Accountants’ Handbook Special Industries and Special Topics 10th Edition_16

Chia sẻ: Up Up | Ngày: | Loại File: PDF | Số trang:43

Thêm vào BST

Báo xấu

51
lượt xem 7
download

Download Vui lòng tải xuống để xem tài liệu đầy đủ

Tham khảo tài liệu 'accountants’ handbook special industries and special topics 10th edition_16', tài chính - ngân hàng, kế toán - kiểm toán phục vụ nhu cầu học tập, nghiên cứu và làm việc hiệu quả

Chủ đề:

Bình luận(0) Đăng nhập để gửi bình luận!

Lưu

Nội dung Text: Accountants’ Handbook Special Industries and Special Topics 10th Edition_16

40.2 ACCOUNTING FOR PARTNERSHIP OPERATIONS 40 9 • before deducting partners’ salaries; partners’ salaries are treated as a means of dividing partner- ship income.”5 Dixon, Hepworth, and Paton, on the other hand, indicate that the interpretation of partners’ salaries should vary with the circumstances: Where there are a substantial number of partners, and salaries are allowed to only one or two mem- bers who are active in administration, there is practical justiﬁcation for treating such salaries as oper- ating charges closely akin to the cost of services furnished by outsiders. This is especially defensible where the salaries are subject to negotiation from period to period and are in no way dependent upon the presence of net earnings. Where there are only two partners, and both capital investments and contributions of services are substantially equal, there is less need for salary adjustments; if “salaries” are allowed in such a situation it would seem to be reasonable to interpret them as prelim- inary distributions of net income—an income derived from a coordination of capital and personal ef- forts in a business venture. Between these two extremes there lies a range of less clear-cut cases . . . .6 (iii) Bonuses. Where a particular partner furnishes especially important services, the device of a bonus—usually expressed as a percentage of net income—may be employed as a means of provid- ing additional compensation. The principal question that arises in such cases is the interpretation of the bonus in relation to the ﬁnal net amount to be distributed according to the regular income ratio, as illustrated in the following example. Stark and Bruch share proﬁts equally. Per the partnership agreement, Bruch is to receive a bonus of 20% of the net income of the ﬁrm, before allowing the bonus, for special services to the ﬁrm. If in a particular year the credit balance of the expense and revenue account is $27,000 before allowing the bonus, proﬁts are divided as follows: Stark Bruch Total Bonus, 20% of $27,000 $05,400 $05,400 Balance equally $10,800 $10,800 $21,600 $10,800 $16,200 $27,000 If the bonus is to be treated as an expense item in the computation of the ﬁnal net income, the $27,000 credit balance of the expense and revenue account represents both the bonus and the ﬁnal net income. Hence the $27,000 is 120% of the net income, and the net income is 100%, or $22,500. Under this method the proﬁts are divided as follows: Stark Bruch Total Bonus, 20% of $22,500 $04,500 $04,500 Balance equally $11,250 $11,250 $22,500 $11,250 $15,750 $27,000 (iv) Debtor–Creditor Relationship. At times, when a partnership is formed, a partner may not be interested in investing more than a certain amount of assets on a permanent basis. He, therefore, may make an advance to the partnership that is viewed as a loan rather than an increase in his capi- tal account. The ﬁrm may thus obtain the initial ﬁnancing it needs without having to negotiate with an outside source on less favorable terms. The loan may be interest bearing and may be repayable in installments. As noted by Meigs, Johnson, and Keller (1966), interest charges on such loans 5 Norman M. Bedford, Introduction to Modern Accounting (Ronald Press, New York, 1962). 6 Robert L. Dixon, Samuel R. Hepworth, and William A. Paton, Jr., Essentials of Accounting (Macmillan, New York, 1966).
40 10 PARTNERSHIPS AND JOINT VENTURES • should be treated as an expense of the partnership, and the loan itself should be disclosed clearly as a liability of the ﬁrm. Occasionally, a partner may withdraw a sum from the partnership. This type of transaction should be treated in the manner dictated by the circumstances. If the loan is material relative to the partner’s net personal assets, if no repayment terms are stipulated, and if the loan has been long outstanding, the loan is, in effect, a withdrawal and should be viewed as a contraction of the ﬁrm’s capital. If, on the other hand, the partner has every intention of repaying the sum, the loan may be regarded as a valid receivable. (v) Landlord–Tenant Relationship. In some cases, a partner may rent property from or to the partnership. Transactions of this type should be handled exactly as rental agreements with others are handled. The only possible difference in recording this type of event would ﬁnd the rent receivable from a partner being debited to his drawing or capital account instead of to a “rent receivable” account. If the rent was owed to the partner, the payable could be recorded as a credit to either the partner’s drawing or capital account. To minimize the possibility of confu- sion, it is preferable to record rental transactions with partners in the same manner as other rental agreements. (vi) Statement Presentation. Receivables and payables arising out of transactions between a partner and the ﬁrm of which he is a partner should be classiﬁed in the balance sheet in the same manner as are receivables and payables arising out of transactions with nonpartners. However, any such receivables and payables included in the balance sheet should be set forth separately; they should not be combined with other receivables and payables. SFAS No. 57 indicates that receivables or payables involving partners stem from a related party transaction and, as such, if material, should be disclosed in such a way as to include these four: 1. The nature of the relationship(s) involved 2. A description of the transactions including transactions to which no amounts or nominal amounts were ascribed, for each of the periods for which income statements are presented, and such other information deemed necessary to an understanding of the effects of the trans- action on the ﬁnancial statements 3. The dollar amounts of transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period 4. Amounts due from or to related parties as of the date of each balance sheet presented and, if not otherwise apparent, the terms and manner of settlement7 (e) CLOSING OPERATING ACCOUNTS. The operating accounts are closed to the expense and revenue account in the usual manner. That account is then closed by crediting each partner’s capital account with his share of the net income or debiting it with his share of the net loss. The drawing ac- count of each partner is then closed to the respective capital account. (i) Division of Proﬁts Illustrated. The articles of copartnership of (the ﬁctitious ﬁrm of) Ahern and Ciecka include the following provisions as to distribution of proﬁts: Partners’ loans. Loans made by partners to the ﬁrm shall draw interest at the rate of 6% per annum. Such interest shall be computed only on December 31 of each year regardless of the pe- riod in which the loan was in effect. 7 Financial Accounting Standards Board, “Related Party Disclosures,” Statement of Financial Accounting Standards No. 57, FASB, Stamford, CT, 1982.
