Sign Tennessee Assignment of Partnership Interest Mobile

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today we'll be talking about chapter 12 which is accounting for partnerships and limited liability companies we're going to start by discussing proprietorships partnerships and llcs we're excluding corporations because we are going to cover that in chapter 13. so a proprietorship is a company owned by a single individual and because of this it is quite simple to form it's just you it could be something as simple as a business you run out of your home one of the main disadvantages of proprietorships is the fact that they have no limitation on legal liability so what this means is the owner is personally liable so if you're suing the proprietorship you are suing the owner for everything they have it could be any of their personal assets like their home their car etc so that's a main disadvantage proprietorships are not taxable and what i mean by that is proprietorships are considered passed through entities and we'll talk about this more we discuss taxes but basically the proprietorship itself isn't taxed uh the income flows through a proprietorship to the actual individual and then the individual is taxed so it's not that the proprietorship and all the earnings generated from that aren't being taxed it's just that it's a pass-through entity so the proprietorship itself is not taxed directly the owner is taxed on their earnings proprietorships have limited lives if the owner decides to shut it down or the owner dies or anything like that the proprietorship does not live on and proprietorships also have a limited ability to raise capital because it is just one person what they have and anything they can get from bank loans etc now we're going to talk about partnerships which will be the main focus of this chapter so a partnership is two or more people who own and manage a business for profit and it's for profit because as i said at the very beginning this course will focus on for-profit businesses partnerships are moderately complex to form they're not a super difficult but they're a little bit more complex than a proprietorship and this is mainly because of the partnership agreement the partnership agreement is really important because it formalizes investments it formalizes any limits of the partnership one of the main things is it talks about distribution of income and losses and it is as i've emphasized here very important for reasons i'll talk about in a moment you should always have a partnership agreement so everything is clear from the outset what your expectations are what your partner's expectations are how you'll divide the income everything like that partnerships similar to proprietorships have no limitation on legal liability so the partners are personally liable as we discussed before they are not taxable as i discussed before they have a limited life and again a limited ability to raise capital this time it's the income of uh sorry the contributions of the partners and any bank loans they can get but still a limited ability to raise capital one of the main differences in a partnership because it's two or more people rather than one is what's called participation in income so net income and losses are distributed according to the partnership agreement so in the partnership agreement you say partner a does more of the work they get more of the income or something like that and we'll talk about the distribution of income later but having a partnership is a very important because if there isn't a partnership agreement your net income or loss is going to be divided equally and that's regardless of the work that you do so if you're doing 90 of the work and your partner's only doing 10 of the work but there's no partnership agreement you both split the income uh evenly so that might lead to some problems down the road so again it is very important to have a partnership agreement okay now we have limited liability companies or llcs these are a legal entity that provides limited liability to its owners but it is treated as a partnership for tax purposes so it combines some of the benefits of a corporation with some of the characteristics of a partnership so it is moderately complex to form because you have that legal aspect you need to fill out some forms and paperwork uh etc unlike a partnership and a proprietorship there is limited legal liability now so what that means is only members investments are subject to the claims of creditors so as before we had the situation where everything you had as the owner or a partner was subject to the claims of creditors so your house your car anything like that you are fully personally liable now only what you invest is subject to the claims of creditors so only what you put into the business can be lost so that's the main advantage here limited legal liability um and then llcs are not taxable again they are passed through entities they have unlimited lives and that's has to do with the forms and legal issues you go through when you're forming the llc and they also have a moderate ability to raise capital and that's another difference the reason for this is the limited legal liability people are more willing to invest in an llc and contribute money because they know that they won't become personally legally liable so that attracts more investors okay so the main focus of this chapter is partnerships how do we form a partnership it's quite simple just from the accounting perspective so all we're going to do is do the following the investments of each partner are going to be recorded separately so you'll do partner a partner b etc the assets contributed