
 The remaining partners are considered
limited partners.

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 LO 1
Limited Liability Companies

A limited liability company (LLC) is a form of

legal entity that provides limited liability to
its owners, but is treated as a partnership for
tax purposes. Characteristics include:
 Moderately complex to form
 Limited legal liability
 Not taxable
 Unlimited life
 Moderate ability to raise capital (funds)
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objectives

1. Describe the 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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 LO 2
Forming a Partnership

Joseph Stevens and Earl Foster, owners of competing

hardware stores, agree to combine their businesses in
a partnership. Stevens agrees to contribute the
following:

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 LO 2
Forming a Partnership

The entry to record the assets and liabilities

contributed by Stevens is as follows:

The noncash assets are normally recorded at current

market value. 9
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 LO 2
Forming a Partnership

If a limited liability company is formed, the following

entry is made:

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 LO 2
Dividing Income—Services of Partners

The partnership agreement of Jennifer Stone and

Crystal Mills provides for Stone to receive a
monthly salary allowance of $5,000 ($60,000
annually) and Mills to receive $4,000 a month
($48,000 annually). If there is any remaining net
income, it is to be divided equally.
Income and losses of the partnership would have
been divided equally if no partnership agreement
existed or if the partnership agreement did not
specify how the division was to occur.

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 LO 2
Dividing Income—Services of Partners

The firm had net income of $150,000 for the year.

Stone shared the net income as calculated below.
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

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 LO 2
Dividing Income—Services of Partners and Investments

The partnership agreement for Stone and Mills

divides income as follows:
 Partner salary allowances: $5,000 monthly for
Stone and $4,000 monthly for Mills
 Interest of 12% on each partner’s capital balance
as of January 1
 Any remaining income divided equally

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 LO 2
Dividing Income—Services of Partners and Investments

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
Net income $83,400 $66,600 $150,000

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 LO 2
Dividing Income—Allowances Exceed Net Income

Assume the same salary and interest allowances as

in the preceding example, but that the net income is
only $100,000. In this case, the total of the
allowances exceeds the net income by $41,600
($100,000 - $141,600).

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 LO 2
Dividing Income—Allowances Exceed Net Income

The division of the partnership net income is

determined as follows:
J. Stone C. Mills Total
Salary allowance $60,000 $48,000 $108,000
Interest allowance 19,200 14,400 33,600
Total $79,200 $62,400 $141,600
Deduct excess of
allowances over income 20,800 20,800 41,600
Net income $58,400 $41,600 $100,000

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 LO 2
Dividing Income—Allowances Exceed Net Income

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 Learning Objective 3

1. Describe the 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.
3. Describe and illustrate the accounting for
partner admission and withdrawal.

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 LO 3
Admitting a Partner

A person may be admitted to a partnership

by either of the following:
 Purchasing an interest from one or more
of the existing partners
 Contributing assets to the partnership

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 LO 3
Purchasing an Interest from Existing Partners

On June 1, Tom Andrews and Nathan Bell each sell

one-fifth of their partnership equity of Bring It
Consulting to Joe Canter for $10,000 in cash. On
June 1, the partnership has net assets of $100,000,
and both existing partners have capital balances of
$50,000 each.

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 LO 3

Purchasing an Interest from Existing Partners

The only entry required in the partnership accounts is as

follows:

For a limited liability company, the following entry is

required:

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 LO 3
Contributing Assets to a Partnership

Partners Tom Andrews and Nathan Bell each have

capital balances of $50,000. On June 1, Joe Canter
contributes $20,000 cash to Bring It Consulting for
ownership equity of $20,000.

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 LO 3
Contributing Assets to a Partnership

The entry to record this transaction is as follows:

For a limited liability company, the following entry is

required:

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 LO 3
Revaluation of Assets

 If the partnership’s 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.
Partners Andrews and Bell each have capital balances
of $50,000. 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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 LO 3
Revaluation of Assets

The entry to record this transaction is as follows:

For a limited liability company, the following entry is

required:

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 LO 3
Partner Bonuses

Jenkins and Kramer have capital balances of $20,000

and $24,000, respectively. They agree to admit Diaz to
the partnership 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. Diaz is paying Jenkins and Kramer a $6,000
bonus to join the partnership.