40.2 ACCOUNTING FOR PARTNERSHIP OPERATIONS 40 11 • Partners’ salaries. On December 31 of each year, salaries shall be allowed by a charge to the ex- pense and revenue account and credits to the respective drawing accounts of the partners at the following amounts per annum: Ahern $14,400; Ciecka, $12,000. Partners’ salaries are to be al- lowed whether or not earned. Interest on partners’ invested capital. Each partner is to receive interest at the rate of 6% per annum on the balance of his capital account at the beginning of the year. Such interest is to be al- lowed whether or not earned. Remainder of proﬁt or loss. The balance of net income after provision for salaries, interest on loans, and interest on invested capital is to be divided equally. Any loss resulting after provision for the above items is to be divided equally. On December 31, the books of the partnership show the following balances before recognition of in- terest and salary adjustments: Sundry assets $309,000 Sundry liabilities $066,000 Ahern, capital $120,000 Ahern, drawings $015,000 Ciecka, capital $060,000 Ciecka, drawings $009,000 Ciecka, loan $030,000 Expense and revenue $000,000 $057,000 $333,000 $333,000 Balances of the capital accounts on January 1 were: Ahern $105,000; Ciecka $48,000. The loan from Ciecka was made on April 1. Division of proﬁts is as shown in Exhibit 40.1. (ii) Statement of Partners’ Capitals Illustrated. Formal presentation of the activity of the partners’ capital accounts is often made through the statement of partners’ capitals (Ex- hibit 40.2). (f) INCOME TAXES. According to Hoffman: Unlike corporations, estates, and trusts, partnerships are not considered separate taxable enti- ties. Instead, each member of a partnership is subject to income tax on their distributive share of the partnership’s income, even if an actual distribution is not made. (Section 701 of Sub- chapter K of the 1954 Code contains the statutory rule that the partners are liable for income tax in their separate or individual capacities. The partnership itself cannot be subject to the in- come tax on its earnings.) Thus, the tax return (Form 1065) required of a partnership serves AHERN AND CIECKA, PARTNERSHIP Schedule of Division of Net Income For the year ended December 31, 20XX Total Ahern Ciecka Interest on loan $01,350 $01,350 Interest on capital 9,180 $6,300 2,880 Salaries allowed 26,400 14,400 12,000 Remainder—equally $20,070 $10,035 $10,035 Proﬁt earned $57,000 $30,735 $26,265 Exhibit 40.1 Division of proﬁts.
40 12 PARTNERSHIPS AND JOINT VENTURES • AHERN AND CIECKA, PARTNERSHIP Statement of Partners’ Capitals For the year ended December 31, 20XX Total Ahern Ciecka Balances: January 1 $153,000 $105,000 $48,000 Add: additional investments 27,000 15,000 12,000 net income for year—per schedule $057,000 $030,735 $26,265 Total $237,000 $150,735 $86,265 Less: withdrawals $024,000 $015,000 $09,000 Investment, December 31 $213,000 $135,735 $77,265 Exhibit 40.2 Sample statement of partners’ capitals. only to provide information necessary in determining the character and amount of each part- ner’s distributive share of the partnership’s income and expense.8 Some states, however, impose an unincorporated business tax on a partnership that for all practical purposes is an income tax. 40.3 ACCOUNTING FOR CHANGES IN FIRM MEMBERSHIP (a) EFFECT OF CHANGE IN PARTNERS. From a legal point of view, the withdrawal of one or more partners or the admission of one or more new members has the effect of dissolving the original partnership and bringing into being a new ﬁrm. This means that the terms of the original agreement as such are not binding on the successor partnership. As far as the continuity of the business enterprise is concerned, on the other hand, a change in ﬁrm membership may be of only nominal importance; with respect to character of the business, operating policies, relations with customers, and so on, there may be no substantial difference between the new ﬁrm and its predecessor. To determine the value of the equity of a retiring partner or the amount to be paid for a speciﬁed share by an incoming partner, a complete inventory and valuation of ﬁrm resources may be required. Estimation of interim proﬁts and unrealized proﬁts on long-term contracts may be involved. In any event, there should be a careful adjustment of partners’ equities in accordance with the new relation- ships established. A withdrawing partner may continue to be liable for the ﬁrm’s obligation incurred prior to his withdrawal unless the settlement includes speciﬁc release therefrom by the continuing partners and by the creditors. A person admitted as a partner into an existing partnership is liable for all the obligations of the partnership arising before his admission as if he had been a partner when such obligations were in- curred, except that this liability shall be satisﬁed only out of partnership property. (b) NEW PARTNER PURCHASING AN INTEREST. It is possible for a party to acquire the inter- est of a partner without becoming a partner. A member of a partnership may sell or assign his interest, but unless this has received the unanimous approval of the other partners, the purchaser does not be- come a partner; one partner cannot force his copartners into partnership with an outsider. Under the Uniform Partnership Act, the buyer in such a case acquires only the seller’s interest in the proﬁts and losses of the ﬁrm and, upon dissolution, the interest to which the original partner would have been en- 8 William H. Hoffman, Jr., ed., West’s Federal Taxation: Corporations, Partnerships, Estates and Trusts (West, St. Paul, MN, 1978).
