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CHAPTER 12ACCOUNTING FOR PARTNERSHIPS AND
LIMITED LIABILITY COMPANIES
QUESTION INFORMATION
Number Objective Description Difficulty Time AACSB AICPA SS GLEO12-1 12-1 Easy 5 min Analytic FN-Measurement EO12-2 12-1 Easy 5 min Analytic FN-Measurement EO12-3 12-1 Easy 5 min Analytic FN-Measurement EO12-4 12-1 Easy 5 min Analytic FN-Measurement EO12-5 12-1 Easy 5 min Analytic FN-Measurement EO12-6 12-2 Easy 5 min Analytic FN-Measurement EO12-7 12-3 Easy 5 min Analytic FN-Measurement EO12-8 12-3 Easy 5 min Analytic FN-Measurement EO12-9 12-3 Easy 5 min Analytic FN-Measurement EO12-10 12-3 Easy 5 min Analytic FN-Measurement EO12-11 12-3 Easy 5 min Analytic FN-Measurement EO12-12 12-3 Easy 5 min Analytic FN-Measurement EO12-13 12-3 Easy 5 min Analytic FN-Measurement EO12-14 12-4 Easy 5 min Analytic FN-Measurement EO12-15 12-5 Easy 5 min Analytic FN-Measurement PE12-1A 12-2 Journalize partner's
original investmentEasy 5 min Analytic FN-Measurement
PE12-1B 12-2 Journalize partner's original investment
Easy 5 min Analytic FN-Measurement
PE12-2A 12-2 Dividing partnership net income
Easy 5 min Analytic FN-Measurement
PE12-2B 12-2 Dividing partnership net loss
Easy 5 min Analytic FN-Measurement
PE12-3A 12-3 Revalue assets and contribute assets to a partnership
Easy 5 min Analytic FN-Measurement
PE12-3B 12-3 Revalue assets and contribute assets to a partnership
Ex12-26 12-2, 12-5 Partnership entries and statement of part-ners' equity
Moderate 15 min Analytic FN-Measurement Exl
Ex12-27 FAI Financial analysis and interpretation
Easy 10 min Analytic FN-Measurement
Ex12-28 FAI Financial analysis and interpretation
Easy 10 min Analytic FN-Measurement
Pr12-1A 12-2 Entries and balance sheet for partnership
Moderate 1 hr Analytic FN-Measurement Exl KA
Pr12-2A 12-2 Dividing partnership income
Moderate 1 hr Analytic FN-Measurement
Pr12-3A 12-2, 12-5 Financial statements for partnership
Difficult 1 1/2 hr
Analytic FN-Measurement Exl
680680
Number Objective Description Difficulty Time AACSB AICPA SS GLPr12-4A 12-3 Admitting new partner Difficult 1 1/2
hrAnalytic FN-Measurement KA
Pr12-5A 12-4 Statement of partner-ship liquidation
Moderate 1 hr Analytic FN-Measurement Exl
Pr12-6A 12-4 Statement of partner-ship liquidation
Moderate 1 hr Analytic FN-Measurement Exl
Pr12-1B 12-2 Entries and balance sheet for partnership
Moderate 1 hr Analytic FN-Measurement Exl KA
Pr12-2B 12-2 Dividing partnership income
Moderate 1 hr Analytic FN-Measurement
Pr12-3B 12-2, 12-5 Financial statements for partnership
Difficult 1 1/2 hr
Analytic FN-Measurement Exl
Pr12-4B 12-3 Admitting new partner Difficult 1 1/2 hr
Analytic FN-Measurement KA
Pr12-5B 12-4 Statement of partner-ship liquidation
Moderate 1 hr Analytic FN-Measurement Exl
Pr12-6B 12-4 Statement of partner-ship liquidation
Moderate 1 hr Analytic FN-Measurement Exl
SA12-1 12-1 Partnership agree-ment
Easy 10 min Ethics BB-Industry
SA12-2 12-2 Dividing partnership income
Easy 10 min Analytic FN-Measurement
SA12-3 FAI Revenue per em-ployee
Moderate 20 min Analytic FN-Measurement
SA12-4 FAI Revenue per em-ployee
Moderate 20 min Analytic FN-Measurement
SA12-5 12-1 Partnership agree-ment
Easy 10 min Analytic FN-Measurement
681681
EYE OPENERS
1. Proprietorship: Ease of formation and non-taxable entity.Partnership: Expanded owner expertise and capital, nontaxable entity, and ease of forma-tion.Limited liability company: Limited liability to owners, expanded access to capital, nontax-able entity, and ease of formation.