are going to be debited to the partnership asset accounts any liabilities will be credited to partnership liability accounts um and then the partnership capital account will be credited for the net amount so everything you would normally do if a partner is contributing assets you're going to debit them as you normally would if the partner is bringing any liabilities into the partnership you would credit them and then you would credit the capital account for the net amount assets minus liabilities so i'll show you an example of that right now so we have partner a contributed equipment worth twenty six thousand dollars inventory worth twelve thousand dollars and cash worth fifty thousand dollars to the partnership the partnership also assumed a ten thousand dollar notes payable from partner a how would we journalize this well as i said before you are going to debit any assets that were contributed so we are going to debit cash for fifty thousand dollars equipment for twenty six thousand dollars and inventory for twelve thousand dollars then you are going to credit any liabilities and that is going to be notes payable being credited for ten thousand dollars and then you have to figure out the net amount of uh the net increase for the capital account so your owner's equity or the partnership equity is going to be assets minus liabilities so that is going to be the eighty-eight thousand dollars in assets minus the ten thousand dollars in liabilities equals seventy eight thousand dollars as a net increase in um owner's equity so we are going to credit partner a capital for 78 thousand dollars and that is how we would record partner a's um entry into the partnership okay so well as i said earlier the partnership agreement and the division of income is one of the main considerations here so dividing income as i said earlier the income or losses of the partnership are divided as specified in the partnership agreement and if there isn't one income or losses are divided equally so straight 50 50. when we're dividing income there are two common methods the first is services of the partners and the second is both services of partners and investments or original capital contributions and i'm going to talk about those in just a second but main idea here is income and losses are divided as specified in the partnership agreement and if there isn't a partnership agreement you split the income or loss equally okay so these are the two main methods of dividing income the first services of partners divides partnership income based on the services provided by each partner and the services are recognized by salary allowances so you might have partner a who does most of the work and partner b who does a little bit of the work so you might reward partner a with a higher salary than partner b and that is how you would recognize the services of each partners based on how much work they do for the company and they're paid accordingly and when you're using this method you take your net income you pay out the salaries first and then you divide the remaining income equally or however it specifies in the partnership agreement so it might say you pay out salaries first and then income is divided equally or might say income is divided in a ratio of two to one or something like that the second method is services of partners and investments so it's still going to recognize services so what you do for the company and you'll be paid a salary accordingly but it's also going to reward partners with more invested in the company so whoever paid a more uh who contributed more to the partnership and assets at the outset might get a little bit more money because of that initial investment in the company so again you start with the net income you're going to pay out partner salary allowances then you're going to pay interest on capital investments and i'll explain that in an example in a second and then the remaining income is divided equally or whatever the partnership agreement says okay so here is an example of how a question might be presented so we have company x earned a net income of one hundred thousand dollars to be divided as follows so partner a is receiving a monthly salary allowance of six thousand dollars partner b is receiving a monthly salary allowance of four thousand dollars and then it tells us our interest is ten percent on the partners capital account balances so partner a originally contributed 150 000 and partner b originally contributed a hundred thousand dollars and then the remaining income will be divided equally so i'm going to show you how i do this you don't have to do it how i do it but i think it's a logical process and it kind of allows you to check your own work so i would recommend doing it this way okay so i'm going to create a little table and it looks like this so you are going to have your salary allowance and then you are going to have your interest of 10 then you are going to have your remaining income and then you're going to have your net income and then you're going to have partner a partner b and your total and then you are going to make a little table out of all of this okay and sorry if this table isn't completely even or equal okay and now we are going to fill in this table so starting with salary allowances it told us that partner a is receiving six thousand dollars and partner b is receiving four thousand dollars so partner a we are going to write six thousand dollars partner b is getting four thousand dollars so in total we are paying out ten thousand dollars in salary allowances and that's the six thousand dollars plus four thousand dollars then we look up and see okay what are we paying in