chapter 2 partnerships

8/3/2019 Chapter 2 Partnerships

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The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin

Chapter 2

Partnership

Organization

and Operation

Accounting for Partnerships


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2

Partnership is

Association of two or more persons to carry on,

as co-owners, a business for profit

Persons includes Individuals

- other partnerships- Corporations

- Not for profit organizations


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3

Liablities

General Partnership ALL partners have unlimited

personal liability for P/S debtsLimited Liability Partnerships Now prevalent

Individual Partner is Liable for his own actionsand for the actions of partnership employees

under his supervision.

The LLP as whole however is responsible for theactions of all partners and employees.

Accounting is the same for both, taxes same too.


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Characteristics of a limited liability

partnership

Ease of formation

Limited life (changes in ownership legally dissolves the

partnership and a new one is formed) Mutual agency each partner can make normal

operating contracts on P/S behalf (some contractsrequire a partner to have special authorization)

Co-ownership of partnership assets (each partner hasequity in net assets of the partnership)

Every partner has an interest in the partnershipearnings


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LLP CONTRACT

An Agreement that will establish many issues

that arise Disputes between partners not referenced in

contract can be resolved:

- Arbitration

- In court


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LLP contract should include

1. Date of formation and planned duration of the partnership, namesof the partners, and name and business activities of the

partnership.2. Assets to be invested by each partner and the procedures forvaluing noncash assets invested.

3. Authority , rights and duties of each partner

4. The accounting period to be used, the nature of accountingrecords, and financial statements.

5. The plan for sharing net income and losses.

6. Salaries and drawings allowed to partners and any penalties forexcessive withdrawals.

7. Insurance on the lives of partners, P/S as beneficiary

8. Provisions for arbitration of disputes.


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Income-sharing Plans for LLP (if noexplicit plan for sharing earnings, the law requires

equal division)

1. Equally, or in some other ratio.

2. In the ratio of the partners' capital account balances ona specific date, or average capital account balances .

3. Allowing interest on partners' capital account balancesand dividing the remaining net income or loss

4. Allowing salaries to partners and dividing the resultantnet income or loss in a stated ratio.

5. Bonus to managing partner based on income.

6. Allowing salaries and interest on capital accountbalances, and dividing the remaining net income orloss in a stated ratio.


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LLP v/s Corporation

LLP

No Income Tax

(flows through to Partners)

File Information Return

Partners reports their

share as ordinary netincome and liable topay tax.

Corporation

Subject to Income Tax

Distribution of Income alsotaxable in hands ofStockholders(double taxation)

A Subchapter S corporation

may elect to be treated as apartnership for income taxpurposes.


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What is a

Subchapter S Corporation ?

A form of corporation, allowed by the IRS formost companies with 75 or fewer shareholders,which enables the company to enjoy thebenefits of incorporation but be taxed as if it

were a partnership.
http://www.investorwords.com/2566/IRS.htmlhttp://www.investorwords.com/4527/shareholders.htmlhttp://www.investorwords.com/2413/incorporation.htmlhttp://www.investorwords.com/4879/taxed.htmlhttp://www.investorwords.com/3609/partnership.htmlhttp://www.investorwords.com/3609/partnership.htmlhttp://www.investorwords.com/4879/taxed.htmlhttp://www.investorwords.com/2413/incorporation.htmlhttp://www.investorwords.com/4527/shareholders.htmlhttp://www.investorwords.com/2566/IRS.html


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Partnerships follow GAAP

Basically the same as for a corporation ,

except for Owners Equity

What about thegoing concern

principle?


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LLP is a separate Legal Entity

The partnership

May own property in its name May enter into contracts

May Be sued

May bring suit against others Must keep accounting records

Report the result of its operations, etc. to

the IRS


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Financial Statement of LLP

Income Statement

Statement of Partners Capital Balance Sheet


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Ledger Accounts for each partner

Capital Accounts

Drawing or Personal Accounts Accounts for loans to and from Partners


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CAPITAL ACCOUNT

INCREASED BY FAIR VAUE OF NET ASSET INVESTED

SHARE OF NET INCOME

Decreased BY:

WITHDRAWL OF CASH SHARE OF NET LOSS


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LOANS TO/FROM PARTNERS

PARTNER LOANS MONEY TO

PARTNERSHIP; EVIDIENCED BYPROMISSARY NOTE

Classified as Non-Current

LOANS RECEIVABLE CLASSIFIED ACCORDINGMATURITY; CURRENT VS NON-CURRENT


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DRAWING ACCOUNT

WITHDRAWING OF CASH OR OTHERASSETS (lets call it DRAWING of cash)

