CHAPTER 12
ACCOUNTING FOR PARTNERSHIPS AND
LIMITED LIABILITY COMPANIES
DISCUSSION QUESTIONS
1. a. Proprietorship: Ease of formation and nontaxable entity.
b. Partnership: Expanded owner expertise and capital, nontaxable entity, and moderate
complexity of formation.
c. Limited liability company: Limited liability to owners, expanded access to capital,
nontaxable entity, and moderate complexity of formation.
2. The disadvantages of a partnership are that its life is limited, each partner has unlimited
liability, one partner can bind the partnership to contracts, and raising large amounts of
capital is more difficult for a partnership than a limited liability company.
3. Yes. A partnership may incur losses in excess of the total investment of all partners. The
division of losses among the partners is made according to their agreement. In addition, because
of the unlimited liability of each partner for partnership debts, a particular partner may
actually lose a greater amount than his or her capital balance.
4. The partnership agreement (partnership) or operating agreement (LLC) establishes the income-
sharing ratio among the partners (members), amounts to be invested, and admission and
withdrawal of partners (members). In addition, for an LLC the operating agreement specifies
if the LLC is owner-managed or manager-managed.
5. No. Maholic would have to bear his share of losses. In the absence of any agreement as to
division of net income or net loss, his share would be one-third. In addition, because of the
unlimited liability of each partner, Maholic may have to bear more than one-third of the losses
if one partner is unable to absorb his share of the losses.
6. Yes. Partnership net income is divided according to the income-sharing ratio, regardless
of the amount of the withdrawals by the partners. Therefore, it is very likely that the
partners’ monthly withdrawals from a partnership will not exactly equal their shares of net
income.
7. a. Debit the partner’s drawing account and credit Cash.
b. No. Payments to partners and the division of net income are separate. The amount of one
does not affect the amount of the other.
c. Debit the income summary account for the amount of the net income and credit the
partners’ capital accounts for their respective shares of the net income.
8. a. By purchase of an interest, the capital interest of the new partner is obtained from the old
partner, and neither the total assets nor the total equity of the partnership is affected.
b. By investment, both the total assets and the total equity of the partnership are increased.
12-1
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 12 Accounting for Partnerships and Limited Liability
Companies
DISCUSSION QUESTIONS (Continued)
9. It is important to state all partnership assets in terms of current prices at the time of the
admission of a new partner because failure to do so might result in participation by the
new partner in gains or losses attributable to the period prior to admission to the
partnership.
To illustrate, assume that A and B share net income and net loss equally and operate a
partnership that owns land recorded at and costing $20,000. C is admitted to the partnership,
and the three partners share in income equally. The day after C is admitted to the
partnership, the land is sold for $35,000 and, since the land was not revalued, C receives a
one-third distribution of the $15,000 gain. In this case, C participates in the gain attributable
to the period prior to admission to the partnership.
10. A new partner who is expected to improve the fortunes (income) of the partnership, through
such things as reputation or skill, might be given equity in excess of the amount invested to
join the partnership.
12-2
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
, CHAPTER 12 Accounting for Partnerships and Limited Liability
Companies
PRACTICE EXERCISES
PE 12–1A
Cash 51,000
Accounts Receivable 65,000
Patent 195,000
Accounts Payable 12,000
Allowance for Doubtful Accounts 3,000
Rachel Bell, Capital 296,000
PE 12–1B
Cash 36,000
Inventory 42,000
Land 175,000
Notes Payable 35,000
Austin Fisher, Capital 218,000
PE 12–2A
Distributed to Orr and Graham:
Orr Graham Total
Annual salary............................$28,000 $ 0 $28,000
Interest………………………… 3,6001 9,000 2 12,600
3
Remaining income................... 3,600 1,8004 5,400
Total distributed to partners…$35,200 $10,800 $46,000
1
$60,000 × 6%
2
$150,000 × 6%
3
($46,000 – $28,000 – $12,600) × 2/3
4
($46,000 – $28,000 – $12,600) × 1/3
Orr: $35,200
12-3
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
, CHAPTER 12 Accounting for Partnerships and Limited Liability
Companies
PE 12–2B
Distributed to Prado and Nicks:
Prado Nicks Total
Annual salary..............................$ 0 $38,000 $ 38,000
Interest…………………………… 1,0001 2,500 2 3,500
Remaining income...................... 35,250 35,250 3 70,500
Total distributed to partners… $36,250 $75,750 $112,000
1
$20,000 × 5%
2
$50,000 × 5%
3
($112,000 – $38,000 – $3,500) × 50%
Nicks: $75,750
PE 12–3A
a. Land 45,000
Tony Vale, Capital 22,500
Jordan Henry, Capital 22,500
($125,000 – $80,000) × 50%.
b. Jordan Henry, Capital 26,250
Amar Harb, Capital 26,250
($30,000 + $22,500) × 50%.
