chapter 5 limited

Question 1

A limited partnership is formed between two general partners and three limited partners. All five partners contribute $85,000 to the partnership. A creditor obtains a judgment against the limited partnership for $2,100,000. What is the maximum amount, beyond their initial investment, that any one limited partner could be personally liable to the creditor for?

1. $0
2. $85,000
3. $700,000
4. $2,100,000

Answer 1

Correct Answer: 1

the key thing here is that the question is asking “ beyond their initial investment” - the question did not ask you the amount the limited partner would pay which would be $85,000 that they invested.

Option (1) is correct because the form of organization is a limited partnership, where the limited partners do not take part in the day-to-day operations of the partnership, therefore their personal liability is limited to the amount paid into, or agreed to pay into partnership.

Options (2), (3), and (4) are incorrect because they do not show the maximum amount that a limited partner may be held personally liable for beyond their initial investment.

Question 2

Which of the following statements regarding forms of business organizations is TRUE?

1. A limited partnership (LP) is a variation of a general partnership where all partners are actively involved in management and are jointly and severally liable.
2. A limited liability partnership (LLP) requires that limited partners are passive investors only, who cannot be involved in the management of the firm.
3. A corporation can never cease to exist.
4. A corporation has the ability to defer income taxes for the owners by keeping profits in the form of retained earnings.

Answer 2

Correct Answer: 4

Option (4) is correct because when a corporation earns profits, the directors can choose to distribute the income to the shareholders in the form of dividends or choose to keep the profits invested in the company in the form of retained earnings.

Option (1) is incorrect because limited partnerships (LPs) are not a form of general partnership in that they include both passive and active partners, with their risk of liability defined by their involvement within the partnership.

Option (2) is incorrect because a limited liability partnership (LLP) allows each limited partner to be active and to be involved in managerial decision making. Only limited partners in a limited partnership (LP) are required to be passive investors.

Option (3) is incorrect because a company can cease to exist if it is terminated by the shareholders.

Question 3

Cardinal Limited has three shareholders: Asviny and Bassam each own 40% of the shares while Ciara owns the remaining 20%. The retained earnings as at December 31, 20X1 were $120,000. No dividend payments or withdrawals by shareholders were made between December 31, 20X1 and December 31, 20X2. The shareholders’ equity section of the balance sheet as at December 31, 20X2 of Cardinal Limited is as follows:

Shareholders’ Equity
Shares $300,000
Retained Earnings $185,000

Cardinal Limited decided to distribute some of its 20X2 net income between the shareholders in proportion to the amount of shares they owned. Asviny and Bassam each received $26,000 in dividends before tax. If Ciara’s personal tax rate is 30%, how much will her after-tax share of the net income distributed at December 31, 20X2 be? Assume that there is no dividend tax credit.

1. $9,100
2. $13,000
3. $6,000
4. $2,600

Answer 3

Correct Answer: 1

Option (1) is correct because Ciara’s after-tax share of net income distributed on December 31, 20X2 is $9,100. There are two ways to calculate this. First, consider that Asviny and Bassam each received 40% of the net income, dividends distributed ($26,000 × 2). Thus, the total net income distributed was $65,000 ($52,000/0.80).

Since Ciara receives 20% of the total net income distributed or $13,000 ($65,000 × 0.20), her after‑tax share of the net income distributed is $9,100 ($13,000 × (1 – 0.3)).

The total net income distributed could also have been found by determining the increase in retained earnings from 20X0 to 20X1 ($185,000 – $120,000 = $65,000).

Ciara’s after‑tax net income would then be found as above.

Option (2) is incorrect because $13,000 is Ciara’s share of the total net income distributed before taxes.

Options (3) and (4) are incorrect because they are not the after-tax share of net income distributed to Ciara.