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 LO 3
Partner Bonuses

The entry to record this transaction is as follows:

For a limited liability company, the following entry is

required:

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 LO 3
Withdrawal of a Partner

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 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.
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 LO 3
Withdrawal or Death of a Partner

If the partnership purchases the withdrawing

partner’s interest, the assets and the owners’
equity of the partnership are reduced by the
purchase price.
 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.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objectives

1. Describe the 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.
3. Describe and illustrate the accounting for
partner admission and withdrawal.
4. Describe and illustrate the accounting for
liquidating a partnership.

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 LO 4
Liquidating Partnerships

When a partnership goes out of business, the

winding-up process is called the liquidation
of the partnership.
 Although liquidation refers to the payment
of liabilities, it includes the entire winding-
up process.
 When the partnership goes out of business
and the normal operations are
discontinued, the accounts should be
adjusted and closed.
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 LO 4
Liquidating Partnerships
Farley, Green, and Hall decide to liquidate their
partnership. On April 9, after discontinuing business
operations and closing the accounts, the following
trial balance is prepared:

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 LO 4
Gain on Realization
 Farley, Green, and Hall share income and losses in a
ratio of 5:3:2 (50%, 30%, 20%).
 All noncash assets are sold in a single transaction for
$72,000, resulting in a gain of $8,000. Partner capital
accounts are credited $4,000, $2,400, and $1,600 to
Farley, Green, and Hall, respectively.
 Creditors are paid $9,000, and the remaining cash of
$74,000 is distributed to the partners.
 A statement of partnership liquidation summarizes the
liquidation process.
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 LO 4
Gain on Realization

Sale of Assets (Step 1)

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 LO 4
Gain on Realization

Division of Gain (Step 2)

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 LO 4
Gain on Realization

Payment of Liabilities (Step 3)

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 LO 4
Gain on Realization

Distribution of Cash to Partners (Step 4)

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 LO 4
Loss on Realization

Farley, Green, and Hall sell all noncash assets for

$44,000. A loss of $20,000 ($64,000 – $44,000) is
realized. The loss is distributed to Farley, Green, and
Hall in the income-sharing ratio of 5:3:2.

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 LO 4
Loss on Realization

Sale of Assets (Step 1)

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 LO 4
Liquidating Partnerships

Division of Loss (Step 2)

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 LO 4
Liquidating Partnerships

Payment of Liabilities (Step 3)

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 LO 4
Liquidating Partnerships

Distribution of Cash to Partners (Step 4)

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 LO 4
Loss on Realization—Capital Deficiency

The share of a loss on realization may be

greater than the balance in a partner’s
capital account. The resulting debit balance
in the capital account is called a
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.

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 LO 4
Loss on Realization—Capital Deficiency

Sale of Assets (Step 1)

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 LO 4
Loss on Realization—Capital Deficiency

Division of Loss (Step 2)

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 LO 4
Loss on Realization—Capital Deficiency

Payment of Liabilities (Step 3)

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 LO 4
Liquidating Partnerships

Receipt of Deficiency (Step 4)

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 LO 4
Liquidating Partnerships

Distribution of Cash to Partners (Step 4)

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objective 5

1. Describe the 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.
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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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 5
Statement of Partnership Equity

The changes in the partners’ capital

accounts for a period of time are reported in
a statement of partnership equity.
The statement of members’ equity for an LLC
is similar to that of a partnership. It reports
the changes in member equity for a period.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objectives

1. Describe the 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.
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.
6. Analyze and interpret employee efficiency.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 6
Revenue per Employee

Revenue per employee is a measure of the

efficiency of the business in generating
revenues.
Revenue
Revenue per Employee =
Number of Employees

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 LO 6
Revenue per Employee

2013 2012
Revenues $220,000,000 $180,000,000
Number of employees 1,600 1,500

Revenue per $220,000,000

= = $137,500
employee, 2013 1,600

Revenue per $180,000,000 = $120,000

employee, 2012 =
1,500

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Accounting for Partnerships and Limited Liability Companies

The End
Student Version
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.