Chapter 1: Partnership:

Organization and Operation

 Limited Liability Partnership
• The basic Characteristics of an LLP are:
– Ease of Formation
– Limited Life
– Mutual Agency
– Co-ownership of Partnership
• Deciding between an LLP and a corporation
– An LLP pays no income tax but is required to file an annual
information return showing its revenues and expenses. The partners
report their respective shares of the ordinary net income from
partnership.
– A corporation is separate legal entity subject to a corporate income
tax.
– An LLP may incorporate as subchapter S corporation to retain the
advantage of limited liability.
 Limited Liability Partnership
• The Partnership Contract – The most important points covered in
the contract include:
– Date of formation and the profile of the partnership
– The assets to be invested and other related information
– The authority, rights, and duties of each partner
– Accounting principles to be used
– The net income and loss sharing plan
– Salaries, penalties and drawings to partners
– Insurance of the lives of partners
– Provision for arbitration of disputes and liquidation of
partnership at the term agreed or at the death or retirement of
a partner
 Limited Liability Partnership
• Ledger Accounts for Partners
– Accounting for an LLP differs from accounting of other businesses
with respect to sharing of net income and loss and the maintenance
of the partner’s ledger accounts
– Partnership accounts consists of:
• Capital accounts
• Drawing or personal accounts
• Accounts for loans to and from partners
– The partner’s capital account is increased by additional investments
and by a share of net income.
– The partner’s capital account is decreased by withdrawal of cash or
other asset and by a share of loss
– Another possible source of increase/decrease in partner’s account
results from changes in ownership.
 Limited Liability Partnership
• Loans to and from partners
– A partner may receive cash from the LLP with the
intention of repaying this amount. Such transactions may
be debited to the Loans Receivable from Partners ledger
account rather than to the partner’s drawing account
– A partner may make a cash payment to the partnership
that is considered a loan rather an increase in the
partner’s capital account balance. This transaction is
recorded by a credit to Loans Payable to partners and
generally is accompanied by the issuance of a
promissory note
 Limited Liability Partnership
• Income-Sharing Plans for LLPs
– The many possible plans for sharing net income or loss among
partners are summarized below:
• Equally, or in some other ratio
• In the ratio of partner’s specific date of capital account balances
or the average capital account balances during the year.
• Interest on partner’s capital account
• Salaries to partners
• Bonus to managing partner based on income
• A combination of above plans
– These alternative income-sharing plans value the personal services
rendered by individual partners as the amounts of capital invested
by each partner.
– Partners may have large personal financial resources, thus giving
the partnership strong credit rating.
 Limited Liability Partnership
Example 1: On January 2, 2016, Abdi and Daud established Abdi & Daud
LLP, with Abdi investing $80,000 and Daud investing $70,000 on that date.
The income-sharing provisions of the partnership contract were as follows:
1. Salaries of $30,000 per annum to each partner
2. Interest at 6% per annum on beginning capital balances of each
partner
3. Remaining income or loss divided equally
Pre-salary income of Abdi & Daud LLP for the month of January 2016 was
$20,000. Neither partner had a drawing for that month.

a) Prepare journal entries for Abdi & Daud LLP on January 31, 2016.
b) Show supporting computations in the explanations for the entries
 Limited Liability Partnership
Example 2: Activity in the capital account of the partners of Waberi & Yusuf
LLP for the fiscal year ended December 31, 2015, follows:

Waberi, Capital Yusuf, Capital

Balances, Jan 1 $40,000 $80,000
Investment, Jul 1 $20,000
Withdrawal, Oct 1 $40,000

Net income of Waberi & Yusuf LLP for the year ended December 31, 2015,
amounted to $48,000

a) Prepare a working paper to the compute the division of $48,000 net

income of Waberi & Yusuf LLP on the basis of:
- The average capital account balances before current year’s net
income
 Limited Liability Partnership
Example 3: The partnership contract of Ali, Badri, & Chaliph LLP provides
for the remuneration of partners as follows:
1. Salaries of $40,000 to Ali, $35,000 to Badri, and $30,000 to Chaliph to
be recognized annually as operating expense of the partnership in the
measurement of net income
2. Bonus of 10% of income after salaries and the bonus to Ali
3. Remaining net income or loss 30% to Ali, 20% to Badri, and 50% to
Chaliph

Income of Ali, Badri, & Chaliph LLP before partner’s salaries and Ali’s
bonus was $215,000 for the fiscal year ended December 31, 2015.

a) Prepare a working paper to compute each partner’s share of the 2015

net income of Ali, Badri, & Chaliph LLP
 Limited Liability Partnership
Example 4: The partnership contract of Jama, Khalid, & Ladan LLP
provided for the division of net income or losses in the following manner:
1. Bonus of 20% of income before the bonus to Jama
2. Interest at 15% on average capital account balance to each partner
3. Residual income or loss equally to each partner

Net income of Jama, Khalid, & Ladan LLP for 2015 was $90,000, and the
average capital account balances for that year were Jama, $100,000;
Khalid, $200,000; and Ladan, $300,000.

