Exam #3 Flashcards
What are the pros of a partnership entity?
- Easy to form.
- Lack of formality.
- Single taxation.
What are the cons of a partnership entity?
- Unlimited liability (general partnerships).
- Difficulty in disposing of interests.
- Mutual agency.
Most states have adopted the Uniform Act of 1997 as their model act. What does this cover?
- Relations of partners to one another.
- Relations of partners to persons dealing with the partnership.
- Dissolution and winding up of a partnership.
Partnership formation/agreement should include the following:
- Name of partnership and names of partners.
- Type of business to be conducted and duration.
- Initial capital contributions.
- Complete specification of profit or loss distribution.
- Procedures used for partnership changes.
- Other aspects of operations.
Which of the following is not one of the advantages of general partnerships?
Unlimited liability
What are the four types of partnerships?
- General Partnerships
- Limited Partnerships
- Limited Liability Partnerships (LLP)
- Limited Liability Limited Partnerships (LLLP)
What is a General Partnership
- All partners have unlimited
liability. - Creditors can go after the
personal assets of any or all of
the partners.
What is a Limited Partnership?
- At least one general partner and
one+ limited partners. - General partner →
management responsibility &
personally liable for partnership
obligations.
= Limited partners →liable only
to the extent of their capital
contribution, no management
authority.
What is a Limited Liability Partnership (LLP)?
- Each partner has some degree
of liability shield. - No general or limited partners.
- Partners are not personally liable
for a partnership obligation. - Includes virtually all large public
accounting firms.
What is a Limited Liability Limited Partnership (LLLP)
- Each partner is liable only for
the business obligations of the
partnership, not for malpractice
or other wrongdoing of the other
partners. - Advantage: general partners (though responsible for
management) have no personal
liability for obligations.
True or False:
Limited liability limited partnerships must have at least one general partner.
True!
True or False:
ASC 820 requires contributed assets to be valued at fair value.
True!
What are capital accounts? (the equation)
Initial investment + subsequent capital contributions + profit(loss) distributions - withdrawals of capital.
Capital accounts are defined as…
Deficiencies are usually
eliminated by additional
capital contributions.
What are drawing accounts used for?
They are used to record periodic
withdrawals.
At the end of the period, where are drawing accounts closed to?
To the partner’s capital account.
Loan accounts are shown as payables on where?
On the partnership’s books.
True or False: Unless otherwise agreed, loans shouldn’t accrue interest.
False! Loans should bear interest, and interest expense should be
recorded.
What results in a reduction to a partnership’s capital account?
A withdrawal.
What are the four major profit distribution methods used by partnerships?
- Preselected ratio
- Interest on capital balances
- Salaries to partners
- Bonuses to partners
Method #1: Preselected Ratio
Usually the result of negotiations between partners.
Method #2: Interest on Capital Balances
The partners divide some or all of the income earned among themselves based on the relative balances they have
maintained in their capital accounts.
Method #3: Salary
A fixed amount of company profits to a given partner.
Method #4: Bonus
A portion of profits allocated to a partner based on a predetermined performance formula.
How does a new partner admit to the partnership by purchasing directly?
Through the exchange of cash or other assets outside the partnership.
AB <— (interst) — C
What is the only entry on the book for admission by purchasing directly?
A reclassification of partnership total capital.
What happens to a partnership when a new partner is admitted by investing?
The partnership receives the cash or other assets.
AB + C = ABC Partnership
What are the three methods to minimize inequities?
- Revaluation of Assets/Goodwill Method
- Bonus Method
- Special Profit & Loss-Sharing Provision
What is the new partner’s proportion of the partnership’s net book value?
(Prior capital of existing partners + investment of new partner) * percentage of capital to new partner.
As a new partner, you become jointly responsible for…
- All preexisting partnership liabilities, and
- All preexisting contingent liabilities.
This is a major risk of joining!!
True or False:
A partner that withdraws from a partnership is still responsible for all partnership obligations and contingent liabilities that exist at the time of withdrawal.
True!
Who can expressly release a partner from their responsibility?
Only creditors!
What is disassociation?
The broad term that refers to when a partner is no longer
associated with a partnership.
What is dissolution?
A narrow term that refers to
when a partnership is dissolved, and its affairs must be wound up.
At the time of dissolution, what is the state of the partnership’s existence?
Terminated!
Legal withdrawals of a partner, include:
- Partner’s death
Partner’s voluntary withdrawal - Judicial determination
True or False:
All disassociations result in a partnership liquidation.
That is false.
What events cause dissolution and winding-up?
- An event that makes it unlawful to carry on a substantial part of the partnership business.
- Judicial determination.
- Joint decision by the partners.
Under UPA 1997…
Creditors have the first claim to the partnership assets.
After creditors are fully satisfied, what happens to the remaining assets?
They are distributed to the partners based on their capital balances.
What level of status does loans payable compared to liabilities to third-part creditors?
The same status.
The difference between disassociation and dissolution is:
Disassociation relates to the withdrawal of a partner (disassociating w/ partnership)
and
dissolution relates to the winding up of a partnership (the solution is to end).
What is Lump-Sum Liquidation?
- Noncash assets are converted to cash.
- Creditors are paid to the extent possible.
- One single, lump-sum payment is made to the partners for their capital interests.
In a lump-sum liquidation, how are gains/losses allocated?
Allocated among the partners following their profit/loss sharing ratio.
What makes a partnership insolvent?
If existing cash and cash generated by the sale of assets are not sufficient to satisfy the partnership’s liabilities.
True or False:
If a partner fails to remedy his/her capital deficit, they must come up with outside ways to contribute their proportion on their own.
False. All other partners
must contribute in the proportion
by which they share in profits/losses.
When do lump-sum liquidations take place?
Either all at once or over a short period of time.
With installment liquidations, assets are sold over time. What is the point of this?
To obtain the largest possible realization of assets.
What are the two examples of installment liquidations?
- Schedule of Safe Payments
- Cash Distribution Plan
Schedule of Safe Payments:
- Prepared at each cash distribution date.
- Portrays what could happen in
the future, assuming the worst case scenario.
Cash Distribution Plan:
- Completed only once, at the
beginning of the liquidation process. - Revolves around the calculation
of loss absorption potential.
Before any partners receive cash, assume the following hypothetical worst-case scenarios:
- All noncash assets are worthless.
- Partners absorb any deficits.
The first cash distribution to the partners goes to the partner who has the highest loss
absorption potential. What is LAP?
LAP = the maximum loss that the partnership can realize before the partner’s capital
account balance is extinguished.
How is LAP calculated?
Dividing each partner’s capital account balance by his/her profit and loss sharing percentage.
