230 Chapter 12 Accounting for Partnerships and Limited Liability Companies
partnership does not have sufficient cash to pay Jordan, a liability may be created for the amount
owed the withdrawing partner.
The partnership currently has $17,000 in cash. The book value of its inventory is $5,000 below the
current market value. The book value of its equipment is $8,000 greater than the current market
value. The three partners split income or losses equally. To revalue the partnership assets:
Inventory 5,000
Jordan, Capital 1,000
Kohlenberg, Capital 1,000
Greene, Capital 1,000
Equipment 8,000
To record Jordan’s withdrawal:
Jordan, Capital ($28,000 – $1,000) 27,000
Cash 17,000
Notes Payable 10,000
Death of Partner
You may wish to mention the steps taken when a partner dies:
1. Close the partnership accounts as of the date of death.
2. Determine and divide net income for the current period among partners’ capital accounts.
3. Adjust asset accounts to current values and divide adjustments among the partners’ capital accounts.
4. Close the deceased’s capital account with a debit entry and credit a liability account whose balance is
payable to the deceased’s estate.
5. Remaining partner or partners decide to continue or liquidate the business.
OBJECTIVE 4
Describe and illustrate the accounting for liquidating a partnership.
SYNOPSIS
When a partnership goes out of business, it sells its assets, pays its liabilities, and distributes the
remaining cash or assets to the partners. The four steps in this process are illustrated in Exhibit 4. In
Exhibits 5 and 6, two statements of partnership liquidation are shown. This summarizes the process and
shows the increases and decreases in each capital account. If the loss on realization is greater than the
balance in a partner’s capital account, the resulting capital debit balance represents a claim against the
partner. If the partner pays the deficiency, the ending cash balance is then distributed among the other
partners with credit balances. If the deficient partner fails to pay, the uncollected amount becomes a loss
Chapter 12 Accounting for Partnerships and Limited Liability Companies 231
to the partnership and is divided among the remaining partners. The remaining cash is then distributed to
these partners.
Key Terms and Definitions
• Deficiency – The debit balance in the owner’s equity account of a partner.
• Liquidation – The winding-up process when a partnership goes out of business.
• Realization – The sale of assets when a partnership is being liquidated.
• Statement of Partnership Liquidation – A summary of the liquidation process whereby cash is
distributed to the partners based on the balances in their capital accounts.
Relevant Example Exercises and Exhibits
• Example Exercise 12-5 Liquidating Partnerships
• Example Exercise 12-6 Liquidating Partnerships—Deficiency
• Exhibit 4 – Steps in Liquidating a Partnership
• Exhibit 5 – Statement of Partnership Liquidation: Gain on Realization
• Exhibit 6 – Statement of Partnership Liquidation: Loss on Realization
• Exhibit 7 – Statement of Partnership Liquidation: Loss on Realization—Capital Deficiency
SUGGESTED APPROACH
There are two basic scenarios when partnerships are liquidated: (1) All partners end up with a positive
capital balance and receive cash or (2) one or more of the partners ends up with a negative capital
balance. If a partner has a negative capital balance, that partner should contribute cash to the partnership
equal to his or her deficit so that the remaining partners may receive the cash they are due. If the partner is
unwilling or unable to make up this deficit, his or her deficit must be allocated to the remaining partners.
Use TM 12-13 to review the steps in liquidating a partnership, and use the following Demonstration
Problem to illustrate liquidation.
DEMONSTRATION PROBLEM—Partnership Liquidation
Mary Hills, Beth Smith, and Kathy Grove are partners in HSG Pharmaceutical Company. They decide to
liquidate their partnership when the partners have capital balances of $45,000, $48,000, and $22,000,
respectively. The partnership has $13,000 in cash, $128,000 of noncash assets, and $26,000 in liabilities.
The noncash assets are sold for $78,000. The partners split all income/losses using a 4:3:3 ratio. (Note:
All gains and losses in liquidation are split using the partners’ income-sharing ratio.)
Noncash Capital
Cash Assets Liabilities Hills Smith Grove
Beginning balance 13,000 128,000 26,000 45,000 48,000 22,000
Assets sold + 78,000 –128,000 –20,000 –15,000 –15,000
Balance 91,000 0 26,000 25,000 33,000 7,000
Pay liabilities –26,000 –26,000
Balance 65,000 0 0 25,000 33,000 7,000
232 Chapter 12 Accounting for Partnerships and Limited Liability Companies
In this case, all three partners end up with a positive balance in their capital accounts. All partners will
receive cash equal to their capital balances.