40.3 ACCOUNTING FOR CHANGES IN FIRM MEMBERSHIP 40 13 • titled. He has no voice in management, nor may he obtain an accounting except in case of dissolution of the business; ordinarily he can make no withdrawal of capital without the consent of the partners. To illustrate some of the possibilities in connection with purchase of an interest, assume that the ﬁrm of Hirt, Thompson, and Pitts negotiates with Davis for the purchase of a capital interest. Data are as follows: Capital Accounts Income Ratio Hirt $20,000 50% Thompson 12,000 40% Pitts 8,000 10% $40,000 100% (i) Purchase at Book Value. If Davis purchases a one-fourth interest for $10,000, it is clear that he is paying exactly book value, and the entry would be: Hirt, capital $5,000 Thompson, capital $3,000 Pitts, capital $2,000 Davis, capital $10,000 The cash payment would be divided in the same manner (i.e., Hirt $5,000, Thompson $3,000, and Pitts $2,000) and would pass directly from Davis to them without going through the ﬁrm’s cash account. (ii) Purchase at More than Book Value. Assume now that Davis agrees to pay $12,000 for a one-fourth interest; this is more than book value. In general, two solutions are possible. Bonus Method. Under this method, the extra $2,000 paid by Davis is considered to be a bonus to Hirt, Thompson, and Pitts and is shared by them in the income ratio. The entry is: Hirt, capital $5,000 Thompson, capital $3,000 Pitts, capital $2,000 Davis, capital $10,000 The cash payment of $12,000 is divided as follows: Hirt Thompson Pitts Total Capital transferred $5,000 $3,000 $2,000 $10,000 Premium—in income ratio $1,000 $0,800 $0,200 $02,000 Cash received $6,000 $3,800 $2,200 $12,000 Goodwill Method. That Davis is willing to pay $12,000 for a one-fourth interest indicates that the business is worth $48,000. Existing assets are therefore undervalued by $8,000. Under the goodwill or revaluation of assets method, if speciﬁc assets can be revalued, this should be done. If not, or if the agreed revaluation is less than $8,000, the difference may be assumed to be goodwill. Dividing the gain in the income ratio results in this entry: Sundry assets and/or goodwill $8,000 Hirt, capital $4,000 Thompson, capital $3,200 Pitts, capital $4,800
40 14 PARTNERSHIPS AND JOINT VENTURES • The entry to record Davis’s admission would then be: Hirt, capital $6,000 Thompson, capital $3,800 Pitts, capital $2,200 Davis, capital $12,000 The cash payment will be received in amounts equal to the transfer from the capital accounts. (iii) Purchase at Less than Book Value. Assume next that Davis agrees to pay only $9,000 for a one-fourth interest—that is, less than book value. Again two solutions are possible. Bonus Method. Under this method, the same transfers are made from the three partners to Davis’s capital account as if he had paid book value, but the difference of $1,000 is apportioned to determine the cash settlement, as follows: Hirt Thompson Pitts Total Capital transferred $5,000 $3,000 $2,000 $10,000 Loss—in income ratio $0,500 $0,400 $0,100 $01,000 Cash received $4,500 $2,600 $1,900 $09,000 Revaluation of Assets Method. This approach reasons that a price of $9,000 for a one-fourth in- terest indicates that the business is worth $36,000 and that assets should be revalued downward by $4,000. Where a portion of the write-down can be identiﬁed with speciﬁc tangible assets, the ap- propriate accounts should be adjusted. Otherwise, existing goodwill should be included in the write-down. (1) Hirt, capital $2,000 Thompson, capital $1,600 Pitts, capital $2,400 Sundry, assets and/or goodwill $4,000 (2) Hirt, capital $4,500 Thompson, capital $2,600 Pitts, capital $1,900 Davis, capital $9,000 (c) NEW PARTNER’S INVESTMENT TO ACQUIRE AN INTEREST. The admission of a new partner when he makes an investment in the ﬁrm to acquire a capital interest is illustrated by the fol- lowing cases. Assume that the capital account balances of the partnership of Andrews and Bell prior to the ad- mission of Cohen are: Capital Accounts Income Ratio Andrews $18,000 60% Bell $12,000 040% $30,000 100%
40.3 ACCOUNTING FOR CHANGES IN FIRM MEMBERSHIP 40 15 • (i) Investment at Book Value. If Cohen invests $10,000 in the ﬁrm for a one-fourth interest, the entry is: Cash (or other assets) $10,000 Cohen, capital $10,000 (ii) Investment at More than Book Value. If Cohen is willing to invest $14,000 for a one-fourth interest, the total capital will be $44,000. Bonus Method. Under this method, Cohen’s share is one-fourth or $11,000, and the $3,000 pre- mium is treated as a bonus to the old partners by the entry: Cash (or other assets) $14,000 Andrews, capital $01,800 Bell, capital $01,200 Cohen, capital $11,000 Goodwill Method. If Cohen invests $14,000 for a one-fourth interest, it would seem that the total worth of the ﬁrm should be $56,000. Since total capital is $44,000, under the goodwill or revaluation of assets method, there is justiﬁcation in assuming that existing assets are undervalued to the extent of $12,000. Circumstances may indicate that the $12,000 undervaluation is in the form of goodwill. If it is to be recognized, the entries are as follows: (1) Goodwill $12,000 Andrews, capital $07,200 Bell, capital $04,800 (2) Cash $14,000 Cohen, capital $14,000 If the understatement of the capital of the old partners was attributable to excessive depreciation allowances, land appreciation, an increase in inventory value, or some combination of such fac- tors, an appropriate adjustment of the asset or assets involved would be substituted for the charge to “goodwill.” (iii) Investment at Less than Book Value Bonus Method. If Cohen invests $8,000 for a one-fourth interest, it may indicate the willingness of the old partners to give Cohen a bonus to enter the ﬁrm. Since the total capital is now $38,000, a one-fourth interest is $9,500 and the entry is: Cash $8,000 Andrews, capital $8,900 Bell, capital $8,600 Cohen, capital $9,500 Revaluation of Assets Method. Under this method, the investment by Cohen of only $8,000 for a one-fourth interest may be taken to mean that the existing net assets are worth only $24,000. The overvaluation of $6,000 could be corrected by crediting the overvalued assets and charging Andrews and Bell in the income ratio.