BY PARTNERS IN ANTICIPATION OF NETINCOME OR DRAWINGS THAT ARE SALARY

Withdrawal (distinguished from drawing)More permanent decrease in capital of apartner


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The partnership must make choices

on how to figure income

The partnerships accounting year - same as the partners(If partners have different year ends, the partnership must choose

a year end that minimizes deferral of income declaration).Partners should agree on accounting method, financial

reporting frequency and types of reports to partners,whether to have an audit.

Depreciation method.

Method of accounting for specific items, such asdepletion or installment sales.

Nonrecognition of gain on involuntary conversions ofproperty (by reinvestment).

Amortization of certain organization and start-up costs


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Partnership must report to the IRS

Form 1065

US Return of Partnership Income

Schedule K-1 (copy to each partner withhis/her income)

Partners Share of Income, Credits, Deductions,

etc.


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These items must be separatelyreported to partners on the Schedule K

Ordinary income or loss from trade or business activities.

Net income or loss from rental real estate activities.

Net income or loss from other rental activities. Gains and losses from disposal of capital assets.

Charitable contributions.

Dividends (passed through to corporate partners) that

qualify for the dividends-received deduction. Taxes paid or accrued to foreign countries

Other items of income, gain, loss, deduction, or credit, as

required by regulations.Ex. intangible drilling and development

costs, and soil and water conservation expenses, Special credits.


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Change in ownership of LLP

Operations of a limited liability partnership

generally are not interrupted by a change inpartners;

Changes result when:

Partner is admitted to the firm,

Partner retires from the partnership

Partner dies


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New Partner

by

Acquisition of all orpart of the interest of

one or more of theexisting partners

Investment of assets inthe partnership


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Bonus or Goodwill at the time of

new admission

To Existing Partner

(for the privilege of becoming a

member of a firm with highearning power )

The new partner may invest

an amount that is larger thanthe new partner's percentageshare of net assets, thusrequiring the recognition of abonus to the existing

partners.

To New Partner(if the new partner has unusualability or invests the net assets of abusiness enterprise of superiorearning power in the partnership)

The new partner may invest

an amount that is less thanhis or her percentage share ofnet assets, thus requiring therecognition of a bonus to the

new partner


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Record of Goodwill

New partner invests an amount larger than the carrying amount ofthe equity in net assets acquired, the transaction generally is

recorded by the bonus method because the implied goodwill wasnot paid for by the partnership (No business was acquired by thepartnership)

Restatement of assets and capital accounts reflecting the increase

to current fair value for assets before a new partner is admitted toa limited liability partnership may be the most convenient methodof achieving equity among the partners


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Retirement of Partner

Computation of Settlement Price

Bonus to Retiring Partner Bonus to Continuing Partner


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Retiring Partner

A retiring partner may sell hisor her equity in the

partnership, to an existingpartner, or to a new partner

If the amount received by aretiring partner differs from

the carrying amount of his orher equity, the differencegenerally is recorded as abonus, either to the retiringpartner or to the remainingpartners


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Death of Partner

LLP contract often provide for life insurance policies oneach others lives for settlement of estate of a

deceased partner

Buy-sell agreement may be formed


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Rectification of Net Income of Prior

Period

Errors in the measurement of partnership netincome or loss for prior accounting periodsmust be analyzed

The income-sharing ratio is changed or when achange in partners takes place.

Capital account balances are restated basedon each partner's share of the corrected netincome for each period.


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Formation of LP

Formation of LP is evidenced by a certificate filed with the countyrecorder of principal place of business

Certificate includes a number of items in addition to those found in

the typical contract of a limited liability partnership Membership is offered to prospective limited partners in units

The membership units offered to prospective limited partners mayhave to be registered with the Securities and ExchangeCommission (SEC)

SEC has provided guidance for such registration (In IndustryGuide 5)


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Limited Partnership (LP) is different

from LLP

There must be at least one general partner

Limited partner have no obligation for unpaid liabilitiesof LP

Limited partner can not participate in management ofof LP

Limited partner may not provide services as theirinvestment

Last name of limited partner may not appear in thename of LP

chapter 2 partnerships

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