2. The disadvantages of a partnership are its life is limited, each partner has unlimited lia-bility, one partner can bind the partnership to contracts, and raising large amounts of capi-tal is more difficult for a partnership than a limited liability company.
3. Yes. A partnership may incur losses in ex-cess of the total investment of all partners. The division of losses among the partners would be made according to their agreement. In ad-dition, because of the unlimited liability of each partner for partnership debts, a particu-lar 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 buy-sell agreements between the partners (members). In addition, for an LLC the oper-ating agreement specifies if the LLC is owner-managed or manager-managed.
5. Equally.6. 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, be-cause of the unlimited liability of each part-ner, Maholic may lose more than one-third of the losses if one partner is unable to absorb his share of the losses.
7. The delivery equipment should be recorded at $10,000, the valuation agreed upon by the partners.
8. The accounts receivable should be recorded by a debit of $150,000 to Accounts Receiv-able and a credit of $15,000 to Allowance for
Doubtful Accounts.9. Yes. Partnership net income is divided ac-
cording to the income-sharing ratio, regard-less of the amount of the withdrawals by the partners. Therefore, it is very likely that the partners’ monthly withdrawals from a part-
nership will not exactly equal their shares of net income.
10. a. Debit the partner’s drawing account and credit Cash.
b. No. Payments to partners and the divi-sion 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 re-spective shares of the net income.
11. a. By purchase of an interest, the capital in-terest of the new partner is obtained from the old partner, and neither the total assets nor the total equity of the partner-ship is affected.
b. By investment, both the total assets and the total equity of the partnership are increased.
12. 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 partner-ship. 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 admit-ted 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 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.
13. 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.
14. a. Losses and gains on realization are di-vided among partners in the income-sharing ratio.
b. Cash is distributed to the partners accord-ing to their ownership claims, as indicated by the credit balances in their capital ac-counts, after taking into consideration the potential deficiencies that may result from the inability to collect from a deficient part-ner.
682682
15. The statement of partners’ equity (for a part-nership) and statement of members’ equity (for an LLC) both show the material changes in owner’s equity for each ownership person or class for a specified period.
a. Equipment................................................................... 15,000Stuart Townley, Capital........................................ 10,000Ayesha Starr, Capital............................................ 5,000
b. Cash............................................................................. 28,000Devin Morris, Capital............................................ 28,000
PE 12–3B
a. Land............................................................................. 25,000Leon Browne, Capital........................................... 12,500Craig Little, Capital............................................... 12,500
b. Craig Little, Capital..................................................... 15,250Lane Tway, Capital................................................ 15,250*
*($18,000 + $12,500) × 50%
PE 12–4A
Equity of Masterson......................................................................... $ 90,000Nutley contribution.......................................................................... 50,000 Total equity after admitting Nutley................................................. $ 140,000Nutley’s equity interest.................................................................... × 40% Nutley’s equity after admission...................................................... $ 56,000Nutley’s contribution....................................................................... 50,000 Bonus paid to Nutley....................................................................... $ 6,000
PE 12–4B
Equity of Porter................................................................................ $ 420,000Billings’s contribution..................................................................... 200,000 Total equity after admitting Billings............................................... $ 620,000Billings’s equity interest.................................................................. × 30% Billings’s equity after admission.................................................... $ 186,000