40 16 PARTNERSHIPS AND JOINT VENTURES • (1) Andrews, capital $3,600 Bell, capital $2,400 Sundry assets $6,000 (2) Cash $8,000 Cohen, capital $8,000 Goodwill Method. A third method sometimes offered to handle this situation is the goodwill method, which assumes that the new partner contributes goodwill (of $2,000 in this case) in addition to the cash and is credited for the amount of his interest at book value ($10,000 in this case). This seems illogical, however, since it contradicts the original fact that Cohen’s investment was to be $8,000. (d) SETTLING WITH WITHDRAWING PARTNER THROUGH OUTSIDE FUNDS. The with- drawal of a partner where settlement is effected by payments made from personal funds of the re- maining partners directly to the retiring partner is illustrated by the ﬁrm of Adams, Bates, & Caldwell: Capital Balances Income Ratio Adams $30,000 50% Bates 24,000 30% Caldwell $16,000 020% $70,000 100% (i) Sale at Book Value. If Caldwell retires, selling his interest at book value to the other partners in their income ratio and receiving payment from outside funds of Adams and Bates, the entry is: Caldwell, capital $16,000 Adams, capital $10,000 Bates, capital $16,000 The total payment to Caldwell is $16,000, and payments by Adams and Bates are $10,000 and $6,000, respectively. (ii) Sale at More than Book Value. If payment to Caldwell exceeds book value, either the bonus or the goodwill method may be used. Bonus Method. If total payment to Caldwell is $18,000, the premium of $2,000 may be treated as a bonus to Caldwell. The entry to record the withdrawal of Caldwell is the same as above, and pay- ment would be as follows: Adams Bates Total Capital per books $10,000 $6,000 $16,000 Premium paid $01,250 $0,750 $02,000 Cash required $11,250 $6,750 $18,000 Goodwill Method. In the following situation, Adams and Bates are willing to pay a total of $2,000 more than book value for Caldwell’s interest. Since the latter receives 20% of the proﬁts, this implies that assets are undervalued by $10,000. Under the goodwill or revaluation of assets method, all or part of this amount may be goodwill. The entries to record this situation are:
40.3 ACCOUNTING FOR CHANGES IN FIRM MEMBERSHIP 40 17 • (1) Goodwill or sundry assets $10,000 Adams, capital $05,000 Bates, capital $03,000 Caldwell, capital $02,000 (2) Caldwell, capital $18,000 Adams, capital $11,250 Bates, capital $06,750 (iii) Sale at Less than Book Value. If Caldwell should agree to accept $15,000 for his interest, this is $1,000 less than book value. Bonus Method. The $1,000 may be considered to be a bonus to Adams and Bates. The entry would be the same as in the ﬁrst example, but the cash payments would be calculated as follows: Adams Bates Total Capital, per books $10,000 $6,000 $16,000 Less discount allowed $00,625 $0,375 $01,000 Cash required $09,375 $5,625 $15,000 Revaluation of Assets Method. In this example, it can be argued under the revaluation of assets approach that the discount of $1,000 for a 20% share in ﬁrm proﬁts implies an overstatement of book values of assets by $5,000. If this correction is to be made, the entries to adjust the books and record the subsequent withdrawal of Caldwell are: (1) Adams, capital $12,500 Bates, capital $11,500 Caldwell, capital $11,000 Sundry assets $5,000 (2) Caldwell, capital $15,000 Adams, capital $9,375 Bates, capital $5,625 In preceding examples, the so-called bonus method and revaluation of assets method have been presented as alternatives. Although each method results in different capital account balances in the new ﬁrm that comes into being, it should be observed that the partners in the new ﬁrm are treated rel- atively the same under either method. This is subject to the basic qualiﬁcation that the old partners who remain in the new ﬁrm must continue to share proﬁts and losses as between themselves in the same ratio as before. (e) SETTLEMENT THROUGH FIRM FUNDS. The withdrawal of a partner where settlement is to be made from funds of the business is illustrated by the ﬁrm of Arnold, Brown & Cline. Capital Balances Income Ratio Arnold $040,000 30% Brown 50,000 30% Cline $060,000 40% $150,000 100%
40 18 PARTNERSHIPS AND JOINT VENTURES • (i) Premium Paid to Retiring Partner. Payment is to be made to Cline from the assets of the part- nership. Payment is $64,000, to be made one-half in cash and the balance in notes payable. Under one treatment, the premium of $4,000 is viewed as chargeable to the remaining partners in their in- come ratio. The entry is: Arnold, capital $02,000 Brown, capital $02,000 Cline, capital $60,000 Cash $32,000 Notes payable $32,000 A second method treats the $4,000 premium as payment for Cline’s share of the unrecognized good- will of the ﬁrm. The following entry would be made: Goodwill $04,000 Cline, capital 060,000 Cash $32,000 Notes payable $32,000 A third possibility for recording the retirement of Cline is to recognize a total goodwill or asset revaluation implied by the premium paid for the retiring partner’s share. Since a $4,000 pre- mium was paid for a 40% share, total implied goodwill or asset revaluation is $10,000, and the en- tries are: (1) Goodwill or sundry assets $10,000 Arnold, capital $33,000 Brown, capital $33,000 Cline, capital $34,000 (2) Cline, capital $64,000 Cash $32,000 Notes payable $32,000 Many accountants are inclined to approve of the ﬁrst treatment on the grounds that it is “conservative.” Meigs, Johnson, and Keller state that it is “consistent with the current trend toward viewing a partnership as a continuing business entity, with asset valuations and ac- counting policies remaining undisturbed by the retirement of a partner.”9 The second treat- ment is supported by reference to the rule that it is proper to set up goodwill only when it has been purchased. The third interpretation relies on the idea that it is inconsistent to recognize the existence of an intangible asset and then to record it at only a fraction of the proper amount. The accountant may distinguish between a payment for goodwill and one that represents a partner’s share of the increase in value of one or more of the ﬁrm’s assets. In the latter case, it is generally not reasonable to record only the increase attaching to the retiring partner’s equity. Suppose, for example, that an inventory of merchandise has a market value on the date of set- tlement substantially above book value. Clearly, the most appropriate treatment here is that under which the inventory is adjusted to market value—the value at which it is in effect acquired by the new ﬁrm; to add to book value only the withdrawing partner’s share of the 9 Walter B. Meigs, Charles E. Johnson, and Thomas F. Keller, Advanced Accounting (McGraw-Hill, New York, 1966).
