ACCOUNTING FOR PARTNERSHIPS AND LIMITED LIABILITY COMPANIES
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.
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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.
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