Billings’s contribution..................................................................... $ 200,000Billings’s equity after admission.................................................... 186,000 Bonus paid to Porter........................................................................ $ 14,000
PE 12–5A
Chow’s equity prior to liquidation....................................... $18,000
Realization of asset sales..................................................... $46,000Book value of assets ($18,000 + $25,000 + $1,000)............ 44,000 Gain on liquidation................................................................ $ 2,000 Chow’s share of gain (50% × $2,000)................................... 1,000 Chow’s cash distribution...................................................... $ 19,000
PE 12–5B
Dickens’s equity prior to liquidation................................... $ 55,000
Realization of asset sales..................................................... $ 75,000Book value of assets ($55,000 + $45,000 + $10,000).......... 110,000 Loss on liquidation............................................................... $ 35,000 Dickens’s share of loss (50% × $35,000)............................. (17,500 )Dickens’s cash distribution.................................................. $ 37,500
PE 12–6A
a. Martin’s equity prior to liquidation................................. $ 8,000
Realization of asset sales............................................... $ 5,000Book value of assets....................................................... 28,000 Loss on liquidation.......................................................... $ 23,000 Martin’s share of loss (50% × $23,000).......................... (11,500 )Martin’s deficiency........................................................... $ (3,500 )
b. $5,000. $20,000 – $11,500 share of loss – $3,500 Martin deficiency, also equals the amount realized from asset sales.
PE 12–6B
a. Mee’s equity prior to liquidation..................................... $ 40,000
Realization of asset sales............................................... $ 50,000Book value of assets....................................................... 160,000 Loss on liquidation.......................................................... $110,000Mee’s share of loss (50% x $110,000)............................ (55,000 )Mee’s deficiency.............................................................. $ (15,000 )
b. $50,000. $120,000 – $55,000 share of loss – $15,000 Mee deficiency, also equal to the amount realized from asset sales.
The partners can divide net income in any ratio that they wish. However, in the absence of an agreement, net income is divided equally between the partners. Therefore, Jan’s conclusion was correct, but for the wrong reasons. In addition, note that the monthly drawings have no impact on the division of income.
Income Summary................................................................. 132,000L. Gardner, Member Equity............................................ 77,200L. Ross, Member Equity................................................. 54,800
(2)
L. Gardner, Member Equity................................................. 58,000L. Ross, Member Equity...................................................... 42,000
L. Gardner, Drawing....................................................... 58,000L. Ross, Drawing............................................................ 42,000
Note: The reduction in members’ equity from withdrawals would be disclosed on the statement of members’ equity but does not affect the allocation of net income in part (a) of this exercise.
Ex. 12–8
a.Daily Sun
KXT Radio Rachel Newspaper, Partners Sizemore LLC Total
Dec. 31, 2008 Income Summary............................................. 570,000KXT Radio Partners, Member Equity........ 177,200Rachel Sizemore, Member Equity............. 261,500Daily Sun Newspaper, LLC, Member
Dec. 31, 2008 KXT Radio Partners, Member Equity............. 19,200Rachel Sizemore, Member Equity.................. 143,000Daily Sun Newspaper, LLC, Member Equity.. 12,800
KXT Radio Partners, Drawing.................... 19,200Rachel Sizemore, Drawing......................... 143,000Daily Sun Newspaper, LLC, Drawing........ 12,800
c.MEDIA PROPERTIES, LLC
Statement of Members’ EquityFor the Year Ended December 31, 2008
KXT Daily SunRadio Rachel Newspaper,
Partners Sizemore LLC Total
Members’ equity, January 1, 2008....... $240,000 $40,000 $160,000 $ 440,000Additional investment during the year 50,000 50,000
$290,000 $40,000 $160,000 $ 490,000Net income for the year........................ 177 ,200 261,500 131,300 570 ,000
$467,200 $301,500 $291,300 $1,060,000Withdrawals during the year................ 19,200 143,000 12 ,800 175,000 Members’ equity, December 31, 2008. $448,000 $158,500 $278,500 $ 885,000
Charles Shivers, Capital................................................ 40,000Theresa Pepin, Capital.............................................. 40,000
$120,000 × 1/3
Note: The sale to Shivers is not a transaction of the partnership; so, the sales price is not considered in this journal entry.