40.3 ACCOUNTING FOR CHANGES IN FIRM MEMBERSHIP 40 19 • increase would result in ﬁgures unsatisfactory from the standpoint both of ﬁnancial accounting and operating procedure. (ii) Discount Given by Retiring Partner. Assuming that Cline receives $57,000 for his interest in the ﬁrm and payment is made by equal amounts of cash and notes payable, two possible account- ing treatments are available. First, the discount of $3,000 may be credited to the remaining partners in their income ratio: Cline, capital $60,000 Cash $28,500 Notes payable $28,500 Arnold, capital $21,500 Brown, capital $21,500 In the second method, the implied overvaluation of assets is recognized. Since Cline’s share (40%) was purchased at a discount of $3,000, the total overvaluation of ﬁrm assets may be consid- ered as $7,500. The following entries are made: (1) Arnold, capital $52,250 Brown, capital $52,250 Cline, capital $53,000 Sundry assets $57,500 (2) Cline, capital $57,000 Cash $28,500 Notes payable $28,500 (f) ADJUSTMENT OF CAPITAL RATIOS. Circumstances may arise in partnership affairs when it becomes desirable to adjust partners’ capital account balances to certain ratios—most often the in- come ratio. This may happen in connection with the admission of a new partner, the withdrawal of a partner, or at some time when no change in personnel has occurred. Only a simple case involving a continuing ﬁrm is illustrated here. Assume the following data for the ﬁrm of Emmett, Frye, and Gable: Capital Balances Income Ratio Emmett $50,000 50% Frye 25,000 30% Gable $15,000 020% $90,000 100% If the partners wish to adjust their capital balances to the income ratio without changing total capital, it is obvious that Frye should pay $2,000 and Gable $3,000 directly to Emmett and that the entry should be: Emmet, capital $5,000 Frye, capital $2,000 Gable, capital $3,000 Adjustment of the capital balances to the income ratio by the minimum additional investment into the ﬁrm (as distinguished from the preceding personal settlement) could, of course, be effected by the additional investment of $5,000 each by Frye and Gable.
40 20 PARTNERSHIPS AND JOINT VENTURES • 40.4 INCORPORATION OF A PARTNERSHIP According to Meigs, Johnson, and Keller: Most successful partnerships give consideration at times to the possible advantages to be gained by incorporating. Among the advantages are limited liability, ease of attracting outside capital without loss of control, and possible tax savings. A new corporation formed to take over the assets and liabilities of a partnership will usually sell stock to outsiders for cash either at the time of incorporation or at a later date. To assure that the former partners receive an equitable portion of the total capital stock, the assets of the partnership will need to be adjusted to fair market value before being transferred to the cor- poration. Any goodwill developed by the partnership should be recognized as part of the assets transferred. The accounting records of a partnership may be modiﬁed and continued in use when the ﬁrm changes to the corporate form. As an alternative, the partnership books may be closed and a new set of accounting records established for the corporation. . . .10 40.5 PARTNERSHIP REALIZATION AND LIQUIDATION (a) BASIC CONSIDERATIONS. A partnership may be disposed of either by selling the business as a unit or by the sale (realization) of the speciﬁc assets followed by the liquidation of the liabilities and ﬁnal distribution of the remaining assets (usually cash) to the partners. A basic principle to be ob- served carefully in all such cases is that losses (or gains) in realization or sale must ﬁrst be appor- tioned among the partners in the income ratio, following which, if outside creditors have been paid in full or cash reserved for that purpose, payments may be made according to the remaining capital balances of the partners. Discussions of partnership liquidations usually point out that the proper order of cash distribution is: (1) payment of creditors in full, (2) payment of partners’ loan accounts, and (3) payment of partners’ capital accounts. Actually, the stated priority of the partners’ loans ap- pears to be a legal ﬁction. An established legal doctrine called the right of offset requires that any credit balance standing in a partner’s name be set off against an actual or potential debit balance in his capital account. Application of this right of offset always produces the same ﬁnal result as if the loan or undrawn salary account were a part of the capital balance at the begin- ning of the process. For this reason, no separate examples are given that include loan accounts. If they are encountered, they may be added to the capital account balance at the top of the liq- uidation statement. (The existence of partners’ loan accounts might have an effect on proﬁt sharing, however, in the sense that interest on partners’ loans is usually provided for and prof- its might be shared in the average capital ratio; loans would presumably be excluded from the computation.) Realization of all assets and liquidation of liabilities may be completed before any cash is distrib- uted to partners. Or, if the realization process stretches over a considerable period of time, so-called installment liquidation may be employed. (b) LIQUIDATION BY SINGLE CASH DISTRIBUTION. The illustration below demonstrates the realization of assets, payment of creditors, and ﬁnal single cash distribution to the partners. Losses are ﬁrst allocated to the partners in the income ratio, followed by cash payment to creditors and then to partners. Rogers, Stevens, and Troy are partners with capital balances of $20,000, $15,000, and $10,000, respectively. Proﬁts and losses are shared equally. On a particular date they ﬁnd that the ﬁrm has as- 10 Id.
40.5 PARTNERSHIP REALIZATION AND LIQUIDATION 40 21 • sets of $80,000, liabilities of $47,000, and undistributed losses of $12,000. At this point the assets are sold for $59,000 cash. The proper distribution of the cash is as follows: Total Rogers Stevens Troy Capital balances $45,000 $20,000 $15,000 $10,000 Less undistributed losses 12,000 4,000 4,000 4,000 Adjusted balances $33,000 $16,000 $11,000 $06,000 Less loss on sale of assets 21,000 7,000 7,000 7,000 Adjusted balances $12,000 $09,000 $04,000 $(1,000) Payment by Troy for deﬁciency 1,000 1,000 Balances before distribution $13,000 $09,000 $04,000 -0- Cash available $60,000 Paid to creditors 47,000 Cash paid to partners $13,000 $09,000 $04,000 -0- In this example, it was assumed that Troy was ﬁnancially able to make up the $1,000 deﬁciency that appeared in his capital account. Only by making this payment does he bear his agreed share of the losses. If Troy had been personally insolvent and therefore unable to make the $1,000 payment, the statement from that point on would have taken the following form: Total Rogers Stevens Troy Adjusted balances $12,000 $09,000) $04,000) $ (1,000) Apportion deﬁciency in income ratio (500) (500) 1,000 Balances before distribution $12,000 $08,500) $03,500) -0- Cash available $59,000 Paid to creditors 47,000 Cash paid to partners $12,000 $08,500) $03,500) -0- Troy is now personally indebted to Rogers and Stevens in the amount of $500 each. Just how this debt would rank in the settlement of Troy’s personal affairs depends on the state having juris- diction. Under the UPA, his personal creditors (not including Rogers and Stevens) have prior claim to his personal assets; because he was said to have been personally insolvent, the presump- tion is that Rogers and Stevens would collect nothing. In a common-law state, a deﬁciency of this sort is considered to be a personal debt and would generally rank along with the other personal creditors. In this event, Rogers and Stevens would presumably make a partial recovery of the $500 due each of them. (c) LIQUIDATION BY INSTALLMENTS. It is sometimes necessary to liquidate on an install- ment basis. Two of the many possible cases are illustrated—in the ﬁrst there is no capital deﬁ- ciency to any partner when the ﬁrst cash distribution is made; in the second there is a possible deﬁciency of one partner at the time of the ﬁrst cash distribution. The situation involving a ﬁnal deﬁciency of a partner is discussed above in the partnership of Rogers, Stevens, and Troy. If this situation should appear in the winding up of an installment liquidation, its treatment would be the same as described there.