What if the noncash assets of HSG Pharmaceutical Company were sold for $48,000?
Noncash Capital
Cash Assets Liabilities Hills Smith Grove
Beginning balance 13,000 128,000 26,000 45,000 48,000 22,000
Assets sold + 48,000 – 128,000 –32,000 –24,000 –24,000
Balance 61,000 0 26,000 13,000 24,000 –2,000
Pay liabilities – 26,000 –26,000
Balance 35,000 0 0 13,000 24,000 –2,000
In this case, Grove has a deficit in her capital balance. If Grove will contribute the $2,000 needed to make
up her capital deficiency, the partnership will have $37,000 in cash, of which $13,000 will be distributed
to Hills and $24,000 to Smith. If Grove will not contribute an additional $2,000 to the partnership, her
deficit must be split between Hills and Smith in their 4:3 ratio, as follows:
Noncash Capital
Cash Assets Liabilities Hills Smith Grove
Beginning balance 13,000 128,000 26,000 45,000 48,000 22,000
Assets sold + 48,000 – 128,000 –32,000 –24,000 –24,000
Balance 61,000 0 26,000 13,000 24,000 –2,000
Pay liabilities – 26,000 –26,000
Balance 35,000 0 0 13,000 24,000 –2,000
Deficit allocated –1,143 –857 2,000
Balance 35,000 0 0 11,857 23,143 0
In this case, the $35,000 cash is distributed to Hills and Smith, based on their capital balances after
Grove’s deficit is allocated. Point out that the most common error in partnership liquidation is the
improper distribution of cash to partners. It is wise to always double-check these calculations and
compare them to any liquidation procedures outlined in the partnership agreement.
After completing this explanation, ask your students to journalize the accounting entries to record this
third scenario (noncash assets sold for $48,000; Grove does not contribute cash to make up her deficit).
Solution:
Cash 48,000
Loss on Realization 80,000
Noncash Assets 128,000
Hill, Capital 32,000
Smith, Capital 24,000
Grove, Capital 24,000
Loss on Realization 80,000
Chapter 12 Accounting for Partnerships and Limited Liability Companies 233
Liabilities 26,000
Cash 26,000
Hill, Capital 1,143
Smith, Capital 857
Grove, Capital 2,000
Hill, Capital 11,857
Smith, Capital 23,143
Cash 35,000
OBJECTIVE 5
Prepare the statement of partnership equity.
SYNOPSIS
At the end of the each accounting period, similar to a sole proprietorship’s statement of owner’s equity, a
statement of partnership equity is prepared. An example of a statement of partnership equity is shown in
Exhibit 8.
Key Terms and Definitions
• Statement of Members’ Equity – A summary of the changes in each member’s equity in a
limited liability corporation that have occurred during a specific period of time.
• Statement of Partnership Equity – A summary of the changes in each partner’s capital in a
partnership that have occurred during a specific period of time.
Relevant Example Exercises and Exhibits
• Exhibit 8 – Statement of Partnership Equity
SUGGESTED APPROACH
TM 12-3 lists the names of the equity reports for each form of business. In reality, the equity reports for
proprietorships, partnerships, and limited liability companies (LLCs) are all built on the basic structure
(TM 12-4):
Capital, beginning of the year
+ Investments (also called “Capital Additions”)
+ Net Income (or – Net Loss)
– Withdrawals
Capital, end of the year
234 Chapter 12 Accounting for Partnerships and Limited Liability Companies
Use the Group Learning Activity below to review the equity reports for proprietorships, partnerships, and
LLCs.
GROUP LEARNING ACTIVITY—Equity Reports for Proprietorships,
Partnerships, and LLCs
Handout 12-1 presents a statement of owner’s capital for Vince Gray, owner of Woodhaven Spas. Divide
your students into groups and ask them to complete the handout. It will instruct them to modify the
statement of owner’s capital assuming Vince has a partner. Next, the handout will instruct them to modify
the statement of partnership capital, assuming the business is organized as an LLC. The goal of this
activity is to point out the similarity in equity reporting for proprietorships, partnerships, and LLCs.
The solution is provided below. Note that the change from partnership to LLC will change the
headings to Vince Grey, Member; Anita Carnes, Member; and Total LLC Capital. The amounts
will not change.
Woodhaven Spas
Statement of Owner’s Capital
For the Year ended December 31, 2012
Vince Gray,
Capital
Anita Carnes,
Capital
Total Partnership
Capital
Balance,
Jan. 1
$120,000
75,000
195,000
Investments
$ 15,000
7,000
22,000
Net Income
$ 87,000
22,000
109,000
Less: Withdrawals
($61,000)
(13,000)
(74,000)
Balance,
Dec. 31
$161,000
91,000
252,000
Chapter 12 Accounting for Partnerships and Limited Liability Companies 235
OBJECTIVE 6
Analyze and interpret employee efficiency.