Ex. 12–11
a. $1,172,000 ($2,450,000,000/2,090), rounded
b. $172,000 ($360,000,000/2,090), rounded
c. A new partner might contribute more than $172,000 because of goodwill at-tributable to the firm’s reputation, future income potential, and a strong client base, etc.
Ex. 12–12
a. (1) Kris Perry, Capital (20% × $100,000)...................... 20,000Melvin Newman, Capital (25% × $90,000).............. 22,500
Paul Lester, Capital............................................ 42,500
b. Kris Perry............................................................ 80,000Melvin Newman................................................... 67,500Paul Lester.......................................................... 42,500Steve Hurd........................................................... 40,000
Ex. 12–13
a. Cash............................................................................... 50,000Mike Heil, Capital........................................................... 6,000Alan Delong, Capital..................................................... 6,000
Felix Estavez, Capital................................................ 62,000
b. Mike Heil.............................................................. 69,000Alan Delong......................................................... 79,000Felix Estavez....................................................... 62,000
Ex. 12–14
a. Medical Equipment.......................................................... 20,000Dobbs, Member Equity............................................... 8,0001
Fox, Member Equity................................................... 12,0002
1$20,000 2/5 = $8,0002$20,000 3/5 = $12,000
b. 1. Cash............................................................................. 310,000Dobbs, Member Equity......................................... 9,400Fox, Member Equity.............................................. 14,100Kopp, Member Equity........................................... 286,500
Supporting calculations for the bonus:
Equity of Dobbs.......................................... $308,000Equity of Fox............................................... 337,000Contribution by Kopp................................. 310,000 Total equity after admitting Kopp............. $955,000Kopp’s equity interest after admission.... × 30% Kopp’s equity after admission.................. $286,500
Contribution by Kopp................................. $310,000Kopp’s equity after admission.................. 286,500 Bonus paid to Dobbs and Fox................... $ 23,500
b. 2. Cash............................................................................. 175,000Dobbs, Member Equity............................................... 12,000Fox, Member Equity................................................... 18,000
Kopp, Member Equity........................................... 205,000
Supporting calculations for the bonus:
Equity of Dobbs.......................................... $308,000Equity of Fox............................................... 337,000Contribution by Kopp................................. 175,000 Total equity after admitting Kopp............. $820,000Kopp’s equity interest after admission.... × 25% Kopp’s equity after admission.................. $205,000Contribution by Kopp................................. 175,000 Bonus paid to Kopp................................... $ 30,000
a. J. Trifilio, Capital......................................................... 3,000K. Graham, Capital..................................................... 3,000
b. 1. Cash....................................................................... 50,000J. Trifilio, Capital................................................... 3,400K. Graham, Capital................................................ 3,400
L. Holden, Capital............................................ 56,800
Supporting calculations for the bonus:
Equity of Trifilio..................................................................... $ 87,000 Equity of Graham.................................................................. 147,000 Contribution by Holden........................................................ 50,000 Total equity after admitting Holden..................................... $284,000 Holden’s equity interest after admission............................ × 20% Holden’s equity after admission.......................................... $ 56,800 Contribution by Holden........................................................ 50,000 Bonus paid to Holden........................................................... $ 6,800
The bonus to Holden is debited equally between Trifilio’s and Graham’s capital accounts.
Equity of Trifilio..................................................................... $ 87,000 Equity of Graham.................................................................. 147,000 Contribution by Holden........................................................ 125,000 Total equity after admitting Holden..................................... $359,000 Holden’s equity interest after admission............................ × 30% Holden’s equity after admission.......................................... $107,700 Contribution by Holden........................................................ $125,000 Holden’s equity after admission.......................................... 107,700 Bonus paid to Trifilio and Graham...................................... $ 17,300
The bonus to Trifilio and Graham is credited equally between Trifilio’s and Graham’s capital accounts.