40 22 PARTNERSHIPS AND JOINT VENTURES • The role of the liquidator is especially important in the case of installment liquidation. In addition to his obvious responsibility to see that outside creditors are paid and to convert the various assets into cash with a maximum gain or a minimum loss, he must protect the interests of the partners in their relationship to each other. Other than for reimbursement of liquidation expenses, no cash pay- ment can be made to a partner, even on loan accounts or undrawn proﬁts, except as the total standing to his credit exceeds his share of total possible losses on assets not yet realized. Improper payment by the liquidator might result in personal liability. Therefore, recovery could not be made from the part- ner who was overpaid. (d) CAPITAL CREDITS ONLY—NO CAPITAL DEFICIENCY. Below is the balance sheet of Burns & Mantle as of April 30, when installment liquidation of the ﬁrm began. The partners share proﬁts and losses equally. Assets Liabilities and Capital Cash $006,200 Liabilities $056,000 Other assets $350,000 Burns, capital 220,200 Mantle, capital $080,000 $356,200 $356,200 During May, assets having a book value of $220,000 are sold for cash of $198,000, and $39,000 is paid to creditors. During June, the remaining assets are sold for $90,000, the balance due creditors is paid, and liquidation expenses of $8,000 are paid. Distribution of cash to the partners should be made as follows: Total Burns Mantle Capital, per balance sheet $300,200 $220,200 $80,000 Less realization loss in May $022,000 $011,000 $11,000 Balance after loss $278,200 $209,200 $69,000 Cash available to partners $148,200 Possible loss divided $130,000 $065,000 $65,000 Balances paid in cash $144,200 $04,000 Balances, June 1 $065,000 $65,000 Less realization loss in June $040,000 $020,000 $20,000 Balances after loss $090,000 $045,000 $45,000 Less liquidation expense $008,000 $004,000 $04,000 Final cash payment $082,000 $041,000 $41,000 Cash available to partners at May 31 is calculated as follows: Cash, per balance sheet $006,200 Received from sale of assets—May $198,000 $204,200 Paid to creditors—May $039,000 Reserved for creditors $017,000 $056,000 Available for distribution to partners $148,200 In this example, the ﬁrst payment of $148,200 reduces the capital claims to the proﬁt and loss ratios, and all subsequent charges or credits to the partners’ capital accounts are made accordingly.
40.5 PARTNERSHIP REALIZATION AND LIQUIDATION 40 23 • (i) Capital Credits Only—Capital Deﬁciency of One Partner. This situation is illustrated in Ex- hibit 40.3 using the previous balance sheet but assuming the following liquidation data: Assets Sold Cash Received Creditors Paid Expenses Paid May $180,000 $050,000 $39,000 June $100,000 $060,000 $17,000 July $170,000 $145,000 $8,000 In Exhibit 40.3, each partner received in total the balance of his capital account per the balance sheet minus his share (50%) of realization losses and expenses, the same as if one ﬁnal cash payment had been made on July 31. Note that if Mantle had had a loan account of, say, $20,000 and a capital balance of $60,000, the ﬁrst cash distribution of $60,200 would still have gone entirely to Burns. At this point, after exercising the right of offset, Mantle would still have had a future possible deﬁciency of $40,000. BURNS & MANTLE Statement of Liquidation May 1 to July 31 Total Burns Mantle Capital balances, May 1 $300,200 $220,200 $(80,000 Less realization loss in May $030,000 $015,000 $(15,000 Balances after loss, May 31a $270,200 $205,200 $(65,000 Less realization loss in June $040,000 $020,000 $(20,000 Balances after loss, June 30 $230,200 $185,200 $(45,000 Cash available to partnersb $060,200 Possible loss apportioned $170,000 $085,000 $(85,000 Balances after apportionment $100,200 $(40,000) Further possible loss to Burns $(40,000) $(40,000 Cash payment to Burns $060,200 Balances, July 1 $125,000 $(45,000 Less realization loss in July $025,000 $012,500 $(12,500 Balances after loss, July 31 $145,000 $112,500 $(32,500 Less liquidation expense $008,000 $004,000 $(04,000 Final cash payment $137,000 $108,500 $(28,500 a No cash was distributed to partners at May 31 because only $200 was available at that time. The calculation: Cash, per balance sheet $006,200 Received from sale of assets—May $050,000 $056,200 Paid to creditors—May $039,000 Reserved for creditors $017,000 $056,000 Available to partners—not distributed, May 31 $000,200 b This amount is the $200 not distributed at May 31 plus the $60,000 received in June from sale of assets. Exhibit 40.3 Sample statement of liquidation.