a) Prepare a working paper to compute each partner’s share of the 2015

net income of Jama, Khalid, & Ladan LLP
 Limited Liability Partnership
Changes in Ownership of LLPs
• Most changes in ownership of a limited liability partnership are
achieved without interruption of its operations. However, from a
legal viewpoint, a partnership is dissolved by the death,
admission, or retirement of partner, bankruptcy, expiration of a
time period of LLP contract, and agreement to end the
partnership.
• Dissolution refers to the changes in the ownership interest and
decision by the partners to terminate the partnership.
• Admission of a new partner occurs when:
– Acquisition of all or part of the interest of one or more of the
existing partners
– Investment of assets by the new partner with a resultant
increase in the net assets of the partnership
 Limited Liability Partnership
• In profitable, well-established firm, the existing partners may
insist that a portion of the investment by a new partner be
allocated to them as:
– Bonus, or
– Goodwill
• Sometimes the reverse is true. When the partnership needs
money or potential person, the partnership obliges to provide the
new partner a larger equity in net assets than the amount
invested by the new partner.
• A partnership may allow revaluation of the net assets prior to
admitting new partner.
• A retired partner may receive cash or other asset from
partnership. A retired partner may also be allowed to receive
bonus when the firm is working profitably. Likewise, the reverse
is true.
 Limited Liability Partnership
Example 5: On January 31, 2016, Rahma and Asha were admitted
to Liban, Muse, and Najah LLP, which had net assets of $120,000
prior to admission and an income-sharing ratio of Liban, 25%;
Muse, 35%; and Najah, 40%. Rahma paid $20,000 to Liban for one-
half of his 20% share of the partnership net assets on January 31,
2016, and Asha invested $20,000 in the partnership for a 10%
interest in the net assets of Liban, Muse, Najah, Rahma, and Asha
LLP. No goodwill was recognized as a result of the new admission.

a) Prepare separate journal entries on January 31, 2016, to record

the admission of Rahma and Asha to Liban, Muse, Najah, Rahma,
and Asha LLP.
 Limited Liability Partnership
Example 6: Partners Arte and Botan of Arte and Botan LLP have
capital balances of $30,000 and $20,000 respectively, and they
share net income and losses in a 3:1 ratio.
1) Prepare journal entries to record the admission of Cawale to
Arte, Botan, and Cawale LLP under each of the following
conditions:
a) Cawale invests $30,000 for a one-fourth interest in net
assets; the total partnership capital after Cawale’s admission
is to be $80,000.
b) Cawale invests $30,000 of which $10,000 is a bonus to Arte
and Botan. In conjunction with admission of Cawale, the
carrying amount of the inventories is increased by $16,000.
Cawale’s capital account is credited for $20,000.
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Example 7: Farah and Samir are partners of Farah and Samir LLP
who share net income and losses equally and have equal capital
account balances. The net assets of the partnership have carrying
amount of $80,000. Jama is admitted to Farah, Samir, and Jama
LLP with a one-third interest in net income or losses and net assets.
To acquire the interest, Jama invests $34,000 cash in the
partnership.

a) Prepare journal entries to record the admission of Jama in the

accounting records of Farah, Samir, and Jama LLP under the:
 Bonus Method
 Revaluation of net assets method, assuming the partnership
inventories are overstated.
 Limited Liability Partnership
Example 8: The partner’s capital (income-sharing ratio in parentheses) of
Nur, Omer, Barkhad, & Qalinle LLP on May 31, 2015, was as follows:
Nur (20%) $60,000
Omer (20%) $80,000
Barkhad (20%) $70,000
Qalinle (40%) $40,000

On May 31, 2015, with consent of Nur, Omer, and Qalinle:

1. Barkhad retired from the partnership and was paid $50,000 cash in full
settlement of his interest in the partnership
2. Ridwan was admitted to the partnership with a $20,000 cash
investment for a 10% interest in the net assets of the partnership

a) Prepare journal entries to record the foregoing events

 Limited Liability Partnership
Example 9: Partners Gulied and Hamse admitted Liban to Gulied,
Hamse, & Liban LLP. Liban invested his highly profitable proprietorship.
The partners agreed the following current fair value of the net assets of
Liban’s business:

Current Assets $70,000

Plant Assets $230,000
Total assets $300,000
Less: Liabilities $200,000
Net assets $100,000
Liban’s capital account was credited for $120,000. The partners agreed
further that current fair values of net assets of Gulied & Hamse LLP were
equal to their carrying amounts and that the accounting records of the old
partnership should be used for the new partnership.
 Limited Liability Partnership
The following partner-remuneration plan was adopted for new partnership:
1. Salaries of $10,000 to Gulied; $15,000 to Hamse; and $20,000 to
Liban to be recognized as expenses of the partnership.
2. A bonus of 10% of income after deduction of partner’s salaries to Liban
3. Remaining income or loss as follows: 30% to Gulied, 40% to Hamse,
and 30% to Liban.

For the fiscal year ended December 31, 2015, the partnership had income
of $78,000 before partner’s salaries and bonus.

a) Prepare journal entries for the admission of Liban to the partnership

b) Prepare journal entries for the salaries, bonus, and division of income
for the year ended December 31, 2015.
 Limited Liability Partnership
Example 10: Rage & Sayid LLP was organized and began operations on
March 1, 2014. On that date, Rage invested $150,000 and Sayid invested
land and building with current fair values of $80,000 and $100,000,
respectively. Sayid also invested $60,000 in the partnership on November
1, 2014, because of its shortage of cash. The partnership contract includes
the following remuneration plan:
Rage Sayid
Annual salary $18,000 $24,000
Annual interest on average capital 10% 10%
Remainder 60% 40%
The annual salary was to be withdrawn by each partner in 12 monthly
installments.
During the fiscal year ended Febraury 28, 2015, Rage & Sayid LLP had
net sales of $500,000, cost of goods sold of $280,000, and total operating
expenses of $100,000 (including partner’s salaries expenses but excluding
 Limited Liability Partnership
interest on partners’ average capital account balances). Each partner
made monthly cash drawings in accordance with partnership contract.

a) Prepare a condensed income statement of Rage & Sayid LLP for the
year ended February 28, 2015. Show the details of the division of net
income in a supporting working paper.
b) Prepare a statement of partners’ capital for Rage & Sayid LLP for the
year ended February 28, 2015.