Ex. 12–16
ANGEL INVESTOR ASSOCIATESStatement of Partnership Equity
For the Year Ended December 31, 2008
TotalJan Lisa Sarah Partner-
Strous, Lankford, Rogers, shipCapital Capital Capital Capital
Equity of initial partners prior to admission.................. $120,000Contribution by Rogers................................................... 30,000 Total.................................................................................. $150,000Rogers’s equity interest after admission....................... × 20% Rogers’s equity after admission.................................... $ 30,000Contribution by Rogers................................................... 30,000 No bonus.......................................................................... $ 0
Net income distribution:
The income-sharing ratio is equal to the proportion of the capital balances after admitting Rogers according to the partnership agreement:
Jan Strous: = 24%
Lisa Lankford: = 56%
Sarah Rogers: = 20%
These ratios can be multiplied by the $115,000 remaining income ($140,000 – $25,000 salary allowance to Strous) to distribute the earnings to the respective partner capital accounts.
Withdrawals:
Half of the remaining income is distributed to the three partners. Strous need not take the salary allowance as a withdrawal but may allow it to accumulate in the member equity account.
Ex. 12–17
a. Merchandise Inventory................................................. 30,000Allowance for Doubtful Accounts.......................... 6,200Glenn Powell, Capital.............................................. 10,2001
a. The income-sharing ratio is determined by dividing the net income for each member by the total net income. Thus, in 2007, the income-sharing ratio is as follows:
Utah Properties, LLC: = 25%
Aztec Holdings, Ltd.: = 75%
Or a 1:3 ratio
b. Following the same procedure as in (a):
Utah Properties, LLC: = 20%
Aztec Holdings, Ltd.: = 65%
Cleveland Porter: = 15%
c. Cleveland Porter provided a $287,500 cash contribution to the business. The amount credited to his member equity account is this amount less a $20,000 bonus paid to the other two members, or $267,500.
Ex. 12–18 Concluded
d. The positive entries to Utah Properties and Aztec Holdings are the result of a bonus paid by Cleveland Porter.
e. Cleveland Porter acquired a 20% interest in the business, computed as fol-lows:
Cleveland Porter’s contribution......................... $ 287,500Utah Properties, LLC, member equity................ 530,000Aztec Holdings, Ltd., member equity................. 520 ,000 Total...................................................................... $1,337,500
Porter’s ownership interest after admission ($267,500 ÷ $1,337,500)........................................ 20.00%
Ex. 12–19
a.
Cash balance.................................................. $24,000Sum of capital accounts................................ 35,000 Loss from sale of noncash assets................ $ 11,000
Pitt Leon
Capital balances before realization.............. $15,000 $20,000b. Division of loss on sale of noncash assets 5,500 1 5,500 1
Balances.......................................................... $ 9,500 $14,500c. Cash distributed to partners......................... 9,500 14,500
Final balances................................................. $ 0 $ 0 1$11,000/2
Ex. 12–20
Boling Bishop
Capital balances before realization..................... $43,000 $57,000Division of loss on sale of noncash assets
[($100,000 – $76,000)/2].................................... 12,000 12,000 Capital balances after realization........................ $31,000 $45,000Cash distributed to partners................................ 31,000 45,000 Final balances....................................................... $ 0 $ 0
Ex. 12–21
a. Deficiency
b. $64,000 ($21,000 + $57,500 – $14,500)
c. Cash................................................................................ 14,500Shelby, Capital........................................................... 14,500
Mawby White Shelby
Capital balances after realization....... $21,000 $57,500 $(14,500) Dr.Receipt of partner deficiency............. 14,500 Capital balances after eliminating
Gilley, Member Equity.................................................... 27,000Hughes, Member Equity................................................. 62,000Moussa, Member Equity................................................ 36,000
(1) Income Summary............................................................ 180,000Dal Polivka, Capital.................................................... 90,000Amanda Pratt, Capital................................................ 90,000
(2) Dal Polivka, Capital......................................................... 65,000Amanda Pratt, Capital..................................................... 76,000