interest and it tells us we are paying 10 on each partner's capital balances so that's the 150 000 times 10 for partner a and 150 and a hundred thousand times 10 for partner b so that will be 15 000 and ten thousand uh respectively so we're going to fill that in so for partner a partner a is going to get fifteen thousand dollars and partner b is going to get 10 000 and in total we are paying out 25 000 in interest now this is the step where students typically get most confused in order to figure out the remaining income we have to take net income payout salary allowances and payout interest then we get a remaining income display so what that means is we are going to fill in our net income and then work backwards so our net income is a hundred thousand dollars so we are going to fill in that box and then work through the rest so our net income is a hundred thousand dollars so we're going to take this 100 000 we are going to pay out the salary allowances of 10 000 we're going to pay out interest of 25 000 and then we're going to get a remaining income of five thousand dollars and this is going to be that a hundred thousand minus ten thousand minus twenty five thousand and that's that remaining income then it told us that the remaining income was divided equally so we pay out the salary allowances we pay out interest and then we divide the remaining income equally and this is the step people usually forget so this is really important so you're going to take that 65 000 you're going to split it equally and then each partner is going to get 32 500 dollars and then finally the last step how much income does each partner get well partner a is going to get the six thousand dollars plus fifteen thousand dollars plus thirty two thousand five hundred dollars so they're going to have a net income of fifty three thousand five hundred dollars and partner b is going to get the four thousand dollars plus the ten thousand dollars plus the thirty two thousand five hundred dollars so they are going to get forty six thousand five hundred dollars and then i like this method because you can check to make sure everything works out so if you do if you do a little check fifty three thousand five hundred plus forty six thousand five hundred equals the one hundred thousand dollar total net income here and then you can go down and say okay we had a hundred thousand total of net income we paid out ten thousand salary allowances twenty five thousand in interest and then 65 000 in remaining income so that all adds up to 100 and everything kind of works out so i like this method because it's all presented in a table you can do it out nicely and check your work so that is how you would figure out how much each partner gets now i'd like to change it up a little bit just so you can see what happens if there's a net loss instead or you're dividing a loss so let's go back up here and say that instead of earning a net income of a hundred thousand dollars you only earn a net income of twenty five thousand dollars so you're still making a profit um but i'll show you what happens i also could have said something like you earned a net loss of fifty thousand dollars and you do the same process but let's just go with that so most things are going to stay the same but the last two lines are going to change so i'm just going to erase this whoops i'll fix that after so we're going to get rid of this and we're going to change the bottom steps so the earlier steps are going to stay the same you are still paying out your salary allowances of 6000 and 4000 you're still paying interest of fifteen thousand ten thousand those steps don't change if you have a net income or a net loss the only two lines that change your remaining income and your net income so now instead of 100 000 we have a net income of 25 000. so what happens is we have net income of 25 000 we have to pay out salary allowance of ten thousand dollars and we also have to pay twenty five thousand dollars in interest so now we're left with a remaining income of negative ten thousand dollars so this remaining income is now going to be negative the parentheses mean negative ten thousand dollars so you're going to be splitting a net loss so one more time you take this number here the net income you pay out this um salary allowance you pay out this interest expense and you're left with negative ten thousand so now the partners are going to split a loss so they're going to split a loss of 10 000 to get 5 000 loss here and a 5 000 loss here so now when you calculate their net income it's going to be lower than before they are going to be partner a 6 000 plus 15 000 minus 5 000 is 16 000 and partner b 4 000 plus 15 000 minus 5 000 is 9 000 and again if you check the 16 000 plus 9 000 equals 25 000 in total net income and these are your values for each partner so that works out nicely okay a few remaining topics so next we have partnership admission and with partnership admission there are two ways to do it the first is purchasing an interest and when we do this the e is a transfer of owner's equity from the capital account of the selling partner to the capital account of the new partner and how do we do this we are going to debit the existing owner's capital accounts and we are going to credit the new partners owner's capital account so what we are going to do um basically is completely transfer transfer the equity so we take the existing partners equity we decrease it and then we increase the new partners equity and what's happening here the total assets and total owner's equity are not going to be affected so total assets aren't changing because it's just a simple transfer and total equity