John Wiley Accountants Handbook Volume 2_11 pptx

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 determineth

before deducting partners’ salaries; partners’ salaries are treated as a means of dividing ship income.”5

partner-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 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 defensiblewhere the salaries are subject to negotiation from period to period and are in no way dependent uponthe presence of net earnings Where there are only two partners, and both capital investments andcontributions of services are substantially equal, there is less need for salary adjustments; if

mem-“salaries” are allowed in such a situation it would seem to be reasonable to interpret them as 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

prelim-(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 ing additional compensation The principal question that arises in such cases is the interpretation ofthe bonus in relation to the final net amount to be distributed according to the regular income ratio,

provid-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 thefirm If in a particular year the credit balance of the expense and revenue account is $27,000 beforeallowing the bonus, profits are divided as follows:

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 finalnet 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:

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

40.2 ACCOUNTING FOR PARTNERSHIP OPERATIONS 40 9

5Norman M Bedford, Introduction to Modern Accounting (Ronald Press, New York, 1962).

6Robert L Dixon, Samuel R Hepworth, and William A Paton, Jr., Essentials of Accounting (Macmillan,

New York, 1966)

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’snet 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, onthe other hand, the partner has every intention of repaying the sum, the loan may be regarded as avalid receivable

(v) Landlord–Tenant Relationship. In some cases, a partner may rent property from or tothe partnership Transactions of this type should be handled exactly as rental agreements withothers are handled The only possible difference in recording this type of event would find therent 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 sion, it is preferable to record rental transactions with partners in the same manner as otherrental agreements

confu-(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 samemanner as are receivables and payables arising out of transactions with nonpartners However, anysuch receivables and payables included in the balance sheet should be set forth separately; theyshould 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 capitalaccount 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% perannum Such interest shall be computed only on December 31 of each year regardless of the pe-riod in which the loan was in effect

7Financial Accounting Standards Board, “Related Party Disclosures,” Statement of Financial AccountingStandards No 57, FASB, Stamford, CT, 1982

Partners’ salaries On December 31 of each year, salaries shall be allowed by a charge to the pense and revenue account and credits to the respective drawing accounts of the partners at thefollowing amounts per annum: Ahern $14,400; Ciecka, $12,000 Partners’ salaries are to be al-lowed whether or not earned.

ex-Interest on partners’ invested capital Each partner is to receive interest at the rate of 6% perannum 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 onloans, and interest on invested capital is to be divided equally Any loss resulting after provisionfor the above items is to be divided equally

On December 31, the books of the partnership show the following balances before recognition of terest and salary adjustments:

(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 ties Instead, each member of a partnership is subject to income tax on their distributive share

enti-of the partnership’s income, even if an actual distribution is not made (Section 701 enti-of chapter K of the 1954 Code contains the statutory rule that the partners are liable for incometax 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

Sub-40.2 ACCOUNTING FOR PARTNERSHIP OPERATIONS 40 11

AHERN AND CIECKA, PARTNERSHIP Schedule of Division of Net Income For the year ended December 31, 20XX

only to provide information necessary in determining the character and amount of each ner’s distributive share of the partnership’s income and expense.8

part-Some states, however, impose an unincorporated business tax on a partnership that for all practicalpurposes 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 originalpartnership and bringing into being a new firm This means that the terms of the original agreement assuch are not binding on the successor partnership As far as the continuity of the business enterprise isconcerned, on the other hand, a change in firm membership may be of only nominal importance; withrespect 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 specifiedshare 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 anyevent, 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 hiswithdrawal 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 thepartnership 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 interinter-est,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 theUniform Partnership Act, the buyer in such a case acquires only the seller’s interest in the profits andlosses of the firm and, upon dissolution, the interest to which the original partner would have been en-

AHERN AND CIECKA, PARTNERSHIP Statement of Partners’ Capitals For the year ended December 31, 20XX

net income for year—per schedule $057,000 $030,735 $26,265

Exhibit 40.2 Sample statement of partners’ capitals.