Dal Polivka, Drawing.................................................. 65,000Amanda Pratt, Drawing.............................................. 76,000
b.POLIVKA AND PRATT
Statement of Partners’ EquityFor the Year Ended December 31, 2008
Dal Amanda Polivka Pratt Total
Capital, January 1, 2008................................. $105,000 $135,000 $240,000Additional investment during the year......... 15,000 — 15,000
$120,000 $135,000 $255,000Net income for the year.................................. 90,000 90,000 180,000
$210,000 $225,000 $435,000Withdrawals during the year......................... 65,000 76,000 141,000 Capital, December 31, 2008........................... $145,000 $149,000 $294,000
Ex. 12–27
a. Revenue per professional staff, 2004: = $301,000
Revenue per professional staff, 2005: = $296,000
b. The revenues increased between the two years from $6,876 million to $7,814 million, or 13.6% [($7,814 – $6,876)/$6,876]. Revenue growth has been strong, mostly resulting from Sarbanes-Oxley work. However, the number of employ-ees has grown at a faster rate, from 22,841 to 26,401, or 15.6% [(26,401 – 22,841)/22,841]. As a result, the revenue per professional staff employee has dropped from $301,000 to $296,000. This slight loss in efficiency is probably to be expected. Public accounting firms have had difficulty finding employees for the emerging Sarbanes-Oxley work. From 2004 to 2005, they have aggres-sively hired employees to bring the workforce in line with the demand for work. Prior to this time, the firm was relying heavily on overtime.
Ex. 12–28
a. Revenue per employee, 2007: = $125,000
Revenue per employee, 2008: = $100,000
b. Revenues increased between the two years; however, the number of employ-ees has increased at a faster rate. Thus, the revenue per employee declined from $125,000 in 2007 to $100,000 in 2008. This indicates that the efficiency of the firm has declined in the two years. This is likely the result of the expan-sion. That is, the large increase in the employment base is the likely result of the expansion into the four new cities. These new employees may need to be trained and thus are not as efficient in their jobs as the more experienced em-ployees in the existing cities. Often, a business will suffer productivity losses in the midst of significant expansion because of the inexperience of the new employees.
PROBLEMS
Prob. 12–1A
1.
May 1 Cash...................................................................... 16,500Merchandise Inventory........................................ 43,500
Total expenses............................................................ 167,450 Net income............................................................................. $130,000
Peter May Sato Koening Total
Division of net income:Salary allowance........................................ $ 40,000 $ 50,000 $ 90,000Interest allowance...................................... 9,500* 5,700** 15,200Remaining income...................................... 12,400 12,400 24,800
Net income....................................................... $ 61,900 $ 68,100 $ 130,000
*$95,000 × 10%**($65,000 – $8,000) × 10%
2.SATO AND KOENING
Statement of Partners’ EquityFor the Year Ended December 31, 2008
Peter May Sato Koening Total
Capital, January 1, 2008.................................. $ 95,000 $ 57,000 $ 152,000Additional investment during the year.......... — 8,000 8,000
$ 95,000 $ 65,000 $ 160,000Net income for the year................................... 61,900 68,100 130,000
$ 156,900 $ 133,100 $ 290,000Withdrawals during the year........................... 50,000 70,000 120,000 Capital, December 31, 2008............................. $ 106,900 $ 63,100 $ 170,000
Total liabilities.................................................. $ 4,100
Partners’ Equity
Peter Sato, capital............................................ $ 106,900May Koening, capital....................................... 63,100 Total partners’ equity...................................... 170,000 Total liabilities and partners’ equity............... $ 174,100
Carol Grigg, capital.......................................... 85,0002
Sara Culver, capital......................................... 80,000 Total partners’ equity...................................... 332,000 Total liabilities and partners’ equity............... $364,0001$100,000 + $67,0002$73,000 + $67,000 – $55,000
Prob. 12–5A
1.DANIELS, BURTON, AND RAMARIZ
Statement of Partnership LiquidationFor Period July 3–29, 2008
2. The $3,000 deficiency of Burton would be divided between the other partners, Daniels and Ramariz, in their income-sharing ratio (2:1, respectively). Therefore, Daniels would absorb 2/3 of the $3,000 deficiency, or $2,000, and Ramariz would absorb 1/3 of the $3,000 deficiency, or $1,000.