also isn't changing because it's again a simple transfer the other method is contributing assets so when this happens there is an addition to owner's equity and that's usually in the form of cash but it can be other assets including equipment inventory etc so what you do here you are going to debit the assets contributed to increase them and you credit owner's equity to admit this new partner and what happens that's different is total assets and total and total owner's equity are going to increase now so as before total assets and total owner's equity are not affected now total assets and total owner's equity are going to increase and then we just have partner bonuses so bonuses are usually paid because of higher than normal profits the new or existing partners are expected to contribute in the future and this isn't like your normal bonus so at the end of the year you give every one of your employees a bonus this is specifically a partner bonus when admitting a new partner so there are two types of bonuses that can occur the first is a bonus to existing partners and this happens when the ownership interest received by the new partner is less than the amount paid so basically what's happening is the new partner thinks that the existing partners are really great and they think they run a great business and the new partner really wants to be involved so the new partner is willing to pay more than the ownership stake is worth so the interest stake that the new partner is receiving is less than the amount paid so effectively you're paying a bonus to existing partners so if the interest stake is worth let's say forty thousand dollars the new partner is paying fifty thousand dollars for it so that's basically a ten thousand dollar bonus going to the existing partners because this new partner really wants to be a part of the business the other scenario is a bonus to the new partners so in this case the ownership interest received by the new partner is going to be more than the amount paid and this is the exact opposite scenario so the existing partners really want this new partner maybe they think the partner is going to bring new contacts or great management skills or something like that so they are willing to let the new partner pay less than the interest stake is worth so in this case let's say the interest stake is worth thirty thousand dollars they're lit willing to let that new partner pay only twenty thousand dollars for it so the existing partners are effectively paying a ten thousand dollar bonus to the new partner okay that covers all the content now i just want to go through another example of dividing partnership income because i think that's the real quantitative type thing here everything else is a lot of definitions and concepts so in this problem it says bob and frank formed a partnership by investing 360 000 and 180 000 respectively determine their participation in the year's net income of two hundred fifty thousand dollars assuming the following so a no partnership agreement and b with salary allowances of thirty five thousand dollars and five fifty thousand dollars respectively and a five percent interest rate on the original investments and the remainder divided equally so what will this look like well a i'll tell you right away if there's no partnership agreement we split net income evenly so in this case net income was 250 000 we split it equally so bob gets a hundred and twenty-five thousand dollars and frank gets 125 000 and that is it's as simple as that that's the answer for part a for part b we're going to make a table again so we do the same thing we have salary we have interest of five percent this time we have the remaining income and we have net income and now we just have we have bob first and then we have frank and then we have the total so we're going to make our little table again and fill it in how we normally would and i think this is the best method but again you are free to do it however you'd like so what we're going to do we are going to first figure out our salary expenses so salary was it tells us salary seller allowances of thirty five thousand and fifty thousand dollars respectively so we are going to fill that in so bob is thirty five thousand dollars and frank is fifty thousand dollars so in total we are paying eighty five thousand dollars in salary expenses then for interest it tells us that they had original capital account balances or contributions of 360 000 and 180 thousand and they get five percent on those so five percent of three hundred sixty thousand is eighteen thousand and five percent of a hundred eighty thousand is nine thousand so we're going to put those in so we have eighteen thousand dollars for bob and nine thousand dollars for frank which means we're paying out twenty seven thousand dollars total in interest and then our one little tricky step is the net income so they earned a net income of 250 000 so what we're going to do we have 250 000 down here then you are going to pay out the 85 000 and the 27 thousand dollars so 250 000 minus 85 000 minus 27 000 is 138 000 it told us you're going to divide that equally so bob and frank are each going to get 69 000 added and the net income for each of them bob is going to get 35 000 plus 18 000 plus 69 000 is 122 000 and frank is going to get 50 000 plus 9 000 plus 69 000 is 128 000 so their final net incomes would be 122 000 for bob and 128 000 for frank in part b and then in part a as you remember they each just split it equally so that is everything i have for you for chapter 12. as always please feel free to reach out with any questions concerns etc and i hope you have a great great rest of your day