SYNOPSIS
This chapter discusses the revenue per employee ratio. The performance of partnerships can be measured
by the amount of net income per partner. This ratio is calculated as revenue per employee =
revenue/number of employees.
Key Terms and Definitions
• Revenue per Employee – A measure of the efficiency of the business in generating revenues,
which is computed as revenue divided by number of employees.
Relevant Example Exercises and Exhibits
• Example Exercise 12-7 Revenue per Employee
SUGGESTED APPROACH
This ratio is often used by service-oriented enterprises to measure the average revenue on a per-employee
basis. Comparisons may be made for the same company for different time periods, one company to its
industry average, or one company to another company in the same industry. Remind students that
comparisons across industries aren’t usually useful since the operations among industries are different
insofar as their use of their labor force.
Handout 12-1
Woodhaven Spas
Statement of Owner’s Capital
For the Year ended December 31, 2012
Balance,
Jan. 1
Investments
Net Income
Less: Withdrawals
Balance,
Dec 31
Instructions:
1. Modify the above report, assuming Woodhaven Spas is organized as a partnership. Vince’s
partner is Anita Carnes. Anita’s capital balance on January 1 was $75,000. During the year,
she invested an additional $7,000 and made withdrawals of $13,000. The total company’s
income was $109,000; Anita’s share was $22,000. If possible, make all of these changes in
pencil.
2. Next, modify the above report, assuming Woodhaven Spas is organized as a limited liability
corporation. If possible, make these changes in pen.
Type Item Description LO(s) Difficulty Time Est BUSPROG AICPA ACBSP – APC Bloom’s EE Excel GL SMH FAI Service Real World Writing Ethics Internet Group
DQ 1 1 Easy 5 min. Analytic Measurement Business Forms Remembering
DQ 2 1 Easy 5 min. Analytic Measurement Partnership Remembering
DQ 3 1 Easy 5 min. Analytic Measurement Partnership Remembering
DQ 4 1 Easy 5 min. Analytic Measurement Partnership Remembering
DQ 5 2 Easy 5 min. Analytic Measurement Partnership Remembering
DQ 6 3 Easy 5 min. Analytic Measurement Partnership Remembering
DQ 7 3 Easy 5 min. Analytic Measurement Partnership Remembering
DQ 8 3 Easy 5 min. Analytic Measurement Partnership Remembering
DQ 9 3 Easy 5 min. Analytic Measurement Partnership Remembering
DQ 10 3 Easy 5 min. Analytic Measurement Partnership Remembering
PE 1A Journalize partner’s original investment 2 Easy 5 min. Analytic Measurement Partnership Applying x
PE 1B Journalize partner’s original investment 2 Easy 5 min. Analytic Measurement Partnership Applying x
PE 2A Dividing partnership net income 2 Easy 5 min. Analytic Measurement Partnership Applying x
PE 2B Dividing partnership net income 2 Easy 5 min. Analytic Measurement Partnership Applying x
EX 2 Recording partner’s original investment 2 Easy 10 min. Analytic Measurement Partnership Applying x
EX 3 Dividing partnership net income 2 Easy 15 min. Analytic Measurement Partnership Applying x
EX 4 Dividing partnership net income 2 Easy 15 min. Analytic Measurement Partnership Applying x
EX 5 Dividing partnership net loss 2 Easy 5 min. Analytic Measurement Partnership Applying
EX 17 Withdrawal of partner 3 Moderate 15 min. Analytic Measurement Partnership Applying x
EX 18 Statement of members’ equity, admitting new member 2,3,5 Challenging 20 min. Analytic Measurement Partnership Applying
EX 19 Distribution of cash upon liquidation 4 Easy 5 min. Analytic Measurement Partnership Applying
EX 20 Distribution of cash upon liquidation 4 Easy 5 min. Analytic Measurement Partnership Applying
PR 4A Admitting new partner 3 Challenging 1.5 hours Analytic Measurement Partnership Applying x
PR 5A Statement of partnership liquidation 4 Moderate 1 hour Analytic Measurement Partnership Applying x
PR 6A Statement of partnership liquidation 4 Moderate 1 hour Analytic Measurement Partnership Applying x
PR 1B Entries and balance sheet for partnership 2 Moderate 1 hour Analytic Measurement Partnership Applying x x x
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