Prob. 12–6A
1.ALLEN, DEE, AND ITO
Statement of Partnership LiquidationFor Period October 1–30, 2008
Capital
Noncash Allen Dee ItoCash + Assets = Liabilities + (2/5) + (2/5) + (1/5)
Balances before realization.............. $ 13,000 $ 179,000 $ 50,000 $ 55,000 $ 75,000 $ 12,000Sale of assets and division
Total expenses.......................................................... 335,000 Net income............................................................................ $ 130,000
Dan Ron Warrick Murphy Total
Division of net income:Salary allowance........................................ $ 40,000 $ 50,000 $ 90,000Interest allowance...................................... 11,400* 14,400** 25,800Remaining income...................................... 7,100 7,100 14,200
Net income....................................................... $ 58,500 $ 71,500 $ 130,000
*$95,000 12%**($140,000 – $20,000) 12%
2.WARRICK AND MURPHY
Statement of Partners’ EquityFor the Year Ended December 31, 2008
Dan Ron Warrick Murphy Total
Capital, January 1, 2008.................................. $ 95,000 $ 120,000 $ 215,000Additional investment during the year.......... — 20,000 20,000
$ 95,000 $ 140,000 $ 235,000Net income for the year................................... 58,500 71,500 130,000
$ 153,500 $ 211,500 $ 365,000Withdrawals during the year........................... 45,000 50,000 95,000 Capital, December 31, 2008............................. $ 108,500 $ 161,500 $ 270,000
Total liabilities.................................................. $ 5,600
Partners’ Equity
Dan Warrick, capital........................................ $108,500Ron Murphy, capital........................................ 161,500 Total partners’ equity...................................... 270,000 Total liabilities and partners’ equity............... $275,600
Prob. 12–4B
1. May 31 Asset Revaluations.................................... 3,300Accounts Receivable............................ 2,500Allowance for Doubtful Accounts....... 800*
2. The $1,200 deficiency of Newby would be divided between the other partners, Nichols and Patel, in their in-come-sharing ratio (1:2 respectively). Therefore, Nichols would absorb 1/3 of the $1,200 deficiency, or $400.00, and Patel would absorb 2/3 of the $1,200 deficiency, or $800.00.
Prob. 12–6B
1.STREET, RHODES, AND FLYNN
Statement of Partnership LiquidationFor Period June 3–29, 2008
This scenario highlights one of the problems that arises in partnerships: attempt-ing to align contribution with income division. Often, disagreements are based upon honest differences of opinion. However, in this scenario, there is evidence that Tate was acting unethically. Tate apparently made no mention of his plans to “scale back” once the partnership was consummated. As a result, Crowe agreed to an equal division of income based on the assumption that Tate’s past efforts would project into the future, while in fact, Tate had no intention of this. As a result, Crowe is now providing more effort, while receiving the same income as Tate. This is clearly not sustainable in the long term. Tate does not appear to be concerned about this inequity. Thus, the evidence points to some duplicity on Tate’s part. Essentially, he knows that he is riding on Crowe’s effort and had planned it that way.
Crowe could respond to this situation by either withdrawing from the partnership or changing the partnership agreement. One possible change would be to provide a partner salary based on the amount of patient billings. This salary would be highly associated with the amount of revenue brought into the partnership, thus avoiding disputes associated with unequal contribution to the firm.
SA 12–2
A good solution to this problem would be to divide income in three steps:
1. Provide interest on each partner’s capital balance.
2. Provide a monthly salary for each partner.
3. Divide the remainder according to a partnership formula.
With this approach, the return on capital and effort will be separately calculated in the income division formula before applying the percentage formula. Thus, Wise will receive a large interest distribution based on the large capital balance, while Sanchez should receive a large salary distribution based on the larger service contribution. The return on capital and salary allowances should be based on pre-vailing market rates. If both partners are pleased with their return on capital and effort, then the remaining income could be divided equally among them.