40 24 PARTNERSHIPS AND JOINT VENTURES • (ii) Installment Distribution Plan. A somewhat different approach to the problem of installment liquidation is illustrated below. Fox, Green, and Harris are partners sharing proﬁts equally. Following is the partner- ship balance sheet as of December 31, at which time it is decided to liquidate the ﬁrm by installments. Assets Liabilities and Capital Cash $003,000 Liabilities $024,000 Other assets $186,000 Fox, capital 79,000 Green, capital 52,000 Harris, capital 34,000 $189,000 $189,000 Using the balance sheet above, computation of correct cash distribution is as follows: Total Fox Green Harris Partners’ capital balances $165,000 $79,000 $52,000 $34,000 Loss that would eliminate Harris, who is least able to absorb $102,000 $34,000 $34,000 $34,000 Balances $063,000 $45,000 $18,000 Loss that would eliminate Green $036,000 $18,000 $18,000 Balances $027,000 $27,000 The amount of the loss that will extinguish each partner’s capital account is determined by divid- ing his capital account by his percentage of income and loss sharing. Hence, for Harris, this amount is $34,000 331⁄3%, or $102,000. From the computations, it is possible to prepare a schedule for the distribution of cash as follows: Cash Liabilities Fox Green Harris First $21,000 $21,000 Next $27,000 All 1 1 Next $36,000 ⁄2 ⁄2 1 1 1 All in excess of $84,000 ⁄3 ⁄3 ⁄3 It is assumed that the $3,000 cash on hand on December 31 is used in payment of liabilities. The fol- lowing liquidation data are given: Assets Sold Cash Received Creditors Paid January $064,000 $041,000 $24,000 February $060,000 $037,000 March $062,000 $054,000 Totals $186,000 $132,000 $24,000 Based on these data, the application of the computations already made results in the following payments to creditors and partners:
40.6 LIMITED PARTNERSHIPS 40 25 • Amount Liabilities Fox Green Harris January $041,000 $21,000 $20,000 February $037,000 $07,000 $15,000 $15,000 March $054,000 $03,000 $03,000 $16,000 $16,000 $16,000 Totals $132,000 $21,000 $61,000 $34,000 $16,000 40.6 LIMITED PARTNERSHIPS (a) DEFINITION OF LIMITED PARTNERSHIPS. Limited partnerships are business partnership structures that permit partners to invest capital with the proviso that there will be limited control over business operations and, accordingly, assumption of liability limited to the extent of capital contri- butions. In general partnerships, the potential liability that can accrue to individual partners is unlimited. That unlimited liability has always been a major drawback of the partnership structure. Limited part- nerships evolved to a great extent in order to overcome that disadvantage. The legal provisions governing limited partnerships are provided by the Uniform Limited Part- nership Act and the Revised Uniform Limited Partnership Act, which have been adopted in some form by each state government. (b) DIFFERENCES BETWEEN LIMITED PARTNERSHIPS AND GENERAL PARTNERSHIPS. In addition to limitations on the liability of partners, limited partnerships differ from general partner- ships in these ways: • Limited partners have no participation in the management of the limited partnership. • Limited partners may invest only cash or other assets in a limited partnership; they may not provide services as their investment. • The surname of a limited partner may not appear in the name of the partnership. (c) FORMATION OF LIMITED PARTNERSHIPS. The formation of limited partnerships is generally evidenced by a certiﬁcate ﬁled with the county recorder of the principal place of busi- ness of the limited partnership rather than a partnership agreement such as that described in Sub- section 40.1(e). Such certiﬁcates include many of the items present in the typical partnership contract of a general partnership. In addition, certiﬁcates must include the name and residence of each general partner and limited partner; the amount of cash and other assets invested by each lim- ited partner; provision for return of a limited partner’s investment; any priority of one or more lim- ited partners over other limited partners; and any right of limited partners to vote for election or removal of general partners, termination of the partnership, amendment of the certiﬁcate, or dis- posal of all partnership assets. Interests in limited partnerships are offered to prospective limited partners in units subject to the Securities Act of 1933. Thus, unless provisions of that Act exempt a limited partnership, it must ﬁle a registration statement for the offered units with the Securities and Exchange Commission (SEC) and undertake to ﬁle periodic reports with the SEC. Large limited partnerships that engage in ven- tures such as oil and gas exploration and real estate development and issue units registered with the SEC are called master limited partnerships. The SEC has provided guidance for such registration and reporting in Industry Guide 5: Preparation of Registration Statements Relating to Interests in Real Estate Limited Partnerships.
40 26 PARTNERSHIPS AND JOINT VENTURES • (d) ACCOUNTING AND FINANCIAL REPORTING CONSIDERATIONS. As a general rule, the accounting records of limited partnerships are kept on a cash basis. However, the SEC requires that limited partnerships registrants prepare and ﬁle basic ﬁnancial statements in conformity with generally accepted accounting principles (GAAP). For example, SEC Staff Accounting Bulletin Topic 4F requires the equity section of the limited partnership’s balance sheet to distinguish between general partner and limited partner equity, with a separate statement of changes in partnership equity for each type of participation provided for each period for which a limited partnership income state- ment is presented. The SEC also believes it is appropriate for a limited partnership registrant to include ﬁnancial data on a tax basis of accounting, with an appropriate reconciliation of differences in major disclosure areas between tax and ﬁnancial accounting. Whether GAAP-basis ﬁnancial statements (along with the data necessary for income tax return preparation) should be distributed to the participants of SEC-reporting limited partnerships is a matter covered by the proxy rules. AICPA Practice Bulletin No. 14 provides reporting guidance along with guidance on certain ac- counting issues regarding the application of existing authoritative literature for limited liability com- panies and limited liability partnerships (jointly referred to herein as LLCs). (i) Financial Statement Reporting Issues. According to Practice Bulletin No. 14, a complete set of LLC ﬁnancial statements should include the following: • Statement of ﬁnancial position as of the end of the reporting period • Statement of operations for the period • Statement of cash ﬂows for the period • Accompanying notes to ﬁnancial statements Limited liability companies should also present information related to changes in mem- bers’ equity for the period, either in a separate statement combined with the statement of op- erations or in the notes to the financial statements. The headings of an LLC’s financial statements should identify clearly the financial statements as those of a limited liability company. Practice Bulletin No. 14 stipulates that the financial statements of an LLC should be similar in presentation to those of a partnership. Since the owners of an LLC are referred to as “members,” the equity section in the statement of financial position should be titled “members’ equity.” If more than one class of members exists, each having varying rights, preferences, and privileges, the LLC is encouraged to report the equity of each class sepa- rately within the equity section. If the LLC does not report the amount of each class sepa- rately within the equity section, it should disclose those amounts in the notes to the financial statements. Even though a member’s liability may be limited, if the total balance of the members’ equity ac- count or accounts described in the preceding paragraph is less than zero, a deﬁcit should be reported in the statement of ﬁnancial position. If the LLC maintains separate accounts for components of members’ equity (e.g., undistributed earnings, earnings available for withdrawal, or unallocated capital), Practice Bulletin No. 14 permits disclosure of those components, either on the face of the statement of ﬁnancial position or in the notes to the ﬁnancial statements. If the LLC records amounts due from members for capital contributions, such amounts should be presented as deductions from members’ equity. Practice Bulletin No. 14 notes that presenting such amounts as assets is inappropriate except in very limited circumstances when there is substantial evi- dence of ability and intent to pay within a reasonably short period of time. Presentation of comparative ﬁnancial statements is encouraged, but not required, by Chapter 2A, “Comparative Financial Statements,” of Accounting Research Bulletin (ARB) No. 43, “Restatement and Revision of Accounting Research Bulletins.” If comparative ﬁnancial statements are presented, amounts shown for comparative purposes must be in fact comparable with those shown for the most