8William H Hoffman, Jr., ed., West’s Federal Taxation: Corporations, Partnerships, Estates and Trusts

(West, St Paul, MN, 1978)

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 thefirm of Hirt, Thompson, and Pitts negotiates with Davis for the purchase of a capital interest Dataare as follows:

Capital Accounts Income Ratio

(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:

(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

The cash payment of $12,000 is divided as follows:

Premium—in income ratio $1,000 $0,800 $0,200 $02,000

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 theagreed revaluation is less than $8,000, the difference may be assumed to be goodwill Dividing thegain in the income ratio results in this entry:

Sundry assets and/or goodwill $8,000

The entry to record Davis’s admission would then be:

(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 determinethe cash settlement, as follows:

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 propriate accounts should be adjusted Otherwise, existing goodwill should be included in thewrite-down

(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 lowing cases

fol-Assume that the capital account balances of the partnership of Andrews and Bell prior to the mission of Cohen are:

ad-Capital Accounts Income Ratio

(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

(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

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 orrevaluation of assets method, there is justification in assuming that existing assets are undervalued tothe extent of $12,000 Circumstances may indicate that the $12,000 undervaluation is in the form ofgoodwill If it is to be recognized, the entries are as follows:

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:

Andrews, capital $8,900

Bell, capital $8,600

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 Theovervaluation of $6,000 could be corrected by crediting the overvalued assets and charging Andrewsand Bell in the income ratio

40.3 ACCOUNTING FOR CHANGES IN FIRM MEMBERSHIP 40 15

(1)Andrews, capital $3,600

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) Thisseems 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 maining partners directly to the retiring partner is illustrated by the firm of Adams, Bates, &Caldwell:

re-Capital Balances Income Ratio

(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:

(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 ment would be as follows:

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 impliesthat 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:

(1)Goodwill or sundry assets $10,000

(2)Caldwell, capital $18,000

(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:

Capital, per books $10,000 $6,000 $16,000

Less discount allowed $00,625 $0,375 $01,000

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 bookvalues of assets by $5,000 If this correction is to be made, the entries to adjust the books and recordthe subsequent withdrawal of Caldwell are:

(1)Adams, capital $ 2,500

Bates, capital $11,500

Caldwell, capital $11,000

(2)Caldwell, capital $15,000

In preceding examples, the so-called bonus method and revaluation of assets method have beenpresented as alternatives Although each method results in different capital account balances in thenew 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 partnerswho remain in the new firm must continue to share profits and losses as between themselves in thesame 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

(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 Underone treatment, the premium of $4,000 is viewed as chargeable to the remaining partners in their in-come ratio The entry is:

(1)Goodwill or sundry assets $10,000

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 trendtoward viewing a partnership as a continuing business entity, with asset valuations and ac-counting policies remaining undisturbed by the retirement of a partner.”9The second treat-ment is supported by reference to the rule that it is proper to set up goodwill only when it hasbeen purchased The third interpretation relies on the idea that it is inconsistent to recognizethe existence of an intangible asset and then to record it at only a fraction of the properamount

The accountant may distinguish between a payment for goodwill and one that represents apartner’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 thatunder 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

9Walter B Meigs, Charles E Johnson, and Thomas F Keller, Advanced Accounting (McGraw-Hill, New

York, 1966)

increase would result in figures unsatisfactory from the standpoint both of financial accountingand 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 ing treatments are available

account-First, the discount of $3,000 may be credited to the remaining partners in their income ratio:

(1)Arnold, capital $ 2,250

Brown, capital $52,250

Cline, capital $53,000

(2)Cline, capital $57,000

(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 come ratio This may happen in connection with the admission of a new partner, the withdrawal of apartner, or at some time when no change in personnel has occurred Only a simple case involving acontinuing firm is illustrated here

in-Assume the following data for the firm of Emmett, Frye, and Gable:

Capital Balances Income Ratio

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 entryshould be:

40.3 ACCOUNTING FOR CHANGES IN FIRM MEMBERSHIP 40 19

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 byincorporating Among the advantages are limited liability, ease of attracting outside capital withoutloss of control, and possible tax savings

A new corporation formed to take over the assets and liabilities of a partnership will usuallysell stock to outsiders for cash either at the time of incorporation or at a later date To assurethat the former partners receive an equitable portion of the total capital stock, the assets of thepartnership 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 ofthe assets transferred

The accounting records of a partnership may be modified and continued in use when the firmchanges 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 liabilitiesand 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 capitalbalances of the partners

Discussions of partnership liquidations usually point out that the proper order of cashdistribution 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 thatany credit balance standing in a partner’s name be set off against an actual or potential debitbalance in his capital account Application of this right of offset always produces the same finalresult 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 uidation statement (The existence of partners’ loan accounts might have an effect on profitsharing, 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.)

liq-Realization of all assets and liquidation of liabilities may be completed before any cash is uted to partners Or, if the realization process stretches over a considerable period of time, so-calledinstallment liquidation may be employed

distrib-(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 creditorsand 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-

10Id

sets of $80,000, liabilities of $47,000, and undistributed losses of $12,000 At this point the assets aresold for $59,000 cash The proper distribution of the cash is as follows:

-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 hisagreed 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 followingform:

Cash paid to partners $12,000 $ 8,500) $ 3,500)

-0-Troy is now personally indebted to Rogers and Stevens in the amount of $500 each Just howthis 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 priorclaim 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 thissort is considered to be a personal debt and would generally rank along with the other personalcreditors In this event, Rogers and Stevens would presumably make a partial recovery of the $500due each of them

(c) LIQUIDATION BY INSTALLMENTS. It is sometimes necessary to liquidate on an 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 possibledeficiency of one partner at the time of the first cash distribution The situation involving a finaldeficiency of a partner is discussed above in the partnership of Rogers, Stevens, and Troy If thissituation should appear in the winding up of an installment liquidation, its treatment would be thesame as described there

install-40.5 PARTNERSHIP REALIZATION AND LIQUIDATION 40 21

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 assetsinto cash with a maximum gain or a minimum loss, he must protect the interests of the partners intheir 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 bythe 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 shareprofits and losses equally

Mantle, capital $080,000

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 bemade as follows:

Less realization loss in May $022,000 $011,000 $11,000

Cash available to partners $148,200

Less realization loss in June $040,000 $020,000 $20,000

Cash available to partners at May 31 is calculated as follows:

In this example, the first payment of $148,200 reduces the capital claims to the profitand loss ratios, and all subsequent charges or credits to the partners’ capital accounts are madeaccordingly

(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

of $40,000

40.5 PARTNERSHIP REALIZATION AND LIQUIDATION 40 23

BURNS & MANTLE Statement of Liquidation May 1 to July 31

aNo cash was distributed to partners at May 31 because only $200 was available at that time Thecalculation:

Received from sale of assets—May $050,000 $ 56,200

Available to partners—not distributed, May 31 $000,200

bThis amount is the $200 not distributed at May 31 plus the $60,000 received in June from sale ofassets

Exhibit 40.3 Sample statement of liquidation.

(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 ship balance sheet as of December 31, at which time it is decided to liquidate the firm byinstallments

Using the balance sheet above, computation of correct cash distribution is as follows:

Partners’ capital balances $165,000 $79,000 $52,000 $34,000Loss that would eliminate

Harris, who is least able

Amount Liabilities Fox Green Harris

(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 overbusiness 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 nership Act and the Revised Uniform Limited Partnership Act, which have been adopted in someform by each state government

Part-(b) DIFFERENCES BETWEEN LIMITED PARTNERSHIPS AND GENERAL PARTNERSHIPS.

In addition to limitations on the liability of partners, limited partnerships differ from general ships in these ways:

partner-• 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 notprovide 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 isgenerally 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 partnershipcontract of a general partnership In addition, certificates must include the name and residence ofeach 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 orremoval 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 theSecurities 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 theSEC 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.

40.6 LIMITED PARTNERSHIPS 40 25

(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 requiresthat limited partnerships registrants prepare and file basic financial statements in conformity withgenerally accepted accounting principles (GAAP) For example, SEC Staff Accounting BulletinTopic 4F requires the equity section of the limited partnership’s balance sheet to distinguish betweengeneral partner and limited partner equity, with a separate statement of changes in partnership equityfor 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 areasbetween tax and financial accounting Whether GAAP-basis financial statements (along with the datanecessary for income tax return preparation) should be distributed to the participants of SEC-reportinglimited partnerships is a matter covered by the proxy rules

AICPA Practice Bulletin No 14 provides reporting guidance along with guidance on certain counting issues regarding the application of existing authoritative literature for limited liability com-panies and limited liability partnerships (jointly referred to herein as LLCs)

ac-(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 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 financialstatements should identify clearly the financial statements as those of a limited liability company

mem-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 financialstatements

Even though a member’s liability may be limited, if the total balance of the members’ equity count or accounts described in the preceding paragraph is less than zero, a deficit should be reported

ac-in the statement of financial position

If the LLC maintains separate accounts for components of members’ equity (e.g., undistributedearnings, earnings available for withdrawal, or unallocated capital), Practice Bulletin No 14 permitsdisclosure of those components, either on the face of the statement of financial position or in thenotes to the financial statements

If the LLC records amounts due from members for capital contributions, such amounts should bepresented as deductions from members’ equity Practice Bulletin No 14 notes that presenting suchamounts 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, “Restatementand 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

recent period, or any exceptions to comparability must be disclosed in the notes to the financial ments Situations may exist in which financial statements of the same reporting entity for periodsprior 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 aspart 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 presentedshould be restated.

state-(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, andprivileges 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 fromanother type of entity, the notes to the financial statements for the year of formationshould 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, “BusinessCombinations.”

