Understanding Partnerships: Legal Relationships, Accounting, and Allocations - Prof. Micha, Study notes of Financial Accounting

Download Understanding Partnerships: Legal Relationships, Accounting, and Allocations - Prof. Micha and more Study notes Financial Accounting in PDF only on Docsity! 1 1 - Forming Partnerships - Heading Chapter 13 – Forming Partnerships 2 - Relationship Between Partners - Heading Legal Relationship Between Partners 3 - Relationship Between Partners - #1 • Some basic legal concepts: – Partnership (Pp)
People get together to conduct a business – Regular Pps are General Pps – Law governing GPps is Uniform Partnership Act (UPA) 4 - Relationship Between Partners - #1 • UPA also provides basic agreement between Prs in the absence of a Pp Agreement – Pp Agreement can overide these provisions • E.g., UPA says Prs get equal share of Pp income, but Pp agreement can provide differently – Pp Agreement can treat Prs differently • Prs can get different shares of Pp income/withdrawals of capital 2 5 - Relationship Between Partners - #1 • Partners (Prs) have fiduciary relationship with each other & Pp – E.g., Pp property cannot be used by any Prs for personal purposes w/o consent of all other Prs 6 - Relationship Between Partners - #3 • Prs have mutual agency – Each Pr is agent for other GPs and Pp – One GP can bind entire Pp – Even though not authorized – “Apparent Authority” Doctrine • Pp is bound
If other party did not know GP not authorized • Pp not bound
If other party knew GP not authorized – Pp can sue GP for unauthorized action 7 - Relationship Between Partners - #4 • Prs have Jointly & Severally Liability for Pp debts – All Prs are personally liable, & – Creditor can collect entire debt from any 1 Pr – Pr then has to collect respective shares of debt from other Prs 8 - Relationship Between Partners - #5 • Limitation of liability for newly admitted Prs – Unlimited liability for Pp debts incurred after admission – For pre-existing obligations
Can only lose capital contributions • Limited Liability like corp shareholder 5 17 - Legal Theories - Heading Conflicting Legal Theories Concerning Essence of Partnerships 18 - Legal Theories - 1 • 1st
law viewed Pps as a group of individuals – Not an entity – Called “Proprietary Theory” & “Aggregate Theory” • Later
law began to view Pps as entities – Called “Entity Theory” • Law today is mixture of both theories – Sometimes Pp viewed as group of individuals – Sometimes Pp viewed as an entity 19 - Legal Theories - 2 • E.g.s of Aggregate Theory: – Unlimited liability • GPs liable for Pp debt (as if their own debt) – Pps do not pay taxes • Pps file “informational” tax return • Pp does not pay taxes • Pr receives a Form K-1 – Pr pays taxes on share of Pp income – Pp legal termination on death, withdrawal or bankruptcy of 1 GP • Pp may dissolve, but Prs can agree to continue the business in a new Pp – It is a different group of prs • Pps don’t have “continuity of life” – Different than corps 20 - Legal Theories - 3 • E.g.s of Entity Theory: – Pp may enter contracts in its own name – In CA, Pp may own real estate in its own name – A Pp may declare bankruptcy 6 21 - Legal Theories - 5 • A GPp doesn’t need a written GPp agreement – Still is a GPp • A LPp – LPps needs a written LPp agreement – States require that certain forms must be filed or recorded – If you don’t do everything required