*Revenue per partner is determined by dividing the total revenue by the num-ber of partners for each firm, adjusting the revenues for the fact that they are expressed in millions in the table. Revenue per partner is determined as fol-lows:
Deloitte & Touche revenue per partner: = $2,677,570
**Likewise, the revenue per professional staff is determined by dividing the to-tal revenue by the number of professional staff, adjusting the revenues for the fact that they are expressed in millions in the table. Revenue per profes-sional staff is determined as follows:
Deloitte & Touche revenue per professional staff: = $339,170
b. The amount earned per partner is not significantly different between the four firms. Ernst & Young has the highest revenue per partner, while Pricewater-houseCoopers (PWC) has the lowest. PWC’s revenue per partner is about 14% below the highest revenue per partner firm, Ernst & Young [$2,755,500 – $2,358,636)/$2,755,500]. The revenue per professional staff is significantly lower for PWC. PWC revenue per professional staff member is 29% below the highest revenue per professional firm, KPMG LLP [($346,789 – $244,649)/$346,789]. Indeed, PWC appears to be somewhat of an outlier in its revenue earned per professional staff. Together these data indicate that PWC may not be operat-ing its firm as efficiently as the other three firms. The mix of services offered by the firms does not appear to impact these numbers. It is interesting to note that only Deloitte & Touche is significantly more involved in management ad-visory services (MAS) than the other three firms. The other three firms have sold their MAS operations in order to better conform to the Sarbanes-Oxley Act, which prohibited audit clients from using MAS services from the same firm. Deloitte & Touche has decided not to sell its consulting practice.
SA 12–4
a. A key distinction between a partnership and a corporation is that all of the partners (owners) are not only investors but also work in the partnership. The partners provide both capital and “sweat equity.” This is a key distinction that provides insight about the performance of the firm. The expected income from the partnership is given as the country average, or $260,000.
The following is what each partner actually earned from the partnership.
Allocation of partnership income ($44,000,000 ÷ 200 partners) = $220,000 per partner
Note that the partners’ earnings are less than what might be expected from the expected, or average, income. Thus, the partnership has performed below the partners’ expectations.
b. The income statement indicates some large litigation losses. These losses appear to be the major reason for the partnership’s poor performance. With-out the losses, the partnership net income allocation would have been $295,000 [($44,000,000 + $15,000,000) ÷ 200]. The $295,000 exceeds the mar-ket-based compensation of $260,000 per year. In addition, the staff profes-sional salaries of $80,000 per year ($120,000,000 ÷ 1,500) is slightly higher than average ($75,000). This would also have led to a smaller income to the partners than might have been expected.
SA 12–5
When developing an LLC (or partnership), the operating (or partnership) agree-ment is a critical part of establishing a business. Each party must consider the various incentives of each individual in the LLC. For example, in this case, one party, Dave Lester, is providing all of the funding, while the other two parties are provid-ing expertise and talent. This type of arrangement can create some natural conflicts because the interests of an investor might not be exactly the same as those oper-ating the LLC. Specifically, you would want to advise Lester that not all matters should be settled by majority vote. Such a provision would allow the two nonin-vesting members to vote as a block to the detriment of Lester. For example, the salaries for the two working members could be set by their vote, so that little profit would be left to be distributed. This would essentially keep Lester’s return limited to the 10% preferred return. Lester should insist that salary allowances require unanimous approval of all members.
A second issue is the division of partnership income. The suggested agreement is for all the partners to share the remaining income, after the 10% preferred re-turn, equally. Lester should be counseled to consider all aspects of the LLC con-tribution to determine if this division is equitable. There are many considerations including the amount of investment, risk of the venture, degree of expertise of noninvesting partners, and degree of exclusivity of noninvesting members’ effort contribution (unique skills or business connections, for example). Often, the sim-ple assumption of equal division is not appropriate.
In addition, it is sometimes best to require even working members to have an in-vestment in the LLC, even if it is small, so that they are sensitive to the perspec-tive of financial loss.