40.7 NONPUBLIC INVESTMENT PARTNERSHIPS 40 27 • recent period, or any exceptions to comparability must be disclosed in the notes to the ﬁnancial state- ments. Situations may exist in which ﬁnancial statements of the same reporting entity for periods prior to the period of conversion are not comparable with those for the most recent period presented, for example, if transactions such as spin-offs or other distributions of assets occurred prior to or as part of the LLC’s formation. In such situations, sufﬁcient disclosure should be made so the compara- tive ﬁnancial statements are not misleading. If the formation of the LLC results in a new reporting en- tity, the guidance in Accounting Principles Board (APB) Opinion No. 20, “Accounting Changes,” paragraphs 34 and 35, should be followed and ﬁnancial statements for all prior periods presented should be restated. (ii) Financial Statement Disclosure Issues. Practice Bulletin No. 14 requires that the following disclosures be made in the ﬁnancial statements of a limited liability company: • A description of any limitation of its members’ liability. • The different classes of members’ interests and the respective rights, preferences, and privileges of each class. If the LLC does not report separately the amount of each class in the equity section of the statement of financial position, those amounts should be disclosed. • LLCs subject to income tax should make the disclosures required by FASB SFAS No. 109, “Accounting for Income Taxes.” • If the LLC has a ﬁnite life, the date the LLC will cease to exist should be disclosed. • For LLCs formed by combining entities under common control or by conversion from another type of entity, the notes to the financial statements for the year of formation should disclose that the assets and liabilities previously were held by a predecessor en- tity or entities. LLCs formed by combining entities under common control are encour- aged to make the relevant disclosures in paragraph 64 of APB Opinion No. 16, “Business Combinations.” (iii) Accounting Issues. Practice Bulletin No. 14 requires that an LLC formed by combining en- tities under common control or by conversion from another type of entity initially should state its as- sets and liabilities at amounts at which they were stated in the ﬁnancial statements of the predecessor entity or entities in a manner similar to a pooling of interests. Limited liability companies generally are classiﬁed as partnerships for federal income tax purposes. An LLC that is subject to federal (U.S.), foreign, state, or local (including fran- chise) taxes based on income should account for such taxes in accordance with FASB State- ment No. 109. Practice Bulletin No. 14 points out that in accordance with FASB Statement No. 109, an entity whose tax status in a jurisdiction changes from taxable to nontaxable should eliminate any deferred tax assets or liabilities related to that jurisdiction as of the date the entity ceases to be a taxable entity. FASB Statement No. 109 requires disclosure of signiﬁcant components of income tax expense at- tributable to continuing operations including “adjustments of a deferred tax liability or asset for . . . a change in the tax status of the enterprise.” 40.7 NONPUBLIC INVESTMENT PARTNERSHIPS Statement of Position (SOP) 95-2, “Financial Reporting by Nonpublic Investment Partnerships,” provides ﬁnancial reporting guidance for investment partnerships that are exempt from SEC regis- tration pursuant to the Investment Company Act of 1940 and deﬁned as investment companies in paragraph 1.01 of the AICPA Audit and Accounting Guide, “Audits of Investment Companies,” ex- cept for:
40 28 PARTNERSHIPS AND JOINT VENTURES • • Investment partnerships that are brokers and dealers in securities subject to regulation under the Securities Exchange Act of 1934 (registered broker-dealers) and that manage funds only for those who are ofﬁcers, directors, or employees of the general partner • Investment partnerships that are commodity pools subject to regulation under the Commodity Exchange Act of 1974 SOP 95-2 provides that the ﬁnancial statements of an investment partnership, when prepared in conformity with GAAP, should, at a minimum, include a condensed schedule of investments in se- curities owned by the partnership at the close of the most recent period. Such a schedule should cat- egorize investments by: • Type (such as common stocks, preferred stocks, convertible securities, ﬁxed-income securities, government securities, options purchased, options written, warrants, futures, loan participa- tions, short sales, other investment companies, etc.) • Country or geographic region • Industry The schedule should report the percentage of net assets that each such category represents and the total value and cost for each type of investment and country or geographic region. The schedule should also disclose the name, shares or principal amount, value, and type of: • Each investment (including short sales) constituting more than 5% of net assets • All investments in any one issuer aggregating more than 5% of net assets In applying the 5% test, total long and total short positions in any one issuer should be considered separately. Other investments (those that are individually 5% or less of net assets) should be aggregated without speciﬁcally identifying the issuers of such investments and be categorized by type, country or region, and industry. Also note that the foregoing information is required when the partnership’s proportional share of any security owned by an individual investee exceeds 5% of the reporting part- nership’s net assets. Disclosure of the required information for such securities may be made either on the schedule itself or in a note thereto. SOP 95-2 also requires that investment partnerships present their statements of operations in con- formity with the requirements for statements of operations of management investment companies as set forth in the AICPA Audit and Accounting Guide, “Audits of Investment Companies,” which re- quires, among other things, separate disclosure of dividend income and interest income and realized and unrealized gains (losses) on securities for the period. Investment companies organized as limited partnerships typically receive advisory services from the general partner. For such services, a number of partnerships pay fees chargeable as ex- penses to the partnership, whereas others allocate net income from the limited partners’ capital ac- counts to the general partner’s capital account, and still others employ a combination of the two methods. SOP 95-2 states that the amounts of any such payments or allocations should be pre- sented in either the statement of operations or the statement of changes in partners’ capital, and the method of computing such payments or allocations should be described in the notes to the ﬁnan- cial statements. 40.8 JOINT VENTURES (a) DEFINITION OF JOINT VENTURE. Joint ventures are partnerships formed when two or more parties pool resources for the purpose of undertaking a speciﬁc project, such as the develop-