then LPp is treated as GPp 22 - Methods of Accounting - Heading Different Methods of Accounting Used By Partnerships 23 - Methods of Accounting - #1 • Pps are usually small businesses • Many small businesses don’t use GAAP – Not worried about certified FS – Use other methods of accounting • The American Institute of Certified Public Accountants (AICPA) notes that the following methods are popular with small businesses: – E.g., Cash method & tax basis of accounting 24 - Methods of Accounting - #2 • Tax basis of accounting – Keep books same way as required for Pp tax return – E.g., depreciation –MACRS rules & immediate write offs – This way have all information ready to prepare Pp tax return 7 25 - GAAP Partnership Accounting - Heading GAAP Partnership Accounting 26 - GAAP Partnership Accounting - #1 • Pps & Sole Proprietorships have different capital set up from corps – Corp has 2 types of capital • Paid-in capital (e.g., common stock) & • RE – Each account applies to entire corp • Pp - each Pr has his/her own capital account that contains both: – Capital contributions & – Prs share of Pp RE 27 - GAAP Partnership Accounting - #2 • Capital account – Normally has credit balance – Credited for capital contributions – Credited for the GP/LP’s share income – Debited for Pr’s share of losses – Debited for Pr’s withdrawals John Doe, Capital Account Share of Partnership Losses Capital Contributions Withdrawals Share of Partnership Income 28 - GAAP Partnership Accounting - #6 Pp are diff than Corps with respect to capital • With corps
When corp liquidates each stkholder gets same amount per share • With Pps
Pp BV is already divided up between the Prs – Need this because income can be allocated differently to Prs – Cash can be withdrawn by Prs are different rates – Prs cap acct bal says this amount of Pp’s BV belongs to this Pr 10 37 – Journal Entries - #3 • When Pr C makes $3K loan to Pp: D. Cash $3,000 C. Pr C, loan $3,000 38 – Journal Entries - #4 • When a Pr D withdraws $5K cash from Pp: D. Pr D, Drawing $5000 C. Cash $5000 39 – Journal Entries - #5 • Income of Pp goes into capital accounts – No RE account in Pps • E.g., Pp earns $10K income & allocates income between Prs E & F 50%/50% D. Income Summary $10,000 C. Pr E, Capital $5,000 Pr F, Capital $5,000 40 – Journal Entries - #6 • Pr’s drawing account is closed to Pr’s capital account • E.g., Pr G has $1K balance in drawing acct at end of year: D. Pr G, Capital $1,000 C. Pr G, Drawing $1,000 11 41 – Income Allocations - Heading Income Allocations 42 – Income Allocations - #1 • UPA § 18 – If the Pp agreement is silent
profits and losses allocated equally among Prs 43 – Income Allocations - #2 • Pps have flexibility in allocating profits: – Prs can share profits any way they want • Can use capital ratio • Can use different ratio – E.g., Able gets profits from Long Beach store (where Able is manager) & Betty gets profits from Torrance store (where Betty is manager) • Not like corps
RE shared according to stock ownership ratio 44 – Income Allocations - #4 • Pp may pay interest on capital account balances & • Allocate remaining Pp profits using another ratio • When Pp pays interest to a Pr – It isn’t an expense – It is an allocation of income 12 45 – Income Allocations - #5 • If Pp pays interest on capital acct
# of issues: – Will drawings be netted against capital acct balances? – How does Pp calculate capital acct balance on which interest paid? • Can use capital acct balances at the end of the period; • Can use capital acct balances at the beginning of the period; or • Can use the weighted average of the capital accts balances of the partners during the year 46 – Income Allocations - #6 • E.g., Pp has $20,000 net income – Prs get interest on capital accounts – Any remaining profits shared equally among Prs Able Betty Total Interest on Beginning Capital: Able: 10% x $100,000 $10,000 $10,000 Betty: 10% x $60,000 $6,000 $6,000 $16,000 Balance per profit ratio (equally): $2,000 $2,000 $4,000 Allocation of profit: $12,000 $8,000 $20,000 47 – Journal Entries - #5 • This calculation provides the numbers for the following journal entry: D. Income Summary $20,000 C. Able, Capital $12,000 Betty, Capital $8,000 48 – Income Allocations - #7 • Pp can pay salaries to Prs • Salaries to Prs are an allocation of Pp profits – Pr salaries are not treated as expenses – Remember
don’t confuse a drawing with a salary • A bonus is also an allocation of profits – Often, the bonus is a % of Pp net income – Bonus may be % of Pp income reduced by interest on capital, Pr salary, and/or the Pr bonus