(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 sets and liabilities at amounts at which they were stated in the financial statements of the predecessorentity or entities in a manner similar to a pooling of interests

as-Limited liability companies generally are classified as partnerships for federal income taxpurposes 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 entitywhose tax status in a jurisdiction changes from taxable to nontaxable should eliminate any deferredtax 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 achange 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 inparagraph 1.01 of the AICPA Audit and Accounting Guide, “Audits of Investment Companies,” ex-cept for:

40.7 NONPUBLIC INVESTMENT PARTNERSHIPS 40 27

• Investment partnerships that are brokers and dealers in securities subject to regulation underthe Securities Exchange Act of 1934 (registered broker-dealers) and that manage funds only forthose who are officers, directors, or employees of the general partner

• Investment partnerships that are commodity pools subject to regulation under the CommodityExchange Act of 1974

SOP 95-2 provides that the financial statements of an investment partnership, when prepared inconformity 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 thetotal value and cost for each type of investment and country or geographic region The scheduleshould 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 consideredseparately

Other investments (those that are individually 5% or less of net assets) should be aggregatedwithout 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’sproportional 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 onthe schedule itself or in a note thereto

SOP 95-2 also requires that investment partnerships present their statements of operations in formity with the requirements for statements of operations of management investment companies asset 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 realizedand unrealized gains (losses) on securities for the period

con-Investment companies organized as limited partnerships typically receive advisory servicesfrom 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 twomethods 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 themethod 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-ment or marketing of a product Joint ventures are owned, operated, and jointly controlled by a smallgroup of owners or investors as separate business projects operated for the mutual benefit of the own-ership group Joint ventures may take the legal form of partnerships or they may be separately incor-porated entities.

The owners or investors (venturers) in a joint venture may or may not have equal ownership terests in the venture A venturer’s share may range from as low as 5% or 10% to over 50%, but noless All venturers usually participate in the overall management of the venture Significant decisionsgenerally require the consent of all venturers regardless of the percentage of ownership so that no in-dividual venturer has unilateral control

in-(b) ACCOUNTING BY JOINT VENTURES Regardless of their legal form of organization,

joint ventures must maintain accounting records and prepare financial statements just like anyother enterprise The primary users of the joint ventures financial statements are the venturers, whoneed to record their share of the profit or loss of the venture and to value their investment in it Most

of the accounting principles and procedures used by joint ventures are the same as those used byother business enterprises

The most significant accounting issue for most joint ventures is the recording of initial capitalcontributions, particularly noncash contributions Such contributions should be recorded on thebooks of the venture at the fair value of the assets contributed on the date of contribution, unless thefair value of the assets is not readily or reliably determinable or the recoverability of that value is indoubt This general rule does not apply, however, to assets contributed by a venturer who controls aventure In those circumstances, the assets should be recorded on the books of the venture at thesame amount at which they were carried on the venturer’s books because there has been no effectivechange in control over the assets

(c) ACCOUNTING FOR INVESTMENTS IN JOINT VENTURES. Since joint venturershave rights and obligations that may differ from their ownership percentages assuring them ofsignificant influence even at ownership percentages of less than 20%, the application of cus-tomary equity or consolidation accounting is not always appropriate Interests in incorporatedjoint ventures are accounted for in accordance with APB Opinion No 18, which mandates use

of the equity method Accounting for interests in joint ventures that are organized as nerships or undivided interests is discussed in an AICPA staff interpretation of APB Opinion

part-No 18 that states that many of the provisions of that Opinion are appropriate in accounting forsuch investments

In 1979, the AICPA’s Accounting Standards Executive Committee issued an Issues Paper entitled

Joint Venture Accounting The Issues Paper contains the following advisory conclusions:

• The portion of APB Opinion No 18 dealing with investments in joint ventures should bere-examined

• The one-line equity method described in APB Opinion No 18 should be required for ments in joint ventures (whether incorporated or unincorporated) that are subject to joint con-trol, except that the cost method should be permitted for investments that are not material tothe investor

invest-• If an entity that otherwise meets the definition of a joint venture is, in fact, controlled

by majority voting interest or otherwise, the entity should be required to be accountedfor as a subsidiary of the controlling investor and to be fully consolidated by that investor

• If an entity that otherwise meets the definition of a joint venture is not subject to joint control,

by reason of its liabilities being several rather than joint as in some undivided interests, ments in the entity should be required to be accounted for by the proportionate consolidationmethod

invest-• The use of the same method in the balance sheet and income statement should be required

40.8 JOINT VENTURES 40 29