PE 12–3B
a. Equipment 9,000
Kevin Camden, Capital 6,000
Chloe Sayler, Capital 3,000
($39,000 – $30,000) × 2/3.
b. Cash 60,000
Demarco Lee, Capital 60,000
12-4
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
ACCOUNTING FOR PARTNERSHIPS AND
LIMITED LIABILITY COMPANIES
DISCUSSION QUESTIONS
1. a. Proprietorship: Ease of formation and nontaxable entity.
b. Partnership: Expanded owner expertise and capital, nontaxable entity, and moderate
complexity of formation.
c. Limited liability company: Limited liability to owners, expanded access to capital,
nontaxable entity, and moderate complexity of formation.
2. The disadvantages of a partnership are that its life is limited, each partner has unlimited
liability, one partner can bind the partnership to contracts, and raising large amounts of
capital is more difficult for a partnership than a limited liability company.
3. Yes. A partnership may incur losses in excess of the total investment of all partners. The
division of losses among the partners is made according to their agreement. In addition, because
of the unlimited liability of each partner for partnership debts, a particular partner may
actually lose a greater amount than his or her capital balance.
4. The partnership agreement (partnership) or operating agreement (LLC) establishes the income-
sharing ratio among the partners (members), amounts to be invested, and admission and
withdrawal of partners (members). In addition, for an LLC the operating agreement specifies
if the LLC is owner-managed or manager-managed.
5. No. Maholic would have to bear his share of losses. In the absence of any agreement as to
division of net income or net loss, his share would be one-third. In addition, because of the
unlimited liability of each partner, Maholic may have to bear more than one-third of the losses
if one partner is unable to absorb his share of the losses.
6. Yes. Partnership net income is divided according to the income-sharing ratio, regardless
of the amount of the withdrawals by the partners. Therefore, it is very likely that the
partners’ monthly withdrawals from a partnership will not exactly equal their shares of net
income.
7. a. Debit the partner’s drawing account and credit Cash.
b. No. Payments to partners and the division of net income are separate. The amount of one
does not affect the amount of the other.
c. Debit the income summary account for the amount of the net income and credit the
partners’ capital accounts for their respective shares of the net income.
8. a. By purchase of an interest, the capital interest of the new partner is obtained from the old
partner, and neither the total assets nor the total equity of the partnership is affected.
b. By investment, both the total assets and the total equity of the partnership are increased.
12-1
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 12 Accounting for Partnerships and Limited Liability
Companies
DISCUSSION QUESTIONS (Continued)
9. It is important to state all partnership assets in terms of current prices at the time of the
admission of a new partner because failure to do so might result in participation by the
new partner in gains or losses attributable to the period prior to admission to the
partnership.
To illustrate, assume that A and B share net income and net loss equally and operate a
partnership that owns land recorded at and costing $20,000. C is admitted to the partnership,
and the three partners share in income equally. The day after C is admitted to the
partnership, the land is sold for $35,000 and, since the land was not revalued, C receives a
one-third distribution of the $15,000 gain. In this case, C participates in the gain attributable
to the period prior to admission to the partnership.
10. A new partner who is expected to improve the fortunes (income) of the partnership, through
such things as reputation or skill, might be given equity in excess of the amount invested to
join the partnership.
12-2
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
, CHAPTER 12 Accounting for Partnerships and Limited Liability
Companies
PRACTICE EXERCISES
PE 12–1A
Cash 51,000
Accounts Receivable 65,000
Patent 195,000
Accounts Payable 12,000
Allowance for Doubtful Accounts 3,000
Rachel Bell, Capital 296,000
PE 12–1B
Cash 36,000
Inventory 42,000
Land 175,000
Notes Payable 35,000
Austin Fisher, Capital 218,000
PE 12–2A
Distributed to Orr and Graham:
Orr Graham Total
Annual salary............................$28,000 $ 0 $28,000
Interest………………………… 3,6001 9,000 2 12,600
3
Remaining income................... 3,600 1,8004 5,400
Total distributed to partners…$35,200 $10,800 $46,000
1
$60,000 × 6%
2
$150,000 × 6%
3
($46,000 – $28,000 – $12,600) × 2/3
4
($46,000 – $28,000 – $12,600) × 1/3
Orr: $35,200
12-3
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
, CHAPTER 12 Accounting for Partnerships and Limited Liability
Companies
PE 12–2B
Distributed to Prado and Nicks:
Prado Nicks Total
Annual salary..............................$ 0 $38,000 $ 38,000
Interest…………………………… 1,0001 2,500 2 3,500
Remaining income...................... 35,250 35,250 3 70,500
Total distributed to partners… $36,250 $75,750 $112,000
1
$20,000 × 5%
2
$50,000 × 5%
3
($112,000 – $38,000 – $3,500) × 50%
Nicks: $75,750
PE 12–3A
a. Land 45,000
Tony Vale, Capital 22,500
Jordan Henry, Capital 22,500
($125,000 – $80,000) × 50%.
b. Jordan Henry, Capital 26,250
Amar Harb, Capital 26,250
($30,000 + $22,500) × 50%.
PE 12–3B
a. Equipment 9,000
Kevin Camden, Capital 6,000
Chloe Sayler, Capital 3,000
($39,000 – $30,000) × 2/3.
b. Cash 60,000
Demarco Lee, Capital 60,000
12-4
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
